A Registered Education Savings Plan, or RESP, is a special savings account designed for parents who want to save up for their children’s post-secondary education.
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If your kid is about to start freshman year at a college or university this year and you’ve got a tidy sum of money for her or him in one such account, you can pat yourself on the back.
But do you know everything there is to know about withdrawing funds from an RESP?
Many parents don’t, according to Scott Evans, a certified financial planner at BlueShore Financial, a B.C.-based boutique financial firm.
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Normally, financial advisers have nothing but good things to say about RESPs. Canadians can open an account as soon as their child is born and the government will help build their education savings by topping up their contributions. You get 20 cents for every $1 you put in, up to $500 in federal grant money per year. Low-income families get a little extra help, and several provinces offer their own RESP incentives, too.
However, when it’s time to take the money out, there are “a number of complexities” that parents should be aware of, said Evans.
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Two ‘buckets’ of RESP money
Not all of your RESP money is created equal, he explained. The funds falls in two buckets, one made up of contributions, and one of what Evans calls “income,” which includes the amount of any government top-up, plus any interest and capital gains earned over time.
Funds withdrawn from the first bucket are called “refunds of contributions” (ROCs) and there isn’t much to know about them. Your contributions were made with after-tax dollars so ROCs are not taxable. All you need to get the money out is to show your financial institution proof of your child’s enrolment in a post-secondary school, said Evans.
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That doesn’t need to be a university, as RESP savings can be used to pay for a range of higher education institutions, including community colleges and trade schools, noted Tea Nicola, co-founder of robo-adviser WealthBar, and a former trainer of financial advisers.
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However, money coming out of the second bucket, formally called “educational assistance payments” (EAPs), is taxable. There are two things, in particular, that parents should keep in mind about EAPs, according to Evans:
1. These funds will be taxed at the marginal rate that applies to the student. This is good news, as students generally fall into a lower tax bracket than their parents. But taking full advantage of this tax treatment requires some careful planning, said Evans. For example, it may make sense to use EAPs for years in which your child’s income from other sources is lowest. EAPs count as income and could push students into a higher tax bracket if they also earn money from, say, a side job. If your kid isn’t planning to bring in any extra money, she or he may be able to avoid paying taxes entirely if the amount of EAPs is under Canada’s minimum taxable income, which is around $12,000 per year.
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2. If you don’t use this money, you risk losing a chunk of it. If there are still funds left in that second bucket when your child is done with school, the government will take back any grant money. You’ll also have to withdraw any remaining income, which will be taxed at your marginal tax rate, plus an additional 20 per cent punitive tax.
That’s why in most cases it makes sense to prioritize emptying out the second money bucket while potentially spreading those withdrawals over several years in order to minimize taxes, according to Evans.
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Note that leaving contributions in the RESP could backfire, too, as those will likely continue to earn interest and generate investment income that will have to be withdrawn after your RESP hits its maximum life span of 35 years.
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Still, if the time comes to close your child’s RESP and there’s money left in that tricky second bucket, you can minimize the tax hit by rolling over up to $50,000 into your RRSP, noted Nicola. That’s assuming you have enough contribution room, and the government will still take back any grant money, she warned. Still, that allows you to defer the income tax and avoid the penalty.
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Other things you should know about RESPs
Despite the intricacies of RESP withdrawals, setting up one such fund for your school-bound kid is nearly always a great idea, said Nicola. Here are a few more things parents should know about these savings accounts:
- The RESP contribution that lets you maximize government top-ups is $208.33 per month. In most cases, the government will put in 20 per cent for everything you contribute, up to $500. In other words, if you save $2,500 a year, you’re entitled to $500 more over the same period. If you’d rather not contribute through a lump-sum every year, plan on squirreling away about $209 per month.
- Don’t have any money to put into an RESP? It might still be worth opening one. Young parents who are struggling with reduced income from maternity leave and the eye-popping costs of child care may not have any spare change to put into an RESP, noted Nicola. But they should still open one. Some provinces, like B.C., will kick in an additional grant for any child aged six and older who has an RESP – no contributions needed (but you do need to apply before your kid turns nine).
- RESP money doesn’t have to be used for tuition alone. Parents often believe RESP funds can only go toward tuition and things like textbooks and schools supplies, said Nicola. In reality, though, there are few strings attached to RESP withdrawals. The money can definitely be used to finance a student’s day-to-day expenses as well, she noted.
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