RESP’s 101: The Basics

If you’re an avid Money Talks reader, you likely caught our articles covering the basics on two of the most popular types of registered investment accounts - TFSA’s and RRSP’s. Now comes time for the third: the RESP. 

For those that aren’t familiar with them, an RESP is a registered account just like a TFSA and a RRSP, meaning they’re investment accounts that are registered with the government to receive special tax privileges. However, an RESP serves a more specific purpose than an RRSP or TFSA, as they’re designed to help Canadians save for the cost of a child’s post-secondary education. As account holders make contributions to their RESP, they can also earn grant money from the government to help with the cost of their child’s schooling.

Due to their specialized nature, RESP’s have a few more restrictions you’ll need to be mindful of before you start saving in one. As compared to TFSA’s and RRSP’s, which can (and should!) be opened by all adults in charge of their own finances, an RESP is not an ideal investment plan for everyone. So, to help you understand what an RESP is and who benefits from having one, we’ve compiled some of the basics here. Welcome to RESP’s 101!

• A Registered Education Savings Plan, better known as an RESP, is a type of registered investment account intended to help Canadians save for a child’s post-secondary education. Though they’re most commonly opened by parents, they can be opened by anyone on behalf of a child, including grandparents, family friends, aunts and uncles and so on. 

• You can open an RESP with most financial institutions, like banks or credit unions. You do not need a bank account to open an RESP. Every RESP is different; some have a monthly contribution amount you must meet, while others will allow you to contribute whenever you’d like. Be sure to check with your financial institution before signing any papers! 

• There are three different kinds of RESP: family plans, individual plans and group plans. Each fit a slightly different set of needs, so again, be sure you understand what works best for you and your child before starting.

  • Family plan: Allows multi-child households to save into one joint plan. Each child is named as a beneficiary, and the money in the plan can be flexibly used to cover the needs of each as needed. The children must be related to the account holders by blood or by adoption.

  • Individual Plan: Allows a person to save for one child they’re not directly related to. 

  • Group Plan: Offers the chance to save for one child who you’re not directly related to, but it combines your RESP savings with other peoples’ in one joint plan. This type of plan is often offered by group plan providers who select a number of low-risk investments for the entire group. When it comes time to distribute funds amongst the beneficiaries of the plan, it’s split up evenly amongst the number of children named in the plan who need money for school that year. In general, you’ll need to commit to a series of regular payments to join a group plan, so be sure you can afford to keep up your regular contributions, or you may face fees from your plan provider for it. 

• You can make contributions to an RESP until 31 years after you first open it. This length of time is allotted because kids don’t always pursue further education right after high school. You have until the end of the 35th year to use the funds in your RESP before it expires (more on that in a minute). 

• Like all registered accounts, there are defined limits on the amount of money you can contribute to an RESP. RESP’s were first introduced in Canada in 1998, and between then and 2006, there was one set of contribution limits. After 2006, a new set of contribution limits was introduced.

  • 1998 - 2006: annual contribution limit = $4000, lifetime contribution limit = $42,000

  • 2007 - present: no annual contribution limit, lifetime limit = $50,000 (including all contributions made prior to 2007)

• One of the reasons RESP’s are unique is that the Government of Canada offers RESP holders the chance to earn extra money towards their child’s education each year as they contribute to their plans. This is grant money, meaning you don’t have to pay it back as long as it gets used on education-related costs! This is the major pull for starting an RESP. The government wants you to save for your child’s post-secondary education, and they’ll reward you for starting as early as possible. For you, that means you’ll be earning even more interest thanks to the grant money you receive for your child over time. There are two types of grant programs offered by the Government of Canada: the CESG (Canada Education Savings Grant) and CLB (Canada Learning Bond). 

• Anyone who actively makes contributions to an RESP is eligible to earn CESG funds. The CESG benefit is not available outside of an RESP. That means, parents who are interested in taking advantage of the benefit must be actively contributing to an RESP to receive it. 

• CESG funds are available to RESP holders until the calendar year the beneficiary turns 17. However, if you were to open an RESP for a child who’s currently 16, you’d still have to meet a few restrictions in order to claim the grant. That is, the child must be a Canadian resident, have a valid SIN and be named as the beneficiary of the RESP. 

• The lifetime maximum amount a beneficiary can receive through CESG is $7,200. As you make contributions to an RESP, the government will match 20% of your contributions per year up to $500/year. To max out your CESG contribution in 2021, you’ll need to save $2,500 in your child’s RESP. However, children from middle-to-low income families are eligible to earn additional CESG payments if they meet requirements based on the adjusted income level of the child’s primary caregiver. Though there’s a full description on the CRA’s website, adjusted income roughly translates to a person’s income (line 236 of their income tax return) plus their spouse or common-law partner’s income minus any child care benefits they receive. 

• The CLB offers additional grant money for children from low-income Canadian households. Eligible children earn $500 for their first year of eligibility and $100 for each additional year that they’re eligible. Like the CESG, CLB funds are only available through an RESP (to receive the benefit, a child must be a beneficiary of an RESP).

