Today we’re reviewing the popular RESP, the Registered Education Savings Plan, a fantastic tool that is available to save for the next generation’s post-secondary education needs.
It is a really neat tool that the government started several years ago. A truly great program to help save for education costs for your child, a niece/nephew, grandchild or even a family friend.
Thankfully it’s not just restricted to your direct children. Most people will set them up for their own children because it’s easier to track the government grants, right? Oh wait, what are these grants?
The grants (CESG – Canada Education Savings Grants) are the key to the popularity of this savings vehicle in Canada, in which the government will match 20% of the first $2,500 of contributions annually.
Let’s say you contribute $2500 to your child’s RESP, the government will kick in an additional $500!
That is an instant 20% return on your money and free money to help your children pursue post-secondary education.
Given this level of RESP grants being provided, there are certainly RESP contribution limits, as you can’t simply contribute as much as you want and get a 20% bonus.
There is a lifetime maximum grant limit of $7,200, which means after lifetime contributions of $36,000, you will no longer get any grant monies.
However, the RESP limit for lifetime contributions actually is $50,000, you just won’t benefit from any more grant money.
Now the RESP rules limit the amount of grant you can get in one year, which is based on $5000/year for contributions (using your current year limit plus one catch up year), but we will cover that shortly.
If you want to maximize the full value and the full grant, you could contribute $2000 per year for 18 years.
That would equal the $36,000 in contributions or you could do $2,500 for approximately 14-15 years.
The government also has another form of a grant, which is called the Canada Learning Bond (CLB). The CLB is designed to help those with low or modest income levels to save for future education costs.
Upon opening the RESP, the account automatically gets the CLB of $500 and then an additional $100/year for every year your household meets the requirements.
Many families may find finances a bit tight while raising a young family and they may not have surplus cash to add to the RESP until the later years.
The great part of the RESP, as we eluded to earlier, is the ability to make up for past unused contributions.
Perhaps your children are now seven, eight, or even ten years old and you have a better cash flow. You can actually contribute up to $5,000 per year, per child to maximize the grant monies.
However, if you decided to put $10,000 in today for one child, the government would only match up to one year of carry forwards.
This means $2,500 for the current year plus your $2,500 for one prior unused year.
This would result in $1000 of CESG for your $5000 of contributions and $0 of CESG on the other $5000 contributed.
Of course, all the RESP excitement does not stop there. Let’s review the benefits of a Family Plan RESP.
Using a family plan is critical, if you have more than one child, are considering having more than one child, or beneficiary, then you want a family plan.
As you likely know, kids have different ambitions and different goals and will likely take different paths in life.
Let’s discuss a possible scenario about how great the family plan would be.
Perhaps my son chooses not to go to university, but my daughter decides that she does wants to go – she can actually use the grant and the contributions for my son and take it out in her name.
So, the family plan is a great way of having access to the entire funds to benefit any of your beneficiaries.
What investment options are available for your RESP account?
RESPs have the same investment options that you can take advantage of with your RRSP or TFSA.
This provides you with access to a variety of asset classes. You can invest in stocks, you can invest in bonds, you can invest in preferred shares and more.
Choosing the right investment mix is critical, and best of all with a RESP you already know your exact investment time horizon as to the earliest they will begin university.
Any investment growth or income generated within the portfolio, is fully tax sheltered until withdrawn, thereby allowing a greater rate of growth.
A quality Portfolio Manager will help you determine the best investments to grow your children’s RESP.
Now your children are going to school and require money, how does that work?
Generally, you can take out a maximum of $5000 in the first 13 weeks provided your child is registered in a qualified post-secondary education institution.
Once they are in their second semester and are still registered fulltime, then there is essentially no limit on the withdrawals available.
When you complete the withdrawals, there is no requirement to show proof of what the funds are used for.
However, the funds are intended to be used towards education related expenses (Tuition, Room & Board, Books, Laptops, Fuel, Bus Pass, Parking etc).
What is the catch? Well, you received all this free government grants and tax-sheltered growth, at some point there will be tax, right?
When you withdraw the funds for education costs, there are two forms of withdrawals, Education Assistance Payment “EAP” or Capital.
EAP is the grants, investment growth/income or any CLB in the account.
EAP payments are taxable to your child when withdrawn and the capital portion is already after-tax dollars and is tax free upon withdrawal.
The majority of the time, your child is in a very low tax bracket while attending post-secondary education and could pay little or no tax on their income.
Not only does the RESP help with education costs, it is also a great tax planning tool to use!
What happens if your children or beneficiaries don’t actually pursue further education.
Well, there are time frames required for the plan to be open for and ages for the beneficiaries, however you do get your money back!
The grant money goes back to the government, there is a penalty charge of 20% (which coincidently equates to any income/growth on the grant money).
Any income or growth left is taxable in your hands; however, it can be sheltered in your RRSP if you have adequate room. Your contributions go back to your pocket tax-free.
In the end, the RESP is a really exciting tool to use in save for future education costs.