REGISTERED EDUCATION SAVINGS PLAN (RESP)
Registered education savings plans are a tax-advantaged incentive program to encourage individuals to accumulate savings to provide for the post-secondary education of named “beneficiaries”, typically children or grandchildren. There are two types of plans sponored group plans, offered by RESP promoters, and plans offered by financial institutions, mutual fund companies, brokers etc., that are similar to RRSPs. As sponsored plans are controlled by the company offering the plans and there is no flexibility around investments etc., this discussion will focus on the plans offered by financial institutions.
There are essentially two types of RESPs available: individual plans, where the beneficiary is a named individual, and family plans. There are no relationship requirements imposed between the contributor and beneficiary, so that you may set up an RESP for any relative or deserving beneficiary. However, individuals such as aunts or uncles who are not considered under the Income Tax Act to be connected to the children by blood or adoption but want to save for a number of children through RESPs may do so only through separate individual plans. To provide subscribers of separate individual plans with the same flexibility to allocate assets among siblings that exist under family plans, changes were made in 2011 that allow certain transfers between individual RESPs for siblings without penalty.
The benefits of an RESP arise through three mechanisms:
- tax-free compounding of investment income, in that income earned on the (non-deductible) contributions you make to the plan is not subject to tax as it is earned; accordingly, income accumulates far more rapidly in the plan than it would in the hands of the contributor in a non-registered account;
- income splitting, in that when education assistance payments are paid out of the plan for the post-secondary education of a beneficiary they will be taxed in the hands of the beneficiary, whose tax rate is typically much lower at that time than the contributor’s tax rate; and
- incentive grants, in that the government will actually match contributions with 20% grants paid to the plan on contributions of up to $2,500 per year; the government will also grant an additional grant of up to 20% on the first $500 of contribution.
As a contributor (subscriber) to an RESP, you are not entitled to a deduction in respect of your contribution; however, the interest income (or other investment income) earned in the plan on your contribution is not taxed in your hands. Rather, the investment income earned in the plan is accumulated free of tax and will be taxed in the student’s (child’s) hands only when the child receives funds from the plan.
Annual contribution limits to an RESP have been eliminated. However, there is a lifetime limit of $50,000 per beneficiary. It is important to note that this limit applies to the beneficiary and therefore captures contributions made by any and all subscribers to RESPs for that beneficiary. This can be hard to administer in practice where there are several RESPs — perhaps one set up by the parents and others set up by uncles and aunts. Exceeding the limit will trigger a punitive penalty tax of 1% per month on any excess contributions until the excess is withdrawn.
Generally speaking, an RESP is permitted to make an educational assistance payment (EAP) to an individual only if, at the time of the payment, the individual is enrolled as a student in either a qualifying educational program (which is generally a full-time program) or a specified educational program (which is a part-time program) at a post-secondary educational institution. Individuals enrolled in a qualifying educational program may receive up to $5,000 of EAPs during their first 13-week period of study. Thereafter, there is no dollar limit on the amount of EAPs. Students enrolled in a specified educational program may receive up to $2,500 of EAPs during each 13-week period of study. The requirement that EAPs be made only during periods of enrolment was relaxed by providing a six-month grace period for making EAPs. An RESP may now provide for the payment of an EAP to an individual for up to six months after the individual ceased to be enrolled as a student in a qualifying educational program or a specified educational program, as the case may be. However, this additional flexibility will apply only where the payment would have qualified under the normal rules for EAPs if it had been made immediately before the individual’s enrolment ceased.Thus, for example, an individual who received a $2,000 EAP while enrolled in a 10-week specified educational program would be entitled to receive up to $500 of additional EAPs during the six-month period following the end of the program (that is, without having to enrol in another program).
The benefits of RESPs must be weighed carefully- not simply in tax terms, but with an understanding of plan provisions in the event that beneficiaries do not ultimately attend designated schools within the anticipated time frame. As noted above there is some flexibility in this regard in terms of reallocating RESP income to alternate beneficiaries in the event that the intended beneficiaries do not attend qualifying programs in both family and individual RESPs. It is important to check the terms of a plan in this regard before investing.
CANADAEDUCATION SAVINGS GRANT (CESG)
The Canada education savings grant program is intended to create a further incentive for taxpayers to save through RESPs by providing a direct federal grant to any valid RESP equal to 20% of the first $2,500 per year contributed for each child less than 18 years of age. Grants are limited to a specified annual amount. (There is also an overall lifetime maximum of $7,200 of grants for each beneficiary of an RESP.) The grant itself is not included in calculating the lifetime RESP contribution limit.
The basic annual grant limitations are $500 per year. This basic limit is enhanced by doubling the matching rate to 40% on the first $500 of annual contributions to an RESP for the child of a family with income up to the limit of the lowest marginal rate bracket. (Such families may also be entitled to benefit from the Canada Learning Bond program.) Families with incomes in the second rate bracket will be entitled to a 30% matching rate on the first $500 of annual contributions to an RESP. Family income will be determined under the Canada Child Benefit rules.
The supplemental grants for lower income families mean that the maximum grant is now $600 per year for a family with income below the lowest marginal rate (40% of the first $500 contributed plus 20% of an additional contribution of up to $2,000) and $450 per year for a family with income below the second rate bracket. However, the lifetime grant limit for each child remains $7,200.
If contributions are withdrawn for non-educational purposes from an RESP which has received a CESG, the RESP trustee will be required to make a CESG repayment equal to 20% of the withdrawal. Where a plan contains both contributions which did and contributions which did not earn CESG, the CESG earning contributions will be considered withdrawn first; that is, the 20% repayment will be required on withdrawals until the CESG is, in effect, exhausted.
Grant repayment will also be required where a payment of RESP income is made for non-educational purposes, where a beneficiary is replaced (except by a sibling or a beneficiary related to the subscriber by blood or adoption), and where a plan is terminated or revoked. Repayments may also be required on transfers between plans.
Grants will not be earned for “family plans” unless the plan provides that no beneficiary 21 or older may be added. Similarly, grants will not be allowed to plans unless they provide that educational assistance payments in respect of courses of less than three months do not exceed the cost of tuition plus $300 per week of study (as all new plans must provide).