Canada’s Registered Education Savings Plan can be a great tool to help save and pay for post-secondary education. But in order to get the most out of the plan, you need to first understand how an RESP works in Canada. Here are some common RESP questions and answers to help clarify how to maximize your RESP.
What is an RESP?
An RESP is a Registered Education Savings Plan sponsored by the government of Canada. Although similar to the American version of a 529 plan, an RESP has its own unique advantages.
The money invested in an RESP grows tax-free and then is taxed at the marginal tax rate of the withdrawer (not the contributor). Because university students are usually in a lower tax bracket than their parents (the potential plan contributor) there is a tax advantage to be had here (more on this later).
What types of RESPs are there?
There are 3 types of RESPs – an individual RESP, a family RESP and a group RESP.
An individual RESP can be opened by anyone for a beneficiary. It has the least amount of restrictions and is the easiest to open. As it is an individual plan there can only be one beneficiary with an individual RESP.
A family RESP can only be opened by someone who is directly related by blood or adoption, this includes parents, grandparents, and siblings. A family plan can have more than one beneficiary as long as the beneficiaries are related. Family RESPs are slightly more restrictive than individual RESPs but can be a great option if more than one child is in the picture.
A group RESP is usually administered by a foundation. With group RESPs, your contributions are pooled together with all the other beneficiaries born in the same year. The contribution amount is calculated and kept consistent until the beneficiary is 18.
But be careful with group RESPs because there is often a lot of fine print involved and if you miss a payment you could forfeit all your previous payments. Group RESPs are the most restrictive and in my opinion, should be avoided.
How does an RESP work in Canada?
When talking about an RESP there are 3 main people to keep in mind: the subscriber – the person who opens the account, the beneficiary – the person who will benefit from the account, and the promoter – the financial institution that controls the account.
On a very basic level the subscriber opens an account and contributes to it, these funds are then invested in something (there are a number of different eligible investments). The government of Canada will then match 20% of the contribution (this is called the Canada Education Savings Grant) up to a maximum match of $500 per year.
The contributed money can then grow tax free until it is ready to be used for post-secondary.
From the time of opening an RESP account, the subscriber can contribute to it for 31 years. But the CESG will only be granted for contributions made before the beneficiary turns 18.
Contributions can be made for 31 years but the RESP can be active for 35 years from the time it is opened. After 35 years the funds must be used or there could be tax implications (see below).
What are the benefits of an RESP in Canada?
There are three main benefits of an RESP in Canada:
- The CESG
- Contributions grow tax free
- Withdrawals are taxed at the marginal tax rate of the student
Let’s dive into these RESP benefits.
Canadian Education Savings Grant
The CESG (Canada Education Savings Grant) is a match of 20% of your contributions up to a maximum of $500 a year and $7200 lifetime maximum. That is an instant 20% return on your investment even if you do nothing else with the contribution but open the account and have it sit there in cash (something I do not recommend).
Contributions are accumulated every calendar year and not by the birthday of your little one. This is how our little one was able to receive $1500 in government grants before she turned 2.
In order to receive the grant when the beneficiary turns 16/17 there are a few conditions that need to be met. If you have regularly been contributing to an RESP then there will be no issues.
If not, the CESG will only be deposited into the RESP of a 16/17-year-old beneficiary if:
- There is a minimum of $2000 in the RESP before the calendar year the beneficiary turns 15
- There have been contributions of $100/year for 4 years (does not have to be consecutive years) before the calendar year the beneficiary turns 15
Your contributions grow tax-free. Similar to an RRSP (Registered Retirement Savings Plan), the money you invest in an RESP grows tax-free and is not taxed until withdrawal.
Marginal Tax Rate Advantage
And the third main benefit of an RESP in Canada is the withdrawal is taxed at the marginal tax rate of the student. Because post-secondary students usually do not have super high incomes this can be a huge advantage.
Let’s look at a hypothetical example.
A parent opens an RESP account for their child, the parent is a high-income earner and is currently at the 26% marginal tax rate federally. We are going to ignore the provincial tax rate just to simplify things.
The contributions grow tax-free and the child eventually decides to attend post-secondary. While in school they work a bit but also have a few deductions they can claim. Come tax time their income falls into the 15% tax bracket. This is an income tax savings of 11% on the growth of the contributions.
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How to open an RESP?
Opening an RESP is as easy as reaching out to your financial institution of choice. This could mean booking an in-person appointment or signing up for an RESP online.
In order to open an RESP, you will need the social insurance number of the beneficiary (child), and depending on the type of RESP and promoter (financial institution) you may also need the social insurance number of the subscriber (person opening the account) and signature of the parent (if not the subscriber).
