What is an RESP?
What is an RESP account?
An RESP stands for a Registered Education Savings Plan. This account is used to save for a child’s post secondary education. Government contributions are made through the Canada Education Savings Grant as contributions are made by the account holder. There are numerous tax advantages with this plan and different ways the account can be set up.
Any person in Canada can open an RESP and anyone can contribute. All you need is the SIN number of the child (the beneficiary) and that of the individual who wants to open the account (subscriber). The contributions made for the minor’s education will grow tax free in an RESP until he/she is ready to use it. Below I will discuss what is an RESP in great detail.
How Does an RESP work?
In simple terms, An RESP is a tax advantaged savings account. The assets in the plan grow in a tax free environment until withdrawn. When the minor goes to post secondary, he/she is taxed at their bracket (very small or nil) for education expenses.
The four parties involved in an RESP are the subscriber, the beneficiary, the promoter and the federal government.
The subscriber is typically the parents or grandparents who open the Registered Education Savings Plan and make the contributions. The beneficiary is the minor who receives the contributions for post secondary and the expenses that come with it. The promoter is the bank or financial institution who organizes and set up the RESP. Lastly, the federal government makes contributions through the Canada Education Savings Grant to the beneficiary. This grant money is received only when contributions are made to the account.
What can an RESP be used for?
As stated earlier, an RESP is most beneficial when a child pursues a post secondary education. This is because the government grant money can be kept. However, if your child does not go to university or college, the grant must be returned. Furthermore, the income earnings are taxed and there is a 20% penalty on the earnings as well. Income earnings is defined as the money generated by the investments.
There are three types of RESPs. They are designed differently for a single beneficiary, a family, and a group of kids. With the group account, the beneficiaries do not have to be related, but can be. Below are the 3 types.
An Individual Registered Education Savings Plan is set up for a single beneficiary or child. The subscriber does not have to be related. However, this type of account is most commonly set up by the parents or grandparents of the beneficiary.
When contributions are made by the subscriber or any individual, the federal government will give grant money to the account. The yearly maximum is $500. However, it’s important to know that the lifetime maximum contribution by the CESG is $7,200. If $2,500 is contributed each year to the plan, the government will put in the full $500. It will take 15 years for the CESG to give the entire $7,200.
Because of the yearly government grant, its most appropriate for the contributions to reach $2,500.
Multiple children will make a family RESP the best post secondary savings plan. This account allows for more than one beneficiary to be part of the account. However, each beneficiary registered on the plan must all must be related to the subscriber. Examples of relatives include step children, nephews and grandkids. Adopted children will qualify as well.
The subscriber for a family RESP will most likely have a set annual contribution. This is solely due to maximizing the money recieved from the CESG.
Lastly, the subscriber can can designate specific amounts of money to each beneficiary as required. If one child has higher expenses than the other, the subscriber can give a greater sum of money to that child. Once a second child is added into a family, it is best to covert an individual Registered Education Savings Plan to a family one.
A group plan is set up for only one child. While this may sound confusing, the purpose of this plan is to group payments with other investors who have children of the same age. The assets are pooled into a low risk investment and money from the plan is accessed at the same time as the other investors (when the kids go to school). The payment plan is fixed and is on a schedule. Contributing is mandatory and there are penalties for missed payments. Overall, these plans have a defined set of rules that must be followed.
RESP rules in Canada.
There are RESP rules in Canada that must be followed. For example, if your child does not go to university the grant money must be returned to the government. Furthermore, each beneficiary can only receive a lifetime maximum of $50,000. Contributions over this amount will incur tax penalties. Below are some benefits and negatives of registered education saving plans.
Benefits of RESPs.
Tax free savings.
RESP savings will grow and compound in a tax deferred environment. The investments in the account are tax free as long as they stay within the plan. Ultimately, the taxes are deferred to the beneficiary until he or she uses the account. This brings us to the next point.
The beneficiary pays little or no tax on the RESP payments.
The child receives money from the RESP in the form of incremental payments from the account. These payments are called educational assistance payments, abbreviated EAP’s. When the beneficiary receives the funds, it is highly unlikely that the money is taxed. This is because the beneficiary will have little to no income (as they enter school). Taxes from the subscriber (which be otherwise higher) in simple terms would be “deferred” to the child.
Deferring taxes and allowing the money to compound tax free is the greatest benefit of an RESP.
Who can contribute to an RESP?
Any person can set up and contribute to a minors Registered Education Savings Plan. A family members is typically the subscriber of the account. Friends and distant relatives can make contributions at any given time and these gifts will help the beneficiary with educational expenses.
