RESP mini-series 1: Introduction

RESP is Registered Education Savings Plan, and, like RRSP or TFSA, it is one of the tax-advantaged accounts available in Canada. Like other such accounts, RESP has its own benefits and limitations, and so it may work for some goals but not for others.

The largest benefit of allocating assets to RESP is the Canada Education Savings Grant (CESG), which tops up your contribution up to a certain amount. The grant room starts accumulating from the year of the child’s birth and can be used until the child turns 17 (with conditions). Although investing early may generate higher income in the future (as the assets would be invested for longer), the grants can be “caught up” later (but only up to a maximum per year). Arguably, as soon as the maximum lifetime CESG amount is reached, further contributing to an RESP account may not make sense as the limitations for the use of funds may outweigh the benefits.

I developed a model to forecast the optimal schedule of RESP contribution for the family with up to three children. The model considers contributions made to date and suggests the schedule for both regular and catch-up contributions in order to maximize the CESG. The template is available in my Etsy store www.etsy.com/ca/shop/PocketHamsterCA.

There are other benefits of using RESP. The income earned by the assets within RESP (capital gain, dividends, interest) is not taxable in the hands of parents. The child will have to pay tax when the money is taken out of RESP to pay for education and related expenses. Normally, the expectation is that a child’s tax rate will be quite low, because of the low income, and this provides the benefit of reducing the tax, compared, let’s say to saving money for education in a regular saving account (but not in TFSA).

For low-income families, CESG is supplemented by the additional Canada Education Savings Grant and Canada Learning Bond. Some provinces (British Columbia and Quebec) supplement all of the above with their own provincial grants.

The benefits of RESP are quite clear: government grants produce immediate return on your RESP contribution and also become invested to generate income.

But these benefits come with limitations. The most important of them is that the money can be used only for education purposes (different RESP providers are stricter on what this constitutes, some are less so). If your child decides not to pursue education, there may be adverse consequences such as the obligation to repay the CESG as well as tax penalty.

The amounts of grants and the lifetime amount of contributions are limited. Currently, the maximum amount of CESG is reached before the lifetime contribution limit. After that, it may make more sense to continue saving money in TFSA (if there is available room), and RESP may become second best for education savings (it still provides the benefit of lower taxation than a regular savings account). The moment when the maximum grant amount is reached warrants a consideration whether a course adjustment is required.

While it is most common that the beneficiary of the RESP is a child, it is not a requirement. An RESP can also be opened for an adult (older than 17), however, the Canada Education Savings Grant will not be applied. Which defeats the main benefit of RESP because an adult opening a RESP has all the limitations but almost none of the benefits. Using RESP as an adult makes sense if there is no available TFSA room that can be used, because the TFSA provides more flexibility and completely tax-free accumulation of income.

This and other templates are available at my store: www.etsy.com/ca/shop/PocketHamsterCA

Disclaimer: I am not a certified financial planner and this article does not constitute financial advice. Please do your own research before acting on the material of this article.