For the vast majority of Canadian parents, the government grants and the tax-free growth potential that’s attached certainly get one caught up in the mechanics of the Registered Education Savings Plan (RESP). However, just like any financial strategy, there are challenges and limitations to the RESP that are not immediately obvious. Think of the early saver for a child’s education whose child later chooses not to pursue a higher education and is left wondering what to do with funds accumulated over the years. Think of a single mom setting up an RESP for her daughter, only to later deal with the fact that the inflexibility of investment options will not allow her to align with the financial situation in which she now found herself. Many people get excited when they think about planning their child’s educational future, but these true stories show some of the problems and issues that are important to keep in mind in order to give a fair picture. Registered Education Savings Plan Canada is one of the most popular ways to save money, but this blog post takes a close look at its flaws, which every family in Canada should think about before starting. We take these characteristics to the next level by modeling them in real-life situations. This way, you can get a full picture and decide if a RESP is right for your family.
Let’s know the Patel family situation in order to understand how complex contribution limits in the Registered Education Savings Plan (RESP) impact financial planning. The Patels, like most other parents, were very enthusiastic savers; unfortunately, they did not realize their mistake regarding the government’s matching in the RESP. So, in year one, they made a huge contribution of $10,000 to maximize the government’s match. As per the structure of the Canada Education Savings Grant (CESG), however, the government matches 20% of the first $2,500 contributed annually to a maximum of $500 per year. Such limitation, provided by the government, is the most crucial part of the RESP structure that every subscriber needs to understand if they are looking to optimally structure their contributions. Have you at some time been so enthusiastic and motivated about something and then later on realized that you missed some information that could have changed how you would go about that very thing? That is what happened to the Patels. Their story is not unique but only goes ahead to show how important it is to take full note of the good and the bad about the RESP before making decisions that may create huge mistakes—mistakes that would prevent them from taking advantage of that free money that could have been available.
Now consider the case of Saima, which illustrates one of the major shortcomings of the RESP: restrictions on investment options. When Saima opted for tax-free growth for an RESP, she thought she would have the flexibility to change her investments in case her financial situation changed. Instead, she quickly discovered that her RESP provider had access to only a few investment options—most of them too risky or too conservative to suit her increasingly changing needs. Have you ever made a decision and later regretted it? Saima did. She wanted to lock in her contributions but now felt like she was chained down to investment choices that were not that good. This lack of full flexibility can be a strong source of stress and dissatisfaction as it comes in the way of subscribers like Sarah expressing their full ability to tailor an investment strategy to meet specific risk tolerances and financial goals.
A Registered Education Savings Plan Canada has many benefits, including tax-free growth and government payments, but it also has a number of drawbacks and difficulties that should be carefully considered. There are drawbacks that could have a major impact on your family’s financial situation and your children’s educational chances. We recommend that you carefully consider these things and consult with an Education Savings Specialist to go through this correctly. If you are an existing or potential RESP holder and are reviewing your existing education savings strategy, remember that Canada’s best insurance brokerage, Canadian LIC, is here to help you. Our consultants are well-versed in the ins and outs of RESP and are in a good position to offer appropriate advice on a case-by-case basis that fits your unique family’s interests and objectives. An RESP will actually be a strong pillar towards building a bright educational future for your child. Contact Canadian LIC today so your education savings plan will be effective and beneficial, maximizing every dollar towards a brighter tomorrow for your child.
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Consider Liam and his parents: Liam, after much thought, decided that college was not for him. His parents, who had been saved in an RESP, were between a rock and a hard place. They could take out their contributions without a penalty, but the earnings on their contributions would be taxed at a high rate—their marginal tax rate, plus an additional 20%. On top of that, all government grants were required to be paid back. The topic of how flexible a savings plan should be is brought up by this case, which highlights one of the main drawbacks of the RESP in the unlikely event that the funds are not used for education. For many families, the penalties attached to the non-educational withdrawal can feel like a harsh punishment too, especially for a child’s decision to take a non-academic path, and therefore the RESP becomes less attractive.
The experience of the Chen family drives home the potential risk of over-contributing to an RESP. Since there are multiple contributors within one family, it’s easy to lose track of the total being deposited, especially when there isn’t a stringent annual limit on contributions. When the Chens exceeded the lifetime maximum of $50,000 for an RESP, they were penalized 1% per month on the overage. They could have found a way to withdraw that excess in some other manner, thus avoiding the penalty. It really shows how important record-keeping and communication between contributors is. A mistake as small as contributing too much can lead to unnecessary strain on the family finances and use valuable time fixing the problem. Can you remember a similar situation where a small mistake created unnecessary work and stress?
To continue with the Thompson family, they had set up an RESP for their three children. They thought the RESP would simplify everything since it would treat all their children equally. However, when their children got closer to the age of going to university, they needed help managing the plan equitably. The costs for their oldest daughter to attend medical school were four times higher than the fees for the other two children’s programs. Can you think of a way that in the above case, where the Thompsons had set up a family RESP, this could have been foreseen and prevented? In other words, what could they have done in advance to make sure all the children had an opportunity for education without too much pressure on family finances?
| Pros of RESP | Cons of RESP |
|---|---|
| Government Contributions: The government matches 20% of annual contributions up to $2,500 per beneficiary, to a maximum of $7,200. | Contribution Limits: There’s a lifetime contribution limit of $50,000 per beneficiary, which can restrict funding beyond this point. |
| Tax-Deferred Growth: Investments grow tax-free until withdrawn for educational purposes, enhancing potential returns. | Penalties for Non-Educational Withdrawals: Withdrawing funds for non-educational purposes incurs heavy taxes and penalties, plus the return of government grants. |
| Flexibility in Investment Options: Subscribers can choose from a range of investment options depending on the RESP provider. | Limited Investment Flexibility: Some plans have restrictive investment options, which may not align with every investor’s risk tolerance or financial goals. |
| Family Plan Benefits: Allows for funds to be shared among siblings, which can simplify managing education savings for multiple children. | Complex Fund Management: Managing funds and ensuring fair distribution can be challenging in family plans, especially if beneficiaries have different educational needs. |
| Transferability: Under certain conditions, if the beneficiary doesn’t pursue higher education, the plan can be transferred to another eligible family member. | Risk of Over-Contribution: Exceeding the lifetime limit incurs penalties, requiring careful monitoring of contributions. |
| Promotes Savings Discipline: Regular contributions to an RESP can instill financial discipline with a focus on long-term educational goals. | Maturity Limitations: RESP accounts must be closed after 35 years, which can complicate planning if the beneficiary delays education. |
Find Out: What is the RESP Limit in Canada?
Find Out: How to check an RESP in Canada?
Find Out: Why to choose an RESP?
For further reading and to delve deeper into the nuances of Registered Education Savings Plans (RESPs) in Canada, including their advantages and disadvantages, consider exploring the following sources:
Website: Canada Revenue Agency
Website: ESDC
Website: Investopedia RESP Section
These sources provide reliable and in-depth information that can help parents and guardians make informed decisions about financing their children’s education through RESPs.
