An RESP allows your savings to grow tax-deffered to pay for the education costs of a named beneficiary to receive the new Canada Education Savings Grant. All capital gains, dividends and interest remain untaxed as they compound in an RESP, providing an effective and easy way to save for the swelling costs of post-secondary education. When these earnings are passed on to the plan beneficiary, they become part of his or her taxable income. And since students are generally in lower tax brackets and have various tax credits, they will pay little or no tax.
Quick Questions & Answers About RESPs
- Who should consider and RESP?
Anyone saving for post-secondary education should consider an RESP. The earnings remain untaxed as they accumulate, and virtually anyone who will be enrolled full-time in qualifying education programs at designated educational institutions can be a beneficiary.
- Who qualifies as a beneficiary?
An individual plan allows for only one beneficiary, who can be anyone, related or not. In a family plan, you can name more than one beneficiary, but each must be related to you by blood or by adoption as defined in the Income Tax Act. Note that you can change the beneficiary at any time (subject to certain conditions).
- Which educational institutions qualify for an RESP?
Designated Canadian universities, community colleges, CEGEPs and junior and technical colleges qualify, as do designated universities outside Canada, educational institutions that provide approved post-secondary study, and certain correspondence courses. A beneficiary can change institutions, as well as courses, while continuing to receive money from the RESP.
The money can be used to pay for tuition, books, accommodation, and anything that will assist the beneficiary during his or her studies.
- When is the best time to start an RESP?
It's best to start as soon as you can so that your money begins to compound on a tax-deferred basis. Contributions can be made each year for 21 years, up to a maximum of $50,000.
- What is the annual contribution limit?
There is no annual limit, although the maximum lifetime limit is $50,000.
- When should contributions be made?
You should contribute as early in the year as possible to fully benefit from compounding. But if you can't make a lump-sum contribution, you can invest regularly and easily throughout the year with a Horizon Investment Plan.
- How is the money paid to the beneficiary?
You determine how much and when the beneficiary will be paid. The subscriber may instruct that the funds be paid directly to the beneficiary.
- What is a Canada Education Savings Grant?
To promote saving for a child's education and to give a boost to RESPs, the 1998 federal budget introduced the Canada Education Savings Grant (CESG). The CESG, which is deposited directly into the RESP, is equal to 20% of the annual contributions made to an RESP, to a maximum of $500 per year per beneficiary. The CESG is not included in determining the lifetime $50,000 RESP contribution limits.
- Can unused CESGs be carried forward?
Yes. Starting in 2007, every child who is under the age of 18 will begin to accumulate CESG contribution room of $2,500 per year. CESG contribution room is used to determine the maximum amount of CESG that a plan can receive from the government in a year. Unused CESG room is automatically carried forward from year to year; however, the maximum CESG for any one year is limited to $1,000.
- How can contributions, income, and CESGs be withdrawn from the plan?
Remember, this money is for your child's education. So although you can withdraw contributions from your RESP any time tax-free, you should avoid withdrawls for anything but their intended purpose.
The government has put in place several anti-avoidance rules to ensure the CESG system is not abused. As a result, when you remove a contribution from a plan that has received a CESG, you must repay the government an amount equal to 20% of the contribution withdrawn for non-educational purposes up to the amount of CESGs that were received. Restrictions may apply to future CESGs
- What happens to the money in an RESP if the beneficiary does not attend a post-secondary institution?
If all intended beneficiaries are not pursuing higher education by age 21 and the RESP has been in existence for at least 10 years, the subscriber can withdraw the income from the plan. You can then transfer up to $50,000 of this income to your or your spouse's RRSP, as long as you have enough contribution room available.
In an individual plan, if the beneficiary does not attend school, the CESG must generally be repaid. In a family plan, other beneficiaries can use the CESG to a maximum of $7,200 per beneficiary. The remainder must be repaid.
- What types of tax receipts will I receive?
You won't receive tax receipts, because contributions to an RESP, unlike an RRSP, are not tax-deductible. When the beneficiary withdraws the income from the plan, the growth portion is classified as "other income" on his or her T4A supplementary tax slip.
Invest the Maximum - Invest it Early
A contribution of $2,000 in an RESP invested at the beginning of each year for 18 years and growing at an average annual compounding rate of return of 10% grows to over $100,000 at a cost to you of $36,000. With an additional $7,200 in CESGs, the total value grows to almost $120,000.
However, if you contribute the maximum of $4,000 for only the first six years, and don't make any further contributions, your investment will reach almost the same value after 18 years at a cost to you of only $24,000. CESGs of $2,400 ($400 x 6 yrs) increase the growth to a total value of $116,589.
Invest Regularly
Not everyone can afford to invest a lump sum at the beginning of the year. An alternative is to make regular monthly contributions. For example, if you contributed $100 monthly to your child's RESP, the government would contribute a CESG of $20 per month, paid on a quarterly basis. At an average annual compounding rate of return of 10%, the total investment (including CESGs) of $25,920 will grow to more than cover your child's education costs.