Got kids? Planning to have them? Want them to go off to post-secondary education one day? Then you’d better make sure you understand how the Registered Education Savings Plan (RESP) works!
What is an RESP used for?
Like its name suggests, an RESP is useful for helping you save for your kid’s post-secondary schooling. According to this article from Stats Canada, the cost of schooling has increased by 40% over the past decade (2006-2016), well above the rate of inflation.
Your kid now costs an average $6,373 per year to put through school. That’s over $25,000 for a four-year degree. With that knowledge in hand, we need to be taking every edge we can get!
Why Save in an RESP Instead of a Regular Account?
So glad you asked. There are some major benefits to saving in an RESP versus a regular taxable investment account. First off though, know that you can contribute a maximum of $50,000 per kid over their lifetime. Now, here’s why you should do it:
The government kicks in a bonus 20%.
That’s right. The federal government will match 20% of your yearly contributions to the RESP, up to an annual maximum of $500 and a lifetime max of $7,200 per kid. If you save $2,500 per year, you’ll get the maximum matching contribution from the government. Heads-up though: you have to open the RESP when your kid is 14 or younger to be eligible for this grant.
It’s worth noting that it’s much easier to start saving for your child’s education sooner, rather than later. You need to save consistently over multiple years in order to get the maximum matching amount from the government. Plus, saving over time means lower monthly contributions, and it gets compound interest working in your favour, too. Boo-yah.
Your savings grow tax-free until the money is withdrawn.
Like RRSPs, money you invest in an RESP gets to grow tax-free until it’s needed. You won’t pay any capital gains or income tax on the money your investments earn each year, until that money is withdrawn. And even then…
Earnings withdrawn from an RESP is taxed in the hands of your kid.
Why is that so awesome? Well, if your kid is in school, how much income are they likely to be earning? Not a lot, if anything at all. Which means they’ll be paying little to no tax on the growth of the investments you’ve worked so hard to save for them. Another huge benefit of the RESP. Note: you pay no tax on the contributions you made, since they’re made with after-tax dollars. I’m only talking about the growth on those investments, plus the government grant and its growth.
What happens if my kid doesn’t go to post-secondary school?
Great question. You have a few options if your kid chooses not to attend post-secondary school.
Wait it out.
RESP accounts can remain open and intact for 36 years, so your kid may change their mind about school within that timeframe. Be patient!
Pick a new beneficiary for the account.
If you have more than one kid, you can name a new beneficiary for the RESP. Careful, though: you’ll forfeit all of the government contributions unless the new beneficiary is a sibling and under age of 21. You’ll also need to add all government contributions from the first plan to the second plan, assuming the new beneficiary already had an RESP going. Since the max lifetime amount from the government is $7,200 per kid, you’ll have to pay back any amount over and above that when you name the new beneficiary.
Roll over the funds into an RRSP.
The maximum amount for this is $50,000 per contributor, meaning that if a husband and wife are joint contributors (both putting money in), they can each take up to $50,000 from the account to roll over into an RRSP.
You need to have the contribution room available, and the RESP needs to have been open for at least 10 years. All grant money from the government, and earnings from those grants, will be repaid back to the government. Also, you’ll pay tax in the earnings from your own contributions. They’ll be taxed at your marginal tax rate, plus a penalty of 20% on top of that. It sucks, but that’s how it is.
Withdraw the funds.
You can get your own money back to put into an unregistered chequing or investment account, but all of the same drawbacks at the above apply – grants and their earnings are repaid, and you’ll pay tax on money your own contributions earned.
Who Can Open an RESP for my Kid?
Anyone, that’s who. Parents, grandparents, other family members, friends… anyone can open an RESP for your kid – just remember that the same per-child lifetime maximums still apply, so you need to keep track of that.
Wrapping it Up
If you have (or are planning to have) a kid and you plan on them continuing their education after high school at least partially on your dime, you should be doing anything and everything you can to set up and contribute to an RESP for them. It’s one of the best tools the government has given us to save for a big purchase in a tax-sheltered and assisted way. So what are you waiting for? Get out there and speak to your financial guy or girl about setting one up!
If you want to do some more reading, here is the Government of Canada website on RESPs for you:
Government of Canada Website – RESPs
Remember: I’m not a financial advisor. You shouldn’t take what I write here as formal financial advice – these are just my opinions on topics I happen to feel strongly about. Always speak with a qualified financial advisor before taking action on any of this stuff!
