Registered Education Savings Plan Basics
While this topic is not market related and may not apply to you, for those that it does apply to, these investment vehicles can often be confusing. An RESP is a great and tax-efficient way to save for your child’s or grandchild’s education, but contributions, grants, withdrawal and taxation rules can be difficult to navigate. Below I will discuss the RESP basics.
1. Contributions and Grants
The Canadian Education Savings Grant (CESG) is one of the most attractive benefits of an RESP. The grant will pay you 20% on the first $2,500 you contribute each year per beneficiary, up to a maximum $500. While there is no annual contribution limit and a $50,000 lifetime limit, since the CESG is only eligible on the first $2,500 per year up until the year the child turns 17, you effectively lose the grant money if you contribute more than $2,500. We encourage clients to set up automatic monthly contributions so we and you can keep track and earn as much “free” government money as possible. The maximum lifetime CESG is $7,200.
On the topic of “free” money, BC has recently introduced the Training and Education Savings Grant (BCTESG) of $1,200 eligible for children born in 2006 or later, if the parent and child are residents of BC. You may apply for this one-time grant when your child is between the age of 6 and 9. Be sure to take advantage of this grant.
2. Withdrawals and Taxation
An RESP is made up of three portions: Contributions; Grants; Income. The easiest way to understand how withdrawal taxes work is: if you have paid tax already on that portion of the RESP, you will not have to pay tax again.
When you contribute to an RESP you do not get a contribution receipt, like you do with an RRSP. So when you withdraw money, the contribution portion (also known as Capital) will not be taxed.
Grants are tax free when contributed by the government, therefore upon withdrawal, tax is owed.
Income (interest, dividends, capital gains) has been sheltered from tax within the plan, therefore upon withdrawal, tax is owed.
This brings us to what is generally the least understood part of the RESP process: How to withdraw your funds. The differences relate to taxable vs. non-taxable status and if the child is a student or not.
On RESP withdrawal forms, there will be three options for withdrawal. Option A is if your child is not going to school, and option B and C if your child is a student.
A) Capital Withdrawal to subscriber (parent): This is a return of contributed capital and issued to the subscriber, and is non-taxable since you will have paid tax on it already before you contributed it, BUT, if you withdraw this portion while there is still grant money in the plan, you will have to repay it. No proof of enrollment is required.
B) Capital Withdrawal to beneficiary (student) otherwise known as a Post Secondary Education Withdrawal (PSE). This is non-taxable but proof of enrollment is required.
C) Educational Assistance Payment (CESG+Income accumulated in the plan): This is issued to the beneficiary and will be taxed in their hands since it includes tax-free grant money and/or tax-sheltered accumulated income. There is an automatic government formula for the ratio of CESG and Income that is used when you pick this option so there is no need for you to specify. Proof of enrollment is required.
We are able to give you the breakdown of funds relating to each portion of your plan, but it has to be specified on your withdrawal form what portion you want to withdraw from. We are happy to help you decide this depending on personal circumstances.
While the details can be difficult, there are a few general “big picture” points that might be most helpful to understand:
- In order to maximize the grant money from the government, we recommend that you contribute $2,500 a year ($208 monthly) rather than a large lump sum. We can move this money from your cash/margin accounts, or you can set up a recurring payment from your online banking account.
- Do not leave income and grant money in the plan. When planning withdrawal, since the capital (contributed portion) can be withdrawn at any time, it’s best to withdraw the EAP portion early on, to ensure it’s used while the beneficiary is still a student. If you try to withdraw funds from the plan when they are no longer enrolled then outstanding grant funds have to be returned back to the government.
- While the EAP and PSE are taxed in the hands of the student, for the most part the tax should not be a deterrent to using this portion. The student is most likely in a low tax bracket so taxes should be minimal in most cases.
I hope you have found this helpful but as always, we encourage you to call or email the team with any
questions. Have a great week!
Consistently Working In Our Clients’ Best Interest
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