It’s not a free-for-all, though; the Canadian government has laid out a number of guidelines and restrictions for RESPs. It’s important to follow these guidelines or you may miss out on benefits — or even face penalties.
Don’t worry; we’re going to lay it all out for you today and teach you everything you need to know about how RESPs work.
How RESPs Work: The Different Plans
The Canadian government has laid out three education savings plans, each tailored towards different situations.
You’re allowed to have as many plans per child as you’d like as long as you don’t exceed the lifetime contribution limit of $50,000 per beneficiary. If you exceed this amount, you’ll pay a penalty of 1% per month until you withdraw the excess contributions.
In some cases, you’re allowed to switch plan types — something that becomes much easier when working with an RESP provider like Knowledge First Financial.
A family plan is intended for those looking to save for multiple children.
As with all types of RESPs, by the way, the intended recipients of the funds are referred to as “beneficiaries,” while the people contributing to the plans are known as “subscribers.”
If you’re the subscriber, the plan’s beneficiary must be less than 21. They must also be your child or grandchild through blood, adoption, or marriage (in the case of step-children).
Under an individual RESP, you have fewer restrictions regarding who can be a beneficiary under the account.
While there can only be one beneficiary, that person can be anyone, including another adult or yourself. In both of those cases, however, you won’t receive the Canada Education Savings Grant (CESG) or Canada Learning Bond (CLB) since those have their own requirements, one of which is that the beneficiary is not an adult. More on these programs and their limitations shortly.
A group plan pools your contributions with other investors and invests those funds with a maturity date in mind. Many providers will automatically adjust the assets held within the plan as that maturity date approaches, switching to more conservative investments as needed.
Under a group plan, you have a set contribution schedule (including one-time, annually, or monthly).
A good group RESP provider will, however, leave you some room for flexibility should you need to adjust your contribution schedule or amounts.
How RESPs Work: Taxation
An RESP has more in common with a Tax-Free Savings Account (TFSA) than a Registered Retirement Savings Plan (RRSP) in that you can’t deduct contribution amounts from your income.
In other words, contributing to an RESP won’t reduce your taxes owing.
The good part?
Gains on investments made within an RESP won’t be subjected to capital gains tax.
However, when it’s time for the student to withdraw funds, the gains and government grant amounts (cumulatively referred to as Education Assistance Payments) will be taxed as income for that student.
This isn’t a big deal for a few reasons.
For one, chances are high that the student will fall into a low or no-tax bracket when they withdraw the funds, particularly if they’re claiming other education credit amounts against any income they have.
Secondly, because contributions to an RESP are allowed to grow tax-free right up to withdrawal, you get to take advantage of compounding interest for as much as 36 years, which is how long the government allows you to keep an RESP open.
In investment accounts that aren’t tax-advantaged, you would pay capital gains taxes yearly, limiting the degree to which your investment gains can go on and produce additional gains.
Early Withdrawal Taxation
Things get messy when you prematurely withdraw investment gains and government grant amounts from an RESP or close the account altogether.
According to the government of Canada, you will forfeit any grant amounts they’ve paid into the RESP. You’ll then have to pay income tax, plus a 20% penalty on investment gains you withdraw.
You may be able to defer these taxes by transferring the investment gains to an RRSP owned by your or your spouse with the help of a financial advisor provided you meet a number of criteria, including:
- The RESP is at least 10 years old
- All beneficiaries of the RESP are 21 or older and are not seeking post-secondary education
- You have room in your RRSP
- You are a Canadian citizen
How RESPs Work: Normal Withdrawals
Now that you know about the penalties for premature RESP withdrawal, let’s talk about the standard practice for normal withdrawals.
Firstly, you don’t have to pay taxes on withdrawals of contribution amounts — even if you withdraw early and for non-education purposes.
Withdrawing Money to Pay for Your Beneficiary’s Education
The beneficiary cannot withdraw investment gains or grant amounts (EAPs) from the plan; you as the subscriber have to take care of that on their behalf.
The government allows you to do this without penalty once the beneficiary has graduated from high school and enrolled in a qualifying full-time or part-time post-secondary program.
