How to get the most out of registered education savings plans (RESPs)

What is an RESP?

An RESP is an investment plan that lets people save for post-secondary education. That can mean college, university, apprenticeships or trade schools. While you can set one up for an adult — even yourself, if you want — they’re typically used to save for kids. RESPs are such an effective way to save up for your own or your child’s future educational needs because there are numerous benefits, including government grants like the Canada Education Savings Grant (CESG), which matches 20% of annual contributions up to a specific limit, providing free money to boost your savings. Furthermore, your money grows tax-free until you take it out.

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How does an RESP work?

Here’s how an RESP works.

The “subscriber” (the parent or guardian) sets up the RESP, usually through a bank or other financial institution, and then makes contributions over the years. You can grow your money in the plan through various investment options, including stocks, GICs and mutual funds.

There’s no limit to how much you can contribute per year, but each child can only be assigned a maximum of $50,000. Anything above that amount is taxed at 1% per month until you remove it. When it comes time to pay for school, the subscriber withdraws on behalf of the “beneficiary” (the campus-bound child). The beneficiary can’t withdraw independently but can use the money you give them to pay for almost anything, including tuition, books, transportation, rent or a meal plan.

Why should I use an RESP?

It's simple. You get free money — a reward from the Government of Canada for supporting higher education.

The Canada Education Savings Grant (CESG) adds 20% to the contributions you make for your children. The grant maxes out at $500 per year, so if you have more than $2,500 on hand, you should stagger your investment to maximize the grant amount you'll receive.

If you don't have that much ready to go, that's okay. Any unused grant money is carried forward, though you can only net up to $1,000 in free cash annually. The grant lasts until the beneficiary turns 17, and you have to start saving before age 15 to get the last two years.

Lower- and middle-income families can get an even more significant return on their contributions, up to an additional 20% on the first $500 they save.

In addition to the CESG, low-income families can get the Canada Learning Bond. Your eligibility and the amount you receive depends on how many children you have and how much money you make.

You don't need to put a dime into your RESP to qualify for the bond; you need one. The government will contribute up to $2,000, starting with up to $500 for the first year and $100 installments for every year the child is eligible until they turn 15.

The other big benefit of RESPs is related to taxation. Like registered retirement savings plans (RRSPs), RESPs are tax shelters: All capital gains, dividends and interest are completely safe while your investment grows. However, unlike RRSPs, you can't deduct your contributions from your income tax.

When it's time for the student to use the funds, they'll only pay income tax on your earnings in the RESP — not the original amounts you invested. And since students are a notoriously low-income demographic, they probably won't make enough to warrant any income tax at all.

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What happens if my kid doesn’t go to school?

First, the beneficiary has ample time to reconsider their decision not to attend secondary education. You can contribute to an RESP for up to 31 years after it's opened, and the plan can remain open for up to 36 years. This means that if you started an RESP when your child was born, they can still access and use the funds well into their 30s, which gives them ample time to reassess their educational goals.

Don't freak out if your child scraps plans for higher education altogether. You can get your money back.

Your personal savings can be withdrawn tax-free, though you will lose the interest and the government grants unless certain conditions are met. For example, the RESP must be at least 10 years old, and the beneficiaries must be over 21. If you tick all the boxes, you'll get the extra money but be taxed at your regular income tax rate plus 20%.

Alternatively, the RESP can be transferred tax-free to a sibling's RESP as long as the sibling is under 21. You can also roll up to $50,000 into your own RRSP, as long as you have the room.

RESP Canada rules

Here are the main rules to keep in mind if you are planning on investing in an RESP:

• Contribution limits: There is a lifetime contribution limit of $50,000 per beneficiary. This includes all RESPs naming the child as a beneficiary. There are also no annual contribution limits for your RESP account though you will want to ensure you make the minimum required amount to be eligible for government contributions.
• Length of account opening: RESP accounts may remain open for 36 years maximum.
• Taxes: Contributions grow tax-free within the RESP. Investment income, such as interest, dividends, and capital gains, is not taxed until it is withdrawn. Taxes for withdrawals for educational purposes are then paid by the beneficiary, who typically has little or no income, resulting in minimal tax liability.
• Withdrawal rules: If the beneficiary does not pursue post-secondary education, the income earned in the RESP can be withdrawn by the subscriber. You’ll only pay taxes on the amount the RESP earned at a rate 20% higher than your income tax rate.
• Penalty tax: Contributions exceeding the $50,000 lifetime limit are subject to a penalty tax of 1% per month on the excess amount until it is withdrawn.

What type of RESP should I get?

Family plans:

These can only be opened by the parents, grandparents or siblings of the beneficiaries. Family plans are great if you have more than one child because a single family plan can be shared among several children.

Individual plans:

These plans only allow for one beneficiary and are ideal for an only child or a beneficiary you’re not directly related to. So, if you have a niece or nephew you’re especially fond of, an individual plan is best.

Group scholarship plans:

These plans allow multiple subscribers to pool their money to invest for their children. Be sure to read the contract carefully if you’re considering a group plan; the private companies that sell them have received a lot of negative press for their sales fees and mandatory contribution schedules.

Where can I set up an RESP?

You can get an RRSP from banks, credit unions, trust and investment companies and other select organizations that specialize in RESPs. The government of Canada has a website that enumerates a list of RESP providers (known as “promoters”).

How to open an RESP

The process itself is easy. Just have your social insurance number, your child’s social insurance number and birth certificate handy.

You can start an RESP anywhere — at a bank, credit union or with your financial planner. Depending on where you go, you may have to pay fees to set up an account, maintain it or make investments.

If you’re new to investing or find it challenging to manage your own accounts, consider the option of opening an RESP with a robo-advisor. This automated service, after you've selected your preferred risk level, will design a portfolio for you and make necessary adjustments as the market fluctuates.

By understanding RESP Canada rules and how it works, you can maximize the benefits of a registered education savings plan.

With files from Sandra MacGregor

Sources

1. Statistic Canada: Key Trends in Elementary to Postsecondary Student Enrolments, Graduations and Tuition Fees (Jan 16, 2024)