The RESP – or Registered Education Savings Plan – is a Canadian registered investment account. It’s meant for saving for a kid’s post secondary education – typically, a parent would open one for a kid who’s likely to attend post-secondary schooling after high school.
The RESP as we know it today was created in 1998, when the Canadian government introduced a grant program where they give free money to people putting money into their kids RESP account already.
What Is The RESP?
Similar to the TFSA and RRSP, the word saving in the title of this account is a little misleading, because the real benefit to having an RESP is that you can buy investments within it.
This is because the RESP is another tax-advantaged account. When you contribute money to an RESP, it doesn’t impact your taxable income now, but the money can grow tax free, so that all of the gains made in the account grows without any taxes, as long as they money is inside of the account.
Then, when you go to withdraw money out of the account for a kid’s education, the money that you contributed can be withdrawn completely tax-free – but, the income that was earned off of your investments? That money is taxed, but it’s taxed based on the kid’s income tax bracket (keep in mind that this kid will likely have a much lower income than their parent, and therefore will pay very little taxes).
To sum that up, you can add money to this account, it will grow tax free, and then when you take money out of the account, some of it will be tax free to withdraw, and some of it will be taxed within a very low income tax bracket.
This is exactly why the account should be used to invest – that’s where you see the benefit of tax free gains. If your money can grow tax free, and you can have even more money than you added in yourself for your kid’s education, you should take advantage of that.
Benefits Of The RESP
Canadian Education Savings Grant
Another benefit of using an RESP account for a kid’s education is that you can get free money from the Canadian government – they have something called the Canadian Education Savings Grant.
This program gives every person who’s contributing to an RESP a 20% match up to $500 per account, per child, per year. So, if you add $2,500 into an RESP per year, the government will add in $500 – and if you add in $10,000 into an RESP per year, the government will add $500 – but, if you add in $1,000 into one RESP per year, they’ll only add $200.
Now, there is a maximum total amount that they’ll give you, which is $7,200. Something to note on top of that lifetime limit is that the government only matches up to $500 per year until the kid turns 17 years old – this is why you want to maximize your contributions up until that point.
Once the kid turns 17, you can still add money (up to the maximum limit of $50,000), and you keep adding money up to that maximum limit until the RESP hits its 31st year of being open. Then, although the contributions have to be stopped by its 31st year, the RESP can stay open until its 36th year.
This means that the money in this account could in theory sit there and grow tax-free until the kid is in their 30’s, and could at any point in those 36 years start being pulled out to pay for their education.
Canada Learning Bond
On top of this program, kids who are lower income – $49,020 and below – can be eligible for additional money from the Canada Learning Bond. In that case, there would be an additional $2,000 added.
Additionally, if your household income is below $98,020, you can get another $50 per year. Instead of a $500 per year max, it would be a $550 per year max. Then if your household income is below $49,020, you can get another $100 per year. Instead of $500 per year max, it would be $600 per year max. But, they still have the same lifetime maximum of $7,200 – these increased deposits simply help you get to that maxed out point.
To sum everything up, by opening up an RESP for a kid’s education, as long as you add money to the account you’ll get more money from the government, and if you invest the money inside then you’ll get tax-free gains.
For example –
- Let’s say that you opened up an RESP for a kid when they’re born, and contributed $2,500 per year
- After 14 years, you’d have contributed $35,000, and the government will have given you an additional $7,000
- Then, in the 15th year, you add in $1,000 to get the final $200 of government matching you’re eligible to receive (at this point, you now have $43,200 – $36,000 from you, and $7,2000 from the government)
- Now, on top of the money you’ve added in, you’re also investing that money and ideally seeing returns
- If you saw a 6% return on your investment, your $43,200 would gain over $21,000 in interest, for a total of about $63,045.20 for the kid’s education
The RESP Contribution Limit
There are several rules that you need to keep in mind when opening an RESP. For starters, can only be opened on behalf of a kid who has been born, and who has a Canadian SIN.
Additionally, just like the TFSA and RRSP, the RESP has contribution limits. What’s different about the RESP contribution limits is that it’s not a set limit each year, or a changing limit each year, or based on age – instead, there is a lifetime maximum contribution limit of $50,000 per kid.
The other important thing to know here is that the $50,000 contribution limit is just for your own contributions – it doesn’t include the government matching of up to $7,200 (or, of course, any money that grows on top of your contributions).
If you were following the example above of adding in $2,500 per year for 14 years, plus an additional $1,000 the next year, you could only add another $14,000 total on top of that. Or, if you didn’t open up an RESP when the kid was 18, or if you want to contribute in random chunks, just remember that $50,000 maximum limit.
If you go over the contribution limit, there are penalties similar to the TFSA. There’s a 1% fee on the money that’s over the limit, per month, or a total of 12% per year, until you remove the excess money. For example, if you contribute $60,000, that extra $10,000 isn’t allowed, so you’d have to pay a $100 fee the first month for not removing it, and it would grow from there.
How To Maximize Government Contributions
Remember that the optimal case would be adding in $2,500 per year for the first 14 years, because that’s the way you would be able to get that maximum $7,200 match from the government.
However, you can actually skip one year of contributing and make up that money you missed out on.
For example –
- Let’s say that you added $2,500 in year 1, and received the $500 grant
- Then, you did the same thing in year 2, but in year 3 you forgot to contribute and didn’t add any money in (or receive any government money)
- Then, in year 4, you could add in $5,000 (that years limit + the prior years limit that you missed)
- But, you can only do this for one year at a time – so, if you missed year 3 and year 4, and contributed $7,500 in year 5, you’d still only get $1,000 from the government (you’ll never receive the the additional $500 that you missed out on)
Withdrawing From Your RESP
So what happens when you start to actually withdraw from the RESP in the future in order to pay for school?
The money inside of the RESP is split into three categories, and there are different ways to withdraw money from these three categories –
- The money you put in – You can take this out at any time, and when you do it’s called Post-Secondary Education Withdrawals (PSEs). This money doesn’t have to go towards your kid’s education, even though it’s meant for that, and you can take it out tax free. So, the money taken out can go towards either the parent or the kid.
- The money the government put in – See below.
- The income earned on your investments growing – Government money and income earned are coupled together. This money has to be used for post secondary education, so once the kid is officially enrolled in school, it can be taken out. When it’s withdrawn it’s called an Educational Assistance Payment (EAP). This money can only be taken out by the kid, not the parents and you have to show proof of enrollment in order to use it. You should also use this money first, because it’s the money that has to be used for school. Remember that it will be included in the kid’s taxable income for the year, which should be low (or potentially nothing).
TLDR? The money you put into an RESP can be withdrawn tax-free at any time. The government and income earned money has to be taken out once the kid is enrolled in school, and is taxed as their personal income. Use this money first, then the portion you contributed last.
What If The Kid Never Goes To School?
Wait a second – what if the kid never goes to post-secondary school? If that happens, then you can still withdraw the money you contributed – tax-free – easily, but withdrawing the money that the government put in and all of the gains you made in that account works a little bit differently.
You have a few options –
- You can transfer the money to a sibling’s RESP, if they’re under 21 years old
- You can give the government money back, and select one of the following options to withdraw the income earned on your investments
- This money can be transferred into your personal RRSP, if you have contribution room (there are are few other conditions that you should be aware of, as well)
- You can withdraw the money, but it will be taxed according to the parents tax rate plus an additional 20% penalty tax (very high fees)
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