You Think You Know RESPs? Three RESP Facts Parents Need To Know

If you’re a Canadian parent who has ignored registered education savings plans (RESPs) please take your head out of the sand and realize your child’s future education shouldn’t be buried on the priority list along with painting the fence and pursuing those foreign language lessons. Take it from a kid who was on the receiving end of a modest RESP—it’s one of the best gifts parents can give a child.

Here is a sobering statistic for you, Mom and Dad. A report on post-secondary tuitions and compulsory fees by the Canadian Centre for Policy Alternatives shows that since 1990 costs at the undergraduate level have risen by 6.2% annually—or roughly three times the rate of general inflation for that period. Those cost increases don’t look to be going down any time soon. In other words, you might be sitting there saying to yourself, “Sure school costs more today, but so does everything else. Back in my day you could buy a chocolate bar and a soft drink for a loonie, so basically everything just costs more now. My kids will work their way through school with a good summer job just like I did.” If that pretty much sums up your view, please answer your door: it’s reality knocking. TD Bank reported in 2009 that by 2027 the total cost of a four-year program for a student living away from home will be $137,013. If your child is in kindergarten right now, they will need $100,000 or so in 13 years in order to graduate debt-free (assuming they can find part-time and/or summer work as well–by no means a safe assumption).

With post-secondary costs escalating, good jobs for youth being tough to find, and a post-secondary education of some kind becoming more and more necessary for long-term career success, RESPs need to be emphasized in family financial planning. The chances your child will need financial help when they are old enough to go to school are ridiculously high. This is especially true if you live in a rural area and your child has to go away in order to pursue post-secondary education or if your child is simply determined to get out of the house and spread their wings a little as they attend school. As a parent you can either cross that intimidating bridge when you come to it, or you can start building that bridge now with free money the government will throw your way. If you missed it the first time around, check out the November/December 2013 edition of Canadian MoneySaver for a basic primer on what this whole RESP thing is all about, then hustle back for a few more reasons why you should jump on the RESP bandwagon before it’s too late.

Your Child Doesn’t Need To Go To University Or College To Use An RESP

In my home province of Manitoba you can use RESP money if you attend the Brandon Flying Club, European School of Esthetics, Hua Xia Acupuncture & Herb College of Canada, or the Massage Therapy College of Manitoba (MTCM), just to name a few.

If your child is not going to one of Canada’s large universities they can still make use of an RESP. A student doesn’t even have to attend a post-secondary institution fulltime in order to qualify. The government has made the RESP program so flexible that you can even use RESP money to study abroad as long as you remain a Canadian permanent resident. To review the rules on using an RESP account check out http://www.canlearn.ca/eng/ savings/using_resp.shtml. If you wish to confirm that a specific institution qualifies, you can call the Canada Revenue Agency at 1-800-959-8281 or check out their list of designated educational institutions at http://www. canlearn.ca/eng/tools/designated/index.shtml.

In today’s hypercompetitive jobs market, some form of credential or post-secondary schooling is almost always an  asset. One of the biggest misconceptions many parents have voiced to me is that “because my kid isn’t the university type” they don’t need to put money into an RESP. One could argue that this overemphasis on credentials is counterproductive, but practically speaking, it’s better to help your child prepare for the job market than to rage against the machine.

Almost Nobody Pays Taxes On Money Made In An RESP

Unlike your RRSP, RESP contributions are funded with after-tax income. This means that like TFSA contributions, when you put money into a RESP account you don’t get a larger tax refund, but you also don’t have to pay taxes when the money gets taken out. The only parts of an RESP account that will count as taxable income when it is taken out is the money gained over and above what was originally contributed.

To make things easier to understand, money that is withdrawn from an RESP account is classified in one of two categories:

1. Post-Secondary Education Payment (PSE) – This is a withdrawal of money that was directly contributed to the account.
2. Educational Assistance Payment (EAP) – This is a withdrawal of money that was gained within the RESP account through government contributions such as the Canadian Education Savings Grant (CESG) and any investment gains made within the RESP.

