RESP Guide To See Your Children Succeed

RESP Executive Summary:

1. There are 3 types of RESP accounts available (Individual, Family, and Group).
2. Things needed to open an RESP: SIN number, birth certificate and/or passport.
3. A minimum of 20% ROI is guaranteed on the initial $36,000 of contributions if the child attends a post-secondary institution.
4. Do NOT contribute more than $2,500 per year to maximize the free money component!
5. If your child decides not to pursue post-secondary education, you do have alternative options, however, it differs between the contribution portion, the grant portion, and the gains portion.

RESP Basics:

What’s RESP? The RESP was introduced in Canada in 1974 and is short for ‘Registered Education Savings Plan’. It was introduced to help lower and middle-income children from attending a qualified post-secondary institution to further their education, and to help their parents save on behalf of the child. The child must have a SIN number, but you’ll also have to take their birth certificate and/or passport with you in order to open an account and the child must be named the beneficiary of the Registered Education Savings Plan.

The lifetime contribution room for each child is $50,000. If you happen to go over that amount, you’ll end up with a penalty of 1% per month, so it works out to a 12% penalty annually per child, which is a hefty ‘tax’ so let’s try not to be put into that situation.

The maximum government portion of the grants works out to a lifetime value of $7200, and the maximum payout would be $500 per $2500 contributed per year. The simple math is $2500 x 20% = $500. This is how we achieve a guaranteed 20% return on the contributions portion, up to $36,000. The Government grant is called CESG or short for Canadian Education Savings Grant.

Lower-income families have additional options in order to collect the portion of the grant quicker and have it make gains tax-free longer. Families with a household income less than $106,717 can get an extra $50 so an adjusted max of $550 per year. Households with incomes less than $53,359 or less can get an extra $100 so the adjusted max is $600 per year as of 2023. In either of these situations regardless of household income the max you’ll get from the CESG is $7200. The benefit is you’ll be able to hit that max grant value sooner which then allows the money to compound faster and longer due to the initial years.

What happens if the parents fall into hard times and can’t contribute for one of the years? In this instance you can carry forward a maximum of $500 in grants per child to the following year, so just make up the $2500 contribution in the following year and you’ll still receive the grant. However, the limitation is that this can only be done one year at a time. In other words, you can’t miss two years in a row and make up for it in the third year; in this instance, you could only make up the second year missed in the third year.

A Registered Education Savings Plan account can be kept open for up to the 36th year (or to be safe think of it as till the 36th birthday). However, the Government grants would stop being applied as soon as the 17th year (or till the 17th birthday of the child). There are two additional points of time to keep in mind which is the 31st year, which is the final year you can contribute towards the RESP account. As well as 21st year, which is when you can transfer from one child to another if you have a second child – we’ll go into this later.

The contributions are made with after-tax dollars, like a TFSA, however, the gains inside the RESP works like an RRSP in that the growth happens tax-free and is only taxed at the time the funds are withdrawn. Gains for the purpose of our discussion include capital appreciation, dividends generated, as well as interest made (some also refer to gains as income). We’ll discuss the withdrawal elements further on.

RESP Account Types:

Three types of Registered Education Savings Plan accounts exist in Canada:

1. Individual RESP Plans
2. Family RESP Plans
3. Group RESP Plans

Individual RESP Plans are opened and affiliated to a single child and can be opened by anyone (parents, grandparents, godparents, aunts, uncles, friends and so forth). You could also open multiple individual plans for one child and/or for each child you have. One aspect to keep in mind in the event there are multiple accounts opened for a single child is to coordinate the annual contributions made to the account in order to maximize the annual benefits and not exceed the lifetime contribution room of $50,000. As mentioned, anyone can open a plan, but the beneficiary of the plan must be the child.

