Are you looking for a way to save for college? If you want to give your kids a good start in their adult lives, the RESP is a great tool. But what should you know about the RESP?
Basics about the RESP
The RESP is the Registered Education Savings Plan. The word registered means that a third party is administering the account and the CRA knows that it is valid. Education is the purpose of having the account. The monies generated are expected to go towards post-secondary education. The words savings plan refer to the fact that the RESP is used to accumulate money that will pay for education. The person who sets up the RESP is called the subscriber and the person who will eventually use the money is called the beneficiary.
What differentiates an RESP from a regular savings account that will be used for education purposes? The key differences are that the account is registered, the government has different tax rules for the RESP, and there may be government grants deposited into the RESP that would not occur in a regular savings account.
Advantages of using an RESP to save for college
The two large advantages to having an RESP are that income generated inside the account is tax-deferred. Notice that this is not tax-free. Tax-deferred means that taxes are paid later – when the money is withdrawn for the education costs. Tax deferring is still an advantage because you can reinvest the income without paying taxes for many years until the time it is needed.
The second advantage is that the government will give you extra money called a “grant” that you can also invest on a tax-deferred basis until school begins. Combining your grant with an RESP can be a great way to supercharge your efforts to save for your children’s future education.
Rules to understand when using an RESP
There are a number of rules to adhere to and traps to avoid when obtaining an RESP. It is assumed that the money accumulated inside an RESP will be used for education. It is typical that the education is for a child, but it can also be used for an adult if they name themselves the beneficiary. An RESP can only stay open for a maximum of 36 years.
The amount of money one can contribute is limited to $50,000 over a lifetime, and there are yearly contribution limits to maximize what you would receive in government grants. If you over contribute, there will be penalties charged until the extra money is withdrawn. If the money is not used by the original beneficiary, you can name a different beneficiary for the RESP.
It’s also possible to transfer the RESP balance to an RRSP if the following conditions are met:
The RESP has been open for at least 10 years
There is enough RRSP contribution room
Your beneficiaries are at least 21 years old
You are a Canadian resident
If you decide to close the RESP, your contribution amounts are returned to you and the grants are returned to the government. You can withdraw the investment earnings but they are taxed as well as having an additional 20% penalty.
If you have a group RESP where there are multiple plan members, there may be different restrictions, so you should consult with the RESP provider to understand these rules before opening the account.
When the money is withdrawn, it is usually taxed in the hands of the beneficiary, who is usually a child. Since the student is going to school, their income is generally low and the taxes paid are minimized. Attending post-secondary school also generates tax credits which can offset future income. If the child has income while attending school, these assumptions might not be true. Examples are if the student is already working or has income from a business or investment income.
The RESP is designed to encourage people to save for post–secondary education. There should be some planning done in advance to ensure that options are left open for life changes and to maximize what you can obtain from the RESP.