Edge | Financial Crooks

Last week I pointed out some of the possible drawbacks of having two Registered Education Savings Plans for the same child. There are some cases, though, where it might be a good idea to open a second RESP for a loved niece, nephew, grandchild, godchild or other loved one.

Using a Second RESP to Minimize Income Tax Payable On Savings for Post-Secondary Education

You don’t have to open a RESP to help a child save for their post-high school education. Why not just invest the money, pay income tax annually on any profits at your own personal income tax level and then write a cheque for the child when they start their university or college education?

Well, if you know the parents will not use the full $50 000 in RESP contribution room per child, it may be aggravating to see the potential tax savings wasted.

Contributions to a Registered Education Savings Plan allow the investments to grow tax free until the child takes it out. If the child is in a low income bracket when they take out the money, and most students are, then the income tax paid on the income (dividends, capital gains, interest etc) generated over the years by the contributions to the RESP may be lower than the income tax paid if the contributor declared the annual earnings on their own personal income tax return.

Using a Second RESP to Reduce Risky Investment Choices for Savings for University, a Trade, or College

You might also want a second RESP, if you do not trust the investing choices that would be made by the persons who set up the first RESP, such as the parents. If you think the parents are investing in choices that will result in the RESP losing money, you may not want to give them even more money to invest unwisely!

In this case, you would contribute to a second RESP up to the amount that the parents are not “maxing” it out. There is a lifetime maximum of the total of all contributions to all RESPs for a child of $50 000. So you can only contribute if the parents have left enough room.

Using a Second RESP if the Contributors for the First RESP Are At Risk of Bankruptcy or Debt

You might also want a second RESP if you don’t think the parents are financially stable.

Contributions to a RESP can be withdrawn at any time by the contributor. There is a penalty: the CESG earned by those contributions must be re-paid immediately to the government. And there is tax owing on any income (interest, dividends, capital gains etc.) earned by the original contributions to the RESP. And there may be a penalty tax as well, depending on what is being withdrawn and when.

If you think the parents might get so desperate for cash that they would withdraw the contributions from their child or children’s RESP to spend themselves, then you might be wary. You might not want to give them cash to contribute themselves to the RESP they opened. If they contribute it, then they can withdraw it. And you can’t stop them, nor can their child. You may want to contribute to a RESP you opened, so that only you can withdraw the contributions, which you would undoubtedly wait to do until the child needs the money for their education.

Using a Second RESP If the First RESP is a RESP Group Plan With a Poor Reputation

If the first RESP is a group plan RESP and the parents decide later that they do not feel it is a good investment, then a second RESP might be helpful.

If the parents can reduce their contributions to some minimum in the group RESP that still leaves them with annual RESP contribution room, they might want to open a second RESP and use it for all of the additional contributions. This could be the case if, for example, they are not sure their child will attend a post-secondary education program that meets the requirements for payout of the group RESP.

Also, if the parents are nervous that they may have to take out their RESP contributions (due to a financial emergency) before the child goes to post-secondary education, they are more likely to be able to withdraw the contributions without penalty from a standard personal bank RESP than from a group plan.

If the parents are not contributing the maximum to their Group RESP plan, you could also open a second RESP and contribute it to the maximum. You would have control over the investments for that second RESP even if you couldn’t change anything about the Group RESP itself.

We only have a single Family Plan RESP for our children. I can see, though, that there are times when two RESPs per child might be the right solution.

Related Reading

Join In
Do you have a second RESP for a loved child? Please share your views with a comment.

Parents in Canada often open a Registered Education Savings Plan for their child or children. Other loving adults in that child’s life may also want to help save for the child’s future education costs. Sometimes they consider opening a second RESP for the child to allow the contributions they want to make to grow tax-free until the child takes the money out. (With any RESP, the income and grants earned by the contributions are taxed when the child takes it out at the child’s tax rate at that time.) I would caution people to consider some of the possible drawbacks of setting up a second RESP for the same child before they start contributing even if it’s for a nephew, niece, grandchild, godchild or other beloved toddler.

I’m Thinking About Opening a RESP for My Sister’s Child: Should I?

Personally, I would talk to the parents. They would probably prefer to keep all the RESP money in the same account. RESPs have many rules that can be unexpected.

Here are some examples:

Having Two RESPs Doubles the Hassles When It Is Time to Withdraw the Money

If you’ve ever set up a RESP you know there is paperwork to be filled out. Unfortunately, when it is time to withdraw the money, there is MORE paperwork to be filled out.

Having 2 RESPs doubles the required paperwork.

Transferring the cash from one RESP to another RESP can only be done before the child starts making any withdrawals.

Transferring assets including cash from one RESP to another may also require paying a fee. That fee reduces the value of the RESP to the student.

Proving a Child Is a Student To Make a RESP Withdrawal Often Costs Money

If you set up a RESP and the parents also set up a RESP, there may be some extra costs at the time to make the withdrawals. For example, some financial institutions require a special letter or form from the university, college or trade school to prove the child is enrolled before they will release any money from the RESP.

The educational institution may charge a fee to complete the form or mail the letter. If there are two RESPs, the student may brave to buy two copies of the letter stating the child is enrolled, one for each bank that hosts a RESP, before the money can be taken out.

Having 2 RESPs Can Complicate Where the CESG Money Is Deposited

For each dollar deposited in a RESP, up to a limit of $2500 per year, the government pays $0.20 of a Canada Education Savings Grant into the RESP account. (If the full $2500 is not contributed each year, the contribution room carries forward. The contributor can put in up to $5000 in one year if there is enough contribution room to get a maximum CESG of $1000 for that year.)

