RESPs: Back-to-school basics

Summer vacation is over. Personal finance class is now in session. Lesson number one: never turn down free money — especially if it can help pay for the soaring cost of education.

A new survey by RateSupermarket.ca pegs the total cost of post secondary school education for students not living at home at $78,817. The average tuition for college and university alone is $5,366 a year according to Statistics Canada.

As governments clamp down on spending, the cost of a higher education is expected to keep rising and that's why it makes sense for parents to start a Registered Education Savings Plan while their kids are still young.

RESP basics

Registered Education Savings Plans can be opened at most financial institutions. You can't deduct contributions from your taxable income like a Registered Retirement Savings Plan (RRSP), but any gains on the amount invested are not taxed -- similar to a Tax Free Savings Account (TFSA).

When the money is withdrawn from an RESP those gains are taxed in the hands of the student.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.

RESPs apply to most colleges and universities. For a complete list see the Government of Canada website.

Money for nothing

Here's where the free money comes in. Any contribution made by a parent will be matched with a 20 per cent contribution by the Federal government called a Canada Education Savings Grant. The annual grant 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 cough up $2,500 a year, Ottawa will cough up $500. You can help reach that goal by mentioning the RESP to friends and relatives looking for the ideal holiday or birthday gift.

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 their own additional incentives.

Host to invest in your RESP

Unlike RRSPs which will have decades to grow, RESPs have a shorter time horizon — up to 18 years depending on when parents start investing.

The earlier you start investing, the less conservative you need to be when the plan begins, and that creates the potential for higher returns. As the child nears high school graduation, and the time nears to begin withdrawing the money, the investments should be more conservative. As an example, the portfolio should have a higher proportion of stocks in the early years and that should eventually shift to a higher proportion of fixed income securities as the child approaches graduation.

Managing your own portfolio can be tricky so several mutual fund companies offer target-date-funds to help re-balance RESP portfolios as time goes on. The target dates are typically 5, 10, 15 or 15 plus years into the future depending on when you expect your child to begin college or university. To determine which one is right for you simply calculate the years until your child graduates and selected the closest date.

One note of caution: some fund companies charge annual fees as high as 3 per cent plus an additional fee when the fund is either bought or sold. Other companies charge less than 1.5 per cent with no additional fees. When you strip out the fees, returns are fairly consistent so keep in mind every dollar spent on fees is one less dollar going to your child's education.

What if your child doesn't continue with higher education?

If a child ends his or her formal education after high school parents get the amount they contributed to the RESP back and are not taxed. However, they must pay tax on the money earned in the plan. That money is taxed at the parent's individual tax rate plus an additional 20 per cent to cover the gains made on the government's contribution.

According to the Canada Revenue Agency parents may be able to reduce the taxes they have to pay by transferring the accumulated income to one or the other's RRSP.

The Federal grant money can be shared with a brother or sister if they have grant room available. If not, it must be returned to the Government of Canada … money for nothing only goes so far.