An RESP is an investment vehicle created in Canada to allow parents to fund a savings plan for financing their children’s post-secondary education. The two most significant benefits and advantages of RESPs are government contributions and tax-free investment growth within the account. The catch about an RESP, however, is that withdrawal can be very cumbersome- it has rules on how and when one can withdraw those funds. This guide will go on to discuss the rules set by this type of account, the variety of withdrawals you can make from it, and how to maximize an RESP.
What is an RESP, and How Does It Work?
A RESP is an account that is registered with the government, allowing Canadian parents, guardians, and family members to save for a child’s future education. However, contributions to the RESP are not tax-deductible, though income from investments grows tax-free within the account until these savings are withdrawn. In addition to personal contributions, the government provides incentives in the form of grants, such as CESG and the Canada Learning Bond (CLB), for the effective saving of families.
RESPs are created to finance post-secondary education. As for the restrictions placed on withdrawals, they categorize them depending on whether the amount withdrawn is made from personal contributions or government grants and accumulated income.
Types of Withdrawals in RESPs
RESP withdrawals are classified into two main categories:
- Post-Secondary Education Payments (PSEs): These withdrawals are deducted from the contributions of the RESP account holder. PSEs are usually tax-free as the contribution is done through post-tax income. The PSE benefit may be applied towards all costs that have to do with tuition, including residence, books, and other associated education expenses.
- Educational Assistance Payments (EAPs): EAPs, consisting of government grants and reinvestment income such as interest, dividends, and capital gains are taxed as ordinary income in the hands of the beneficiary. Nevertheless, most students are at lower levels of income and pay little or no tax on EAPs.
When and How to Withdraw from an RESP
Eligibility for Withdrawals:
Withdrawing under RESP – Withdrawals are only available when the recipient is a registered student at a qualifying post-secondary institution. Proof of registration by admission letter or course timetable is needed to make a withdrawal.
Steps to Withdraw from an RESP:
- Check Enrollment Requirements: The beneficiary must be enrolled in a post-secondary program that qualifies under RESP rules.
- Determine the Type of Withdrawal: Decide whether to withdraw funds as a PSE, EAP, or both. Keep in mind that there are specific limits for EAP withdrawals, especially in the early stages of study.
- Submit Withdrawal Requests: Most financial institutions require a withdrawal form and proof of enrollment. You’ll need to specify the amount to be withdrawn and the type of withdrawal.
- Manage Taxes Efficiently: EAPs are taxed in the hands of the beneficiary, so planning withdrawals to stay within a low tax bracket can help reduce tax implications.
Understanding Educational Assistance Payments (EAP) Limits
When you first start withdrawing EAPs, the government places limits to prevent misuse. Here are the main points to consider:
- EAP Limit for Full-Time Students: For full-time students, the EAP withdrawal is limited to $5,000 during the first 13 weeks of enrollment in a qualifying program. After the first 13 weeks, the withdrawal amount is unlimited as long as the funds are used for education-related expenses.
- EAP Limit for Part-Time Students: Part-time students have a $2,500 limit for each 13-week period of enrollment in a qualifying educational program. If a student takes a break longer than 12 months, the 13-week limitation resets.
The Importance of Planning EAP Withdrawals
Proper planning ensures that beneficiaries maximize RESP benefits and avoid unnecessary taxes. Here are some tips to consider when planning EAP withdrawals:
- Utilize Low-Income Years: Since EAPs are taxed as income, it’s wise to make withdrawals during years when the student’s income is low to minimize tax implications.
- Withdraw Grants First: Since contributions are not taxed, but EAPs are, it’s often beneficial to withdraw government grants and investment income first to maximize tax-free growth in the account.
- Maximize Annual Withdrawals: There’s no limit on PSEs, so taking advantage of these withdrawals in addition to EAPs can ensure adequate cash flow for education costs.
Withdrawing Contributions
This means contribution can be withdrawn at any time and is tax free. The account holders are allowed to withdraw this amount to deal with the expenses of their education or store this money as tax-free cash for any expenses. However, one has to withdraw the contribution when government grants are still available in the account. Withdrawal of contributions may lead to the refund of a portion of the CESG and government grant payments that could have been paid out before the recipient enrolls in a post-secondary institution.
Rules for Non-Educational Withdrawals
In some cases, the beneficiary may not pursue post-secondary education, leaving the RESP funds unused. If this occurs, account holders have the following options:
- Transfer to Another Beneficiary: RESP accounts allow for the transfer of funds to another beneficiary, such as a sibling, under certain conditions.
