An RESP strategy that goes beyond the basics

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Registered education savings plans (RESPs) are used to save for and fund post-secondary education expenses. Most people know the basics, such as how the government deposits grants to the account to match your contributions. But a good RESP strategy goes beyond the basics and considers the type of account, the investment opportunities, and the tax and estate implications.

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Now that kids are heading back to school, here is a lesson for parents and grandparents on the ins and outs of RESP accounts.

Avoid scholarship plans

Group RESP accounts, known as scholarship plans, are heavily promoted to new parents. These accounts tend to have high fees, penalties for missing contributions, conservative investments with low returns, and restricted eligible post-secondary programs.

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Regulators like the Ontario Securities Commission warn consumers about these drawbacks to pooled RESPs. Fathers like me who are financial planners encourage clients to open individual RESP accounts. If you have more than one child, a family RESP may be a good option.

Open a family RESP

Family RESPs can be used for multiple children. A parent can open a family plan if they have two or more children, or a grandparent can open an account for their grandchildren. Family plans allow the subscriber to add future children after they are born.

The beneficiaries must be blood relatives, which includes children, stepchildren, adopted children, or grandchildren. Although you could have a single RESP for grandchildren from multiple families who are cousins, a grandparent in this situation might consider opening different RESP accounts for each family.

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The primary advantage of a family RESP is that the government grants and income can be withdrawn for any beneficiary of the account. The withdrawals can be used disproportionately, depending on the needs of each beneficiary. A secondary benefit is only having to manage one account.

Asset allocation should evolve

Ideally, when a child is young, you should pursue a more aggressive asset allocation for the investments. A newborn may not need these savings for 18 or more years. This is a long time horizon, over which stocks should provide strong returns. If you are investing regularly, an early stock market decline just means you can subsequently buy more stocks at a discount, with plenty of time for the initial investments to recover.

As a child gets closer to needing the money, your stock allocation should decrease — especially if they are within five years of post-secondary education (i.e., approaching or entering high school). This is because stocks are more likely to have negative returns over a shorter period, and you would hate to have to sell investments during a significant market downturn.

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Unlike retirement, which may last 30 or more years for a registered retirement savings plan (RRSP), an RESP may be depleted within four years once withdrawals begin.

Plan for taxable withdrawals

A portion of the withdrawals from an RESP comes out tax free. When you take money from an RESP, you can elect to have some of it treated as a post-secondary education (PSE) withdrawal and some treated as an education assistance payment (EAP).

A PSE represents the original contributions to the account. An EAP is the accumulated income and growth, as well as the government grants and bonds. PSE withdrawals are tax free and EAPs are taxable. The taxable withdrawals are reported by the student beneficiary and since their incomes tend to be low, they may not end up paying tax on the withdrawal. Especially given they can claim a tax credit for post-secondary tuition to reduce tax if their income exceeds the basic personal amount.

A parent should try to plan their mix of withdrawals to minimize tax and not be left with taxable amounts still in the RESP. If this happens and a child is no longer enrolled in post-secondary education, a RESP subscriber could end up paying back government grants or bonds, or paying a 20 per cent penalty tax plus regular income tax on an accumulated income payment (AIP). AIPs can be transferred to the RRSP of the subscriber or their spouse up to $50,000.

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A child will not pay federal tax on their first $15,705 of income in 2024, and provincially, it ranges from $8,481 to $21,885. So, you should try to take taxable RESP withdrawals up to at least the point where a child’s part-time job and RESP income are still tax-free to use up their low tax brackets.

RESPs for grandkids

A grandparent can open an RESP for their grandkids or they can give their child money to fund RESP contributions for their grandchildren. A beneficiary can have multiple RESP accounts.

Some grandparents would prefer to manage the account on their own, whereas others would rather leave it to their children to figure out how best to invest the money.

Name a successor subscriber

Some financial institutions allow joint RESPs. This is good for couples from a practical perspective, as well as for their estate planning. But it is also advisable to appoint a successor subscriber, if the RESP provider permits it.

A successor subscriber can take over a RESP account if the original subscribers die. Subscribers can also include a clause in their will appointing one. These designations are important — especially for grandparents who are more likely to die before an RESP account is depleted.

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Takeaways

Scholarship plans should probably be avoided, and family plans should be considered for those with multiple children. Investments should be more aggressive when beneficiaries are young, and try to plan for the tax implications of withdrawals.  

Grandparents can open an RESP for their grandchildren, but can also just give money to their kids to fund contributions. Grandparents and parents alike should name successor subscribers for their RESP accounts.

RESPs are the best way to save for post-secondary education. Planning ahead can help you maximize them.

Jason Heath is a fee-only, advice-only certified financial planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever. He can be reached at jheath@objectivecfp.com. 

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