Funding post-secondary education is a major financial goal for many Canadians. It costs a pile of money, and there are multiple options to plan how to pay for it. Used well, a registered education saving plan (RESP) is an excellent investment vehicle for this mission. The government even adds fuel to the tank. Unfortunately, many people do not realize how an RESP works and their options. Learn more to ensure that you set it up well. Do this asap to avoid costly mistakes that are hard to undo and to maximize the free money and tax-sheltered compounding.
The Main Stakeholders in an RESP
The first thing to understand is that an RESP is an account that you open. It is often marketed by promoter companies as a product that you buy. When you open a self-directed RESP, you can fill that account with whatever investments you want. If a promoter company salesperson sells you a spot in their group RESP, then they control the investments. They also make many of the rules of the game in that structure. Similar to the insurance game, they make sure that they win. More on that later, but first you must have a basic understanding of the players in the RESP game.
The subscriber opens the account. Anyone can contribute.
An RESP can be opened by anyone, as the “subscriber”. It can even have joint subscribers who are the parents/guardians, spouse, or common-law spouse. For an individual RESP, the subscribers own the account. For a group RESP, the promoter company owns the account.
You don’t need to be a subscriber to contribute to an RESP. Common non-subscriber contributors would be grandparents, other relatives, and family friends.
The beneficiary.
The “beneficiary” can be any individual (Non-Family Plan), or a group of individuals related by blood or adoption (Family Plan). They do not own the money in the account. The subscriber does. However, the profits and grants that grow inside the account must be used to benefit their education or training. That money is also taxed in their hands which means very little or no tax for the average low-income student. The original contribution amounts could be withdrawn tax-free.
Different Types of Registered Education Saving Plans
This is something to understand 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 emotions and sleep deprivation that accompanies a new baby is not usually the best time for making big financial decisions on the fly. It is a great opportunity for predatory sales though.
Group Registered Education Savings Plan
A group RESP is very structured and administered by a promoter company. They usually have whimsical names that sound like a philanthropic scholarship program. They are heavily marketed by salespeople to new parents. Some people find that structure helpful because they otherwise wouldn’t take the time to invest in an RESP. However, a group RESP is also laden with fees and restrictions for delegating that responsibility.
The embedded fees can come in various forms. Expensive insurance you don’t really need and administrative fees are common. The investments used also have some restrictions and performance drag from embedded management fees. Historically, they have returned around 5%/yr.
Many only appreciate that fact when they go to access the money and realize there isn’t very much because the fees ate it. You may also face more restrictions upon withdrawals in addition to the usual government regulations. Further, money not used usually gets absorbed by other plan members. Theoretically, you might be able to get some money back. However, they have fees, and penalties, and keep the growth. The reality is often stark.
Sadly, a newspaper article or regret doesn’t fix problems. So, pay attention and ask the right questions if you go this route. If you have regrets and enrolled less than 60 days ago, you can opt out.
Individual Registered Education Savings Plan
The best route for most people is to use an individual or family RESP. This structure is more flexible and cost-effective than a group RESP. An individual RESP is a good option for a beneficiary unrelated to you or an only child. It is an account type that you open via your financial advisor, bank, or discount brokerage. That usually costs nothing and has minimal or no administrative fees, depending on the institution and balance.
You can choose the investments. That could be an easy and extremely effective all-in-one ETF that you manage on your own for <0.25%/yr. If you use a bank, they will likely put you in their more expensive mutual funds. Fees drag on performance and retail mutual funds may have fees in the 2-3%/yr range. You may be investing with a financial advisor, in which case the cost is their fees plus the fees of their products. Usually in the 1-3%/yr range. Consider the cost and benefit of the different options. At least you have a choice.
When it comes time to withdraw the money, you request how much you need. There are some limits in the first 13 weeks of school. It is paid out as a mix of grants, growth, and returned capital, determined by a formula. You determine the “reasonableness” of expenses. As long as it is less than $23K/yr, indexed to inflation, the CRA is unlikely to hassle you. You can get your original contributions out and if there is money left, it could be rolled over to a family member (if a family plan) or your RRSP. More on that later.
A Family RESP
A family has all of the same features as an individual RESP. The difference is that it is shared amongst blood or legally adopted relatives. That could include siblings, children, and grandchildren. However, they must be under 21 years old when named a beneficiary.
The grants and maximum contributions remain individual to the beneficiary. However, the growth of the invested money is pooled. That gives more flexibility if the beneficiaries have radically different incomes or costs during their training. When the money comes out, you will need to know how much grant money each child has and use it individually. If you need more money for one beneficiary after their grant is consumed, it will come out of the shared growth and not others. Most brokerages track that for you, but keeping track yourself couldn’t hurt.
In the event of divorce, for either an individual or family RESP, there are options to include it in the division of assets or continue to keep it for the kids and make a management agreement.
RESP Contribution Rules
You contribute to an RESP using personal after-tax money. You cannot contribute directly from a corporation and you don’t get a deduction against your income. That is analogous to a TFSA. Similarly, there is also a limit to how much you can shelter in an RESP. When the money comes out, only the grants and growth are taxed. More on that later.
You can contribute:
- Up until the beneficiary turns 31
- Up to $50000/beneficiary over their lifetime.
- Excess contributions result in a 1% per month penalty. Brutal.
- You can take your original contributions back out without paying tax at any time for any reason.
Canada Education Savings Grants
And now for the great part…. FREE KITTENS. I mean money!!!!
Who gets Canada Education Savings Grants?
When you contribute to the RESP of someone under 18 years old, the beneficiary can get a Canada Education Savings Grant (CESG).
Although you can take your contributions back out without paying tax. If you got a CESG, you must pay that back via penalties if not removing it as an Education Assistance Payment (EAP).
