I still remember being introduced to the concept of an RESP when a sales representative approached me in my hospital room the second day after my son was born. I was initially skeptical, but was drawn to the idea of providing my son with a lifelong gift of higher education. Now as a parent of an undergraduate student myself, I am currently reaping the benefits from the early planning and growth offered by an RESP.
Tuition fees have been increasing steadily for decades, leading to the current national undergraduate average of $6,463 (Statistics Canada). These fees balloon when considering professional degree programs such as dentistry or medicine, with annual payments rising to nearly three times that of undergraduate tuition fees. Strategic planning can make a world of difference, so it is wise to take advantage of the benefits offered by an RESP.
What is an RESP?
An RESP is a tax-deferred savings plan designed to allow you (the subscriber or contributor) to save for a beneficiary’s post-secondary education. There are two popular types of RESPs: a group plan (also known as a pooled RESP or Scholarship Trust Plan) and an individual/family RESP. Although they share similar benefits, an individual/family plan might be a better fit for investors who enjoy flexibility in their contributions and planning.
Benefits of an RESP
Tax-sheltered growth – Contributions to an RESP are not tax-deductible, but all of the interest, dividends, capital gains and government grants in the plan grow on a tax-deferred basis. There is a $50,000 lifetime contribution limit per RESP beneficiary, but no annual maximum limit. When funds are withdrawn for education, they are taxed in the student’s hands, which, given their low-income status, often results in little or no tax owing.
Benefit from the Canada Education Savings Grant – For many subscribers, the Canada Education Savings Grant is the most attractive feature of an RESP. The government contributes 20% of the first $2500 of your annual contributions to a maximum annual grant of $500 for each beneficiary. The lifetime limit of CESG for each beneficiary is $7,200. If the beneficiary has unused grant room from a previous year, the annual maximum that can be received is C$1,000. One thing to keep in mind is that the last year to receive the CESG is when your child turns 17, and specific rules exist for children who are 16 and 17 years old.
Enjoy built-in flexibility – One of the benefits of a family RESP is that the accumulated CESG contributions do not have to be paid out equally among beneficiaries. The beneficiaries under a family plan can share the pool of funds to meet specific needs. The maximum life span of an RESP is 35 years, which offers a nice amount of flexibility in case a beneficiary takes one or more gap years before pursuing post-secondary education.
Tax-Planning and the RESP
Original contributions to an RESP can be withdrawn at any time and are not taxable if paid to the subscriber or to the beneficiary of an RESP. An Educational Assistance Payment (EAP) is a payment of funds from the accumulated growth made to the beneficiary (proof of enrolment to a post-secondary program is required). An EAP is taxable income and will need to be reported on the beneficiary’s personal tax return, starting in the year when the beneficiary receives a T4A after RESP withdrawal.
The combination of principal payments and/or EAP payments could be tactically allocated in conjunction with the beneficiary’s current income, if any, to reduce their tax burden.
Speak to your advisor for more information on how to strategically manage an RESP in order to maximize compounding returns and minimize the tax effect. As we now approach the holiday season, one of the best gifts for your child might be setting up an RESP or contributing to an existing one. They may not thank you now, but they certainly will in the future.