Registered Education Savings Plans
Markus Muhs - Aug 24, 2020
Below you'll find my recently updated "RESP Wiki". As the name suggests, I update this post annually with any changes to legislation, as well as to add info based on questions from clients. It has, admittedly, gotten rather long.
Updated: August, 2020
Table of Contents
- A Word About Group RESPs (Scholarship Trusts)
- Getting Started: What is an RESP?
- Who Should Open an RESP? (new for 2020)
- Family RESPs
- Contribution Strategies
- How Much Will Education Cost?
- Investing in an RESP
- RESP Withdrawals
If I've left any questions unanswered, or if you're ready to start an RESP for your child(ren) now, contact me.
A Word About Group RESPs (aka: Scholarship Trusts)
They will tell you that their plans are better and will cost you less over the long-term, and that because their organization is a non-profit (despite their salespeople being 100% on commission) this makes them somehow more altruistic. Yes, if you compare them to a typical bank mutual fund RESP the fees amount to less over the lifetime of the plan, but fees in a GRESP are front-loaded; your first X number of contributions go 100% to paying fees, instead of being invested on your behalf. Keep in mind that the low-fee alternative is that you can open an RESP with a discount brokerage, since you will get exactly the same amount of investment advice there as you will from your friendly GRESP salesperson.
The worst part about GRESPs is the commitment. Once in, if you don't want to avoid sacrificing a lot in fees, you're stuck. When you deal with any investment advisor (whether me, or at a bank, or wherever) a key thing you need to ensure is that you always have a way out, in case the relationship sours. Any regular RESP can be transferred (or at least should be transferable!) from institution to institution, including all the grant money the plan collects.
Okay, I know I'm biased, because I offer the aforementioned "normal RESPs" and compete against GRESP providers, but if you've been approached by a salesperson of one of these plans, Google their company name and read some of the articles that come up, like this one, or any web forum posts by parents trying to take their money out of such plans. Here's some further reading from some less biased sources (not investment dealers):
- Less opinionated but factual piece from the OSC's Get Smarter About Money
- A scathing piece from the more self-help oriented Boomer & Echo
- Overhaul of Group Scholarship Plan Rules Needed to Protect Consumers: When the Foundation for Advancement of Investors Rights is setting their sights on such plans, they're probably not a good idea for your newborn.
As a general rule of thumb, to avoid getting scammed, you should never EVER enter into any kind of financial service agreement without first doing some due diligence on the web. Google is your friend!
Alright, enough ranting about GRESPs, if you've never heard of them before reading this, GREAT; if it's the only type of RESP you've ever heard of, READ ON.
Getting Started: What is an RESP?
For the completely uninitiated: what is an RESP and what is its purpose? Obviously, as the name suggests, RESPs are a type of registered trust that can be used to save for someone's education (generally a child's).
You can open RESPs at just about any bank, credit union, or investment dealer. To start, you'll need to apply for a Social Insurance Number for a child, and most institutions will generally require a SIN and a birth certificate for the child to open an RESP.
The key benefits of saving via an RESP vs. any other way, or not saving at all are:
- Generous grants from the federal government and some provinces, which I'll get into a bit later.
- Tax deferral of investment income: Investments compound tax-free and in ideal circumstances when money is withdrawn from the plan all accumulated growth, income, and grant money is taxed in the hands of the student, usually at a very low tax rate, if at all.
Promoter: The institution with which the RESP is opened (bank/dealer/credit union/scholarship trust)
Beneficiary: Canadian resident with a SIN, who will eventually use the funds. Usually the child(ren).
Subscriber: Contributors to the plan. Usually, parents/guardians but can also be other family or friends, with permission from parents/guardians. RESP accounts are held in the name of the subscriber(s), individually or jointly.
Lifetime maximum RESP contributions: $50,000. Can be contributed at any time. There is no longer an annual maximum, however, grants are only paid out yearly up to the maximums the beneficiary qualifies for (more on this below).
