It’s a terrific tax shelter, but you have to know the rules
If you’re considering opening a Registered Education Savings Plan (RESP) to help fund rising college costs, you might find the rules a bit complicated and information that seems to come from several different government departments. To help you get a handle on this powerful tax shelter, here’s a crash course in basic RESP rules and regulations you’ll need to know.
It’s easier to understand if you recognize that there are three parties involved in an RESP.
First, there’s the “subscriber” – the parent or grandparent or other person who makes the actual contributions to the plan. Unlike RRSPs, contributions are not tax deductible to the subscriber.
Second, there’s the “promoter.” This is the sponsor of the RESP contract, often a financial institution, but sometimes also a firm whose sole business is the sale of RESPs.
Third are the “beneficiaries.” These are the students who receive payments from the promoter when they attend qualified educational institutions.
Who administers RESPs?
Things get a tad complicated in the administration side of things. The RESP is actually administered by three different entities:
The Canada Revenue Agency basically administers and applies the RESP rules provided under the Income Tax Act, registers the plans, and provides income-related information related to eligibility for the CESG and Canada Learning Bond.
Employment and Social Development Canada administers the regulations under the Canada Education Savings Act, processes and pays government grants.
The RESP promoter (the company that offers the plan to the subscriber) does everything else, including asking the Canada Revenue Agency to register the plans on behalf of the subscribers, and maintaining and submitting monthly records of RESP transactions to Human Resources and Skills Development Canada.
Who is eligible for an RESP?
The rules for eligibility for the Registered Education Savings Plans are pretty clear. According to the Canada Revenue Agency, “you can designate an individual as a beneficiary under the RESP only if the individual’s social insurance number (SIN) is given to the promoter before the designation is made; and the individual is a resident of Canada when the designation is made.”
Once an RESP is set up, and the student goes on to enroll in a qualifying educational program at a post-secondary educational institution, Educational Assistance Payments (EAPs) will be paid towards the student’s tuition from the RESP by the promoter. For Canadian residents, the payments consist of funds contributed to the RESP and earnings on those funds, the Canada Education Savings Grant (CESG), the Canada Learning Bond (CLB) for eligible students, and any provincial savings programs the student may be eligible for.
A university or college outside Canada qualifies as a post-secondary institution eligible for EAPs, provided the student has been enrolled full-time in a course of not less than three consecutive weeks and remains a resident of Canada.
Note, however, that a student beneficiary must be a resident of Canada to begin with in order to receive the Canada Education Savings Grant or Canada Learning Bond as part of the EAP. Residency requirements may also apply for provincial grants and incentives.
Residency status is a bit trickier. Even if you are a Canadian citizen, the Canada Revenue Agency rules state that you are a non-resident for tax purposes if you:
* Normally, customarily, or routinely live in another country and are not considered a resident of Canada; or
* Do not have significant residential ties in Canada; and you live outside Canada throughout the tax year; or you stay in Canada for less than 183 days in the tax year.
What are the contribution limits?
According to the CRA, from 1998 (the first year the program started) to 2006, inclusive, the annual contribution limit is $4,000 to a lifetime maximum of $42,000, including any contributions made before 1998.
From 2007 to present, there is no annual contribution limit and the lifetime maximum is $50,000, including all contributions made prior to 1998.
What makes the RESP so attractive is a federal government grant called the Canada Education Savings Grant, of 20% of your annual contributions to an RESP to a maximum $500 for each beneficiary (the CESG will be $1,000 if there is unused grant room from a previous year), to a lifetime CESG limit of $7,200.
Unlike RRSPs and TFSAs, there are no annual contribution limits. Theoretically, you could contribute the entire lifetime maximum of $50,000 today if you have never opened an RESP. However, the Canada Education Savings Grant (CESG) will be given only on the first $2,500 in contributions per year, or up to the first $5,000 in contributions if sufficient carry forward room exists. Any contributions over and above these amounts will not receive any CESG for the current year or any subsequent years. Contributions above the $50,000 maximum won’t be eligible for the grant, even if the maximum $7,200 of grant is not reached.
Note that there are penalties for overcontribution to an RESP that could be as high as a 1% per-month tax on the excess contribution that is not withdrawn by the end of the month. Be sure to ask your RESP promoter to explain any conditions or penalties that may apply if you overcontribute to the RESP.
What are qualified investments?
RESPs may hold the same qualified investments as other registered plans such as RRSPs. These includes stocks, bonds, exchange-traded funds, mutual funds, guaranteed investment certificates, cash (including foreign currency subject to limitations), stock options, warrants, and rights, and even gold and silver bullion and coins, and more.
While many financial institutions and brokerages offer online self-directed RESPs, novice investors would do better consulting their financial advisor for the best investment strategy to suit their circumstances. After all, an RESP is designed to help fund post-secondary education, which can run to $40,000-$50,000 per year or more, depending on the institution and program of choice. You don’t want to jeopardize the tax-deferred, compound long-term growth within your RESP with inappropriate or ill-advised investment choices.
© 2016 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited. This article is for information only and is not intended as personal investment or financial advice.