The following excerpt is Chapter 1 of Mike Holman's new book, The RESP Book: The Complete Guide to Registered Education Savings Plans for Canadians.
Chapter 1 Summary
- RESPs are intended to help with a child's post-secondary educational costs. Penalties will be applied if the money is used for other purposes.
- RESP accounts are tax-sheltered accounts that are eligible for government grant money based on contributions. The grants are worth 20% of any eligible contributions.
- RESP accounts can be opened with most financial institutions and can contain a wide variety of investments, from GICs to individual stocks.
- Educational costs can vary between programs. If a student lives at home, his costs will be much cheaper than if he were living on his own.
- RESPs can be used for adults, but the TFSA is a better choice for this purpose.
What is an RESP?
RESP stands for Registered Educational Savings Plan. An RESP is an investment account that can receive extra grants from the government based on the amount contributed. The investments in these accounts enjoy tax-free growth and earnings, meaning more money will be available for future educational costs.
There are many rules, regulations and limits for RESPs, so this book covers the important information that the typical RESP investor needs to know. The basics of investing and how to open an RESP account are also outlined.
RESPs can be opened at most banks, with a financial advisor or even on your own as a self-directed RESP. Scholarship, group or pooled plans are also available, but I don't recommend them because of high costs and restrictive rules.
It's important to know that RESPs are a type of investment account, not a type of investment. You can put the same types of investments in an RESP as a Registered Retirement Savings Plan (RRSP). Guaranteed Investment Certificates (GICs), stocks, bonds, mutual funds, exchanged traded funds (ETFs) and good old cash are all eligible investments for your RESP.
The purpose of having an RESP account is to help save for a child's education. Typically, parents open RESPs for their own children, but you can open an RESP account for any child.
6 Reasons to Start an RESP
There are many reasons why you should start an RESP. Saving for your child's education will likely improve the odds that she will participate in post-secondary education by diminishing financial barriers and building a financial nest egg. An RESP account should make it easier on your budget when she is in school.
Here are some of the great things about RESP accounts:
i. CESG (Canadian Education Savings Grant)
RESPs can receive extra grants called CESGs from the government based on the amount contributed to the account. CESGs are worth 20% of each dollar you contribute and are basically free money. The CESG is the single biggest reason why an RESP account is usually far superior to any other type of savings or investment account for educational saving purposes.
ii. Tax-free compounding
All interest payments, dividends and capital gains earned inside an RESP account are not taxable. This means you get to keep all of the money earned, increasing the amount of money available for your child's education. If you start the RESP account when your child is young, there will be many years for that investment to grow tax-free.
iii. Dedicated savings account
It is a good idea to have a separate savings account for a major financial goal like post-secondary education. If this money were mixed in with other types of savings, it would be easier to spend it on items other than education.
iv. Reduce your liabilities when your child is at school
Some parents find themselves in the situation where their child is attending college or university, and they end up having to funnel a large amount of their budget to pay for the schooling. With a fully funded RESP, there should be little or no financial demands on the parents once the child starts post-secondary education.
v. Reduce student loans for your child
One alternative to parents paying for a large amount of the education is for the child to apply for student loans. While this strategy isn't the worst thing in the world, it would be ideal for the student to avoid any debt while in school.