By Nizam Shajani, CPA, CA, MBA
Registered education savings plans managed effectively will allow for a free $7,200 Grant (Canada Education Savings Grant (CESG)) to be used for education purposes towards a child’s education plus investments that can grow tax deferred.
The CESG is based on 20% of a $2,500 contribution made each year and available until the calendar year in which the beneficiary turns 17. Contributions must commence prior to the year in which your child turns 15. The maximum contributions per RESP account is $50,000 per child. Note excess contributions are subject to tax of 1% per month, compounded.
In addition – to someone at the highest tax bracket, the grant would have a potential tax savings of an estimated $19,247 as the gains on the withdrawals (based on a 5% annual gain on the investment that would otherwise be taxed at 34.31% in the hands of the contributor) would be taxed in the assumed lowest tax bracket of the child.
To receive the maximum benefit, a contribution of $3,333 per year for 15 years would need to be made for a total of $50,000. The contributions would grow to an estimated $90,866 at the end of year 17 based on a 5% return each year.
Note you will need to provide some documentation that the beneficiary is going to an approved school to make withdrawals, however the RESP can stay open for 35 years from the date it was initially opened. If the beneficiary does not go to an approved school, there are taxes and penalties on the withdrawals. However, there are strategies in place to help minimize this.
Withdrawals on contributions are not taxed. Withdrawals on the accumulated income, including grants, interest, dividends and capital gains are taxable to the recipient. Students will have the tax advantage of the personal exemption, tuition tax credits and a lower tax brackets. Withdrawals while the student is at these lower tax brackets are usually the most advantageous.
In our example, if the student were to take $14,025 into income in each of years 18, 19, 20 and 21, with the remaining $50,000 contribution returned to the initial contributor in year 21 – the tax savings (assuming the contributor is at the highest tax bracket and the student has no other income) would be approximately $19,247 in addition to the $7,200 in CESG provided to the beneficiary.
|RESP 21 Year Plan|
|Opening Balance||$ –|
|Annual Contribution||$ 3,333|
|Withdrawals at Year 18||$ 14,025|
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