Tax sheltered growth plus $7200: 50 years later RESPs are still a great idea

Parents and grandparents cherish the day when a young family member graduates from higher education. Particularly when behind the joyful smiles and embraces a collective financial effort has helped make the dream a reality. 

A Registered Education Savings Program (RESP) can be a key part of achieving that shared success. Your financial advisor can assist with opening it, investing the funds, accessing government grants and eventually disbursing the funds in a tax-efficient manner. 

A GROWING NEED

Higher education is increasingly costly and it’s not only the tuition. Housing is a major expense when a student does not live at home. Other necessities include textbooks, food, phone, internet and transportation. Inflation has driven up prices and fees for them all and those non-tuition costs can be a larger share of the total expense, adding $10,000 or more per school year.

Depending on the degree program and location (rents have risen across the country but major cities remain the most expensive) the total for a 4-year undergraduate education can reach $80,000.

• In 2023/24 the average undergraduate tuition in Canada is $7,076.
• The highest is Nova Scotia ($9,575)
• The lowest are Quebec ($3,461) and Newfoundland and Labrador ($3,481)

Graduate programs, depending on the degree, usually cost more. Law and MBA tuitions, for example, can range from $14,000 to $60,000 per year.

 With few exceptions a university degree opens career opportunities and access to higher employment income. A graduate degree such as medicine or law can significantly enhance lifetime earnings potential. According to Statistics Canada, women with a bachelor's degree earn approximately 40% more than women with a college diploma and approximately 60% more than women with a high school diploma. But paying for post secondary education entirely on their own is out of reach for most young people. An RESP can be a critically important source of financial support and help prevent heavy debt loads upon graduation.

RESPs were created by the federal government in 1974 as a tax-deferred savings plan to encourage parents to put money aside for a child’s post-secondary education. Today you can open one for your child, grandchild, niece, nephew or even a family friend. The future student (the RESP beneficiary) must be a Canadian resident and have a social insurance number (SIN). Anyone can contribute to an RESP.  

WHAT TYPES OF EDUCATION ARE ELIGIBLE?

 The federal government maintains a detailed list on their website but generally speaking RESPs can be used to pay tuition and a range of student expenses for full or part time study at the following institutions.

• A university, college, CEGEP, trade school or other designated educational institution in Canada.
• An educational institution in Canada certified by Employment and Social Development Canada (ESDC) as offering non-credit courses that develop or improve skills within an occupation.
• A university, college or other educational institution outside Canada that provides courses at the post-secondary school level and where the student is enrolled on a full-time basis.

QUALIFYING EXPENSES

• Tuition fees, related mandatory student fees and text books
• Living expenses, including housing, food and transportation
• Expenses for special needs (such as note-takers, interpreters)

THE CANADA EDUCATION SAVINGS GRANT (CESG)

The CESG, matching money the federal government contributes directly into an RESP, is one of the most important benefits of an RESP. There are also provincial grants available to eligible beneficiaries in British Columbia and Québec.

KEY CESG INFORMATION

• It provides matching funds of up to $7,200
• Contributions must be made to an RESP to be eligible for the CESG
• The CESG matches 20% of RESP contributions up to a maximum of $500 per beneficiary, per year, so a $2500 annual contribution nets the maximum.
• If you do not contribute $2500 in a given year you can still receive the CESG in future years by making higher contributions.
• The CESG is available until the end of the year that the beneficiary turns 17.

Students living in British Columbia may also be eligible for an additional one‑time $1,200 grant, and those living in Québec may be eligible for a refundable tax credit with a lifetime maximum of $3,600.

STRATEGIES FOR CONTRIBUTING

The most common is to contribute $2500 annually to generate $500 in CESG. This can be done monthly, quarterly or whenever is convenient for the contributor during the year. This approach takes 14.4 years to reach the total contribution of $36,000 needed to generate the lifetime CESG maximum of $7,200. If you have more than one child – and RESP – then annual contributions rise accordingly. The lifetime contribution limit is $50,000 per RESP account, so you can keep contributing beyond $36,000 to take advantage of tax-sheltered investment growth. 

There is no annual limit on RESP contributions, which allows for contributing the entire $50,000 lifetime limit in the first year. The advantage of this strategy is to capture the compound growth potential of a large sum. The disadvantage is that only $500 of the CESG will ever be received because contributions are only made in the first year. 

RESP INVESTMENT STRATEGIES

There is no optimal asset allocation for an RESP but its trajectory has some similarities to a retirement savings investment plan. If established when the beneficiary is very young, growth equities are a logical choice to maximize compound growth potential. At the start of high school reallocating to a balanced strategy may be advisable before prioritizing capital preservation in the final years of high school. 

Your advisor can suggest an asset mix best suited to the circumstances of both you and the beneficiary. For example, a student may, at the beginning of undergraduate study, already be intent upon pursuing a specific graduate degree. This could mean RESP funds will be needed across multiple degrees or even kept largely for the often higher tuitions of graduate study. As with any investment plan, meeting with your advisor to review the  portfolio and discuss rebalancing when needed is prudent. 

TAX CONSIDERATIONS 

Contributions are not tax deductible but any investment gains on them and CESG money within the RESP are tax free. RESP withdrawals are included in the beneficiary’s income and taxed accordingly. However, since students typically have relatively low incomes withdrawals may attract little to no tax after various deductions available to students are accounted for.

There are two types of RESP withdrawals, an Educational Assistance Payment (EAP) and a Post-Secondary Education Payment (PSE). An EAP is drawn from the CESG portion of the RESP and investment gains earned on contributions. EAP withdrawals trigger a T4A in the name of the student and must be added to their taxable income in the calendar year of the withdrawal.

PSE withdrawals consist of the annual contributions (so as much as $50,000) and are tax free in the hands of the student. It is important to consult with your advisor about which type of withdrawals are made and any tax implications. If the student has very little income an EAP withdrawal could be the tax-efficient choice. Your advisor can tell you how much of EAP funds are available in the RESP. A withdrawal can be from either EAP or PSE or a combination of both. It can make sense to deplete EAP funds first, so long as the tax consequences are insignificant. 

CASE STUDY: PARENTS

It is best to open an RESP as soon as possible following the birth of a child to maximize compound growth potential. One challenge can be maintaining contributions while also paying bills for a young (and perhaps growing) family. A solution is to set up a relatively small RESP auto deposit. This allows you to still collect the 20% CESG match on even a modest contribution. As your career and income progresses you can start catching up on untapped CESG money from earlier years. An auto deposit can also help make building an RESP nest egg a routine “set it and forget it” part of life. 

CASE STUDY: GRANDPARENTS   

One of the best gifts a grandparent can give a child is access to education. RESP options for grandparents include topping up annual parental contributions to collect the full CESG  or gifting $2500 annually for the same purpose. Alternatively, a grandparent may choose to open and fund the RESP independently. There is also the option of making the lifetime maximum contribution of $50,000 when the child is born. You will forego all but $500 in CESG money but if the capital compounds at 5% annually the RESP could hold $122,000 after 18 years. If your grandchild’s taxable income is negligible as a student, the majority to almost all this money (except for the $500 CESG) could flow to them tax-free to fund their post-secondary or graduate education. If you have numerous grandchildren, this strategy could become part of your intergenerational wealth transfer planning.