Family RESP Plans can be opened for multiple kids related by blood but can also include adopted children. Family plans are pooled funds made up of contributions, grants, and gains generated. The positive of family plans is that it’s easier to manage with one account. The downside of family plans is i) ensuring each child only withdraws a maximum of $7200 of the grant funds to avoid penalties, but ii) also they only take 50% of the fund’s accumulated dollar value amount to keep it fair with the second child. For this reason, the individual plans might be easier to manage and keep separated for fairness, but also depending on age difference and the type of investments you make on their behalf. Important: Aunts, Uncles, Friends, and Godparents should not open family plans for RESPs – if you’re opening one create them under individual plans

Both individual and family plans give you the flexibility to manage 100% of the RESP funds and the investments that are held within the funds.

Group RESP Plans are our least favourite way to manage the Registered Education Savings Plan funds. With Group Plans there is a professional money manager involved who manages the funds, you have no control over what they invest in, and they tend to charge a higher MER (Management Expense Ratio) to look after your RESP funds. Due to the higher MER by the time your child is ready for their funds, they’ll get much less. In our opinion, it’s better to open an individual or family plan and invest the funds into an index fund like VFV on the TSX, which is a mirrored product of VOO, the Vanguard S&P 500 on the NYSE with a much lower MER so you maximize the gains the RESP makes.

Ok now that you understand the basics of RESPs as well as RESP account types, what’s next?

RESP Maximization Strategy:

As soon as the child is born, and you have a SIN number get your behind to a financial institution of your choosing and open an RESP account for them. As for the funds here’s the optimal way to contribute to the Registered Education Savings Plan:

· Initial 14 years: Contribute $2500 per year (total contributed $35,000)

· Final 15th year: Contribute $1000 only (total contributed $36,000)

At this point, you’ve achieved the max lifetime grant value of $7,200. And you’ll still have $14,000 contribution room left which we’ll discuss in a bit.

What should you invest your RESP funds into?

As soon as the funds are in the account invest it in VFV on the TSX. The reason for suggesting VFV is as mentioned before it mirrors VOO which tracks the 500 largest stocks on the NYSE (New York Stock Exchange), and VFV has generated a CAGR (compounded annual growth rate) of 14.6% over the past 10 years and 16.2% since it’s creation, which we’d consider pretty good returns. Not to mention with a MER of only 0.09% it’s reasonable!

Also, ask your financial institution to help set up the RESPs into a DRIP (Dividend Reinvestment Plans) program, which means your dividend payments get automatically re-invested into the investments that generated the gains.

Now the above is just a simple suggestion based on past performance with safety in mind (but could differ in the future), however, if you want other options you could go with other low-cost ETF’s and/or if you’re comfortable go with individual Blue-Chip stocks. However, under no circumstance buy penny stocks inside a Registered Education Savings Plan, remember this is for your child’s education so let’s take a calculated risk, not speculate on stocks and take higher than needed risks because “you have a feeling”.

YouTubeVideo: Vanguard Performance Over Time

Vanguard Performance Over Time (Disclaimer: Past performance does not dictate the future outcome.)

Initial $36,000 Contributions: What types of returns are possible with RESPs?

We know on the initial $36,000 you’d make an easy 20%, however, how much would you make overtime assuming you stopped at $36,000 in contributions plus $7,200 in government grants and you had decided to go with VFV assuming the CAGR remained at 14.6%. In this scenario, the child would have $235,155 in their account by the time they got enrolled into a post-secondary institution – crazy right?!?

Now let’s assume all the $ figures stayed the same as the above scenario but now let’s assume instead of a 14.6% CAGR we had years of horrible economic times and the ETF only had a CAGR of 7.3% – half the current rate, in this instance the child would have $99,884 ready for school, still a pretty good chunk of change, isn’t it? The wonder of compounding over time is mind-boggling so for fun I also calculated a rate of return of 4.5% which would be an extremely conservative rate of return and our Excel calculator spit out $72,210. Time is our best friend when it comes to investing, WOW! Feel free to download the Excel file at the bottom.

What about the remaining $14,000 to max out the RESP room?

