Area of Law: Investments and Securities
Answer # 264
Registered Education Savings Plans (RESP) and "In Trust" AccountsRegion: Ontario Answer # 264
Two alternatives for education savings available to Canadians are Registered Education Savings Plans (RESPs) and the informal “in trust” account.
Registered Education Savings Plans, called RESPs, are designed to help people save for post-secondary education costs. All RESPs are registered with the Government of Canada because they provide the contributor with tax benefits. In most cases, it is parents who invest in RESPs for the education of their children.
Registered Education Savings Plan (RESP)
In an RESP, an individual, known as the contributor or subscriber, names a beneficiary (student or students) and makes contributions to the RESP. In turn, the contributions, and income earned on them, are paid to the beneficiaries by the promotor. These payments are known as educational assistance payments (EAPs).
To receive the EAP, the beneficiaries must either:
- be enrolled in a qualifying educational program, or
- be 16 or older and enrolled in a specified educational program.
Educational Assistance Payments (EAPs) limits
As per CRA, the maximum amount of EAPs that can be made to a student as soon as he or she qualifies to receive them is:
- For studies in a qualifying educational program – $5,000, for the first 13 consecutive weeks in such a program. After the student has completed the 13 consecutive weeks, there is no limit on the amount of EAPs that can be paid if the student continues to qualify to receive them. If there is a 12-month period in which the student is not enrolled in a qualifying educational program for 13 consecutive weeks, the $5,000 maximum applies again; or
- For studies in a specified educational program – $2,500, for the 13-week period whether or not the student is enrolled in such a program throughout that 13-week period.
Visit CRA for information on EAPs and qualifying educational programs.
RESP contribution limit
The annual contribution limit per beneficiary is unlimited, with a lifetime contribution limit of $50,000.
Do RESPs ever have to be repaid?
As the money in an RESP is intended for post-secondary education expenses, the contributor will have to repay the grant portion if the beneficiary does not attend a post-secondary institution and another qualified beneficiary is not appointed.
As well, if the beneficiary does not pursue a post-secondary education, the contributor may withdraw their contributed amounts of the RESP earnings in cash. Doing this, however, would be disadvantageous because the contributor will be charged an additional 20% penalty tax in addition to his or her income tax rate. The better choice is to transfer the earnings in the RESP to an individual or spousal RRSP. The rules permit up to $50,000 in RESP earnings to be transferred to RRSP’s provided there is contribution room.
The RESP contributor is free to select both domestic and international investments with no foreign content restrictions. Although the contributions to RESP’s are not tax deductible, the earnings in the plan are allowed to compound tax free. It is the beneficiary who pays tax on the earnings on both the contributions and the grant payments, but not until the money is withdrawn from the plan to pay for college or university. This is advantageous because in most cases, the student’s tax rate will be lower than the contributor’s.
For more information, visit the Government of Canada’s website on How an RESP works.
Canada Education Savings Programs (CESP)
To assist families, and as an incentive to save for post-secondary education, the Federal Government created two Canada Education Savings Programs in which Employment and Social Development Canada (ESDC) will also add to your child’s savings in an RESP: the Canada Education Savings Grant (CESG), and the Canada Learning Bond (CLB).
Canada Education Savings Grant (CESG)
The CESG has two parts:
- The Basic Canada Education Savings Grant will give you 20% on every dollar to a maximum of $1,000 per year if there is accumulated grant room
- The Additional Canada Education Savings Grant could give you an extra 10% or 20% on every dollar of the first $500 you save in your child’s RESP each year, depending on your net family income. (visit canada.ca for current amounts)
The maximum lifetime grant the Government of Canada can give your child through the Canada Education Savings Grant is $7,200.
Children who are Canadian residents and are named in a RESP are eligible to receive the CESG until the end of the calendar year they turn 17.
Canada Learning Bond (CLB)
The CLB is an additional incentive of up-to $2,000 to help modest-income families save for their child’s education.
Through the CLB, families will receive:
- an initial $500 to children born on or after January 1, 2004
- an additional $100 for each eligible year for up-to 15 years for a maximum of $2,000
The CLB money is deposited directly into the child’s RESP.
Informal “in trust” account
An alternative to the Registered Education Savings Plan is the informal “in trust” account.
The “in trust” account can be a flexible savings vehicle because 1) there are no restrictions on how much can be contributed to an “in trust” account, and 2) if the child does not pursue post-secondary education, the funds can be used for any purpose that benefits the beneficiary. It is referred to as informal because no formal trust document is signed, but a beneficiary is designated. Accordingly, all savings and earnings must be used for the benefit of the beneficiary.
An informal “in trust” account may be used by itself or in combination with an RESP. The RESP can be used to shelter earnings and qualify for the federal government grant, while an informal trust account can be used to make contributions beyond RESP limits. As is the case with RESPs, informal trust accounts allow for complete flexibility in selecting securities for the plan, without any restrictions on foreign content.
Unlike RESPs, where tax payments are deferred while earnings in the plan compound tax-free, informal trust accounts do not give earnings tax shelter. Instead, they allow a contributor to divide some of the taxable income in the plan with the beneficiary. Interest and dividends are taxed in the contributor’s hands, while capital gains are taxed in the hands of the beneficiary.
You now haveoptions: