Changes to RESP Rules Provide Planning Opportunities
Arthur Drache, March 26, 2007
The changes to the rules relating to registered Educational Savings Plans announced in the federal budget modestly improve the plans for contributing parents and grandparents.but offer some new and very interesting strategies for the well heeled.
Up to the time of the Budget, there were three variables to consider. First, the maximum annual contribution was $4,000.00 per plan with one plan per child. Second, there was a total limit of contributions $42,000.00 per plan. Finally, through the Canada Education Saving Grant scheme, the government would ante up a further 20% of the contribution to a maximum of $400.00 a year. The maximum “lifetime” CESG payments for each plan was $7,200.00.
Probably the most common annual contribution made to these plans was $2,000 a year, designed to maximize the CESG payment.
But the rules have changed. The new proposals include
. Eliminating the $4,000.00 limit on annual RESP contributions.
. Increasing the lifetime limit on RESP contributions-for the first time since 1996-to $50,000.00 from $42,000.00
. Increasing the maximum annual amount of CESG that can be paid in any year to $500.00 from $400.00 (and to $1,000.00 from $800.00 if there is unused grant room from low contributions made in previous years).
Each child will continue to be eligible to receive up to $7,200.00 in CESGs over the “lifetime” of the plan.
Now the obvious change in contribution patterns by parents and grandparents will be to increase the annual contribution per child to $2,500.00, ensuring that the maximum CESG of $500.00 is received each year. Because the maximum amount of the CESG remains at $7,200.00, this approach simply means that it will take just over 14 years to get the maximum whereas under the old system, it took 18 years.
But what is the implication of the elimination of annual limits. Let’s look at the extreme case.
If a well-heeled grandparent celebrated a child’s birth by making the maximum contribution of $50,000.00 to the plan when the child was born, the government would only kick in a one-time $500.00. But given that the RESP is not taxable, this means that the plan can invest $50,500.00 for about 18 years. Providing the investment yield is reasonable, the tax-free buildup of investment income is likely to be significantly higher than the $6,700.00 of CESG which would have been received by contributing over 14 or 15 years. Indeed, even without the CESG contribution, it would take a very poor annual rate of return not to produce a $100,000.00 pot at the end of 18 years when the child is likely to be ready to go to post-secondary school and start drawing down the funds.
Even if it is not possible to plunk down $50,000.00 at once, it is likely better to contribute as much as possible as quickly as possible despite foregoing some of the CESG. Only where the child is approaching the time when the RESP will be drawn down and there won’t be significant years to accumulate investment income tax-free, will the maximizing of the annual CESG likely to be the more attractive option.