• When it comes time to actually use the money you’ve saved towards your child’s education, you’ll need to request to release the funds or interest earned in the RESP on your child’s behalf. This is referred to as an Educational Assistance Payment. The money in your child’s RESP can be used to cover a number of school-related costs, but is most often used to pay for tuition, books, transportation to/from school and housing. In most cases, you can use common sense reasoning that if the purchase will further your child’s pursuits towards getting their education, the RESP will cover it. 

• Once you withdraw money from an RESP, it has to be reported as taxable income for the beneficiary in the year it gets taken out. The benefit here is that most students aren’t paying a very high tax rate while they’re in school, so the impact isn’t nearly as great as it would be for you as a working adult. 

• To withdraw money from an RESP, you’ll need to contact your RESP provider with some evidence of what you need the funds for. Though money in an RESP can be used for anything, investment income gets taxed at a different rate if it’s to be used for anything other than school expenses (see our next point). As such, your RESP provider isn’t likely to give it to you freely. They’ll need to see proof that your child is currently enrolled in school, and will likely want to see any outstanding invoices or receipts for purchases like tuition or books. 

• As mentioned above, RESP’s expire at the end of the 35th year after an account holder opens it. For many, the funds in their RESP’s are drained completely and closed years before this point. However, there are plenty of people who still have money left over in their RESP’s when the 35th year rolls around. 
  If you still have money in an RESP when it expires, anything you contributed to the account will be returned to you tax-free. If any of the money in the account is from the CESG or CLB, it gets returned to the government. If your child does not go on to pursue post-secondary education, you’ll be required to pay back any CESG and/or CLB payments you received in full. As for any interest earned in the RESP (either on money you actually contributed or on any government grants you received), it’ll get returned to you, but only in the event that three conditions are met:
  - the children you named in the plan are 21 or over and don’t qualify for an Educational Assistance Payment
  - you’re a Canadian resident
  - the RESP was opened 10+ years ago

• In the event you do use funds from your RESP for anything other than your child’s education, be prepared to part with a portion of your investment income (sorry!). Let’s say a young family diligently saves in their only child’s RESP for years, but their kid ends up starting a business right out of high school and never pursues higher education. With no other siblings to put those funds towards, that money will never be put towards the intended purpose of paying for school-related costs. 

  As such, they decide to withdraw the money they saved in their child’s RESP when their child turns 25. Because they meet the three conditions mentioned in the point above, they’ll get to keep the interest they earned on the funds held in the account over the years. However, when they make that withdrawal, they’ll be taxed at their regular income rate (not their child’s) in the year they take it out + an additional 20% on all the investment income they earned in that RESP. To be clear, this is just on the interest earned and not on the money they contributed to the plan. 

  While it’s not their fault that their child never ended up going to school, the parents will have to part with a chunk of what they earned in the RESP before they can claim it as income. Because the government chips in on RESP contributions, the amount of interest a person can earn can be dramatically higher than what they might earn in a TFSA or RRSP (more money in your plan translates to more investment income). So, in the event that money is withdrawn to be used for something other than post-secondary education, the government is going to tax you at a significant rate to compensate for the fact that you earned more investment income thanks to their contributions.

• When an RESP expires, you also have the option to transfer up to $50,000 in investment income to an RRSP tax-free. However, you can only do so if you meet a number of conditions:
  - the RESP has been open for 10+ years
  - all beneficiaries are at least 21 years old and are not continuing their education after high school
  - you have the contribution room available in your RRSP
  - you are a Canadian resident
  - the rules of your RESP allow it (remember, every plan is different!)
  In the event you don’t meet these criteria, you’ll be required to withdraw that investment income when your plan expires and pay the increased tax rate on it as mentioned above. As you can tell from the conditions, the 10+ year rule continues to pop up over and over again. This is an incentive for people to start their RESP’s while their children are very young!

• One of the tricky aspects of RESP’s is that you have no idea if your child will end up pursuing post-secondary education. No one can predict the future, and while it’s essential that you plan well ahead of time to fund the costs of your child’s post-secondary pursuits, not every kid ends up going to college. Though you get to keep everything you contribute to your child’s RESP in the event they don’t use it, you’re going to get taxed heavily on the interest you earned in the plan if you withdraw it, meaning you may end up losing quite a bit of investment income that could have otherwise been kept if saved in a different kind of plan. 
  
  In his book The Wealthy Barber Returns, Canadian finance guru David Chilton has some advice for parents who don’t know how to navigate the issue. Chilton shares that due to the extra help from the government and the extra interest it allows account holders to accrue, “...the odds favour the RESP being a better mathematical move than the TFSA or the RRSP, as long as its beneficiaries go on to pursue higher education”. However, he also cautions that it’s entirely reasonable to plan for the reality that your child might not go to school. He suggests spreading out your savings between a TFSA, RRSP and an RESP in order to ensure you’re benefiting from earning tax-free interest in more than one plan. Your child might go to university one day, but retirement is inevitable. If you can take advantage of an RRSP and/or a TFSA at the same time as an RESP, you’ll be hedging your bets and ensuring that you’re earning interest in more than one place.

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