In our opinion, we’d say if you have the funds, put it into your own TFSA account and max your TFSA value out first so it can grow 100% tax-free. TFSAs also don’t get taxed at the time of withdrawal. The purpose of contributing to the RESP is to get the free 20% return. Now if your TFSA is maxed out then feel free to go back to contributing further into the child’s RESP account to max it out, but the way we see it is you might as well grow it inside your own TFSA account and when the time comes up you can give them those funds and it’ll have grown tax-free and won’t be taxed at the time of withdrawal unlike RESP’s. If you want to make it easier for yourself, you could just open another TFSA account, so you know the funds in that account are for the child in the future. Also, it adds an extra security level if they screw up you don’t hand them the funds and/or if they decide not to go and get a post-secondary education you can give it to them without major penalties as you’ll see below.

Final thought around RESPs, don’t hold US dividend stocks inside the account to avoid withholding taxes like holding US dividend stocks inside of a TFSA. Similarly, don’t just hold cash inside the Registered Education Savings Plan and have it not work for your child’s future.

What are the RESP withdrawal rules?

Registered Education Savings Plan withdrawals are not as straightforward as TFSA withdrawals as there are three components of funds composed inside the RESP. The first one is contributions, which is what you put in from the start, the second one is grants which is the amount contributed by the Canadian government, and the third portion is the gains from the growth, dividends and interest made on top of the combined contributions and the grants.

The contribution portion is very easy to take out. The after-tax dollars you contributed can be taken out at any time and put towards whatever without tax consequences. There are no limits to this withdrawal amount and is like withdrawing from a TFSA. The withdrawal of the contribution portion has a special term called PSE, which is short for post-secondary education payment, another name that institutions use is ROC which is short for refund of contributions. The contributions withdrawn can go into either the beneficiaries account and/or the sponsor/parent who made the contributions on behalf of the child. The key takeaway is that the contribution amount can be taken out anytime including after graduation.

The grants portion as well as the gains made on top of the contributions and grants have a few restrictions. To start withdrawals of these portions should only be initiated once the child is registered at a post-secondary institution like a university, college, and/or trade school. The institution can be located both in Canada and internationally as long as you are enrolled and have proof of enrollment obtained, the financial institution will require it. The grant and gains portion of the withdrawal is called EAP or short for education assistance payments.

The grant and gains portion can only be withdrawn by the student and only while they are officially in attendance at a post-secondary institution. For this reason, our suggestion to the student is to withdraw the grant and gains portion first before touching the contribution amounts. Another reason it’s beneficial to use the grants and gains portion first is because that portion is taxable upon withdrawal. It grows tax-free, but you still pay tax on the withdrawal and the financial institution who releases the funds would issue a T4A tax receipt to the young adult. There is an extra benefit to withdrawing the grants and gains portion first and paying the taxes which is while in school the student would be at their lowest possible tax bracket and would end up paying the lowest taxes possible. Considering all Canadians automatically get no taxes applied on the first $13,000 of income, and students also get additional tax credits on tuition fees, it’ll be optimal to withdraw the funds from earlier stages of student life. If I were in that position, I’d take out the max I could without triggering too much in taxes, using what I needed for school purposes, put the remaining into a TFSA and invest it into an interest-producing – yet no-risk vehicle like the ones discussed in our emergency fund article like the Purpose Investment ETF or equivalent offered by TD or RBC. To emphasize, the idea is not to invest those funds you’ll need, but rather to keep the capital 100% safe while it produces a bit higher of a return vs keeping the funds in a savings account barely doing anything for you.

As mentioned, you will need proof of enrollment for withdrawal, such as tuition bills or a letter from the post-secondary institution. There’s also a limit of $8,000 maximum a full-time student can withdraw during the initial first semester (13 weeks). This limit was $5,000 before the 2023 federal budget raised it. If more is needed in the first semester for housing, laptops, books, etc. they should withdraw from the contribution portion if needed as a backup, but, if possible, delay this decision. All the withdrawals can be spent on anything and for now, no proof is required so you could technically use it for car payments, school trips, meal plans, etc. Another limitation is the maximum a student can withdraw per year is $26,860 which is the limit for 2023, the EAP limit for the year. If absolutely needed, you can withdraw more than the $26,860 but then you’ll be asked to provide proof and for this reason, our advice is to avoid it and to limit the taxes paid to keep the total income as low as possible.

