16. Registered Education Savings Plans featuring Steven Guenther, CFP
Transcript:
Evan Neufeld: Hello, and welcome back to season two of the Canadian Money Roadmap podcast. I'm your host, Evan Neufeld. Today, our topic is registered education savings plans, and I'm bringing back my first repeat guest, my colleague and certified financial planner, Steven Guenther. We're going to be talking about some of the basics and then get into some of the more details that will be critical when you're setting up an RESP for your child.
So, Steven, thanks so much for joining me today.
Steven Guenther: Thanks for having me back.
Evan Neufeld: So a registered education savings plan, we call that an RESP. What are they used for? Can I use that for myself if I'm saving up to go do a master's program or something like that? Give me kind of a breakdown of why they exist and how they got started.
]Steven Guenther: So education of course, is the goal here, but it's typically for a minor, so this can be your child, it could be a niece and nephew. You could be a grandparent setting it up for your grandchild, but it has to be somebody under the age of 16, I believe when you start the plan and it's intended for saving for that particular child's education. Now as far as why they exist, basically the government wants to incentivize and encourage Canadians to save for their children's post-secondary education. They recognize that this is something that will benefit Canada and benefit society in the long run and something that they want to help encourage people to do. So they kind of do that through a few mechanisms. One is offering some incentives. So depending on your situation,
Evan Neufeld: Incentive sounds like free money, Steven.
Steven Guenther: They want to encourage financially. Let’s put it that way. They do it through two main avenues. One is called a grant and the other one is through a bond. And we can get into the details of what those are later, but the third thing is some preferential tax treatment as well within the plan.
Evan Neufeld: So we're already kind of touching on some of the unique vocabulary that's involved with an RESP. So maybe give me a breakdown of some of the terms that we're going to use throughout the rest of the podcast. Just so people are all on the same page to start off with.
Steven Guenther: Yeah. There can be a lot of acronyms and financial speak, so to speak.
So let's just run through a few of them. First person that gets involved is what's called the subscriber. Subscriber is the person that opens the account, is the adult and typically is a parent or a grandparent. They contribute the money and they sign the forms and deal with all the administration of the plan.
The second person is the beneficiary. This is usually a child of the subscriber, a grandchild or relative. The subscriber doesn't need to be, but that's typically the case. They will actually be the people that will benefit from the plan in the long-term.
The third party is the promoter. A promoter is effectively who is actually administering the plan from a compliance regulatory standpoint.
And so that can be a bank, a credit union, firms like ours investment firms and we are considered promoters who facilitate the opening of the RESP and manage it over the years.
Evan Neufeld: Perfect. That sounds good. So now when we get into the government portion, you know, you mentioned government incentives like grants and bonds. Could you clarify the difference between those two?
Steven Guenther: So the umbrella term is incentives, but it covers both with grants and bonds. And the easiest way to remember the difference is grants are for everyone, regardless of your household income and bonds are an income tested incentive. And that's based on your total household income. You may or may not be eligible for bonds as well as grant, but everyone, regardless of their household income would be eligible for some grants.
Evan Neufeld: Okay. So we've got the language out of the way here. So now once an account is set up and maybe we'll get to that again in a second here, but the RESP composition. So it sounds like you'd make some contributions and there'd be the government portion comes in at a certain time. Or how does that work? Does the government only contribute to it or?
Steven Guenther: So once an RESP is set up, there's basically three pots of money all within the account. The first is your original contributions. I'm saying “you're” assuming that you're opening it for your child, for example. So you’re original contributions go in. And that's kind of tracked separately. Secondly, there's the government grants and bonds. So the incentive component, that's what the government contributes to the plan. And depending on the scenario, those will come in at different times. And then the third component is the growth within the account. And so when you contribute and when the government puts in their incentives, that money is typically invested. Whether it's in a guaranteed savings account, GIC, or investments that we would offer through an office like ours. That earnings is the third component and it has to be tracked as well.
Evan Neufeld: And you just want to double check with your promoter to see if there are options available for investing or how they treat those different pots of money. So we've kind of covered some of the basics and let's dig into the more specifics, because as we know the devil's in the details. Let's go back to that government incentives thing. So grants, you mentioned the grants are the portion that everybody qualifies for, not necessarily just lower income households. So let's break down the grants, who's eligible and how much you can receive.
