The RESP (Registered Education Savings Plan) is an incentive given by the federal government to Canadian taxpayers to help save for a child’s future post secondary education costs. The lifetime contribution limit is $50,000 per child. Anyone can open one at any time for someone else – parent, grandparent, uncle, aunt, etc.
Canada Education Savings Grant
The Canada Education Savings Grant (CESG) is a contribution made by the federal government towards a child’s RESP. The government contributes 20% of the annual contributions per child (up to a maximum of $500 per year and a lifetime maximum of $7,200).
Help for Lower Income Families
Additional grants are also available for low and middle-income families. A family with a net income of $42,707 or less (using 2012 amounts) could get an extra $600 per year per child in the RESP. Families with a net income between $42,707 and $85,414 (using 2012 amounts) could receive a maximum of $550 per year per child. The Canada Learning Bond (CLB) is also available to lower income families and can pay up to $2,000 per child.
What’s the Catch?
For a family to receive the CESG (or additional funding for lower income families) the RESP needs to be setup before the child turns 16 with a minimum of $100 put into the plan for the previous 4 years. The other option is to deposit $2,000 (or more) into the plan before the child turns 16. The government essentially requires that an RESP be set up sooner rather than later.
Taxes – Assuming the child goes on to post secondary
The earnings within the fund (ie. dividends, interest, etc.) are not taxed until they are taken out of the fund to pay for the student’s education – Educational Assistance Payments. These are taxed in the hands of the student. This is an advantage because the student likely has a low income and their marginal rate is low so they can likely take it out tax free. Personal contributions made by the parent, grandparent are returned to them tax free.
Taxes – Assuming the child does NOT attend post secondary
Personal contributions made by the parent, grandparent are returned to them tax free – the tax hit relates to the earnings within the fund. The earnings (ie. dividends, interest, etc) – called ‘Accumulated Income’ – are taxed in the hands of the contributor plus an additional 20%. This money can be transferred to a contributor’s RRSP if they have room, but if not they can prepare to pay steep taxes (marginal rate in the year of withdrawal plus 20%).
- it allows for tax-free growth while in the plan, similar to an RRSP
- The CESG is basically free money towards an RESP and can really add up over time
- No annual contribution limit (only a lifetime limit of $50,000 per child). For a family of three children, this means the maximum lifetime limit is $150,000
- The principal amounts contributed towards the plan are not taxed upon withdrawal and can be withdrawn at any time
- Withdrawals while the child attends post secondary schooling are taxed in the hands of the child, which is advantageous because their income is likely low while attending school and therefore their marginal rate is low
- Additional grants are available for low income families
- If the child doesn’t attend post-secondary schooling, the contributions are returned to the contributor (usually a parent) tax-free. The earnings face steep taxes but can be transferred to an RRSP
- The CESG can be shared between siblings provided they have grant room
- contributions are not tax deductible (unlike an RRSP) and therefore can’t reduce your taxable income
- The CESG has a lifetime maximum of $7200 per child and is only paid on the first $2500 contributed each year
- Any contribution above the RESP lifetime limit of $50,000 per child is subject to tax at the marginal rate
- The money must be used to pay for educational costs – tuition, textbooks, residence, etc
- A maximum of $5,000 can be withdrawn in the first 13 weeks that the child is in post-secondary. This seems low since the student will have lots of costs to cover when they start school
- Grants given by the government (such as CESG) must be paid back if the child doesn’t attend schooling
- If the child doesn’t attend post secondary schooling, an additional 20% tax applies on the fund’s earnings and is included as income for the contributor (usually a parent) that year on top of their marginal rate. If your marginal rate is 30% – this means you’ll be paying 50% taxes on the earnings in the fund.
Conclusion: The federal government is offering a small incentive to help with future (sky-rocketing) post secondary costs for their children. On the flip side, there could be a large tax liability if the post secondary plans do not work out. If your child is likely to attend then this is a great way to save for the costs, but if they’re unsure it might be better to open a TFSA and simply make conservative investments that will grow over time.
What are your thoughts on the RESP?
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