Understanding Registered Education Savings Plans (RESPs) in Canada

A Registered Education Savings Plan (RESP) is a specialized savings account designed to help Canadian families save for their children’s post-secondary education. The major advantage of an RESP is that contributions grow tax-free until the funds are needed for education expenses, making it a practical and efficient tool for long-term education planning.

How Does an RESP Work?

RESPs revolve around three primary roles:

• Subscriber: The person who opens the RESP account and makes contributions. This could be a parent, grandparent, or another individual.
• Promoter: The financial institution or organization that administers and manages the account.
• Beneficiary: Usually a child or grandchild who will use the funds for post-secondary education.

Subscribers make contributions, which the promoter invests to generate income. The best part is that the investment growth remains tax-free while in the RESP. When the beneficiary begins higher education, funds are withdrawn to help cover education expenses.

Types of RESPs

There are three main types of RESPs to suit different needs:

1. Individual Plan: Created for one beneficiary, who does not necessarily have to be related to the subscriber.
2. Family Plan: Designed for multiple beneficiaries, all of whom must be related to the subscriber by blood or adoption (e.g., siblings).
3. Group Plan: Pools contributions from various subscribers for beneficiaries within the same age group. These plans are typically offered by specific organizations.

Contributions and Limits

An RESP has no annual contribution limits; however, there is a lifetime maximum contribution limit of $50,000 per beneficiary. It’s critical to monitor contributions across all RESPs opened for a single beneficiary to avoid exceeding this lifetime limit, as over-contributions are subject to penalties.

Government Grants and Incentives

The Canadian government provides several financial incentives to boost RESP savings:

• Canada Education Savings Grant (CESG): A grant of 20% on the first $2,500 contributed annually, up to $500 per year, with a lifetime maximum of $7,200 per beneficiary.
• Canada Learning Bond (CLB): Families with lower incomes can receive up to $2,000 in grants, starting with an initial $500 grant and annual contributions of $100 up to the child’s 15th birthday—even if the family does not contribute to the RESP themselves.
• Provincial Incentives: Some provinces, such as Quebec and British Columbia, offer additional incentives like the Quebec Education Savings Incentive (QESI) and the British Columbia Training and Education Savings Grant (BCTESG).

Making Withdrawals and Payments

When the beneficiary begins a qualifying post-secondary education program, withdrawals can be made from the RESP in two distinct ways:

• Educational Assistance Payments (EAPs): These payments consist of investment earnings and government grants. EAPs are taxed in the hands of the beneficiary, who typically has little to no other income, resulting in minimal or no tax owed.
• Refund of Contributions: Subscribers can withdraw their original contributions tax-free since those funds were contributed using after-tax dollars.

What Happens if Education Isn’t Pursued?

If the beneficiary does not pursue post-secondary education, the subscriber has the option to withdraw the accumulated income as Accumulated Income Payments (AIPs). However, these withdrawals are subject to regular income tax plus an additional 20% tax.

There is some flexibility for unused funds:

• Up to $50,000 of the AIP can be transferred tax-free to a Registered Retirement Savings Plan (RRSP) or a spousal RRSP, provided there is sufficient RRSP contribution room.
• The subscriber can change the beneficiary, provided the new beneficiary is under 21 and meets certain requirements (e.g., being related by blood or adoption in a family plan).

Tax Benefits and Considerations

RESP contributions are not tax-deductible, but any income earned within the RESP is tax-deferred. When funds are distributed as EAPs, they are taxable to the beneficiary, who generally benefits from a lower tax rate during their time as a student.

To avoid penalties, it’s essential to be mindful of specific RESP tax rules, such as:

• Over-contributions, which result in penalties.
• Non-qualified or prohibited investments, which may incur additional taxes.

Conclusion

A Registered Education Savings Plan (RESP) is an excellent strategy to save for a child’s future education while taking advantage of generous tax breaks and government grants. Families can maximize their savings by carefully understanding the rules, limits, and government programs available. Consulting with a financial or tax advisor can provide invaluable guidance in navigating RESP details.

Certified professionals, like JHG Corporate and Tax Services Inc, are an excellent resource to ensure compliance and help families make the most of their RESP and tax-saving opportunities.

Source: Canada Revenue Agency’s “Registered Education Savings Plans (RESPs)” (RC4092).