Saving Money for Your Children’s Education: RESPs and More
For years, Canadian parents have saved for their children’s education using Registered Education Savings Plans, or RESPs. This popular government-sponsored savings plan offers several advantages. But RESPs also have some limitations, so it’s important to consider other savings options as well. In this article, I’ll cover some RESP basics and provide you with a few alternatives for saving money for your child’s education.
What Is an RESP?
A Registered Education Savings Plan is the most common type of savings vehicle for a child’s education. It’s a government registered savings program that offers two key benefits: tax-sheltered growth and a government grant (CESG) added to the contributions made to an RESP during the plan’s life.
How Do RESPs Work?
As long as your child has a Social Insurance Number, you can open an RESP account for them. As their parent, you would be considered the subscriber of the RESP plan, and your child would be the beneficiary. Grandparents and other family members and friends can also open RESP accounts.
Individual vs. Family RESP Plan
These days, most financial institutions offer both individual and family RESP plans. An individual plan can accommodate one beneficiary (child), while a family plan allows for multiple beneficiaries under the same account. This provides some added flexibility for families with more than one child.
While balances inside a family plan are tracked separately for each child, parents have the option of transferring funds between beneficiaries if needed. This comes in handy if one or more children decide not to pursue post-secondary education. Rather than relinquishing the grant, the funds can be transferred to another child.
Contributing to an RESP
Unlike RRSPs, RESPs do not have an annual contribution limit. They do, however, have a lifetime contribution limit of $50,000. Through the Canada Education Savings Grant (CESG), the Canadian government provides a 20% match on all annual contributions up to and including $2500. In other words, an annual contribution of $2500 would result in a $500 grant being added to the account every year, up to the lifetime maximum grant of $7200. Additional grants, such as the Canada Learning Bond, are available for low-income families.
Growth of the RESP
Funds held in an RESP account are tax-sheltered until they are withdrawn. This includes client contributions and grant money. Eventually, when funds are withdrawn to pay for post-secondary education, they are taxed in the beneficiary’s hands rather than their parent’s. This makes RESPs a tax-efficient way to save.
Drawbacks of an RESP
For all of their benefits, RESPs are not perfect. For example, if your child opts out of post-secondary schooling, not only is the grant money forfeited, but the funds are taxed in the hands of the subscriber (parent), which can result in a large income tax bill. There is an option to transfer unused RESP money to the subscriber’s RESP, but several conditions must be met before this can happen.
Whether or not you’re currently saving inside an RESP, here are some other, more flexible savings options to consider for your children’s education.
1. High Interest Savings Accounts
Known for their low fees and attractive interest rates, high interest savings accounts are a staple of several Canadian online banks, such as Tangerine, EQ Bank, and Simplii. While this type of savings doesn’t offer grant money or tax-sheltered growth, non-registered savings accounts provide safety and a high level of flexibility by allowing account holders to withdraw funds for any purpose at any time. For these reasons, a high interest savings account can complement a Registered Education Savings Plan.
2. Tax Free Savings Accounts
Tax Free Savings Accounts (TFSAs) are another form of a registered savings plan. Much like an RRSP or RESP, they offer tax-sheltered growth on contributions. While you can’t open a TFSA in a child’s name (account holders must be the age of majority), you could use some of your TFSA room to set aside funds for their education if it isn’t already fully funded.
Currently, the annual contribution limit for a TFSA is $6000. If you have never opened a TFSA account, the lifetime contribution room is $75,500 for 2021. You can open a TFSA account at just about any financial institution in Canada.
3. Corporate Dividends
If you’re self-employed and own a corporation, you may be able to use your business to fund your child’s education by paying them out a corporate dividend from the company’s accumulated savings. This would be a tax-efficient way to save, as the dividends would be taxed in the child’s hands.
To receive a dividend, your child would first need to own shares in the corporation. If this situation applies to you, talk to your accountant about the possibilities of using corporate dividends to help you save.
A Caution About Group RESPs
Some RESP plans are known as Group RESPs. These plans are very different from regular RESPs and lock subscribers into contractual contribution agreements. The penalties can be severe if parents opt out of contributing to the plan for any reason. Many Group RESP companies impose other restrictions on plan holders. I strongly recommend that parents stick with traditional RESP plans offered by banks and other investment companies.
Final Thoughts on Saving for Children
For parents who haven’t yet opened a Registered Education Savings Plan, it’s a great first step to save for a child’s education. However, remember that it’s not the only way to save. If your child is already in high school, you may decide that it’s not worth starting an RESP due to limitations placed on CESG eligibility if an RESP is not opened before a child turns 15. The good news is that non-registered savings accounts and TFSAs are viable alternatives. For maximum flexibility, your best bet may be a combination of the three.