As a parent, you’re concerned with the ever increasing costs of post-secondary education. You want your child to have at least the same opportunities you had – if not better opportunities! And, you want to know what options you have to save for your child’s education.

This bulletin describes Registered Education Savings Plans (RESPs) – a tax-effective way of saving for your child’s education. RESPs are attractive due to their flexibility and because they enable you to tap into the federal government’s Canada Education Savings Grant (CESG) and the recently proposed Canada Learning Bond (CLB) – the latter being available to children from families that qualify for the National Child Benefit supplement. On the provincial front, Alberta has also introduced a new program called the Alberta Centennial Education Savings Plan to assist with education savings (that is linked to RESPs), which we will discuss later in the bulletin. As well, we will consider “in-trust” accounts – an alternative way of saving for your child’s future.

Though the rules for RESPs are fairly complex, we believe understanding how they work is useful because of the important benefits RESPs provide for those interested in funding their children’s future education.

We have prepared this bulletin in a question and answer format, attempting to anticipate the questions you will have about RESPs, CESGs and CLBs. The questions are categorized under major headings so you can quickly find the information you are looking for.

Although we have tried to deal with as many issues as possible, you may have a question that is not covered by the material in the bulletin. Contact your BDO advisor for help with any questions that you may have.

Part A – RESP Basics

A1. What is an RESP?

To put it simply, RESPs are an agreement between you, as plan “subscriber”, and the plan “promoter” for an individual (the plan “beneficiary”) who will benefit from the income earned in the RESP. In most cases, the beneficiary is your child or grandchild, but you can also name a spouse or even yourself as beneficiary (see question A11). RESPs are offered by various companies (typically financial institutions or mutual fund companies) that act as “promoters” and are registered with the government to ensure conditions are met for favourable tax treatment.

Under the terms of the plan, you make contributions over a period of years and the promoter manages and invests the contributions, as well as the accumulated income earned on the contributions. If the RESP qualifies for the CESG, the promoter will invest the money from these deposits, as well. For those individuals that receive the proposed CLB, these deposits will also be invested with the RESP funds.

When the RESP beneficiary pursues a post-secondary education, the promoter pays out to the beneficiary Education Assistance Payments (EAPs) from the income accumulated on the RESP contributions, as well as the CESG amounts and income earned on them. EAPs will also include the proposed CLB amounts and income earned on them. Because subscribers make contributions to RESPs from after-tax dollars, these contributions are generally returned to the subscriber free of tax. Unless otherwise stated in this bulletin, we have assumed you will be using an RESP to save for your child’s education.

Unlike your RRSP, contributions to an RESP are not deductible. Despite this, RESPs still provide the following benefits:

• Tax Deferral – Earnings on RESP investments accumulate without tax. This helps you save for your child’s education much faster, since savings compound much quicker if the investment return is not subject to tax.
• Income Splitting – When the accumulated income is paid out from the RESP as an EAP, it will be taxed in your child’s hands. With education and tuition credits, as well as lower marginal tax rates, your child should pay much less tax than you would on this income.
• CESG Deposits – If the RESP qualifies, the government will add an additional 20% to the RESP (up to certain annual and lifetime maximums). As well, the government recently proposed an enhanced CESG rate for low and middle-income families. We discuss the rules for the CESG in Part C of this bulletin.

CLB Deposits – As mentioned, in 2004 the government proposed a new form of education savings assistance called Canada Learning Bonds. For children born in 2004 and after, if the family of the beneficiary qualifies for the National Child Benefit supplement, the child will be entitled to a CLB, which is also added to the RESP. We discuss the rules for the proposed CLB in Part D of this bulletin.

A2. What kinds of RESPs are available?

When you read brochures prepared by RESP promoters, you’ll notice that they refer to many types of RESPs. But RESPs can be broken down into two broad categories, which we’ll refer to as:

• individual plans, and
• group plans.

Individual plans

Of the two general RESP types, individual RESPs are more straightforward. There are two kinds of individual plans – non-family plans and family plans. A non-family plan is a plan you set up for just one beneficiary, and there are no restrictions on who can be a beneficiary of such plan. A family plan can have more than one beneficiary; however, each beneficiary must be connected by blood or adoption to each living subscriber under the plan or have been connected to a deceased original subscriber.

Under these types of plans, as you make RESP contributions each year the funds are deposited for the benefit of a specific child (the beneficiary). As investment income is earned, it is also deposited into the RESP account. When your child pursues a post-secondary education, the accumulated income is paid out as an EAP. The amount of income available to the child will be based on the performance of the investments you select.

Group plans

The other basic type of RESP is a group plan (also referred to as a pooled plan or a scholarship plan), which is a set of individual non-family plans that are administered based on a specific age group. Similar to an individual plan, you make regular contributions to a group plan that are deposited for the benefit of your child, along with the accumulated investment income. Note that for a group plan, the amount and frequency of contributions stay the same as long as the beneficiary has not turned 18. The main difference between group and individual plans is how each calculates the amount of accumulated income available to the student when he or she goes to college or university. In a group plan, when each plan matures, contributions are returned to the subscribers and the total investment earnings of the plan are transferred to an account for all of the plans that matured in the year. Each year of post-secondary education covered by the plan is given an equal part of the funds transferred from the matured plans, and these equal parts are divided among the beneficiaries who qualify to receive EAPs in each of their post-secondary years of education.

The RESP rules allow a subscriber to recover RESP income when a child doesn’t go to college or university (which we’ll discuss later in this bulletin). Most individual plans allow for these income recovery rules, while some group plan promoters have made changes giving group plan subscribers more flexibility when a child doesn’t pursue a post-secondary education. Keep in mind that it is important to carefully review the terms and conditions of any RESP before signing, as the treatment of accumulated income varies.

A3. Who can be an RESP subscriber?

Generally, an RESP subscriber must be an individual. Practically speaking, the subscriber is usually a parent, relative or friend of the RESP beneficiary. There is generally only one plan subscriber, though spouses can be joint subscribers.

A4. Does it matter who sets up an RESP for my child?

From a practical point of view, the person saving for a child’s education (usually the child’s parents) will be the RESP subscriber. However, if others are saving for your child’s education, the choice of subscriber becomes relevant.

For example, let’s say you and your parents are all saving for your child’s education. As we’ll discuss in Part B, RESP contribution limits are tracked on a per-beneficiary basis. So, the amount you and your parents can contribute to an RESP for your child will be restricted to one set of contribution limits. Where the total amount being saved by you and your parents each year exceeds the RESP contribution limits, you’ll need to decide on who will be using an RESP and who will be saving money outside the plan.

Although this decision will depend on a number of factors, such as the marginal tax rate for you and your parents, there are some specific RESP rules to keep in mind. In question F2, we point out that RESP beneficiaries can be changed without penalty as long as the old and new beneficiaries are both related to the subscriber by blood or adoption. Consequently, if your parents have other grandchildren, they could name another grandchild as beneficiary should your child not go on to college or university, even if that grandchild is a beneficiary of another RESP.

On the other hand, it may also be possible to transfer accumulated RESP income to the subscriber’s RRSP when the beneficiary doesn’t pursue a post-secondary education. These rules are discussed in more detail in question G4. In this case, you’ll want to be the RESP subscriber if your parents will be too old to have an RRSP if and when RESP income is returned.

A5. How will I know if someone else sets up an RESP for my child?

Plan promoters must notify beneficiaries (or their parents where the beneficiary is under 19 and lives with their parents) within 90 days of the establishment of an RESP on their behalf. As part of the notification, the promoter must give the beneficiary the name of the subscriber. This rule is important because of contribution limits. For example, let’s say your sister establishes an RESP for your child as a gift. If you did not know that your child was a beneficiary of that RESP and you set up an RESP for the child as well, and both of you are making contributions, there is a risk that the contribution limits would be exceeded.

A6. Can the plan subscriber be changed once the plan has been set up?

Generally speaking, the subscriber can’t be changed after the plan has been set up. However, changes are allowed in the following situations:

• Marriage Breakdown – If a spouse or former spouse acquires the subscriber’s rights under an RESP due to marriage breakdown, that spouse can become the RESP subscriber.
• Death of Subscriber – In the event of the death of a subscriber, the deceased’s estate may become the subscriber. As an alternative, the surviving spouse (or another person) can replace the original subscriber on death.

You’ll need to check the terms and conditions of your RESP as well, to see if these changes are allowed under the terms of the plan.

A7. Can I set up an RESP with more than one beneficiary?

As we discussed earlier, you can set up a family plan with more than one beneficiary. Under this option, each beneficiary must be related to the subscriber by blood or adoption. You are related by blood to your children, grandchildren, great grandchildren, brothers and sisters. However, this group does not include yourself or your spouse. Since 1998, contributions to family plans in respect of a beneficiary are generally only allowed where the beneficiary is under 21 at the time of being named a beneficiary and at the time of the contribution.

A8. Can I add a beneficiary to a family plan once it has been set up?

Yes (subject to plan restrictions), so long as the beneficiary is under 21 and is related to the subscriber by blood or adoption, the beneficiary can be added. So, as additions to your family come along, they can be added as beneficiaries to a family plan RESP.

A9. One of my daughters lives overseas with her mother. Can I establish an RESP for her?

Since 1999, new plans (and those that replaced plans entered into before 1999) cannot be registered unless the beneficiary’s social insurance number (SIN) is provided on the application. Under proposed changes, beginning in 2004, an individual can be designated as a beneficiary (and contributions can be made on that person’s behalf) only if his or her SIN number is provided before the designation (or contribution) is made and the individual is resident in Canada when the designation (or contribution) is made.

There are a couple of exceptions to this rule. Designation as a beneficiary and contributions will still be allowed if:

• a contribution is made by way of a transfer from another RESP that the individual was a beneficiary of immediately before the transfer, even if the beneficiary is not resident in Canada (but a SIN number will still be required), or
• the plan was entered into before 1999, in which case existing beneficiaries can be non-residents and need not have SINs.

If either of these exceptions apply, contributions are permitted, but they will not qualify for the CESG.

Since your daughter is not resident in Canada, you cannot establish an RESP for her at this time. If she returns to Canada and has a SIN, you can name her as an RESP beneficiary.

A10. How long can I contribute to an RESP?

Contributions to a non-family plan can be made to an RESP for 21 years following the year the plan is set up, or possibly an earlier date, if amounts have been transferred from an existing RESP. Contributions to a family plan can only be made until the earlier of the following three dates:

• The date the beneficiary turns 21,
• After the 21st year that follows the year the subscriber enters into the plan, or
• Where property is transferred from an existing RESP, after the 21st year that follows the earlier of the year the transferring plan was entered into or the year the receiving plan was entered into.

Note that both types of plans must be terminated on or before the last day of the 25th year following the year the plan was set up.

A11. I have been working for a number of years and I am thinking of leaving my job to get a university degree. Can I set up an RESP for myself?

You can set up an RESP where you are both subscriber and beneficiary. This could be beneficial if you’ll be saving money for university over a number of years because you’ll be earning investment income on those savings while you’re working and the income won’t be taxed. You can then receive the accumulated income as an EAP when you go back to school. With education and tuition credits, you may pay little or no tax on the accumulated income.

You can also use a similar strategy for saving for a spouse’s education with either you or your spouse as subscriber. Because of your age, however, you (or your spouse) will not be eligible for the Canada Education Savings Grant (CESG).

A12. I am a U.S. citizen living in Canada. Can I set up an RESP for my child?

U.S. citizens or Green Card holders resident in Canada can invest in RESPs – but doing so may have negative consequences for U.S. tax purposes. The main disadvantage is that, unlike Registered Retirement Savings Plans (RRSPs) and Registered Retirement Income Funds (RRIFs), as a U.S. citizen, you cannot elect to defer the taxation of income earned in an RESP. As well, since an RESP is a foreign trust, you are subject to special U.S. reporting requirements for foreign trusts. Lastly, there is an element of double taxation, because for U.S. tax purposes the plan income will be taxable to you as the contributor and for Canadian tax purposes the income will generally be taxable in the hands of your child when they go to university or college.

So, you may want to consider an RESP for your child in order to take advantage of the Canada Education Savings Grant. However, in this situation it would be better for another relative in Canada (who is not a U.S. citizen or Green Card holder) to set up the RESP. For example, if a U.S. citizen marries a Canadian and they have a child; contributions by the parents of the Canadian spouse could be made for their grandchild, thereby avoiding the U.S. issues.

Part B – RESP contribution rules

B1. How much can I contribute to an RESP for my child?

For each beneficiary, you can contribute up to $4,000 annually to an RESP. There is also a cumulative lifetime contribution limit of $42,000. These contribution limits apply to all RESPs set up for your child. As we’ll discuss in Part C, although you can contribute up to $4,000 per year, only a portion of it will be eligible for the CESG.

B2. My mother and I both set up RESPs this year for my 10-year-old daughter. I was planning to contribute $4,000 to the RESP I set up and my mother is thinking about contributing $2,000 to the plan she established. What are the consequences?

The contribution limits discussed in question B1 apply for all plans set up for the same beneficiary, so all subscribers must share the contribution limits for your daughter. Therefore, the total amount you and your mother contribute for your daughter will have to be compared to your daughter’s annual and lifetime RESP limits.

Dealing specifically with your situation, if you and your mother together contribute $6,000 in one year to RESPs for your daughter, the total contribution will be in excess of your daughter’s $4,000 annual RESP limit. This would result in a penalty of 1% per month on the $2,000 overcontribution. A contributor’s share of the penalty is based on the proportion of their contribution compared to all contributions. Consequently, your share of the penalty tax would be 2/3 ($4,000/$6,000) and your mother would have to pay the remaining 1/3. Given the overcontribution penalty, the total amount you and your mother contribute should be reduced to $4,000.

It should be noted that overcontributions can be withdrawn by the subscriber. This reduces or eliminates the penalty tax, however, when determining whether the $42,000 lifetime RESP limit has been exceeded, overcontributions (even those that have been withdrawn) count as contributions for the beneficiary. So, care should be taken to avoid overcontributions.

B3. When should I make my RESP contribution?

Your RESP contribution for a particular taxation year must be made during that calendar year. Unlike an RRSP, an RESP contribution made during the first 60 days following a taxation year will not count as a contribution for the previous year.

Planning tip – You can maximize the accumulated income in an RESP by making contributions early in the year. This will provide a larger amount of money for your child’s education and will also maximize the income splitting potential provided by RESPs.

B4. Should I make RRSP contributions or RESP contributions? Or should I pay off my mortgage and save for my child’s education later?

For those of us with children and a mortgage, most will have three saving priorities that seem to conflict:

• saving for a child’s education,
• paying off our mortgage, and
• saving for retirement.

The key to dealing with these conflicting objectives is to prioritize them. For example, if you are a member of a pension plan, the amount you can contribute to an RRSP may be fairly small. Therefore, saving for your child’s education and paying down your mortgage may be more important. With the ability to carryforward RRSP room indefinitely, you could wait and make RRSP contributions later.

If you decide all of these priorities are equally important, then a balanced approach may make sense. For example, you could use your income tax refund from RRSP contributions to fund an RESP contribution and additional mortgage payments.

One priority you’ll want to consider is setting aside $2,000 a year for each child for RESP contributions so you can earn the maximum CESG. It isn’t often that the government gives you money, so you should ensure you take advantage of it.

Planning tip – When you are raising children, finding money to put in an RESP may seem impossible. Consider arranging pre-authorized monthly RESP withdrawals from your bank account. This will ensure you won’t have to come up with a lump-sum contribution each year.

B5. Should I borrow to make RESP contributions?

You can borrow to make an RESP contribution – but you won’t be able to claim the interest expense as a tax deduction. So, borrowing doesn’t make sense from a tax point of view. Borrowing could make sense when you’re nearing year-end and you expect to have enough money for an RESP contribution in a few months. By borrowing and making a contribution now, you’ll ensure CESG room is not carried forward. As we discuss in question C3, you won’t be able to use up CESG room accumulated over a number of years quickly.

B6. What happens if I contribute less than $4,000 per year?

Unlike an RRSP, if you don’t contribute to the RESP in one year, you can’t carry the $4,000 annual contribution limit forward to make a catch-up contribution in a subsequent year. However, keep in mind that with a $42,000 lifetime contribution limit, this limit can be utilized in 11 years, so you don’t need to make the maximum annual contribution every year to use up the lifetime limit.

But, before you decide not to contribute to your RESP this year, you should take a look at the terms and conditions of the RESP. Depending on the terms of a group plan, you may forfeit the RESP income if contributions are not made on time.

Part C – Canada Education Savings Grant

C1. How does the CESG work?

The Canada Education Savings Grant (CESG) is a federal grant that is added to your child’s RESP as contributions are made. The amount of the grant is equal to a percentage of the RESP contribution, to an annual maximum. In the 2004 budget the government proposed an “enhanced” CESG for low and middle-income families which is to begin January 1, 2005. First we’ll discuss the current CESG program, then we’ll explain how the proposed enhanced CESG will work.

The current CESG program

The current CESG is equal to 20% of RESP contributions made, to an annual maximum CESG of $400 per beneficiary. In other words, to earn the maximum $400 CESG in any given year, $2,000 of RESP contributions must be made on behalf of the beneficiary. This annual maximum is referred to as the “CESG room”. The maximum lifetime CESG grant for a beneficiary is $7,200 (based on $400 per year for 18 years).

This CESG room begins to accumulate in the year your child is born and stops accumulating in the year your child turns 17. Your child is entitled to the CESG regardless of whether you’ve actually set up an RESP for your child, so you don’t have to rush out and immediately set one up for a child born late in the year. The CESG room accumulates regardless of whether an RESP is established for the child – it’s just that the sooner you actually set up the RESP, the sooner the investment income starts to accumulate on the CESG.

The CESG program began in 1998, so no CESG room is earned for years before 1998. Consequently, only children born after 1997 will actually benefit from the maximum CESG of $7,200.

Finally, to qualify for the grant, your child must:

• be a Canadian resident at the time of the contribution, and
• have a SIN.

As well, contributions to the plan must be made before the end of the calendar year in which your child turns 17 year of age. Note that there are restrictions for beneficiaries that are 16 and 17 years of age, which we’ll discuss at C2.

You can apply in person for a SIN for your child at a Human Resource Centre of Canada (HRCC) (located in most large cities), or by mail. For more information, check the Social Development Canada website at: www.sdc.gc.ca/en/gateways/topics/sxn-gxr.shtml.

The enhanced CESG program

Under 2004 budget proposals, the proposed enhanced CESG matching rate is 40% for the first $500 contributed to an RESP on behalf of a beneficiary who is under 18 throughout the year and whose family has qualifying net income in respect of the year of $35,000 or less. If this child’s family has qualifying net income in respect of the year of greater than $35,000 but less than $70,000, the enhanced CESG matching rate is 30% on the first $500 contributed. All other contributions made on behalf of such beneficiaries (up to the annual $2,000 limit for all contributions) will qualify for the basic 20% CESG rate. What this means is that the maximum CESG has been increased to $500 for families with income under $35,000, and to $450 for families with income between $35,000 and $70,000.

As noted, qualification for the enhanced CESG rates is based on qualifying net income, which will generally be family net income used to determine eligibility for the Canada Child Tax Benefit with respect to the child in January of that calendar year. Therefore, this condition will be based on family net income for the second preceding taxation year. It should be noted that the $35,000 and $70,000 qualifying net income thresholds applicable to the enhanced CESG will be indexed for inflation for 2005 and subsequent taxation years.

Contributions related to RESPs set up by parents, grandparents and other individuals may be eligible for the enhanced CESG matching rates. However, where the RESP subscriber is not the primary caregiver (or his or her spouse or common-law partner), consent from the primary caregiver is required before the enhanced CESG rate will be paid on contributions made by such subscribers. Unless consent is obtained, the basic CESG matching rate of 20% will apply on eligible contributions. In any event, the enhanced CESG matching rate is only applicable to the first $500 contributed each year to all RESPs of which a child is the beneficiary.

This proposed measure is to be effective January 1, 2005, however the first payment of the enhanced CESG will not be made until after legislation is enacted and administrative systems are put in place by the government.

C2. My son will turn 16 this year. Will contributions to his RESP be eligible for the CESG?

When contributions are made for a child who turns 16 or 17 in the year of contribution, special rules apply that may restrict CESGs, depending on the timing and amount of contributions made in prior years.

Since your son will turn 16 this year, one of the following two conditions must be met for his RESP to qualify for the CESG this year:

• contributions to all RESPs for your son during prior years totaled at least $2,000, or
• contributions of at least $100 per year were made to RESPs for your son in any four prior years.

If one of these two conditions is met this year, you’ll be able to make a contribution next year which will also qualify for the CESG.

Your question also highlights a planning opportunity where a new RESP is being set up for an older child. You’ll want to ensure the rules above are met prior to the year your child turns 16. For example, if your child will turn 15 in 2004 and you’re thinking about setting up an RESP, you’ll want to contribute at least $2,000 before the end of 2004 so that the RESP can earn CESGs in 2005 and 2006.

C3. What happens if I can’t contribute $2,000 in a year? Do I lose the CESG room for that year?

If you’re unable to make an RESP contribution large enough to earn a full basic CESG grant (the 20% CESG) in a particular year, the beneficiary’s unused basic CESG room is carried forward. But, if you accumulate basic CESG room for more than one year, don’t count on being able to catch up right away. Where basic CESG room is carried forward, the maximum grant available in a year is equal to 20% times the least of:

• the amount of basic CESG room available,
• your RESP contributions for that year, and
• $4,000.

This means that in addition to using $2,000 of current basic CESG room, you’ll only be able to clear $2,000 of basic CESG room carried forward.

Remember, there is no carry forward of unused amounts of the enhanced CESG, so those qualifying for an enhanced CESG should try to contribute $500 where possible.

An example will show how the rule regarding unused CESG room works. Assume Tina’s family income is greater than $70,000 each year. Let’s say Tina contributes $500 to an RESP for her child in both 2004 and 2005. Since a contribution of $2,000 per year would qualify for the grant, $3,000 of CESG room will be carried forward to 2006 ($1,500 from 2004 and $1,500 from 2005). If Tina contributes $4,000 to an RESP in 2006, it will qualify for a CESG of $800 (20% x $4,000), being the maximum amount under the formula described above. This will still leave $1,000 of excess CESG room, which can be carried forward to 2007. To clear this room and the new CESG room for 2007, Tina will want to contribute $3,000 in 2007. The chart below summarizes the CESG room, carryforwards and grants for these years.

As this example shows, there is a limited ability to use CESG room carried forward, so you shouldn’t let too much room accumulate.

C4. If I contribute more to an RESP than I need to for a full basic CESG this year, can I carry forward the excess to next year for an additional CESG claim?

If you contribute more than the available CESG room to an RESP, you can’t carry the excess contribution forward to another year and use it to earn the grant. For example, assuming your available CESG room is $2,000 – if you contribute $4,000 to an RESP this year, you can’t use $2,000 to get a $400 grant this year and the remaining $2,000 next year to get another $400 grant. Consequently, if you’re not sure you can contribute an additional $2,000 next year, you should consider contributing $2,000 this year and waiting until next year to contribute the remaining $2,000.

C5. I opened an RESP several years ago. Are contributions to this RESP eligible for the CESG?

Contributions to existing plans may qualify for the CESG, but you’ll have to make sure certain changes were made to the plan before 2000. These changes include:

• In the case of a family plan, the terms of the plan must prohibit the addition of beneficiaries over the age of 21.
• The plan restricts education assistance payment (EAPs) during the first 13 weeks of a course to $5,000 (we discuss this in more detail in question G2).
• The plan rules for EAPs have been amended so that EAPs paid to a beneficiary do not include accumulated basic CESG amounts where the individual became a beneficiary after turning 21.

If you’re not sure the changes were made, it may make sense to open a new RESP that already meets these conditions.

Remember also that to be a recipient of the CESG, the RESP beneficiary must be a resident of Canada at the time the contribution is made and have a valid SIN that has been provided to the plan promoter.

C6. Before CESGs began, I set up an RESP for my child. I don’t have the funds to make contributions this year. Can I withdraw contributions from the old plan and use it to make RESP contributions to a new plan to get the CESG?

The government anticipated this idea when it first introduced CESGs in 1998, so it implemented rules at that time to prevent you from recycling contributions made to an RESP before 1998 that didn’t qualify for the CESG.

The government has now also proposed special rules to prevent subscribers from withdrawing existing RESP contributions and recycling them to an RESP in hopes of obtaining the enhanced CESG. These special rules will apply to withdrawals from RESPs after March 22, 2004 for non-education purposes where contributions previously qualified for the CESG. Where such withdrawals occur, a 20% CESG matching rate will apply to all eligible contributions made to any RESP in respect of those beneficiaries until the total level of contributions to RESPs for those beneficiaries returns to the level attained prior to the withdrawal.

C7. I have set up an RESP for my son to get the CESG. Are there any negative tax consequences associated with an early withdrawal of contributions?

To deter you from withdrawing early, if you withdraw money from your son’s RESP you’ll have to pay back CESGs received. For the purpose of the repayment, RESP contributions are broken down into two pools, “assisted contributions” (those qualifying for the CESG) and “unassisted contributions.” Early withdrawals of contributions are paid from the assisted pool first.

Where an assisted contribution is withdrawn, the RESP administrator is required to repay some or all of the accumulated CESGs. The amount repayable is equal to 20% of the withdrawal, up to the total accumulated CESGs.

Part D – Canada Learning Bond

D1. What is the Canada Learning Bond? Who qualifies for it?

In the 2004 federal budget, the government proposed a new source of education savings for children from low-income families called the Canada Learning Bond (CLB). The CLB program is effective for children born on or after January 1, 2004. Note, however, that the legislation regarding this program had not been released at the time of writing; therefore the information provided in this bulletin is based on the government’s intention as outlined in the 2004 budget papers.

This new program will provide each child born on or after January 1, 2004 with a CLB in each year that the child’s family is entitled to the National Child Benefit (NCB) supplement, up to and including the year the child turns 15. The amount of the CLB in the first year of entitlement will be $500, and any subsequent CLBs will be in the amount of $100. The CLB will be payable into an RESP of which the child is a beneficiary.

The first payment of the CLB will be made after the relevant legislation is passed and once delivery systems are put in place. So, it is not expected that CLB payments will be made before January 2005.

Note that the CLB will not affect RESP or CESG contribution limits, and no CESG will be paid on the CLB amounts transferred into an RESP. CLB entitlements will be allocated to a specific child and, unlike the CESG, cannot be shared with other beneficiaries in a family plan or group plan.

Entitlement to the CLB will be determined at the time of the first monthly payment of the NCB supplement in a benefit year in respect of a child. The NCB supplement is paid on a 12-month benefit year cycle (beginning in July) based on family net income for the preceding tax year. Because eligibility for the CLB is linked to entitlement for the NCB supplement, for the child to be entitled to the CLB, it will be necessary to make an application for the Canada Child Tax Benefit. Children for whom a Children’s Special Allowance is paid will also be eligible for the CLB.

As with the enhanced CESG, although any person can subscribe to an RESP for the benefit of a child, only the primary caregiver for a child (generally the person receiving the NCB supplement) can authorize the transfer of the CLB into an RESP for the benefit of the child.

To better understand how the CLB will work, let’s consider a couple of examples. Assume that in 2004 the Smith family welcomes their new baby – Terry. Because the Smiths receive the NCB supplement for that year, Terry will be entitled to a $500 CLB at birth. If Terry’s parents continue receiving the NCB supplement each year, including the year Terry is 15, he will be entitled to a $100 CLB for each year (after his year of birth), so that his total CLB amounts will be $2,000. If Terry’s parents set up an RESP for Terry in 2005, income on the CLB amounts would grow at the rate of return applicable to the RESP.

Now let’s consider Chris’ family. Chris was born in 2004 as well, but in 2004 the family’s income is about $40,000, which is above the NCB supplement range. But, in 2005, 2006 and 2007 the family’s income is lower, such that they receive the NCB supplement. As a result, Chris will be entitled to the first CLB of $500 in 2005 and an additional $100 CLB in 2006 and 2007.

D2. Money is tight – what if I can’t afford to set up an RESP?

To encourage families qualifying for the CLB to set up RESPs, an additional $25 will be paid into the RESP to which the initial CLB of $500 is deposited. This $25 is intended to help recognize the one-time incidental expenses that may be associated with opening the RESP. Remember, to set up an RESP you will need a SIN for the beneficiary.

D3. Must I set up the RESP right away?

No, the Department of Human Resources and Skills Development will keep track of CLB entitlements as they accumulate for each child. A CLB in respect of a child can be transferred to an RESP at the request of a primary caregiver any time before the child reaches 18 years of age. However, no interest will be paid on CLB entitlements that have not been transferred to an RESP, so establishing an RESP sooner is more advantageous in order for income to begin to accumulate on the funds.

If CLB entitlements in respect of a child have not been transferred to an RESP by the time he or she reaches 18, the child will have up to three years to open their own RESP and receive CLB funds. In this case, the child will be both subscriber and beneficiary of the RESP. However, once he or she turns 21, the CLB entitlements will be lost if not transferred to an RESP.

Part E – Alberta Centennial Education Savings Plan

E1. What is the Alberta Centennial Education Savings Plan?

In March 2004, the Alberta government passed into law this new savings plan which becomes effective in 2005 and will provide $500 for every child born to, or adopted by, Alberta residents. To access the grant funds, the child will need to have an RESP and an application submitted on their behalf for the funds no later than the last day of the year after the child is born or adopted. Grant payments will be deposited into the child’s RESP. Unlike the federal CLB, this program is not income tested.

In addition to the initial $500 grant, the Alberta government will provide $100 to an RESP for children attending school in Alberta at ages 8, 11 and 14. The $100 grants will begin to apply to children born in 2005 - so, the first $100 grants will be issued in 2013.

A child will not have to receive previous grants in order to qualify for subsequent grants, and grant payments will not be taxable, nor will they affect RESP contribution limits.

Part F – Managing your RESP

F1. What investments can I hold in my RESP?

Since 1998 there have been rules in place regarding what types of investments are “qualified investments” for RESPs. In general, these rules parallel the eligible investment rules for RRSPs. You can hold the following investments in your RESP:

• cash and bank, trust company or credit union deposits, including GICs;
• shares listed on the TSX Venture, Toronto and Montreal stock exchanges;
• shares listed on most foreign stock exchanges;
• shares or units of Canadian-based mutual funds that meet prescribed guidelines (mutual funds are certified as RRSP eligible, and therefore RESP eligible, by the Canada Revenue Agency);
• shares of Canadian public corporations not listed on the stock exchanges above;
• options on the purchase of eligible investments;
• segregated fund policies; and
• most government debt and debt of corporations listed on the Canadian stock exchanges noted above.

Note that unlike your RRSP, there is no limit to the amount of foreign property you can hold in an RESP.

If a non-qualifying investment is acquired by your RESP, a penalty tax will apply. The penalty tax is equal to 1% per month of all non-qualifying investments held at the end of each month. In addition, the Canada Revenue Agency has the right to revoke any RESP that holds non-qualifying investments.

Grandfathering rules are available for property held on October 27, 1998. You can continue to hold “October 27, 1998 property” in the RESP without penalty. However, if you dispose of this property, it can’t be reacquired later.

In addition to the tax rules, the terms of your RESP may restrict the range of investments you can hold. For example, a mutual fund company may offer an RESP with little or no fees provided you purchase only that company’s funds. An RESP that is fully self-directed offers the most flexibility, but the fees may also be higher.

F2. Can I change a plan beneficiary?

Depending on the terms of the RESP, you may be able to change the plan beneficiary. With the exception of family plans (where beneficiaries are members of the same family), tax rules generally do not restrict who may be named as a new beneficiary. However, there is an important tax rule that you have to keep in mind. If you name a new beneficiary, all contributions made to the plan over the years for the former beneficiary are generally deemed to have been made for the new beneficiary at the time the contribution was originally made. As a result, if the new beneficiary is already an RESP beneficiary under a different plan, a large overcontribution penalty could arise, especially if maximum contributions have been made to both plans over the years.

Fortunately, the deeming rule does not apply if the former beneficiary and the new beneficiary are both related to the plan subscriber by blood and both are under 21, or if the two beneficiaries are siblings and the new beneficiary is under 21. In addition, where the old and new beneficiaries are related by blood or are siblings, and the new beneficiary is under 21, the accumulated CESG deposits may not be lost (depending on the terms of the plan). Note that there are restrictions on the amount of CESGs that can be paid to one beneficiary as an EAP (see question G5 which discusses this situation under a family plan).

In question A4, we mentioned that having a grandparent act as subscriber could be beneficial. If your parent is the subscriber of an RESP for your child, the size of the group eligible for the exception to the deeming rule that applies when new beneficiaries are named is broadened to include other grandchildren. This could be beneficial for families with just one child. If your child doesn’t go on to college or university, then your niece or nephew could be named as a beneficiary without the application of the deeming rule.

Historically, many group plans did not allow a change in beneficiary under the terms of the plan. However, some group plans may now allow for substitution, so be sure to check the terms of your RESP.

Part G – Payments from an RESP

There are generally four types of payments that can be made from an RESP. Education Assistance Payments (EAPs) are payments to beneficiaries out of RESPs to fund their post-secondary education. Contributions to the RESP can be returned to the subscriber or paid to the beneficiary, subject to the terms of the agreement. Such amounts (which are referred to as “refunds of payments”) are not subject to tax regardless of who they are paid to, because the contributions were originally made from after-tax dollars. An RESP may also provide for payments to a Canadian designated educational institution. Finally, a payment of income earned from an RESP that does not include one of the above noted payments is considered an Accumulated Income Payment (AIP), and is usually paid to the subscriber.

G1. Now that my son is going to university, how does he get money from the RESP I set up and how will he be taxed on the payments received?

Now that your son is going to university, he will be eligible to receive EAPs from the accumulated income in the plan if he:

• is studying on a full-time basis,
• has courses that are at least three consecutive weeks in length, and
• spends at least 10 hours per week on the courses or on work in the program.

Exceptions to this rule are allowed for students who are disabled.

Note that the education program will not qualify if it is taken while the student is also receiving employment income and if the program is being taken in connection with or as part of the student’s employment. This does not include part-time or temporary employment of the student for purposes of financing their studies.

Before making an EAP payment the plan promoter will likely want proof the beneficiary is enrolled full-time in a qualifying educational program.

If contributions made to your son’s RESP qualified for the CESG or the proposed CLB, the EAPs he receives will be a combination of CESG and CLB deposits and income accumulated on those funds. The CESG component will be based on the ratio of the CESGs paid into the plan compared to the total investment earnings in the plan. A specific portion of each EAP will also be considered to be attributed to the CLB.

EAPs received by your son are reported on a T4A Supplementary slip. Note that your son won’t be taxed on the amount you contributed to the RESP – only on the income earned in the plan and on any CESGs and CLBs paid out. When he reports this income on his tax return, he may pay little or no tax after he claims his personal, tuition and education tax credits. Note that these payments are not considered scholarship payments for the $500 or $3,000 scholarship exemptions.

G2. Is there any limit to the amount my son can withdraw from an RESP?

The amount that can be paid as an EAP during the first 13 weeks of your son’s studies is limited. Until your son has completed 13 consecutive weeks of a qualifying education program, the maximum amount that can be received as an EAP is $5,000. There is no restriction after the first 13 weeks, provided your son continues to meet the general conditions discussed in question G1. If there is a 12 month period where your son is not enrolled in a qualifying educational program for 13 consecutive weeks, the $5,000 maximum payment restriction will apply again.

Note that the Minister of Human Resources and Skills Development Canada is allowed to approve an EAP exceeding $5,000 in the first 13 weeks of study on a case-by-case basis. However, because the limit applies for a short period, it is likely that the Minister will approve a greater amount only in exceptional cases, such as where the cost of tuition for a particular program is substantially higher than average.

G3. What happens if my son decides to attend a foreign university?

If your son attends a foreign college or university he can receive EAPs, provided the course is at least 13 consecutive weeks in length.

Your son’s residency for tax purposes is also an important consideration. EAPs paid to a non-resident can’t include accumulated CESGs. This means that as your son receives money, the accumulated income balance will be depleted while accumulated CESGs will remain in the plan. If the accumulated CESGs are still in the RESP when all the investment income is paid and the plan is terminated, this money must be repaid to the government. It is not known at the time of writing how CLBs will be treated in this situation.

Residency is based on an individual’s specific situation and depends on the individual’s intention at the time of the move, as well as on personal and social ties to Canada compared to the foreign location, and other factors. Therefore, your son may want to ensure he keeps enough ties with Canada to remain a Canadian resident or he should ensure all EAPs are received and the RESP is collapsed before he becomes a non-resident.

The implications associated with emigration can be complex. Consult your BDO tax advisor.

G4. I have set up an individual RESP for my son. What happens if he doesn’t go to college or university?

If your son doesn’t go on to post-secondary education, you still have some options so that you won’t lose the accumulated income in the plan. Remember, the alternatives discussed below are based on the assumption that they are allowed under the specific terms of your RESP.

Assuming your son does not pursue a post-secondary education, the following alternatives are available to you:

• Naming a new beneficiary (which we discussed in question F2),
• Transferring the accumulated income to your RRSP, or
• Receiving the accumulated income as a direct receipt.

Before you can transfer the accumulated income to your RRSP or receive the accumulated income as a direct receipt, you must meet the following conditions:

1. You must be resident in Canada,
2. Each plan beneficiary for whom you made contributions must be over 21 and not currently eligible to receive EAPs, and
3. The RESP must have been in existence for at least 10 years.

It should be noted that the Canada Revenue Agency can waive conditions 2 and 3 if the RESP beneficiary is mentally impaired and as a result it is reasonable to expect that they will not be able to pursue post-secondary education.

When an AIP is made from a plan (regardless of whether it’s transferred to an RRSP or if it’s received directly), the CESG must be returned to the government. Keep in mind, however, that the income earned on the CESG is not returned to the government. Also, given that the rules applied to CLBs are to be similar to those applied to CESGs, it is likely that when an AIP is paid the CLB will also have to be returned to the government (however, this outcome will not be certain until the legislation governing CLBs is enacted).

As well, remember that as long as the terms of the plan allow it, the promoter can return to the subscriber the original contributions tax-free.

Transfer the accumulated income to your RRSP

If you qualify for a return of income and you have RRSP contribution room, you can transfer the AIP amount to your RRSP or to your spouse’s RRSP (if you are joint subscribers and if he or she has enough contribution room). The maximum amount you can transfer is $50,000. Under this option, you’ll include the accumulated income in your income and then claim an RRSP deduction for the amount transferred to your RRSP.

Receive the accumulated income directly

The other way to recover the accumulated income is to simply receive the funds directly. This option will appeal to you if you have no RRSP contribution room available or if you are over age 69 (as you would have already collapsed your RRSP).

When you receive the AIP directly, however, you’ll be subject to regular income tax on the income. In addition, a 20% penalty tax will be payable (12% for residents of Quebec). This penalty tax is charged to offset the benefit of the tax deferral you previously enjoyed.

In question A4, we mentioned that there is a downside to having a child's grandparent be the RESP subscriber. If the grandparent is over 69 when the RESP income is recovered, the grandparent won’t be able to use the RRSP transfer option. A cash refund, subject to the penalty tax, will be the only option for recovering accumulated plan income. You may want to consider this when deciding on a subscriber.

Planning tip – If it becomes apparent your child won’t be going on to post-secondary education, you may want to reduce your RRSP contributions in the years prior to the year when the RESP must be collapsed. This will increase the amount you can transfer from the RESP to your RRSP and help you minimize the penalty tax.

Planning tip – If a subscriber wants to contribute an AIP amount to his or her RRSP but the subscriber does not have enough RRSP room, consider adding the subscriber’s spouse as a joint subscriber to the RESP – this can be done at any time before termination of the RESP. That way, AIP amounts can be transferred to the spouse’s RRSP, assuming there is contribution room in the spouse’s RRSP.

Note that when AIPs are made from an RESP, the plan must be terminated before March of the year following the year in which the first AIP is made.

G5. I have set up a family plan for my son and daughter. I don’t think I’ll be able to contribute enough to receive the maximum CESG for each child. If only one child goes to a college or university, can that child receive all of the accumulated CESG deposits as an EAP? What about accumulated CLBs?

In the case of a family plan, if one child doesn’t go on to post-secondary education (let’s say your son), then it may be possible to pay the accumulated CESG deposits on contributions for him to your daughter. However, the CESG amount paid to your daughter can’t exceed her lifetime maximum.

This may sound complicated, but it becomes much clearer if we take a look at an example. Let’s assume your net family income is greater than $70,000 (therefore you do not qualify for the enhanced CESG available to low and middle-income families) and your son and daughter were both born after 1997. Therefore, both children can potentially be paid EAPs from a family plan that includes $7,200 of accumulated basic CESGs. However, let’s assume you will contribute $25,000 over time for each child. Assuming this amount is contributed evenly over the years, you will have $5,000 of accumulated CESGs in the RESP for each child.

When your daughter goes to college or university, she can receive $7,200 of the accumulated basic CESGs – $5,000 of her own and another $2,200 of CESGs accumulated for your son. The remaining $2,800 of your son’s CESG balance will have to be repaid.

Under current proposals and unlike CESGs, the CLB entitlements will be allocated to a specific child and cannot be shared with other beneficiaries in a family plan.

Part H – Other Education Savings Alternatives

H1. What is an “in-trust” account? How can this be used to save for my child’s education?

Apart from simply investing money personally, the most popular alternative to an RESP is an “in-trust” account. Under this type of arrangement, you can deposit funds into an investment account for a minor child and hold the money in trust until he or she reaches majority. If you choose investments that produce capital gains, such as equity mutual funds, these capital gains will be taxed in your child’s hands. With their personal tax credit, your child may pay little or no income tax on this income. If other income is earned in the account, such as dividends and interest, however, this income will be attributed to you and included in your income.

There are a number of important considerations when deciding on whether to use an “in-trust” account or an RESP. We have summarized the more important considerations in the chart on the last page of this bulletin.

Many ask the question: “Should I use an RESP or an “in-trust” account to save for my child’s education?” An important point to keep in mind is that you can use both options. For example, if you are saving $4,000 each year for your child’s education, you don’t have to put it all in an RESP. You may want to contribute $2,000 to an RESP (to get the CESG) and deposit the rest in an “in-trust” account. Remember that even though RESPs are relatively flexible, there are still a number of conditions that apply. Consequently, a balanced approach may be the best course of action.

Summary

Planning for your child’s education is important and there are many options available. And, given that the government is providing more incentives to save with CESGs and CLBs – it makes sense for you to consider RESPs.

The combination of the tax rules, investment conditions and seemingly unlimited choice of products, however, may make the task of making the best savings decisions seem overwhelming. Remember that your BDO advisor is ready to help you understand the RESP options available and to assist you in planning for your child’s education.

                                                         RESP or "In-Trust" Account?

Two strategies have emerged when saving for a child’s education: the RESP and the “in-trust” account. Each alternative has advantages and disadvantages, which we have summarized below.

Notes:
(1) For more information on income splitting, ask your BDO advisor for our Income Splitting bulletin.
(2) Students have the option of carrying forward unused tuition and education credits for their own use or transferring these amounts to a supporting person. Before a credit can be transferred or carried forward to a subsequent year the student must utilize current year credits to fully offset current tax.