Canada Education Savings Grant (CESG)
- Applies to all RESP beneficiaries who are Canadian residents up until the end of the calendar year in which they turn 17.
- Grant: 20% federal government matching on first $2500 contributed each calendar year.
- Lifetime maximum grant of $7200 (as of 2020). If contributing $2500 per year for a child from birth, the maximum grant, at $500 each year, is hit in the 15th calendar year.
- Unused grant eligibility is forfeit if not used by the end of the calendar year in which the beneficiary turns 17.
- To dissuade parents from taking advantage of RESPs at the last minute, grant eligibility may be forfeit if the beneficiary is 16 or 17 and there wasn't at least $2000 in total RESP contributions for the beneficiary before the end of the calendar year in which the beneficiary turned 15 OR a minimum $100/yr in contributions in each of any four prior years.
- If it's not clear already, grant eligibility and limits always go by calendar year, not age of the beneficiary. If Child A was born December 31st, 2019 she is now (in 2020) eligible for 2 years' worth of grants (you can contribute $5000 in 2020 for a $1000 grant). Child B born a day later has one less year of grant eligibility. On the flipside, Child A's final year of grant eligibility is a full year earlier than Child B's.
- Unused grant eligibility carries forward to future years, however the maximum grant paid out each year is $1000 per beneficiary, meaning if you wish to "catch up" for past years missed for a child, the maximum contribution each year should be $5000 ($2500 for previous missed year, $2500 for the current year for $1000 of total grant).
- Annual grant eligibility was increased from $400 to $500 in 2007. When calculating carry-forward grant eligibility for a child born prior to 2007 count $400 for each year 2006 and prior, $500 for each year 2007 and subsequent.
- When it comes to the "expiry" of carry-forward CESG eligibility, the only things to be mindful of are that the year in which the child turns 17 is the final year in which CESG will be paid. Because of the $1000 per year maximum grant payout, if wanting to reach the $7200 lifetime limit an RESP should be opened no later than the year in which the child turns 10.
- Beneficiaries in families considered to be "low income" or "medium income" qualify for an additional 10-20% grant on the first $500 contributed to a qualifying RESP. Not every family can afford to save $2500/yr for each child, but these enhanced grants make it more enticing to at least put $500/yr aside for each child's future education.
- Eligibility is based on family net income, which consists of the net income of the primary caregiver (line 23600 on their most recent income tax return) plus that of a spouse or common-law partner, if applicable. The below income brackets are updated annually and can be found here.
- $48,535 and under (2020): additional 20% grant (a total of 40%, or $200 on the first $500 contributed)
- $48,536 to $97,069 (2020): additional 10% grant (totaling $150 on first $500 contributed)
Canada Learning Bond (CLB)
- An additional supplement available to children who were born after December 31, 2003, whose families receive the National Child Benefit Supplement. Generally, this includes most families who qualify for the 20% ACESG mentioned above. More details on the CLB here.
- The CLB pays $500 into a qualifying RESP upon application (no contribution from the subscriber required) and then $100 each year the family is eligible until the calendar year in which the child turns 15.
- To sum up CLB and ACESG, if eligible for both, a family can open an RESP, contribute $500, and receive a total of $700 of grants in the first year. In following years, provided continuing eligibility for both, a family can contribute $500 per year and receive $300 in grants.
- Various provinces have from time to time implemented additional supplemental RESP grants. Some have come and gone, like Alberta's ACES and Saskatchewan's SAGES. More details below on currently active provincial grants (will try to update this each year as needed):
Not all RESPs are eligible for all grants. To ensure that your plan, or the one you plan to open, is eligible for the grants applicable to your family, a full listing is available at Employment and Social Development Canada.
