This Blog was written by Joanna Mazin, Estate and Trust Planning Lead at MD Financial Management Inc. which is part of Scotia Wealth Management
Many clients I work with are interested in finding a tax-efficient way to financially support their minor grandchildren’s savings for post-secondary education. I often suggest that they consider opening or contributing to a Registered Education Savings Plan (RESP). Presenting each of these options comes with instructions on how an RESP works and the risks involved.
How an RESP works
An RESP is an arrangement between an individual (the subscriber) and a person or organization (the promoter). Under the arrangement, the subscriber names one or more beneficiaries and agrees to make contributions for them. The promoter arranges with a trust company to hold the assets, and the promoter agrees to manage, invest and distribute the assets held in the RESP according to certain rules. There are no tax implications for the subscriber when contributions are made to an RESP.
Government grants will be deposited directly into the RESP. These grants could be the Canada Education Savings Grant (CESG), Canada Learning Bond (CLB), or any designated provincial education savings program. Basic CESG amounts to 20% of annual contributions made to all eligible RESPs for a qualifying beneficiary to a maximum CESG of $500 per year for each beneficiary ($1,000 in CESG if there is unused grant room from a previous year), and a lifetime limit of $7,200. Therefore, to receive the maximum annual CESG of $500 for each beneficiary of a given RESP, an annual contribution of $2,500 would need to be made for each beneficiary of the RESP. Additional CESG could be paid for each beneficiary, based on the criteria outlined here. The CLB is an additional incentive of up to $2,000 to help modest-income families start saving early for their child’s post-secondary education.
While subscribers may contribute more than $2,500 for each beneficiary annually, there is a $50,000 lifetime contribution limit for each beneficiary which, if exceeded, would result in a penalty for the subscriber of 1% per month on overcontributions.
Once contributions have been made, and income is generated from those contributions, it can grow tax-free for a maximum of 35 years (or 40 years if the beneficiary has a disability). When contributions and income are distributed to a beneficiary, the income (not the contributions) is taxable to the beneficiary, assuming the beneficiary attends an eligible post-secondary institution. As a student, the beneficiary will likely not have much other income and would be eligible for the tuition tax credit, so they will likely pay little or no tax on the amount of the taxable distributed funds. Investment income distributions from an RESP are taxable as regular income, even if the income was earned as dividends or capital gains, which are usually taxed at lower rates.
Here are a few (of many) scenarios for grandparents to consider:
- The grandchild’s parents have opened an RESP for the grandchild:
- Generally speaking, if the grandchild’s parents contribute less than $2,500 in any given year, a grandparent could make up the difference by gifting money to the grandchild’s parents, who could make contributions to the grandchild’s RESP with that money.
- A grandparent could open a separate RESP for the grandchild, though they would need to exercise caution. The parent and grandparent subscribers should be mindful of the $50,000 lifetime contribution limit for each beneficiary to avoid incurring the 1% monthly penalty for overcontributions.
- The grandchild’s parents have not opened an RESP for the grandchild:
- A grandparent could open an RESP for one or more of their grandchildren, and contribute to it, while keeping in mind the rules relating to maximum contributions.
- An RESP has been opened by a grandparent (subscriber) for their grandchild, and that grandchild decides not to enroll in an eligible post-secondary institution:
- The grandparent could transfer assets held in the RESP to another RESP, under certain conditions and up to certain maximums; and
- Where assets remain in the RESP, the grandparent could choose to collapse it. Subject to the terms of the contract, the promoter would:
- return the grants to the government;
- return the contributions to the grandparent tax-free; and
- transfer the accumulated income to the grandparent if certain conditions are met. The grandparent would have to include this amount in their income for the year the transfer is received, and the grandparent’s regular income tax rate would apply. The transfer would also be subject to a 20% additional tax (12% for residents of Quebec).However, in some cases, the grandparent can reduce or eliminate the regular income tax and additional tax payable on the accumulated income by transferring some or all of the income to:
- the grandparent’s Registered Retirement Savings Plan (RRSP) or spousal RRSP by rollover up to a maximum of $50,000 and to the extent that there is unused contribution room. However, at that point, the grandparent and their spouse (if any) may be beyond RRSP age (the year the grandparent or spouse turns 71), and RESP funds cannot be transferred to a Registered Retirement Income Fund (RRIF); and
- a Registered Disability Savings Plan (RDSP) by rollover up to a maximum of $200,000, if the grandchild has an RDSP and other conditions have been met.The accumulated income could also be donated to a Canadian designated educational institution or to a trust for such an institution. No donation receipt is issued, as it would not be considered a donation by the subscriber, but rather the RESP.
- If the grandparent dies before the grandchild decides not to attend an eligible post-secondary institution, then the opportunity to transfer the accumulated income held in the RESP to the grandparent’s RRSP (if one exists) on a rollover basis, has been lost. Only the original subscriber of an RESP, the spouse or common-law partner of a deceased subscriber, or an individual who acquired the subscriber’s rights under a decree, order, or judgment of a tribunal, or under a written agreement after a separation or divorce, is entitled to the RRSP rollover. Thus, even if the grandchild’s parent becomes the RESP successor subscriber upon the grandparent’s death, the parent would not be entitled to rollover the accumulated income to their own RRSP.
The simplest option in most cases is to have the parents of the grandchild open a family RESP for all the parents’ children, and have the grandparent provide an annual gift of up to $2,500 for each of the parents’ children. While this may be the most practical solution, it does leave the grandparent without control over the investment or distribution of assets held in the RESP.
Lastly, those who are thinking of opening an RESP for their grandchild should know that the contributions could be subject to their creditor claims and included in a division of family property in the event they suffer a relationship breakdown. As always, every solution should be analyzed considering each client’s goals and circumstances to determine the best solution for each client.
For an excellent review of RESPs within the context of an estate plan, please see Alicia Mossington (Godin)’s AAE post here: Have You Considered Your RESP in Your Estate Plan? and for those who are looking to delve deeper into RESP rules, please see the Canada Revenue Agency’s Information Circular on RESPs: IC93-3R2
Thanks for reading.