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 When the money is withdrawn, it is subject to tax on the interest, but because most students are in a low income bracket, they usually avoid paying any taxes on these withdrawals.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:
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.
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 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:
- The birth certificate of the beneficiary (if it is you, two pieces of regular ID will do)
- 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.