My wife and I recently had our first child, and through all the excitement and joy that comes along with that, there are also a lot of financial questions. I wanted to make sure I was doing as much as I could to provide a good future for her, and part of that is saving for her education. I’ve always heard different comments about RESPs from people:

“You have to start it as soon as she’s born!”
“What if she doesn’t go to post-secondary school?! What if there’s free tuition by then?”
“You won’t qualify for the grants with your income!”
“A TFSA is better!”

So, I decided to do my own research, and put it all in this blog post to share with everyone else (and so I can refer back to!).

Disclaimer: This blog post may contain affiliate links, where I may earn a small commission if you sign up. This blog post is not financial advice and is meant for informational/entertainment purposes only.

 

What is a RESP?

A RESP (Registered Education Savings Plan) is a special savings plan to allow first introduced by the Canadian Federal government in 1974 (applied retroactively to 1972) to help families save for the costs of education. Since than the RRSP has gone through many changes, most notably in 1998 when they introduced the CESG (Canada Education Savings Grant) and 2004 when they introduced the CLB (Canadian Learning Bond). Since then, some provinces have also come out with additional grants towards the RESP, such as Quebec and British Columbia.

 

How does a RESP work?

A RESP allows people to save for the beneficiary’s future post-secondary education. In doing so, the government will contribute additional grant money to the RESP, allowing you to compound the savings over time. RESPs have no annual contribution limit, though grants are only received on the first $2,500 per year. The lifetime contribution limit is $50,000 per beneficiary, and you will be taxed if you over contribute (until it is withdrawn). You can have multiple plans at different institutions for each beneficiary, though the grants will be received on a first contributed first paid basis.

The CESG will provide 20% of annual contributions up to $2,500. For beneficiaries from low/middle income families, there is an additional 10-20% available on the first $500 contributed. This equates to an additional $50-$100 per year. The lifetime maximum CESG a beneficiary qualifies for is $7,200.

The CLB will provide up to $2,000 lifetime to an RESP. This includes $500 in the first year of eligibility as well as $100/year until they turn 16. To be eligible for the CLB, the beneficiary must be from a low-income family.

The BCTESG (British Columbia Training and Education Savings Grant) is a grant available to people living in British Columbia. It will provide $1,200 in additional savings when the child turns 6.

 

How does a RESP work for the child/beneficiary?

When the beneficiary has enrolled in full-time or part-time qualifying post-secondary education, the subscriber (person who set the RESP up) is able to withdraw money from the RESP. The money can be used for any cost related to education, such as tuition, books, rent, computer, vehicle, etc.

There are two types of withdrawals, the first being PSE (Post-Secondary Education) which are withdrawals consisting of what you contributed. The second type of withdrawal is EAP (Education Assistance Payment) which consist of investment earnings, grant money (including CESG, CLB, and any provincial grants/incentives.

EAP withdrawals are limited to $5,000 ($2,500 if part-time) for the first 13 weeks of consecutive enrollment, at which point there is no limit to how much you can withdraw. There are no limits on PSE withdrawals.

 

How are RESP withdrawals taxed?

Taxes are an important factor on making withdrawals from a RESP. In this section we will talk about how withdrawals are taxed if the beneficiary does attend post-secondary school, while in the next section we talk about how taxes work if the beneficiary does not attend school.

As previously mentioned, there are two types of withdrawals, and they are both taxed differently.
PSE withdrawals (which consist of only money that was contributed to the plan) are not taxed on withdrawal, as they were contributed on after-tax income.
EAP withdrawals (which include grant money and investment income) are taxed in the beneficiary’s name. Since the beneficiary is in school and will likely have low income and some tax credits, they will often end up paying no tax.

 

What happens if the beneficiary doesn't go to post-secondary school?

If the beneficiary chooses not to go to post-secondary school, you have a few options to choose from.

First, it’s important to understand what exactly a RESP can be used for, so you don’t miss the opportunity. To qualify for a RESP, a full-time course of study must last at least 3 weeks in a row with at least 10 hours per week. A part-time course must last at least 3 weeks and require students to spend a minimum of 12 hours per month on the program. This can include apprenticeships/trade school as well as some online courses.

