The cost of post-secondary education in Canada has been sharply increasing: According to Statistics Canada, the cost of tuition rose 135% between 1990 and 2000. In dollars and cents, this means that an average undergraduate student, living at his or her parents' home, now has to shell out more than $10,000 per year just for tuition.

One popular way to relieve some of this burden is for parents to start saving for their child's education through Registered Education Savings Plans (RESPs). In this article, we'll explore how these plans work and what you need to know before you sign up. (For related reading without the Canadian focus, check out Investing In Your Child's Education and Don't Forget The Kids: Save For Their Education And Retirement.)

How RESPs Work
An RESP is a tax-deferred investment account that is set up to pay some or all of the costs of the beneficiary's post-secondary education. The money you put into an RESP is invested by you or a professional and allowed to grow, tax-free, until the beneficiary withdraws it. However, unlike a Registered Retirement Savings Plan (RRSP), the contributions to an RESP aren't tax deductible.

All the common investments, stocks, bonds, GICs, etc., can be held within the RESP. When the money is withdrawn, it is subject to tax on the interest, but because most students are in a low income bracket, they usually avoid paying any taxes on these withdrawals.

Three Ways To Save
The rules for individual RESPs are more flexible than most savings plans in that anyone can open one for anyone. You could even open one for yourself if you intend to go back to school someday. (For more on the long-term financial benefits of going back to school, check out Invest In Yourself With A College Education.)

There are a number of different RESP plans:

Family RESP
The most common RESP is the family plan. These can only be opened by family members for other family members who are under the age of 21 when they are chosen as the beneficiary. The RESP can have more than one beneficiary, but the plan itself must be closed out within 25 years. This could mean that your youngest child won't be able to take advantage of the family plan if there is a significant age gap.

Individual RESP
Both the family RESP and the individual RESP can either be self-managed (a self-directed RESP) or professionally managed. If you are comfortable investing on your own, a self-directed RESP is likely the best choice as it will usually cut down on the fees you need to pay a professional.

Group RESP
Group plans, also referred to as scholarship trusts or pooled trust RESPs, operate in a very similar way to money market mutual funds in that your money is pooled with that of other investors and then invested in low-risk, fixed-income investments. You either buy into group plans in the form of shares or by signing a contract promising regular payments over time. (To learn more, see Introduction To Money Market Mutual Funds.)

What to Watch For
Although some factors, such as taxation, are the same for all types of RESPs, there are quite a few differences. One thing that holds true for all is that, as of 2007, you have a maximum contribution of $4,000 per year and $42,000 over your lifetime for each beneficiary. This amount is stipulated by the government, but it could change in the future.

Some RESPs, however, may have additional limits on how much and how often you can contribute. Also, be aware that some RESPs have service fees and management fees - especially the professionally managed ones.

If you start the plan early, you will be able to invest aggressively and enjoy years of compounding. However, some professionally managed group plans have low returns that are split up among all the participants who have children attending post-secondary schools that calendar year. This can result in much lower payments than if you had done the planning yourself.

How do I sign up?
To open a registered education savings plan, you need to find an RESP provider. Almost all banks, credit unions and financial institutions offer RESPs. For a comprehensive list of all the registered providers, check the website for the Financial Consumer Agency of Canada. Once you have found a provider and a plan you like, you will need:

  1. The birth certificate of the beneficiary (if it is you, two pieces of regular ID will do)
  2. The beneficiary's social insurance number.

If your child doesn't have a social insurance number yet, you can get the application forms from Human Resources and Social Development Canada. There are no age limits.

Things to Ask
Before you sign the dotted line, you will want to ask your provider a few questions:

  • Are there any fees, including fees to open and close the account, and, if so, how much and what are they for?
  • Is there a minimum initial contribution or regulated contributions afterward? If so, what happens if you miss a payment?
  • If the RESP is professionally managed, what are the historical returns?
  • Can you withdraw money if you need it? Are there any penalties or fees?
  • What is the cost of transfer for the RESP?
  • Are there any limitations on the type of post-secondary institutions? For example, are trade schools and technical colleges included?
  • What happens if you close the RESP early?
  • What happens if the beneficiary doesn't go to post-secondary school?

The answers will give you a good idea of whether you have found your provider or if you should keep looking.

