By Guest Blogger Sinan Terzioglu
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I’m a dad. And a financial guy. So I know an RESP can be a significant part of a family’s plan since post-secondary education costs are continually rising. According to the Canada Student Loans Program the tuition cost in 2035 will be over $17,000 per year, more than double the cost today.
Statistics Canada estimates nearly 50% of Canadian parents are not taking advantage of Registered Educations Savings Plans (RESPs). So these families are not maximizing the potential and leaving money on the table – specifically the federal government’s contributions. Ottawa supports families through the Canadian Education Savings Grants (CESG). That adds a maximum of 20% per beneficiary up to $500 per year – $7,200 per beneficiary in total.
The lifetime RESP contribution limit per child is $50,000. There are no annual contribution limits, but the CESG max is $500 a year. So if you contribute $2,500 one year, the federal government will grant $500. You can catch up on missed years but only one year at a time. If you miss a year and contribute $5,000 the government will then grant $1,000 (two years of max contribution) – $500 for the current year and $500 for a missed year.
The best time to start contributing is as soon as you have a social insurance number for your new born. If you’re not working with an advisor it’s best to open a self-directed RESP at your bank’s discount brokerage or an independent brokerage and invest in diversified low-cost growth ETFs in the early years. If you have more than one child or are planning to have more, open a family RESP which can be shared among your children. If one child decides not to pursue post-secondary education, savings can be directed within the plan to the others. Keep in mind though that the government grants cannot be shared but all other contributions can.
As with all investments, contributing early and consistently will provide the best chance of growing the money. You get the automatic return of 20% per year from the government grant as well as the power of compound growth over time. For example, contribute $2,500 per year for each child by putting in a little over $100 every two weeks for 14 years. Over those years you would have contributed $36,000 and the government grants would total $7,200 – for a total of $43,200. But with the money invested and earning an average annual rate of 6%, the account would grow to nearly $70,000.
Withdrawals are taxed in the hands of the beneficiary. This is helpful as the child will very likely be in a low marginal tax bracket at the time of the withdrawals. An individual or family RESP can stay open for 36 years so if your child doesn’t continue his/her education, you can keep the plan open in case they decide to resume studies later. If your child is unlikely to pursue post-secondary education or all the funds in the plan are not required, you may be able to transfer up to $50,000 tax-free to your RRSP (if you have available contribution room) so long as the RESP has been open for at least 10 years and all beneficiaries are at least 21 and not currently pursuing higher education.
Anyone can open an RESP for a child – parents, guardians, grandparents, relatives or even friends. The person(s) that establish an RESP are called ‘the subscribers’. Funds invested in an RESP remain the property of the subscriber(s) until withdrawals are made for the benefit of the beneficiary. An RESP is not a trust so if a subscriber dies the RESP will form part of his or her estate. Therefore have a plan in place, clearly stated in a will, in case the subscriber passes away. A subscriber can appoint someone as a ‘successor subscriber’ or can appoint a testamentary trust as successor subscriber but this is complex and expensive. To avoid these challenges I generally recommend grandparents do not open an RESP for their grandchildren and instead gift the money to the parents and have them establish an RESP as subscribers.
In case of divorce, an RESP can be dealt with in a few different ways. Under the Income Tax Act, RESPs are not required to be divided so both parents can continue to be joint subscribers and continue to contribute to the RESP, however, you cannot open a joint subscriber account once you are divorced. An RESP can also be split equally and transferred from one RESP to another so long as the beneficiaries stay the same but it is more complicated than it sounds so it is likely best to keep the plan in place because if an RESP is split all future contributions will need to be coordinated. Another important consideration is that an RESP is not protected from creditors so if you or your ex ever files for bankruptcy, creditors could demand all or part of the RESP.
There are many considerations when opening, contributing and withdrawing from an RESP. It is a powerful investment opportunity to plan for the long term education needs of your family assisted by the government grants and ability to grow the money on a tax-deferred basis. To avoid future complications consider many scenarios to ensure the RESP is maximized for the benefit of the kids.
Sinan Terzioglu, CFA, CIM, is a financial advisor with Turner Investments, Private Client Group, Raymond James Ltd. He served as vice-president of RBC Capital markets in New York City and VP with Credit Suisse in Toronto.