Steven Guenther: So how grants work is that for every year a child is alive, the government will pay out a grant equal to for the most part, 20% of your contributions up to a maximum of $500. So there is a lifetime limit on that amount. So you can't get it all in one year. And if you put in a bunch of money every year, there are limits to how much grant will be paid out. But the kind of limits to keep in mind is $500/year and then $7,200 for their lifetime.
There is a catch or a caveat, however, the government will allow you to catch up for one year at a time. So for instance, a child starts an RESP or their parents start an RESP at the age of three. Well, there's been a couple of years where they made no contributions because they had no plan open. And so starting at, in third year of their life, they would be able to catch up in the years, three, four, and five to make up for the other calendar years, the child would be alive. And so you're only able to catch up one year worth of grant per calendar year. So that amounts to having to put in $5,000 as a subscriber to get a thousand dollars of grant. So 2,500 for the year at hand, and then 2,500 for a past year of carry forward or catch up.
Evan Neufeld: So just to break that down, the subscriber puts in 2,500, government puts in 500. Okay. So now let's go to that bond portion. Who's eligible there. You mentioned that it's an income tested thing. Can you just give me the income thresholds there and how much can somebody receive in this case?
Steven Guenther: Bonds have nothing to do with your contributions. So that's something that if you're considering opening an RESP and thinking, you know, I just don't have the money. Bonds are another way that might motivate you to open an RESP, even if you make no contributions. So you can look at your household income, but households under about 48,500 is who the bond component would be eligible for. So households that are earning less than 48,500 that's who would be eligible for bonds. And it's different in sense that grants require a contributions. Bonds do not. And the first year that you open an RESP, there's actually even a one-time payment or a one-time bond of $500. So maybe you've never opened an RESP before. You've never had the money to contribute to an RESP and your income is lower than 48,500. We'd certainly recommend that you still open an RESP because you got $500 right away, free money from the government.
Plus, every year that that account is opened, the government will put another a hundred dollars in up until including age 15,
Evan Neufeld: As long as you're still under that income threshold.
Steven Guenther: That's correct. So every year, they look at your taxes effectively, or the household taxes for the subscribers or the custodial parents.
And then they'll use that to determine whether bonds are eligible. So technically speaking. Let's say you opened it up and you were under the threshold your whole life or the child's family was under that threshold their entire life. They could get up to $2,000 of free money towards their education without you contributing a dime.
Evan Neufeld: That's great. So even now, maybe with COVID with you know, maybe one partner receiving less income, or maybe the household income in general is quite a bit lower, even if you can't afford to open that RESP and make contributions yourself to earn grant. It might be worth it to take a look at your situation, to open one anyways, to see if you might be eligible for some bonds from the government.
Steven Guenther: Certainly bonds are probably the least understood and they probably have the most impact, especially if you consider the children from lower income households, probably have less opportunities for higher education in general. So this is something we love talking about because we feel like it could make a huge difference in providing those children to a brighter future.
Evan Neufeld: So we’re kind of covering off the basics here, but the main question that a lot of people are probably wondering is how do you get that money out? Yes, it's designed for education and things like that, but can you give me a breakdown of how the money is actually withdrawn from an RESP?
Steven Guenther: Yeah. At the end of the day, you set up an account for education savings for the purpose of withdrawing it one day and it’s kind of the most important part here of talking about how to best use an RESP and use it properly. So there's kind of a few, I'll call them exit strategies. Overwhelmingly when we set these up, the reason or the way we take the money out is through something called an education assistance payment. And what that amounts to is, is a child or a beneficiary of the RESP needs to be enrolled in a post-secondary institution. And there's a list of eligible institutions on the government's website. And you can see kind of all kinds of schools and different trade schools and academies that would be eligible. But effectively what an education assistance payment is, is a payment either to the subscriber or to the beneficiary for educational purposes. And so the only thing that we talk to people about is to make sure that they have something called a proof of enrollment letter, and that will give us the necessary tools to be able to take money out. and not just money that you contributed, but also the government's money and that would be the incentive component within the account.
