Common questions on Registered Education Savings Plans (RESPs)
When kids go back to school, I always get an increased number of questions on RESPs. This week, as a result here arefour frequently asked questions on RESPs.
What are the rules around taking money out of RESPs?
RESPs have been around for a long time but got a big overhaul in 1998 where the government introduced the Canada Education Savings Grant (CESG) for contributions to a RESP. The focus on RESPs has been around contributions and grants but as we move forward,more and more parents and adult children are now at the stage of taking money out. The rules can be complicated but hopefully my article onRESP withdrawal ruleswill shed some light on the topic
Are RESPs the best way to save for children’s education?
RESPs are not the only way to invest for future education. There’s no question it is one of the most attractive options given the Canada Education Savings Grant (CESG) from the government. Some parents and grandparents elect to use other alternatives for savings like informal trust accounts. Informal trusts are popular because the money does not have to be used strictly for education purposes. The money can be used to start a business, buy a house, used for travel after school or for education. Quite frankly, it can be used for anything. Naturally with informal trust accounts, the government does not kick in anything and depending on how you structure the investment, taxes may have to be paid on the growth each and every year. With both the RESP and the informal trust account, the contributions are not tax deductible like RRSPs.
Related article: Different options to save for education
What if the child does not go to school?
Before the changes to RESPs 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 flexibility in these situations.
- Keep the RESP going, just in case. The RESP can stay open for 36 years so if the child does not go to school right away, don’t panic.
- The money can be transferred to a sibling but there are lifetime grant limits per child ($7200). If a siblings total grant exceeds this amount after the transfer, excess grant money must be returned to the government.The replacement beneficiary must be connected to the subscriber by blood or adoption. The replacement beneficiary or any of the other beneficiaries can use the CESGs paid into the family plan as long as they are under the age of 21.
- If the funds cannot be transferred to another sibling, all contribution money can still go back to the contributor with no tax implications
- All grant money (20%) has to go back to the government unless there is a sibling to transfer it to.
- The only thing left in the plan is the growth from the contributions by the subscriber and the government. All remaining money is taxed at your marginal tax rate + an additional 20% tax. If you have RRSP contribution room, you can transfer money to your RRSP to avoid the tax.
How should you invest RESPs?
There are many investment options like GICs, mutual funds, stocks, bonds, etc. It is important to shop around for the right RESP investment just like any other investment. Typically the subscriber (parent) makes all the investment decisions on behalf of the beneficiary (child). From my perspective, whenever you are investing money for someone else, it is important to use more discretion and prudence.
Some people will argue that when the children are young, you should invest in stocks and equity mutual funds for the long term despite the risk. The problem is I have seen many accounts where subscribers have put money into high-risk tech funds, for example, only to lose the free money from the government and almost half of the original contributions. I think that being more conservative is prudent especially since the government puts in the 20% CESG. That’s kind of like making a 20% return without taking any risk to begin with. Whatever the case may be, think twice before taking too much risk when investing RESPs.
Related article: Investing strategies for RESPs
According to statistics Canada, it is estimated that by 2019, the total cost of a four-year university education will be $74,000 and a three-year college education will total $45,000. Now that’s motivation enough to start saving into the RESP.