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Everything You Need to Know About RESPs
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Short for a Registered Education Savings Plan, an RESP is a necessary part of any household’s financial portfolio. It enables parents to plan ahead for their children’s education, taking some of the financial pressure off when it comes time to enroll in a post-secondary institution. Unlike a standard savings fund, when used properly, an RESP lets families benefit from government contributions, accelerating the growth of the account. Whether you already have an RESP in place or are considering starting one, it is important to understand how they work and how you can benefit most from the service.
What is an RESP?
An RESP (Registered Education Savings Plan) is an investment account designed to foster savings for your child’s future education. It is built to shelter contributions against taxes, with the contents gaining interest without you needing to pay tax either on the principal or the growth amounts. The purpose is to enable parents to set aside funds for their child’s future, without facing any tax burden on that amount.
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As an extra benefit, because RESPs are registered through the government, account holders can access substantial grants. In fact, over the course of the RESP maturation, the government can contribute up to $7,200 to the fund. When the child reaches the age of majority and registers in an accredited program, then they can access the savings and put it toward everything from tuition to textbooks.
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How does an RESP work?
A Registered Education Savings Plan involves three people, each serving a different role. These roles are as follows:
This is the account holder, the adult whose name is on the account. They are the individual who can make contributions as well as withdrawals. When the beneficiary (the child) reaches the age of majority and enrolls in a program, it is the responsibility of the subscriber to provide proof that they are enrolled. This enables access to the funds. These withdrawals are called Post-Secondary Education Payments (PSE) and are not taxed. The amount is sent either to the subscriber or to the beneficiary.
Looking for additional tax breaks for your child? Check out these tax credits and deductions for students.
This refers to the provider of the RESP, the financial institution that holds the account. Among the many available promoters are major banks, scholarship companies, and companies that deal in mutual funds. This institution is responsible for informing either the subscriber or beneficiary about the RESP. The promoter also must request the Canada Revenue Agency (CRA) to register the account. This is also the party that applies for grants and is in charge of informing the subscriber of whether the grant was approved. As the administrating party, they are also in charge of dealing with Employment and Social Development Canada to release funds, get grants, and vet the parties involved for criteria such as enrollment.
The beneficiary of the account is the individual for whom the proceeds are intended. Typically, when the account is started, the beneficiary is a minor. Therefore, most of the administration is done by the subscriber and promoter. The beneficiary has the least responsibility of all the parties, with the goal of allowing them to focus on their studies. They are named by the subscriber and are the recipient of the Educational Assistance Payments sent by the promoter during their post-secondary enrollment. The only time they would need to repay any amount is if a grant was issued over the $7,200 amount.
RESPs Contribution Limits
As with any savings account registered through the government, an RESP has a contribution limit. This applies both to government contributions and to the amounts invested by the subscriber. Government contributions max out at $7,200 over the account’s lifetime. If the child doesn’t attend an accredited post-secondary, then any grant funds must be returned. However, since an RESP can stay open for 36 years, there is ample time to use the savings.
In terms of contribution limits for subscribers, these are broken down into two categories, detailed below.
There are limits to the amount a subscriber can contribute each year. The subscriber can put up to $2,500 per year, an amount that is matched by a government grant of 20%. The subscriber can contribute more than that amount, though the government grant maxes out at the $2,500 mark. For example:
- Year 1 Subscriber Contribution: $2,500
- Year 1 Government Grant: $500 (20% of $2,500)
- Year 1 Total: $3,000
- Year 2 Subscriber Contribution: $3,000
- Year 2 Government Grant: $500 (20% of $2,500)
- Year 2 Total: $3,500
Keep in mind that, if you start the RESP later, the contribution amount rolls over from previous years. Therefore, if you missed, for example, three years, you can still access the $1,500 worth of grants, though you would have to contribute $7,500 to access it.
Each RESP has a lifetime investment limit of $50,000 per beneficiary. This means that, over the course of the RESP, regardless of when you start saving, the subscriber can only contribute $50,000 per named beneficiary. Unlike the annual limit, there is no wiggle-room on this amount.