Evan Neufeld: Thing to keep in mind is that the proof of enrollment is actually a specific document. It is not a proof of enrollment, meaning like a photo of a receipt or a confirmation email or anything like that? It's a specific document that the child is attending school would get from the institution directly, typically from a university registrar and this document has the length of the program, the name of the program, how far along they are and things like that. So those are the details that the promoter would need to make sure that they can actually release the money to the child. So if we go back to the beginning where we mentioned that there's three components or three notional pots of money in an account, there's the contributions, the grants, and I'll call it growth. So contributions, grant and growth. Those are all taxed differently, if at all. Can you kind of break that down and how that's taxed
Steven Guenther: So when it comes time for a child to attend a post-secondary education institution and they are withdrawing money in the form of an educational assistance payment, which we addressed earlier. There's again, different pots of money, but because the contributions that you originally added to the account were from after tax dollars, the withdrawal of those contributions in a future date are also tax-free effectively. The principal that goes in, can come out always tax-free. So that's the first pot addressed, but the second and third are subject to taxation upon withdrawal. Now where this becomes interesting is that tax can actually be attributed to the beneficiary, not to the subscriber. So take again, the example of say a middle-class household, typically their earning the households, earning a decent income and they're paying tax on that income. And if they were to add any investment income to their total income, that would again be attracting their highest tax rates. Technically income attribution to the beneficiary allows for what would have otherwise been income to the subscribers to become income for the beneficiary. And because the beneficiary typically is not working at all because they're in school or maybe working in a part-time job, their tax burden is relatively minimal. And so in some cases, the growth and the incentives will actually come out tax free when it's all said and done. Now this is dependent on the beneficiary scenario, but overall, typically it's a more efficient way of taking money out if that same income was attributed back to the subscriber.
Evan Neufeld: Because if you look at a situation where a student, especially in their first or second year of university, they might have some income or working part-time or things like that. And keeping in mind too, that every person in Canada gets a personal exemption amount depending on your province. But in the ballpark of $12,000, you can actually have that much income and not pay any tax on it at all. Let alone, some of the credits you might have from paying tuition and all that kind of stuff. So in theory it is taxable, but depending on your situation, it will change how much tax is actually owed on that money. So if some of you are listening to this and you have a little one at home, or maybe a little one on the way. And you'd like to get an RESP set up. What are some of those things that you need to have in place before you can actually put the wheels in motion.
Steven Guenther: Very simple, three main items. You need a social insurance number for the child, you need their legal name and you need their date of birth. There's other information that we'll need from you on a personal level, like your address and phone number and things that you would have. But as far as the beneficiary, that's specific to them. It's just those three items. So social insurance, date of birth and legal name so if you have those three things, you can go into your bank, credit union, come into an investment firm like ours or other similar firms, and you can open up an RESP.
Evan Neufeld: Perfect. Okay, so say I've got a couple of kids at home. Do I need to set up an account for each one of them or what kind of structures are available?
Steven Guenther: Yeah, so there's two basic options. There's something called a family plan and then there are individual plans. We will overwhelmingly use family plans here in our office because of the flexibility they provide. The only thing to note there is the beneficiaries of a family plan needs to be siblings and this will allow flexibility when it comes to take the money out. If for instance, one of the children doesn't go to school, their siblings can actually share in some of the money the government had contributed. So we'll get down to that a little bit later, but effectively, I would say opt for family plans, unless you're getting advice otherwise
Evan Neufeld: And for some people, they really like to track things very closely and just for their own peace of mind and budgeting and how they like to plan things. This is Johnny's money and this is Sally's money. You can still kind of keep that mental accounting in place with a family plan if you'd prefer, but there's no problem with doing an individual plan necessarily. If that separate structure is something that you prefer just for your organization purposes.
Steven Guenther: The simple rule of thumb is family plans are the most flexible and so that's kind of where you should start and should be the default.
