RESP Explained: The Ultimate Guide

Dividend Earner

Dividend Earner

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RESP, or Registered Education Savings Plan, is an investment account used by parents to save for their children’s post-secondary education in Canada.  There are many advantages for parents and future students in saving for college or university using RESPs, including access to the Canada Education Savings Grant. Here is what you need to know about using these accounts to save for your children’s education.

RESP Explained – How RESP Works

A RESP is designed to be a post-secondary savings account used by parents to save for their children’s education.  It provides tax and other education benefits for students once they enroll in a post-secondary program.  Parents and others can contribute to the account and provide savings for a student’s future education.

Any principal contributed to the account can be withdrawn at any time by its contributor.  If the student (or beneficiary) decides not to attend college, any accumulated interest may be withdrawn by the contributor after certain circumstances have been met (such as the plan must have existed for ten years and the student must be over 21).  If the interest or gains on the account are withdrawn, the income is taxed as ordinary income unless it is rolled into an RRSP.

Don’t forget to figure out your investing strategy as you have 15 to 20 years. The easiest is to go with an index investing strategy. Before you think about other investing strategies like REITs for income, make sure you clearly understand the long term performance.

The RESP Tax Benefits

The tax benefits from the RESP contributions are such that the investment income and growth is taxed at withdrawal at the recipient’s tax rate (i.e. the student).  Because the student typically has a low income, the tax rate is usually nothing or very little.

Depending on the needs during the year and the province you live in, the first $8,000 (approximate figure) or so will be tax-free in terms of income. If you have a part-time job during the year pushing your overall income past the minimum, you would pay some taxes.

Even if there is earned income for the student, education and tuition tax credits will usually reduce the income tax rate.  As a result, the interest from these accounts is nearly tax-free for the student.

The Government Grants (CESG)

As part of the incentive to use the RESP, the Canadian government also provides the Canada Education Savings Grant (CESG) to compliment RESP contributions.  This is where the government of Canada will contribute 20% of the first $2,500 in annual contributions made to a RESP, with a maximum lifetime contribution of $50,000.  This income is available upon withdrawal by a post-secondary student.

Depending on your income, the first $500 contributed can receive up to 40% in grant. See the CESG table for more information. The maximum lifetime CESG stays at $7,200 for all income per child. If you were to make a full contribution every year, you would reach the maximum after 15 years but you can continue to contribute even if you reached the CESG limit.

There is also the Canada Learning Bond, which helps low-income families save for post-secondary education.  If you receive the National Child Benefit, you will receive an additional $500  when you open a RESP and $100 for each year they remain eligible for the National Child Benefit.  The governments of Alberta and Quebec also have additional incentives that can be contributed to the RESP and facilitate even more savings for college.

Available RESP Plans

There are 3 RESP plans that parents, relatives or friends can choose from.

  • Family Plan: This account should be the standard even if you have one child. The children must be related to you in order to open the account. It stipulates that any children in the family can benefit from the savings.
  • Individual Plan: An individual account is setup for one child and the savings can only be used by the designated beneficiary. This is the ideal account for non-parents wanting to contribute. The child does not need to be related to you and there are no limits.
  • Group Plan: The rules are relatively complicated and group plans are administered outside the government. I am not sure I would recommend that as I can only imagine the fees one need to pay for someone to administer a group plan for many children.

Why It Benefits Students

RESPs are significant benefits to students for several reasons.

  • Due to the rising cost of education, getting a post-secondary or college education can be extremely expensive.  Any savings for college can significantly benefit the beneficiary. However, students should still be encouraged to apply for scholarships or other financial aid.  And when they do, they usually have to submit proof of income and assets to see if they are eligible. Since the student is just the beneficiary of the RESP and not the owner, the assets in the RESP do not count towards the child’s assets when applying for scholarships.
  • With all of the government programs that help improve the amount of money in the RESP, you are getting significant returns just by opening and funding an RESP.  When it comes time to pay for educational expenses, this bonus will go directly to the student. At a minimum, you will receive 20% from the government.

These funds can also be used for other educational needs beyond tuition, such as books, computers, software, and more.

RESP Explained – Account Options

Getting the right account is also important and not always well explained. If you go to a financial institution, they will usually focus on the products and on how to leverage their products. The government doesn’t explain all the account setups available, and unfortunately, the accounts do not all have the same flexibility.

  • Self-Directed RESP Account: This is the most powerful one. You need a discount broker, and you control all the investments. It’s up to you to choose what you want to buy and invest it yourself. This account provides you with the most flexibility.
  • Financial Advisor Account(s): Depending on the mutual funds you buy, you must open an account with each mutual funds provider. The advisor manages everything for you and he/she can buy any funds for you but you are still left with multiple accounts at the different providers. If you are happy with your advisor, his/her report should aggregate your performance and make it look like one account. You are limited to the products your advisor sells.
  • Bank-Specific RESP Account: This account is through a bank but not through a discount broker. It operates similarly as the financial advisor account but it’s specific to the products the bank sells. Depending on the products you want, you may need more than one account to be set up. You are limited to the bank’s products and affiliates.

In the end, you are going to need to learn how to withdraw from the RESP account.