Parents should consider RESPs

Parents who want to save for their children’s education should look closely at Registered Education Savings Plans.  It beats putting money in a bank account or waiting until the tuition is due.

Parents will often choose to save for tuition by setting aside savings in a bank account because it is a simple option, not realizing all the facts.  One question we are asked regularly is, “What if my child does not pursue further education?”  We will answer this question and highlight the important changes to RESP accounts that were announced on March 19, 2007 by the federal government.

RESPs are registered accounts that enable you to make contributions now towards the cost of future education.   Unlike RRSP contributions, amounts put into an RESP are not tax deductible.  Investments within an RESP have the potential to grow and income is tax-sheltered until paid out to the beneficiary.  RESPs may be very attractive for those beneficiaries who qualify for the Canada Education Savings Grant.

Within an RESP account the total dollar amount generally includes three components – original contribution, Canada Education Savings Grant and investment income.

Contributors would be wise to understand these components and the recent legislation changes.

Original Contributions

Ottawa has eliminated the $4,000 annual contribution limit and has raised the lifetime contribution limit from $42,000 to $50,000.   As noted, the subscriber does not receive a tax deduction for your contribution.  If the beneficiary does not attend a qualifying educational institution then this amount may be returned to you without tax consequences, assuming the account has sufficient capital to do so.

Canada Education Savings Grant

The CESG grant was introduced in the 1998 federal budget, and the maximum amount has recently been increased from $400 to $500 for the 2007 taxation year.  The government now pays a grant of at least 20 per cent of the first $2,500 of annual contributions, directly into the qualifying beneficiary’s RESP.  Qualifying beneficiaries are generally below the age of 18 and may receive a lifetime maximum CESG totalling $7,200 per beneficiary.  Your child must have a social insurance number to receive the grant.  If a beneficiary does not attend a qualifying institution then the CESG must be paid back to the government.

Investment Income

What happens to any potential investment income that has been generated within the plan?  Previously the rules governing RESPs were onerous.  If the beneficiary did not attend a qualifying institution the investment return (interest, dividends and capital gains) went to the educational institution designated on the RESP contract.  The good news is that the Canada Revenue Agency has significantly modified the RESP rules and the termination options.  Subscribers may withdraw the investment income earned in the RESP if the following criteria are met:  (1) all beneficiaries named in the plan are at least 21 years old and are not eligible for education assistance payments, (2) contributor is a Canadian resident, and (3) RESP was opened at least ten years ago.

Investment income withdrawals are referred to as Accumulated Income Payments (AIP).  Provided the above three criteria are met, the AIP that has not been paid out to the beneficiary can be returned to the contributor by either: (1) transferring up to $50,000 to the contributor’s RRSP or a spousal RRSP (the contributor must have sufficient RRSP contribution room available) or (2) having it taxed in the contributor’s hands at their marginal rate plus an additional 20 per cent tax is levied, (3) donating the income to a post-secondary institution (no donation tax credit provided).

Self directed RESPs have flexibility with respect to the types of investments within the account.  In addition, if the beneficiary does not attend a qualifying institution then you have the three AIP options above.  All of these options are considerably better than losing the entire investment income amount.

An RESP has to be terminated on or before the last day of the twenty-fifth year after the year in which the plan was entered into.  The consequence of this deadline is similar to the beneficiary deciding not to pursue post-secondary education.

Rules are continually changing with respect to RESPs.  The recent changes in 2007 have resulted in several different strategies for funding education.  One strategy for children eligible for the CESG may be to contribute $2,500 per year for fourteen years and $1,000 in year fifteen.   This strategy enables the contributor to obtain the maximum grant amount of $7,200 ($36,000 x 20 per cent).  Another strategy is to combine the above (contributions over 15 years) with an additional contribution of $14,000.  Although the $14,000 would not attract the grant, the extra dollars invested would maximize the lifetime contribution limit of $50,000.

Individuals should always consult with their personal tax advisors before taking any action based upon these columns.