Evan Neufeld: Yeah, you won't necessarily earn more grant money by having the kids in the same account by using a family plan or anything like that. It's more so just from a structure and organization standpoint,
Steven Guenther: Just another comment there, Evan is that we often will see grandparents that do want to open these for their grandchildren, and that will work. There's no issue with somebody else opening the account. However, the custodial parents still have to sign some of the documents to set it up. And so if there's a good relationship between, you know, kids and their parents and beneficiaries, then we always recommend just having the parents set the account up and the grandparents giving them the money to the kids to be able to put into the account. Of course, again, this is dependent on everybody's situation, but that creates as little headache, not only now, but also down the road, when it's time to take the money out.
Evan Neufeld: Yeah, that's a good point. So, you mentioned this already, and this is the question I get the most from people that are setting up our RESPs for the first time. What if my son or daughter doesn't go to school? What are my options? Is this money just forfeited? Does the Government keep it? How does that work?
Steven Guenther: Yeah, this is definitely a barrier to taking money out or starting one in the first place. Is what if the child doesn't go to school? What if they pursue a small business or maybe they travel for many years and, you know, that's just not something that they end up going to or start working right out of high school. Those are all, you know, very frequent options for children. What we say is that, first of all, that there's a pretty broad list of institutions that are eligible. A lot of people think about it as just universities, but in fact, it would include all your trade schools. So maybe you're going to go to get your plumbing tickets or your carpentry ticket, that would be covered. It could also cover fine arts or culinary arts school, or there's a number of different institutions that are eligible. So we always recommend taking a look at the extensive list that's provided. And maybe you have an idea of what the child might be wanting to pursue. And that can give you a little bit of an idea. Now, of course, if they're young, it's just not going to be that helpful. But lot of times it's more broad than people first recognize.
Evan Neufeld: Yeah. It doesn't necessarily have to be a four year university degree. I've seen clients who have, you know, one year interior design certificate or administrative assistant program or things like that. It's like Steven mentioned, it is much more broad than you might anticipate. So even if they go traveling right out of high school and they're not really that keen on going to school yet, I think age 36 is as long as it can remain open, which would be a unique scenario to still be involved with your parents financially at that age. But there is no rush on getting these things closed if they don't want to go to school right away.
Steven Guenther: Yeah. Waiting is the kind of the default option. There's maybe the child goes to school later on in their life. There's nothing forcing you to close that plan right away. And like mentioned, if you have a family plan, you know, maybe there's two or three kids in the family in today's day and age, typically at least one of them is doing something in the post-secondary world as far as education goes. And so that means that there's very little. barriers to have someone use the money. And so maybe Johnny doesn't want to go to school and never has, but his sister Sally does. And so Sally can use the grant money and the bonds that were given to the benefit of Johnny for her own education. So it can be flexible and at least means that that money is not being wasted or being lost.
Evan Neufeld: Now here's the, the ultimate scenario. You've waited. There are no other kids. They're not going to school. The money is still in the RESP. Now what?
Steven Guenther: Well, unfortunately the government incentives do have to be repaid in that scenario. If no one goes to school from the family plan, then the bonds and the grants are repaid to the government. However, we still have two other pots of money, so you've got the earnings within the account. And then you also have the original contributions, the original contributions you can take back. It's your money. No tax implications with that. However, the earnings if you withdraw them would be taxable and so that would be added to your investment income for the given year. However, there's another couple of avenues. One would be transferring those earnings to your own RRSP. This would be again, if this is the subscriber doing this and they can do that on a tax deferred basis. So there's no tax implications in a year withdrawal, or secondly, depending on the scenario again, If perhaps one of the RESP beneficiaries either becomes disabled or is now receiving the disability tax credit, for whatever reason, they may be eligible for something called a registered disability savings plan and that earnings can actually be transferred to an RDSP. Now this isn't an RDSP podcast, but you can take a look at that if that might be a scenario that you see yourself in with a child that maybe becomes disabled or won't be going to school. Because of a disability, there is that idea that you can move some of those earnings into this RDSP plan.
Evan Neufeld: One thing to keep in mind when transferring to your RRSP in this case is that especially if you've set up an RESP for the child at a young age, there might be a significant amount of investment growth here. And so you have to be careful if you're in this situation for transferring that growth to your RRSP, because you actually have to have that contribution room available to be able to make the transfer over. So you can't have a maximized RRSP and then transfer over 20,000 of our RESP investment growth necessarily. You can do it, but you have to have RRSP contribution room yourself. We've kind of covered all of the nuts and bolts or the vast majority of them. Anyways, there's plenty. But now what are some typical strategies that one could use to set this up well, and to use it to the child's best advantage?
