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RESP Explained

RESPRESP, 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, as well as future students, for saving for college or university using RESPs, including access to the Canada Education Savings Grant.  These plans are similar to the US Coverdell Savings Account or 529 Plans for those familiar with them.   Here is what you need to know about using these accounts to save for your children’s education.

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 a tax benefits and other education benefits for students once they are enrolled in a post-secondary program.  Parents and others can contribute to the account and provide a 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Any principal contributed to the account can be withdrawn at any time by its contributor.  If the student (or beneficiary) decides not to attend college, any accumulated interest may be withdrawn by the contributor, after certain circumstances have been met (such as the plan must have existed for 10 years and the student must be over 21).  If the interest or gains on the account are withdrawn, the income is taxes as ordinary income unless it is rolled into a RRSP.

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 depending on 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 end up paying some taxes.

Even if there is earned income for the student, education and tuition tax credits will still 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 an RESP, with a maximum lifetime contribution of $50,000.  This income is available upon withdrawal by a post-secondary students.

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 familes save for post-secondary education.  If you receive the National Child Benefit, you will receive an additional $500  when you open an 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 form the savings.
  • Individual Plan: An indivdual 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 a great benefits to students for several reasons.

  • Due to the rising cost of education, it can be extremely expensive to get a post-secondary or college education.  Any savings for college can greatly benefit the benificiary. 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.  This bonus will go directly to the student when it comes time to pay for educational expenses. 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 Accounts

Getting the right account is also important and not always well explained. If you go to a financial institutions, they will usually focus on the products and on how to leverage their products. The government doesn’t really 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 will have to 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 in a similar fashion 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 setup and you are limited to the bank’s products and its affiliates.

Readers: Do you intend to help your children with their education?

Image: FreeDigitalPhotos.net

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12 Responses to "RESP Explained"

  1. Kinoli says:

    I’m sure there are several drawbacks to having an RESP account rather than simply setting up a self directed investment account for your children. Derrik Foster mentions that he doesn’t think they are a good idea because he would rather have his children lean about how to manage money and invest and they may not even want to go to university. What are your thoughts on that and do you see any pitfalls to using an RESP?

    • The Passive Income Earner says:

      @Kinoli

      I think you are touching on 2 separate parts; 1) child education about money 2) the benefits of RESP.
      1) providing for an education doesn’t imply a lack of education around money and investing for children. There are many approaches to educate about money. I have a number of posts on the subject but it really starts with talking about money at home.
      2) an RESP account is just another account with tax free growth and a 20% grant from the government. Until my children go to school and make use of it, that money is mine and not the children. So it’s another way to grow money tax free whether or not your children leverages it.

      Do you really think that leaving 20% on the table form the CESG is valid that you would basically donate the money to your kids for them to invest? Not to mention that you have to do it properly to avoid the tax attribution rule… Derek’s book The Lazy Investor showed me the way for DRIPs with Computershare but I don’t share this RESP comment if he said that. Children education about money is really based on EVERYTHING the parents do and teach about money over the years.

      I have not covered the withdrawal in the post but you can read a little about it here: http://www.moneysmartsblog.com/resp-withdrawals/
      Your contributions are yours if your child doesn’t go. 20% of the CESG is given back and then you pay taxes on the income (almost like a RRSP withdrawal). Feel free to do some math to assess what is better for the scenario where your child doesn’t go and then factor that with the chances of your child going to a post-secondary.

      Consequently, part of your plan might not be to fund it fully or to stop at a certain limit. Certainly, you should factor that in with your RRSP and TFSA contributions.

      I hope the helps :)

      • The Passive Income Earner says:

        I should also add, that in the case they don’t go to school, you could always withdraw and then fund your RRSP to limit the taxes paid at the time …

  2. Kinoli says:

    Ya, I just hate being forced down the governments path for my investments. They lock you in so you never want to touch the money because of the penalties involved in withdrawing it. And it also will push you to want your kids to go to an overly expensive 4 year govt run education that they could likely get through doing their own research online or in books in less than a year.

