Registered Education Savings Plans (RESPs) are a government of Canada savings plan designed to encourage parents, relatives, or any other individuals to save for a child’s post-secondary education in a tax efficient manner. As savings tools, RESPs are very useful for a number of reasons. Firstly, they allow the contributor to grow all contributions (up to $50,000 per beneficiary) in a tax deferred account. Secondly, RESP contributions can attract a government grant called the Canadian Education Savings Grant (CESG) which will also grow on a tax deferred basis.

Unlike Registered Retirement Saving Plans (RRSPs), which deduct contributions from your income in the year they are made, RESP contributions do not create income tax deductions, that is to say, they are made with after tax dollars. For this reason, contributions into the plan can be removed without paying additional tax. Any interest, dividend income, or capital gains that are earned during the life of the plan (35 years from inception) will not be taxed while within the plan. These should be used to fund the beneficiary’s education, at which point they will be taxed in the hands of the student at what is likely a lower rate. This type of payment out of an RESP is called an Education Assistance Payment (EAP).

Contributions to an RESP will attract the CESG at a rate of 20% per year on the first $2,500 contributed, up to a lifetime total of $7,200. Because of this structure, and the tax deferred status of an RESP, there is an optimum method of contributing to a plan. By contributing $16,500 in year one, and $2,500 annually thereafter, you will reach both the RESP contribution and CESG limit in year 15. The larger up front contribution is done to maximize the amount of time that capital is sheltered within the plan. By the end of year 15 you will have contributed $50,000 and attracted $7,200 in CESG for a total of $57,200. If we assume a constant rate of return of 5% annually, this total will have grown to over $90,000, representing a gain of $32,000 which can be taxed in a potentially much lower tax bracket.

As a final note, there is a characteristic of EAPs that many are not aware of: EAPs do not necessarily have to pay for tuition. As long as the beneficiary is enrolled in a qualified post-secondary program, any payment made to them during their post-secondary years from the RESP will be considered an EAP. Cash may be distributed to the beneficiary who may then use the funds to help with rent, textbooks, or other expenses.