Monday, February 16, 2015

RESP Strategy - The Parent's Giveth and The Parent's Taketh Away!

RESP - Savings Plan or TFSA In Disguise


I am not a tax professional. You should consult one prior to making investment decisions with tax implications. The documentation from CRA details that contributions can be returned to the subscriber for RESP's when the child is in school, but ensure you fully understand the rules on this most complicated investment account. You may find this article quite useful.

 Your RESP Contributions - Can Be Returned To You

Previously, in 5 RESP Strategies, I wrote about several different options for funding a child's education. Thanks to an anonymous comment, and thinking more about the rules for withdrawing money from an RESP, there's a better way to think about an RESP.

Most people, contribute $1000, or $2500, thinking their child will withdraw and use the following to fund their education:
  1. The original contribution ($1000 or $2500)
  2. The government matching money
  3. The investment gains on (1) and (2)
IF you are fortunate enough to be looking for more tax free or tax sheltered investment room, by purely giving your child #2 and #3 from the above, you can be taking better advantage of the the tax-free nature of the growth.

Comparing $2500 / month for matching vs. Front Loading

Referring to the obligatory spreadsheet here, consider the following:

  1. Contributing $2500 per month until your child goes to school, total investment gains $38,852, total value $93,552. (assuming 5% return)
  2. Front loading the account with $14,000 in addition to $2500, then $2500 per year to get the matching until the 7th year, contributing $1000 --- total investment gains $58,501, total value $115,701.

With option 2, you are getting the same full amount of government matching, as well as having an additional  $11,500 from year 1 growing tax free for 18/19 years. With a modest 5% estimated return, this yields an additional $19,649 in investment growth.

The Parent's Giveth and Taketh Away

 If you're concerned your RESP will have too much money, particularly if your investment returns are greater than 5%, the subscriber can remove their contributions and keep the money. This essentially lets you fund your child's education off of the tax free gains, while you keep your contributions.

This approach of investing the money, and taking back your contributions, lets you fund your child education, while preventing $14,000 of money being invested in a non-registered, taxable account (assuming you've run out of TFSA or RRSP room), all at approximately the same "cost" as the $2500 per year, since you recover your contributions.

UPDATED 2015-02-17: RESP, not quite tax free

I should've mentioned, but the earnings, as well as the government matching money is eventually taxed. When the funds are withdrawn, they are taxed in the hands of the student. The student may end up paying no tax, or potentially being in the lowest bracket if summer job / co-op earnings are combined with RESP withdrawals. This is still far preferable to gains being taxed in the hands of the parent's who are in potentially top or higher income tax brackets.