RESPs are different from Registered Retirement Savings Plans (RRSPs) because RESP contributions are not tax deductible, and so will never lower your tax payable. It means you will not receive a receipt to claim it on your tax return
The tax advantage of RESPs is that the money invested in the fund is allowed to grow tax-free until it is withdrawn. So, you do not report the interest or dividends earned by the account every year.
And once you make a withdrawal to pay for school, the income earned by the fund is taxed in the hands of the student, and not the parent. Since most students have a limited income and can claim tuition and education credits, the tax obligation is usually reduced to a small amount – or even to zero. This is essentially a form of income splitting.
RESPs can be opened by parents, grandparents, aunts, uncles and other interested parties. But the child has to have a Social Insurance Number (SIN) in order for the plan to be opened. Until a couple of years ago, there were annual limits on RESP contributions, but now there is only a lifetime limit of $50,000. Technically, that means you can deposit $50,000 as soon as your child is born but you would miss out on the Canada Education Savings Grant (CESG).
The CESG program pays 20 per cent of your annual contributions into the RESP, up to a maximum of $500 per year. Families with income less than $41,544 get an additional 20% on the first $500 of contributions. Families with income between $41,544 and $83,088 get an additional 10%.
Lower-income families may benefit from the Canada Learning Bond (CLB). If you are entitled to the National Child Benefit supplement, your child will receive a $500 CLB as well as $25 to cover the fee of opening an RESP. The HRSDC will then deposit $100 every year the child qualifies for the National Child Benefit, until the age of 15. If the child decides not to go to school, the money is returned to the government. You do not need to apply for the CLB; your RESP provider will apply for it for you and deposit it to your child’s RESP account. You only need to file tax returns to receive the initial CLB deposit, as well as the $100 per year.
Make sure you understand the plan you select and the amount of risk involved. RESP returns are not guaranteed. Some group plans require regular contributions or there are penalties. Some financial institutions offer plans that are self-directed, which gives you more flexibility but also more active involvement.
If your child decides not to go to university, all the RESP advantages are lost. Any CESG money has to be returned and the accumulated total reported as income for the plan holder. There is also a 20% penalty to the extent that you do not have the RRSP deduction room to transfer the accumulated income to an RRSP. And most plans will have cancellation charges if you decide to close the account.
RESPs may not be the best saving vehicle for every parent, but if you understand the specifics of any given plan and can accept some level of risk, investing in a RESP now may make the costs of post-secondary school a little easier to manage.