Tax-Effective Saving For School: The RESP

The biggest advantage
Making sure your kids have enough
Picking a plan that suits you
What if your kids do not go to university?

Depending on whose numbers you look at, the cost of a post-secondary school education could reach as much as $100,000 within the next 20 years. Whether or not it gets that high is debatable. But there's no doubt it's increasing significantly. There are different ways of saving for your kids' education, but the most tax-effective one is with a Registered Education Savings Plan (RESP).

The biggest advantage.

Any money you contribute to an RESP grows tax-free until it is withdrawn from the plan. When your kids begin tapping into those savings to pay for their education, they are taxed on the money they withdraw. And naturally, as low-income students, they will incur little or no tax on that money.

Proposals in the February 24th, 1998 Federal Budget will create an additional advantage if enacted. The government proposes to partially match contributions to an RESP in the form of a Canada Education Savings Grant (CESG).

Making sure your kids have enough.

The sooner you start, the more an RESP will be worth when it's needed. It's particularly important to get a head start on an RESP, because that money will be needed relatively soon much earlier than your retirement savings, for example. As well, the contribution restrictions are more severe than with RRSPs. You can contribute up to $4,000 per child per year, with an overall contribution limit of $42,000. For each RESP you open, you name a beneficiary, typically one of your children, although plans can also be set up for you, your spouse, grandchildren, and even non-family members.

CESGs will be paid directly to the RESP for beneficiaries under the age of 18. Beneficiaries will accumulate contributed room at the rate of $2,000 per year. The maximum CESG paid each year will be 20% of the lesser of: The lifetime maximum CESG payable on behalf of one child is $7,200. The rules regarding CESGs are not entirely clear at this point as the government has not yet introduced the legislation which will govern them.

Picking a plan that suits you.

When you consider an RESP, you'll find there are two types of plans to choose from. The first are group plans which are also known as pooled RESP or scholarship trust plans. With these, you set up a monthly contribution arrangement. Typically this sort of plan holds conservative investments, such as Guaranteed Investment Certificates, government-insured mortgages and government bonds. Usually when the child is ready for university, the money you contributed (less fees and expenses) is paid out all at once. Following that pay-out, earnings on your investment are paid out over the next three or four years. The second type of plan is the self-directed RESP. This plan gives you more control over how your money is invested and more access to your portfolio. Like a self-directed RRSP, this control allows you to be more growth-oriented in your investment approach by including mutual funds and, in some cases, individual stocks and bonds in your portfolio. And naturally, this gives you greater growth potential than a group RESP.

What if your kids do not go to university?

RESPs are a good investment as long as the plan beneficiary actually does pursue a post-secondary school education. But what if your kids suddenly change their minds and don't continue on in school? The answer depends on what type of plan you have.

Beginning in 1998, up to $40,000 ($50,000 for 1999 and subsequent years) of an RESP's accumulated growth that is not used to fund post-secondary studies may be paid out directly to you, or transferred over into your RRSP (or a spousal RRSP). To benefit from this, you must have sufficient RRSP contribution room, and you must meet a number of other conditions. Any accumulated growth that you withdraw but don't transfer into your RRSP will be taxed as income and subject to an additional 20% penalty.

Keep in mind that even though the government may allow you to access your RESP earnings, the company offering the RESP may not. Self-directed plans offer flexibility. Typically, group plans do not check with the carrier of your RESP to determine the status of your plan.

With plans that don't permit access to your earnings, your contributions are returned (less fees and expenses) but your earnings are forfeited and either reinvested for the plan's other participants or donated to the post-secondary school of your choice.