Why the Registered Education Savings Plan (RESP) Is Such a Powerful Savings Tool

Every parent wants their kid to go to university, but the reality is post-secondary education is becoming more and more unaffordable. According to Statistics Canada, tuition fees for an undergraduate program in Canada costs an average of $6,580 annually. That means a four-year bachelor’s degree can set you back over $25,000 – and that’s not even including other expenses such as textbooks and accommodation costs if your child chooses to study in a different city or province.

You may feel overwhelmed and wondering how you’re going to put your kid through college. Sure, there are always student loans, but the last thing you want is for your child to graduate with a mountain of debt. This is where an RESP comes in handy. Launched in 1998 by the Government of Canada, this special savings account offers great tax breaks so you can easily save for your child’s post-secondary education.

What is an RESP?

A Registered Education Savings Plan (RESP) is a tax-sheltered account that helps you save for higher education such as university, college and qualifying programs like trade schools and apprenticeships. 

Just like RRSPs and TFSAs, an RESP allows cash and investments (GICs, mutual funds, stocks, bonds, ETFs) within the account to grow tax-free. That means you don’t have to pay taxes on the money earned until it’s withdrawn. Even when withdrawals occur, they are taxed in your child’s hands, resulting in little to no tax since students generally have low incomes. 

The biggest benefit of all is the government grants. The federal government provides contributions up to $7,200 over the course of the plan to help you grow your savings faster.

Who can open an RESP?

From parents and grandparents to close friends and other relatives, almost anyone can open an RESP as long as the account opener and beneficiary are Canadian residents. You can also open an RESP for yourself if you plan on going back to school in the future.

How do I open an RESP?

You can open an RESP with your bank, credit union, and even robo-advisor. To open an account, you’ll need documentation such as your SIN number and your child’s SIN number and birth certificate.

What types of RESPs are there?

There are three kinds of RESPs:

Individual RESP: This type of plan has one beneficiary and can be opened by anyone, including immediate family, relatives, and friends. Consider opening an individual RESP if you have one child or multiple children with large differences in age as separate accounts give you more time to make contributions for younger kids. 

Family RESP: A family plan may be best if you’re saving for more than one child. This RESP allows you to name multiple beneficiaries, as long as they’re related to you or formally adopted by you. Funds don’t need to be distributed equally amongst the beneficiaries.

Group RESP: Also known as a scholarship fund, a group RESP is sold by scholarship plan dealers. Everyone in the group names one beneficiary and contributes to the plan so their beneficiary can have a share of the pooled earnings when they go to university. Group RESPs are the least popular option because they often charge high fees and have strict contribution and withdrawal schedules. 

How much can I contribute to an RESP?

The lifetime contribution limit is $50,000 for each beneficiary. There is no annual limit though, so you can contribute as much or as little as you want every year.

Does the government match RESP contributions?

The Canada Education Savings Grant (CESG) matches 20% of your RESP contributions every year, up to a maximum of $500. For example, if you contribute $500 in one year, the government will give you $100 in grant money. Deposit $2,500 and you’ll get the full $500. Keep in mind the CESB has a lifetime limit of $7,200 per child.

There are additional grants available for low-income families. The Canada Learning Bond (CLB) contributes up to $2,000. Provinces like British Columbia, Quebec, and Saskatchewan also provide supplemental grants. 

How much should I put in an RESP?

You don’t have to make large contributions to grow a sizeable nest egg. What’s most effective is slow and steady contributions over a long period of time. Let’s say you contribute $25 a week for 18 years. Your RESP would be worth over $50,000 in the end, assuming a 6.26% rate of return and including all CESG payments. Consider automating your savings so you never miss a weekly, bi-weekly, or monthly contribution.

What are the tax benefits of an RESP?

RESP contributions do not reduce taxable income because they are not tax-deductible. The main benefit of an RESP is that it allows your savings to grow tax-free. Investment gains aren’t subject to capital gains tax or income tax as long as the money stays in the RESP.

When is the cut off for RESP contributions?

You can contribute to an RESP for up to 31 years. Afterwards, you have until the end of the 35th year to use the funds before the RESP expires.

Do students have to claim RESP funds as income on their taxes?

There are two types of RESP withdrawals that can be made, and each is taxed in a different way. The contributions you put in can be withdrawn tax-free as Post-secondary Education Payments. 

Government grants, capital gains, and investment income are withdrawn as Educational Assistance Payments (EAPs). These withdrawals are considered income and taxed in the student’s hands. That means students who use these funds must claim the amount on their income taxes. However, they most likely will pay little to no tax since students generally don’t make much money while they’re in school. Even if their job puts them in a higher tax bracket, they can take advantage of tuition and education tax credits which will reduce their tax burden. Your RESP provider will send the student a T4A slip when tax season rolls around.

What happens if my child doesn’t go to university?

There are options if your child chooses not to pursue post-secondary education. RESPs are valid for up to 36 years, so you can always keep the account open in case your child changes their mind. You can also transfer the RESP money to the child’s sibling if you have a family plan. 

Can the funds in an RESP be used for things other than schooling?

Yes, but there are strings attached. If your child chooses not to continue education after high school, you can withdraw your original contribution tax-free and without penalty, however, all government grants must be returned to the government. Any capital gains and income from dividends and interest are sent back to you as an Accumulated Income Payment (AIP), which is taxed at your regular income tax level, plus an extra 20%. 

You may be able to reduce the amount of taxes you owe by transferring your AIP to your RRSP or your spouse’s RRSP. In order to do this, your child has to be over age 21 and the RESP must have been open for at least a decade. You also need to have enough RRSP contribution room.

Should I invest in an RESP or RRSP?

Registered Retirement Savings Plans (RRSPs) and RESPs may sound similar, but they work quite differently. RRSPs let you contribute up to 18% of your income every year. These contributions lower your taxable income, however, you will have to pay taxes when you withdraw the money in retirement. RRSPs are an excellent way to minimize your lifetime income tax burden since you’ll most likely have a lower income in retirement compared to your working years.

Choosing between an RRSP and RESP will depend on your finances and personal situation. If you already have a decent amount saved for retirement, it makes sense to open an RESP for your child. After receiving the CESG lifetime maximum, you can go back to saving for retirement. 

It’s a good idea to focus on an RRSP if you haven’t started saving for retirement yet. Look at it this way, your child can easily get a student loan for university, but it will be difficult for you to get a loan when you’re retired. With Canadians living longer and longer, RRSPs are a smart choice because they can help you achieve long-term financial security. They can even help you save for your child’s education. The more you contribute to your RRSP, the higher your income tax refund will be. Instead of spending your income tax refund, you can always deposit it into your child’s RESP.

Should I invest in an RESP or TFSA?

Tax-Free Savings Accounts (TFSAs) and RESPs share similar benefits, including the ability to grow savings tax-free and non-deductible contributions. There are some key differences though. TFSAs provide more flexibility because the funds can be used for anything, not just education expenses. It’s also easier to withdraw money from a TFSA – you can do so anytime and without penalty. All withdrawals are also never taxed. 

The downside of the TFSA is it’s not eligible for the CESG. The best thing about the RESP is that the government gives you free money – up to $500 every year to a lifetime maximum of $7,200. This high return on investment is hard to beat, especially if you’re set on sending your child to university.

Once you pick an account, make sure to start saving as early as possible to give your investments as much time to grow. Make saving a habit and contribute regularly to get the most out of these tax-sheltered accounts.