Canaccord Genuity Wealth Management RESPs offer all federal grants, as well as the BCTESG and QESI. At many of the banks, RESPs are offered through their banking channel (GICs and savings), mutual fund affiliate, as well as their brokerage affiliate. Be aware that not all grants are available in all of their different RESPs (you may need to open multiple RESPs to get all grants you qualify for).
Who Should Open an RESP? (new for 2020)
In most cases the person(s) opening the RESP (the Subscribers) are the parent(s) or guardians of the child or children (Beneficiaries). Pretty simple and straightforward then.
RESPs are not limited to just the parents of the beneficiaries though. For that matter, any adult can open one that names themselves as a beneficiary, or pretty much anyone else, though CESG grants don't come into play then as the beneficiary isn't 17 or under. When an RESP is opened by anyone other than the parents/guardians of the beneficiary an extra addendum form is needed to apply for federal grants in which the parents/guardians give permission to the third-party to apply for grants. This is to at least give the parents a chance to coordinate with the third-party in terms of contribution limits and grants.
The most common third-party Subscribers I see are grandparents. It's reasonably common that new parents don't have the financial resources to start saving for their kids' education right away (and they should consider prioritizing their retirement savings first anyway), while grandparents often have better financial capacity to do so. Should the grandparents be the ones to to open up the RESP though?
Based on experience, my advice is that—whenever possible—it should be only the parents opening an RESP, and the grandparents gifting money to be contributed into that RESP. The main reasons are as follows:
- Coordination: it's just much easier when there is only one RESP per beneficiary. One account that's tracking contributions, applying for grants, etc. When there are multiple, you'll never know if a contribution puts that beneficiary over the limit to qualify for grants, or even over the total contribution limit.
- Survivorship: in the rare event that one parent passes away before the RESP is used up, an RESP with both parents as joint subscribers simply stays in the subscriborship of the surviving parent, or if the RESP was only in one parent's name the surviving parent determines the fate of that RESP, presumably to the benefit of the child(ren). With grandparents as subscribers, not only is there a greater chance they may pass before the beneficiary is in their 20s and done drawing from the RESP, but there may also be other people involved in determining the fate of that RESP, if one of the beneficiary's parents doesn't happen to be Executor of the grandparent's Estate.
In short, grandparents as subscribers—or any other family members for that matter—are not my recommendation. If all parties can come together and agree on a savings strategy for a newborn child, it's best that the RESP is open by the parents and money gifted from grandparents to parents to be contributed into the RESP. Only if the benefactor has worries that the parents aren't the best stewards of this money, should they consider opening an RESP themselves.
Family RESPs work just like individual RESPs, only they have multiple beneficiaries. Generally, to make the most of the grants and avoid any issues down the road in terms of transferability, family plans are opened for full-siblings only (half-sibling plans are possible but not eligible for all grants, such as additional CESG for example).
The main benefit of a family plan is that the funds saved for one beneficiary can potentially be used by another beneficiary, in the event one child doesn't attend any post-secondary schooling or if one child does more years of education or goes to a fancier school.
Generally, at brokerages, such plans are set up as one big account with multiple beneficiaries (contributions and grants for each beneficiary are still individually tracked), while at banks they tend to set them up as individual sub-accounts (one for each beneficiary) that are tied together under a family plan. Each has its pros and cons, to be considered when setting up the plan. Primarily it's a decision of whether you prefer the RESP investments pooled together into one account or segregated so that you know which money effectively belongs to which kid.
Personally, I feel the "pooled" family RESPs at brokerages work better when it comes to managing the money within a plan and aligning it to the beneficiaries' time horizons. For example, say a family has 2 children aged 8 and 14. Rather than having the 14-year-old's account invested conservatively and the 8-year-old's more aggressively, you're managing the whole pool of money in a family plan and can allocate some money to GICs/bonds maturing each year the 14-year-old needs the money for school (ie: maturities in 4yrs, 5yrs, 6yrs, 7yrs) while still managing the rest of the account for a longer time frame and having all new contributions (for both children) invested aggressively as they'll be eventually used by the 8-year-old. On a very tiny scale, this is sort of how pension funds work.
