RESP primer and update

Changes to RESP contribution rules
	Before 2007	Current
Lifetime contribution limit	$42,000	$50,000
Maximum annual contribution	$4,000	No limit
Maximum annual CESG	20% of the first $2,000 contributed, or $400	20% of the first $2,500 contributed, or $500
Total lifetime CESG available	$7,200	$7,200
Maximum CESG in any one year including carry-forward	$800	$1,000
Plan may stay open for up to	26 years	26 years

The CESG may be claimed retroactively as far back as 1998 (when the CESG was introduced) or the year of the child's birth (if the child was born after 1998). Also, unused basic CESG amounts can be carried forward for use in future years. The maximum amount is $400 for each year up to 2006, and $500 for 2007 and each subsequent year until the calendar year in which the child turns 17. However, the maximum CESG that may be claimed in a single year is $1,000, so maximizing retroactive amounts may require some planning.

Under the new rules, a subscriber opening an RESP today may fully fund the plan with a onetime contribution of the $50,000 lifetime maximum. Since investments inside an RESP grow tax-free until the money is withdrawn to pay for qualified post-secondary education, this strategy could mean up to 25 years of tax-deferred compound growth. (An RESP must be terminated at the end of the 25th year following the year in which it was opened.)

Incentives to save The CESG is calculated for each beneficiary individually, even when a plan has more than one beneficiary. In general, children up to age 17 are eligible to receive the Canada Education Savings Grant (CESG). However, beneficiaries who are 16 or 17 years old when the grant is claimed are subject to restrictions; for instance, contributions made in previous years must total at least $2,000, and contributions of at least $100 must have been made in four or more years before the year in which the beneficiary turns 16. Annually, the maximum basic CESG is equal to 20% of the first $2,500 RESP contribution in a given year to a lifetime maximum of $7,200. Eligibility for additional CESGs is based on family income. These additional annual grants are 40% on the first $500 contributed to an RESP if the family's annual income is less than $37,178; or 30% on the first $500 RESP contribution if family income is between $37,178 and $74,357. Another benefit tied to income level, the Canada Learning Bond (CLB), is available to children born after 2004. Families who receive the Canada Child Benefit Supplement qualify for this grant of up to $2,000 per child over a 15-year period, in addition to the CESG. Meanwhile, the Alberta Centennial Education Savings Grant (ACES) is a one-time grant of $500 available to children in that province born or adopted on or after January 1, 2005. Additional grants of $100 are paid at ages 8, 11 and 14. ACES does not require an RESP contribution. More recently, for residents of Quebec, a refundable tax credit known as the Quebec Education Savings Grant was introduced in 2007 as a complement to the CESG. The Quebec grant offers a maximum annual amount of $250 (with an additional $50 for middle-income and low-income families) and a maximum lifetime grant of $3,600 -- or 50% of the CESG -- and is payable for any RESP contribution made since February 21, 2007. Note that while the deadline for RRSP contributions in order to generate a tax deduction for the previous year generally falls 60 days after year end, the deadline for contributing to an RESP in order to qualify for the (CESG) for the current year is Dec. 31.

This strategy doesn't make sense for most people, according to Jamie Golombek, vice president, taxation and estate planning with AIM Trimark Investments. "The problem with making a lump-sum contribution is that you're going to limit your ability to collect grants," says Golombek.

While a $50,000 contribution this year would generate the maximum annual CESG of $500 -- or up to $1,000 if CESG room has been carried forward from prior years -- in the future no CESGs would be available since the RESP has now been maxed out. Because the lifetime limit of $50,000 has been reached with a single contribution, the RESP cannot generate further CESGs.

For subscribers with a lump sum of $50,000 to invest for education, a number of factors help determine the best RESP funding strategy, according to Golombek. Considerations include the age of the child, the type of income earned (capital gains, dividends or interest) from any non-registered savings, rates of return earned inside and outside the RESP, and the child's potential tax liability on payments from an RESP. However, Golombek's number crunching found that most people would come out ahead by gradually funding an RESP to take full advantage of the CESG.

Audrey McFarlane, a financial advisor with Edward Jones in Victoria, BC, agrees that the "free money" of the CESG is the most important feature of RESPs. She further advises subscribers to catch up on missed CESGs using the retroactive feature of RESPs. For example, in the case of four-year old child with no RESP to date, "the first year, you put in $5,000 and you get [the maximum annual] $1,000 grant; the next year you put in $5,000 and get the $1,000 grant, and that maxes out the second year you missed. In four years, you've maxed out the four years you missed. Now you fall back to [contributing] $2,500 a year to get the maximum grant again," says McFarlane. But this may not be possible in all cases. "If you have a child who is 16 and there hasn't been an RESP set, it makes sense [to contribute more]," she adds.

Tax efficiency also makes an RESP a good choice when saving for education, according to both McFarlane and Golombek. While contributions to an RESP are made in after-tax dollars and, unlike contributions made to RRSPs, do not generate tax deductions, the potential tax savings are nonetheless significant.

"When the growth comes out of an RESP, that money is going to be taxed in the hands of the child," says McFarlane. Given all the tax deductions available to Canadian students, including the basic personal amount, the tuition credit, the education amount and the new textbook tax credit, it's realistic that a beneficiary won't face any tax at all on RESP withdrawals, adds Golombek.

Outside of an RESP, equity investors may consider holding a tax-efficient mutual fund that allows taxes to be deferred, says Golombek. The majority of payouts from these types of funds are considered return of capital that affect an investor's adjusted cost base but are not taxable in the current year.

But more conservative investors may not have this option for tax deferral outside a tax- sheltered plan. "If you want to be in fixed income, [which generates highly taxed interest income] then you have to go to an RESP," says Golombek.

Nonetheless, there are important tax considerations for RESPs. Although contributions may be withdrawn from an RESP for non-educational purposes with no tax consequences, the earnings portion of any withdrawals are subject to income tax for the year as well as a 20% tax penalty. As well, any grants generated by the original contributions would have to be paid back.

If the beneficiaries decide against post-secondary studies, the plan subscriber may transfer up to $50,000 from the RESP to his or her RRSP, or to a spousal RRSP, without tax consequences provided there is sufficient RRSP contribution room.

These potential outcomes call for some planning, says Audrey McFarlane, who points out that some RESPs allow subscribers to select a new beneficiary or beneficiaries if the named beneficiaries opt out of higher learning. RESPs are a good option for almost anyone concerned with education costs, says McFarlane. "I've never found a situation where these [RESPs] haven't been a positive thing."