- Transfer to an RRSP: If the account holder has an unused RRSP contribution room, up to $50,000 of accumulated income (excluding government grants) can be transferred to an RRSP.
- Withdrawal with Penalty: Account holders can withdraw contributions tax-free, but the accumulated income will be taxed at the regular income rate plus an additional 20% penalty.
- Return Government Grants: Any unused government grants, such as the CESG and CLB, must be repaid to the government if the funds are withdrawn for non-educational purposes.
Transfer Rules for Family RESPs
Family RESPs can have a multitude of beneficiaries from the same family. If a beneficiary in the RESP has not utilized the money, then the owner cannot transfer a portion of that money to any eligible member of that family. Only an account can be transferred if:
- A new beneficiary must be under 21 years of age at the time of designation.
- If the RESP includes government grants, the new recipient has to be a sibling to be qualified for the CESG.
- Family RESPs can keep funds in the account and do not lose any grant if one beneficiary does not utilize funds and no more tax needs to be paid if one beneficiary does not require them.
Government Grant Repayment Rules
Withdrawing funds from an RESP for non-educational purposes or before enrollment can trigger the repayment of government grants. HHere’squick breakdown:
- Canada Education Savings Grant (CESG): If contributions are withdrawn while the beneficiary is not in school, a portion of the CESG matching contributions must be returned to the government.
- Canada Learning Bond (CLB): Similarly, the CLB is forfeited if the beneficiary does not pursue post-secondary education.
By adhering to withdrawal rules and structuring withdrawals to cover educational costs, families can avoid the repayment of these valuable grants.
RESP Withdrawal Scenarios: Real-Life Examples
Scenario 1: Maximizing Withdrawals for a Full-Time Student
Lily is a full-time student and has $20,000 in an RESP, consisting of $10,000 in contributions, with the remaining $10,000 in EAPs. At the end of her first semester, she withdraws $5,000 in EAPs that are within the 13-week limit for full-time students. She continues to report every year throughout her years of schooling and withdraws only what is needed for that year to avoid going into a higher tax bracket.
Scenario 2: Sibling Transfer in a Family RESP
James has a family RESP with his younger sister, Emily, as the beneficiary. James chooses not to pursue further post-secondary education and leaves $15,000 in government grants. Because they have a shared family RESP, the account holder can transfer JJames’s grants and income to Emily without penalty.
Scenario 3: Withdrawing RESP Contributions for Other Needs
Mike and Sarah have invested $25,000 in their son’s RESP. The RESP also contains $15,000 of government grants and income generated from investments. Finally, when the son changes his mind and decides that he wants to delay going to college, Mike and Sarah take out $10,000 of their contributions to use for household expenses. They pay no tax on this withdrawal because it’s part of their initial contribution, but then they avoided withdrawing too much so as not to lose the CESG for educational purposes.
Tips for Managing RESP Withdrawals
- Create a Withdrawal Schedule: Plan withdrawals based on your child’s academic calendar to cover tuition, books, and living expenses without disrupting cash flow.
- Limit EAP Withdrawals Initially: If your child is in their first term, limit EAP withdrawals to the set amounts ($5,000 for full-time and $2,500 for part-time) until they complete 13 weeks of study.
- Minimize Taxes on EAPs: Since EAPs are taxed in the student’s hands, spreading out withdrawals over the duration of studies can reduce the tax burden.
- Stay Informed on Changing Rules: RESP rules are periodically updated, so check with your financial institution or consult a financial advisor to stay current.
RESP Withdrawals and Tax Implications
While contributions to an RESP grow tax-free, withdrawals may still have tax implications:
- PSE Withdrawals: Personal contributions are not taxed, making them ideal for non-educational needs if needed.
- EAP Withdrawals: Taxed in the beneficiary’s hands, usually at a lower tax rate due to limited student income.
- Accumulated Income Payments (AIPs): If the RESP isn’t used for education, income earned could be withdrawn as an AIP, subject to regular income tax and a 20% penalty unless transferred to an RRSP.
Conclusion: Making the Most of RESP Withdrawals
RESP dollars offer fantastic savings opportunities for post-secondary education, but knowing which rules apply to withdrawal is important to reap all the benefits. Accordingly, with just the right planning concerning when and how much to withdraw, families will then be able to put
RESP dollars in support of their children’s education at a reduced tax burden as they work their way out of the debt incurred in repaying grants. There are options to consider, strategies to plan a withdrawal, and keeping track of which RESP rules are newly developed to use this marvellous saving opportunity.
Know More: The Impact of RESPs on Student Loans