1. Pay down non tax-deductible debt as quickly as possible
2. RRSPs are the best tax-saving method available to the average taxpayer in Canada
   1. Are you better off  to pay down your mortgage, or contribute to an RRSP?
3. How compounding interest can work against you
4. Lower your insurance costs.
5. How much will you have if you save $1 per day?
6. How much must be deposited today to have $1 million in the future?
7. RESPs - Be Aware, and Beware!
   1. There are much better ways to save for your child's education!!!
   2. The risks and restrictions of RESPs.
   3. How does a Registered Education Savings Plan (RESP) work?
   4. Beware!
   5. How much can be contributed?
   6. How much will the government contribute?
   7. How are the funds paid out of the RESP, and are they taxable?
   8. What happens if we miss a payment or cancel the RESP?
   9. What Types of RESPs Are Available?
   10. Other resources

1. Pay $1,187 per month in mortgage payments to pay off a $100,000 mortgage in 10 years, then continue to pay $1,187 per month into your RRSP for 15 years, and also invest the tax savings in your RRSP, or;
2. Pay only the required $739 per month on your mortgage, and pay it off over 25 years, and invest the difference of $448 ($1,187 less $739) plus tax savings in an RRSP.

a. There are much better ways to save for your child's education!!!

Pay Down Debt! - The best way to save for your child's education is to pay down debt on which the interest is not tax deductible!  Pay down debt with the highest interest rate first.  

RRSPs - Once your debt is paid off, make sure you have contributed the maximum to your RRSP, and to your spouse's RRSP.

Once the RRSPs are at their limit, start saving in a non-registered investment account.  If you save money outside of an RRSP, it is better for tax purposes to have assets which produce capital gains or Canadian dividends instead of interest.  See Try to earn your investment income (outside of RRSPs) at the lowest tax rate possible, on our Personal Income Tax page.

Another option is an informal Trust account for your child, at a financial institution or brokerage.  Any interest and dividends on the account are taxed in the hands of the contributor, but capital gains are taxed in the hands of the child (beneficiary).  Interest and dividends from re-invested earnings are taxed in the hands of the child.  If deposits are made with family allowance or child tax benefit payments received for the child, then all earnings from these deposits are taxed in the hands of the child.  The disadvantage of the trust account is that the funds automatically become the property of the child when the child turns 19, so the contributor has no control over how the funds are used.  With a non-registered account in your own name, this problem does not occur.

If you are debt-free when your child begins post-secondary education, and have saved some money, you will have much less difficulty funding that education.

b. The risks and restrictions of RESPs.

With a Registered Education Savings Plan comes both risk and restrictions.  The greatest risk is that your child will not take part in qualifying post-secondary education.  This will result in paying back the federal grant portion of the RESP, and could result in forfeiture of the earnings in the RESP.  At best, the earnings can be transferred to an RRSP (maximum amount $50,000) if there is contribution room available, if the RESP has existed for at least 10 years, and the beneficiary is at least 21 years old and not pursuing post-secondary education. If no RRSP contribution room is available, the earnings can be returned to the subscriber, again only if the RESP has existed for at least 10 years, and the beneficiary is at least 21 years old.  This will attract tax at the subscriber's marginal tax rate, plus an additional tax of 20%.  If the RESP is held in a pooled group scholarship plan, the earnings may be completely lost, with the subscriber getting back less money than was originally contributed, due to fees paid to the promoter.

RESPs are restricted to being used for qualifying post-secondary education.  With many plans, there is a set payment schedule which must be followed.  If the payment schedule is not followed, interest may be charged, or the plan may be terminated.

If you are still determined to start an RESP, make sure you read and understand all the details first!

c. How does a Registered Education Savings Plan (RESP) work?

A Registered Education Savings Plan (RESP) is an Education Savings Plan (ESP) that has been registered with Canada Revenue Agency (CRA).  It is a method for parents to save for their children's post-secondary education, with the earnings in the plan growing tax-free.  The federal government will also contribute to the RESP, by giving a Canada Education Savings Grant (CESG), based on the amount of contributions to the RESP by the subscriber.

An RESP must be terminated no later than the last day of the 25th year following the year in which the plan was entered into.

The people involved in the RESP are:

• subscriber - this is the person who sets up the RESP and contributes to it.
• beneficiary - this is the child for whom the RESP is set up, and who will be the one to use the RESP for education costs.
• promoter - This is the organization with whom the RESP is arranged, who administers the RESP, and who receives a fee for the administration of the RESP.
  
  

d.    Beware!

It is very important to understand exactly what fees are going to be paid out of the RESP to the promoter, and when the fees are taken.  Normally the fees are paid before the RESP earns any income, and a subscriber could lose all contributions to the fees if payments to the RESP are discontinued.  

In 2003, a compliance review of scholarship plan dealers was performed by the Canadian Securities Administrators.  The entire report, titled Industry Report on Scholarship Plan Dealers, can be accessed on the Ontario Securities Commission Compliance web page.  Note that Adobe Acrobat 6.0 is required to properly view documents on the Ontario Securities Commission web site.  The following is a quotation from Section 2.2 (Inadequate Disclosure) of the compliance report:

The following weaknesses were noted with respect to the disclosure provided to clients:

• Sales representatives lacked adequate knowledge of the product being sold to clients, and its associated costs.
• Enrolment fees were misrepresented in some cases, leading clients to believe that the potential for loss was nil.
• Enrolment fees and the related consequences of terminations were not always discussed with clients.
• The 60 day grace period was not always explained to clients.
• In some cases, there was no mention of other types of fees incurred by the plans.

 

e. How much can be contributed?

