One of the problems with RESPs is the number of rules surrounding them. This creates a product that is very expensive to administer for the RESP providers and government and very hard to understand for the average parent. Since the rules in their current form (more or less) have been around since 1998 and the government and financial companies have already created their systems and processes for these accounts there is not much point in changing them now. However, I’d like to put forth my ideas on how the RESP program should have been done.
One of the complicating factors of RESPs is the lifetime and annual limit on contribution grants. Because of this, the financial companies and government have to keep track of all the contribution amounts and for family plans, the allocation between beneficiaries.
A better way to do RESPs might have been to just offer tax free accounts ie you make contributions  with no tax rebate  , the investments grow tax free and then upon withdrawal the money is taxed in the hands of the student or if the student doesn’t go to school then it’s taxed in the hands of the subscriber as normal income (no AIP) tax.
What about the grant money you ask? Good point – take the money that would have been paid out in contribution grants and just hand it out to children of a certain age which is similar to Alberta’s ACE program. For example the government might give $100/yr to every child under 10. These grants would have to be put into RESP accounts and would be subject to the normal withdrawal rules outlined above.
Another option with the grant money would be to just give it to students who are actually in or about to start school. That way there are no grants to track and no investments accounts.
One of the benefits of this new RESP would be that it would cost the government the same amount of grant money, both the government and investment companies would benefit from lower administrative costs and lower income people can participate more easily. Currently it’s more middle and higher class people who get the biggest benefit from the RESP program but they are not the ones who need it as much.
That’s it for the RESP series so hopefully you enjoyed reading and learning from it (I know I did) and can use it for reference in the future.
I did an analysis of some different resp and non-registered account scenarios (child goes to school or not) in order to determine the different amounts of money that would result from each scenario. The idea was to try to see how well the resp does in the different situations compared to putting the money in a non-registered account. Thanks to the Money Gardener for the idea.
The spreadsheet showing all the calculations is here. Basically it’s an account with $150/month contributions into an equity security. In real life an investor might switch to a more conservative portfolio later on but I decided to keep it simple for this example.
The equity return is 0.5% per month which works out to just over 6% per year, it also gets a 2% dividend at the end of each year. The dollar figures were calculated at the 18 year mark which is when the student would normally be going to school.
The average tax rate on the withdrawal of the subscriber who is working is 40%, subscriber who is retired is 15%
RESP account – student uses the money for school. This scenario is the typical “hoped for” scenario where the student uses the money to go to school. I assume that the student doesn’t pay any income tax on this money. All dollar figures are future dollars.
RESP account – subscriber collapses plan before retirement. If the child doesn’t go to school then the subscriber will pay the marginal tax rate on the income in the account.
RESP account – subscriber collapses plan during retirement. In this case the student doesn’t go to school but since the subscriber is retired they have a lot more flexibility with respect to income tax rates. Keep in mind that the plan doesn’t have to collapsed until the 26th year of it’s existence so there is time to do this option even if you are working when the child decides not to go to school.
Non-registered account – money is withdrawn before retirement. For non-reg accounts since the money is always taxed to the owner of the account it doesn’t matter whether the child goes to school or not – the taxation is the same.
Non-registered account – money is withdrawn during retirement. In this case the capital gains paid by the account owner will probably be less than when they were working.
Amount of $$
RESP account – student uses the money for school.
RESP account – subscriber collapses plan before retirement.
RESP account – subscriber collapses plan during retirement.
Non-registered account – money is withdrawn before retirement.
Non-registered account – money is withdrawn during retirement.
If the child goes to school then the RESP account is the clear winner with a total of $87,556. The non-reg account would only provide $66,953 or $62,284 depending on if the account owner is retired or not. This is not surprising considering the 20% grant available to the resp as well as the zero tax drag during the accumulation phase.
If the child does not go to school then the results are dependent on if the subscriber is working or retired when the plan is collapsed. If the subscriber is retired then there is not much difference between the resp ($64,039) and non-reg account ($66,953). If the subscriber is working, then the non-reg ($62,284) fares quite a bit better than the resp ($51,870).
If your child goes to school then the RESP account will have about 30% more money than the non-reg account. If the child does not go to school then the non-reg account will have 5% more money than the resp if the subscriber is retired, if subscriber is working then non-reg account will have about 19% more.
Bottom line is that if you are an older parent (like me) and are pretty sure that you’ll be retired (or can control your income) by the time the resp plan is 26 years old then the resp is the winner hands down. If you are a younger parent then the choice is not so clear, although there is a big upside (30%) to the resp, there is also a significant downside (19%) if the child doesn’t go to school.
Things to think about
Commander T pointed out that if you transfer the non-contribution portion of a collapsed RESP to your rrsp (if you have the contribution room) then you can avoid the 20% penalty. I personally don’t plan to have this much room, but this is a great strategy if you can do it.
One strategy to think about if you are a younger parent is to wait a few years before starting the resp account since that’s when the clock starts ticking on the age of the account. If the child doesn’t go to school then collapsing the resp plan when you have no other income will reduce the income tax considerably. Most younger parents have mortgages, rrsp room so waiting a few years to start the resp is probably a good idea anyways.
How many kids? Having two or more kids will improve the odds that the resp money will get used since you can transfer between beneficiaries. This generally only works if the older child doesn’t go to school or they are very close in age.
Establishing a trust for your child is another method of funding their education and saving taxes. The reason I didn’t get into trusts here is because I consider them a completely different animal compared to non-reg accounts and RESPs. Unlike RESPs and non-reg accounts where the parent owns and invests the money and controls the account all the way through the process, with a trust you give the child the money and will never get it back. My problem with this is that if the kid doesn’t go to school then I don’t want him to get any of the education money since he probably doesn’t need it. This is not to say I wouldn’t help him out if he needed it. The other problem I have with trusts is that it might encourage the child not to go to school. Think about it, if you are 18 and have a trust account with $50k in it and you have a choice between going to school or buying a fancy sports car or travelling the world for a few years – which would you choose?