Types of RESPs
As with all savings accounts, there is more than one type from which to choose. This is because all families have different situations, and can get more benefit from a different type of account. The options are as follows:
Individual RESP Plans
These are the simplest type of RESP in that anyone can act as a subscriber. In most cases, it will be a parent or family member, though it isn’t restricted to relatives. Anyone from a passionate teacher to a wealthy neighbour can establish an Individual RESP.
Family RESP Plans
Designed for households with more than one child, these accounts are built to have multiple beneficiaries (though there is the option to only name one). The beneficiaries must be related to the subscriber. To add a beneficiary to a Family RESP Plan, they must be younger than 21 at the time they are named on the account.
Group RESP Plans
With these arrangements, one person has named the beneficiary, though they don’t have to be a relative of the contributor. Many people contribute funds to these RESP, so the beneficiary ends up sharing the earnings of the account along with other children attending post-secondary education. These are the least common type of RESP and have more regulations than other RESP arrangements.
Advantages of an RESP
In addition to the clear-cut benefits of improving your child’s future finances and cutting down on the need for student loans, there are many other advantages to having an RESP in your portfolio. Among the many draws are:
- Tax-Free Growth: While standard savings accounts make you pay taxes on the interest accrued, RESPs do not. Often referred to as a tax-advantage account, the Canada Revenue Agency gives breaks on taxes since these funds are designated for higher education. Though you are taxed on the income used to contribute, any of the principal contributions to the account, when withdrawn in the future, are not taxed. However, any earnings, once withdrawn, are subject to tax which becomes the onus of the beneficiary.
Learn more about how to avoid capital gains tax.
- Save For Your Child’s Education: The key benefit of an RESP is that it lets you save for your child’s future. Instead of your youngster reaching the age of majority and being left to the world of student loans, an RESP can take a lot of the pressure off. This not only incentivizes the beneficiary to pursue higher education, but it also starts them off with a better financial situation and thus sets them up for success.
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- Access to Grants: In order to foster a strong and educated workforce, the government facilitates education savings through grants. While you may intend to use standard savings for your child’s education, it won’t give you access to that $7,200 in government grants. Especially when you plan ahead and access the yearly grant early, the RESP can accrue substantial interest over the long term. If you are going to be saving for the future, it only makes sense to access the extra support from the government.
What Happens if Your Child Doesn’t Continue Their Education?
If the child does not pursue education, then there are still some options available to you. The most popular solution is to keep the account open. You can maintain the RESP, with all grants intact, for a total of 36 years (or until the child turns 31). If the beneficiary has a disability, the account can stay open until they are 35.
Transfer to Another Beneficiary
Another option is to transfer the funds to another beneficiary. If you have another child or family member who plans to pursue education, then you can name them on the RESP and there will be no changes.
Transfer to an RRSP
Alternatively, you can transfer the money to an RRSP, up to $50,000. The transfer is non-taxable, so long as the account has been active for a full decade and all beneficiaries are at least 21 years old and not attending post-secondary. Additionally, you need to have room in your RRSP for that contribution.
Consider Closing The Account
If none of these options work for you, there is the option to close the account. All contributions are returned and no tax is charged. However, you will have to return any grants issued by the government. In terms of investment earnings, tax is charged and there is a 20% penalty fee.
RESPs and Taxes
As with any other financial decision, you must consider the tax ramifications. Though there are other registered accounts (TFSAs and RRSPs), they don’t have the same access to grants. However, while an RESP is tax-advantaged, the funds are meant for a different purpose than the other accounts, so there are fewer tax benefits. Earnings made by an RESP account aren’t taxed, though there are spending restrictions since you can only use the funds toward educational expenses.
An RESP will tax withdrawn earnings. However, since the beneficiary is responsible for paying those taxes and will generally have a lower income, they will be in a lower tax bracket. As a result, the amount of tax actually paid on RESP funds is typically fairly low.
What if you over contribute to your RESP?
How much can you get through the RESP grants?
Final Thoughts on RESPs
Any opportunity to save for the future is a good thing, especially when the government will contribute to your plans. Not only do RESPs offer tax-free earnings, but they also give you the chance to set your child up for the future. Even if you aren’t sure whether your child will use the account down the line (after all, who knows what the future holds), there is fairly little risk with opening an RESP. Given the potential benefit associated with these accounts, opening an RESP is a terrific way to plan for the future.
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