If the beneficiary doesn’t meet any of that criterion, you might consider keeping the RESP open in case they change their mind. Canada allows a RESP to stay open up to 36 years.

You can also transfer the RESP to another beneficiary, though you may have to pay back any grants in case of excess contribution for the new beneficiary. If the beneficiary has a sibling, you may be able to transfer it to them tax-free, including CESG.

If you are sure the beneficiary will not attend post-secondary education, and are ready to close the account, there are a few things you need to know. Any contributions can be withdrawn tax-free at any time, but the grants the RESP received will have to be returned to the government. Investment income cannot be withdrawn until the RESP has been open for at least 10 years, and the beneficiary has reached the age of 21 and is not pursing post-secondary education. At that point the investment income can be withdrawn as AIP (Accumulated Income Payments). Once AIP is requested, the RESP will be closed in February of the next calendar year. AIP are taxed at the subscribers marginally tax rate plus 20%.

In order to prevent paying tax on withdrawal of the RESP, they allow subscribers to transfer up to $50,000 ($100,000 for joint subscribers) tax-free to their or their spouses RRSP, if they have sufficient room.

Beginning in 2014, if the RESP beneficiary also has an RDSP (Registered Disability Savings Plan), the AIP can be transferred to the RDSP if sufficient room is available.

 

How do I start a RESP?

So, you’ve made the big decision to start a RESP, congratulations! Whether it is your child, grandchild, or other relative, they are lucky to have you! The next step is to find a provider. When deciding on a provider, you need to consider fees, minimum deposits, investment options, etc. Higher fees can have a huge effect on investment returns over a long period.

I decided to go with Questrade, which offers hands-on or hands-off investment paths. If you prefer to choose your own investments within the RESP, like myself, they have free ETF purchases, no account fees, and no inactivity fees. If you prefer a hands-off approach, which may be a good idea with a RESP, Questrade offers a platform called Questwealth, which will ask you a bunch of questions to get your risk tolerance and will invest the money for you for a small fee. QuestWealth has very low fees compared to traditional funds, and are rebalanced by their managers, who also take advantage of tax loss harvesting.

For a full review of Questrade, check out this blog post!

 

How to take full advantage of a RESP

To take full advantage of a RESP, you must do some planning. That starts at the very beginning, by putting your contributions to work in an investment that will grow at a good rate and continue to compound. The difference between earning 8% compared to 2% while contributing $2,500/year is $55,817. That doesn’t mean you should be investing in risky investments in an attempt to get a higher return. Your child’s education is not something you want to gamble away! Unlike your retirement savings, a RESP will likely be required in a specific year, so you may be unable to put off withdrawals waiting for the market to recover.

The next stage of planning is when the beneficiary has decided what their post-secondary plan is. At that point you can start calculating how much they will need per year in tuition, living expenses, books, food, etc. Then you should ask your RESP provider for a breakdown of how much of the RESP is contributions/investment income/grant money and decide how much you should take out of each to prevent the beneficiary from paying too much in taxes (ideally no taxes at all).

 

Is it worth contributing to an RESP?

A RESP is almost always worth contributing to, assuming your budget allows you to. Starting early allows the investment to compound for a longer period of time, creating a bigger snowball effect. There are a few scenarios where it may not be worth it for you to start an RESP.

One of those scenarios is if you’re fairly certain the beneficiary won’t attend post-secondary education, and you wouldn’t have room in your RRSP to avoid the taxes if you had to close the RESP. Another scenario is if your budget does not allow it. You don’t want to sacrifice your own retirement savings attempting to save for the beneficiary.

 

Conclusion

A RESP is a great way to save for your child’s future. Over 1.7 million Canadian students currently have student loans, totaling $22 billion in student debt. With the average cost of post-secondary education now reaching over $80,000, it’s more important than ever to start saving early.

“I want to give my kids enough so that they could feel that they could do anything, but not so much that they could do nothing.” – Warren Buffett

In this post we’ve tried to put together all the most important information you need to understand everything about RESPs, but if you’re looking for more details they have a pretty good guide on federal Canada website at www.canada.ca