When one child is 18 and attending university, while the other is still 12 you can have the 12-year-old's contributions go in, collect the grant, and then take the cash right back out again to pay for the 18-year-old's schooling, not having to invest money for one child while at the same time figuring out what to cash out for the other child.
In short, in most cases it's beneficial to open a family RESP, even for your firstborn (it's very easy to then add additional beneficiaries). In rare circumstances it may not be (mixed families, half-siblings), but this really needs to be assessed case by case. Even if RESPs were opened individually for each child, it is still possible to transfer an unused RESP, minus grants, from an older sibling to a younger sibling under the age of 21.
Many parents follow a pretty simple strategy of opening up RESPs for children when they're born (or adding them as beneficiary to an already existing family plan) and maximizing contributions to the point where they obtain the maximum CESG each year. At current grant levels, this means contributing $2500 each year (or $210/mo, rounded) to obtain $500 CESG. This strategy works for most people, if the $210 per month doesn't bust the monthly budget, and dollar cost averaging works well through volatile markets. The plan is rewarded with a steady trickle of grants (generally these come in monthly on a one or two month delay).
What if a family has the financial resources to max out an RESP right away? As mentioned earlier, the lifetime maximum for an RESP is $50,000 per beneficiary. If all this money were contributed at once at the birth of a child the plan is only eligible for one year worth of CESG ($500) and nothing thereafter. While this means forfeiting $6700 worth of CESG over the life of the plan, if the money is invested properly and market returns over the following 18 years are more or less "average", the longer time in the markets more than offsets the forfeiture of grant money.
To illustrate, in an example where the average growth rate of the plan is 6% over 18 years (contributions made at the beginning of each calendar year):
- Contributing $50,000 at the start, plus $500 grant - End value: $144,144, only $500 of which are grants that could theoretically be clawed back.
- Contributing $50,000 over 15 years ($3333/yr and let's assume at some point the max lifetime CESG is increased to $7500 to make the math easier) - End value: $112,634, of which $7500 is grant money.
For those who do have the financial resources to make a large lump sum contribution at the birth of a child, but who wish to still make the most of CESG eligibility and dollar-cost-averaging, might I suggest a bit of a hybrid contribution strategy: Contribute $15,000 in the first year, then $2500 per year in the following 14 years to reach the lifetime maximum of both contributions and CESG by age 15. Using the same math and assumptions as before, by age 18 the plan would be worth $133,959.
How much will education cost?
Those are some impressive "end values" above, no matter which strategy you follow, but will each child really need over $100K to pay for their university education... in Canada?
There is no magic crystal ball, no one can be sure what tuition will cost in the future. Over my own lifetime tuition in Canada has been going up faster than the consumer price index, roughly 4% annually, but will it continue to? Who knows, but if we assumed that a full year of tuition plus books typically costs around $10,000 at a Canadian university today: at a 4% inflation rate a 4 year education in 20 years will cost around $90,000. If we assume a more normal 2% rate of inflation, $40,000 in today's dollars still becomes $60,000 20 years from now.
If you contribute $2500 per year for a child from ages 1-17 (total $42,500 contributed), collecting the maximum available CESG, at around a 6% investment growth rate, the RESP should be worth around $90,000 by age 18.
In short, by starting regular contributions at the birth of your child and investing it properly you can expect that the RESP will cover all or at least most of the expenses of an undergraduate degree, but probably not much more.
Investing in an RESP
Pretty much anything you can own in an RRSP or TFSA is an eligible investment for an RESP as well. It should be a parent's prerogative to invest a child's RESP with an appropriate timeframe in mind and an objective to outpace a 4% rate of inflation on tuition.
