Post-secondary education has now become a standard for most students graduating from high school. Further education can lead to great opportunities and good quality jobs (if you choose a field that is in demand). But the cost of attending post-secondary has grown at a rate greater than inflation and is leaving many students with large debts when they graduate.
What I would like to achieve in this article is to provide information on one of the best tools available in Canada geared towards post-secondary savings for your little loved one(s). That tool is the Registered Education Savings Plan offered by the government of Canada. As I write, I am going to keep new parents in mind. This is the group who will benefit most from the information provided. Although, the information in this post will also those parents, relatives, and grandparents who want to start putting money towards their little loved one’s education, no matter what age they are.
The main reason why RESPs have been on my mind for the past few months is because in November 2011, I became an uncle (or zio in Italian). I wanted to help my little nephew plan for his future education (be it college, university, trades, or any other profession he would like to pursue), even if he is only just over 9 months old; the earlier, the better.
I am going to separate the article into three main parts. First, I will explain what an RESP is. I will describe its unique features and benefits as well as its limitations and rules. Second, I will explain two of the grants available to RESP accounts. Lastly, I will give information on how to open up an RESP.
So let’s begin!
SECTION #1: Defining an RESP
What is an RESP?
An RESP is a registered Government of Canada savings account with the intent to help families save for their child’s post-secondary education. An RESP helps parents and loved ones save early to ensure the financial needs for education can be met.
An RESP is not an investment in itself. An RESP is a basket that holds qualified investments. Qualified investments include savings accounts, GICs, bonds, mutual funds, ETFs, stocks, and other securities. An RESP can hold many of the same investments that qualify for an RRSP.
There are primarily two parties involved in an RESP: the subscriber and the beneficiary.
The subscriber is the person or persons who contribute to the account. The subscriber is usually closely connected to the beneficiary (a parent, grandparent, relative, or friend) since they are investing money towards the beneficiary’s future, not their own.
The beneficiary is the individual who will benefit from the plan. This is usually a young child, but the child being young is not a requirement.
Some other benefits to an RESP for savings are the ability to grow investments tax-free (which improves compounding returns) and grants available through the Canadian Government. These features will be described in more detail in the sections that follow.
Types of RESPs
There are two main categories for RESPs and two main structures for investing in them.
An RESP account can be opened as either a Family RESP or an Individual RESP. A family RESP allows for more than one beneficiary to be attached to a single account (for families with more than one child). An Individual RESP is assigned to one specific individual.
A family RESP has the benefit that funds can be transferred to the other child if one of the children does not attend post-secondary university. This transfer helps minimize any tax or paybacks that may occur when a beneficiary does not use the RESP for post secondary education.
The two main structures of RESPs are Pooled RESPs and Self-Directed RESPs.
- Pooled RESP: a managed account where annual contributions are pre-set and the administrator determines the amount paid out to beneficiaries. By law, the institutions who invest the money for you are required to invest in very conservative securities. Because the account is managed, there is a fee connected to the account that could either be included in the returns of the account or a payable fee each year.
- Self-directed RESP: a flexible plan that gives the contributor full rights to both the amount of contributions paid each year and the amount paid out to beneficiaries. Self-directed RESPs are available at most financial institutions including the big banks in Canada.
Limitations and Rules
There is no limit to contributions made each year in an RESP (although there may be a set amount planned for a pooled RESP). There is, however, a lifetime contribution limit of $50,000 for the RESP account. The account is able to rise above $50,000 through interest and gains, but the contributions cannot exceed $50,000.
Contributions made to an RESP are not tax deductable as is the case for an RRSP. Any interest, dividends, or capital gains earned in the account are not taxed in the year they are earned. Instead, they are taxed when the funds are withdrawn by the beneficiary (only the interest, dividends, and capital gains are taxed, the original contributions are not taxed since they were invested with after-tax dollars).
You are allowed to make contributions for up to 31 years after the RESP account is created and the account has a maximum life of 35 years after which the account must be terminated.
Any over-contributions made to the RESP are taxed at 1% per month.
When money is withdrawn by the beneficiary, the income is taxed on the beneficiary, not the subscriber. This effectively lowers the tax payment because the beneficiary (student) will most likely be in a lower tax-bracket than the subscriber (parent, grandparent, relative, friend…) of the account.
