The benefit of an RESP arises through three mechanisms:
Tax deferral, in that income earned on the (non-deductible) contributions you make to the plan is not subject to tax as it is earned; accordingly, income accumulates more rapidly in the plan that it would in the hands of the contributor;
Income splitting, in that when amounts are paid out of the plan for the post-secondary education of a beneficiary they will be taxed to beneficiary, whose tax rate is typically lower at that time than the contributor’s tax rate; and
Incentive grants, in that the government will actually match contributions with 20% grants paid to the plan on the plan on contributions of up to $2,000 per year.
CANADA EDUCATION SAVINGS GRANTS (CESG)
The Canadian education saving grant program, announced in the 1998 federal budget, is intended to create a further incentive for taxpayer’s to save through RESPs by providing a direct federal grant to any valid RESP equal to 20% of the first $2,000 per year ($2,500 for 2007 and subsequent years ) contributed for each child under 18 years of age. Grants are limited to a specified annul amount.(There is also an overall lifetime maximum of $7,200 of grants for each beneficiary of an RESP). The grant itself is not included in calculating the lifetime RESP contribution limit, nor in calculating annual contribution limits (before annual contribution limits were withdrawn in 2007). Thus, where a $4,000 Contribution was made in a year, the grant would provide an additional 20% of 2,000 (i.e., $400), so that the total added to the plan would be $4,400 (plus income earned in the plan), notwithstanding that (before 2007) the annual contribution limit was $4,000. Similarly a contribution or series of contribution which reach the current $50,000 annual limit (for a particular beneficiary) will generate grant in addition to the $ 50,000.
To obtain the grant, the beneficiary must obtain a Canadian Social Insurance Number (SIN), which has to be used when applying for the grant, and must be resident in Canada at the time the grant is made. Obtaining a SIN for a Canadian resident child typically presents no difficulty and it enables you to open an RESP for the child. The RESP provider should provide you with details about the grants available to you and make the necessary applications on you behalf.
If contributions are withdrawn for non-educational purposes from an RESP which has received a CESG, the RESP trustee will be required to make a CESG repayment equal to %20 of the withdrawal. Where a plan contains both contributions which did and contributions which did not earn CESG (because they were before 1998 or in excess of grant contribution room), the CESG earning contributions will be considered withdrawn first; that is, the 20% repayment will be required on withdrawals until the CESG is in effect exhausted.
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