There are two types of resp accounts that you can have: individual and family. This post will outline some of the rules and differences of these account types.
Individual Plan RESP
Individual plans can only have one named beneficiary. The beneficiary can be any individual named by the subscriber including the subscriber (Individuals can open RESPs for themselves). There are no age restrictions on this type of account, however CESG and other grants can only be paid to beneficiaries under the age of 18. The beneficiary on the account can be replaced by anyone else but if the new beneficiary is not blood related to the subscriber then any CESG (grants) have to be repaid. The last contribution date is the end of the 21st year of plan’s existence. Plan has to be collapsed during it’s 36th year.
Family Plan RESP
Family plans can have one or more beneficiaries. The beneficiaries must be connected to the subscriber by blood or adoption. This includes children, grandchildren or siblings of the Subscriber, either by blood, adoption, or marriage. The beneficiaries must be under 21 years old when named. Beneficiaries can be removed or added anytime during the life of the plan.
If there is more than one beneficiary then the contributions have to be allocated to each beneficiary. For example if you have twins you might set the allocation at 50% for each child. If you have two kids that are different ages and you don’t set up the resp until the second child is born then you might choose to allocate more of the contribution to the older child in order to catch up on their contributions.
One rule which is always in effect for both types of plans is the maximum lifetime grant amount of $7200 per child. If you have a situation where both of your children have received the maximum grant and you want to transfer some of the contributions to a different beneficiary then you will lose the corresponding grants. This also applies to transfers with individual accounts as well.
So which is better? Family or Individual?
If you only have one child then the individual account is the obvious answer. For multiple child families it may appear at first glance that family accounts are more flexible than individual accounts however in fact they are pretty much the same thing, because the rules allow transferring money between any type of accounts. In case one of your kids doesn’t go to school, it doesn’t matter whether you have your kids in a family account or individual accounts since you are allowed to transfer money to the kid(s) who are still going to go to school in either case. I would suggest that family plans are slightly better if you have more than one child mainly because it will save on account fees and it might simplify the paper work a bit. Bottom line is that it doesn’t really matter so pick the cheapest and most convenient option.
Tip – If you have one child, you can set up a family account for future expansion
Multiple RESP accounts for same beneficiary – Communicate!
When setting up a RESP for a child, it’s important to communicate with other relatives and friends who might have also set up a resp for the same beneficiary. The government will add up all the contributions attributed to each beneficiary in order to enforce the various grant limits and maximum amounts. This applies to any RESP accounts set up for a beneficiary – it doesn’t matter if they are set up in different financial institutions by different subscribers.
You might be wondering why someone would set up an RESP for a relative (ie nephew) rather than give the money to the parents to set up an RESP? For one thing, if that parent is not as financially sound as you are and perhaps you don’t trust them, you might not want to give them the money directly for fear that they won’t set up the RESP account or maybe they will withdraw the money before the child goes to school. Another scenario is if the child doesn’t go to school, the money goes back to the subscriber, so you might want to make sure you get your money back in that case.
More detailed RESP information
Check out the RESP rules page for a list of more detailed RESP articles on this site.
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.
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.
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.
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.
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.
Plan Collapse – what happens if the student doesn’t go to school?
RESP is a type of investment account in which all income and growth are tax sheltered until the time of withdrawal and there are government grants which equal 20% of the contributions.
One bit of advice is not to worry about contributing to an resp right away unless you are on solid financial ground. Make sure your own finances are secure before you start saving for a future uncertain cost. I’ve found that opening an account does allow relatives (read grandparents) a great avenue for gifts so that’s one reason not to wait too long.
You have up to 18 grant contribution years starting in the year where your child is born or 1998 whichever is later. The last year you can get a grant is the year when they turn 17. Each of those years, the child accrues $2500 of eligible “contribution room” which means they will receive the 20% CESG grant. In any given year, they can get a maximum grant of $1000. For example if a child is born in 2007 and the parents start the resp in 2008, they can contribute $5000 right away and get $1000 in grants. Lower income families are eligible for more grants as well.
When the money is withdrawn by the student, the original contributions are tax free (since they were already taxed) and the growth and income portion is taxed in the hands of the student. If the child does not go to school then the subscriber of the account can collapse the account and get the original contributions returned tax free and the growth and income portion will be taxed at their marginal tax rate + 20%. In that case the grants will be returned to the government. One thing to keep in mind is that the resp doesn’t have to be collapsed until the 26th year so even if you know the kid isn’t going to school you can delay the collapse and hopefully time it with retirement which would really cut down the tax bill.
I think these plans are a great way to save for your child’s education because of the government grants as well as the fact that no taxes will be paid on the account until withdrawal – and even then the growth portion of the account will be taxed in the hands of the student, not the subscriber. There is the risk that the child will not go to school which would be a problem because of the taxes involved. However I’d say that one way to look at it is to think about how much money you will get back from the resp if the child goes to school (zero) and how much you’ll get back if they don’t go to school – not as much as if you had just invested it outside the resp but it’s still a lot more than zero.
You can set these accounts up at pretty much any bank although I think the discount brokerages are the best place for these since they give you easier access to low cost index funds. TD e-funds are the best choice for these accounts.
I would suggest having a high component of equity in the beginning (I have 100%) and then gradually switch to be more conservative over the years. I would think by the time the child is about 14, the account should be mostly money market or short term bonds.
Warning – Don’t buy into group pooled plans since they are not a very good deal. If you are already in one then don’t worry about it, it’s not worth changing.