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Registered education savings plans (RESP)
If you’re looking to invest in your child’s future post-secondary education, an RESP can help.
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With the cost of post-secondary education skyrocketing, parents need all the head start they can get when it comes to financing their children’s tuition. A registered education savings plan (RESP) offers you government bonuses and a tax shelter to achieve that goal.
What is an RESP?
As the name implies, an RESP is an investment account that helps you save for a child’s education. Like the tax-free savings account (TFSA) and registered retirement savings plan (RRSP), an RESP allows your investments to grow tax free. That means all the gains made on your investments do not incur capital gains taxes.
When you put money into an RESP, the federal government matches the contribution up to a certain percentage. The matching benefits apply to the first $2,500 in contributions per year. The maximum grant you can receive from the government is $7,200 over the lifespan of the RESP. When you do the math, that’s up to $500 a year in free money from the government if you contribute the maximum amount.
Once your child enters college, he or she receives money from the plan in the form of educational assistance payments (EAPs). That money becomes taxable income for the beneficiary (in this case, your child).
Benefits of using a Registered Education Savings Plan
The main benefits of using an RESP include the following:
- Bonus money from the government. The Canadian government wants to reward you for saving for your child’s education, so it’ll match 20% of your contribution up to a maximum of $2,500 each year. Your child’s RESP can earn up to $7,200 in bonus money from the government over its lifespan, including the interest earned on it.
- Prepare your child for college or university. Post-secondary education costs are skyrocketing in Canada. If you want to give your child the option of pursuing whatever career they want, the RESP is one of the best savings tools available.
- Tax-free investing. Like the TFSA and RRSP, an RESP account lets you grow your money tax-free.
- Long lifespan. Your child doesn’t have to go to university right after high school to receive payments. Each RESP account remains open for up to 36 years, which means the beneficiary has plenty of time to decide whether to pursue post-secondary education.
Disadvantages of using an RESP
The following are the main disadvantages of using a registered education savings plan :
- Use it or lose it. If your child decides not to pursue college, university or trade school within the 36-year window, the government may request the grant money back.
- Redemption penalty. If money is taken out of the RESP for any purpose other than the beneficiary’s education, it’ll be taxed as income and incur an additional 20% penalty.
- Child pays the tax. Once your child starts receiving payments from the RESP for school, the money will be taxed as income. However, since post-secondary students usually have very low income, the tax is usually low.
How to open a Registered Education Savings Plan
Anyone can open a Registered Education Savings Plan for a child, not just the parents. Guardians, grandparents, other relatives or friends are also eligible.
Once you’ve decided to open one, you need to contact your bank, credit union or online broker and ask them to open a self-directed RESP account. Simply provide your social insurance number (SIN), the beneficiary’s SIN and their birth certificate to get started.
What investments can you put into an RESP?
There are two investment options for RESP accounts: fixed-income assets and equities.
Fixed-income assets are short-term bonds, guaranteed investment certificates and cash held in an investment savings account. Equity investments are publicly traded stocks and equity mutual funds. If you’re not sure which investment options are best for you, consider seeing an investment advisor.
How much should I be contributing to my RESP?
Most people will contribute $2,500 per year into their RESPs to get as much “free” money from the government as they possibly can. To maximize your eligibility for grants, it’s recommended that you put away $2,500 a year for 14 years and then an extra $1,000 in your 15th year. This way, you’ll get the highest possible return on your Canada Education Savings Grant.
If you keep up with payments, this amount will equal $7,200 in government grants over the course of your investment. If you aren’t able to contribute $2,500 per year, don’t worry, you’ll still be able to take advantage of grants. The amount you get will just be 20% of whatever amount you contribute into your RESP each year.
For example, if you only invest $1,000 each year, you’ll get $200 in grants ($1,000 x 0.20% = $200). If you invest $500, you’ll get $100 in grants – and so on and so forth.
What’s the best time to open an RESP?