PSE withdrawals are not taxable for anyone. EAP withdrawals are taxable, but here is the key: they are taxed in the hands of the student. Most of the time students do not make enough money at their summer jobs and/or through part-time work during the school year to pay any taxes. Even if a student does make a substantial amount of money as they go to school, they almost always get taxed at the lowest possible rate. In other words, your child will usually be able to withdraw any part of the RESP tax-free.

Planning ahead of time can aid in this quest to avoid paying unnecessary taxes. For example if your child just graduated from high school and is about to attend university, they are likely to have their lowest yearly income relative to the years when they have four-month summers with which to pad their bank accounts. This might represent an excellent time to use more of the EAP portion of the RESP account (a $5,000 maximum in the student’s first 13 weeks of schooling). If you have a family account with three children in post-secondary studies, then perhaps you would choose to use more of the PSE money for the child who earns a higher income due to the fact they’re in a co-op program, rather than for the other two children who are in more traditional university streams and could take more of the EAP without taking a tax hit.

If Your Child Doesn’t Go To University Your RESP Money Doesn’t Disappear

Another major fear parents have expressed to me is that, if little Johnny or Jane pursues their dream of becoming a rock star after high school, the government will simply take their hard-earned money. This is not the case at all. To start with, it is important to note when talking about these options that in all instances the original money that you contribute to the plan can be taken out tax-free (after all, you already paid taxes on it before putting it into the plan).

There are four main options when it comes to what to do with a RESP when the “rock star scenario” is encountered. You can leave the money in your RESP, change the beneficiary, transfer your money to an RRSP, or collapse the RESP entirely.

Before you decide to liquidate an RESP you should keep in mind that the plan can be left open for up to 36 years. That should leave plenty of time for Johnny to find himself by travelling through Europe or to pursue his calling as a professional surfer and still come back to the reality of the current post-secondary-dependent job market.

Depending on your provider, even if you have an individual RESP set up for a specific child, you may be able to replace the beneficiary. If you have a family plan you can simply transfer the RESP assets to another child—as long as you don’t go over any of the contribution maximums of course.

If the first two options don’t appeal to you and you’re like the vast majority of Canadians that still have contribution room left in their RRSP, then the best option is to transfer the money there (both parents’ RRSPs are eligible if they are co-subscribers). Up to $50,000 can be transferred from your RESP to your RRSP(s) providing the RESP has been open for at least 10 years, all beneficiaries are at least 21 and not currently continuing their education after high school, you are a Canadian resident, and the rules of your specific provider allow  it. If you choose this option it makes sense to withdraw your original contribution amount since that is already after-tax dollars. At this point the government grants that got tossed into your RESP will be sent back by the plan provider. What is left in the RESP is the investment gains made within the account. In other words, interest from bonds and/or GICs, dividend payments, and capital gains are all treated the same way and are known as the accumulated income amount. This amount is what you want to transfer to your RRSP if at all possible in order to shelter it from taxation.

The final option of collapsing the RESP account and directly withdrawing as much as possible is best avoided. As in the case of transferring to your RRSP, you can withdraw your original contributions tax-free, the grant money is forfeited, and you’re left with the accumulated income amount. If you decide to withdraw this money directly instead of transferring it to an RRSP, it will not only be taxed as income, but a 20% tax will also be added on top of your marginal tax rate! This tax is referred to as the accumulated income payment and makes it extremely unattractive to move the accumulated income amount straight from your RESP to your chequing account.

Don’t Procrastinate!

I should mention that I have yet to find a RESP-related question that Mike Holman, author of The RESP Book can’t answer. In addition to the book, Mike has a ton of free information about RESPs you can find all over the Web. At this point, he likely knows the program better than the people responsible for administering it. Don’t watch your precious little angel grow up and obliviously hope that their career will launch itself. There are still some outlier examples out there of successful folks who moved away from home at a young age and were able to get through school debt-free, but those examples are becoming fewer and fewer every year. The best time to start an RESP was the year your little bundle of joy was born, but the second best time is today!

Kyle Prevost is a business teacher and personal finance writer helping people save and invest over at MyUniversityMoney. com and YoungandThrifty.ca. His co-authored book, More Money for Beer and Textbooks, is available in book stores.