The annual limit of contributions per beneficiary is $4,000, and the lifetime limit is $42,000.  If excess contributions are made, there is a penalty of 1% per month.  Excess contributions can cause a plan's registration to be revoked.



f. How much will the government contribute?

The federal government will contribute a Canada Education Savings Grant (CESG) of 20% of contributions to the RESP by the subscriber, to an annual limit of $400 (grant room), and to a lifetime limit of $7,200.  To be a recipient of the CESG, the RESP beneficiary must be a resident of Canada at the time the RESP contribution is made, and must have a valid social insurance number.  

Starting January 1, 1998, every child who is a Canadian citizen started to accumulate CESG available of $400 per year, even if no RESP had been started for the child.  The grant will not be actually received by the child until RESP contributions are made.  This means that if an RESP is started when a child is 3 years old, CESG "grant room" available of $1,200 has accumulated (3 years x $400 annual limit).  If the subscriber contributes the maximum of $4,000 to the RESP in the first year,  then the government will contribute $800 (20% x $4,000).  The actual maximum CESG contribution per year is the lesser of $800 or 20% of the RESP contribution.  

CESG will not be paid in any year after the beneficiary turns 17 years of age.  CESG will be paid in the years in which the beneficiary turns 16 or 17 only if:

• a minimum of $2,000 in contributions has been made to, and not withdrawn from, RESPs for the beneficiary before the year in which the beneficiary turns 16 years of age, OR
• a minimum of $100 in contributions has been made to, and not withdrawn from, RESPs for the beneficiary in at least any 4 years before the year in which the beneficiary turns 16 years of age.
  
  Although the CESG accumulates, the annual limit of $4,000 per beneficiary for contributions does not accumulate.
  
  The 2004 Federal Budget proposes to increase the CESG percentage on the first $500 of contributions in a year to a child's RESP, for low and middle income families.  The percentage will increase from 20% to:
  
  • 40% for families with incomes up to $35,000
  • 30% for families with incomes between $35,000 and $70,000.
    

g. How are the funds paid out of the RESP, and are they taxable?

An RESP consists of the following:

• contributions made by the subscriber
• contributions of CESG made by the federal government, and
• accumulated earnings on all contributions

After administration and other fees are paid to the promoter out of the RESP contributions by the subscriber, how the funds are paid out depends on whether or not the beneficiary pursues post-secondary education.  

1. If the beneficiary uses the funds for education, the tax consequences are as follows:

• The subscriber contribution portion of the payments to the beneficiary is not taxable.
• The CESG and accumulated earnings on all contributions are paid out to the beneficiary as Educational Assistance Payments (EAP), and are considered taxable income to the beneficiary.  However, the beneficiary may claim tuition tax credits and education tax credits to offset the income.
  

2. If the RESP is not going to be used by the beneficiary for education costs:

• the assets of the RESP can be transferred to another RESP under certain circumstances
• subscriber contributions can be refunded tax-free to the subscriber or beneficiary, after all fees are paid to the promoter out of these contributions.
• CESG must be repaid.
• earnings are forfeited with some plans, or
• earnings may be paid out to the subscriber, under certain conditions, as Accumulated Income Payments (AIP).  AIP are subject to regular income tax plus an additional 20% tax, both of which may be avoided if the AIPs are transferred to the RRSP of the subscriber or the subscriber's spouse.  There must be sufficient contribution room in the RRSP, and the transfer is limited to a maximum of $50,000.

Accumulated Income Payments (AIP) can only be made if each beneficiary for whom contributions were made under the RESP

    i.  has reached 21 years of age and is not eligible to receive educational assistance payments; or

    ii. has died, and the RESP has existed for at least 10 years.  There are also other conditions.

h. What happens if we miss a payment or cancel the RESP?

Consequences of missed payments or RESP cancellation depend on the type of RESP (see f.  What Types of RESPs Are Available?), and the individual contract.  It is extremely important to understand the terms of the RESP contract before signing.

Possible consequences of missed payments, depending on plan:

• interest may be charged
• membership in the plan may be terminated

Consequences of cancellation of the RESP:

• CESG (grant) must be repaid
• subscriber contributions may be returned to the subscriber tax-free, after all fees are deducted

Further consequences of cancellation, depending on the type of plan:

• earnings may be forfeited
• earnings may be paid to the contributor as Accumulated Income Payments (AIP), with tax paid at marginal tax rates plus 20% (see the conditions under (e)(ii) above).
• earnings may be rolled  into the contributor's RRSP, if contribution room is available, thus avoiding the taxes (see the conditions under (e)(ii) above).
  

i. What Types of RESPs Are Available?

RESPs can be:

• non-family plans, which can have only one beneficiary.  The subscriber is not governed by a payment schedule, but can make payments as desired, up to the annual limits.  The beneficiary does not have to be related by blood or adoption to the subscriber.  These plans can be self-directed plans with a financial institution.
• family plans, which can have one or more beneficiaries, all of whom must be connected by blood or adoption to the subscriber.  The subscriber is not governed by a payment schedule, but can make payments as desired, up to the annual limits.  
• group plans, which are usually offered by scholarship plan dealers.  There are normally fixed payment schedules and higher fees associated with these plans.  They are often restricted to investing in low-risk securities, which historically have a lower return on investment.
  

j. Other resources

• Investor Education site of the Ontario Securities Commission - RESPs - Saving For Your Child's Education
• Canada Revenue Agency (CRA) web page on Registered Education Savings Plans
• CRA Frequently Asked Questions - Registered Education Savings Plans
  
• CRA publication RC4092 Registered Education Savings Plan
• Canada Education Savings Grant, on the Human Resources and Skills Development Canada (HRSDC) web site
• Department of Justice Canada - CES Grant Regulations