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Three Misconceptions About RESPs

I had a conversation recently about education savings and some of the misconceptions about RESPs. Here are the three biggest misconceptions about RESPs we identified.

There is no deduction so it’s not worth it. True you do not get a tax deduction for your contribution to an RESP, but the investments will grow tax deferred. When the funds are eventually drawn for post secondary education the growth is taxed in your child’s hands and the original contributions can be taken out tax free.

An in-trust account works the same as an RESP. False. Using an in-trust account to save for education has two flaws: First, interest and dividends are taxed in the contributor’s hands and any capital gains are taxed in the child’s hands. The second flaw is that once the child reaches the age of majority, they are entitled to the funds and can use them for any purpose they chose. With an RESP, if the child does not go to school, you can collapse the fund and get your money back.

The government takes 20% of the RESP if my child does not go to school. The government provides a grant of 20% of your contribution on the first $2,500 per year to a maximum of $7,200 per beneficiary (higher limits are available for those with family income below $77,000). If your child does not take up a post secondary education, then you forfeit the grant and any growth earned on the grant.

The forfeiture of the grant is justified since the money was not used for the original purpose and you get back your contributions plus your proportion of the investment income.

RESP’s are an excellent tool to help save for a child’s education. You benefit from generous government grants and tax deferred growth of the investment income. When your child needs the income for school, the growth is taxed in their hands (contributions are tax-free withdrawals!). Finally, if your child does not attend school, you can withdraw your contributions tax-free and only the growth is taxed.