RESP 101 – It pays to gain RESP education

What is an RESP?  Registered Education Savings Plans are registered accounts that enable you to make contributions now towards the cost of future education.   Unlike an RRSP, your contributions 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.

The Good News: Previously the rules governing an RESP were onerous. If the beneficiary did not attend a qualifying institution (i.e. college or university), any growth, interest, dividends and capital gains went to the educational institution that was designated on your RESP contract.  The good news is that the Canada Revenue Agency has significantly modified the RESP rules. In addition to the tax advantages, there are increased savings limits and additional termination options.

General Rules:  Although contributions to an RESP are not tax deductible, any income within the plan compounds on a tax deferred basis. Furthermore, when the accumulated income is withdrawn from the plan to pay for education expenses, the student pays the taxes, not the contributor.  In most cases, this income would attract little tax because the student’s basic personal exemption along with tuition and education credits help to offset the tax liability.  Any individual can set up an RESP including grandparents, aunts, uncles, godparents and friends.

Contributions:  These plans allow the contributor (called a subscriber) to deposit any amount up to $4,000 annually per beneficiary.  Contributions may be made for up to 21 years following the year in which the plan is entered into, to a lifetime maximum of $42,000 per beneficiary. If these limits are exceeded, a one per cent per month penalty tax is charged until the over-contributed amount is withdrawn from the plan.

Canada Education Savings Grant (CESG):  The CESG grant was introduced in the 1998 federal budget.  Currently, beneficiaries are not required to have an existing RESP to accumulate CESG contribution room. Under this program the Government of Canada pays a grant of at least 20 per cent of the first $2,000 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 totaling $7,200 per beneficiary.  Contributions for beneficiaries aged 16 and 17 will only receive a CESG subject to certain stipulations. CESG room may be carried forward until the beneficiary turns 18.  Beneficiaries must have a social insurance number to receive the CESG.  If contributions are not made to the plan then the CESG contribution room may be carried forward and used when RESP contributions are made in future years.

Education Assistance Payments (EAP):  Once the beneficiary of an RESP is enrolled in a qualified school, education assistance payments may commence.  Any income or growth earned within the plan may be paid out to the beneficiary once they are attending a recognized post-secondary institution.  EAPs are taxed in the hands of the beneficiary, who reports it as “other income” on their tax return.

No Post Secondary?  If the beneficiary of the RESP does not proceed with post secondary education, the contributions are returned to the contributor with no tax consequences and the CESG, if applicable, is returned to the government. Contributors may withdraw the income earned in the RESP if the following criteria are met:  (1) all beneficiaries named in the plan are at least 21 year old and are not eligible for EAP payments; (2) contributor is a Canadian resident and ;(3) RESP was opened at least ten years ago.   These income withdrawals are referred to as Accumulated Income Payments.

Accumulated Income Payment (AIP):  Provided the above three criteria are met, the Accumulated Income Payment 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);(2) having it taxed in the contributor’s hands at their marginal rate plus an additional 20% tax is levied; (3) donating the income to a post-secondary institution (no donation tax credit provided).

Maturity:  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.  All contributions will be returned tax-free to the contributor and the CESG repaid to the government.  Any income that has not been paid out to the beneficiary must be returned to the contributor as an AIP.

An RESP is one of several vehicles individuals may choose to help fund post secondary education.  Rules are continually changing with respect to RESPs.  Individuals should always consult with their personal tax advisors before taking any action based upon these columns.