Saving for a child’s education is a top financial goal for many families, and both the U.S. and Canada have developed tax-advantaged accounts specifically designed for this purpose. In the United States, 529 plans are a popular choice, while in Canada, families often turn to Registered Education Savings Plans (RESPs). While both accounts encourage education savings through tax benefits, they differ in structure, contribution limits, eligibility, and withdrawal rules. In this article, we’ll explore the similarities and differences between 529 plans and RESPs, helping you make informed choices based on your financial goals and country of residence.
Similarities Between 529 Plans and RESPs
Both 529 plans and RESPs are education-focused accounts that offer unique benefits to incentivize saving for post-secondary education. Here are some key similarities:
1. Tax-Advantaged Growth
Both accounts allow contributions to grow tax-free within the account. In a 529 plan or RESP, investments, including ETFs, grow without being taxed on the capital gains, dividends, or interest earned. This ETF tax advantage can significantly increase the value of contributions over time, making them a powerful tool for education saving.
2. Qualified Education Expense Withdrawals
When funds are withdrawn for qualified education expenses, both accounts provide tax benefits:
- 529 Plans: Qualified withdrawals for tuition, fees, books, and even certain K-12 education costs are tax-free in the U.S., offering a significant tax advantage for families saving for education.
- RESPs: In Canada, when RESP funds are withdrawn for post-secondary education, they are generally taxed in the student’s hands. Since students often have a lower tax rate, this results in minimal or no tax liability, further enhancing the ETF tax advantage when these investments are part of the RESP portfolio.
3. Contribution Flexibility
Both accounts are flexible in terms of who can contribute. Parents, grandparents, or others can contribute to a child’s 529 plan or RESP, making it a versatile tool for families to pool resources toward a student’s education.
Key Differences Between 529 Plans and RESPs
While both accounts aim to support education savings, their rules and benefits vary significantly, largely due to differences in U.S. and Canadian tax systems and education policies.
1. Contribution Limits
- 529 Plans: There is no annual contribution limit set by the federal government, though contributions are subject to gift tax rules (currently up to $18,000 per year per contributor, or up to $90,000 if contributing five years’ worth at once without triggering the gift tax). Total 529 plan balances vary by state but can reach $300,000 to $500,000, allowing for substantial savings.
- RESPs: The Canadian government caps lifetime RESP contributions at $50,000 per child. While there is no annual limit, government incentives like the Canada Education Savings Grant (CESG) only apply to the first $2,500 in contributions each year, making gradual contributions more advantageous for families looking to maximize grants.
2. Government Grants and Incentives
- 529 Plans: There is no federal grant associated with 529 plans, though some states offer their own incentives, such as state tax deductions or credits on contributions.
- RESPs: Canada provides substantial support for RESP savers through the CESG, which matches 20% of annual contributions up to $2,500, providing a maximum of $500 per year and a lifetime maximum of $7,200 per beneficiary. Low-income families may also qualify for additional grants like the Canada Learning Bond (CLB), which provides government contributions even if no personal contributions are made.
3. Eligible Education Expenses and Use of Funds
- 529 Plans: Funds can be used for a wide range of education-related expenses, including tuition, fees, books, supplies, and even some room and board expenses. 529 plans can also be used for K-12 tuition (up to $10,000 per year) and qualified apprenticeship programs. Recent changes allow up to $10,000 of 529 funds to be used toward student loan repayment as well.
- RESPs: RESPs are specifically for post-secondary education costs, including tuition, textbooks, and living expenses. Funds must be used for accredited institutions in Canada or other eligible schools abroad. RESP rules do not allow for K-12 tuition or apprenticeship costs.
4. Ownership and Control of the Funds
- 529 Plans: The account holder (usually a parent) retains control of the 529 plan funds, allowing them to change the beneficiary or even withdraw the funds for non-educational purposes (though this incurs taxes and a penalty on earnings).
- RESPs: The subscriber (account holder) also controls the RESP and can change beneficiaries within the family, provided the new beneficiary is under 21. However, if funds are not used for education, only the original contributions can be withdrawn without tax. The grant and growth portions must either be transferred to a sibling’s RESP or returned, with the earnings subject to taxes and penalties. If there is room, unused RESP funds can be transferred to an RRSP as an accumulated income payment.
5. Penalties for Non-Educational Use
- 529 Plans: If funds are withdrawn for non-qualified expenses, the earnings portion of the withdrawal is subject to income tax and a 10% penalty. However, exceptions apply, such as if the beneficiary receives a scholarship, in which case the penalty is waived (though taxes still apply). Due to recent changes, you can now transfer unused 529 funds to your Roth IRA.
- RESPs: For RESPs, unused contributions can be withdrawn without penalty, but any government grant money (such as CESG) must be repaid to the government. Additionally, investment earnings may face a 20% penalty and income tax if not transferred to a Registered Retirement Savings Plan (RRSP), provided the account holder has available contribution room.
6. Transferability Between Family Members
- 529 Plans: 529 plans offer considerable flexibility in changing the account beneficiary, allowing funds to be transferred to another family member without penalty. This makes it easy to reallocate funds if the original beneficiary doesn’t need them.
- RESPs: RESPs allow beneficiary changes within family limits (e.g., siblings) without tax implications. However, the transfer may impact grant amounts or eligibility, particularly if the new beneficiary has already reached their lifetime CESG maximum.
7. Cross-Border Considerations
- 529 plans were not included in the Canada-U.S. Tax Treaty, so they receive no preferential treatment in Canada. The CRA views your 529 plan like a taxable account so while your growth and income in the account are not taxable in the U.S., it is taxable to the owner in Canada, not the beneficiary. Quantifying the Canadian taxable income can be difficult because no 1099 or other tax form will be generated since the account is not taxable in its home country. Also, any interest, dividends, or capital gains need to be converted to CAD on the date of the transaction for tax reporting purposes. Canadian education expenses can still be considered qualified so there may be no U.S. tax upon distribution. If the whole family will be moving to Canada and the 529 plan is in a parent’s name, it may be prudent to transfer ownership of the account to a grandparent or another trusted U.S. resident to avoid the Canadian tax complexities.
Conclusion
Both 529 plans and RESPs are effective education savings tools, tailored to the specific tax systems and education policies in the U.S. and Canada. Families with cross-border ties should carefully consider the eligibility, contribution limits, and usage rules for each plan to make the most of these tax-advantaged accounts. Consulting a financial advisor with cross-border expertise can help maximize education savings while staying within the unique requirements of each country’s plan. By taking advantage of the specific features of either a 529 plan or a RESP, families can ensure they’re well-prepared to meet future education expenses. Reach out to us at 49thparallelwealthmanagement.com to get the conversation started. From the Desert to the Tundra, we are your cross-border retirement experts!