    I like Derrik’s approach to this. I would hate to just sign over a big check to my kids once they hit 18. I see more value in teaching them the value of money and how to invest by giving them their own account to manage through their youth and once they hit 18, they can do whatever they like with it… buy a car, downpayment on a house, start a business, education. Let them make the decision (with guidance), rather than push them into more education that they likely don’t really need.

    Another thing the govt can do is to add restrictions and more penalties on these plans in the future. And thats a good possibility as they get more in debt. They will want to create more ways to take your money as they find out they can’t afford the things they want to do.

    Those are just my thoughts. I’m having a kid soon, and I’ve been trying to understand this better so I can approach this the smartest way possible and so far this is where I’m going with it.

    • Kinoli says:

      Also, I’m not trying to come down on your post. I did enjoy reading it and learned a few more things about it. I just was hoping to learn more about the pitfalls of having an RESP. Or perhaps you could do a post about RESP vs Self Directed Account. Something like that. Anyways, I enjoy your website a lot. Cheers.

      • The Passive Income Earner says:

        @Kinoli

        No worries at all. It’s a good discussion as others might think about this too. Unlike RRSP, the RESP is targeting someone else and you can’t necessarily control or force the education path. I had my education covered and had no debt when I finished university. This is a path I wan to provide for my children and the savings that you mention still happens with my kids but differently. I have them setup with Computershare :)

        What is important when it comes to any accounts is to assess what you want from them. As you mention, there are other ways to provide an education. RESP is fairly new, it did not exists back in the day and my parents did something similar to what you mentioned. The money was in my name and I used the income to pay for school. I considered that but the 20% is just a really good return annually. I would recommend you build a table of contribution inside RRSP and outside and assess the tax benefits for all cases. I might just do that and share on the blog.

        Thanks for your comments!

    • The Passive Income Earner says:

      Also, there are no penalties from the government when it comes to RRSP or RESP. They are just a pre-tax or after-tax concepts. If you don’t do RRSP or RESP, you just pay taxes up front. Those registered accounts simply allow you to defer taxes in order to grow the money faster. Compound growth works much better the more money you have.

      At the end of the day, I see those accounts (including TFSA) as tools in your investment toolbox. If they work, then it’s good, if they don’t then you focus on something else.

      I hope this clarifies the concept of a registered account when it comes to taxes.

      • The Passive Income Earner says:

        I stand corrected, it appears that if your child doesn’t go to a post-secondary and doesn’t initiate withdrawals, there is a 20% tax on the IAP (Income and growth above contributions). I am researching that more as it’s not easy to find the details on the government websites.

        • Kinoli says:

          Yeah, thats what I had thought. Do you know if your child ends up going to University out of country, if they would still be able to use their RESP money without penalties?

          • The Passive Income Earner says:

            @Kinoli

            Good question. I will have to look into that. If someone knows, please share.

  3. Nathan says:

    What the government does if the child doesn’t go to school is take 20% of the principal (makes sense since this was their money in the first place) as well as 20% of the interest/growth (which would not have been yours anyways if you had not gotten the CESG)

    Basically, if your child does not go to school, this is just another RRSP account that you could use. (Depositing up to $50,000)

    Also, I’d like to point out that your child doesn’t have to use the RESP to go to University. They can also use it to go to college, trade school, or other courses to further their education.

    If your child wants to take a few years off from high school, the money in the RESP can still grow without penalty until your child turns 35. After 35 years, the money must be withdrawn under your name or your child’s name. You can also continue to contribute to the RESP until your child turns 31.

    More information here if you need it: https://www6.royalbank.com/educationcentre2/english/ip/account-services/resp-faqs.html#7

    • The Passive Income Earner says:

      @Nathan

      Thanks for commenting. You are right, it’s pretty much a RRSP account if they don’t make use of it and there is lots of time to collapse it as you mention.

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