This article is brought to you by Insurance for Children, Canada’s leader in financial planning for children and the creator of Child Plan ™ the fastest growing alternative to the RESP.
Planning for our children’s future in an increasingly complex world is not easy. What will their life be like when they become an adult?
We are so busy with our daily lives today, who has time to think about tomorrow, or 18 years from now?
One priority for most responsible parents and grandparents, wanting to give their children the best opportunities in life, is to ensure they can have a suitable education.
Post-secondary education is not cheap, and it pays to begin saving early. The default plan for the last 24 years in Canada has been to invest into an RESP and benefit from the Canada education savings grant (CESG).
Registered Education Savings Plan
RESP is an acronym for the Registered Education Savings Plan, a government-designated savings account at a financial institution introduced by the federal government in 1998. An RESP enables parents to save for their child’s post secondary school education at a designated educational institution.
However, an RESP provides limited options for this savings goal and lacks flexibility if the child’s goals change.
How Does an RESP Work?
You can save as little or as much as you want into an RESP each year, but no more than $50,000 lifetime maximum amount. You can start a Registered Education Savings Plan anytime from the child’s birth to age 18. It can continue for up to 36 years.
The government of Canada contributes Canada Education Savings Grants of up to $7,200, spread over each year until the child turns 18, so the sooner you start, the more ‘free’ money you get from the government. To get the full $7,200 you need to contribute $36,000 of your own money before the child is 18. Any money you pay into an RESP above that amount, or after the child turns 18, doesn’t attract any incentive.
Low income families may also be eligible for a further $2,000 maximum from the Canada Learning Bond, and some provincial grants can also apply.
When your child comes to pursue post secondary education at one of the government’s designated educational institutions you can apply to your fund for an education assistance payment to meet specific education expenses.
What are the Tax Risks of Opening an RESP?
The RESP has always been promoted as free money for your child’s future education. But it is free money with lots of strings attached. Many of those strings are well hidden and you only find out about them when you need to withdraw the money.
Like any government funded program, every cent needs to be accounted for so there are lots of rules to make sure nobody is cheating the public tax payer. After all, it is the taxpayer who is the real entity providing these education benefits.
These rules not only state where your child must be pursuing post secondary education, but also what they can study, and what the educational assistance payments can be used for.
We are sold on the fact that an RESP is tax-free.
But in reality, there are a number of tax risks when opening an RESP. These can impact your child when they make withdrawals, and they can impact the parents if the child does not attend a government approved educational institution.
Every country in the world needs a strong well-educated trades workforce. These are the builders, electricians and plumbers who build our nation. But no trade school has ever been eligible for RESP funding.
If your child loves playing with their Lego set, perhaps their career interests might ultimately lie in practical work like one of the trades. In which case, an RESP will not help you or your child.
And who knows what opportunities for study may exist 18 years from now? You can already access outstanding courses in a wide range of subjects from institutions half a world away, from the comfort of your bedroom. But an RESP does not support that kind of study.
If you have an RESP and your child is not going to go to an approved educational institution, you will want to close your RESP account as soon as possible.
When registered education savings plans are closed, you can withdraw your contributions without incurring taxes. These contributions originally came from your after-tax income. The government grants are returned to the Canada revenue agency. But there are penalties and income tax incurred on investment earnings that are withdrawn from an RESP and not used for your children’s post secondary education or a vocational school. Any gains returned to you are taxed at your marginal tax rate, PLUS another 20% tax penalty.
After saving for 18 or more years into a government program your child can’t use, you may be hit with as much as 60% in taxes and fees.
As described above, there are three parts to withdrawing from an RESP: your contributions, the Canada Education Savings Grant and the Canada Learning Bond (CLB) grants, and the investment gains. If you withdraw all the money as one amount, you will be taxed not only on the investment gains on your contributions, but also on the earnings on the grant money.
But if you specify withdrawing each of the three parts separately, you will reduce the amount you are taxed. But nobody tells you that.
If you were investing into mutual funds or similar investments, when you sell investments and you deduct losses from one investment against the gains of another, you reduce the capital gains tax you need to pay.
You can’t do that when closing an RESP.
If your child does qualify to withdraw from RESP for their education expenses, any investment growth becomes their taxable income. If they earn very little while studying, that might not have much impact in terms of having to pay tax, but it can still impact their eligibility and the amounts they can receive from bursaries and student loans.
Are there any tax-free savings plans for children’s education?
A Child PlanTM participating whole life plan is the fastest growing alternative to RESP and the only tax-free investment parents or grandparents can open for their children in Canada.
From the day you open a Child PlanTM your child will receive a tax-free annual dividend for life which they can use towards ANY education around the world without restrictions. Or alternatively, they might use it to buy their first home, start a business, or fulfill some other personal dream or financial goal.
Child PlanTM is a set and forget plan for life. It is a tax-free investment for your child’s future with no tax risks and is simple to access and manage. To see how the value of Child PlanTM grows over time, put some figures into your illustration.
To learn more about Child Plan ™, please visit insuranceforchildren.ca.
How Much Can I Contribute to a Registered Education Savings Plan?
You make any amount of RESP contributions, but no more than $50,000 over the lifetime of the plan. Even with the government grants added on and good investment growth, this could still be insufficient to cover the rising costs of your child’s post secondary education 18 years from now.
What happens to the RESP if it is Not Used?
If you don’t use the RESP for your child’s education, you can choose to close the account, or it will be closed for you after 35 years. All contributed government grants are returned to the Canada Revenue agency, you receive back your contributions and any investment earnings.
How are RESP Withdrawals Taxed?
If you have closed the RESP, any investment earnings are taxed when you receive it at your marginal tax rate, plus a 20% tax penalty.
If used for educational expenses, your child will be taxed at their marginal tax rate. If their income is low, they may not have to pay anything.
Are there any taxes when I transfer ownership of Child Plan TM to my child? No.
You simply take your name off as the owner and add your child. The plan transfers completely tax free to them.
Are there any taxes when my child withdraws from Child Plan TM?
This depends on which of the four following ways you withdraw:
1. You can request the dividend be paid in cash rather than redeposited – no tax.
2. You can request a full withdrawal and the payment received will be taxed as a capital gain.
3. You can borrow from the plan against the full cash value – that is tax free.
4. Any chartered Canadian bank will provide you a loan of up to 90% of the cash value of the plan – tax free.
Does the Child Plan TM have to be closed if my child doesn’t attend post secondary education?
If your child doesn’t attend post-secondary education, you can keep the plan open and let the cash value continue to grow until some other financial need arises. After 20 years the plan is self-funded, but you can make further contributions and watch the interest continue to grow.