RESP: Really Essential Schooling Plan

Photo Credit: National Bank

Good morning Toronto! Children are indeed expensive. When it comes to post-secondary education, the fees can quickly add up! Today, we will break down how the Registered Education Savings Plan (RESP) can be used to efficiently save for future children’s educations. Specifically, we will discuss the rules surrounding contributions and withdrawals from the Plan.

As the name suggests, the RESP is a Registered Plan that helps people (the subscriber) save money for someone else’s (the beneficiary’s) education. Usually, parents/guardians open up RESPs for their child(ren)’s future education.

Technically, anyone can contribute to an RESP and name a beneficiary, provided the beneficiary has a SIN number (which must be provided to the financial institution) and is a Canadian resident at the time of the designation. For this reason, a beneficiary can have multiple RESP accounts – for example, one held by the parents and one held by grandparents. Regardless of how many RESP accounts exist, there is a lifetime contribution limit of 50k across all accounts. Although it is possible to contribute a lump sum, this is generally NOT advisable, for reasons which will soon be apparent.

Like many other Registered Plans, RESPs are regular accounts where so-called Qualified Investments can be held. As a quick refresh, most investments (such as GICs, stocks, mutual funds, etc) are Qualified. Generally, Investments become prohibited only when someone owns a ‘substantial’ portion of a company, although these cases are fairly rare. See RRSP: Really Radical Savings Plan? article for a more detailed discussion of acceptable investments.

Some companies offer RESP management services, but this is *highly* NOT recommended due to many of these plans coming with high fees, penalties, and restrictive contracts. Generally, it is much better to hold the RESP as a regular self-directed account (where the subscriber has the option to choose investments themselves). A common strategy for investments is to buy and trade stocks, mutual funds, and ETFs during the first 10-15 years of the child’s life, and then liquidating these investments in favour of less volatile GICs (term deposits) as the child gets closer to graduating high school.

Like other Registered Plans, there are incentives to save. Perhaps most well-known is that the government matches a portion of contributions to the account. With the Canada Education Savings Grant (CESG) scheme, the government matches 20% of the first $2.5k of contributions, to a lifetime maximum of $7,200 of CESG. As discussed earlier, while there is no annual contribution limit, the government still highly encourages subscribers to contribute on a regular basis, rather than in a few lump sums, through the CESG scheme. If a child has multiple RESPs, then the CESG is given to the account that makes the first contribution. Contributions, unlike RRSP/FHSA contributions, are NOT tax-deductible.

Should someone not contribute the full amount in a year, then CESG ‘room’ is carried forward, and subscribers can continue to receive the match on contributions made until the end of the calendar year in which a beneficiary turns 17. However, when the beneficiary is 16 or 17, one of two covered exceptions MUST apply to be eligible for the CESG grant. Namely:

• At least $2000 was contributed across all RESPs before the end of the calendar year the child turned 15, OR
• At least $100 was contributed across all RESPS in AT LEAST four (4) calendar years before the beneficiary turned 15.

For lower-income families, the Canadian government also offers incentives for savings through additional matching incentives. The government matches an additional 10% on the first $500 of contributions of CESG for families with combined net incomes between $55,867 and $111,733*. If the net income is under $55,867, the match is now an additional 20% on the first $500. However, the lifetime CESG limits are still in place, so this additional CESG is essentially a scheme to lower the contributions needed to qualify for the maximum grant.

Separately from the above, there is also the Canada Learner's Bond (CLB). The income qualification for this scheme is based on both the number of children in the family and the child size. Currently, if a family has 1-3 children and their combined net income is under $55,867*, they qualify. As the number of children goes up, so does the income threshold. If the family qualifies, $500 per child is deposited into the RESP during the first year they qualify, with an additional $100 per year for each year they continue to qualify, until the year the child turns 18.

*The net income figures are indexed (rise/decrease) to match inflation.

On top of these, some provinces in Canada offer their own grants for education. For example, in British Columbia, the government offers a one-time payment of $1.2k into the RESPs of eligible children. Ontario has no such program.

Unlike most of the Registered Plans we’ve discussed, the CESG and CLB are NOT governed by the Act or the Regulations. Instead, both are legislated in the Canadian Education Savings Act (CESA), which, amongst other requirements, states that a child MUST be ‘resident in Canada’ to receive either benefit. While beyond the scope of this article, a child can live abroad and still be considered a factual tax resident of Canada under specific circumstances. However, the implications of CESA mean that these people DO NOT qualify for either benefit.

Somewhat questionably, the definitions of ‘residence’ or ‘resident’ are not defined in the Act. Rather, several landmark cases (see Thomson v. Minister of National Revenue, 1946 SCR 209) have essentially interpreted ‘resident in Canada’ to mean the person in question is physically present in Canada AND ordinarily living here.

As seen, funds inside an RESP can come from multiple sources – subscriber contributions, government grants, and investment growth. When the time comes to withdraw the money, there are restrictions and rules for withdrawing from each source of funds.

Most common of these are Educational Assistance Payments (EAPs). EAPs are paid to the beneficiary if they are enrolled in a qualifying post-secondary program, which, for the most part, are colleges, universities, or trade schools. The funds are intended to help cover the costs of education, such as tuition, books, and living expenses. There are limits to withdrawals, which are:

• $8k in the first 13 weeks of a full-time program, and unlimited for any period afterwards.
• $4k per every 13 weeks of a part-time program.

EAPs are drawn from the government grant and investment growth portion of the RESP, and are considered taxable income for the student. Generally, students tend to have little earned income during their studies. Any taxes are usually offset by the Tuition Tax Credit.

The government also allows the original contributions to be withdrawn on a tax-free basis, since they were made with money that was already taxed when the original subscriber contributed to the account. These amounts can be paid to either the contributor or the beneficiary.

However, sometimes the beneficiary chooses not to immediately attend school. In these cases, the government allows the RESP to remain open for up to 35 years. If the beneficiary qualifies for the Disability Tax Credit in the tax year of the 31st anniversary of the plan, then the RRSP is allowed to remain open for 40 years.

*Generally, this means the beneficiary has significant impairment in performing 1 or more major life function(s) due to physical or mental disability.

Should the plan meet the deadline, it must be closed. Before closure, the account must be liquidated. The contributions are returned, tax-free, to the subscriber. All provincial grants, CESG, and CLB monies are repaid to their respective governments. The investment growth is paid out as Accumulated Income Payments (AIPs), which are taxed like regular income, plus an additional 20% surtax. It should be noted that AIPs can also be paid out under additional pretexts, such as if:

• The RESP is opened for >10 years AND the beneficiary is > 21 years old AND not eligible for an EAP (this is satisfied if they are not attending a post-secondary institute); OR
• All the beneficiaries under the RESP are deceased

In any event, if an AIP is paid, the RESP must be fully closed by the end of the next February after the first AIP is paid.

Alternatively, AIP amounts can be transferred (where applicable) to the beneficiary’s Registered Disability Savings Plan on a tax-deferred basis, but are subject to, and will reduce, the $200k lifetime contribution limit for that plan. More commonly, up to $50k can be rolled-over to the subscriber’s RRSP, provided there is still contribution room. However, these contributions are not tax-deductible. If qualified, it is much more preferable to do either of the above rollovers, as opposed to paying the 20% surtax. If none of these options are viable, the funds must be withdrawn and subject to the tax.

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