When you’re saving for a child’s post-secondary education, the government makes it easier with registered education savings plans. RESPs let you save on a tax-deferred basis and, even better, they boost your progress by providing government grants. But there are two types of RESPs out there — and it’s important to know the differences between them when you’re making this savings decision.
1. What are the two types of RESP?
In the same way that an RRSP encourages Canadians to set aside funds for retirement, an RESP encourages families to save for post-secondary education.
There are two types of RESP accounts:
- A regular RESP is similar to other registered accounts, like an RRSP, in that you set it up through a financial institution like your bank or investment dealer.
- A group RESP — called a scholarship trust plan or scholarship plan — is only available from companies that provide these plans. Your contributions are pooled with those of a group and invested together by the plan provider.
With both types, the RESP can be set up for one child (i.e., one student beneficiary) or can have multiple beneficiaries, often siblings.
In both regular and scholarship trust RESPs, the investments grow tax-free; the growth is only taxed on withdrawal. When a beneficiary is ready to go to college or university, the student makes the withdrawals (not the parents/contributors), which usually means little or no income tax to pay.
The federal government provides extra help to fund post-secondary education through Canada Education Savings Grants (CESG) paid into any RESP account. Each year, the government will match 20% of your contribution up to a maximum of $500 for each child, with a lifetime CESG maximum of $7,200 per child.
Both kinds of plans are equally eligible for all federal and any provincial grants, including the federal CESG, the enhanced CESG for modest-income families, and the Canada Learning Bond for low-income families. Both types of RESP have a $50,000 lifetime contribution limit for each beneficiary.
Beyond these similarities, however, there are some important differences between regular RESPs and scholarship trust plans.
2. How much can you contribute?
Regular RESP: Once you’ve set up an individual or family RESP through your bank or investment dealer, you decide how much you’re going to invest and when. There are no maximums or minimums, other than the $50,000 lifetime maximum.
Group RESP/scholarship plan: With a scholarship plan, you enter into a contract to buy a specified number of plan “units” on a specified schedule, which you are locked into.
3. Are there fees?
Regular RESP: The costs to invest in a regular RESP are similar to an RRSP or tax-free savings account (TFSA): they are limited to account fees charged by the financial institution and the costs associated with the investments in the account, such as commissions or charges on the purchase or sale of stocks or mutual funds. While there is usually no charge to open an RESP account, a financial institution may charge annual account administration fees and fees for any administrative changes, such as changing the beneficiary of an account.
Group RESP/scholarship plan: These plans have enrollment (or membership) fees that you pay when you open an account. Once you’ve entered into a contract with a scholarship plan provider, if you miss scheduled payments or if your child doesn’t end up pursuing post-secondary education, those fees, which are usually several thousand dollars for each beneficiary, are not returned to you. Scholarship plans usually also charge annual fees as well.
4. Who makes the investment decisions?
Regular RESP: With a regular RESP, you make all investment decisions, similar to your RRSP or TFSA (with help from a financial advisor, if you have one). You decide how much to contribute (within the lifetime limit of $50,000 per beneficiary), when to contribute, and what the investment allocation will be inside the account. Any investment type, like mutual funds, stocks, etc., that is eligible for an RRSP or TFSA is also eligible for an RESP account.
Group RESP/scholarship plan: With a scholarship plan, you don’t make any investment decisions. Instead, your funds are pooled with contributions from others with children of the same age and invested by the plan’s managers, typically in fixed-income funds.
5. How much money will an RESP accumulate?
Regular RESP: The total you can amass for your child in a regular RESP depends on the contribution amounts, including grants; and the investment returns on the funds in the account.
The investment returns, for their part, depend on how the funds are invested, and for how long. When a contributor opens an account, they usually map out an investment plan. They can then review, reassess and rebalance the contributed funds to make sure they’re on track to cover their child’s education.
Group RESP/scholarship plan: With a scholarship plan, the total amount accumulated for your child’s education depends on how much is contributed, including grants; the investment returns on the funds in the account; and how many members of their cohort end up drawing on the plan.
Because scholarship plans typically allocate the funds to low-risk investments with very low expected returns, investment growth is usually very modest.
Instead, the amount available for your child’s education depends on how many participants have dropped out along the way, and how many beneficiaries don’t pursue post-secondary education. In those cases, the enrollment fees they paid upfront are forfeited and then partially used to fund payments to your child and other beneficiaries in the same cohort.
6. What happens if a child doesn’t pursue post-secondary education?
Regular RESP: If your child does not pursue a qualifying course of post-secondary education, you can withdraw your contributions and the investment returns in full.1 Note that taxes will be due on the investment returns.
Group RESP/scholarship plan: If your child does not pursue a qualifying course of post-secondary education, your contributions to the scholarship plan are refunded, but the plan keeps the upfront membership or enrollment fees and any investment earnings.
Making the optimal choice to save for post-secondary education
As you can see, scholarship plan RESPs are very different from regular RESPs. They’re riskier for contributors — not because they invest in risky securities, but because their strict terms mean it’s much more likely that a contributor will fail to adhere to the plan’s contractual requirements, for example by missing a scheduled contribution. When that happens, the hefty enrollment fees you paid at the outset of plan participation are lost.
With a regular RESP, in contrast, you have much more flexibility and control over your participation, including deciding how much and when to contribute.
If you’re thinking about how to save for a child’s post-secondary education, it’s important to understand what you’re getting into and to have all the facts. Your MD Advisor* can help you develop a personalized plan to meet this important savings goal while benefitting from the freedom that regular RESPs offer.
*MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.
1 You can transfer up to $50,000 to an RRSP if the RESP has been open for 10+ years, all beneficiaries are at least age 21 and none are pursuing post-secondary education, you are a Canadian resident and you have sufficient RRSP contribution room. If an RESP is closed/transferred, your contributions are returned to you/transferred to an RRSP (or registered disability savings plan), the grants are returned to the government that issued them, and you can get the investment earnings if certain conditions are met, subject to income tax plus a 20% penalty.
The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.