RESPs Worth Another Look
An attractive saving solution for clients
by Jamie Golombek
When discussing registered education savings plan (RESP) changes with advisors, I sometimes get the objection: "Oh, I don't bother with RESPs - they're only a couple of grand and the administrative work involved makes them too cumbersome".
A quick word - ignore RESPs at your clients' peril! Given the recent changes at both the federal and provincial levels, RESPs have become far more attractive than ever as a saving solution for clients saving for their children's post-secondary level education.
In March's federal budget, the government proposed two major changes to the contribution rules for RESPs: the elimination of the $4,000 annual RESP contribution limit and the increase of the lifetime RESP contribution limit to $50,000 from $42,000.
The Canada Education Savings Grant (CESG) rules are also changing. The maximum annual contribution that will qualify for the 20 per cent CESG will be increased to $2,500 from $2,000, thereby increasing the maximum annual CESG per beneficiary per year to $500 from $400. For beneficiaries with unused CESGs from prior years, the new maximum CESG will be $1,000, based on a $5,000 RESP contribution. The $7,200 maximum lifetime CESG limit, however, remains unchanged.
The newfound ability to lump-sum fund an RESP for a child's post-secondary level education by up to $50,000 in a single year opens up a new opportunity for those who have the cash. But does it make sense?
The complication lies with the fact that by doing so, you waive your ability to collect CESGs in future years. In other words, for a parent who has never opened up an RESP before, by contributing $50,000 to an RESP today, the child would be entitled to either a $500 CESG for 2007 if the child was born this year or up to $1,000 in CESGs if the child was born prior to 2007. No future CESGs would be available.
So, do the benefits of tax-deferred compounding for up to 25 years outweigh the loss of future CESGs? It depends on a number of factors, including the age of the child and, perhaps most importantly, the type of investment returns generated (income, dividends or capital gains) and the rate of return.
It also depends on the parent's own personal tax rate during the accumulation period. To properly do the math, you would have to assume that if you have the $50,000 to lump-sum fund an RESP today, the alternative would be to invest it in a non-registered account for the next 25 years. Then compare the after-tax values of both the RESP and the non-registered account to see if you're further ahead.
For a conservative investor at the highest marginal tax rate, the benefits of sheltering 25 years of interest income inside an RESP can outweigh the loss of the CESGs. On the other hand, if a parent would otherwise invest the lump sum that would go into an RESP into tax-deferred investments that generate primarily capital gains when ultimately sold, it may prove more worthwhile to move $2,500 annually (or $5,000 annually, if catch-up CESGs are available) into an RESP to collect the $500 (or $1,000) annual CESG.
Also, recall the CESG enhancements made in 2005 for low- and middle-income families. Specifically, the first $500 contributed annually to an RESP will attract a 40 per cent CESG if the child's family' net income is less than $37,178. For middle-income families with income between $37,178 and $74,357, the CESG on the first $500 of annual RESP contributions is 30 per cent. For 2007 contributions, eligibility for these enhanced grants is normally based on the family's 2005 reported income.
February's Quebec provincial budget introduced a provincial enhancement to the RESP grant program for Quebecers by introducing a "new refundable tax credit for education savings" that will be paid directly into the RESP itself, similar to the CESG. The Quebec credit, which is in addition to the federal CESGs, is equal to 10 per cent on the first $2,000 of annual RESP contributions for children under 18, up to a lifetime maximum of $3,600.
Quebec's move to add additional financial incentives for parents to save for their kids' education follows Alberta's Centennial Education Savings Plan (ACES). Launched in 2005, ACES pledges to contribute $500 to the RESP of every child born to Alberta residents in 2005 and beyond. Effective January 1, 2005, grants of $100 are available to children at ages 8, 11 and 14, provided the children are attending school in Alberta and parents have invested a minimum $100 in an RESP within one year prior to application.
RESPs could become more popular than ever if Liberal MP Dan McTeague has his way. In May 2006, he introduced a private member's bill in the House of Commons that would allow RESP contributions to be tax-deductible. The bill received second reading in the House on November 8, 2006, and has been referred to the Standing Committee on Finance, which began discussions on February 8, 2007. Stay tuned.