This post was updated on April 10, 2013
There are different ways to finance a university education. When the time comes and depending on your circumstances, you may use some combination of:
- Your savings (e.g., withdrawals from a registered education savings plan (RESP) or a non-registered account)
- Your current earnings
- Scholarships your child may receive (wouldn’t that be great!)
- Your child’s savings or their own earnings (ditto!)
Only one of these options offers tax advantages as well as financial incentives, and that is an RESP. The RESP was created to encourage parents or other relatives to save for their children’s post-secondary education. The amounts you put into an RESP are not tax deductible – that is, you must first pay tax on the money you contribute. But you do not pay tax on any gains or investment income you earn while the funds remain in the plan – they are sheltered from tax.
The other major benefit of using an RESP to save for your child’s education is that the government will match your savings – called the Canada education savings grant (CESG). Twenty per cent of the amounts you contribute will be matched – up to a maximum of $500 per child per year and a lifetime limit of $7,200. (Lower-income families may even receive additional grants.) Your child will qualify for the CESG until the end of the year they turn 17.
Don’t leave money on the table – try to contribute at least $2,500 per year per child in order to maximize the government grant. Where else can you get a guaranteed risk-free return of 20%? There is no annual maximum contribution to an RESP, but the lifetime total for each child is $50,000. Try to open the plan and start investing early, so that the power of tax-free compounding can work for you.
Anyone can open and contribute to an individual RESP, including parents, grandparents, aunts, uncles and friends. If you are saving for more than one child, you or a grandparent can open a family plan.
Earnings accumulated in an RESP, as well as government grants, must be used to pay for the cost of post-secondary education, such as university or college. These amounts are taxable income to the student in the year they’re paid out. However, many tax credits are available to students to reduce or eliminate tax they would otherwise owe (we will talk about this in the next blog post in this series). Either you or your child (the student) can withdraw the original contributions tax free.
But what happens if, despite your best planning, your child does not go to university? In general, you must repay the grants to the government. If the RESP has been running for at least 10 years, and your child does not go to university by 31 years of age, you can transfer the accumulated income to your or your spouse’s registered retirement savings plan (RRSP). The transfer is subject to your RRSP contribution limit and has an overall maximum of $50,000. Any surplus is taxed at 20%.
However, if you have other children, you can transfer RESP savings between individual RESPs for siblings without any tax penalties and without having to repay any CESGs. The child who benefits must be under 21 years old at the time of the transfer.
In the next blog post in this series, we’ll be looking at tax breaks for students.