If the parents open a RESP and you open a second RESP, you could cause confusion with the CESG.

If you accidentally contributed to a separate RESP earlier in the year than the parents did, your account would usually get the CESG (or part of it if you put in less than $2500 per child) leaving them with less or none to get when they made their contributions later in the year.

It may be possible to open your second RESP with instructions that the bank should NOT apply for or accept any CESG or other grants related to your contributions. Check BEFORE you open the RESP.

If the Second RESP Receives Grant Money, the Contributor Must Be Careful Not to Accidentally Forfeit It

If you open a second RESP and some CESG or other grant money is deposited into the account, please take care not to forfeit it!

If your financial situation changes suddenly, you might have to withdraw from the RESP you created in an emergency. If you make a withdrawal, the CESG your account had received would have to go back to the government. Once it goes back, it is forfeited. It can NOT be obtained again by anyone including the parents so it’s lost forever.

Having 2 Small RESPs Makes Investing Decisions More Difficult and Sometimes More Expensive

Some financial institutions charge fees for small RESPs. By only having one RESP, fees may be reduced.

If you are contributing to a separate RESP from the parents, you both may be trying to invest small amounts.

Handling small amounts may make it harder or moor expensive to invest. For example, to buy units of an ETF you often have to pay a fee. Buying two small amounts requires paying a fee twice.

Managing 2 Small RESPS Makes Investing Monitoring and Balancing More Difficult

You may choose to invest in a RESP following a model like the Canadian Couch Potato where you invest A % in GICs or a bond fund, B% in a mutual fund or ETF that mirrors the Canadian TSX, and C% in a mutual fund or ETF that mirrors the world’s biggest stock exchanges.

If the invested money is in two small RESPs, it will be harder to keep the money “balanced.” You would have to track how much was in each category in each account. If you need to sell some units of bonds and buy some units of Canadian stocks, you may find there isn’t enough cash to make the purchase all in one chunk in one account. Instead, you may have to pay fees to make two purchases, one in each account.

You also would need information from the contributor to the other RESP to know the value of the assets so you can balance them across the two accounts.

If You Are the Contributor (Subscriber) to a RESP You Need to Update Your Will

Also, if you do set up a RESP, make sure you update your will. You want to make sure to name a new “contributor” to own that account in the event you die. That person should agree that the money is to go to the child for their education.

Otherwise, if you die, there is a strong chance that the executor will close the RESP, include it as part of your estate, and the money will go to your heirs as set out in your will, not specifically to that child. If there is any CESG, the grants would be sent back to the government.

You can read an article on wills and RESPs online.

If there are two RESPs for the child, there are likely two wills that need to be updated.

Be Careful of the Annual and Total Contribution Limits If a Child Has 2 RESPs

There is no limit on how large a RESP can grow. If you can turn $100 into $10 000 using regular legal investments inside a RESP you can do it. (Be aware, though, that the student will have to pay income tax on that $9 990 when they withdraw it.)

There are two limits on how much can be contributed to RESPs for one child, however.

Each child has a lifetime maximum RESP contribution limit of $50 000. If they have two RESPs, the maximum that can be contributed to both accounts must add up to only $50 000. It is NOT the responsibility of the financial institution to advise you of this limit or of when the limit is reached. You may incur penalties from the government if you over-contribute.

There is also a maximum annual contribution that will be matched by the Canada Education Savings Grant or CESG. Each calendar year, the child is permitted another $2500 of contribution room that will be matched by a 20% CESG grant. If no contribution is made one year, the next year, up to $5000 can be contributed to receive a 20% grant.

If you want all of the CESG grant money to go into a particular RESP account, then you must either

make sure that the second RESP account is not set up to receive the CESG

keep track closely of the contributions to the first RESP and ensure all of the current and previous years’ contribution room has been used before making a contribution to the second RESP

Why the Child or Parents May Not Want You to Set Up a Second RESP

RESPs require a certain amount of trust.

The Contributor to a RESP can always withdraw money from the RESP.

If the Contributor withdraws money from the RESP before the child starts their post-secondary education, though, any CESG received for that contribution must be paid back to the government. Once it is paid back, it cannot be re-earned. It’s gone. The parents and child have to trust that you won’t make a withdrawal and “waste” the CESG.

Also, if you opened a RESP tomorrow, put in $50 000, and the next day took out the $50 000, the parents would never be able to open a RESP for the child!

Obviously, the parents would try to appeal to the government but I don’t know how easy this kind of problem would be to fix. And equally obviously you wouldn’t do something like that but it is a potential problem.

Using an In Trust Account to Reduce Income Tax Payable On Savings for Post-Secondary Education

You might want to check the rules about setting up an investment account in trust for the child before you set up a second RESP. However. In some relationships, you would probably have to pay income tax on some of the income from the investments due to attribution rules.

(For example, you might have to pay income tax on savings account interest if you are a grandparent.) You would need to get information from someone who understands income tax rules better than I do to know what you can do and not do with an “in trust” investment account. You need to know, for example, if and when the child has to report the income and whether the child has to file an annual income tax return.

Overall, while it’s great to want to help a child with the future costs of their education, you want to take some time and consider the best way to save and invest that money. After all, it will likely be years before they need it. You can afford to take a few days to work out the best solution!