Use RESPs to fund education savings

The sooner you start, the greater the tax-deferred growth

Parents and grandparents naturally look to the future education of their young children or grandchildren. After all, 17 years really isn’t such a long time when you get down to it, and time flies! Post-secondary education is pricey, so the sooner you start saving, the better. Fortunately, there is a registered savings program that can help parents fund tuition when the time comes, and that also has some extra bonus points in the form of tax-deferred growth: the Registered Education Savings Plan (RESP). Here’s a look at how it works and some tips on how to get the most from it.

While contributions to RESPs are not tax-deductible as they are with Registered Retirement Savings Plans, they are invested in a special fund in which earnings accumulate tax-free until they are distributed as payments for post-secondary education to children, grandchildren, or other designated beneficiaries.

There are, however, no relationship requirements between the contributor and beneficiary, so that you may set up an RESP for any relative or deserving beneficiary who is a Canadian resident and can provide a Canadian Social Insurance Number (SIN).

Three types of RESPs

1. Individual RESP plans: This plan is simple – anyone can open an individual RESP for a particular beneficiary and contribute to it. This can be a parent, a grandparent, or anyone who wants to benefit the child.

2. Family RESP plans: In a family plan, you can have one or more beneficiaries, although they all have to be related to the contributor (this includes nieces and nephews). The beneficiaries also have to be under 21 when they’re added to the plan.

3. Group RESP plans: In a group plan, one single child is the beneficiary, and that child does not have to be related to you, but many people are contributing to this plan. So essentially, the beneficiary shares the pooled earnings of investors with children of the same age. Group plans tend to have more restrictions and rules than other plans.

RESP financial and tax benefits

Tax deferral. Income earned on the (nondeductible) contributions you make to the plan is not subject to tax; accordingly income accumulates more rapidly in the plan than it would in the hands of the contributor;

Income splitting. When amounts are paid out of the plan for the post-secondary education of a beneficiary, they will be taxed to the beneficiary. This can result in little or no tax on the earnings, since a taxpayer (i.e., the child) with no other income can earn at least about $14,000 (at current rates) annually completely tax free, by virtue of the basic personal tax credit, with additional tuition and education tax credits being available to also increase the effective tax-free amount. Even if these tax-shelter sources are exhausted, the lowest tax bracket would then apply.

Incentive grant. The government will actually match RESP contributions under the “Canadian Education Savings Grant” (CESG) with a 20% grant paid to the plan on contributions of up to $2,500 per year (more details below).

As a contributor (subscriber) to an RESP, you are not entitled to a deduction for your contribution; however, the interest income (or other investment income) earned in the plan on your contribution is not taxed in your hands. Rather, the investment income earned in the plan is accumulated free of tax and will be taxed in the student’s (child’s) hands only when the child receives funds from the plan.

While there is no annual limit for contributions to RESPs (as of 2007), the lifetime limit on the amounts that can be contributed to all RESPs for a particular beneficiary is $50,000.

Excess contributions

A penalty tax of 1% per month of any excess contributions is assigned pro rata to each contributor’s contributions. This means that the lifetime limit cannot be avoided by establishing more than one RESP or by having different subscribers establish RESPs. Note: Payments made to an RESP under the Canada Education Savings Program (CESP) or any Provincial Education Savings Programs are not considered for the $50,000 lifetime limit.

The penalty tax is payable within 90 days after the end of the year in which there is an excess contribution. An excess contribution exists until it is withdrawn (so yes, you can withdraw the excess). However, you have to inform the CRA of your share of the excess contribution to all RESPs for a beneficiary.

In general, the rules ensure that plans must provide that education benefits are only paid to bona fide students in full-time attendance in qualifying educational programs at post-secondary educational institutions.

Planning points

* RESP rules in general make these plans far more attractive as an income splitting vehicle for setting aside savings for the higher education of your children, grandchildren, or other young relatives.

* If you have invested in a RESP and it begins to appear that no beneficiary will use the plan before its mandatory 25 year expiration, you should consider foregoing RRSP contributions if necessary, to ensure adequate contribution room to cover a return of plan earnings.

Next time: Withdrawing funds from RESPs.

Samantha Prasad, LL.B., is a Partner with Toronto law firm Minden Gross LLP, a Meritas Law Firm Worldwide affiliate, and specializes in corporate, estate, and international tax planning. She writes frequently on tax issues, and is the co-author of Tax and Family Business Succession Planning, 3^rd Edition. She is also co-editor of various Wolters Kluwer Ltd. tax publications. A version of this article first appeared in The TaxLetter, © 2022 by MPL Communications Ltd. Used with permission.

Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.