In this guide, you will learn how RESPs function, their advantages and disadvantages, and some strategies on how to make the most of them. So whether you are an experienced investor or just starting to consider your child’s future, this ultimate guide will equip you with what you need to know to maximize an RESP.
What Is a Registered Education Savings Plan (RESP)?
An RESP is an account that you can save in, in the purpose of helping Canadians' to save for their child post-secondary education. The account pulls together private payments, tax-sheltered investment growth, and generous grants from the government, creating one of the best ways to save for education. RESPs are different from traditional savings accounts as they are specifically intended to support educational expenses such as tuition, books, and even living costs.
Parents, guardians, grandparents, and even family friends can open RESPs, with the child (or children) as the beneficiary. The Canadian government also helps greed up saving in the form of grants such as the Canada Education Savings Grant (CESG) and the Canada Learning Bond (CLB) that deposit free money into your account.
Key Features of an RESP
- Tax-Sheltered Growth: The earnings from your investments grow tax-free in the account.
- Government Grants: Programs like CESG and CLB allocate more funds which the government provides.
- Flexibility: Funds from RESPs can cover a variety of educational costs, including international programs.
- Lifetime Contribution Limit: $50,000 per beneficiary.
- Education Only: Penalty for non-educational withdrawals; tax consequences as well.
Why You Should Make RESPs Part of Your Education Savings Plan
The national average annual tuition for undergraduate programs in Canada exceeded $6,800 in 2023, with education expenses growing faster than inflation. When you factor in the cost of expenses such as housing, transportation, and textbooks, a four-year program can easily run over $80,000. Without a plan, this costs can put a strain on families and saddle students with large amounts of debt.
RESPs offer a structured and tax-efficient way to save for these costs. In addition to the immediate financial aid, RESPs encourage long-term family financial planning and literacy.
How Does an RESP Work?
RESP accounts work through a simple process that combines contributions with tax benefits and government incentives to grow your savings. Here’s how it works:
Opening an RESP
You can start an RESP at banks, credit unions, mutual fund companies, or specialized financial institutions. You’ll have to give the beneficiary’s Social Insurance Number (SIN) to set up the account.
Making Contributions
Although contributions to an RESP are not deductible for tax purposes, they give you access to government grants and tax-deferred growth. The amount you decide to contribute is up to you, but if you’d like to get the most bang for your buck you’d want to contribute at least $2,500 annually to receive the full CESG grant.
Earning Government Incentives
The Canadian government helps grow your savings in two main ways:
- Canada Education Savings Grant (CESG): Automatically adds 20% to your annual contributions, topping up to $500 a year, with a lifetime maximum of $7,200 per beneficiary.
- Canada Learning Bond (CLB): Upon application, your child receives up to $2,000 for free if you come from a low-income family; you do not need to contribute personally to receive the CLB.
Investing Within the RESP
The money in a RESP can be invested in a wide array of financial instruments including:
- Stocks: Greater potential growth but also risk.
- Bonds: Stability and regular income.
- Mutual Funds and ETFs: Portfolios of various assets to align with your risk tolerance.
- Guaranteed Investment Certificates (GICs): Guaranteed returns but more conservative.
Which you choose depends on your time frame, risk tolerance, and financial goals.
Withdrawing Funds
Withdrawals from an RESP fall into three categories:
- Educational Assistance Payments (EAPs): Composed of government grants and funds growth, taxed in the hands of the student (and likely taxed at a low rate as income is meager).
- Return of Contributions (ROC): Withdrawn tax-free since contributions were made with after-tax dollars.
- Non-Educational Withdrawals: If the beneficiary chooses not to enter post-secondary education, the grants must be paid back to the government, but contributions are paid back tax-free.
Benefits of an RESP
RESPs have many advantages as an educational planning tool:
Tax-Free Growth
The earnings from your RESP investment grow tax-free, unlike regular savings accounts. This lets your money compound over time without being harmed by taxes, greatly increasing your savings.
Government Contributions
The CESG and CLB act as powerful boosts on your savings, with the CESG providing guaranteed 20% returns in contributions up to $2,500 a year. This essentially makes RESP deposits a high-reward, low-risk investment.
Flexible Use
The funds can be used for tuition, textbooks, laptops, and other education-related expenses as well as living expenses. RESP funds can be used for eligible programs outside the Canadian institutions.
Open to All Income Brackets
The CLB allows families with limited means to still benefit from government contributions without making substantial personal contributions.
RESP Challenges and Limitations
Although RESPs have many advantages, they also have a few limitations:
Contribution Limits
The limitation on lifetime contributions of $50,000 per beneficiary may hinder savings for families with a lot of education expenses.
Grant Restrictions
There’s a lifetime limit of $7,200 for the CESG — it doesn’t matter how much you contribute to the RESP.
Punishments for Using Outside of Education
If the beneficiary doesn’t attend post-secondary education, the government grants have to be repaid and growth on investments may be taxed at the contributor’s rate.
Investment Risks
As with any investment account, returns are tied to the performance of the underlying assets. Investment losses may stem from a poorly diversified portfolio.
RESP vs TFSA: Which One is Right for You?
Feature | RESP | TFSA |
---|---|---|
Destination | College savings | General savings |
Tax Benefits | Tax-free growth, CESG/CLB grants | No tax on growth and withdrawals |
Contribution Limit | $50,000 lifetime per beneficiary | $6,500 per year (2023) |
Withdrawals | Taxable as EAP or tax-free as ROC | Completely tax-free |
How to Maximize RESP Benefits
- Start Early: The sooner you open an RESP, the more time your money has to grow. In addition, starting early can help you maximize CESG grants over several years.
- Contribute Consistently: Set up automatic contributions to ensure you’re maximizing annual CESG benefits and staying on track.
- Diversify Investments: Building a balanced portfolio with stocks, bonds, and ETFs can help your investment grow over time while managing risk. To reduce volatility, reallocate your investments as your child nears post-secondary age.
- Use Catch-Up Contributions: If you missed out on CESG benefits in previous years, catch-up contributions may allow you to claim unused CESG dollars. Annual catch-up contributions can increase your CESG to $1,000.
- Strategically Plan Withdrawals: Minimize taxes by coordinating RESP withdrawals. First, withdraw from EAPs since these distributions are taxed in the beneficiary’s hands, and leave ROC withdrawals for later.
Commonly Asked Questions (FAQs)
- What is the maximum CESG amount?
The CESG offers a lifetime limit of $7,200 per beneficiary, with a 20% match of annual contributions up to $2,500. - Can RESP funds be used for studying abroad?
Yes, the program can be eligible as per the requirements from the Canadian government. - What if my child doesn’t go to college?
Government grants have to be paid back, but contributions are returned tax-free. Investment growth can be rolled into an RRSP or taken out (with penalties). - Can multiple contributors add to an RESP?
Yes, anyone can contribute to an RESP for a specific beneficiary, but total contributions cannot exceed $50,000. - Are RESP contributions tax-deductible?
No, contributions are not tax-deductible. But what grows in the account is tax-free. - How does the CLB work?
The Canada Learning Bond provides up to $2,000 for low-income families. The CLB does not require personal contributions to be received.
Conclusion
RESPs help Canadian families prepare for the rising cost of post-secondary education through tax-free growth, government grants, and investment options.
To get the most out of your RESP, start early, deposit regularly, and invest wisely. With careful planning, you can ensure your child’s path to education is financially secure, allowing them to succeed without the burden of significant student debt. As a parent, guardian, or even a grandparent, the RESP is an essential part of any complete financial plan.