Registered Education Saving Plans

One of the least understood registered savings accounts is the registered education savings plan, or the RESP for short. Perhaps you are expecting your first child, or already have one or more children, and haven’t really considered the benefits of an RESP yet. Hopefully after this post, you will have a better understanding of how you can use an RESP and whether it’s worth it for you to utilize.

Firstly, I just want to clarify what an RESP is. An RESP is a savings account that is allowed to grow tax-free and can be used to fund a university/college education for the stated beneficiaries of the plan. It’s important to note that when the money is contributed to an RESP, you do not receive an immediate tax deduction (as with an RRSP contribution). When the money is eventually withdrawn for the beneficiary’s education costs, tax is paid on the earnings generated in the RESP; however, the beneficiary usually pays the taxes. This is advantageous because students are usually very low income earners, and end up paying minimal (if any) taxes on the RESP funds used for education.

Why else would you want to open an RESP? The most important reason by far is that the government actually contributes money to the RESP annually, through 2 programs:

1)Canada Education Savings Grant – Essentially, the government will match a portion of your savings, depending on your family net income and annual savings. Here is the exact amounts:
a)If your family net income is under $37,885 – the government will contribute 40% of your contributions to the RESP for the first $500 you contribute and 20% for next $2,000 you contribute, up to a maximum of $600 per year.
b)If your family net income is between $37,885 and $75,769 – the government will contribute 30% of your contributions for the first $500 you contribute, and 20% for the next $2,000 you save, up to a maximum of $550 per year.
c)If your family net income is over $75,769 – the government will contribute 20% for all contributions up to $2,500, for a maximum government contribution of $500 per year.

The maximum money that can be earned in an RESP from the Canada Education Savings Grant is $7,200. But obviously, those government contributions can earn interest – and there’s no maximum on that. And as well, don’t forget that the above noted numbers are per child.

2)Canada Learning Bond – This program is targeted for lower income families. To qualify for it, your child must have been born after December 31, 2003, and you receive what’s called the National Child Benefit Supplement (monthly payments from the government to help lower-income parents with raising children). The CLB works differently than the CESG – here’s a summary:
a)The CLB will pay $25 to help cover the cost of opening an account
b)The CLB will make a start-up payment of $500 to the RESP
c)The CLB will contribute $100/year until your child is 15 (as long as you still receive the National Child Benefit Supplement
The CLB can contribute up to a maximum of $2,000 for your child’s education. One important note about the CLB – you don’t have to be contributing any annual amount to receive the above-noted government contributions – just by simply opening an account, you can receive CLB benefits.

So is it worth it for you to open an RESP? The question is, when else do you receive free money from the government? And remember, the earlier you collect the government’s funds, the more time it has to earn interest and grow.

What happens if you need to withdraw RESP funds early? You will have to pay normal tax rates (the withdrawals are considered as income) plus an additional 20% penalty (yikes!). As well, you must return any government grants earned over the years of the plan (including the above-mentioned CLB and CESG), although not the interest earned on any grant. However it’s important to note that you only pay taxes on the interest earnings – the principle contributions you made throughout the life of the plans are after-tax dollars (they were already taxed before being contributed anyways). Therefore, the tax hit is not as bad as it seems. There are other ways to mitigate the strict penalties, including transferring the RESP contributions to an RRSP, donate the RESP balance, transfer the balance to another RESP, etc. Talk to your financial advisor.

What constitutes an educational program that an RESP can fund? Well – the list might be a little longer than you think. Besides the obvious Canadian post-secondary institutions, many part-time and even foreign institutions qualify.

The last issue that needs to be dealt with regards the actual plan itself. Should it be self-directed (i.e. you choose the investments) or should it done via mutual funds? Well, it is completely up to you. What I definitely would advise is to invest the majority of it in equities (risky assets), since the time frame is pretty long until you need the funds, and therefore, it’s ok to go for the higher returns. Many banks and different scholarship funds (like “Heritage”) offer RESP plans that may be a better fit for many investors. Why? Because often, RESPs are funded in small amounts over many years. If you self-direct your RESP, than the transaction costs for purchasing equities every time you contribute a little more money can be over-bearing. Scholarship funds will automatically add your money to the fund so you don’t have to incur the transaction costs constantly. When choosing a particular fund, make sure to ask questions like, “Is there an annual service fee?” “Is there a penalty for withdrawing funds?”

For a complete list of relevant questions, and for more information on RESPs, visit http://www.hrsdc.gc.ca/eng/learning/education_savings/public/resp.shtml

I hope you now have a better understanding of RESPs, and I definitely would recommend putting aside some money into an RESP, and watching it grow, along with receiving government payments. This is especially true in a case where parents are young, since a) you often qualify for higher government contributions and b) there’s more time for your RESPs to grow, so that the cost of your child(ren)’s education may become less of a burden in the long run.