When setting up a resp account it’s important to determine and monitor the asset allocation of the account. Typically the asset allocation is determined by the risk profile of the investor and the amount of time remaining until the money is required. Equities are considered risky assets but over a longer term they are fairly reliable. If you are making an investment and you need the money in two years then equities are not advisable because there is too much risk that their value will go down over those two years. Short term bonds or a high interest savings account is a better investment for money that is required in the short term. The idea is not get superior returns but to ensure that the money is there when needed.
So if equities are a good investment over the long term but not the short term, the question has to be asked – how long is the “long” term and how short is the “short” term. I would say that short term is anything less than five years and the long term is 15 years or more. Please note that this is strictly my opinion so don’t write it in stone!
Unlike retirement planning where you don’t know how long the portfolio will be in use for, RESP planning is a bit easier since you can make a pretty good estimate of the start date of withdrawals and the end date of withdrawals.
For this example I’ll assume that the student goes to school starting the year they turn 17 and finish up four years later.
I’ll go through different stages of the resp in terms of how old the student is:
Age range
Equity%
Bonds%
0-5
100
0
6-11
60
40
12-17
40
60
In school
0
100
Once they are starting school all the money will be withdrawn within five years so it should be in very safe securities such as high interest savings accounts, short term bonds or money market funds.
If you are a more conservative investor then you might want to do the following:
Age range
Equity%
Bonds%
0-5
60
40
6-11
50
50
12-17
25
75
In school
0
100
I would invest equally in Canadian, US and EAFE for the equity portion and in short term bonds ETF or a bond index fund for the bond portion. You can add other asset classes to the mix as well. This example is intended to show a simple asset allocation.
I’ve indicated the allocations at five or six year terms. If you are really keen and plan to rebalance every year then you can also adjust the allocation every year.
Obviously none of the above allocations are perfect for every investor so try to keep in mind the idea that money which is required in the short term should be invested in safe investments and try to adapt the above suggestions to your situation.
When the RESP beneficiary (student) is ready to go to school, the subscriber (owner of RESP account) needs to start withdrawing money from the RESP account. To withdraw money you have to provide some proof to your resp provider that the resp beneficiary (child) is going to an approved post-secondary school. You don’t have to show receipts for specific purchases.
Two types of money in the RESP account
In your RESP account, there are two different types of money: contributions and accumulated income.
The contribution amount is the sum of all the contributions that you made to the account over the years.
The accumulated income is made up of grants, capital gains, interest, dividends earned in the account.Any money that is not a contribution is considered to be accumulated income.
This distinction is important because the taxation of withdrawals from the contribution portion of the account is different than withdrawals from the accumulated income portion.
Contribution withdrawals are not taxed.
EAP (educational assistance payments) which are withdrawals of accumulated income, are taxed as income at the hands of the student.
The good news is that students have the personal exemption, as well as tuition tax credits which helps lower their tax bill. Obviously income earned during summer jobs or on co-op work terms will affect their taxes as well.Another bit of good news is that you can tell your financial institution if you are with drawing contributions or EAP (or both) so you can manage the taxes to some degree.
Please note there is no withholding tax on any kinds of RESP withdrawals, so if the student ends up in a taxable situation, they will have to pay the taxes at tax filing time.
A withdrawal limitation
First – one withdrawal rule to get out of the way – you are only allowed to withdraw $5,000 of accumulated income in the first 13 weeks. After 13 weeks, you can withdraw as much accumulated income (via EAP) as you wish. There are no limits to withdrawals from the contribution portion as long as the child is attending school.
Basic RESP withdrawal strategy
When planning the withdrawals, try to withdraw as much accumulated income money as you can tax free.For example when the student first starts school, they will have just completed a short summer (two months) so they probably won’t have much income for the year. That might be a good time to maximize payments from the accumulated income portion of the account (EAP).
On the other hand, if the student is in a co-op program and has two work terms in one year and only one school term, that might be a good year to take out contributions rather than accumulated income.
You don’t want to end up with accumulated income in the RESP account if the child is no longer going to school.
What if your child doesn’t go to school?
What happens if Junior decides that school is not for him? You have to collapse the plan and pay a pile of tax on it.
First of all you have lots of time to collapse the plan so don’t do it right away. It’s always possible that your child will give up on their pro hockey or musician career and will need the money for schooling later on. You can keep the account open for 35 years after the year in which the account was opened.
If you do collapse the plan, the contributions are tax free, anything else (accumulated income) is added to the subscriber’s gross income for taxation purposes.And on top of that, the accumulated income is charged a tax of 20%.
