As parents, we are constantly looking for ways to secure our children’s future. One powerful tool in this endeavor is the Registered Education Savings Plan (RESP). In this blog post, we’ll delve into how RESPs work and explore the compelling reasons why parents should consider opening one for their children.

RESP Basics

RESPs are a tax-advantaged (fancy way of saying there are tax benefits) investment vehicle available to Canadian residents (you need a SIN to open one) to save for a child’s post-secondary education. RESPs are designed to help parents, grandparents, and other family members save early for the high costs associated with higher education.

Unlike an RRSP, contributions to an RESP are not tax-deductible. Still, investments within an RESP are able to grow on a tax-deferred basis (meaning you don’t pay tax each year you make money), until they’re eventually withdrawn from the account.

Like life insurance policies, RESPs have a beneficiary – namely, your child(ren), or a child of a relative. When the beneficiary goes off to post-secondary education, they become eligible to receive the funds, including the base contributions, investment earnings, and government grants and bonds, which we’ll talk about in a moment.

Types of RESPs

There are three types of RESPs: individual, family, and group. Group RESPs are beyond the scope of this post, and I’m generally not a fan of them for most people.

An individual RESP has a single child as a beneficiary. If the child doesn’t end up attending post-secondary school, the beneficiary will need to be changed or the funds will need to be withdrawn, the implications of which we’ll talk about later.

A family RESP can name multiple children as beneficiaries. The children must be related by blood or adoption, but you can have as many as qualify in a family RESP. If one child ends up not attending post-secondary education, the others can make use of the funds instead.

RESPs have a maximum contribution limit, just like other types of registered accounts. Unlike other registered accounts though, the contribution limit for RESPs isn’t annual; it’s lifetime. The lifetime maximum for an RESP is $50,000. Despite this, you may want to cap how much you contribute each year, in order to maximize government benefits. Let’s talk about those now.

Your secret weapon: The Canada Education Savings Grant (CESG)

The government will help you save for your child’s education by kicking in some money alongside your own contributions. The main aid comes in the form of the CESG, which provides you a 20% matching contribution on money you put in, up to $500 per child per year, with a lifetime maximum of $7,200 per child. This means that, to get the max government grant each year, you need to contribute $2,500 per child.

Low-income families may also be eligible for the Canada Learning Bond, which can provide up to $2,000 per child (this is a lifetime max) without requiring contributions on your part.

Withdrawing from an RESP

When your child goes to post-secondary school, they’re able to withdraw funds from the RESP, which are then taxed in their name. This is great, because students generally fall into a very low tax bracket. Withdrawals fall into two categories, one of which is taxed and the other which isn’t.

Education Assistance Payment (EAP)

The EAP is made up of investment gains, government grants and bonds; in short, money you didn’t contribute yourself into the account. Because you didn’t contribute it, these types of withdrawals are taxable in the hands of the child.

Generally, it’s good practice to use up all of these payments before dipping into capital withdrawals, which we’ll look at next. The reason will be clear later on.

PSE Capital Withdrawal

PSE capital withdrawals are just a return of your own contributions back to you. Because you contribute to RESPs using after-tax dollars, these withdrawals aren’t taxable. You’ve already paid your tax on them!

What if my kid doesn’t go to school?

If your child (or children, in the case of a family RESP) doesn’t end up attending post-secondary education, you have options for the money. Generally, you can’t remove funds from an RESP until:

• The RESP is open for at least 10 years, and
• Your child is over age 21 and has decided to not go to school

If these conditions are met, then a few things happen when you close the account. First, all CESG and CLB benefits get paid back to the government. You don’t get to keep those, unfortunately. Second, you’ll pay tax on all of your investment gains, including gains on the CESG and CLB money. Those gains are taxed at your marginal tax rate, plus a 20% penalty (ouch, right?), and are known as Accumulated Income Payments (AIP). Lastly, you’ll get all of your original contributions back without tax or penalty.

To avoid paying tax on your AIPs, you may be able to transfer the money directly into an RRSP, as long as you have the contribution room and the account allows for this type of transfer.

It’s worth noting that you don’t HAVE TO collapse the account at the 10-year mark; you can leave it open for longer, in case your kid changes their mind about going to school. The RESP can remain open for up to 35 years.

Wrapping it Up

RESPs are a smart investment tool for parents looking to secure their children’s future education. By taking advantage of the tax benefits, government grants, and flexible investment options offered by RESPs, parents can build a solid financial foundation to support their children’s educational aspirations. Start early, save regularly, and watch your child’s future unfold with the power of RESP.