Back-to-school RESP withdrawals

Rules for getting education payments

Those with kids going on to post-secondary education next month may be in for a case of sticker shock. In Canada, an average four-year program will cost about $70,000 including tuition, books, board and lodging, and living expenses. It’s more than double that for professional degrees like law, medicine, dentistry, and engineering. If your aspiring university applicant is looking to enter a U.S. Ivy League school, the minimum is US$76,000 for one year. Parents who set up Registered Education Savings Plan (RESP) 17 years ago and made regular contributions will be congratulating themselves on their foresight. But RESP withdrawals aren’t treated like a bank account. There are plenty of rules about how they’re administered.

Educational Assistance Payments

Funds received from RESPs are are called “Educational Assistance Payments,” or EAPs. The basic rule is that the student must be enrolled in a qualifying post-secondary educational program (three consecutive weeks and 10 hours per week), whether in person or by distance learning.

A $5,000 maximum EAP ($2,500 for specified educational programs) can be made to a student for the first 13 consecutive weeks for studies in a qualifying educational program. After that, there’s no limit on EAPs that can be made, provided the student continues to qualify to receive them. If the student drops out for 12 months, the $5,000 maximum applies again.

RESP payments are taxable income, but this isn’t all bad news. The student reports EAPs on their tax return as income for the year they receive them. Presumably, the student will be in a very low tax bracket and therefore will pay little or no tax on the EAPs.

Students who decide to do something else

If a student who is a beneficiary of an RESP decides not go on to post-secondary school, the investment income earned in the RESP is paid to one subscriber (typically a student’s parent) in the form of Accumulated Income Payments (AIPs). To be eligible for AIP payments, the RESP must be at least 10 years old, and the student beneficiary must be at least 21 and not eligible to receive EAPs. These payments will then become taxable to the subscriber who receives them and must be included in income for the year in which they are received. In addition to being taxed at the recipient’s marginal tax rate, AIP payments are also subject to a further 20% federal tax (12% in Quebec). The tax hit can be reduced if you roll over the AIP payments to an RRSP or certain other registered pension plans, provided you stay within your contribution limit, not exceeding a lifetime maximum of $50,000 in AIPs.

What to do with unused RESPs

* Keep it open. RESPs can be left open for up to 36 years before the funds must be deployed. There’s no pressure to use the funds immediately, and money in the RESP will continue to grow. If you haven’t contributed the maximum, consider topping up the plan during this period if your child simply wants to take a gap year but is still planning to go on to university later.

* Consider other programs. RESPs can be used for apprenticeship programs, as well as eligible trade and business schools. Likewise, RESP funds may be used for qualifying part-time education programs.

* Transfer beneficiary. An RESP may be transferred to another beneficiary – a sibling, for example. Check with the plan sponsor to see how this can be done.

* Close the RESP. You may shut down the RESP and have your original contributions returned to you tax free. But you will pay tax on the income generated by those contributions (the AIPs) at your top marginal rate plus an additional penalty of 20% (12% in Quebec). There is no capital gains tax on investment growth in an RESP. And any government top-up grant money received by plan must be returned to the government.

* Transfer funds to an RRSP. To defer tax on the AIP and avoid the 20% penalty on terminating an RESP, you may be able to transfer up to $50,000 of AIP to your or your spouse’s RRSP, provided you have contribution room available and the RRSP allows this type of transfer. You can only make a transfer if the RESP has been open for at least 10 years, your child is 21 or older and has decided not to go on to post-secondary, and you are a Canadian resident.

Transferring investments in kind (as is) from an RESP to an RRSP may be a way of avoiding transaction costs. Not all financial institutions allow transfers, but because this is not a statutory rule, there may be ways to get around this. Check with your advisor and financial institution.

Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at rthompson@castlemarkwealth.com for a confidential planning consultation.

Notes and Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.