If you are retired or have any way to reduce your income in the year you collapse a resp plan, do it to save taxes.
What if the child does more than one session at school (ie multiple degrees)?
You are allowed to use the RESP for one degree and then keep some money in the account for future education. The only limit is the 35 year limit previously mentioned. Be warned that it’s not a bad idea to take out all the RESP money during the first degree so that there are minimal taxes and no penalties. If you save money in the RESP account for future degrees and the child doesn’t end up using the money, there will be increased taxes and penalties.
How to withdraw excess money from your RESP account. Some strategies for withdrawing extra RESP money without penalty. This applies if the student started school and quit early or ended up with extra money.
The regular RESP grants (CESGs), calculated at 20% of contributions, are available to all eligible Canadians regardless of their individual or family income. It doesn’t matter whether you earn $20 a year or $2,000,000 a year – you still qualify for the basic RESP grants.
Besides the 20% basic grant, the government offers additional grants based on family income.
There are a large number of middle (and lower) income Canadians who are eligible for these additional grants – and probably don’t know about it.
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The income levels for additional grants apply to the primary caregiver of the child and not the person who opens the account.
These additional RESP grants apply to the first $500 of contributions each year, unlike the normal RESP grants, which are payable on the first $2,500 of contributions per year.
There are two different income levels to qualify for these additional grants.
Families with a net income between $42,707 and $85,414 are eligible for an extra 10% grant on the first $500 of contributions each year for a total of $50 per year.
Families with a net income of $42,707 or less are eligible for an extra 20% grant on the first $500 of contributions each year for a total of $100 per year.
These income ranges are for 2012. To get updated value for future years, please visit this CanLearn page.
The family income in this case refers to the primary caregiver, who might not necessarily be the subscriber or owner of the account.
Net income: This is the amount on Line 236 of your T1 general tax form. It is your income net of RRSP contributions, child care expenses etc.
Canada Learning Bond – no RESP contribution required . $500 initial one-time payment followed by $100 per year for 15 years – total potential of $2000.
Eligibility – If primary caregiver is eligible to receive NCBS – National Child Benefit Supplement – this supplement is generally for families with a net annual income below $42,707 .
You have to apply for the initial contribution within 6 years of the child being born and the subsequent contributions, 6 years after the birthdays. There is no income test for ACES grants.
Both the CLB and ACES grants do not require a contribution, so anyone who qualifies for them should take advantage of the program and get the grants. For the addition CESG grants, these require a normal RESP contribution to be made before getting the additional grant, so I would caution anyone who is in a lower income range to make sure that you have your own finances in order before contributing to an RESP.
Let’s look at an example!
Mary and Steve make a combined family income of $71,500 which makes them eligible for an extra 10% CESG grant on top of the regular 20% grant.
If they contribute $1000 in a year then they will get:
Normal CESG grant of 20% = $200.
Additional CESG grant of 10% on the first $500 of contribution = $50.
So the total CESG grant on their $1000 contribution will be $250.
More detailed RESP information
Check out the RESP rules page for a list of more detailed RESP articles on this site.
One of the main benefits of RESP accounts is the federal Canadian Educational Savings Grant (CESG). This grant is 20% of any eligible contributions in an RESP account.
How the RESP grant system works
Let’s say you open an RESP account for your bouncing new baby and contribute $1,000 into the account. Your financial institution will send the account and contribution information to the Canadian government for grant approval. If the grant is approved, the institution receives the grant money and deposits it into your account.
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The math
20% of the $1,000 contribution is $200, so you will now have an extra $200 in the account courtesy of the Canadian government. This basically gives you an extra 20% one-time return on your contribution.
$2,500 – Amount of annual grant-eligible contribution room accrued each year starting in 2007 or the year the child was born (whichever is later). The contribution room continues accruing up to and including the year when the child turns 17 years old. This amount is based on the calendar year and not the birth date.
$2,000 – Amount of annual grant-eligible contribution room accrued each year starting from the year the child was born or 1998 (whichever is later) up to and including 2006.
20% – Amount of grant earned on an eligible contribution. For example: a $1,000 contribution would earn a grant of $200, if that contribution is eligible for a grant. There are additional grants available for lower income families.
$500 – Maximum amount of grant a beneficiary is eligible to receive for each calendar year from the year they were born or 1998 (whichever is later) to the year they turn 17 years old. This amount was only $400 for years prior to 2007. A calendar year is from January 1st to December 31st.
$7,200 – Lifetime grant limit per beneficiary. If you contribute $2,500 every year, you will hit the maximum grant level in the fifteenth year, and no more grants will be paid to the beneficiary. This limit includes additional grants available to lower income families.
