Saving for education using the RESP
This time of year we are all looking for gift ideas. I’ve always said that an RESP may be one of the best gifts for children and grandchildren. I know it’s not as interesting or exciting as the latest toy or trendy outfit but given some of the latest statistics on post-secondary education, it may be the most practical gift to give children.
What is an RESP?
A Registered Education Savings Plan (RESP), is a tax-deferred education savings vehicle through which the federal government allows a subscriber to save money for a beneficiary’s post-secondary education. Money invested in the RESP is not tax-deductible like the RRSP but the growth of the investments is tax-deferred.
In 1998, the government made some very significant changes to the RESPs to make them much more attractive. In this article, we will discuss some of the more important basics of the RESP.
Before we go too far, we need to establish an understanding of some of the important terms with regards to the RESP.
- A subscriber is a person who creates the plan and who makes contributions to the plan. This could be anyone. However, if the RESP is a family plan, the beneficiaries must be related by blood or adoption to the subscriber. For this purpose, blood relationships include children, brothers, sisters, grandchildren, and great-grandchildren. The subscriber is responsible for tracking the total amount contributed to all RESPs on behalf of the beneficiary.
- A beneficiary is a person who will draw upon the RESP to finance their education.
- An individual plan is an RESP set up by a subscriber for one beneficiary. A subscriber may designate anyone as the beneficiary of the plan, including themselves, a spouse or common-law partner.
- A family plan is an RESP set up by a subscriber on behalf of one or more beneficiaries. However, each beneficiary must be under 21 years of age at the time of designation and must be related to the subscriber by blood or adoption. Children, grandchildren, brothers, and sisters are considered blood relations, while nieces and nephews are not.
The most significant change made to RESPs is that the government has created the Canada Education Savings Grant (CESG) to promote education savings and give a boost to RESPs. The government will contribute 20 percent of the annual contributions made to an RESP, up to a maximum of $500 per calendar year per beneficiary.
The CESG and the accumulated earnings, when paid out to the beneficiary for educational purposes, are taxed as income in the hands of the student. The return of contributions to the subscriber is not taxable because contributions to an RESP are made with after-tax money.
Money invested in an RESP must be used for the purpose of education. The money can be used to cover the student’s tuition, housing, transportation, books, supplies and other incidentals relating to the student’s education.
What happens if the child does not go to school?
This is the most common question that is asked about RESPs. Before the changes in 1998, the RESP was very restrictive in terms of options if the child did not go to school. Today, the RESP rules provide more options in case the child does not go to school. No matter what happens, the subscriber is able to withdraw the original contributions without any tax implications.
- Option 1 – Change the beneficiary. The replacement beneficiary must be connected to the subscriber by blood or adoption. The CESGs paid into the family plan can be used by the replacement beneficiary or any of the other beneficiaries as long as they are under the age of 21.
- Option 2 – Transfer earned income to the RRSP. The subscriber may transfer up to $50,000 of the earned income to the RRSP or that of your spouse or common-law partner, provided an unused RRSP contribution room is available.
- Option 3 – Pay the tax and penalty. Any accumulated income you receive that is not transferred to an RRSP will be fully taxed in your hands at your top marginal tax rate. In addition, you will pay a penalty of 20 percent of the withdrawn accumulated income. For example, if the subscriber is in a 40% tax bracket, the accumulated income would be taxed at 60%.
- Option 4 – leave the money for a while. You may wish to leave money in the plan for a few years in case the beneficiary changes his or her mind.
Next week, I will continue talking about the RESPs and focus on the contribution limits.