I touched on Group RESPs/Scholarship Trusts at the top of this post, and another major reason why these are inappropriate for a newborn child is because they generally invest very conservatively in bonds, which have no hope of earning anywhere close to 4% annually over the next two decades. Bond yields are at historical lows today and rising rates will cause these bonds to depreciate, at best yielding 0-2% annually over those 20 years. Bonds may be appropriate in the RESP of an 18 year old, but in the RESP of a newborn they could be disastrous in terms of eroding away your purchasing power as well as potentially some of your capital.
The pitfall parents often find themselves in is that they start an RESP with an asset allocation appropriate for a 20 year time horizon, but don’t make any adjustments to the account along the way, as the child gets older. Students beginning their studies in 2008 took a major hit to their education savings. The markets did recover, but not fully until after those students needed the money.
Key to any investment strategy is rebalancing regularly and also re-assessing the investment time horizon. Generally, RESPs are shorter term than RRSPs both during the accumulation phase (generally around 17-18 years) and the withdrawal phase (4-6 years as opposed to decades of retirement). The mix of assets for an RESP for a newborn is obviously not appropriate in the RESP for a 14 year old. To simplify things, parents might want to look at target-date mutual funds, offered by a number of different fund companies. These funds start out with relatively aggressive portfolio mixes that gradually become more and more conservative over time until the “target year” is reached, at which point they should be in an appropriate mix for someone withdrawing from the portfolio.
Withdrawing from an RESP is a bit less straightforward than contributing to one. While your money is invested in an RESP and growing over the years, the RESP promoter is keeping track of two balances in the account:
- Your capital which you contributed.
- "Accumulated Income" which comprises government grants and the growth and income derived from investments.
These two balances are treated very differently upon withdrawal, whether the child attends qualifying post-secondary education or not. There are four types of withdrawals that can be made from an RESP:
If the beneficiary is attending post-secondary:
- Education Assistance Payments (EAP): The EAP is a withdrawal of accumulated income and is taxed directly in the hands of the beneficiary (the beneficiary receives a tax slip).
- Post Secondary Education (PSE) capital withdrawal: The subscriber withdraws their own capital from the plan. This money is generally made payable to the subscriber for them to gift (as is generally done) to the beneficiary. There are no tax consequences because this was already after-tax money when it was originally contributed to the RESP. This withdrawal does not affect government grants in any way.
If the beneficiary is NOT attending post-secondary:
- Non-Education Capital Withdrawal (NCW): Just like a PSE, however this type of withdrawal causes a "clawback" of any grants that were earned from the original contribution.
- Accumulated Income Payments (AIP): The remaining accumulated income, after grants are clawed back, is taxed in the subscriber's hands at their marginal tax rate PLUS a 20% penalty tax. This penalty tax is to compensate for the many years of deferred taxation in the RESP but it can be avoided if the AIP is rolled directly into the subscriber(s)' RRSP(s), provided they have contribution room.
In general practice, before withdrawing from an RESP for education purposes (EAP or PSE), only a confirmation of enrollment of the beneficiary is needed. EAP withdrawals are limited to $5000 in the first full-time semester (half that if enrolled part-time), then unlimited thereafter, so long as the beneficiary continues in a full-time program. PSE withdrawals are unlimited at any time that the student is enrolled. More details, again, at the government's website here.
John and Jane contribute $2500 per year to their son's RESP over 17 years. In total, they've contributed $42,500, earned $7200 worth of CESG and the RESP has grown to be worth $100,000.
- Capital: $42,500
- Accumulated Income: $57,500 (of which $7200 is grant)
Their son Jimmy got accepted to the Alberta School of Business. The total cost of tuition, books, campus residence and living expenses for Jimmy comes out to around $25,000 per school year over 4 years. It should be noted here that when making EAP/PSE withdrawals from an RESP, generally all that is needed is proof of enrollment. RESP money does not necessarily need to be spent on tuition and books, but can be spent on other expenses necessary for the furtherance of education. An RESP provider will generally only ask for proof of expenses when an EAP withdrawal is in excess of a certain threshold, detailed here.
