Jordan Tarasoff September 8, 2023 Personal Wealth RESP Myth: Offsetting Receipts “I’d like to withdraw $6,311.49 from my daughter’s RESP this semester.” This withdrawal request is precise, which is unusual. Registered Education Savings Plan (RESP) withdrawals are usually a round number. They are rarely down to the penny. This request indicates the subscriber may believe a common RESP myth. The primary purpose of a RESP is to save for a beneficiary’s post-secondary education. There is ample content describing the benefits of contributing to an RESP. I will not restate those benefits here. This post concerns a common and specific mistake when making RESP withdrawals. Someone who opens an RESP account is called the subscriber. The subscriber usually funds the account and later requests withdrawals on behalf of a beneficiary. The beneficiary is often their child or grandchild. Withdrawals intend to support the child’s post-secondary studies. Subscribers often believe they need dollar-for-dollar offsetting receipts for withdrawals. This belief is common but incorrect. Origin: The 529 Plan Americans have a similar account to save for their children’s education: the 529 plan. Rules for 529 plans differ by state. They generally have a mechanism to allow tax-free withdrawals of otherwise taxable investment growth. Withdrawals are not taxable if plan holders and beneficiaries have sufficient eligible expenses. Eligible expenses include college tuition, housing, and textbooks. The IRS (America’s CRA) calls eligible expenses qualified higher education expenses (QHEEs). If QHEEs exceed 529 withdrawals, withdrawals are tax-free. If withdrawals exceed QHEEs, taxes and a penalty may apply. Plan holders prefer to have QHEE receipts on hand before a withdrawal. They can avoid taxes and penalties if they know their QHEEs in advance. American media often finds its way into Canadian culture. The same is true for their financial planning rules. Canadians often mistake that they need receipts to withdraw from an RESP. RESP Withdrawal Requirements RESP withdrawals can trigger taxes, penalties and clawbacks if a beneficiary is not in school. Subscribers can request an Educational Assistance Payment (EAP) if the beneficiary is in a qualified program. An EAP is a withdrawal of investment growth mixed with government grants and bonds from an RESP. The EAP is taxable to the beneficiary but does not trigger penalties or clawbacks. A financial institution that holds the RESP is the promoter. Promoters require proof of enrollment to withdraw EAP from the RESP. Proof of enrolment differs from receipts. Receipts document paid educational expenses. Proof of enrolment confirms a beneficiary’s status in an eligible program. Students may enroll in an inexpensive program or have resources from family and employment to cover education costs. In all cases, the beneficiary can still request an EAP if they provide valid proof of enrollment. Being in school is a requirement. Having high costs with low resources is not. An EAP can fund purchases beyond the equivalent of QHEEs. EAPs are more flexible than 529 withdrawals. Beneficiaries can use EAPs to cover rent, tuition, late-night pizza, or a new laptop. Usually, RESP subscribers do not need to prove any expenses to withdraw from the RESP. They must only confirm that the beneficiary is in a qualified post-secondary program. Edge case: High expenses in the first semester The CRA recently changed the rules to allow an $8,000 maximum EAP in a beneficiary’s first semester of full-time studies. The limit for part-time students is $4,000. This limit increased in 2023 from $5,000 and $2,500, respectively, in previous years. These EAP limits can be flexible. The Government of Canada’s guide to RESPs states: “If you need to withdraw more money than the limits allow for full- or part-time studies, your RESP promoter can submit a request to the Minister of Employment and Social Development for approval. If the request is approved, the promoter must then complete a request form on your behalf and submit it to the Canada Education Savings Program.” Receipts support this request. Edge case: unreasonable expenses RESP Bulletin No.1R3 states annual limits for EAPs. If subscribers request withdrawals above the annual limit, they must prove the expenses are ‘reasonable.’ As of 2023, the EAP limit is $26,860. A promoter will ask for proof the funds are for reasonable expenses to withdraw over the limit. Proof = receipts. Reasonable expenses include indirect costs like food, a vehicle, and furniture. Vacations from school or going to the spa to recover from exams are usually unreasonable. In most cases, for most RESPs, these listed edge cases do not apply. Offsetting receipts are unnecessary for regular, reasonable withdrawals. RESP withdrawal planning Many Canadians withdraw an estimate of what they need to fund post-secondary education each year. This unstructured withdrawal strategy often leaves a large balloon withdrawal in the final year of school. A large, single-year withdrawal triggers more tax for a beneficiary. Households must consider these taxes when creating an RESP withdrawal plan. As mentioned, an EAP is taxable to the beneficiary in the year of withdrawal. In some years, a beneficiary will have a lower income than others. Low income = low tax. Low tax is an opportunity to make extra taxable withdrawals from the RESP. We can request additional funds even if they are unnecessary for that year’s expenses. A beneficiary may take on difficult courses in the early years of a program. They don’t have time to work. In those years, their taxable income may be low. If they can work in later years, their taxable income will be higher. Despite constant education costs, we may withdraw different amounts in different years. We make large withdrawals from the RESP in the early years and small ones later. This strategy will keep the beneficiary’s income and tax bracket consistent. Consistent income minimizes lifetime taxes versus spiking income in any single year. An alternative strategy will apply to a different pattern of income or graduate studies. At PWL, we build personalized strategies for RESP withdrawals. We optimize to: Avoid clawback of government grants and bonds. Smooth the beneficiary’s taxable income over the total time they are in school. Smoothing taxable income results in less tax. Maximize the tax-deferral and expected investment growth of the RESP account. To dive deeper into this or any other financial planning topics, use this link to book 30 minutes in my calendar. Sources: SEC.gov | Updated Investor Bulletin: An Introduction to 529 PlansRegistered Education Savings Plans and related benefits – Canada.caRegistered Education Savings Plan (RESP) Bulletin No.1R3 – Canada.ca Share: Facebook Twitter LinkedIn Email CIRO Advisor Report
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