With kids now back in school, what better time to remind our clients that they should ensure they're taking full advantage of registered education savings plans (RESPs). For clients with excess non-registered funds, that means not just making the $2,500 annual contributions needed to maximize the Canada Educations Savings Grants (CESGs) of $500 a year per child, but topping up each child's RESP by an extra $14,000.
Although RESPs have been around for many years, they really took off in 1998 with the introduction of the matching 20% CESGs. As most advisors know, the RESP is a tax-deferred savings plan that helps an individual, typically a parent, save for a child's post-secondary education. Similar to other registered plans, the RESP is, in essence, a wrapper in which you can hold various eligible investment products, such as guaranteed investment certificates, mutual funds and even individual stocks and bonds. Unlike RRSPs, contributions to an RESP are not tax-deductible — nor are they taxable when withdrawn.
The main benefit of the RESP is the ability to have all earnings (capital gains, dividends and interest) on the investments inside the RESP accumulate tax-free until withdrawn. When the funds are paid out, the contributions come out tax-free and so long as the beneficiary attends a qualifying post-secondary institution, the income (as well as the CESGs) are included in the student's income. Presumably, though, the child will be in a low- or zero-tax bracket on account of the various tax credits available to the student (including, most commonly, the basic personal amount and tuition credits, as the education and textbook credits were eliminated in 2016) that little, if any, taxes will ever be paid on the earnings when withdrawn. That's why I like to refer to RESPs as TFSAs for kids.
The other benefit, of course, is the aforementioned CESG, equal to 20% of the annual contributions, to a maximum of $500 (or $1,000 if there's unused grant room from previous years). The maximum CESG entitlement is capped at $7,200 per child.
When funding an RESP, one missed opportunity is that parents often only start thinking about contributing to their kids' RESPs several years after their children are born. But contributing to an RESP as soon as possible can reap significant financial rewards down the road thanks to the tax-free compounding of the contributions, CESGs and the investment returns.
For parents who can afford to do so, consider maximizing the tax-deferred (or, most probably, tax-free) compounding by contributing beyond the annual amounts needed to maximize the CESGs. This can be done by making an additional lump-sum contribution of $14,000, bringing the total amount contributed up to the lifetime maximum of $50,000 per child.
One last thought: It never makes sense to frontload an RESP by more than $16,500 ($14,000 plus the $2,500 annual contribution) for a newborn child. Otherwise the parents' lose the ability for the RESP to receive the maximum $7,200 of CESGs as the maximum CESG in one year (assuming no catch-up CESGs) is limited to $500 (20% of $2,500). If the parents do have excess funds beyond the $16,500, they could consider an in-trust account in which there's no parental attribution of capital gains.