The cost of a four-year university program for a child born today could be a staggering $150,000, according to a study by the Canadian Scholarship Trust Foundation. To make higher learning more affordable, registered education savings plans (RESPs) enable Canadians to benefit from government grants and tax-advantaged growth.
There are two main types of RESPs. One is an individual or family plan in which you decide what securities or other assets to hold. These are available from banks, brokerages, mutual-fund dealers and other financial-services providers. With these plans, the timing and amounts of both contributions and withdrawals are up to you.
The other main type is scholarship plans, for which you sign a contract with a provider that makes investments for you. With group plans, your contributions are pooled with those of many other subscribers, and there are specific contribution requirements and a common maturity date. With individual and family scholarship plans, you have flexibility to decide when to contribute and when to make withdrawals.
Regardless of what type of RESP you hold for the benefit of one or more children, it makes sense to start as soon as you can. Opening an RESP at the child's birth can help alleviate the future burden of having to come up with the funds all at once, says Peter Lewis, vice-president of regulatory and corporate affairs at C.S.T. Consultants Inc., the wholly owned Canadian Scholarship Trust Foundation subsidiary that manages and administers CST scholarship plans.
"Delaying contributions can reduce the value of the RESP by reducing the time that contributions can grow tax-free," says Sam Sivarajan, head of investments at Manulife Private Wealth. "For example, waiting till the child is two before the first contribution can reduce the value of the RESP when the child enters school by $4,000 to $8,000 or more just from lost tax-free investment growth."
Perhaps the biggest benefit of RESPs is free government money. Available to all families is the Canada Education Savings Grant (CESG). The basic CESG matches 20% of the first $2,500 contributed to an RESP each calendar year, until the child turns 18, with a lifetime maximum CESG amount of $7,200 per child. If you don't contribute enough to qualify for the maximum annual grant, the unused amount can be carried forward to a future year.
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Another federal grant, aimed at lower-income families, is the Canada Learning Bond (CLB). It provides $500 at the outset to eligible families, followed by an extra $100 each year until the child turns 15, to a maximum of $2,000 per beneficiary. The CLB is for children who were born after Dec. 31, 2003, and whose families receive the National Child Benefit Supplement. This money doesn't count toward the lifetime RESP and CESG contribution limits and can grow on a tax-deferred basis within the RESP.
Families with incomes below a certain level can also take advantage of the Additional Canada Education Savings Grant, or ACESG. "Depending on the family income levels, the ACESG is 10% or 20% of the first $500 contributed each year," says Sivarajan. "This is on top of the CESG."
In several provinces, additional aid is available. For instance, the Quebec Education Savings Incentive (QESI) provides a 10% provincial grant on the first $2,500 contributed annually, up to a lifetime maximum of $3,600. Also, for children who are residents of Quebec and whose family income falls below a certain level, RESPs might qualify for another 5% to 10% on the first $500 contributed each year. Elsewhere, Alberta and Saskatchewan currently also offer RESP-related grants to their residents.
There's no tax deduction for RESP contributions. However, income and capital gains aren't taxed within an RESP, and only the government contribution is taxable when money is withdrawn from the plan. Withdrawals are taxed in the hands of the beneficiary. And since many students have little or no income, they pay little or no tax on RESP withdrawals.
Despite the availability of various federal and provincial grants, RESPs have had surprisingly low participation rates. In 2012, RESP contributions registered only 3% year-over-year growth, according to the Canada Education Savings Program (CESP), The federal agency's study notes that of 1.81 million children eligible for the CLB in 2012, fewer than 500,000 (27%) ever received it.
Clearly, with the average annual RESP contribution per beneficiary being below $1,500, Canadians who could most benefit from government grants are leaving free money on the table.
"People sometimes assume they can't afford to save in an RESP," says C.S.T.'s Lewis. "You can save as little as $9.50 a month. While that will not cover all of your child's university expenses, every dollar that is set aside for post-secondary education is a dollar you don't have to find down the road."
For those with no shortage of funds, there's a different consideration: Whether to make the lifetime maximum contribution of $50,000 upfront, thus maximizing the period for which taxes on capital gains and income can be deferred, or whether to make annual contributions in order to maximize government grants.
Affluent contributors who opt for the $50,000 upfront contribution will collect $500 in CESG in the year they contribute, and nothing afterward. Thus, they'd forgo the remaining available $6,700 in CESG payouts.
However, the benefits of tax-free compounding may eventually trump that of maximizing the grant. Assuming a 5% annual return, $50,000 contributed at the birth of a child (plus the $500 CESG) will be worth more than $121,000 by the time the beneficiary is 18.
By comparison, at the same 5% annual return, contributions of $2,500 every year for 17 years, plus $7,200 at the same rate of return, will grow to just over $86,000. This includes $7,200 in CESG plus returns earned on the grant money. Note that a $2,500-a-year contribution for 17 years contributes only $42,500 to the RESP, or $7,500 less than the maximum $50,000 allowed.
Realistically, though, many parents who are juggling mortgages, car payments and other household expenses are unable to afford even a $2,500 annual contribution per child.
"Start with a comfortable amount, even if it seems small," advises Janet Brick, manager of RESP initiatives at RBC. "As it gets built into your cash flow, look for opportunities to increase your contribution. Parents become more committed when they see the funds grow."
