Are RESP Contributions Tax Deductible?

A Registered Education Savings Plan (RESP) is a savings vehicle designed to help families in Canada save for a child’s post-secondary education. Contributions to an RESP are not tax-deductible, meaning the money has already been subject to income tax. Despite this, RESPs are a valuable tool for education savings due to their tax-deferred growth potential and generous government grants. These features can substantially boost the total amount available for educational expenses.

Understanding RESP Contributions

Contributions to an RESP are made using after-tax dollars and do not provide an immediate tax deduction. Unlike Registered Retirement Savings Plans (RRSPs), RESP contributions do not reduce taxable income. However, investment earnings within an RESP grow on a tax-deferred basis. This allows principal and accumulated gains to compound without annual taxation, enhancing savings potential.

There is no annual contribution limit for RESPs, but a lifetime contribution limit of $50,000 applies per beneficiary. Contributions exceeding this limit are subject to a 1% per month penalty tax on the excess amount. Any individual, including parents, grandparents, or friends, can contribute to an RESP, provided they have the beneficiary’s Social Insurance Number (SIN).

Subscribers, who open and contribute to the RESP, maintain control over the funds. Contributions can be made with a flexible schedule, including regular deposits or lump-sum payments. This tax-sheltered growth allows savings to accumulate more rapidly than in a taxable investment account.

Government Grants and Incentives

The Canadian government provides incentives to encourage saving for post-secondary education through RESPs. The primary federal grant is the Canada Education Savings Grant (CESG), which matches a percentage of annual contributions.

The basic CESG provides 20 cents on every dollar contributed, up to $500 per beneficiary per year on the first $2,500 in contributions. There is a lifetime CESG limit of $7,200 per beneficiary. Unused CESG room can be carried forward, allowing for larger grant amounts in subsequent years, up to $1,000 per year. An additional CESG is available for beneficiaries from low- and middle-income families, providing an extra 10% or 20% on the first $500 of annual contributions, depending on adjusted family net income.

The Canada Learning Bond (CLB) assists low-income families. The CLB provides an initial payment of $500 into an eligible child’s RESP, followed by $100 for each additional year of eligibility, up to age 15, for a maximum of $2,000. Personal contributions are not required to receive the CLB.

Some Canadian provinces also offer their own RESP grants, such as Quebec’s Quebec Education Savings Incentive (QESI) and British Columbia’s former Training and Education Savings Grant (BCTESG). These provincial grants provide additional funds directly into the RESP based on contributions or eligibility.

Taxation of RESP Withdrawals

When money is withdrawn from an RESP, it is categorized into two components: Post-Secondary Education (PSE) withdrawals and Educational Assistance Payments (EAPs). PSE withdrawals represent the original contributions made by the subscriber. These amounts are returned tax-free to the subscriber or student, as contributions were made with after-tax dollars. There is no limit on PSE contributions that can be withdrawn.

EAPs comprise the accumulated investment income within the RESP and any government grants received, such as the CESG and CLB. EAPs are taxable to the student beneficiary, not the subscriber. This is advantageous because students often have minimal income, placing them in a lower tax bracket. The tax liability on EAPs is generally low, or even zero, for many students. Limits apply to EAP withdrawals; for instance, $8,000 can be withdrawn during the first 13 weeks of a full-time program, and $4,000 for a part-time program. After this initial period, there are no specific limits.

If a beneficiary does not pursue post-secondary education, or the RESP remains unused, special rules apply to the accumulated investment income, known as Accumulated Income Payments (AIPs). AIPs are taxable to the subscriber at their marginal income tax rate, plus an additional 20% penalty tax. Any government grants, such as CESG or CLB, must be repaid to the government if the beneficiary does not enroll in a qualifying program. Subscribers may avoid the penalty tax on AIPs by transferring up to $50,000 of the investment income to their Registered Retirement Savings Plan (RRSP), if they have sufficient contribution room.

Optimizing Your RESP

Maximizing RESP benefits involves strategic planning and consistent action. Contributing early and regularly capitalizes on tax-deferred growth over an extended period. This allows investments more time to compound, potentially accumulating a larger sum for future educational expenses.

To fully leverage government incentives, contribute at least $2,500 per beneficiary each year to receive the maximum basic Canada Education Savings Grant (CESG) of $500 annually. This consistent contribution ensures the RESP receives the full matching grant, boosting overall savings. Even small, regular contributions can lead to substantial growth due to tax deferral and government grants.

Selecting appropriate investments within the RESP is also important. The choice of investments, such as stocks, bonds, or mutual funds, should align with the beneficiary’s age and the subscriber’s risk tolerance. For younger beneficiaries with a longer time horizon, a growth-oriented strategy might be suitable. A more conservative approach may be preferred as the beneficiary approaches post-secondary enrollment.