Back to school is upon us, and if you haven’t already thought about a Registered Education Savings Plan for your child, then this could be a good time to find out more about them.
A RESP is a powerful way to save for your child’s education. It’s an investment account similar to your RRSP that allows your deposits to grow tax free. Though you will not receive a tax refund on your contributions as with your RRSP, you will pay no tax on capital gains, or income tax on interest and dividend payments. The biggest benefit is that you get a boost of up to $7200 per child from as the government pays you to invest.
The sponsor of the plan (a parent or guardian) can start saving as early as they want to after a child is born. As they contribute to the plan the government kicks in 20% up to a maximum contribution of $2500 per year, (that’s up to $500 per year in free money!). This contribution is known as the Canadian Education Savings Grant, it goes to the beneficiary’s account and the sponsor can invest it anyway they wish. Investing is usually done similar to a RRSP or TFSA in cash, stocks, bonds, GIC’s, mutual funds and foreign investments.
Families with an income less than $45,916 get an additional 20% on the first $500 contributed, a total grant of 40%. Families with incomes more than $45,916 but less than $91,831 get an extra 10%, a total grant of 30%. If you can’t contribute the $2500 needed to get the full grant, unused grant room can be carried forward and used in future years, but $1000 is the maximum that can be claimed in any one year.
So, it makes sense to open a RESP rather than saving in your own TFSA where you will not get the government grants. When your child does go on to higher education, they can start to withdraw the money and as they will probably have a low income, they will pay either little or no income tax. RESP’s can remain open for 36 years so there is lots of time for kids to make a decision about their education.
It’s easy to open a RESP, you can either do it through your bank or financial planner as a self-directed RESP, or you can use a RESP provider. However, a self-directed RESP is the lowest cost and simplest option. To get the maximum government grant you need to contribute $208.33 per month, but even an amount of $25 per month will add up over the years.
If you have more than one child, you can start a RESP family plan which works like an individual account with the same contribution limit ($50,000 per child). You need to take this limit into account should grandparents also start a plan for your child, otherwise you will be penalized by the government with a tax of 1% per month on the excess money.
To get the government grant your RESP provider will apply for it on your behalf, sometimes once a month or once or twice a year. You should ask your provider how often you will receive the grant.
If you child decides not to go on to further education, your original investment can be withdrawn tax free, but all interest, capital gains and income from dividends will be taxed in the year that you receive it and is subject to an additional 20% penalty. All grants received must be returned to the government. To avoid this tax hit you can transfer an amount up to $50,000 to your RRSP, as long as your child is over 21 and the RESP has been open for at least 10 years, and if you have the room to do so. If you don’t have the room, you can delay the transfer until it becomes available.
For more information on RESP's check out the Government of Canada website at:
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