Did you know there are ways to reduce taxes on RESP withdrawals?
Starting university is an exciting time for students but can be a stressful one for their parents. While it’s natural for parents to be concerned about where their kids will live or what they’ll eat if they’re studying away from home, the biggest worry may be around how to pay for tuition and accommodation.
Fortunately, those who have been saving diligently in a Registered Education Savings Plan (RESP) should have enough money to cover most, if not all, of those costs.
The RESP is certainly an important savings vehicle at a time when higher education is extremely valuable but becoming increasingly expensive. It’s the only financial instrument that tops up contributions by up to 20% through the federal Canada Education Savings Grant (CESG) – and some provinces chip in as well. And a key RESP tax benefit is that it allows contributions to grow on a tax-deferred basis.
However, many people don’t realize that there are RESP withdrawal strategies that can help you draw funds in the most tax-efficient way. With smart planning, your child may be able to cover the costs of their education from their RESP while paying little or no tax.
First of all, work out how much they’ll need
Before you do anything, sit down with your child, at least six months before they start university, and calculate how much their education will cost, in total. If your child only wants to attend a four-year undergrad course, then you should plan to use the money up within four years.
If they expect to go to graduate school, you’ll need to hold some money back to cover those expenses. And bear in mind that tuition and living expenses vary by institution and program. For example, engineering typically charges higher tuition fees than a general arts program, even at the same institution.
Also, if your child has other sources of income earmarked for education, such as a scholarship or money from a summer job, you may not need to withdraw as much from their RESP to begin with.
In addition to tuition, RESP withdrawal rules allow your child to pay for any expense related to post-secondary education from these savings: books, residence, living expenses and even trips home. Proof of enrolment at an accredited institution and in an eligible educational program are usually all that’s needed.
RESP withdrawal strategies that minimize your child’s tax
Before withdrawing from an RESP, you should have a tax strategy in place. It’s important to understand that there are three distinct types of money in an RESP, each with different tax implications:
- Your RESP contributions can be withdrawn tax-free
- Government grants
- Grants are taxable
- Income earned on investments
- Income (such as interest, dividends and capital gains) is taxable
While RESP withdrawal rules allow contributions to be withdrawn tax-free, you should only start withdrawing from them once your child has enrolled in post-secondary education. If you make a withdrawal from contributions prior to that time, it will cause a claw back of the government grant.
Since many 18-year-olds don’t earn a hefty salary, they won’t have to pay much tax, if any, on the taxable portion of their withdrawals. However, if your child took the year off to work and earned money, or if they’re in a medical school residency and earning a decent wage, RESP withdrawals could bring about tax implications.
In this instance, a key RESP withdrawal strategy is to designate the type of funds you’re withdrawing. So, for example, you can specify if you want to withdraw contributions or grant money. If you think your child will earn a salary before they’re finished using their RESP, then it could make sense to withdraw the income and grant money first, in years when they’re in a lower tax bracket.
It therefore makes sense to consider tax-planning strategies before making any withdrawals.
RESP withdrawals: a case study
The Gonzalez family opened an RESP at birth for their child who is now 18 years old, planning to major in engineering and then go on to graduate school. That’s six years of university education, with potential opportunities for paid internships.
On the advice of their IG Wealth Management Consultant, the Gonzalez family contributed a total of $36,000 to their child’s RESP over 15 years, enough to receive the full Canada Education Savings Grant of $7,200.
At an average rate of return of 4.75%, the RESP funds available to their child at age 18 would be $74,322. Here’s how the Gonzalez’s RESP withdrawal strategy might look:
|Parent contributions||Investment income earned||Government grant|
|Not taxable||Taxable to student||Taxable to student|
|Use this when student’s income is higher, for example, during paid internships.||Access this portion early in student’s university years, when income is low.||Access this portion early in student’s university years, when income is low.
For illustration purposes only.
You need to keep your RESP growing
Investing can be tricky during the withdrawal phase. You’ll obviously need some money immediately, but if your child is planning on going to school for several years, you’ll also need to continue growing those savings.
Any immediate withdrawals should be transferred into short-term investments, such as money market funds or guaranteed investment certificates (GICs), which don’t fluctuate in value. For instance, when your child is in Grade 12, move the money you’ll need in year one into short-term investments. Then in year one, move year-two money into short-term investments, and so on. By following this RESP withdrawal strategy, you’ll ensure the money you’ll need now won’t be impacted by market fluctuations.
Funds that may not be needed for a few years can stay invested in a mix of mutual funds, stocks and bonds, with a view to being more conservative the shorter the time horizon. However, if your child is in a program that lasts, say, eight years, then you can be more aggressive with some parts of your money.
What should you do with the RESP if your child doesn’t go to school?
In this case, it can be a good strategy to wait as long as possible before withdrawing from an RESP for non-educational purposes, in case your child changes their mind. Parents can also transfer or allocate funds from one sibling to another, but the total Canada Education Savings Grant that is paid to the new child cannot exceed $7,200.
If you eventually decide on withdrawing from an RESP for purposes other than your child’s education, you should know that the grant money will be returned to the government. As for the income or growth within the RESP, it will be taxable to you, the subscriber of the plan, and could be subject to penalties.
What’s the best RESP withdrawal strategy for your children?
Withdrawing funds from an RESP is clearly not always a straightforward process. It’s a wise idea, therefore, to arrange a meeting with your IG advisor at least six months before your child starts post-secondary education.
Your IG advisor can help determine the best approach for your family to optimize tax planning before your child makes any RESP withdrawals. If you don’t have an IG advisor, you can find one here.
Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Wealth Management Consultant.
The Canada Education Savings Grant and Canada Learning Bond (CLB) are provided by the Government of Canada. CLB eligibility depends on family income levels. Some provinces make education savings grants available to their residents.
GICs issued by Investors Group Trust Co Ltd., and/or other non-affiliated GIC issuers. Minimum deposit, rates and conditions are subject to change without notice.