RESP is a wonderful savings tool that helps pay for your children’s higher education in Canada. Read this article to find out how it works.
The first part of the article includes answers to such questions as what RESP is, how to open it, how it works, reasons to open it, and how to plan finances if you have several children. In the second part, we will look into the following:
- Is there a contribution limit?
- How do you get the RESP grant?
- How should you invest an RESP?
- How are RESPs taxed?
- What if your child does not want to go to school?
1. Is there a contribution limit?
There is no annual limit on the amount you can contribute to your child’s RESP, but there is a lifetime limit of C$50,000. You can contribute C$50,000 to the RESP all at once as soon as you open it and not pay taxes for it. But if you do this, keep in mind that you will receive a CESG grant from the state only for the first C$2,500 of this amount. And you will basically throw away C$6,700 of extra government money.
The lifetime limit of the contribution per child applies to all open RESP accounts — for instance, if in addition to the parents, the grandparents also opened an RESP in the child’s name.
If you exceed the C$50,000 limit, you will be fined by the Canada Revenue Agency at a 1% rate per month for the extra money before it is withdrawn.
2. How do you get the RESP grant?
RESP providers usually apply for a CESG grant automatically on your behalf. Many institutions notify the government about contributions once a month. The transfer of a grant to the RESP can take from 6 to 8 weeks. However, some RESP providers apply for grants only once or twice a year. Be sure to check with your service provider to learn how often grants will be transferred.
3. How should you invest an RESP?
You can invest an RESP in the same way you would do with an RRSP or a TFSA contribution: to buy cash, stocks, bonds, investment certificates (including foreign investment instruments) or invest into mutual funds. Note that a large share of stocks and other risky assets in the portfolio is acceptable while the child is still small, but the older he gets, the better it is to shift the focus from stocks to cash — this is more reliable.
4. How are RESPs taxed?
Despite the fact that the money you invest in the RESP is tax-free, there is a tax that must be paid when the money is withdrawn from the RESP. There are two types of RESP withdrawals, and they are taxed differently.
Money that you contribute to the RESP can be withdrawn tax-free as payment for higher education. But part of the RESP funds received from government subsidies as well as capital gains and investment income is taxed. However, the child must pay this tax. As students have low incomes, as well as access to tuition tax credits, they tend to pay little to no tax.
Since you can specify what type of withdrawal you want to make, first withdraw the taxable amount. And if your child does not finish his studies, or if you have money left in the RESP account, your own contributions will make up most of what is left, and you can withdraw it tax-free.
5. What if your child does not want to go to school?
That can happen. If your child decides not to go to college or university, you have several options.
If you have a family plan, you can transfer money to another child’s account. You can also withdraw your own contributions to the RESP without paying taxes, so if you made the maximum C$50,000 on your own, you can withdraw them without penalty. All grant money must be returned to the government. Everything else in the RESP — capital gains and investment returns — is returned to you as accumulated income and is taxed in the year in which you received it, with a 20% penalty.
You can avoid this by transferring up to C$50,000 to your RRSP account. To do this, the child must be over 21 years old, and your RESP must be open for at least 10 years.
But do not rush into any decisions. An RESP account can remain open for 36 years, which gives your child enough time to make a decision about his education.