If Your Child Doesn't Enroll
If the beneficiary of an RESP decides not to go on to a post-secondary institution, you have several different options. First, you should wait to see if the person changes his or her mind. If you have an individual plan, it can stay open between 21 to 31 years depending on the plan. Second, if you have other children you can transfer the money into one of the other RESP accounts. Third, you can transfer the money into your own RRSP. Finally, you can simply withdraw the money.

In the latter two cases, however, all of the beneficiaries must be older than 21 and the RESP itself must have been open for at least 10 years. You will have to pay taxes on the interest earned: it will be filed under accumulated income and taxed at your regular income level plus 20%. You can reduce this amount if you transfer it to your own RRSP and the total is less than $50,000.

If you have enough deduction room in your RRSP, you will be able to deduct the transfer on your income tax. In the case of a straight-out withdrawal, your provider may place additional conditions on the transaction. Once again, be sure to ask your provider before you sign up. (To learn more, see the RRSP Tutorial.)

Help for Low Income Families
The Canadian government, realizing that saddling students with massive student loan payments was beginning to deter enrollment, created the Canadian Education Savings Grant (CESG) to encourage parents to help their children pay for the cost of education using RESPs.

This, in conjunction with the Canadian Learning Bond, is a government program to supplement contributions, especially contributions by families in lower income brackets. These grants can amount to as much as $500 in contributions per year as well as a $2,000 bond. The biggest allotments are given to families with a net income of less than $36,000, but grants are still available for higher income families. If your child doesn't go to post-secondary, the grant portion of the RESP has to be returned. To find out more about these programs, check the government's CanLearn website.

Using RESPs makes sense for parents as well as adults looking to upgrade their own education in the future. The sooner you open an RESP, the more aggressive you can be, and the more compounding your investment will see in the long run.

If the last ten years have been any indication, it is very likely that the tax benefits of using both RESPs and RRSPs will continue to increase. In the worst-case scenario, you will have saved money for an expense that didn't materialize, but you can still transfer it and use it to help your own retirement goals. That seems like a fine problem to have.

To learn more, check out the Education Savings Accounts Tutorial.

Related Articles
  1. Retirement

    How Are 401(k) Withdrawals Taxed for Nonresidents?

    As a U.S. nonresident, deciding what to do with your 401(k) after you return home comes down to which tax penalties, if any, you're willing to incur.
  2. Investing Basics

    What Does Plain Vanilla Mean?

    Plain vanilla is a term used in investing to describe the most basic types of financial instruments.
  3. Options & Futures

    Pick 401(k) Assets Like A Pro

    Professionals choose the options available to you in your plan, making your decisions easier.
  4. Investing Basics

    5 Things To Ask Before Hiring A Financial Advisor

    Choosing a financial advisor isn't an easy task. Here's a list of the most important things to consider when planning for your financial future.
  5. Investing

    Is Private School for Your Child a Good Value?

    Parents want their kids to get a good education, but whether or not private school is worth it depends on more than just the cost.
  6. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  7. Professionals

    Advisors: Clients Want These Three Things from You

    Calmness, transparency and credentials (and more) are the key elements clients look for when selecting a financial advisor.
  8. Investing Basics

    Hiring a Financial Advisor? Look for the CFP Label

    Don’t skimp on the CFP designation. Here's why those three letters show that someone is qualified in financial and investment planning.
  9. Savings

    The Top Seven 529 Plans for 2015

    With so many choices and so many features (tax advantages, fees, annualized returns) to consider, it's hard to know which 529 plan to choose. Here's help.
  10. Insurance

    Life Insurance & Annuities: Sound Investments?

    There are certain scenarios in which investing in insurance is a savvy move. But expect a big chunk of your money to go toward fees.
  1. Can mutual funds invest in options and futures?

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  2. Student loans, federal and private: what's the difference?

    The cost of a college education now rivals many home prices, making student loans a huge debt that many young people face ... Read Full Answer >>
  3. Can I use my IRA to pay for my college loans?

    If you are older than 59.5 and have been contributing to your IRA for more than five years, you may withdraw funds to pay ... Read Full Answer >>
  4. Can I use my 401(k) to pay for my college loans?

    If you are over 59.5, or separate from your plan-sponsoring employer after age 55, you are free to use your 401(k) to pay ... Read Full Answer >>
  5. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
  6. What are the best MBA programs for corporate finance?

    Opinions vary based on which publications you consult, but the best MBA programs for a career in corporate finance are at ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  2. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  3. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  4. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  5. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  6. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!