The federal government will contribute to a child’s Registered Education Savings Plan. The contributions are made through the Canada Education Savings Grant (CESG). The CESG will give 20% on the contributions put into the account each year. The maximum they will grant is $500 per year. Therefore, a quick calculations shows that a yearly contribution of $2,500 will get you the $500 maximum from the CESG. Any additional sum over $2,500 will not be eligible for the CESG.
Remember, the CESG will contribute a maximum of $7,200 to any given beneficiary. Low income subscribers can also recieve the Canada Learning Bond (CLB) if applicable.
RESP investment options.
The subscriber of the RESP account can invest in multiple assets. These include stocks, bonds, ETF’s, REIT’s, mutual funds and GIC’s. Here is a comprehensive article explaining the different types of the best RESP investments.
Some disadvantages of RESPs are:
Penalties for non education expenses.
If the beneficiary withdraws the money in the plan for non education expenses, the beneficiary will pay a 20% penalty on the earnings. Furthermore, taxes will be paid at the time of withdraw.
Federal government grant money return
Lastly, if the beneficiary does no enroll in a second education, the money from the CESG must all be returned. This amount could be a maximum of $7,200.
Max RESP contribution.
The max RESP contribution to any given beneficiary is $50,000. If the parent decides they want to keep contributing, I recommend opening an informal trust account.
While there are several RESP pros and cons, the are a greater amount of benefits, However, here are the limitations.
The greatest limitation of an RESP is that there is a maximum RESP contribution of $50,000. Each beneficiary can only receive this lifetime amount before the subscriber incurs a monthly tax from the CRA.
Registered education savings plans are the most beneficial if the child goes to a post secondary education. If not, a penalty is paid and the grant money is returned to the government.
The maximum amount of money a child can receive from the CESG is $7,200. After the full grant is gifted, any additional contributions are not matched by the federal government.
If the subscriber has no will and passes away, RESP contribution money would go to court to see what happens with the account. The risk of death intestate is catastrophic and the money may never make it to the beneficiary. Always make a will (online is easy).
What happens if my child does not pursue a post secondary education, or delay it?
If the beneficiary of the Registered Education Savings Plan does not go to post secondary, he or she can;
Delay when they go by keeping the account open. An RESP be kept for 36 years. When the child or young adult decides to pursue a post secondary education, the account will still be there.
The beneficiary can withdraw from the RESP or transfer the funds to another family member.
Transfer to an RRSP.
Withdraw from the RESP.
RESP withdrawals are taxable if not used for education. The subscriber will be taxed on some of the earnings and the grant money must be returned. If the child received funds from the Canada Learning Bond on top of the CESG, this must be given back too.
Some family members may only contribute on the notion of your child going to post secondary. If your child does not, they may want their money returned. The contributions can be given back through the bank the account is in to the original owner.
Is there an RESP withdrawal limit?
RESP’s have no withdrawal limits. RESP withdrawals can be done in the following ways.
How to withdraw from the RESP?
The RESP is a registered tax deferred plan. This means that the subscriber must first do a few things before money is withdrawn. They must;
Find out the school the beneficiary is attending, when they are attending and the payments due.
Get the documents confirming school attendance. Ask the post secondary office of the registrar for the official transcripts.
Move all the investments in the account to cash. You will have to sell your ETF’s, stocks, bonds and such.
Fill out the RESP withdrawal request form. Your financial institution will have this form as this is where the account is managed.
Now that the request form is filled out, there are 4 different types of RESP withdrawals.
RESP withdrawal types.
Educational assistance payments (EAP) – Educational .
EAP’s transfer the income from the RESP’s investments and government grant to the beneficiary. This is the most common method. The EAP’s are described in great detail in the plan’s documents.
Post Secondary Educational Capital Withdrawal (PSE) – Educational.
PSE withdrawals are made to the subscriber or beneficiary from the contributions only in the account. They can be done anytime and are subject to the rules in the plans contract. The withdrawal limit is equal to the contributions put into the plan.
Accumulated Income Payments (AIP) – Not Educational.
Accumulated income payment withdrawals are used for non educational purposes. The accumulated income from the subscriber is given to the beneficiary the same way as an EAP.
Non Educational Capital Withdrawal (NCW) – Not Educational.
An NWC is similar to a PSE, except that the child decides not want to attend a post secondary school. The money is withdrawn and the grant money must be returned.
Request a RESP Withdrawal.
As soon as you’ve determined which withdrawal type is applicable, you can complete an RESP withdrawal request form.
These forms can be obtained by the financial institution in which the account is set up. Fill in the information required and send the form back to the institution.
