Short Course On Investments Episode 13: RESPs

Last update on Aug. 22, 2014.

In the Short Course On Investments, you will learn the basics of investing through simple everyday language. The course covers the same material as The Short Book On Investments.

In Episode 13, I talk about registered education savings plans, also known as RESPs.




Hello, my name is Jin Choi, and I’m the founder of MoneyGeek, and welcome to the 13th episode of the short course on investments.

Today, we’re going to talk about the Registered Education Savings Plans, also known as RESPs.

RESPs work very differently from RRSPs and TFSAs. While using RRSPs and TFSAs save you on your own taxes, using RESPs actually allow you to receive money from the government to help pay for your child’s schooling. Let me explain how this works in more detail.

First of all, when you open an RESP account, you have to specify a beneficiary. In other words, you have name the child who’ll benefit from your RESP account.

When you contribute into an RESP account, you don’t gain any tax benefits. However, when you contribute into an RESP, the government will also put in some money as well. If you put in up to $2,500 in a given year, the government will put in about 20 to 40% of that amount,  depending on your income level.

While you can contribute more than $2,500 a year, you won’t get the government grants for the amount you contributed over the first $2,500. You can also only contribute up to $50,000 per child in your lifetime, so I suggest pacing contributions.

While the money is inside the RESP, you can use it to invest in stocks, bonds and other investments. While it’s in the account, your money will grow tax free, just like it does inside an RRSP or a TFSA. When the child grows up and goes to a college or a university, the child can withdraw the money.

When the child withdraws the money, the child will pay taxes on accumulated gains, but not on the original contributions. For example, let’s say the parents put in $20,000 into an RESP and grow it to $30,000 by collecting grants and through investing gains. That means the RESP contains $10,000 of accumulated gains.

Then, when the child withdraws money from the RESP, he or she will have to pay the full income tax on the portion drawn from the accumulated gains, but nothing on the portion drawn from contributions. Because the child will probably have a lower tax rate than you, you save on taxes in addition to getting free money from the government.

However, if you contribute money into an RESP and your child doesn’t end up going to a university or a college, you’ll end up paying a penalty.  While you will be able to withdraw your own contribution tax free, the government will take back its grants, and they will charge you 20% above your tax rate on the investment gains you accumulated inside the RESP.

For example, let’s say you contributed  $20,000 into an RESP, and the government gave you $5,000. Let’s say that you also grew the $25,000 into $35,000. Then, if your child doesn’t go to college or university, you’ll be able to withdraw the $20,000 tax free. But, the government will take back the $5,000 it gave you, and if your tax rate is 30%, you’ll have to pay 50% taxes on the $5,000 that’s left. In other words, you’ll only get $2,500 more.

In other words, you shouldn’t open an RESP account unless your child really intends to go to a college or university.

Finally, as with RRSPs and TFSAs, you can open an RESP with a discount brokerage or a bank. However, some banks only let you buy their own financial products inside an RESP, so for this reason, I generally recommend going with a discount brokerage instead.

And that’s what I had to say about RESPs. Let’s summarize what we’ve learned today.

We learned that when you contribute into an RESP, the government will also contribute a smaller amount as well. Once the money is inside the account, you can invest and grow it tax free.

You have to name the child who benefits from the RESP when you open an account. When the child goes to college or university and withdraws the money, the child won’t pay any taxes on the money you contributed. However, the child will pay his/her full tax rate on the government grants and investment gains.

Lastly, if the child doesn’t end up going to college or university, you can take back your money, but you’ll pay higher taxes on your investment gains than you otherwise would have.

And that’s all I had for today. Starting in the next episode, I’ll talk about some practical considerations such as whether you should pay down debt or invest. Thanks for watching, and have a great day.

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