Investing for Beginners – RESP Accounts

Surprisingly enough, there are actually many ways to invest in Canada without needing to pay taxes on any capital gains or dividends that you may receive from your investments. Currently, there are three types of tax-sheltered investment accounts: RESPs (Registered Education Savings Plan), TFSAs (Tax-Free Savings Account) and RRSPs (Registered Retirement Savings Plan). We will begin with the RESP account and will explain both the TFSA and the RRSP in a separate blog post.

The first thing we need to understand is that not all countries currently have what is referred to as an RESP account like Canada does so please check if you have a similar tax-sheltered investment account in your country or if you have the potential to open up a similarly-structure account. What is an RESP? Many years ago, the Canadian government was looking for a way to help Canadians invest more money for their children’s future and help educate the next generation. Although the cost of education is low compared to the US, it still costs a substantial amount of money to provide your child with a proper education. The government of Canada decided to undertake an initiative where, through a Registered Education Savings Plan (RESP), they could promote savings in an account created to raise funds for a child’s education. This was done by incentivizing parents and loved ones to accumulate savings in the RRSP and giving the opportunity to the government of Canada to also pitch in a specific amount to match the parent’s contribution. So rather than having the parents pitch 100% of the money to help fund their future child’s education, the government would also take a part, anywhere from 5-15% up to a specific limit, to help provide education to the child. As an example, if you decided to put $2000 a year over 18 years ($36,000) into your child’s RESP account, the government would provide an additional $12,800 over 18 years. Although this is a very specific example and the amount that the government provides is different depending on where you live, the contribution you make into the RESP account and how much money you make a year, it is a great representation of the benefits of opening an RESP account early on for your child as the government shoulders some of the educational costs. The government will usually match 20% up to $2,500 per year. If you are considered to be a low-income household, the government can actually add an additional $2,000 to the RESP account to help with tuition costs. Every situation is different, if you are looking to open an RESP account, please go to the government website to determine what grants are available to you and your child.

Another benefit of opening an RESP account is the fact that your contributions grow tax-free and are only taxed when the funds are taken out of the RESP account at the tax rate of the student which is assumed to be much lower than the individual – usually parents – who put the money into the account in the first place as long as the money is being used for educational expenses. Please note that the original contributions over the years are not taxed, only the earnings are taxed. If you, through the years, put in $50,000 and you made an additional $10,000 in your RESP account through capital appreciation, you would only be taxed on the $10,000 rather than the $60,000 if you were to pull out all of your money from your RESP account. As I mentioned before, parents can open an RESP at most financial institutions – including robo-advisors and online brokerages – in Canada and almost anyone can actually put money into this account if they wish to provide additional funding to this child’s education.

If you understand all of the information above and are still wondering what happens to the money in the RESP account if your child decides not to pursue higher learning and does not go to college, than here is your response: if your child does not attend college, the money that you provided to the RESP would be given back to you in full. So there is no harm of providing funding to an RESP as long as you are aware that the result would be one of the following two options: the child attends college and uses the money to pay for education expenses or the child does not attend college and you receive your money back with the only negative being that it was tied up for many years.

The RESP is a very easy way to start investing and provides a great incentive to begin saving for your child’s education early on. The largest drawback of the RESP is that any funds that are taken out of the plan and used for non-educational purposes do get charged an additional 20% penalty fee on top of the income tax that you would be required to pay. In this case, you should only be using your RESP money for tuition or to purchase items for school rather than as a down-payment to purchase a house.

Basically, the RESP is a fantastic tool that Canadians can use to help incentivize themselves to begin saving for their child’s education but be aware of the fact that if you do not currently have enough money to put towards an RESP, do not open an RESP as the money will be locked-in for approximately 18 years until your child begins college and then will be able to use this money to help pay for their tuition and any other costs related to their education. RESPs do provide free money as the government pitches in and it is a great investment in your child’s future if you are able to open an account when they are born and add to it as much as you can every year to help provide them with a strong financial foundation so that they can begin school without the stress of money and begin preparing for a career that will allow them to remain financial stable and provide great RESPs for their kids and so on.

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