Withdrawals made from an RESP
All income earned in the RESP account is paid out as Educational Assistance Payments (ESPs). The beneficiary of the account includes these EAPs on his/her income earned for the year and is taxed at their income tax bracket. The original contributions are not taxed since they were invested as after-tax monies.
There are certain rules for withdrawing EAPs from an RESP account. The following list describes the rules that apply for withdrawing EAPs from an RESP:
- Limits on EAPs:
- $5,000 for the first 13 consecutive weeks in a qualifying educational program.
- After completion of the 13 weeks, there is no limit for EAPs.
- If a 12 month period passes where the beneficiary is not enrolled in a minimum 13 week consecutive course, then a new $5,000 limit applies.
SECTION #2: Grants Available through an RESP
The Canada Education Savings Grant
One of the biggest advantages of an RESP is the Canada Education Savings Grant available to all individuals who participate in an RESP.
The grant is eligible to all beneficiaries who are under the age of 18. The government will match 20% of the first $2,500 contributed to the account each year. The maximum amount of CESG per beneficiary is set at $7,200. This essentially helps pay for one semester or year of tuition for many post-secondary institutions.
Some families may be eligible for additional CESG over and above the $7,200 base limit.
The following is a list that describes the total amount of CESG available at different family income levels:
- All families: $2,500 x 20% = $500
- Under $41,544: the above $500 plus (20% on the first $500 = $100) = $600
- $41,544 < $83,088: the above $500 plus (10% on the first $500 = $50) = $550
The grant helps add to your asset base and improves your yearly rate of return. It is free to anyone who has an RESP so it is wise to take full advantage of it. Most self-directed RESPs at large financial institutions have the CESG integrated into the account. Pooled investments also have the CESG integrated into their account since they are managed products.
The limit on the CESG is indexed to inflation, so the limit may change from year to year.
The Canada Learning Bond
The Canadian Government also has available funding for families who qualify for the National Child Benefit Supplement who are born after December 31, 2003.
The bond provides a $500 one time bond as well as installments of $100 per year until the age of 15 (granted as long as they continue to qualify for the National Child Benefit Supplement). The maximum CLB for any individual beneficiary is capped at $2,000.
Qualifying for the National Child Benefit Supplement includes family income and Aboriginal status in Canada. For more information on the National Child Benefit Supplement, visit the National Child benefit Webpage.
SECTION #3: Opening an RESP
How to Open an RESP
Opening an RESP is about as easy as opening an RRSP or a bank account.
The first step is to make sure both the subscriber and the beneficiary have a Social Insurance Number in Canada. There is no fee to open a Social Insurance Number, but you will need certain government documents such as a Canadian birth certificate.
The second step is to choose an RESP provider. An RESP provider is an institution (usually a financial institution) where your RESP account is created. All major banks in Canada offer RESP accounts for their clients.
It is important to ask as many questions as possible when opening an RESP with your financial institution so you understand how the account works and if there are any additional fees included when you open, close, or withdraw from the account.
The Canadian Government website “CanLearn” offers some useful questions to ask your financial institution when opening an RESP account. Go to the CanLearn Website to find suitable questions to ask your financial institution when opening an RESP.
If you would like more information on RESPs, I have included four government websites that provide a plethora of information on the subject:
What I recommend is to start early. The earlier you start the better you can take advantage of the CESG, compounding, and the risk reduction benefits of a longer time-horizons. Talk to a financial professional at your bank or a qualified financial planner or investment advisor.
Hopefully, with a little planning and a focused strategy, you will be able to send your little loved one to post-secondary education knowing that it is financially feasible. It will also allow them to graduated with less school debt, which will dramatically help with their future saving needs for a home, car, children, retirement, and everything else life demands.
Is there anything about RESPs that is still not clear? If you have any questions, please leave a comment below and I’ll try my best to answer it. Do you have some tips or info concerning RESPs that you would like to share with other readers? Give us a quick summary below or link us to a site where we can find more on the topic.
Thanks for reading and good luck out there!
Warning/Disclaimer: The above article is not investment advice for an investor to implement. It is meant to educate the investor about options available for investment. Talk to a licensed and accredited financial professional about investment strategies that are best for you and your situation.