RESP’s have been targeted in the last several budgets, with the result that they are now an attractive tax deferral vehicle which should be considered by all parents with eligible children.
Parents (and certain other relatives) are permitted to contribute up to $4,000 per year per child to an RESP. There is an overall lifetime contribution limit of $42,000 per beneficiary.
Although there is no deduction for a contribution which is made to an RESP (unlike an RRSP) the amount in the plan does earn income on a tax free basis.
The latest budget established the Canadian Education Savings Grants, which are a government contribution equal to 20% of the annual RESP contribution, to a maximum of $400 per child per year and to a lifetime maximum of $7,200 per child.
These CESG grants will be made directly by the government into the trust plan on behalf of the child. The grant portion will be administered by the plan trustees along with the RESP contributions made by the parents.
Use of RESP
The income of an RESP, including CESG amounts received and income earned on the CESG, can be paid out to a beneficiary once the beneficiary enrols as a full time student in a qualifying educational program. This would include courses at colleges and universities as well as vocational and technical schools.
Principal payments, being a return of non-deductible amounts, are not taxable on withdrawal.
Income and CESG payments are taxed in the hands of the beneficiaries upon receipt. However, since the beneficiaries are students, they will typically have little other income and they should, in most cases, pay little or no tax on these funds.
Family plans can be set up with multiple beneficiaries all of whom are related to the subscriber by blood or adoption. This is important since RESP income can only be paid out to students in a post-secondary institution. If a plan is set up for an individual beneficiary and that beneficiary does not attend a post-secondary institution the income will not be available for use by that child, but will be paid to the contributor.
Contribution of RESP income to RRSP
The loss of interest on principal contributions where a child did not attend post-secondary education used to be the big disadvantage to RESPs. The rules now permit such income amounts (excluding any CESG grants received), to a lifetime maximum of $50,000, to be paid to the contributor’s RRSP provided the contributor has RRSP contribution room available.
If RRSP contribution room is not available then the amount can be paid to the contributor, but will be taxed at the highest marginal tax rate plus an additional tax of 20%.
Types of Plans
There are presently 2 different types of plans available in the market place.
Group or pool plans are sold by non-profit scholarship companies. All contributions are pooled for the benefit of all plan members. These plans can contain restrictions on how the money is invested, where it can be spent and what can be done if the beneficiary does not attend post-secondary school. They may also contain the old rules resulting in a forfeiture of earned income if your child does not attend a post-secondary institution.
The other main type of plan is an individual self-directed plan. These plans are sold by different financial institutions including scholarship companies, banks and trust companies. As with self-directed RRSPs, the self-directed RESPs can provide a lot more flexibility and control of the fund.
There are also rules in place to prevent abuses of the CESG system. For example when contributions are withdrawn for non-educational purposes from an RESP which has received a CESG, there will be a CESG repayment equal to 20% of the withdrawn amount.