Registered Education Savings Plans
– an essential component of the portfolio for parents.
It’s been a hot dry summer in Ontario, which you may or may not like. Most people are pretty divided on that score.
What is certain is that it is coming to an end and school will be starting in early September. My daughter has already finished her undergraduate degree; however, I advise many families with young children who have 10 or 15 more years ahead of them before starting post-secondary studies.
The questions they have concern the value of the plans, government grants and what happens to the money in the plan if their children don’t go to college or university.
For some simple answers, look at the images of these two piggy banks (photo credit M.Heenan).
In the first bank you have $100 towards post-secondary education. In the second one you have $125 for the same purpose, but in this case your $100 was supplemented by the Canadian Education Savings Grant of $20 from the federal government plus $5 growth in the plan (estimated annual growth over several years of investing). Suppose you want to save $60,000 for a four-year undergraduate degree. By using the Registered Education Savings Plan, the Canadian government will contribute up to $7,200 to your education savings plan (based on 20% or $500 per year for each $2500 you contribute.)*
Now, you only have to save 52,800 loonies. You can’t reduce the number of loonies you invest if you want to get the maximum grant from the government. However, you can grow your loonies by investing your contributions plus those government contributions through compounding, meaning you also invest the money you earn (your return) along with the money you started out with.
For the calculation below, I used the calculator available on the following website www.getsmarteraboutmoney.ca
Your initial investment of $1,000 plus a yearly investment of $2,500 with an annualized interest rate of 4% will be worth $61,408 after 17 years when compounded semi-annually. That is 70% more than the $36,000 you contributed.
Contributions to an Registered Education Savings Plan are not tax deductible to the owner or subscriber of the plan so RESP’s never attract tax on withdrawal. What does attract tax when taken out, are both the government grants and growth in the plan, known as Educational Assistance Payments. These, however. are taxed in the hands of the beneficiary (the child benefitting from the RESP).
Having just one daughter who did a full 4-year undergraduate program, my experience with the RESP was quite straightforward. Here are some examples of how an Registered Education Savings Plan can be used. Examples are for illustrative purposes only.
Monique and Henry are Ontario parents of two boys born in the 90’s. They opened an Registered Education Savings Plan for the two boys as each was born and over the years were able to contribute the maximum of $36,000 for each boy in order to attract the full CESG of $7200 for each one.
Needless to say, the funds helped tremendously to cover tuition, books and accommodation during the college and university years. One of their sons has not yet used up all of his RESP and the parents have kept the funds available in case he returns to school for full or part-time studies. Plans can remain open for 35 years in total, so if your child is one year of age when you open the plan, it can remain open until he or she is age 36.
Sandy and Liane immigrated to Canada from Holland in 2005 and opened a family RESP two years later. At that time, their older daughter was going to start university in a few years, and they had two younger sons to save for. Because their time horizon was short, they decided not to take much risk and bought Terms Deposits.
They built the RESP by collecting eligible the CESG equal to 20% of their contributions. This was a good strategy for them. Sandy and Liane found it hard to get accurate information on the plan, and advise others to research and be well informed before opening a plan.
A concern for some parents is what happens if your child doesn’t go on to post-secondary education and never uses the funds in his/her Registered Education Savings Plan? It probably makes sense to you that there are different rules for the different types of assets in the plan.
- The contributions you made can be withdrawn tax free as you did not get a tax deduction when you contributed them.
- The CESG and any other government grants must be repaid to the government.
- The remaining income is called the Accumulated Income Payment (AIP). It consists of interest or growth in the plan as a result of being invested. If you withdraw these funds, you have to pay tax on them at your marginal rate plus a penalty of 20%. However, under certain rules, you can contribute the AIP to the RRSP of yourself or your spouse.
Contact me at email@example.com for more information and to start an Registered Education Savings Plan for your child to take advantage of government grants and compounding.
It’s just good advice.
*Depending on family income and province of residence, there are different grant amounts available. Contact me for more details.