Steven Guenther: Yeah, this is where I get excited about RESPs, because there's a number of strategies we can implement to maximize the benefit for a family. So the first one is making sure that you're optimizing the incentives that you receive. So there's a number of things that you can do. One is that perhaps in previous years, your household was under the 48,500 income threshold, and you had beneficiaries that were alive at that time. You can actually apply for the one-time or the initial bond from the government, even if the RESP wasn't opened until later when the household income might have been higher. I've had this happen to a client of mine, where we were able to get $500 from a past year just straight from the government. And so that's one thing is looking into your income, not only now, but also in the past. And there might be a position where you can apply for that bond through the promoter and get again, a pretty sizable check within the account of $500. So that's the first thing it's kind of a unique one. You probably won't run into that very often, but something to consider.
The second thing is making catch-up contributions and timing, those contributions accordingly. So depending on when the account is opened, you might have beneficiaries that are in their teens. And so what we would like to see in a lot of those cases, especially if it's a family plan, is that you prioritize the older children while they're still eligible for government incentives with your dollars. So once they grandfather out of the program and they're no longer eligible, then you can put your dollars to the younger children and by doing so you benefit from optimizing the amount of incentives that the whole family will get within the plan. And so that's something to consider, timing. And then also who those contributions are being allocated towards
Evan Neufeld: You've mentioned older children and making contributions while they're still eligible for government grants. The rule here is a little bit complicated and a little bit nuanced, but you can kind of think of it as the year that they turned 17. If you haven't made a contribution until they've turned 16 the rules change a little bit, but you can think of it like 17 is the last year that you can make a contribution to earn government grant.
Steven Guenther: The second thing is from a strategies component is on the withdrawal side. So there are some, some things to consider here. First of all, that we always recommend that you withdraw as much of the government incentive and the earnings within the plan, as soon as possible. Now we say this because if, for instance, you have a family plan and only one of the children goes to school and maybe they only go to school for a couple of years. Once they finished their schooling and none of the other kids go, then you're in a position where you have to repay some of that. And so, in a sense, we want to use it before we lose it in that scenario. And so I may have not mentioned this, but the government doesn't care on how the money is spent. So if you get an education assistance payment, all they're looking for is that proof of enrollment, but it doesn't necessarily have to be spent on textbooks and tuition and things that you'd think of as educational in nature.
So maybe one of your children is going to school. You take out as much education, assistance payment as possible, or you're taking as much incentive and earnings out as possible. So that by the time they're done their, let's say two-year diploma, there's none left. And so then now, you've got all of the government money out, all of the earnings out, and then you're in a good position from making sure you're using all of that and not losing any of it.
Evan Neufeld: There's another little wrinkle here too, in terms of taking out as much as possible. That's a bit of a loaded statement there, because there are rules on how much you can withdraw depending on the program. So essentially what the government's trying to prevent is a situation where Johnny says that I don't want to go to school and he says, well, you've got $25,000 in an RESP. That's going to disappear unless you go to school. So how about you just register for a program, we'll take the money out and then you can leave. So essentially what they allow you to do is take $5,000 of grant and growth that education assistance payment in the first 13 weeks of a program. And then after that first 13 weeks, there's still a limit, but the limit gets quite a bit higher that it's almost as if there's no limit after that point. So $5,000 in the first 13 weeks, and then it opens up pretty significantly from there. So you mentioned the withdrawals aren't necessarily tied to tuition or textbooks. So keeping in mind that these withdrawals can either go to the subscriber or the beneficiary, and that's literally just a payment or a direct deposit to their bank account. And there's no proof beyond that proof of enrollment that's required. So what are some of those other things that some people might use it for? Say, for example, a kid has a lot of scholarships and they don't actually need a lot of financial support, but they have this RESP money. What are some options for them?
