It’s that time of year again when students of all ages head back to school. For younger students, parents are reminded to think ahead and put money into RESPs to help pay for post-secondary education.
Related article: RESP Contribution rules
For those that are now going to post-secondary school, it’s not about putting money into RESPs as it is about getting money out of RESPs.
It’s important to note that 2014 was the first possible year for children to have reached the maximum Canada Education Savings Grant (CESG) of $7,200. There have been thousands of parents across the country with kids who have hit and will hit the $7,200 maximum grant. When it comes to RESP withdrawals, families that are not careful and do not pro-actively use their CESG money may be faced with the potential of having to pay some of it back to the Government down the road!
Let’s walk through an example of Jessica (Mom) and her daughter Brandi who is now going to post-secondary college for the first time to help understand the RESP withdrawal rules
Over the years, Mom has managed to maximize the CESG grant (with a little help from Brandi’s grandparents). $36,000 of contributions went into the RESP. The government contributed the $7200 in grants (CESG). The total value of the RESP is now $61,000 so there is $17,800 of investment growth in the account. Now that Brandi is 18 and going to post-secondary education, these RESPs are going to come in very handy.
Withdrawals from the RESP
To get money out of the RESP, the first step is to contact the financial institution that holds the RESP (in this case, it’s Mom’s financial advisor) to request a withdrawal. The terminology used is the subscriber (Mom) initiates the withdrawal and not the beneficiary (Brandi the daughter). Only the person that sets up the account can initiate the withdrawal.
Related article: Terminology of RESPs
Proof of education
In order to make withdrawals, the RESP beneficiary must attend a qualified post-secondary educational facility as determined by the government. Proof that the beneficiary is enrolled in a qualifying educational program at a post-secondary school level at a designated educational institution is required.
The definition of a qualifying post-secondary education facility is quite broad. As long as you are getting a certificate or degree, it probably qualifies. If you are not sure, you can check with the financial institution that holds your RESP or even the Canada Revenue Agency (CRA). The government has a Verification of Enrolment Form
In 2007, rules were changed to also allow for part-time studies to count for RESP withdrawals.
Some RESP withdrawals are tax-free
If we look at the example of Brandi’s RESP, CRA looks at all the money deposited by her mom ($36,000) as after-tax contributions and therefore any withdrawal of these contributions are not taxable on the way out of the RESP. When Mom originally put money into the RESP, there was no tax deduction and thus there is no tax on the way out. These withdrawals are called Post Secondary Education Payments (PSE).
The government looks at the contributions as Mom’s money. As a result, it is Mom who must request the withdrawal. Mom can have the money go into her bank account or the money can go directly to Brandi at Jessica’s request. There is no limit on the amount of PSE that can be withdrawn once the child goes to a qualifying post-secondary institution and the money does not have to be used directly for Brandi and her education. Mom can take out the $36,000 she put in any time she wants once Brandi is going to school and remember, there is no tax on the PSE.
Some withdrawals are taxed and restricted
If the contributions can be withdrawn tax-free, then the rest of the money in the account is government grants ($7200) and investment growth ($17,800). Any withdrawals of non-contributions are considered taxable to the student (Brandi). CRA calls this Educational Assistance Payments (EAP) and the financial institution will issue a T4A tax form in Brandi’s name for EAP payments only.
Unlike withdrawal of contributions (PSE) which is non-taxable and the limits are unrestricted, the withdrawals of EAP are not only taxable to the student but also limited in the first year.
There is a $5000 limit on EAP withdrawals in the first 13 weeks of schooling. When making withdrawals from RESPs, it is important to designate where the money is being withdrawn from because that affects the taxation of the withdrawal.
It is also important to designate if the money being withdrawn is CESG money because any CESG money that is left over must be returned to the government. It is important that the CESG is withdrawn while Brandi goes to school so none of it is left over.
The current balance of the RESP is about $61,000. $36,000 of the total amount is contributions that her mom put in and the rest is government money ($7,200) and growth ($17,800).
Even though Brandi only needs $3500 for tuition and books in the first year, Mom decides to take out the $5000 allowed in the first 13 weeks of school. It is important that mom specifies that the entire $5000 CESG is taken out first.
She gives Brandi the $3500 to pay for tuition and books and an extra $500 as a congratulations gift to buy some new clothes but keeps the remaining $1000 to hold for future expenses that may arise in the school year.
At this time, Mom could also withdraw $36,000 out of the RESP with no tax consequences. If she leaves it in the RESP and it continues to make money, any growth would be taxable to Brandi at the time of withdrawal. This is better than mom investing the money outside the RESP because Brandi is in a much lower tax bracket than mom.
Let’s say that Mom wants to take out $14,000 from the RESP in the second year to not only pay for tuition but also help Brandi purchase a car. $4000 would go to tuition and books and the other $10,000 can be used towards the purchase of a car. For this withdrawal, Mom should take out the remaining $2200 in CESG first so that all the government money is used up. Then the remaining amount ($11,800) can either be PSE (tax-free withdrawal of mom’s contribution) or EAP (money taxable to Brandi). With a little help from their accountant, Mom decided that $6800 would be EAP and $5000 would be PSE. After the second year, there will be approximately $11,000 of growth left in the plan (no CESG left) and $31,000 of mom’s original contributions.
Brandi is in a 4-year program so if we look ahead to the last 2 years of school, mom plans to take $5500 per year of EAP for 2 years to use up the remaining taxable portion of the RESP. After that most or all withdrawals will be the remaining contributions or PSE. Here’s a chart summarizing the withdrawal plan for the RESP.
I recommend that everyone develops an RESP withdrawal plan (especially when you have more than one child) and the key to this chart is to make sure you have a plan to use up the CESG and the EAP columns. As you can see, when withdrawing money from RESPs it’s important to understand the RESP withdrawal rules. It’s especially important to balance withdrawals based on the different tax rules and the CESG when withdrawing money. Also, make sure your advisor or bank understands the rules.
More than one child
According to Financial Advisor Jeff Burchill in Sarnia, Ontario “When requesting money from RESP accounts from various financial institutions, it is important to always look at the EAP vs the PSE, but we never consider how much of the EAP is CESG and the Fund companies or banks have not been telling us unless we ask for those specifics.”
Burchill also shared an example of a family with 3 kids where it was critically important to specify that withdrawals are grant money.
Imagine a case where there are 3 children, and all 3 children have received the max CESG of $7,200. Let’s say for simplicity that it is a Family plan. There is $21,600 in total CESG in the account. Assume the first 2 kids only use $5,000 of CESG each. By the time the 3rd kid gets around to using the RESP, there is still $11,600 of CESG in the account. The 3rd child can only use $7,200 and the other 2 kids have no interest in going back to school, just to use up some money. $4,400 would have to be sent back to the Gov’t!
Burchill feels parents need to pay attention to this when considering RESP withdrawals. If not, there may be a lot of parents giving money back to the Gov’t in the coming years. Unfortunately, I have met many people that were not told about the different tax rules for RESP withdrawals.