Registered Education Saving Plans (RESP) – Benefits and Planning Opportunities
Registered Education Saving Plans (RESP) are designed to encourage individuals to accumulate savings for the post-secondary education of beneficiaries, typically children or grandchildren. The contributions to a RESP by the contributor do not result in a tax deduction to the contributor and withdrawals of contributions are not taxable when withdrawn by the beneficiary. Contributions to RESPs cannot exceed a $50,000 lifetime limit per beneficiary. Amounts withdrawn from the plan related to investment earnings and grants, referred to as Educational Assistance Payments (“EAPs”) are included in the child/student’s income when withdrawn from the plan.
The three benefits of the RESP
1) Tax deferral tax-free compounding, investment income earned on the contributions made to the plan is not subject to tax as it is earned; accordingly, investments held within the account grow at a higher rate than it would in the hands of the contributor (in a taxable account, investment income is subject to tax in Ontario up to 53.53%).
2) Incentive grants, the government provides incentives in the form of matching grants (Canada Education Savings Grant (CESG) . The government will match contributions with a 20% CESG grant paid to the plan on contributions made in a year, with a $500 annual and $7,200 lifetime maximum.
3) Income splitting, the taxable amounts paid out of the plan for post-secondary education of the child will be taxed to the child whose tax rate is typically lower at that time than the contributor’s tax rate.
Budget 2023 – Increases EAP Withdrawal Limits
Currently, The Income Tax Act requires that RESPs place limits on the amount of EAPs that can be withdrawn. There isn’t an official list of eligible expenses and students aren’t required to keep receipts. That means RESP funds can be spent on any expense relating to your child’s post-secondary education (tuition, living expenses, equipment costs, transportation, textbooks, and supplies). For children enrolled full-time (i.e., in a program of at least three consecutive weeks’ duration requiring at least 10 hours per week of courses or work in the program), the limit was $5,000 (Budget 2023 proposes to update to $8,000) in respect of the first 13 consecutive weeks of enrollment in a 12-month period. Once the 13 weeks have passed, any amount of EAP can be withdrawn. For children enrolled part-time (i.e., in a program of at least three consecutive weeks’ duration requiring at least 12 hours per month of courses in the program), the limit was $2,500 (Budget 2023 proposes to update to $4,000) per 13-week period.
It’s usually better to access EAP payments early in the student’s post-secondary career, when their income is lower, and they have access to basic personal amount and tuition and education credits which may result in little to no tax payable on such withdrawals.
Front loading an RESP – Planning Point.
If you are a top-rate taxpayer and have excess cash, it might be beneficial to front-load your child’s RESP contributions. A couple scenarios to illustrate:
Scenario 1: Front Load contributions, in Year 1, the year of birth the contributor pays the full $50,000. This would generate a grant of $500 but will generate no grants in future years for that child.
Scenario 2: Front load contributions of $16,500 in year 1 in the year of birth, $2,500 in each of the subsequent 13 years, and $1,000 in year 15. Over the 15 years, contributions total $50,000 and the grants will total $7,200.
The question is whether, over the 15 years, the investment return on the additional $33,500 not originally contributed would have substantially exceeded the $6,700 of CESG grant money foregone. Where large upfront funding amounts can be readily contributed, the advantages may outweigh the loss of government contributions.
Please get in touch with us at [email protected] for discussion on this matter. Elliott Stone, CPA, CA, is the founder of MD Tax Physician Services in Toronto.