The only limitation on EAP withdrawals is that during the first 13 weeks (first semester) only up to $5000 can be withdrawn for a full-time student. Thereafter there is no limit whatsoever; the whole plan could be withdrawn at once. Should a student take a break in the middle of their program for more than 12 months, then this 13 week period will reset and apply again on the next withdrawal.
When withdrawals are made, John and Jane get to decide how to allocate those withdrawals between EAP and PSE. Parents tend to prefer withdrawing capital first, perhaps to avoid or defer any taxation, but I generally advise the complete opposite: to withdraw EAP early on. John and Jane should want to avoid a scenario where there is accumulated income left in the plan after Jimmy graduates or in the event that Jimmy drops out of school after a year or two. Also, should Jimmy get a co-op job in his later years, he could potentially be taxed at a higher marginal tax rate on EAP withdrawals.
The ideal scenario has John and Jane making 100% EAP withdrawals in Jimmy's first few years of school (get that growth and grant money out of the plan, either keeping below the annual threshold mentioned above, or providing receipts if over), taxed at Jimmy's low marginal tax rate, and then in the later years removing their capital and gifting it to Jimmy. Since capital will remain invested during his schooling (in a fairly conservative portfolio, of course) the plan will continue to generate a bit of accumulated income, so there will always be a bit of EAP withdrawn up until the end of Jimmy's schooling.
The Other Scenario
In the event that Jimmy doesn't attend any type of post-secondary, here's how the scenario unwinds for John & Jane:
- John & Jane withdraw their original capital of $42,500 tax free.
- $7200 of grant money is clawed back (note: the government does not claw back any of the growth or income derived from the grants, just the original capital).
- The remaining $50,300 in the plan is at worst taxed at a rate of 68% (this is the highest marginal fed+prov tax rate in Alberta for income over $300K, plus a 20% penalty tax), leaving $16,096 after tax, OR it is contributed to either or both of John & Jane’s RRSPs, provided they have room and were joint subscribers of the RESP. The RRSP tax deduction off-sets the taxes due on RESP withdrawal and the 20% penalty is nullified in such a scenario.
Such a scenario is highly unlikely given how lengthy the list of designated educational institutions is (including every manner of vocational and technical skill training school), but I provide this scenario to any parent who has doubt as to whether an RESP is the best way to save for their children's potential education; those who fear there might be a downside. If parents want to be extra careful, to avoid the potential 20% penalty tax, they could ensure that they always have carry-forward RRSP room roughly equal to the accumulated income in the RESP.
Remember the amount subject to this punitive tax rate is only the accumulated income, ex-grants, not the total value of the RESP.
Also of note, an RESP can remain open as long as 36 years from when it was first entered into. A beneficiary should be able to find a use for that money within that time frame.
Even if it's not part of a family plan, an individual RESP, if not used, can still be transferred to a full sibling under the age of 21.
I hope this lengthy post does what I aimed to do, to thoroughly explain RESPs and to answer any question a parent could possibly have. I could go on discussing other scenarios and "what ifs", but they don't apply to most people, so I'll end it here. If you have any question that I did not answer here, please don't hesitate to contact me and I'll do my best to answer your question for you and if it's something worth posting here I'll update this post.
Part of financial planning involves establishing and prioritizing your goals and determining which are achievable and which are not. I caution parents about putting their kids' education costs ahead of their own retirement plans, both while your kids are attending university and while you are saving for it. If you cannot afford to fully fund your retirement savings goals and your education savings goals (or your kids' tuition bills), consider this: if your kids get no help from you to cover their tuition, they'll work part-time during college, they might get scholarships, or otherwise they'll pay off their mountain of debt during their 40 year careers. You, however, will at some point get to an age when you are no longer able to work and will depend on your retirement savings (you don't want to have to depend on your kids!).
Know what your priorities are and contact me to review or complete your comprehensive financial plan.