$50,000 – Lifetime contribution limit per beneficiary. Because there is no annual limit, you could potentially make one single contribution of $50,000 to an RESP if you choose.
Contribution room carry over. One of the great things about the RESP is that you can carry over unused contribution room into future years. However, there is a catch: Only one previous year’s worth of contributions can be used each year.
Contributions are not tax-deductible. You won’t get a tax slip, and you can’t deduct RESP contributions from your taxable income.
For example: If you start an account for your six-year-old child, you can contribute $2,500 (this year’s contribution room) plus another $2,500 (from previously unused contribution room) for a total of $5,000, to receive a grant of $1,000. You are allowed to contribute more than $5,000 in this scenario, but there will be no grant paid on the amount above $5,000. When calculating contribution room carryover from past years, don’t forget that the contribution limit was only $2,000 prior to 2007.
RESP contribution examples
Let’s do some examples to clarify exactly how this works.
Example 1 – Simplest example
Steve was born in 2010. His parents are broke, but one kindly grandmother decides to open an RESP account for him.
She opened the account in 2010 and has $2,500 of contribution room available. She contributes $1,500 to the account in 2010, so the RESP grant is $300 (20% of $1,500).
In 2011, she contributes $1,200, thereby qualifying for a $240 grant.
Example 2 – A more complicated example
Little Johnny was born in 2006. His parents decide in 2010 to set up an RESP account for him. They want to know how much money they can contribute each year to catch up on all the missed government grants.
Let’s add up the current contribution room.
2006 – $2,000 of contribution room
2007 – $2,500 (new rules)
2008 – $2,500
2009 – $2,500
2010 – $2,500
In 2010, the couple has $2,500 of contribution room for the current year plus $9,500 of contribution room from previous years.
Since the rule is that you can only contribute up to $2,500 of previously carried over contribution room each year in addition to the current contribution room, this means they can contribute this year’s amount ($2,500) and another $2,500 for a total of $5,000, which gives a grant of 20% or $1,000 for 2010. Since they only used $2,500 of their available $9,500 of carried over contribution room, they now have $7,000 in contribution room to carry over for the future.
In 2011, they can contribute another $5,000 for a $1,000 grant. $4,500 of contribution room is carried forward to the next year.
In 2012, they can contribute another $5,000 for a $1,000 grant. $2,000 of contribution room is carried forward to the next year.
In 2013, they can contribute only $4,500. $2,500 from the current year plus $2,000 they carried over from the past.
In 2014 and beyond, they can only contribute $2,500 each year and expect to receive the full grant of $500.
Summary of contributions they can make to get all the government grants:
If you have a family plan with two or more beneficiaries, you need to allocate each contribution between the beneficiaries. For example, you might want to set up all contributions to be divided equally between the account beneficiaries. Or you might have a particular contribution that should be allocated to just one beneficiary. You must set the allocation so the government can track the grants for each child.
When you open an RESP account or add a new beneficiary to an existing account, you can set up the default allocation to split the contributions equally among the children on the account. If you want to make a contribution with a different allocation, you have to indicate this on the purchase order.
More detailed RESP information
Check out the RESP rules page for a list of more detailed RESP articles on this site.
This post is part of the Big RESP Series. See the entire series here.
I decided to do a detailed series on the RESP program available to Canadians (my apologies to our non-Canadian readers).This topic has been covered by other blogs and myself in various posts but it’s really a topic for several posts.The tricky part of planning this series was to make it long enough to contain most, if not all of the information an investor may want to know about RESPs but not so long that no one would read it because it would contain too much useless information.My plan is to post this series once a week. This first post briefly explains what an RESP is and the various topics I’ll be covering in the series.
These rules are valid as of 2008.
What is an RESP and how does it work?
Registered Education Savings Plan accounts are government sponsored accounts that you can set up at most brokerages, banks or through a financial advisor.You can contribute money into the account and you will get a 20% grant from the government up to a certain amount.There are no taxes payable on investment income during the life of the account so any interest, capital gains or dividends will not be taxed.When the money is withdrawn to be used by a student then it is taxed in the hands of the student, however the original contributions are not taxed upon withdrawal.If the child does not go to school then the plan is collapsed and there are extra penalties to be paid on the plan.
I’ll be covering the following topics in this series.They won’t all be separate posts but some of them will be.Feel free to send me a question or topic if I’ve missed anything.
Contributions and CESG – rules and regulations.
Other grants – Canada Learning Bonds, Alberta (ACES) plan.
Withdrawals – how they work.
Eligible Institutions.
Plan Collapse – what happens if the student doesn’t go to school?
