July 1998

Those of you who have already discussed education savings plans with me know that, in the past, I have always recommended “in-trust” accounts over the RESP. Now, with the reforms introduced over the last two years, the RESP has become a very attractive investment, making it an option well-worth reconsidering.

Under the new rules, RESPs are much more flexible, but that is not all. As a result of proposed changes in this year’s federal budget, all contributions made to an RESP for a child 15 years of age and younger will qualify for a 20 percent government grant up to a maximum of $400 per child per year. On investments of $2,000 per year or less, that translates into a minimum annual return of 20 percent per child per year – nothing to be sneered at! (Children 16 and 17 years of age may qualify under certain conditions)

So what is an RESP exactly? Basically, it is a government-registered plan similar to an RRSP, but with several important differences. Anyone can set-up an RESP to save for one or more student’s education. There are yearly contribution limits which have recently been raised to $4,000 annually from the $2,000 previously allowed. The lifetime maximum contribution has also been increased to $42,000 per student beneficiary. Unlike an RRSP, the annual contributions are not tax deductible, but the income generated in the plan is tax-deferred. That means that earnings within the plan grow tax-free until the beneficiary begins his or her post-secondary studies. At that point, you the contributor get your capital back (tax free) and the earnings are taxed in the hands of the student beneficiary.

Sounds good so far, except that until recently, if your child did not attend a qualifying post-secondary institution, all the income generated in the plan was forfeited. That immense drawback combined with relatively low annual contribution limits made the RESP a poor choice for most parents. Now, under the new rules, if your child doesn’t go to university, you have the option of rolling the income into your RRSP (provided you have sufficient contribution room). Failing that, you would pay tax plus a 20% penalty on the accumulated growth in the plan, but at least you wouldn’t lose everything.

Of course, what really tips the balance in favor of RESPs is the new Canadian Education Savings Grant worth up to $400 per child per year up to a maximum of $7,200 in total. If your child doesn’t go to university or college, you forfeit the principal amount of the grant, but not the earnings generated from that grant money – a significant cushion to soften the blow of the 20% penalty should you have to pay it.

There is one simple way to maximize the potential benefits of the new RESP and avoid paying any penalties. Under a family plan, you can have as many beneficiaries as you want provided they are all related to you by blood or adoption. That way if one child doesn’t enroll in a post-secondary program, the accumulated growth in the plan could be divided among the other beneficiaries.

There are two types of RESPs: self-administered plans where you control how the funds are invested and pooled funds such as the well-known Canadian Scholarship Trust Plan. Unfortunately, the recent reforms have created a bit of a dilemma for the pooled funds. Here’s why. Under the old rules, income lost by those not enrolling in a post-secondary program was re-distributed to other plan-holders. This meant that those who did make it to university or college could count on a kind of bonus payment over and above the real value of the accrued interest on savings. Now that parents are able to retrieve that lost income, pooled RESPs have just lost a great deal of their original luster. Add to that the fees involved, and the restrictions on investments, your money is not going to go very far. The self-administered plan is by far your best bet and is as easy to set up as an RRSP.

Remember that grandparents, aunts and uncles can all open plans for other family members. Spread the good word to friends and colleagues too. It isn’t often that government decides to put money back into our pockets, so take advantage! A university education has never been so important and our kids are going to need all of the financial support we can muster.