What is an RESP?
An RESP is a savings plan which allows you to save up money for you children’s future post-secondary education. The plan allows the contributions and income generated to grow on a tax-free basis.
An RESP account can be opened as soon as the person the plan is created for is born and has a social insurance number.
Why Should I Contribute?
The main benefits for setting up a RESP are that:
- The Government of Canada provides a grant of 20% of your annual RESP contribution, to a maximum of $500, or $1,000 in situations where there is unused grant room from a previous year. The maximum lifetime limit for the grant is $7,200 for each qualifying beneficiary
- The Government of Quebec also provides a grant of 10% of your annual RESP contribution, to a maximum of $250, or $500 in situations where there is unused grant room from a previous year. The maximum lifetime limit for the grant is $3,600 for each qualifying beneficiary
- The contributions, government grants and income generated by the plan grow on a tax-deferred basis until such time as withdrawals are made
- Withdrawals are reported as income by your qualifying children which likely will be subject to little or no tax
What is My Contribution Limit?
The lifetime contribution for each qualifying beneficiary is $50,000. You could technically contribute the full amount as soon as an account is opened. However, the advantage of the government grants will only apply in the year the contribution is made to the maximum of $500 and $250 from each of Canada and Quebec. A large amount of the grants will therefore be given up in this manner, which is not ideal.
What is My Deadline to Contribute?
RESP contributions can be made any time during the year, in order to be eligible for the government grants for that year. Note that you can catch up on multiple years where contributions were previously not made. However, Canada and Quebec will limit their respective grants to a maximum of $1,000 and $500.
What if I Over-Contribute in the Current Year?
Contributions in excess of the $50,000 lifetime limit are charged a 1% monthly penalty by Revenue Canada until the excess amount is withdrawn.
What Can I Contribute?
In general, the same investments that are permitted for a Registered Retirement Savings Plan (RRSP) are permitted for a RESP account, the most common being:
- Guaranteed investment certificates (GICs)
- Equities both Canadian and foreign
- Mutual funds
Non-qualifying and prohibited investments include:
- Precious metals
- Personal property, including works of art, jewellery and antiques
- Commodity futures contracts
- Debt or equity in corporations where you have an ownership interest of 10% or more
- Shares or private holdings companies and shares of foreign private companies
- Real estate
What Kinds of Plans are Available?
There are individual and family plans.
An individual plan has one beneficiary only and is not required to be related to you. Your beneficiary on this account can be replaced but if the new beneficiary is not a blood relation or adopted, then the grant money must be repaid back to the government authorities. Typically, this would be a plan created for one-child families.
Contributions to individual plans can be made until 31 years from the plan inception, regardless of the age of your beneficiary.
A family plan can have more than one beneficiary. The beneficiaries of this type of plan must either be blood relations or adopted to you. It can be children or grandchildren. If more than one beneficiary is appointed, then you can allocate the contributions to each beneficiary. For example, if there is a significant difference in age then you may want to appoint the largest portion of the contributions to the older beneficiary, since the younger one has time to grow the funds.
Contributions to family plans can be made until the last beneficiary of the plan attains 31 years of age.
How are RESPs Taxed?
Once your beneficiary begins post-secondary education, withdrawals from the RESP are required to be made.
The first withdrawal is a mandatory amount and is $5,000 for the first 13 weeks of full-time enrollment and $2,500 for the first 13 weeks of part-time enrollment. Afterwards, you can request withdrawals for any available amount, with no limit.
Withdrawals that consist of amounts that were your original contributions are not taxable. This is a return of capital on a tax-free basis.
Withdrawals that consist of the government grants and income generated by the plan are taxable income and reported by your beneficiary.
It is recommended to draw down first on the taxable portion, since the beneficiary will likely have little or no tax to pay. In the event that your beneficiary decides to terminate their studies or if there are funds left over, this should consist mostly of original contributions, which can be withdrawn in full on a tax-free basis.
What if My Beneficiary Doesn’t Pursue Post-Secondary Education?
If your beneficiary chooses not to continue with school, there are a few options available:
- The RESP can be left open up to 36 years, which would allow your beneficiary to return to school in the future.
- For an individual plan, you can transfer the RESP plan to another child. If your new beneficiary is not a blood relation or adopted, then all previous grants must be repaid. Where the beneficiary is a blood relation or adopted and has an existing RESP, the lifetime limits on grants for an individual would still apply though, so any excess would have to be returned to the government. For a family plan, you are entitled to use the earnings and grants to pay for the education of another child named in the plan.
- You can collapse the plan. All contributions are returned to you, all grants are repaid to the government and the income earned by the plan is returned as an Accumulated Income Payment (AIP). This AIP is taxed when received and is subject to an additional penalty of 20% charged by the federal tax authorities and 12% by the provincial tax authorities.
- You can transfer the plan amount (to a maximum of $50,000) into an RRSP, if the following conditions are met:
- The plan has been open for at least 10 years
- All beneficiaries of the plan are at least 21 years old and not enrolled in post-secondary education
- You are a Canadian resident
- You have contribution room in your RRSP
- Your RESP plan rules allow for this option
This option would allow for the AIP to be part of the transfer to the RRSP and reduce the taxes payable resulting from the income reported from the AIP.