A Registered Education Savings Plan (RESP), sponsored by the Canadian government, encourages investing in a child's future post-secondary education. Subscribers to an RESP make contributions that build up tax-free earnings. The government contributes a certain amount to these plans for children under age 18.
Contributors do not receive a tax deduction for investments in an RESP. There are no taxes due until funds are taken out to pay for a child’s education. At that time, contributions made into the RESP are returned tax-free, although contributors’ earnings from the plan are taxed. Money the government pays out is taxed to the students. However, since a large number of students have little to no income, many can withdraw the money tax-free.
A RESP lets parents in Canada begin saving for their children’s education at birth, with the government pitching in part of the tab. Parents or guardians simply walk into a bank, credit union or other financial institution to open up an account. Anyone can contribute, whether it's mom, dad, neighbor, or a favorite aunt or uncle.
The federal government then matches the money up to a certain percentage and deposits it into the child’s RESP. The extra funds the government deposits are called the Canadian Education and Savings Grant. The amount provided is graduated, based on family income. Matching benefits apply only on the first $2,500 in contribution per year. The amount of the grant is capped at a maximum of $7,200.
Once in college, the child receives educational assistance payments (EAPs). These EAPs count as income for the child (beneficiary). If the beneficiary doesn't receive payments - either by the choice of the contributor or because the beneficiary does not attend a post-secondary institution, the contributor will receive the amount in the RESP back tax-free.
The number of allowed plans per child is unlimited. However, there is a lifetime contribution limit of $50,000 per beneficiary from all RESPs combined.
Pros and Cons of Registered Education Savings Plans
Generally, the plans are easy to access and provide strong investment incentives. Because parents won't initially pay taxes on the money, they have a dual incentive to save for their child's education; they avoid paying taxes and get bonus money from the government for the child's education in the process.
There are a few catches. If a child doesn't pursue an approved post-secondary education training program, such as college or trade school, within 36 years of opening the account, the government can request the grant money back. Also, any investment earnings that are withdrawn from the RESP that are not used for education-related expenses incur income tax plus an additional 20% penalty.
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