A Registered Education Savings Plan (RESP) is a tax-sheltered investment account where parents can save money towards their child’s post secondary education. Much like the other accounts that fall under the “tax-shelter” umbrella, like Tax-Free Savings Accounts (TFSA) and Registered Retirement Savings Plans (RRSP), a RESP savings account can grow without being taxed. This means no taxes are placed on capital gains and no income taxes on dividend payments or interest.
The best feature of the RESP is the grant from the Canadian government. A grant of up to $7,200 is added to your child’s RESP throughout the life of the account.
How Does an RESP work?
The “sponsor” of the RESP, most times it’s a parent or caretaker who sets up the account, makes contributions to the investment. This can occur monthly or via lump-sum payments. The “beneficiary” of the account refers to the child that the RESP has been set up for.
In turn, the government adds 20 percent of the amount contributed each year. A maximum of $2,500 annually may be contributed by the sponsor, earning $500 in free grant money for the child’s education fund. This government top-up is referred to as the Canadian Education Savings Grant (CESG), and it goes straight into your child’s RESP. The CESG funds are considered a part of the RESP, which the sponsor can invest.
Families that are lower-to-middle income households also have an opportunity for added grants. Should a child’s household income fall under $45,916, the Canadian government will include an added 20 percent on the initial $500 that has been contributed. This equals out to a total of 40 percent in added grants. Children who live in homes where household income falls above $45,916, but under $91,831 are given an added 10 percent, which equals out to 30 percent in total added grants. It’s important to note, the $7,200 lifetime limit on grants still applies.
There’s no need to worry if you can’t make the full $2,500 contribution each year and thus can’t get the full grant from the government. Any unused portions can be carried over and contributed to in the years ahead. Still, one stipulation with the RESP program is that, in any one year during the investment account’s lifespan, the maximum grant that will be added is $1,000.
There’s no limit on the amount a parent or caregiver can place in an RESP; however, the lifetime contribution is capped at $50,000. Should you go over that limit, the Canada Revenue Agency will tax you one percent monthly on the added funds until the money is withdrawn. Plus, this lifetime RESP contribution cap also applies if a child has more than one account, such as when grandparents or other family members open an RESP in the child’s name.
There is a $50,000 RESP contribution limit which a sponsor can contribute when they open the investment, and watch the funds grow, tax-free. With that said, if you do decide to do this, you’ll only receive a first-time $2,500 CESG grant for the funds, losing a minimum of $6,700 in added government yearly grants.
For families with more than one child, an RESP family plan can be opened. The same contribution limits apply per child, but the Investment costs may be lower on these accounts, compared to individual RESPs. When opened, beneficiaries of these plans must all be under 21 years of age, and all be related, either via adoption or blood.
How is an RESP Taxed?
Money in an RESP grows tax-free, much like a TFSA or RRSP; however, sponsors do not receive a tax deduction as with an RESP contribution.
When your child, the beneficiary, uses the RESP to pay for tuition, books, and living expenses, it is taxed on the beneficiary, presumably at a lower tax rate.
If your child decides to take a year or two off from school after high school, don’t panic. RESPs remain available for 36 years.