I tend to favour DIY investing so we have opened a family RESP for our little one (we intend to have another child) with Questrade.
Who can open an RESP?
Remember that anyone can open an individual RESP while only a parent, grandparent, or sibling can open a family RESP
This means you could open an individual RESP for a friend’s little one if you wanted to.
My advice would be to contribute to an already established RESP instead of setting up a new one. Keeping track of multiple RESPs can end up being more work than necessary.
Who can contribute to an RESP?
Only the subscriber(s) can physically contribute to the RESP. But that doesn’t mean that other family and friends can’t be involved.
Personally, we give money to our nieces and nephews for their birthdays so that their parents can put it into their RESPs. And whatever gift money our little one gets goes directly into her account too.
What is the maximum RESP contribution in Canada?
The lifetime maximum RESP contribution in Canada is $50,000. The annual maximum CESG is $500 with the lifetime max being $7200.
Although you cannot carry forward the CESG contribution room, you can catch up on one previous year at a time. Meaning that if you did not contribute to an RESP until your little one was 5 at the age of 5 you could contribute $5000 and get a 20% match of $1000 and then do that for the next 4 years to take advantage of missed contribution time.
There is no annual maximum RESP contribution as long as your contribution doesn’t exceed the lifetime maximum. So I guess this means if you have never contributed to an RESP the annual maximum would be $50,000.
What if I over contribute to an RESP?
Over contributing to an RESP is something that you will definitely want to avoid. The penalty for over contributions is 1% per month.
Keep in mind that the over-contribution rules apply to the total contributions to any RESPs for a particular beneficiary (child).
If your little one as more than one RESP open for them, you will want to keep great records of contributions in each RESP to ensure that you avoid over contributing.
What should I invest my RESP in?
Once you open your RESP account the next step is deciding what to invest it in.
What you decide to invest in will depend on your comfort level and the age of your little one. We are comfortable with risk and our little one is still a toddler so she is invested in 100% equities for the time being.
Kari at Money in Your Tea has a great post on RESP investing from newborn to high school. So if you are stuck on what to invest in, check out what Kari is doing with her kids.
But don’t let the choice of what to invest in stop you from opening an RESP and contributing to it. At the very least, even if you invest the RESP money in a very “safe” GIC (guaranteed investment certificate) you will still be eligible for the CESG. This will be an instant 20% return on your contribution.
Is an RESP tax deductible?
No, different from an RRSP, the contributions made to an RESP are not tax-deductible.
This means that you will not get a tax credit for contributing to an RESP.
But this does have its advantages when it comes time to withdraw from an RESP. Because the contributions are made with after-tax money, you can withdraw that money at any time without penalty or withholding tax.
How to get the most out of an RESP?
In my opinion there are 2 ways you can get the most out of your RESP:
- Make your lifetime maximum contribution as early as possible
- Maximize the annual CESG grant
It’s not about timing the market but rather about time IN the marketUnknown
If you believe that time in the market is the most important thing and you have a large chunk of cash sitting around then one way to maximize your RESP is to put all your cash into it as early as possible.
This way that money can grow tax-free and will only be taxed upon withdrawal at the beneficiary’s marginal tax rate.
The downside to this method is that you would only qualify for one CESG grant of $500 in the year that you made a massive contribution. But that downside is offset by the large chunk of money you have to grow over the next 10 plus years.
This method takes advantage of the power of compounding and time.
Personally we did not have a large chunk of cash sitting around when our little one was born so this method was not for us. But I could see it having value if there was an inheritance involved when your little one is very young.
Maximize the annual CESG grant
Because we didn’t have a large chunk of cash sitting around we decided to get the most out of our little one’s RESP by maximizing the CESG grant.
To do that we will contribute $2500 a year up to a maximum contribution of $36,000. Every year we contribute $2500 the government will give us a $500 matching grant up to a lifetime maximum of $7200 which is where the $36,000 amount comes from.
This is our plan right now, but like anything it could change in the future.
What are the RESP withdrawal maximums?
You have been diligent and have contributed to an RESP for your little one and now they are not so little anymore and are ready to go to post-secondary. It’s time to start withdrawing from that RESP.
Before diving into specific withdrawal maximums we need to understand how the money in your RESP is allocated. There are essentially 2 buckets, your contributions are in one bucket and your earnings and the government grant money is in the other bucket.
Your earnings plus the government grant money are known as Education Assistance Payments (EAPs). So your RESP is made up of your contributions and the EAP.
One of the best things you can do is have a plan for your withdrawals. Your contributions can be withdrawn at any time and there is no maximum or penalty. Remember the money you contributed was after-tax money so it has already been taxed.
