RESPs demystified

Things you should know when setting up a registered education savings plan for a child.

A great way to save for higher education

It could cost $85,000 to send a youngster away to university for four years. Experts say an RESP is the best way of tackling an ever-growing education savings gap. ((iStock))
You're leaving the hospital, new addition to the family in tow, and your thoughts are focused on how your life is about to change forever. No more lazy mornings savouring relaxed cups of java. No more darting out for a night on the town at a moment's notice.

And no more disposable income.

Diapers, day care and summer camps. Organized sports, music lessons and school trips. Driving lessons! Soaring insurance bills!

And — ohmygawd! — tuition fees. Your little genius is definitely destined for a doctorate. What's that going to cost?

 Evolution of the RESP 
 1972: Program introduced 
 1997: Lifetime contribution limit raised to $42,000
 1998: Canada Education Savings Grant of up to $400 a year introduced
 2004: CESG sweetened for low-income families and Canada Learning Bond introduced
 2007: Lifetime contribution limit raised to $50,000 and annual CESG maximum raised to $500
 Source: Department of Finance

The class of 2014 — the kids entering first-year university in September 2010 — can expect to pay an average of almost $5,000 a year just for tuition. And those fees just keep rising.

Living in residence or a shared apartment could easily add $7,000 or so over the school year. Throwing in incidentals — like books, transportation and the odd trip to the pub — can easily add another couple of grand to the yearly tab.

Multiply that for a four-year program and you're looking at a tab of more than $50,000.

What will it run your little bundle of joy 18 years down the road?

If costs rose a modest three per cent a year, you could be looking at a bill of more than $85,000. Throw in some postgraduate study and you're easily into six figures.

To get an idea of how much it could cost to send your offspring to university, the Investor Education Fund has a university cost and debt calculator that can figure out and deliver the bad news personally.

Tax-free growth

For most Canadians, the simplest way to set aside money for a child's education is an RESP, or registered education savings plan. You put cash into it. It grows tax-free until your child needs the money. Your child pays tax on the money withdrawn, but if they have little or no other income, there may be no tax bill at all.

RESPs are similar to registered retirement savings plans, RRSPs, in that they allow money to grow tax-free. The major difference is that you do not get a tax break when you deposit money into the account.

These plans have been around for years. But they started to attract widespread attention only in the past decade, as the cost of post-secondary education soared and the federal government made the programs more attractive.

RESPs are great but ...
The Certified General Accountants Association of Canada recently praised RESPs as "a particularly effective savings vehicle for lower-income families." But the CGA report complained that many people — especially at lower-income levels — aren't taking full advantage of them because of a lack of awareness and understanding of the program.

You can contribute up to $50,000 per child over the life of a plan and there is no longer an annual limit. The 2008 federal budget extended to 35 years, from 25 years, the time RESPs can stay open. Contributions can continue for 31 years after the plan was set up.

The government will also provide a Canada Education Savings Grant that will kick in a maximum of $7,200 to your child's RESP over the life of the plan. The grant amounts to a maximum of $500 on the first $2,500 a year of RESP contribution (20 per cent).

But there's a sweetener for lower-income families. On the first $500 you contribute to the RESP, the government will give you up to $200 if your family income is $40,970 or less, up to $150 if family income is $40,970 to $81,941.

For those with family incomes above $81,941, the first $500 in RESP contributions attracts a CESG of $100 — the regular 20 per cent grant rate.

There's also a Canada Learning Bond available for the RESPs of children born on or after Jan. 1, 2004, and who are from families that get the National Child Benefit Supplement. That can add an extra $500 to an RESP in the first year and $100 in each of the next 15 years for a total grant of $2,000. The good news here is that you don’t have to put any of your own money into an RESP to get the Canada Learning Bond. But you do need to apply for it.

Provincial help for RESPs 
A few provinces — notably Alberta and Quebec — also run programs that deposit money directly into RESPs to help pay for the cost of post-secondary education.

The RESP program does allow for carry-forwards. Unused grant room one year can be used up the next year — or in subsequent years. The grants are not available for adult beneficiaries of RESPs.

Rules while you wait

In the unlikely event your little genius does not go on to an approved post-secondary institution, any money the government added to the RESP will have to be paid back. But income generated from that money remains within the plan.

There are also rules about what happens to the money that grew tax-free while you waited for the halls of academia to welcome your progeny. You can transfer up to $50,000 to your RRSP — or your spouse's — if you have the contribution room.

Anything above that can be withdrawn, but it will be treated as income and will be taxed. The money can go to the beneficiary if he or she is at least 21 and a resident of Canada — and the plan has been in existence for at least 10 years.

Most plans used to be available only through group providers, such as non-profit scholarship trust companies. But that could be a bit of a gamble — if your child opted for work instead of study, you would only get back the money you put into the plan. The tax-free growth would stay in the pool to fund the scholarships paid to plan members who went on to college or university.

There are three types of RESPs: family, group plan and individual plans.

Family plan

  • You can name one or more children as beneficiaries.
  • They must be related to you either through birth or adoption.
  • Any or all of the children named in the plan can use the money.
  • You — or a financial adviser — decide how to invest the money.
  •  Wide range of investment options.

Individual plan

  • There is one beneficiary who does not have to be related to you.
  • The beneficiary can be an adult, including yourself.
  • You — or a financial adviser — decide how to invest the money.
  • Wide range of investment options.

Group plan

  • Administered by a group plan dealer (similar to group RRSPs).
  • Investments normally limited to fixed-income securities, such as GICs, T-bills and bonds.
  • You are often required to sign a contract committing to regular contributions.
  • Savings are pooled and amount of money each pool member receives depends on how much money is in that pool.
  • You can name only one child as beneficiary.
  • If the beneficiary does not go on to post-secondary education, you will get back only what you put into the plan.

So how do you amass that small fortune you'll need to pay the bills? It may not be as painful as it sounds.

If you wanted to set aside $85,000 so your child would not have to divert his/her attention from academic pursuits to flip burgers part-time, you would need to save slightly less than $2,200 a year for 18 years if your plan returned six per cent a year. Ottawa would add $400 a year.

That means setting aside almost $200 a month. Well, maybe $100 a month if you set aside the $100 a month the federal government began offering in 2006 to help offset the costs of raising a child under the age of six.

Before you open that RESP, however, make sure you apply for a social insurance number for your child. You can do this at any office of Service Canada. The government won't hand over any grant money without it.