Steven Guenther: Yeah, we run into this here and there where there's an athletic scholarship or an academic scholarship and the child is maybe living at home, so their expenses are fairly low and a lot of their tuitions are paid for. So in that case, they may not need the money to actually use for educational purposes. However, like mentioned you don't have to use it for those reasons. And so we still recommend taking the money out and then we can do a number of things with it. That could be a new car, that could be saved for a wedding, it could be saved for a first house and even it could be invested. So once a child turns 18, they would have their own tax-free savings account contribution room. And I know Evan has done a tax-free savings account podcast, you can look up, but what it allows for is that money to be withdrawn from the RESP and then reinvested in the beneficiaries tax-free savings account and then benefit from tax-free growth in the future. So even if they're not going to use it for education, there's still a lot of ways that you could be creative with this.
So this is something to consider, as a subscriber especially, if your children are younger as well is perhaps you only have so much money that you can allocate to all these different goals. Well, an RESP is actually a great place to do it because you can save for multiple goals within the same account.
So maybe your plan all along is that you're going to contribute money into here and the government incentives and the earnings are going to go for educational purposes. But the contributions that you put in, for example, might be for the child's first house. That's a great example of where you can use two goals within the same plan and be able to save for both without, losing out on those incentives that you have to contribute to be able to get.
Evan Neufeld: We just have to keep in mind the wrinkle of going to school and being able to make the withdrawals and things like that. So under that specific circumstance where the child doesn't need the money, you've got plenty of other options to do it. So an RESP, it's not a no brainer. I don't like to say that anything's a no brainer, but it's a really good place to save for a variety of different expenses that your child might incur as an early adult.
Steven Guenther: The last thing I'd note is there can be cases where you may not have the money yourself and we'd mentioned this before, so maybe you're eligible for bonds, but you're not able to put any contributions to gain any grant. Well, we have seen where, you know, maybe the beneficiaries get some money at Christmas or at birthdays from grandparents or relatives. Well, that's a great opportunity to use that money as new contributions to the plan.
If you want to get really creative with it, you could even talk to relatives or grandparents and kind of make a plan together to say, you know, I don't have the money to contribute to get any government grants but you might. And so do you want to partner with our child or do you want to partner with us in saving for their education?
I mean, we have seen where cases where grandparents will contribute the money and then when it comes time to actually take the money out, that child will only get the earnings and the government incentives, but then the contributions will actually go back to the original contributor. Well, that's a very specific case, but you can be very creative on how to use these to make sure you're maximizing the incentives within the account.
Evan Neufeld: A situation that I see once in a while is that a grandparent sees all their grandkids growing up and they say, okay, I'd like to support them for this program or help them through school or whatever. It would be much better if that conversation happens about 15 years earlier, where you could actually have that grandparents say, I'd like to support you when you turn 18. So I'd like to make a contribution to your RESP. And again, the reason you want to do that is that so you can get as much government grant as early as possible so that it can compound as much as possible.
Steven Guenther: It's the ultimate gift that keeps on giving
Evan Neufeld: Okay, well, this was a really good nuts and bolts. I'd almost call it a masterclass, Steven. This was a lot of detail here on RESPs. Is there anything you'd like to close with?
Steven Guenther: I would encourage anybody who's listening that's considering opening at RESP to do it. There are overwhelmingly more reasons to do it than not. We've talked about bonds, which you don't need to contribute to even receive. If you're under a certain income threshold as a household, we talked about alternative funding. So maybe grandparents or other relatives could help fund these plans.
We've talked about how it's very flexible to get the money out. So there's a lot of reasons you might consider not doing one, but rarely If you have the goal of education for any of your children, is opening an RESP a bad idea.
Evan Neufeld: Fantastic. Well, thank you so much, Steven, for taking the time here and thanks for joining me today.
Thanks for joining me today on the Canadian Money Roadmap podcast. If you enjoyed today's episode, I'd really appreciate if you left me a review on Apple podcasts with your biggest takeaway. If you have questions or ideas for topics you'd like me to discuss on future episodes, please reach out via my contact info in the show notes.
This podcast is intended to be educational in nature, and you should always consult your Financial, Tax, and legal advisors before making changes to your financial plan. Any rates of return discussed are historical or hypothetical and are to be used for educational purposes only. Evan Neufeld is a Qualified Associate Financial Planner and Registered Investment Fund advisor. Mutual funds are provided through Sterling Mutuals Inc.