Program eligibility depends on the following criteria:
- The program must last for a minimum of three consecutive weeks
- There must be at least 10 hours of instruction weekly
- It must be offered at a recognized institution
Don’t worry; there are a ton of institutions and programs that fit the above criteria. For an idea of how extensive the playing field is, check out Knowledge First Financial’s list of recognized institutions.
Alright, so how do you get your money from an RESP?
You’ll need to get in touch with your RESP provider and give them proof of enrollment as well as details regarding the expenses you’ll be using the money for (including receipts if you’ve already gone ahead and made those purchases).
Your RESP provider will work with you to ensure your expenses meet the criteria.
How Much Can You Withdraw?
During the first 13 consecutive weeks of a beneficiary’s full-time enrollment, EAPs are capped at $5,000. That cap drops to $2,500 per 13 weeks of part-time enrollment.
In both cases, there are no limits on EAPs after the 13-week mark.
If you need more than those amounts to cover eligible expenses, you can work with your RESP provider to file an application with the Minister of Employment and Social Development.
What to do with Leftover EAP Amounts
If an RESP’s beneficiary does not end up using all of the EAP amounts associated with that account, you have a few options.
- Adding a new beneficiary
- Transfering the amounts to another RESP
- Moving them to your RRSP
How RESPs Work: Grants
We’ve mentioned grants a number of times in this article. What are they and how do they work?
Here’s the rundown.
The primary type of grant to keep in mind is the Canada Education Savings Grant (CESG).
About the CESG
Through this grant, the government will contribute to an RESP, up to a lifetime limit of $7,200 per beneficiary under 18.
The government calculates this grant based on the amount of money you contribute to the RESP annually; you’ll receive 20% for the first $2,500 in contributions you make.
This means you’ll receive $500 if you contribute a full $2,500 in a year.
Depending on your income, however, you may receive an additional amount from the CESG program.
Here’s how it works.
Does your household bring in $46,605 or less? You’ll receive an extra 20% in CESG amounts, up to a limit of $100.
If your household makes in between $46,605 and $93,208, however, you’ll receive an extra 10% in CESG amounts, up to a maximum of $50.
The lifetime limit of $7,200 per beneficiary includes this extra amount.
You can claim the CESG amounts by working with your RESP provider and filing an application.
You’re also allowed to play catch-up if you don’t maximize contributions for each year. By contributing $5,000 per beneficiary every year, you’ll fulfill requirements for the current year’s CESG as well as one prior year’s.
You can only catch up one year at a time, though, so if you start after a beneficiary is 10 years old you’ll miss out on the full CESG amount, considering it will take you eight years to build up enough in contributions.
Other Types of Grants
While the CESG applies to everyone, there are other types of grants geared towards specific situations.
One such grant is the Canada Learning Bond (CLB), which exists to help low-income families pay for a child’s education, as long as the child was born in or after 2004, is a Canadian resident, and is a beneficiary to an RESP.
Through this grant, the government will place an initial $500 into a qualifying RESP, followed by $100 for every year that the beneficiary qualifies and until the limit of $2,000 is reached.
Exactly what qualifies as “low-income” depends on the number of children a family has and, of course, the corresponding income.
- 1 to 3 children: $47,630 or less
- 4 children: $53,740 or less
- 5 children: $58,876 or less
- 6 children: $66,011 or less
- 7 children: $72,146 or less
- 8 children: $78,281 or less
This continues all the way up to 16 children, at which point the household income required to be considered “low-income” is $127,362.
Beyond the CLB, there are also provincial grants in British Columbia and Saskatchewan.
For more information about these grants, look at Knowledge First Financial’s article about how to maximize your grants and add potentially thousands of dollars to your RESP over time.
As you can see, the mechanics of RESPs are pretty detailed. There’s a lot to consider!
You can make this process considerably easier by working with a qualified RESP provider like Knowledge First Financial.
They’ll help you select the correct plan for your situation, assist you in the withdrawal process (including navigating taxation), and help you maximize your grants.
Now that you’ve reached the end of this article, you should have a solid understanding of these concepts so you can engage in a good discussion about them with your RESP provider or financial advisor.
This content is sponsored by Alex Hales.