The rising cost of higher education is leading a lot of students to graduate with huge loans. Alternatively, a family might have to endure hardship to get their children through higher education. It is therefore important to plan ahead to try and avoid any of these scenarios. Putting aside enough money to pay for higher education can ease the burden, but some strategies work better than others. One of these strategies is using a Registered Education Savings Plan (RESP). An RESP offers you a lot of benefits and below we will look at what it is as well as its pros and cons.
What is a Registered Education Savings Plan (RESP)?
An RESP is an education savings plan registered with the government to help with your plans to save for and fund your child’s post-secondary education. It is a tax-deferred savings account that the government also contributes to. The government adds 20% of your annual contribution to the RESP. These government contributions help bolster the account and encourage parents to keep contributing to the RESP.
How Do RESPs Work?
There are a few things to understand before you open an RESP. One is the concept of subscribers and beneficiaries. A subscriber is the person who opens the plan and contributes to it. Depending on the type of RESP, a plan can have one or multiple subscribers. On the other hand, the beneficiary is the recipient of the benefits that come from the plan. The subscriber and beneficiary have to both be Canadian citizens and must have a social security number.
Although there is no limit to how many RESPs can be opened for one beneficiary, there is a limit to the total amount set aside for a single beneficiary. Regardless of the number of plans opened, the limit for the total amount of their contributions is $50,000.
The government matches annual contributions by 20% up to a limit of $500. These contributions are made through the Canada Education Savings Grant. Note that there is a penalty for over-contributing. You will be charged a 1% tax per month for any amount above the $50,000 threshold.
Types of RESPs
There are three types of RESPs, with all of them designed to not only help you save for your child’s education, but to also enjoy the tax breaks that come with contributing to these savings plans. The three plans are the individual, family and ground RESP plans.
Individual RESP plans can be opened by anyone who would like to contribute. This could be a family member or even an interested third-party. Individual RESPs are not transferable to anyone other than a sibling. If you have more than one beneficiary, you can opt for a family RESP plan. This plan covers all beneficiaries related to you and they can be your children or those who are formally adopted.
Group RESP plans have a single child as a beneficiary but have a lot of people contributing to the plan. The beneficiary does not have to be related to the people contributing to the plan. Group RESP plans are not that common because they are heavily restricted compared to the other plans.
If you already know which of the three registered education savings plans would work best for you but do not know how to open one, you could turn to services like Wealthsimple. It takes only five minutes to sign up and open an RESP. Wealthsimple also has people standing by to answer any questions you have about RESPs, as well as giving advice on opening and contributing to them.
The Benefits of Using an RESP
One of the most obvious benefits of using an RESP to fund your child’s post-secondary education is the grants offered by the government. The grants from the Canadian Education Savings Grant are offered for all children with an RESP until the end of the year in which they turn 17 years old.
A bonus benefit of having these grants is that they not only incentivise and motivate parents to save, but they also increase the chances that a child will get a post-secondary education. An RESP also makes it easier for parents to save when their children go off to school.
The second benefit is that RESPs are tax-free. This means that all dividends, interest and capital gains from the RESP are not taxed. While you get to keep all the money in the RESP, the amount available to pay for your child’s education also increases. This means that the earlier you start saving into an RESP, the more money you will have in the RESP when your child goes off to college or university.
Third, an RESP makes separating saving accounts easier. When the money meant for college is mixed in with other money, it is possible to spend this money on something other than what was initially intended.
While taking on student loans is a great way for students to pay for college, it is not always the best option. These loans can come back to haunt them in the future. Having an RESP saves your children from having to take on a student loan that can follow them for decades.
Disadvantages of an RESP
If your child opts not to continue with their education, you might want to withdraw the funds from the RESP. Money withdrawn in this way and not used for post-secondary education incurs a 20% penalty. Additionally, the government considers this money income and so you have to pay income tax on it.
Another disadvantage to opening an RESP is that it can lead to lower retirement savings. If you do not have an income that is enough to support saving for retirement as well as contributing to an RESP, you might find yourself prioritising the RESP over your retirement fund. If you are older, you might also be forced to choose between saving for your child’s education and your retirement. Just remember that you or your child can borrow for their education but you cannot pay for your retirement.
There is also a limit to when your child can receive RESP grants. This is usually the year they turn 17. If they are 16 or 17, they might have a hard time getting the grants and will only be eligible under special circumstances. Also, if your child does not benefit from the grants, opening the RESP might not be worth it for either of you, especially if you do not have a large enough income to contribute to the RESP as well as handle all other life expenses comfortably.
Also, all the money the government contributed to the RESP has to be given back if it is not used in 36 years. This might also happen if the subscriber passes away before their beneficiary starts post-secondary education. The process of transferring the RESP can get very complicated in cases like this and the beneficiary might end up not benefiting.
Transferring an RESP After Passing
If a subscriber passes away before the beneficiary has started using the money in their RESP, the process of getting the money to them might be complicated. This is why it is so important to name the RESP’s beneficiary in your estate planning. If you pass away without specifying the beneficiary, two situations might arise.
The first one is the transfer of the RESP after a subscriber’s death. If one subscriber passes away, the account is transferred to the other subscriber automatically. This only applies to joint RESPs, so if you are the sole subscriber, the process of transferring the RESP will go through a probate. This is a very expensive and time-consuming process. On top of the time and expense, taxes will be due after the transfer of the RESP as it will be deemed an asset after the transfer.
To avoid all the above, you could name a successor subscriber in your will. This is the person the account will be transferred to upon your passing. This is usually a person you trust to uphold your initial wishes in establishing the RESP.
The second scenario involves the successor subscriber. The reason why you need to choose the right subscriber is that they are free to use the money in the account as they see fit. For example, they could transfer the money to another beneficiary – even one you had not intended. To ensure this does not happen and that the money goes to the beneficiary you had in mind when you opened the RESP, you can leave a testamentary trust. This trust will administer the RESP upon your passing.
RESPs are one of the best ways to plan for and fund your child’s post-secondary education. However, there are a lot of things you need to know about RESPs and what happens to the account when the unthinkable happens. All in all, if your finances are in good order, you should go ahead and open an RESP. It can help ensure your child receives post-secondary education and that they do not have to be saddled with student loans once they graduate.