The benefits of contributing to a registered education savings plan are well understood.
Not only does your money grow tax-free, but the federal government kicks in the Canada Education Savings Grant (CESG) for an additional 20 cents on every dollar contributed - up to a maximum grant of $500 annually (on a $2,500 RESP contribution) or a lifetime limit of $7,200 a child.
What’s less well understood are the myriad rules that come into play when Junior heads off to postsecondary school and needs to access to the RESP’s funds. With the new school year underway, today I'll explain the rules and offer some pointers on withdrawing money from an RESP.
What’s taxable and what’s not?
When the subscriber (typically a parent or grandparent) makes an RESP withdrawal, he or she designates what portion consists of a return of the original contributions (which are not taxable) and what portion consists of grants, income and capital gains that have accumulated inside the plan (all of which are taxable in the hands of the student). It's generally a good idea to start withdrawing these non-contribution amounts, called Educational Assistance Payments (EAP), earlier rather than later. That's because, if the child finishes school or drops out and there is still grant money and income left in the plan, the grants will ultimately have to be repaid and the subscriber will be taxed on the withdrawal. (More on that later.)
Do I have to provide receipts?
In theory, the financial institution could ask for receipts for textbooks, housing, meals and other expenses to justify an RESP withdrawal. In practice, that rarely - if ever - happens. To tap the RESP’s funds, all the financial institution requires is proof that the beneficiary is enrolled in a qualifying postsecondary program. How the money is spent is up to the student (although most parents who want the money to last would probably want to have a say in that).
How much can I withdraw?
Once the student is enrolled, there are no limits - and no penalties - on the amount of contributions that can be withdrawn. For EAPs, on the other hand, withdrawals are limited to $5,000 during the first 13 consecutive weeks of enrollment. After that, there are no restrictions on EAP withdrawals “unless the student takes a break from his or her studies and does not re-enroll in a qualifying educational program for 12 months. If that happens, the original limit is reinstated,” the government says. Withdrawals of contributions can be sent to either the beneficiary or the subscriber, while EAPs must go directly to the student.
What’s the best withdrawal strategy?
Because students don’t typically have a lot of income, it generally makes sense to exhaust EAP withdrawals while the beneficiary is in school and paying very little - if any - tax. If the RESP is especially large, spreading the EAP withdrawals over several years - to minimize the income tax hit in any one year - may also be a prudent strategy.
What if my child doesn’t attend post-secondary school?
The good news is that any contributions in the plan are yours to keep, with no tax consequences. Grants and income earned inside the plan are a different story.
If you have more than one child, it may be possible in certain cases to transfer the RESP funds to a sibling. The lifetime CESG limit of $7,200 a child still applies, however, so you may have to repay some or all of the grants if the combined amount exceeds the individual limit. If it isn’t possible to transfer funds to a sibling, then all of the grant money must be repaid.
As for the investment earnings in the plan, the subscriber can withdraw this amount if - among other conditions - he or she is a resident of Canada, the plan has been open for at least 10 years and all beneficiaries have reached 21 years of age. In such cases, the accumulated income can be withdrawn by one of the subscribers and taxed at his or her marginal rate, plus an additional tax of 20 per cent (reflecting the fact that some of the accumulated income was generated by the CESG grant). If you have sufficient registered retirement savings plan room available, however, you can transfer up to $50,000 of the accumulated income to your RRSP or your spouse’s RRSP and avoid paying both income tax and the penalty tax.
Another option is to leave the RESP in place in case the beneficiary decides to attend school at a later date. There's no rush: An RESP can remain open for up to 35 years following the year it was started.
E-mail your questions to jheinzl@globeandmail.com.
John Heinzl