The Registered Education Savings Plan (RESP) remains a popular and flexible tool for Canadians looking to increase their children’s savings for post-secondary education. While many are moderately familiar with how this plan works, the parameters and practical uses of the RESP continue to be confusing and may lead investors to seek clarification from their financial advisors.
“Most of the people I’m in contact with are familiar with RESPs and have some grasp of the basics – and then there are some complexities that would come in handy,” says Sandi Martin, Partner, COO and Planner. Financial at Spring Planning Inc.
Here are three important RESP facts advisers say Canadians need to know:
1. An annual contribution of $ 2,500 will not maximize the plan.
Most RESP subscribers know that in order to receive the maximum annual Canada Education Savings Grant (CESG) of $ 500 from the federal government, they must contribute $ 2,500 per year to their child’s plan, starting when they are first year. Using this method, they would reach the maximum Lifetime CESG of $ 7,200 in the child’s 14th year.
“They know that part,” Ms. Martin says. “But then the question is almost always, ‘Why would I put more than that? “
The reason, she says, is that this approach will leave subscribers with $ 36,000 in contributions, which is nowhere near the RESP’s lifetime contribution limit of $ 50,000.
“If you start putting in $ 2,500 a year while your child is [born], then you have an additional $ 14,000 [in contribution room] available [after maxing out the CESG] to bring it up to that $ 50,000 lifetime contribution maximum. [Those extra contributions] don’t attract a subsidy, but could still go into the account and grow on a tax-deferred or tax-transferred basis, ”says Ms. Martin.
“The idea that you might even be doing this is often something that people don’t realize is an option,” she adds.
To take more advantage of the settings, one option is to pay the additional $ 14,000 in the child’s first year, explains Peter Guay, portfolio manager at PWL Capital Inc. in Montreal.
This strategy would allow money to grow efficiently tax-free for 18 years, he said.
2. Not all RESP funds are treated the same.
For many RESP subscribers, understanding that there are three theoretical pots of money in RESPs is the most important area in which they could improve their own experience and use of the plan, says Martin.
From a tax perspective, each category – the investor’s contribution, the government grant, and any growth and income earned in the account – is treated differently.
When withdrawing assets held in an RESP for educational purposes, an individual’s contributions – known as post-secondary education payments – are tax-free. The portion of the grant along with any growth, known as Educational Assistance Payments, will be taxed on behalf of the recipient.
Individuals should review these rules regularly over contributory years, says Martin. They will likely benefit from this when determining how to withdraw funds in the best way for their circumstances.
Generally, Guay says students won’t earn enough income to be taxed on the growth and grant portion of the RESP if withdrawals are spread evenly over the duration of their degree. But in some situations, it may be a good idea to remove this part earlier.
“Depending on what you study, you may earn more in later years in your summer jobs, so taking more of that grant and earning earlier is often the best way to do it so that at least when they ‘ve finished college, there is only capital left, ”he says.
One area where Canadians can easily break the rules is not using all of the plan’s funds before winding it up, says Guay. In these cases, the RESP subscriber will be taxed on any growth left behind and any unused grants will revert to the government. As such, he says, it’s important to have a plan in place to spend it during post-secondary years.
“Even if you don’t intend to spend it all on the child, remember that contributions can be made, tax-free, on your own behalf. So you can still spend the grant money and the growth on the child’s education, then withdraw the contributions and put them in your own RRSP later, ”he says.
3. The complexity of the family RESP
For those with more than one child, Family RESPs can allow funds to be reallocated between beneficiaries up to a maximum of $ 7,200 in CESG per person.
But some subscribers may not realize these plans are complicated, says James Schofield, vice president and senior financial planning advisor at Assante Capital Management Ltd. in Ottawa.
Individuals and advisers need to ensure that monthly contributions are properly redistributed to younger beneficiaries, as older children begin to withdraw assets and are no longer eligible for grants, he says.
Families also need to plan ahead, when it comes to knowing their children and how the money is likely to be distributed, especially in situations where not all recipients are in four-year post-secondary programs.
“Having an advisor is really important because we know our clients,” says Schofield. ” [For example], the first child will go to a one-year trades school which will cost $ 10,000, so let’s get all of his $ 7,200 CESG and as much of his growth back [in the plan] and leave contributions for the other two children who will attend four-year programs.