What Is an RESP and How Does It Work?

Investing in their child’s education is among the most important investments a parent can make. You should always start saving for your child’s post-secondary education sooner rather than later. 

But suppose your family income can’t support such an investment, or other parties are interested in contributing, too. In that case, a registered education savings plan, or RESP, can help you by allowing other contributors, such as family and friends, to invest in your children’s education.

But what is an RESP exactly, and how does it work? Read on to learn more about this subject, including how to open an account, the contribution limits, and other relevant information.

What Is an RESP in Canada?

The registered education savings plan is a long-term investment that offers tax breaks to encourage savings for a child’s post-secondary education. A parent or guardian must open an account on behalf of a beneficiary - the child, in this case.

Contributions made to an RESP are not tax-deductible, but the earnings from the plan are not taxed until they are withdrawn to pay for the beneficiary’s education. The money they receive is subject to taxes, but if the beneficiary has a low income or no income at all, the government allows them to withdraw funds tax-free.

Moreover, RESPs may qualify for government grants, such as the Canada Education Savings Grant or the Canada Learning Bond.

How an RESP Works

So, how does an RESP work? To answer this question, we need to define the main participants first, which are:

• The subscriber - the account holder who makes contributions to the plan. This is usually the child’s parent.
• The beneficiary - the subscriber’s child or another recipient designated to receive education payments from the plan.
• The promoter - the financial institution managing the RESP account and paying out the money once the beneficiary starts attending post-secondary education, such as college, university, etc.

Now, let’s see how an RESP works.

The first step is to open an account. If you’re wondering about who can open an RESP account, it could be a parent, a relative, or someone entirely unrelated to the beneficiary, depending on the plan. 

The subscriber makes payments to the account, and the money grows until it’s time for the child or another recipient to start paying for their education.

Once the beneficiary is ready to start a post-secondary education, they must enroll in a qualifying program to receive payments from the account.

The promoter uses the money in the account and any accumulated interest to provide educational assistance payments for the beneficiary’s expenses, such as tuition fees, books, and accommodation.

How To Use an RESP

Students can use the RESP money to fund various education-related expenses. Besides tuition and necessary equipment, they can use it to pay rent, buy groceries, pay for public transportation passes, or even pay for a personal vehicle. 

It's also worth noting that they can use the RESP money at various types of post-secondary institutions and programs besides universities and colleges, such as:

• Technical schools
• Vocational institutes
• Certain trade schools
• Distance-learning programs

Now that we have answered the titular “What is an RESP and how does it work?” question, let's see how you can open an RESP account.

Opening an RESP Account

Opening the account is pretty straightforward. You need to go to a financial institution that offers RESPs, such as a bank or credit union, to set up the account. The promoter will also help you with the Canada Education Savings Grant or the Canada Learning Bond government contributions if you’re eligible.

You will also have to decide how to invest the money and which investment options fit your needs best, which brings us to the next point.

Types of RESP Accounts

There are three distinct types of RESP plans in Canada, and these are as follows:

Family Plan

Family RESP plans are ideal for families with more than one child since it allows them to have one RESP account for all their children. Eligible beneficiaries are children, grandchildren, and other family members related to the subscriber by blood or adoption. Thus, you can open this type of RESP account for stepchildren and siblings, too.

Note that the subscriber and beneficiary can’t be the same person, so you can’t open a family RESP for yourself.

Individual Plan

With an individual plan, the subscriber can designate themselves or a person they’re unrelated to as the beneficiary. Thus, setting up an RESP account is possible even if you want to help fund the education of someone you have no family ties to or build up savings for your own education.

Group Plan

Also known as group scholarship trusts, these RESPs pool contributions from several families, and the funds are usually directed toward low-risk products. During the first four post-secondary school years, the pool is divided and distributed among the beneficiaries in the form of annual payments.

Note that group registered education savings plans feature higher fees than family and individual plans. Also, RESP participants agree to follow a strict payment schedule on behalf of a single beneficiary, although the beneficiary doesn’t need to be related to the subscriber.

CESG and CLB Donations - How Do They Work?

The Canada Education Savings Grant and the Canada Learning Bond are two federal government programs that can contribute to your RESP. The primary purpose of these programs is to help low-income families save up for their children’s post-secondary education.

Canada Education Savings Grant (CESG) Contributions

If you contribute up to $2,500 per child annually, CESG will add 20% to your annual RESP, meaning that your saved funds can grow substantially with no additional money spent at your end. Moreover, if your family’s annual income is less than $40,970, the government provides an even more generous 40% match on the contributed funds. Note that the lifetime contribution limit for each child is $7,200.

Canada Learning Bond Contributions

The Canada Learning Bond is an RESP benefit available to low-income families that provides up to $2,000 in lifetime grants. The government pays $500 of grant money into the RESP in the first year and adds $100 for each subsequent year until the funds reach the maximum of $2,000. 

