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. 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.
Visit CRA for information on qualifying educational programs.
The RESP offers contributors the option of investing in two different plans, family or specified (non-family), depending on their situation.
A specified plan is ideal for a contributor who intends to set up a plan for one beneficiary who may or may not be related to the contributor. The family plan is well suited to those who are saving for multiple beneficiaries or who are concerned that the earnings in the plan may be forfeited in the event that a beneficiary does not attend a post-secondary institution. This choice gives them the flexibility of transferring the entire earnings in the plan to one or more beneficiaries who are related to the contributor by blood or adoption.
Whether a contributor chooses a specified or family plan, the annual contribution limit per beneficiary is unlimited, with a lifetime contribution limit of $50,000.
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 $500 you save in your child’s RESP each year, no matter what your family income is.
- 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 extra $25 with the first $500 bond to help cover the cost of opening an RESP
- 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.
The subject of education funding and the most advantageous route to take, given your unique set of circumstances, should be discussed with a financial planning consultant.
More information about education savings and RESPs is available at canada.ca.
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