The best time to open an RESP for your child is as soon as they have a Social Insurance Number (SIN). This is because it takes at least 16 years to take advantage of every government grant that you’re eligible for. If you miss a year, you’ll have to play catch-up in future years and if you start late, your pot of grant money will be smaller.
That said, it’s never too late to start an RESP for your child. For example, if your child is 10 years old and you start saving now, you’ll still be able to save up at least 8 years’ worth of grants (if your child goes to post-secondary at the age of 18). This will give you $20,000 in total contributions with an additional $4,000 in government money.
How does an RESP work?
You’ll typically sign up for an RESP with a “promoter”, which is the company you decide to invest with. Once you have your account set up, you’ll start making contributions on a monthly or annual basis. Your promoter will then invest the money you put in and apply for government grants on your behalf.
You can name one or more children as beneficiaries on your plan and you may be able to add more children to a family plan at a later date (provided they’re siblings). Once your beneficiary is ready for college, they’ll receive their money in the form of educational assistance payments (EAPs). This money will be treated as taxable income for your beneficiary when it’s withdrawn.
What happens when my child wants to take money out of their RESP?
When your child is ready to register for post-secondary education or an eligible training program, they can request EAPs. These can be used to pay for tuition as well as other school-related expenses including housing, books, laptops, transportation, meal plans and more.
EAPs are composed of the government grants and interest that your RESP has accumulated over the years. Grants can amount to up to $7,200 for each child while the interest you’ve earned on your contributions will vary depending on how well the markets have performed.
Once these EAPs are used up, you can withdraw your original contributions tax-free (and either use them for yourself or give them to your child).
What is a family RESP?
A family RESP works just like an individual RESP, except it has a couple of different rules. This type of RESP lets you save up for multiple children at one time, though they’ll need to be related to you by blood or adoption. The main benefit of this type of plan is that you won’t have to do as much paperwork and there are fewer accounts to manage.
It’s also possible to split the money you contribute between your children according to their educational needs. The downside of this type of plan is that every child you save up for has to be related to you by blood or adoption. They also need to be added to your plan before the age of 21 and contributions can only be made for beneficiaries up to the age of 31.
What is an individual plan?
An individual RESP is a savings plan that’s set up for one person only. You can set it up for your child or even for yourself if you want to save up for your own education. You’ll be able to open this type of RESP at just about any age, though you may not qualify for government grants beyond the age of 17. Even in this case, you’ll be able to invest money and earn tax-free interest on your investments (so it’s still a win-win).
An added benefit of this type of plan is that your beneficiary can be changed at any time, no matter their age. They also don’t need to be related to you by blood, though this can sometimes interfere with whether or not they earn government grants. The downside of this type of plan is that it takes more time to manage individual accounts if you’re saving up for multiple children.
How are RESPs managed?
Your RESP can be either self-directed or managed by your RESP provider. With a self-directed portfolio, you invest the money yourself and manage your investments on your own time. You can also choose to invest your money with a robo-advisor like Wealthsimple to grow your investments without high commissions or account fees.
If you’re not super comfortable with this strategy, you may want to invest your money with a dedicated financial adviser. In this case, you might like to invest with an RESP investment firm like CST Spark. Firms like this will charge you management fees that will come out of the contributions you make. That said, they’ll also save you from expending the time and energy it takes to manage your funds on your own.
What if my child decides not to pursue post-secondary education?
If your child isn’t quite ready to attend post-secondary, you have a number of options. You can keep the money in their RESP until they’re at least 31 (and older in some cases, depending on when you started investing). If they are dead set against school altogether, you can also transfer their plan to another eligible beneficiary, such as one of their siblings.
If you don’t know who else could use the money, you can also withdraw the funds you put into the RESP (and pay tax on the interest you’ve earned). You can also transfer up to $50,000 worth of interest into your RRSP to avoid paying taxes. From there, you can withdraw your original contributions tax-free (though you’ll lose any government grant money you earned).