Understanding RESP Investments, Limits, and Withdrawals

To learn how to plan an effective RESP strategy, you need to know how to grow the money as well as the limit and withdrawal rules.

RESP Funds Investments

You can invest your RESP funds in various ways. For example, you can invest in stocks, or if you’re after something less risky, you can always invest in Guaranteed Investment Certificates - GICs. 

Parents often choose to invest in stocks when their children are young. This way, there is enough time for the RESP funds to grow before the child starts post-secondary education, even if there are some losses at first. Later, many switch to lower-risk investments when the beneficiary is close to starting their education.

Contribution Limit

As per the RESP contribution limit, the amount you can invest per beneficiary is $50,000. Aside from that, there’s no annual limit to your contributions. If you contribute to more beneficiaries, pay attention not to over-contribute to any of them.

Over-Contribution

Over-contribution is what happens when you exceed the lifetime limit of $50,000 per beneficiary. If you do that, you’ll pay a 1% tax on the excess amount until the funds are withdrawn.

That said, if you can save more than $50,000 for your child’s or another beneficiary's education, you can direct any excess funds into a tax-free savings account.

Contribution Schedule

Different RESP providers have different contribution schedules. Some may require you to follow a specific schedule, while others allow much greater flexibility.

Withdrawals

To withdraw money from an RESP account, you need to contact the RESP provider. They will require documentation confirming the designated beneficiary’s enrollment in a program at a post-secondary educational institution. 

Once this has been confirmed, the provider will start providing the funds to the beneficiary in the form of educational assistance payments.

The provider may also ask for receipts for school-related expenses to confirm that the money is being used appropriately. This includes things such as tuition, textbooks, laboratory supplies, transportation costs, and more.

Other RESP withdrawal rules you should be aware of are:

• The subscriber is the only person who can make withdrawals from the account. Known as post-secondary education payments, they can be sent to the subscriber or the beneficiary.
• Only the beneficiary can receive money from withdrawn government grant funds. 
• The EAP limit per student during the initial 13 weeks of educational enrollment is $5,000 (or $2,500 for specified programs). After that, there are no restrictions on the amount of withdrawn EAP funds. Moreover, there are no limits for PSE withdrawals.

Unused RESP - What Can You Do With It?

What happens to an unused RESP depends on the subscriber. Some options subscribers can resort to are:

Keeping the Account Open

An RESP account can stay open in the beneficiary’s name for up to 36 years. So, the money can stay there if your designated beneficiary doesn’t immediately pursue post-secondary education upon high school graduation, and they can use it to fund further education at a later date.

Changing the Beneficiary

You may be able to change the beneficiary, depending on the chosen plan. If the named beneficiary quits pursuing higher education, you can choose another one for your individual or group RESP.

But what else can an RESP be used for if the beneficiary isn’t interested in pursuing further education?

Transferring RESP Funds to an RRSP or an RDSP

Unless the chosen plan doesn’t allow it, you can transfer up to $50,000 from your RESP to a registered retirement savings plan without being taxed. You can also transfer the same maximum amount to a registered disability savings plan of a disabled designated beneficiary.

The conditions that must be met before the funds can be transferred are:

• The beneficiary is at least 21 years old.
• The RESP had been open for at least 10 years.
• The beneficiary isn’t currently pursuing higher education.

Closing the Account

If the beneficiary who doesn’t pursue further education is over 21 and the account has been open for at least 10 years, you can close it and keep the contributions, which aren’t taxed in any way. However, any grant money must be returned.

RESP - Benefits and Downsides

With all that said, the key RESP pros and cons can be summed up as follows:

Strengths

• Anyone can contribute to the plan.
• The money grows over a long period of time and is not taxed.
• There are three types of plans you can choose from.
• You may be eligible to receive grants from the government.
• Adults can also benefit from an RESP account.
• You can transfer RESP funds to an RRSP or RDSP if the conditions are met.
• RESP is available for students attending various educational institutions besides universities and colleges.

One of the main benefits of an RESP account is that you can open one early on and accumulate a significant amount of money, which can, in turn, help you avoid taking out a student loan later. 

Needless to say, funding your own or someone else’s education using your own money is preferable to paying interest on loans, especially since paying off an average student loan in Canada takes 10 years. 

Weaknesses

• The contribution limit per beneficiary is $50,000.
• Over-contribution is taxable at 1% for the amount exceeding the limit until the money is withdrawn.

The Final Word

Now that we have the RESP explained, it’s evident that this is one of the best ways to save money for your child’s future education. It even allows you to benefit from Canadian government grants.

Furthermore, you can invest in stocks, GICs, and other RESP-eligible investments to grow your savings. Just remember to keep an eye on the contribution limit and over-contribution taxes, which apply to the excess funds until they’re withdrawn.