The RESP – Financial Anatomy 101: Reproductive Anatomy

Leonardo da Vinci, ~1510-1513 AD.

This is the part of basic financial anatomy class where we begin to delve into dealing with the consequences of our most basic of biological imperatives. Children.

After years of “practicing”, you have finally brought a little “Mini-Me” into the world. At first, you will just be happy if they learn how to eat, sleep, and toilette on their own, but eventually you’ll want to ensure that they get a solid education. The reasoning is to maximize the odds of them landing a good job, and most importantly, not living in your basement far into adulthood.

Well, getting your basement back ain’t gonna be cheap.

The average cost of tuition is about ~7K/yr this year for an undergraduate degree and if you think Mini-Me may follow in your footsteps, Evil Medical School will set you back 15-20K/yr after that. Many young adults who get degrees find that they need a college diploma in a vocation to land a job. Many others will go straight to the college route or trades route. While cheaper, that is still 3-4K/yr for training.

Housing and living expenses are another 10-15K/yr on top of tuition. Of course, there is significant variation in tuition and costs of living depending on the school or city.

It is safe to say, that you should plan on setting aside 50-100K for education per kid if you plan on fully covering their education. Enter the Registered Education Savings Plan (RESP).

Main Features:

  • Can be opened by anyone as the “subscribers”. It can have joint subscribers who are the parents/guardians, spouse, or common-law spouse.
  • You don’t need to be the subscriber to contribute. Common non-subscriber contributors would be grandparents, other relatives, and family friends.
  • The “beneficiary” can be any individual (Non-Family Plan), or a group of individuals related by blood or adoption (Family Plan).
  • It is opened via a “promoter”. This can be a company, called a scholarship plan dealer, that sells you participation in their RESP plans. Alternatively, you can open a self-directed RESP via a bank or brokerage.
  • You can contribute up until the beneficiary turns 31, up to $50000/beneficiary over their lifetime. The RESP can stay open up to 4 years after that. Those with disabilities can get a 5 year extension.
  • Excess contributions result in a 1% per month penalty. Brutal.
  • Contributions are with after-tax dollars.
  • When you contribute to an RESP of someone under 18 years old, the beneficiary can get a Canada Education Savings Grant (CESG). It is basically free money for education, but I will discuss the nuances below.
  • Investments in an RESP grow tax-free.
  • You can take your contributions back out without paying tax at any time for any reason. However, if you got a CESG, you will need to pay that back if not removing it as an Education Assistance Payment (EAP).
  • At the time of their post-secondary education in a qualifying institution or programme, the beneficiaries can access the money from the CESG and the tax-free growth as Education Assistance Payments (EAPs) to help pay for their education-related expenses. This is taxed in their hands (likely at a very low marginal rate). Since it was originally made with after-tax dollars, the initial capital that you contributed is withdrawn tax-free.

How to set up an RESP

First, you have to register your progeny as a person in Canada which entails getting their birth certificate and a Social Insurance Number.

Next, you need to decide which flavour of RESP to use.

It is critical to know about this to make an educated decision before you are approached by a scholarship plan dealer selling a group RESP. Somehow their glossy pamphlets find their way to new parents or a salesperson pays them a visit. The state resulting from the mix of hormones, emotions, and sleep deprivation that accompanies a new baby is not usually the best time for making big financial decisions on the fly.

Group RESP: It is very structured and administered by a promoter company. Some people find that structure helpful. However, it is also laden with fees and restrictions for doing so.

  • A product administered via a scholarship plan dealer.
  • Enrollment or Membership Fees: This is a start-up fee and basically is to pay the sales commission. It can consume up to about half of the first three years contributions (ie thousands of dollars). While you can usually get half your fee back if you pull out, that is not much consolation when that money taken at the beginning could have been compounding and growing for all those years. No wonder there is aggressive marketing!
  • Depository Fees: This will vary depending on the frequency of contributions, but are usually negligible.
  • Insurance: Some require group life and disability insurance that will cost 1.5-2% per year.
  • Administrative & Investment Management Fees: This typically runs about 0.7% per year.
  • Typical Investment Returns: What they can invest in is regulated to be moderate to low risk. The returns can vary, but is ~5%/yr historically which is what they advertise.
  • Accessing Funds: When enrolled in part or full-time studies at a qualifying institution or programme you can access funds. Payments are made as an Educational Assistance Payment (EAP) to the beneficiary.
  • There can be restrictions and penalties depending on the plan in addition to the governmental restrictions.
  • The promoter determines the “reasonableness” of expenses.
  • You have 60 days from enrollment to opt-out of a group RESP if you regret joining one.

