Are RESP contributions tax-deductible?
Author: Aditya Nain
At year-end and during tax season, parents and grandparents may have questions about registered education savings plans (RESPs) and their impact on taxes in Canada: Are RESP contributions tax-deductible? Who pays the taxes on RESP withdrawals?
First, a quick refresher on these registered accounts: RESPs provide a tax-advantaged way to invest in your children’s or grandchildren’s future education. Contributions to an RESP account and investments held in an RESP are tax-sheltered as long as they remain inside it. And that’s not the only benefit of opening an RESP. The Canadian government also contributes by matching grants to your child’s RESP through the Canada Education Savings Grant (CESG). (More on government grants below.)
Maximizing RESP contributions and understanding withdrawal rules can save you a lot in taxes while you save for your child’s or grandchild’s post-secondary education. Let’s look at common questions in more detail.
Is an RESP tax-deductible?
Unlike with a registered retirement savings plan (RRSP), RESP contributions themselves do not give you a tax deduction. However, this doesn’t make the RESP account less powerful as an education savings vehicle. The RESP has three significant benefits for investors:
- Tax-sheltered growth: Money invested in an RESP is tax-sheltered, meaning it continues to grow tax-free as long as it stays within the RESP account.
- Withdrawals are taxed in the hands of the beneficiary: Unlike RRSPs, the grant and growth portion of money withdrawn from an RESP and used towards educational expenses is taxed in the hands of the plan’s “beneficiary” (the student), not its “subscriber” (parent or grandparent who opened the account). This is good news, because students are usually in a lower tax bracket than their parents or grandparents and will likely pay little to no income tax as a result of the corresponding tuition credits that eligible programs provide. These are reported on a T2202 form that students receive.
- Government grants: The RESP is made more attractive by the Canada Education Savings Grant (CESG), a 20% boost to your RESP made by the federal government, up to a yearly maximum of $500 and a lifetime maximum of $7,200. If you contribute $2,500 to the RESP in a given year, the government will contribute 20% of that: $500 ($2,500 X 20%= $500 Annual CESG). Some families are eligible for other government grants, too.
Is money earned in an RESP taxable?
Money earned within an RESP could come from interest, dividends or capital gains, along with government contributions mainly through the CESG. As long as these earnings remain within the RESP account, they are not subject to tax, allowing the power of compounding to work its magic. This tax-sheltering of RESP earnings ensures that your investment and government grants can grow unimpeded by taxes, until they’re needed for the beneficiary’s post-secondary education. But, unlike a tax-free savings account (TFSA), RESP withdrawals are not entirely tax-free when withdrawn. The money withdrawn for the beneficiary’s education—whether investment gains or grant money—is categorized as Educational Assistance Payments (EAP) and taxed in the hands of the beneficiary (the student). As mentioned above, contributions to an RESP are funded with after tax dollars, as such the initial amounts contributed can be withdrawn tax free at any time.
How do I report an RESP on tax returns?
Reporting your RESP on tax returns is pretty straightforward. Because RESP gains are tax-sheltered, you don’t need to make any tax declarations until the RESP money is withdrawn as EAPs. Once the money is withdrawn to pay for the beneficiary’s educational expenses, the RESP provider will give the beneficiary a T4 slip specifying the total amount of money received as EAPs in the tax year—including investment income and government grants. The amount from this T4 slip must be entered as “income” on the beneficiary’s tax return.
Are RESP over-contributions taxed?
Although RESPs don’t have a yearly contribution limit, they do come with a lifetime contribution limit of $50,000. And yes, RESP over-contributions are definitely taxable. If contributions exceed the lifetime contribution limit of $50,000, the excess contribution is taxed at 1% per month until it’s withdrawn. This tax on overcontributions must be paid within 90 days after the end of the year in which the overcontribution happened. Overcontributions can be withdrawn and do not need to remain in the RESP.
RESPs serve as a tax-advantaged account for post-secondary educational savings and investments. It beneficially weaves together tax-sheltered investment growth, government grants and favourable withdrawal taxation rules. If you understand RESP contribution and withdrawal rules, the RESP account can be invaluable to your family’s financial toolkit.