RESP today can ease student debt tomorrow

As if new parents don’t have enough to worry about, imagine what the cost of education will be when that bundle of joy graduates from high school.

Better sit down for this: Tuition fees have almost doubled in the past 18 years. A recent federal government study says at the current rate, the cost of an undergraduate degree away from home will top $100,000 in the next 18 years.

At the same time the importance of a post secondary school education will continue to increase – putting the squeeze on moderate-income students and families. A recent BMO survey says right now more than one-in-five students expect to graduate with more than $40,000 in debt.

One thing young parents have going for them is time, and that’s where a registered education savings plan comes in. An RESP gives parents a fighting chance to save, and have the federal government pick up part of the tab.

And yet, only one-third of current students enrolled in post-secondary education have access to an RESP, according to a new BMO survey. Here's what you need to know to make sure your child is financially set before they step foot on campus.

Untangling the acronyms
Unlike a registered retirement savings plan (RRSP), contributions to an RESP can not be deducted from your taxable income. Like a Tax Free Savings Account (TFSA), any gains on the amount invested in an RESP are not taxed until the funds are withdrawn.

When the money is withdrawn from an RESP the gains are taxed in the hands of the student. Since most students have little or no income, that usually means tax-free.

There is a lifetime limit of $50,000 that can be contributed for each child.

Get Ottawa to contribute
Here’s the good part: contributions made by parents will be matched with a 20 per cent contribution from the federal government called the Canada Education Savings Grant. The annual limit is $500 per child up to $7,200 over the life of the plan. A family with three children can get up to $21,600 from Ottawa.

In other words, if you can save $2,500 a year, Ottawa will contribute $500. Family and friends can help out by making contributions as holiday or birthday gifts.

Families with a net income of $42,707 or less can receive an additional 10 per cent in grant money, and Alberta and Quebec have further incentives.

Growing Your RESP
Like RRSPs and TFSAs contributions can be invested. Unlike RRSPs, which will have decades to grow, RESPs have a shorter time horizon – up to 18 years depending on when parents start investing and the child goes to school.

Most major financial institutions offer RESPs. You can manage the investments yourself or let an advisor from the institution deal with the portfolio. Either way, you decide how much risk you are prepared to take. As a general rule, safer investments tend to have lower returns.

Most institutions have formulas for 18- year-time horizons where risk and potential returns are higher at the beginning, and the portfolio slowly becomes more conservative as the time to withdraw the money comes near.

It’s important to note this service is not free. RESPs usually hold mutual funds and mutual funds are subject to management expense ratios – annual fees based on the total amount invested. Fees vary so it’s important to ask the advisor about all management costs. Keep in mind; every dollar spent on fees is one less dollar going to your child’s education.

What if school’s out forever?
If a child doesn’t continue after high school parents get the amount they contributed to the RESP back and are not be taxed.

However, they must pay tax on any gains on the amount invested. That money is taxed at the parent’s individual tax rate plus an additional twenty per cent to cover the gains made on the government’s contribution.

The entire amount can also be transferred to the RESP of a brother or sister if they have grant room available.

If there are no takers, the grant money goes back to the government.