Individual or Family RESP:

  • An account you can open via a bank, credit union, or investment brokerage.
  • Account Management Fees: Could be free or $50-100/yr.
  • Investment Management Fees: Depends heavily on how you invest as described in choosing your financial advisor. It could be <$10/trade at a discount brokerage and low fees on ETFs, you could hire a fee-based advisor to handle it along with your other investments, or you could use mutual funds with fees in the 1.5-3% range.
  • Typical Investment Returns: It depends on how you invest. A balanced portfolio has returned an average of 7%. A more conservative approach since you have a shorter time horizon and defined period where you must access the money may be advisable and would yield lower, but less volatile returns. It depends on your risk tolerance.
  • Flexibility For Contributing: You can deposit on any schedule you want up to the lifetime maximums.
  • Flexibility For Withdrawing: You are subject to the governmental restrictions on EAPs for the CESG portions and the tax-free growth. You determine the “reasonableness” of expenses as long as less than $23K/yr indexed to inflation. You can withdraw the initial capital tax-free.

And now for the great part…. FREE KITTENS. I mean money!!!!

We kept a close eye on our kids in this restaurant.

Yep, that is right. The government will give you free money towards your beneficiaries’ education.

For each year that you contribute to an RESP, up until the end of the calendar year that they turn 17, you get a Canada Education Savings Grant added to the account.

  • 20% of the contribution up to a maximum of $500 per year regardless of your income.
  • If your household income is $45-90K, you get an additional $50 based on the first $500 contributed and if under $45K, it is $100.
  • Lifetime limit of $7200 regardless of income.

This means to use this gift optimally, you need to start contributing early and spread out your contributions. You can only make up for lost time in a small way. If you did not get the full grant in the previous year, you can get up to $1000 that year. Unused CESG grants can accumulate the end of the year they turn 17. However, you can only be granted CESG at a max rate of $1000/yr. So, it is possible to miss out on some CESG if starting after age 10. We explore this in detail in the Optimizing Your RESP Contributions post.

Getting the money out of your RESP

Whenever you put money into a registered account, you need to make sure that you know how to get it out without getting dinged. You need an exit plan.

When it is time to take money from your RESP, the financial institution holding your RESP can give you a breakdown of the money in the account into:

  • original capital contributions
  • CESG grants
  • tax-free growth on investments

If you have a family RESP, then you may need to track which contributions and investments were for each member.

My RESP account at MD Management does this for me automatically. When you take money out, you will need to specify which portion is a Refund of Contributions (original capital) and which is an EAP (made up of CESG and growth).

You want to get the CESG money out asap in case your little angel spends too much time on extra-curricular “chemistry”, “anatomy”, or attempting to achieve the “Legenary” status with the Yard of Ale.

When the beneficiary is enrolled in a qualified educational programme you apply for an Educational Assistance Payment (EAP) to access the CESG and tax-free growth).

  • An EAP can be granted to cover “reasonable expenses” (tuition, room and board, transportation, computers, and learning supplies). If you are part of a group plan, there may be more specific restrictions or requirements.
  • An EAP can be for up to $5000 for the first 13 consecutive weeks of enrollment and is then unlimited afterwards. If they are out of full-time studies for 12-months, this restriction resets.
  • A CRA bulletin states that they won’t audit reasonable expenses under $23K/yr indexed to inflation.
  • An EAP is drawn from the CESG grant and investment growth portions of the RESP. If you have an individual or family plan, then you decide the amount supplemented. If it is a group plan, then the plan promoter does.
  • The EAP is taxed as income in the hands of the beneficiary. The financial institution that holds your RESP issues a T4A for their tax filing.
  • You want to balance your EAPs to make sure you get the CESG money out asap against minimizing the tax that they pay. This is not usually difficult to do since they can get 12-13K/yr without having to pay any income tax due to the basic personal allowance. They could take more income easily if they use their non-refundable tuition tax credits. Alternatively, those can also be carried forward for later use, or up to $5K transferred to a parent or spouse to reduce their tax bill instead.
  • You have up until 6 months after completing a programme to make claims for any unused money that qualifies for an EAP.

The original capital, taken out as a Refund of Contributions, can be paid to the beneficiary or the subscriber at any time in any amount.

What if there is money left in the RESP after the beneficiaries have been educated or no longer require an RESP?

You can access your original contributions tax-free as a Refund of Contributions. Any remaining money from CESGs or accumulated tax-sheltered income is accessed as an Accumulated Income Payment (AIP). To get an AIP, the plan must have been in existence for over 10 years and the beneficiaries over the age of 21 or deceased. The AIP will be subject to your income tax rate plus an additional 20% tax. You can avoid or reduce tax by transferring the AIP money directly to your RRSP if you have room, up to a maximum of $50K. You must close out the RESP after taking the AIP.

Only the subscriber can authorize distributions from an RESP. Not the beneficiary.

This cuts down on the spring break withdrawals considerably I suspect 😉 My spring breaks were spent with family or on campus studying – I didn’t have money to travel.

While I don’t regret not being able to go on spring break party trips back then, the idea of spending a week with people my own age scantily clad on a beach doesn’t hold the same allure anymore for some reason. Besides, that kind of thing could lead to more Mini-mes. I love my little clones, but two is enough for us and as you can see from this post, they are expensive. Saving for their education is only the tip of the iceberg.

In my next couple of posts, we will use an RESP calculator to look at strategies to optimize RESP contributions and how to plan for RESP withdrawals.

 

 

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