Today’s Canadian students are paying through the nose for ever-higher post-secondary tuition. which is probably why so many Canadian graduates have regrets about student debt. In a way, that regret is actually a good thing. It means these kids take personal finances seriously and want to get on track. But it may also mean that some of their parents aren’t taking full advantage of an RESP (Registered Education Savings Plan).
Wouldn’t it be nice if your kids didn’t have to kick off the first phase of their lives away from your home in debt up to their eyeballs? Even better if the government can help pick up the tab! Well, that’s what the RESP is for. It might not cover everything… but it’s definitely going to help.
What is an RESP?
Like the RRSP or TFSA, the RESP is an account that helps Canadians invest for a particular purpose: paying for education.
But it’s not as simple as plunking money into an account and letting compound interest work its magic as your kid grows up. If you do it right, you’ll optimize your payments to take maximum advantage of the Canada Education Savings Grant (CESG)! Why should you do all the heavy lifting when the government can help put your kids through school?
How to optimize your RESP payments and maximize the government’s contribution
It’s simple. There’s a magic number: $208.33, per child. That’s a good rule of thumb what parents can contribute each month into an RESP to get the most out of the CESG, starting when the child is born. The CESG will essentially cover a minimum of 20 cents of every dollar that you contribute, up to the maximum amount. (That’s according to our CEO Tea Nicola – check out this CBC interview starting at the 36-minute mark).
Investing any less basically means you’re leaving money on the table – but if you contribute more than that optimal amount, you’re not able to squeeze any more grant money out of the feds. For more details about how the math of RESP contributions works out (and how you can even get additional grant money), check out these numbers from the Government of Canada.
When is the best time to contribute to an RESP?
As noted above, the absolute best time to start would be as soon as the child comes into this world and gets a social insurance number.
However… that may just not be realistic for many Canadians, who often feel financially squeezed by child care costs. Day care, diapers, food, cribs, baby seats, clothes and toys add up. And at the time you start having kids, you may not yet have hit your prime earning years. When Mommy and Daddy are living hand-to-mouth, an RESP might just not be the top priority.
If you wanted to delay it a bit and start when the child is five years old, starting with some small payments, that’s just fine. Just having it open when the child is born is a smart move, so that when aunts and uncles give birthday or holiday gifts of cash, that money can go into the RESP savings. Baby steps, people.
There are also provincial education savings grants
It’s worth investigating whether your province has a grant akin to the CESG. Some, like BC and Saskatchewan, do have similar programs. It’s probably not worth moving, but if you live in a province that wants to top up your RESP, then you should take advantage. You’ll probably have the option of checking available grants when you’re filing your taxes, depending on your tax software.
It is better to front-load an RESP (if you can afford it)
Hey, we get it: not everyone has tens of thousands of dollars just burning a hole in their back pocket.
But… if you can afford to just throw a big lump sum of $50,000 at a 6% rate of return, you’ll have $136,000 in 17 years.
Let’s compare if you contributed the $50,000, but not all at the start (again because, hey, that’s a lot of money). You put in $16,500 in the first year. Then, for the next 16 years, you took our advice above and contributed 208.33 per month (which adds up to $2,500 a year). With the additions from the CESG, you’ll have nearly $119,000.
With that math in mind, here’s the recommendation. If you have sufficient money available, it’s better to open an RESP and deposit 50,000 in the first year. That nets you more than partial front loading and then maximizing grants.
What about tax-free withdrawals?
When the beneficiary goes to school, the withdrawals from the RESP get taxed in their hands. However, it matters where the withdrawals come from. As well, the account holder has some control over it. In the first year, it is best to withdraw only from grant (CEGS) and the growth on the grant. If this is not sufficient, then withdraw from the growth of the contributions. Use those grants!
Essentially, when the student graduates, if there are any funds left over, it is best if that is contributions only, with very little funds left from growth. That way, the contributor can withdraw the contributions (called a PSE or Post Secondary Education withdrawal) tax free and roll over any growth into their RRSP, if room allows. (Technically, when you request an RESP withdrawal, whether its a EAP or PSE, and supply proof of enrolment, you could pay rent, expenses or anything else with the money!)
Every year, the beneficiary (the student) will get a tax slip (T4A) for the amount issued and it is taxable in their name.
The beneficiary likely has very little income and many tax credits or deductions available (eg. tuition education credit, student loan credit, moving expenses credit, basic personal credit, etc.). That means that adding these all up against any income earned, could mean zero dollars owing to the tax man!
The RESP 35 year rule means you’ve got options
Does your high school graduate want to get right into the workforce or take a little break from school to travel before they enrol in post-secondary education? That’s totally fine.
You can keep an RESP account open for 35 years. After that, if there are still funds in the account, the government gets the grant portion back. As well, any growth on contributions that remains in the account will be fully taxed like salary, plus an additional 20% (or 12% for Quebec). You can use any RRSP contribution room to offset this income. If all that remains in the RESP are the subscriber’s contributions, then just withdraw it, no fuss!
Start saving for your child’s education
Tuition keeps going up. At the same time, education seems more essential to a good career and a good life than ever. The smart move? Open an RESP account with me or transfer an existing one, today.