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Registered Education Savings Plan (RESP)

RESP?

I’m getting to the stage in my life where I have to start considering kids into my life plan. How will kids fit into the financial picture? How will I teach my kids proper financial values? How will I help pay for their education?

The last question, “How will I help pay for their education” is what we’re going to discuss today. I’m not saying that I plan on footing the entire University/College bill, as I paid for my own, but I would like to be able to help my children if they need it. I guess the only way to ensure that money is available when the time comes is to save for it.

In Canada, this naturally leads us to the Registered Education Savings Plan (RESP). The RESP is a government incentive for parents to save for post secondary education for their children.

How RESPs work:

  • Unlike an RRSP, with an RESP, there is no tax deduction on the contributions. You do, however, get tax free growth in your RESP portfolio.
  • The RESP account can grow tax free and taxed in the hands of your lower income child when it comes time for University. Contributions can be withdrawn tax free (at any time) since they are paid with after tax dollars.
  • Maximum contribution is $4000 annually New rules state that there is no maximum annual contribution limit only the lifetime max (21 years) of $50,000.
  • CESG: Contributions up to $2500 annually are eligible for the Canadian Education Savings Grant (CESG). The CESG will give you an extra 20% on your contributions (up to $500 CESG annually).
  • Enhanced CESG: Low income families (<$36,378) are eligible for up to $600 in CESG annually (extra 20% on the first $500 in contributions). If your family income is between $36,378 and $72,756, you are eligible for up to $550 CESG annually (extra 10% on the first $500 in contributions).
  • If there is unused grant room from previous years, you are eligible for up to $1,000 in CESG for that year.
  • There is a lifetime max CESG of $7,200 per beneficiary/child. Caveat: If your child does not go to University, the CESG must be repaid to the govt.
  • RESP funds can be transferred to an RRSP account (max $50k) if not utilized after it’s maximum lifespan.

What I like about RESP’s:

  • The CESG, which would give us a 20% increase on our RESP contribution / year of up to $2,500 ($500 CESG). Ie. A $2,500 contribution would be topped up with a $500 government “gift” giving us $3,000 for that year.
  • Tax free growth – I could mix up the portfolio with fixed income products and not worry about the 100% taxation of interest income.
  • Ability to transfer the portfolio into my RRSP in case my child/chlidren do not go to University (not if I can help it ;)).

What I don’t like about RESP’s:

  • If my child/children do NOT go to University/College (or other qualified educational institutions), I am limited to transferring $50k of the RESP earnings/growth to my RRSP provided that I have the contribution room. If I don’t have the room at the time, I’m assuming that the remaining will have to be withdrawn as INCOME. Which means a 20% penalty AND taxed at my marginal rate! Note that the capital can be withdrawn at any time without taxation.
  • On top of the taxation, I would be forced to pay back all CESG’s given. So assuming that I receive the lifetime max of $7200, that would mean I would have to pay: $7200 + 20% penalty (on growth) + income tax (on growth). Ouch.

The chance that the beneficiary will not go to University has grave tax consequences when it comes to an RESP. Perhaps a better solution would be to open a separate non registered account and invest in dividend paying stocks. At least then, if the child decides against post secondary schooling, you’ll have a nice portfolio to boot.

There are more details regarding the RESP on the Scotia bank RESP basics page.

Update Jan 19, 2007: According to a reader comment, the RESP is the best way to go if you are planning on saving for your child’s educational future. Reason being is that if your household has a fairly high income with education as a high priority, there is a HIGH probability (>75%) that your child/children are going to participate in post secondary education of SOME sort. Also, if your child does NOT take post secondary education, only the GROWTH is taxable which can be transferred to your RRSP.

Update March 2010: Check out The RESP Book (link) written by a fellow Canadian Personal Finance Blogger.  It is one of the only books written on RESP’s and explains all the ins and outs in an easy to understand manner.  Check out my RESP Book review.

Any body out there using the RESP system right now? What do you think of the program? What strategies do you use to maximize the program?

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FrugalTrader About the author: FrugalTrader is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 2 comments… add one }

  • Allison January 12, 2014, 4:14 pm

    You only need room in your RRSP for the growth portion of the RESP, not the contributed portion.

  • Emily November 6, 2015, 1:27 pm

    @Ed Rempel. What if someone already made the mistake of entering into the CST (group RESP) plans? 7 years ago, my husband and I thought we were doing the right thing by starting a plan so early. I quickly realized my mistake but it was too late. If I had of switched my plan, I would have lost $2400 of “enrollment fees.” The HUGE downside to these plans is that you can’t reduce your amount of contributions. It seems like a great idea when you are enjoying a double income of $130000/yr but not when reduced to a single income of $60000. Of course, if I had to, I could have reduced (and just lost the enrollment fees) but I can’t stand that type of loss. I recently called and apparently because I have contributed for so long, I am eligible next year to stop/reduce my contributions without penalty. Should I stop contributing and start a new plan with the bank for her? Now that I’m in so deep, should I just keep going? I made better decisions for the RESP for my son luckily, but since I can vary my monthly contribution, his has accumulated much less :(

    Thanks for all the info! Love this blog..

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