The Lowdown on Withdrawing from Your RESP
With kids back to school this week, I figured it would make sense to go over what happens when your child starts taking money out of their RESP for school.
Quick refresher
I am sure everyone is aware of what an RESP is but just a quick refresher. Using an RESP account is a way the Canadian government incentivizes parents, grandparents or whomever opens up the account, to help save for that child’s university or college education. The government will put into the account 20% of the first $2,500 contributed (so max. $500 per year) up to a life time $7,200 per child. This is called the Canada Education Savings Grants. Maximum amount you can contribute is $50,000.
There are also Canada Learning Bonds that the government will contribute for lower income families. Each contribution into an RESP is NOT tax deductible like an RRSP. But any growth within the plan is tax-free LIKE an RRSP until pulled out.
Taxes When Pulling Out Money
Within your RESP, you are going to have the contributions you made, the government’s contributions and income earned on all these contributions. Each type of withdrawal brings with it different tax elements. The good news is; you can designate which form of income you want to take out:
ROP (Return of payment) - After-tax contribution you made that can be withdrawn tax free to the beneficiary
EAP (Educational Assistance Payment) – These include investment income and the government grants that will be taxable to the student/beneficiary. They will receive a T4A for this amount to be put into their tax return.
AIP (Accumulated Income Payment) – These are paid to the RESP holder/subscriber if your child chooses not to go to school or the subscriber wants money out. They are taxed at your marginal rate plus an additional penalty tax of 20%!
Withdrawal Strategies
The best piece of advice I can give is to sit down, determine the total cost of tuition over the next 4 years as well as see if your child will be earning any income from a part-time job during that time. This will allow you to see what portion should come from the taxable vs. non-taxable part of the RESP.
Because your child will most likely not earn much income when they are withdrawing, most withdrawals will not result in tax owing. They will have their basic personal credit of $15,705 and their tuition tax credit to shield income as well should they need it. At a minimum, they won’t pay tax on their first $15,705 of withdrawals.
It usually makes sense to withdraw from the taxable EAP portion first on withdrawals to try and get it out of the RESP while enrolled and pay little to no tax on it. Keep in mind there is an $8,000 limit on EAP withdrawals for full-time students for the first 13 consecutive weeks of your child’s enrolment. Once the 13 weeks is up, there are no limits on withdrawals as long as the student is enrolled. You can use these amounts to pay for rent, living expenses etc. If you are worried about taking out more than you should, you can just store the extra amount into your child’s TFSA and enjoy tax-free growth on the money.
After School Tax Problem
If there is still money in an RESP account after your child is no longer enrolled, you can transfer the amount to another child going to university in the future by making them the beneficiary of the RESP. Or, because an RESP can remain open for 35 years, you can leave the money in the account in case your child decides to get their MBA or law degree or return to school.
The maximum amount of contributions you can put into an RESP is $50,000 so if your contributions remain in the plan you can transfer up to that amount into yours or your spouse’s RRSP, provided there is contribution room (the RESP has to have been opened for 10 years in order to do this). Or you can collapse the plan and receive an Accumulated Income Payment that is taxed at your marginal rate plus the 20% penalty. I would try to avoid this last method as much as possible.
Bottom Line
You need to have a plan on how you are going to take the money out in order to pay the least amount of taxes. RESP’s can be complicated with all of the rules so I would recommend talking to your advisor before pulling money out.
DISCLAIMER: The articles posted on TaxCrunch should not be considered specific advice to anyone readying. Please reach out to a professional advisor to seek guidance on any issues mentioned in this post before acting upon anything written here. All posts are time sensitive to what is law at the time written and are subject to changes in legislation.