RRSP: The child does not want to attend post-secondary education, now what?

The Registered Education Savings Plan can be kept open for 36 years, which gives the young adult some time to decide in the event the individual changes their mind later which includes part-time post-secondary education ambitions.

The contribution amount can be withdrawn in full up to the $50,000 or the actual contribution amount without a reason and can also be moved over to another sibling.

The grants and gains portion works differently. The grant and gains portion can be transferred to a siblings RESP (within a family plan or from one individual plan to another) without losing any money. But the sibling needs to be 21 years of age or over at the time of transfer and must be the brother or sister to the child deciding not to go to post-secondary education. The maximum the brother or sister may receive from the transfer is the difference between their own maximum grant value minus what they’ve already received without surpassing the $7200 limit. As an example, i) let’s say over the years the parents contributed and received $5000 in grants for the second child, in this case, you can only transfer $2200 from the first child to the second child to get them to the $7200 lifetime maximum and the remaining from the first child would be returned, ii) let’s say both kids had their accounts maxed out, in this case, you won’t be able to transfer as the second child has already received the max $7200 in government grants. The remaining must be repaid.

Gains can be transferred to another child in full (within a family plan or from one individual plan to another).

RRSP: Now let’s say you only have one child or both children decide they don’t want to pursue post-secondary education. You have a few options!

The grant portion up to a maximum of $7200 or whatever has been received over the years must be repaid in full back to the government. No option here.

Contributions, however, as mentioned previously are after-tax dollars you’ve contributed which can be withdrawn in full without penalties.

As for the portion of the gains, this can be transferred into an RRSP account if the young adult has contribution room. The downside with this option is that they cannot deduct it from your taxable income for that year since it’s already been growing tax-free inside the Registered Education Savings Plan. The growth inside the RESP technically speaking has a hidden benefit since you’ll only be repaying the portion of the grant received and not the gains made on top of the portion of the grant but there is a caveat.

What are the conditions to transfer funds from an RESP to an RRSP:

1. The RESP must have been open for at least 10 plus years
2. The young adult(s) are at least 21 years old
3. The young adult(s) are not in school
4. The young adult(s) must have RRSP contribution room available
5. The maximum transfer value is $50,000 in total.

If the RRSP option fails due to a lack of contribution room, then you can withdraw the value of the full gain, but it’ll hurt! The funds withdrawn under this element are called accumulated income payments or AIPs. You’ll get taxed heavily and to make it worse it’ll be taxed under the parent’s name (or the subscriber – the individual who opened the account originally) on top of their regular income for the year, probably also pushing them into a higher tax bracket. And the pain doesn’t stop there, you’ll also get hit with a 20% penalty tax for not using the RESP as intended.

Even if one attends post-secondary, for the above reason, make sure you take out the maximum allowed each year ($26,860 in 2023) so whatever that’s remaining doesn’t get taxed at the above levels.

Registered Education Savings Plan Summary

Where can you open an individual, family, or group Registered Education Savings Plan account? Easy, at any financial institution really. For my godson, we opened it up at TD Canada Trust even though they charge a higher trading fee, for us this was OK because my godchildren’s parents also bank with TD, so we could link our accounts and keep track of the RESPs together and makes it easier to coordinate contributions. There are cheaper online brokerage alternatives available if you plan on trading inside the RESP account periodically and by periodically, we don’t mean day trading we mean infrequently. Again, these are funds for your child’s education so let’s stay conservative, steady and consistent to help their Registered Education Savings Plan pool of funds grow as much as possible. Let’s start now and let time and compounding work their magic, the sooner you start the better your child will be positioned for financial support during those post-secondary educational days.

Link To RESP Excel Calculator – Estimator

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Happy Educating!

HOA