An RESP is a type of investment account that is registered with the Canadian government. They were created in 1974 as a way for families to help pay for a child’s post-secondary education. Parents, grandparents, and other relatives are able to open and contribute to an RESP. The money inside of an RESP grows tax-free and the government will match contributions up to 20%, subject to maximum annual amounts. Once the child for which the RESP was establish goes to school, money can be withdrawn to help cover expenses.
How does an RESP work?
To open an RESP, you must name a beneficiary who is a Canadian resident. You can open an individual or a family RESP. Family plans are more flexible because earnings and the Canadian Education Savings Grant can be shared among the beneficiaries. Individual RESPs can be opened by anyone for anyone while Family RESPs can only be opened by parents or grandparents.
The year a child is born they become eligible to be the beneficiary of an RESP. There are no annual limits for contributions, but there is a lifetime limit of $50,000 per beneficiary. Contributions are not tax-deductible like RRSPs, but like RRSPs grow tax-free until they are withdrawn. Depending on the type of withdrawal, they are taxed differently. In addition to contributions, each year the beneficiaries are eligible to receive the Canada Education Savings Grant.
What is the Canada Education Savings Grant (CESG)?
The CESG is an incentive provided by Employment and Social Development Canada (EDSC) to encourage parents, family, and friends to save for a child’s post secondary education. EDSC matches 20% of annual contributions up to $500 per year (a contribution of $2,500 will max out the grant). However, you are allowed to catch-up an additional year of grant ($500) if you have unused grants from a previous year (a contribution of $5,000 will generate a total grant of $1,000). The maximum grant you can receive in any one year is $1,000 and there is a lifetime limit of $7,200 per beneficiary.
How do you make withdrawals from an RESP?
Once the beneficiary has graduated from high school and enrolled full-time or part-time in a qualifying post-secondary education program, you can withdrawal money from the RESP to pay for their studies.
There are 2 different types of withdrawals you can request:
Education Assistance Payments (EAP) are paid from the earnings and CESG that have accumulated in the RESP. They must be paid directly to the beneficiary and the amounts are taxed as income in the hands of the beneficiary. During the first 13 weeks of enrollment EAPs are limited to $5,000 ($2,500 if the student is enrolled part-time). After the first 13 weeks there are no limits for this type of withdrawal. Students are also able to receive this payment up to 6 months after their enrollment finishes. You will need to provide proof of enrollment for this type of payment.
Post-Secondary Education Payments are paid from the principal amounts. Because they were contributed with after-tax dollars, there are no taxes payable. They can be sent to either the subscriber or the beneficiary with no taxable consequences.
What happens if a beneficiary doesn’t go to school or stops going to school?
There are penalties if an RESP isn’t used for education. Accumulated grants must be paid back and the remaining investment growth is withdrawn as an Accumulated Income Payment (AIP). It is taxed at your marginal tax rate plus a 20% penalty. You may have the option of transferring the AIP to an RRSP if you or your spouse has contribution room. Your principal contribution amounts aren’t taxed upon withdrawal. If you have a family plan the grants (subject to the lifetime maximum of $7,200 per beneficiary) and the earnings can be shifted to other beneficiaries instead.
RESPs are a fantastic option to save for a loved one’s education. They have tax incentives as well as government matched contributions. It is important to understand the nuances to this type of account in order to maximize the benefits. If you are curious to learn more about RESPs please reach out to me through https://www.planningandinvesting.com/contact.
Bobby McBride holds the Certified Financial Planner (CFP) designation and is Financial Planner at Planning with Bobby Inc. He also holds the Chartered Financial Analyst (CFA) designation and is an Investment Advisor at Investing with Bobby of Designed Securities Ltd.
Comments