RESPs were created to encourage Canadians to save for their children’s post-secondary education. The encouragement comes in the form of the Canada Education Savings Grant (CESG) paid into the plan by the government. With proper planning, the CESG can total $7,200 per child over the lifetime of an RESP.
RESP Basics
RESPs are similar to RRSPs because the investment income earned on your contributions is not taxed until it is withdrawn from the plan. The withdrawals, however, are taxable to the plan’s beneficiary – usually a student who will pay little or no income tax on the withdrawal.
RESPs differ from RRSPs in that your contributions are not tax-deductible.
CESG Basics
The CESG payment equals 20% of your contributions, and it is paid until the end of the year in which the beneficiary turns 17.
Annual maximum CESG per child: $500
Contribute $2,500 ($2,500 x 20% = $500) per year per child to receive the maximum annual CESG of $500.
Lifetime maximum CESG per child: $7,200
Contribute $36,000 ($36,000 x 20% = $7,200) over the lifetime of the plan per child to receive the maximum lifetime CESG of $7,200. If you contribute $2,500 per year, it takes about 15 years to realize this $7,200.
RESP Withdrawals
The balance in an RESP has three components:
contributed capital, income growth, and grant money.When making a withdrawal, you choose the components from which to withdraw. Withdrawals from contributed capital (your contributions to the plan) are tax-free; withdrawals from income growth (increase in value) and grant money (the government’s CESG contributions) are taxable to the beneficiary.
What if?
What if your child doesn’t attend university?
If you choose to close the RESP, grant money (CESG) will be refunded to the government, your contributions will be refunded tax-free, and all income growth will be paid out to you as an Accumulated Income Payment (AIP). AIPs are subject to income tax, plus an additional 20% penalty upon withdrawal from the RESP.
Alternately, all taxes may be avoided if the AIP is transferred to your RRSP. You must have sufficient contribution room, and there is a lifetime limit of $50,000 for AIP transfers to an RRSP. Having enough RRSP contribution room to absorb the AIP transfer can be a problem; however, if both parents are RESP account holders, the AIP can be shared between both parents’ RRSPs.
If you’re comfortable with the above concepts, you now know how an RESP works: how money comes into the plan and how it is withdrawn. As with any other registered account, you can hold a mix of investments in the plan (stocks, bonds, ETFs, etc.). The differences between an RESP and RRSP are the rules governing how you contribute to the plan and access the funds. How you choose to invest the money inside these plans is entirely up to you and your advisors.