Most banks have these forms on their website and additionally can be obtained in person at the branch. It takes approximately 5 business days for the first RESP payment to be received.
Most people believe that investments in an RESP must be withdrawn. This however is not the case. Money in a registered education savings plan can be transferred to another RESP or an RRSP. Withdrawals from the account can also be delayed.
Transfer to another RESP.
RESP transfers are straight forward. There are no repayments on the grant and the entire RESP amount can be transferred to another beneficiary. Family plans can designate money in anyway the subscriber chooses.
Transfer the RESP to an RRSP
The beneficiaries have an option to transfer up to $50,000 to their RRSP when they turn 21. The Registered Education Savings Plan must be open for a minimum of 10 years to make the transfer. Furthermore, the federal government grants must be returned.
Registered Education Savings Plan Contribution Strategies
Unless you have sufficient savings, the best RESP contribution strategy is to move $2,500 into the plan each year. This means that when you contribute $2,500 per beneficiary, they will receive $500 from the CESG as well. $2,500 a year contributions would need to be made for 14 years, with a $1,000 contribution on year 15. This would give you the maximum $7,200 grant from the federal government,
If you have the $50,000 plus additional savings, it may make sense to contribute the entire amount. If this larger sum compounds at a decent rate over 18 years, the size of the investment would be much larger than the $2,500 per year strategy.
It is important to remember that the maximum contribution limit is $50,000 per beneficiary. There is no annual maximum contribution limit. You can put the entire amount in as soon as you open the account. If you over contribute, you must pay a 1% monthly tax on the amount above $50,000 until the funds are withdrawn.
The best way to avoid over contribution is to start an informal trust or set up a TFSA when you reach $50,000.
RESP withdrawal rules
Here are the general rules you must know before you withdraw from an RESP.
Only the subscriber can make the withdrawals.
Once the information of the enrolment is obtained, a withdrawal request form must be filled out.
The withdrawals from the PSE can be sent to either the subscriber or beneficiary (the contribution money).
Withdrawals for the EAP’s can only be sent to the beneficiary (the grants and contribution income).
PSE payments are tax free.
Tax is payable on an EAP withdrawals (the earnings on the contributions and grants). The financial institution will issue a T4A tax form in the students name. Usually there will be little tax as the student has a low income.
RESP vs RRSP – RESP vs TFSA
RRSP’s and Tax Free Savings Accounts (TFSA) are tax advantaged registered accounts. A TFSA is funded with after tax dollars and grows tax free. When you take your investments out, you pay no tax. An RRSP is funded with pre tax dollars and you’re taxed when the money is withdrawn. Furthermore, the money in the account grows tax free.
An RESP is funded with after tax dollars, like a TFSA. The money in the account grows tax free (like an RRSP and TFSA) and money is taxed in the beneficiaries name when withdrawn (RRSP). Therefore, a Registered Education Savings Plan resembles both a TFSA and an RRSP in simple terms.
Each one of these registered accounts have specific rules and regulations that must be followed to avoid penalties from the CRA. Lastly, RRSP’s and TFSA’s are savings plans used for retirement while an RESP is used for education purposes.
Common questions of a Registered Education Savings Plan.
RESP’s are straightforward to understand. However, these are the most common questions asked when learning about Registered Education Saving Plans.
How many RESP accounts can I have?
There is no limit on the number of accounts you can make. However, each beneficiary has a lifetime maximum contribution of $50,000.
What is the maximum RESP contribution in Canada?
The maximum lifetime RESP contribution per beneficiary is $50,000. You can deposit the entire sum at any given time. There is no maximum yearly contribution.
Is an RESP worth it?
A Registered Education Savings Plan is absolutely worth it. The money in the account grows tax free and is taxed at a low bracket (because of the beneficiaries little income). Furthermore, you also receive grant money from the government up to $7,200. If the beneficiary chooses not to go to post secondary, there are many options in regards to the funds. The subscriber or beneficiary can withdraw the funds or transfer it to another account.
Is an RESP taxable?
Yes, this account is taxable.
How to open an RESP?
You can open a Registered Education Savings Plan at any bank or financial institution in Canada. You can fill out a form online or go down to the branch directly. All you need is the SIN number of the beneficiary and the subscriber. They may wish to see the birth certificate as well. There is no limit on how many account that can be opened. The process of opening an account takes about 10 minutes.
What are the pros and cons?
There are many pros and cons to an Registered Education Savings Plan.
Tax free growth.
$7,200 grant money.
No investment minimums.
Invest in a wide array of assets.
Easy to set up.
Maximum $50,000 per beneficiary.
Best for post secondary education.
May have to return grant money.
Penalties with over contribution.