Money Monday: How To Send Your Kids To School [RESP]August 13th, 2012 by Aaron Koo
Newsflash… It’s not cheap!
An RESP Can Help
According to Stats Canada, kids born today can expect to pay as much as $120,000 for school (yay for inflation!). Like most things, saving money alone won’t cut it for most people. Without proper investing, your options get pretty slim. If you’re lucky enough to live in Canada, you have the benefit of using the RESP (registered education savings plan).
How Does It Work?
This is a service that was developed by the Canadian government in 1979 as an additional source of tax sheltered growth for people who wanted to save for their kids’ education. Since there is a maximum contribution to RRSPs (or registered retirement savings plan) based on a percentage of your income, an RESP can allow for additional space for tax sheltered investments. That way, you don’t have to screw over your retirement in order to send your kids to school.
The way it works is like an RRSP: you put money in, which can be deducted from your income for tax purposes. While in the RESP, the money can then be invested in any number of investment products. To find out which investment mix is best for you, sit down for a conversation with your financial advisor and discuss. It’s just too big a topic to have here.
When your kids decide that they do actually want to go to school, they can then withdrawal that money and put it toward their education. And again like an RRSP, that money, once withdrawn, is taxed accordingly.
What Makes the RESP Different
On the surface, an RESP may seem quite similar to an RRSP (another topic for another article), but there are a few reasons that you’d typically use an RESP over an RRSP.
Consider the government grant. In 1998, the Canadian government decided to lend an extra hand in planning for education, contributing 20% of what you invest to an RESP to a maximum of $500 a year. Now, don’t start doing the math, because there’s a cap of $2500 for the life of the RESP. And over the life of an RESP, you can’t contribute more than $50,000 total.
Contributions can be made once the child is born but not before. So, if you’re expecting a child and want to get a head start, an RESP won’t help. And to that effect, after your child is 21, you can’t continue to make any more contributions. If your child does in fact plan on post secondary education, there are exceptions to which schools they can choose. If your child is planning on a career with a highly specialized training, for instance, they may not be allowed to use the money from the RESP.
A Few Things To Look Out For
If your child or children do NOT go to university or college, you are limited to transferring $50k of the RESP earnings/growth to your RRSP, provided that you have the contribution room. If you don’t have the room at the time, the remaining amount will have to be withdrawn as INCOME.
That means you get hit with a 20% penalty AND you get taxed at your marginal rate! Note that the capital can be withdrawn at any time without taxation. You would also have to pay back the contribution the government made. So, assuming that you receive the lifetime max of $2500, that would mean you would have to pay: $2500 + 20% penalty (on growth) + income tax (on growth). Ouch!
As you can see, your kids not going to school can seriously screw you on the tax side of things. Don’t let that deter you from saving the money needed to educate you children though. Just be sure to have as clear as possible an understanding of what you and your child want to see happen and act accordingly. If I haven’t drilled this in enough, personal planning always comes before financial planning!