Yep, that is right. The government will give you free money for your beneficiaries’ education. This is one of the only government grants that is not eliminated for those with higher incomes.
How do you get CESG and how much do you get?
You fill out an application for the CESG when you are opening your RESP account. Then, your brokerage or plan promoter will automatically apply and put in the grant each year. For each year that you contribute to an RESP, up until the end of the calendar year that they turn 17, you get CESG money added to the account according to the most recent government parameters:
- 20% of the contribution up to a maximum of $500 per year regardless of your income.
- If your household income is $50-100K, you get an additional $50 based on the first $500 contributed, and if under $50K, it is $100.
- Lifetime limit of $7200 regardless of income.
Can you make up CESG for missed contributions?
You can make up for lost time and still get the full grant if you start before age 10. If you did not get the full grant in the previous year, then you can get up to $1000 in the current year. Unused CESG grants accumulate until the end of the year they turn 17. However, you can only be granted CESG at a maximum rate of $1000/yr. So, it is possible to miss out on some CESG if starting after age 10.
Canada Learning Bonds
A Canada Learning Bond (CLB) is another gift for RESP users from the Federal Government. Like a CESG, it is added to an RESP. Unlike a CESG, it is means-tested based on household income and the number of children. For one to three children, the income threshold is $50K. However, you could get CLB with a household income of up to $134K – but you would have to have 16 children!!!
A CLB is $500 the first year you qualify, then $100/yr afterward if you still meet the income-proliferation threshold. That is up to age 15 or the maximum of $2000 per child. Not all plan providers or brokerages will handle the CLB. So, check before you sign on board. If they do, like CESG, you fill out an application and it will automatically be deposited each year that you qualify.
Provincial Grants
There are some provincial grants in addition to the CESG and CLB. Saskatchewan has the Saskatchewan Advantage Grant for Education Savings (SAGES) worth up to $250. British Columbia has their own version called the BC Training and Education Savings Grant (BCTESG) worth up to $1200. The Quebec government gives a refundable tax credit to RESP contributors.
Again, be sure to check that the brokerage or bank that you are using administers these grants with their RESPs because some do not.
Another important nuance is that most discount brokerages will automatically handle getting the grants. Fortunately, Qtrade (the platform I partnered with) can handle the BCTESG and QESI.
Optimizing Your RESP
How to Optimize RESP Contributions
This is a simple and common question. However, it has a potentially very complicated answer. I will explore the strategies in another post. However, the most important message is to start contributing as early as you can. That takes advantage of the tax shelter on investment income and allows for maximum tax-deferred compounding growth. It also minimizes the risk of missing out on CESG. For most people, that means aiming for $2500/yr contribution.
For those with excess money, it then becomes a balance between the benefits of the RESP vs whatever they are otherwise investing the money in. That includes the account type and investment type.
The theoretically optimal approach depends on having $50K sitting around with nowhere else to go (uncommon) and lump sum contributions based on a bunch of future assumptions. That changes again if the excess money is sitting in a private corporation. In my analyses, I also assumed a smooth withdrawal and minimal student income. A high-earning student is somewhat rare, but if they have to pay income taxes the benefit of lump sum strategies narrows further.
The good news is that the differences between any of those “optimal” approaches are minimal compared to just simply getting started and using a simple low-cost self-directed plan.
Do not let the pursuit of perfection push you into a costly delay or make you think you cannot do it and use a costly plan. Take advantage of the longest tax-sheltered investment horizon that you can.
How to Optimize Your RESP Investments
The biggest thing that you can do to optimize your RESP outcome is to use a self-directed RESP and a simple low-cost investing plan that you can execute instead of paying someone else. I built an educational DIY Investor Hub to help educate and empower you about how to do this. It even has a step-by-step interactive guide with screenshots about how to open, fund, and invest. For an RESP, you have to register your progeny as a person in Canada which entails getting their birth certificate and a Social Insurance Number to apply.
You can hold stocks, bonds, GICs, mutual funds, or exchange-traded funds in an RESP. Just like other investment accounts. There are different ways to consider how an RESP fits into the rest of your investment portfolio and choose your asset allocation. I will unpack that in another post.
How to Optimize Your RESP Withdrawals
At the time of their post-secondary education in a qualifying institution or program, the beneficiaries can access the money from the CESG and the tax-free growth as Education Assistance Payments (EAPs). The money is used to pay for their education-related expenses, including reasonable costs of living. This is taxed in their hands (likely at a very low marginal rate).
A CRA bulletin states that they won’t audit reasonable expenses under $23K/yr indexed to inflation. So, this gives considerable latitude for those who didn’t get roped into a group plan. Only the subscriber can authorize withdrawals (not the beneficiaries). This cuts down on the emergency spring break withdrawals, I suspect.
You have up to 6 months after completing a program to make claims for any unused money that qualifies for an EAP. The RESP can stay open for up to 4 years after the beneficiary turns 31 years old. Those with disabilities can get a five-year extension. You may also be able to roll the RESP over to a Registered Disability Savings Plan on a tax-deferred basis.
Ejecting from a deviated flight plan.
Whenever you put money into a registered account, you should plan how to get it out without getting dinged. You need an exit plan. Usually, the money can easily be used to fund the high costs of training. Even more so, when you have multiple money-sump-kidults in a family plan.
Maybe you don’t use all of the RESP money because your kid didn’t take extra training. Perhaps, they got it paid for by the military. Trades cost less and can be very lucrative careers. There are some very successful college drop-outs that choose a different path. Maybe they are just living in your basement playing video games. Whatever the case, it is natural to worry about your kids. Don’t worry about an unused RESP.
You can usually get the grants and growth out quickly. Even if there is some left, you can get your original contributions out 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.