The maximum you can withdraw from the EAP portion depends on if the student is in school full-time or part-time.
For the purpose of RESP withdrawals, a full-time post-secondary program is considered to be a minimum of 3 weeks with a minimum of 10 hours a week of instruction. If the post-secondary program is outside of Canada, then the program must be a minimum of 13 weeks.
A full-time student can withdraw up to $5000 for qualifying expenses out of their EAP in the first 13 weeks of post-secondary. After that, there is no maximum as long as the withdrawals are reasonable post-secondary expenses.
Your promoter (financial institution) will determine what is a reasonable expense because they are responsible for ensuring the RESP follows the rules set out by the government. Reasonable expenses would include tuition, books, room, and board to name a few.
For a RESP, a part-time post-secondary program is a minimum of 3 weeks long with a minimum of 12 hours of instruction a month.
A part-time student can withdraw up to $2500 for reasonable expenses out of their EAP in the first 13 weeks of post-secondary. Similar to a full-time student, after that there is no maximum as long as the withdrawals are for reasonable post-secondary expenses.
It is important to note that the post-secondary institution must be a qualifying institution according to the government of Canada. There are many institutions that qualify for RESP withdrawals. More information can be found on the government of Canada website.
When it comes time to make RESP withdrawals my suggestion is to liquidate your EAP bucket first. Then if there is money left over in your contributions bucket that money can be withdrawn without penalty.
What if my child doesn’t go to post-secondary?
This is probably the number one question I get asked about RESPs – what if my child doesn’t go to post-secondary now what? Would I be better off saving that money in a TFSA?
The short answer is no. I don’t think you would be better off investing that money in your TFSA. Because at the end of the day, that’s your TFSA. And investing money in your TFSA doesn’t come with the 20% government matching grant.
From the time you open an RESP you have 31 years to make contributions and 35 years before the account needs to be collapsed. That’s a lot of time to decide if your little one wants to go to school or not.
Even if they do not go to post-secondary right out of high school they have many years after to still make that decision and take advantage of the money in their RESP.
After 35 years
If after 35 years your child decides to not attend post-secondary and your RESP has to be collapsed, then you essentially have 3 options:
- Replace the beneficiary of the plan
- Transfer the CESG money to a sibling
- Collapse the plan
Depending on how your RESP was set up, you may be able to replace the beneficiary of the plan. You will need to speak to the promoter (financial institution) for your plan to figure out if this is an option for you.
There is also the option of transferring the CESG money to a sibling if they still have room. Again this will depend on how your RESP was set up so you will want to talk to your promoter to find out your options.
And lastly, the least desirable option is to collapse the plan. For this, any contribution money will be returned to you without penalty. The CESG funds will be returned to the government.
As for the earnings on the contributions and CESG if you have RRSP room you can transfer these funds to your RRSP. But to do so the following conditions must be met:
- Only a maximum of $50,000 can be transferred
- The RESP has to have been open for a minimum of 10 years
- The beneficiaries must be at least 21-years old
- You must be a Canadian resident
If transferring to your RRSP is not an option but you have a child who qualifies for an RDSP (Registered Disability Savings Plan) this may also be an option. Check out the government of Canada website for more information on this.
But what if transferring to an RRSP or RDSP is not an option?
If this is the case, then you may have to be tax on the earnings. All of the earnings that are unused will be counted as accumulated income. Accumulated income is taxed at your marginal tax rate plus a 20% penalty.
For this reason, you will want to do everything you can to try and avoid this scenario. Remember you have 35 years from when you open the RESP before this is your only option.
A few extra notes on RESPs
Some provinces also offer provincial post-secondary grants similar to the Canada Education Savings Grant. A quick google search can help you determine if this is an option in your province of residence.
Canada also offers a Canadian Learning Bond (CLB) for low-income families. If you think you may qualify for this, then check out the government of Canada website for more information.
As you can see there are a lot of intricacies with how an RESP works in Canada.
But don’t let all the details prevent you from taking action. If your little one is still young, then opening a RESP account and investing that money in whatever you are comfortable with can be a great gift when they are ready for post-secondary.
Learning about all the details of a RESP can happen as your little one grows up. Using the information that is timely for where you are right now can help give you the confidence to take action.
Even if you are not sure exactly where to invest your contributions just opening a RESP and contributing to it will qualify the account for the CESG. That’s an instant 20% return on your money – something that is very tough to find anywhere else.
If there are any questions I have missed on how an RESP works in Canada please feel free to drop them in the comments below and I will be sure to answer them for you.