It is a common fact that when it comes to saving the more time one gets to save the longer the asset has to grow into a substantial amount. This wisdom also applies to saving towards your child(ren)’s education goals. A few weeks ago, we had a client couple visit AG Tax who wished to know about beneficial ways to begin saving for their new born child’s education; when it comes to Canada, no other plan could be better than a Registered Education Savings Plan (RESP).
Not only is it beneficial tax-wise, but it also qualifies for various grants from the government. In this article, we have prepared a brief summary on RESP’s, and other factors related to saving into an RESP, which should be informative for many taxpayers with children who intend to save for their children’s education soon or in the near future.
Please note that there are significant filing requirements and potential penalties for U.S. persons holding Registered Education Savings Plans. Please consult with a qualified cross-border tax advisor before opening an RESP if you have any U.S. ties. See this article here (Tax obligations for foreign nationals residing in the U.S.) for more information.
What is a Registered Education Savings Plan?
An RESP allows parents, grandparents, relatives, or any other persons to save for a child’s post-secondary education. The money deposited into an RESP is after-tax but the asset grows tax-free until withdrawal(s) are made by the beneficiary. The asset also benefits from contributions made by the government if the person qualifies.
Additional Benefit: Government Contributions towards an RESP
On opening an RESP, the individual can apply for government grants, such as: the Canada Education Savings Grant (CESG), and the Canada Learning Bond (CLB).
- CESG consists of contributions (maximum $7,200 until the child turns 17 years of age) made by the Canadian Government towards an RESP. It is done to encourage parents to begin saving early for their child’s post-secondary education. The federal government contributes an additional 20% on every dollar contributed by the benefactor on the first $2,500 contributed into a RESP. Additionally, depending upon a family’s net income, the plan may qualify for a further contribution of 10% to 20% of every dollar of the first $500 saved into an RESP each year.
- Similarly, the CLB is a contribution made by the Canadian government to a maximum of $2,000 to encourage RESP savings. If the child is born after 2003 and the family is receiving the national child benefit supplement, the RESP may qualify for an initial $500 contribution from the government to assist in covering the costs of a post-secondary education. After the initial $500 contribution the RESP could receive $100 each year up until the child turns 15, the initial contribution plus annual additions adds up to a maximum of $2,000 per child.
RESP Investments & Types of RESP
RESP’s can be opened at a bank, credit union or at a mutual fund company, invested in mutual funds, or in laddered cash . Often individuals prefer to have it as a mutual fund allowing it to grow significantly within the allotted period, provided the mutual fund continues to excel.
Other than the choice of investment, it is also important to decide upon the type of RESP, i.e. whether it will be an individual plan, a family plan, or a group plan. The differences are as follows:
- Individual Plan: This plan may be suitable if there is only one child for whom the saving is being carried out, and/or if the benefactor is not directly related to the beneficiary. In this case the government grants are available but only if the beneficiary qualifies.
- Family Plan: This plan may be suitable if the account is to be created for more than one child and all of them are related to the benefactor, either by blood (brother/sister, children, or grandchildren), marriage (Step children), or adoption. All the children are equal beneficiaries. The main advantage of a family plan is that the savings can be shared and used for each child according to their need. The government grants may be used by any beneficiary named in the RESP, to a maximum of $7,200. However, some benefits are receivable only if the beneficiaries are siblings.
- Group Plan: Group plans are offered and administered by organizations that offer group scholarship plans, who usually invest the money in low-risk investments. It is for one child only, and the child does not have to be related to the benefactor. This type of plan is ideal if the payments are going to be made on a regular basis. In this type of plan, an individual’s savings are combined with those of other people. How much each child gets depends on how much money is in the group account, and on the number of students of the same age who are in school that year. Fees may apply if you stop these regular payments. Therefore, consider this account only if you are sure about being able to make the monthly (or other frequency) contributions. Also, consider this account only if it is definite that the child will pursue post-secondary education. Be sure to clarify all doubts with the group plan dealer before finalizing this plan.
Other Advantages of an RESP
What makes the RESP special is the flexibility. For example there may be a situation wherein the child has no desire to pursue further studies, and the money saved into an RESP could now be subject to significantly higher taxes. Fortunately, the government provides the following options in case of such a scenario::
- Let the RESP Grow and/or Replace the Beneficiary: An RESP can be left open for up to 36 years. If the child suddenly changes their mind they may utilize the money then to pursue their higher education, or it could be utilized for any other child in the family, and/or grandchildren. Generally, a change in beneficiary designation is possible in individual plans, while for a group plan, a nominal fee may apply. Confirm with the plan administrator/provider about the rules, terms and conditions.
- Transfer the fund towards your retirement: If the RESP is more than 10 years old, and all the beneficiaries are above 21 years of age with none of them continuing their post-secondary education, the RESP funds (maximum of $50,000) may be transferred ‘TAX-FREE’ to a Registered Retirement Savings Plan (RRSP), provided there is room for further contribution in the RRSP.
- Transfer to a Registered Disability Savings Plan (RDSP): Transferring to an RDSP may be possible if the RDSP and RESP have a common beneficiary, and this beneficiary is facing a severe and prolonged mental impairment which prevents the beneficiary from pursuing post-secondary education or if the RESP has been open for 10 to 35 years, with no child below age 21 with a desire to pursue post-secondary education.
If none of the above recommendations apply, the individual may simply close the RESP account. In this case the CESG and CLB or any other government contribution would have to be returned. No taxes have to be paid on the contributions made provided the account has been open for at least 10 years, and none of the beneficiaries (above 21) wish to pursue further studies. However, should you choose to close the RESP there will be a 20% fee and income taxes will apply on the growth to the account.
That being said, an RESP is a special, government supported savings plan for encouraging children’s education, and it is a highly recommended education savings plan for all Canadians with children. It is recommended that a taxpayer ask as many questions as possible before finalizing the creation of an RESP to make sure that it meets their needs.
If you are contemplating between an RESP, or a regular non-qualified savings plan, such as a stock investment, or a mutual fund investment (which would have diverse usage and given the time available to finance your various goals, may seem more appropriate); it is best to consult your accountant or personal financial advisor for a recommendation suitable for your situation.
AG Tax LLP Can Help
If you wish to discuss further on the above issue, or have any tax-related queries or need assistance with tax planning or filing please contact AG Tax. Our tax professionals are highly-experienced with U.S. and Canadian tax laws and can provide you the right guidance to handle your tax situation.
Aylett Grant Tax LLP is a full service accounting firm with a dedicated team of experts, who are highly-qualified and experienced in handling situations related to U.S., Canadian, and other international tax laws.
We can assist with:
- Canadian Personal and Corporate tax returns
- Cross Border Taxation and Business Planning
- U.S. Personal and Corporate Taxation
- Disclosure of Foreign Assets and other information filings
- Retirement planning
- Estate Planning, Inheritance tax advice
To obtain a quote or to arrange for a consultation to discuss your tax related queries, please contact us at:
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Disclaimer: The information in this publication is accurate as of the time of its publication. AG Tax assumes no responsibility for changes to tax legislation subsequent to the publication of this document. The information provided is for general information purposes only and should not be acted upon without seeking professional advice. If you would like to engage our services, please contact our staff and obtain authorization to send our firm confidential information. A client relationship is not created by the transmission of information. A client relationship is only formed with our firm when a scope and engagement letter signed by the firm and the potential client detailing the terms of engagement is present.
