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Finance From A to Z: Week 5 (E)

Finance From A to Z: Week 5 (E)

While pursuing further education at a college or university is often highly stressful for students, it is easy to overlook the similar level of financial stress and burden placed on the parents of those students. Especially for those with modest incomes, paying tuition fees directly out of your regular cash flow can significantly dent your personal savings.

Today’s edition of Finance from A to Z will cover the usage of an education savings account, specifically the Registered Education Savings Plan, otherwise known as an RESP. 

E is for Education Savings:

An RESP is a tax-deferred savings plan that allows parents to contribute up to $50,000 per child toward saving for post-secondary education. This is arguably the best approach when it comes to preparing to pay for your child’s education. By diverting a small portion of savings into an RESP each month, it is a sure bet that the RESP will be ready for use by the time the question of post-secondary education comes into the picture. Indeed, the RESP has withstood the test of time. According to the latest Employment and Social Development Canada’s Annual Statistical Review of RESPs, the RESP continues to be highly favoured among Canadians.

The process to open an RESP is incredibly easy. All that is required is your child's social insurance number and an RESP application that can be obtained at your financial institution. Furthermore, government grants can significantly supplement your own savings contributions. Notably, two tools that exist are the Canada Education Savings Grant (CESG) and the Canada Learning Bond. The former provides a 20% grant on the first $2500 contributed to an RESP every year (that is a free $500 every year up to a lifetime of $7200 per child) and the latter contributes up to $2000 for children from low-income families. Therefore, it is optimal to contribute an annual amount of $2500 to maximize the additional contributions from the CESG. Unfortunately, given that the average RESP contribution in recent years was only $1,657 per child, some parents are not contributing enough to realize this.

Taken directly from the Government of Canada, here are the general steps to how an RESP works:

  1. A subscriber enters into an RESP contract with the promoter and names one or more beneficiaries under the plan
  2. The subscriber makes contributions to the RESP. Government grants (if applicable) will be paid to the RESP. 
  3. The promoter of the RESP administers all amounts paid into the RESP. As long as the income stays in the RESP, it is not taxable. The promoter also makes sure payments from the RESP are made according to the terms of the RESP
  4. The promoter can return the subscriber's contributions tax-free
  5. The promoter can make payments to the beneficiary to help finance his or her post-secondary education
  6. The promoter can make accumulated income payments

RESPs are capped at a sum of $50000 per beneficiary, per lifetime. In the event that an over-contribution occurs, a tax of 1% per month is enforced on the share of the over-contribution until it has been withdrawn. Therefore, it is both important to track any contributions you make toward an RESP. In a family with multiple children, contributions must be tracked for each child named in the plan.

One of the most appealing aspects of opening an RESP is that the savings contained are tax deferred. By definition, an RESP is a tax-sheltered investment account specifically designed to help pay for post-secondary education. By the time the savings are needed, they are returned without being taxed at all. Moreover, the time horizon of an RESP is very forgiving. Contributions can continue to be made into an RESP until 31 years after its initial opening. Even after 31 years have passed, the savings from the RESP can be transferred into another single plan.

In the event that your child does not pursue post-secondary education, RESPs can also be used for programs such as apprenticeships and trade schools. However, if neither of these options seems viable, then the original contributions to the RESP can be withdrawn without being taxed. The grant money, however, from programs like the CESG will have to be returned. Similarly, the capital gains made from the original contributions will have to be taxed in addition to being fined a 20% penalty.

In conclusion, RESPs are an amazing tool to slowly build up educational savings. Not only are they relatively simple to open and maintain, they are also tax-free. 

Share your thoughts in the comments below!

Thanks, and see you in the next edition!

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