There’s no doubt about it—a Registered Education Savings Plan is a great deal for parents.
It provides you with a tax-sheltered way to save for your children’s post-secondary education and grow those savings even faster thanks to government grants.
The Canada Education Savings Grant (CESG) matches 20% on the first $2,500 contributed each year, to a lifetime maximum grant of $7,200 per child. Some provinces, including Quebec, offer additional incentives for parents to save for their children’s education.
However, RESP rules can be tricky when it comes time to start withdrawing money. The key thing to remember when making withdrawals is that the government takes a very different view of money in the plan depending on how it got there.
First, there’s the money you contributed to the RESP over the years. When you withdraw this money, the federal government calls this a Post-secondary Education Payment or PSE. That’s your money and you can withdraw it tax free.
The second category consists of grants and any other government incentives paid into the plan, plus the investment earnings—interest, dividends and capital gains that have accumulated over the years. Together, this portion of the RESP is called the Educational Assistance Payment or EAP when withdrawn, and it’s taxable.
To withdraw money from an RESP, you will have to provide documents showing your child is enrolled in an eligible post-secondary institution, such as a university, CEGEP, college or trade school.
EAP withdrawals are taxable in the hands of your child. A T4 slip (and a Relevé 1 slip for Quebec residents) is issued to the student by the financial institution holding your RESP. This is advantageous because your child’s annual income will typically be low enough that the EAP will trigger no or minimal income tax.
EAP withdrawals are limited to $5,000 for the first 13 weeks of a full-time student’s post-secondary program, but after this period there is no limit on additional EAP withdrawals. However, if the student takes a break from his or her studies and does not re-enroll in an eligible educational program for 12 months, the original $5,000 limit is reinstated. EAP withdrawals for part-time students are limited to $2,500 for every 13-week period.
The good news is that the government is very flexible about what RESP withdrawals can be used for in funding your children’s education and doesn’t require you to submit receipts.
Of course, the money can be used to cover tuition, fees, books, and other direct costs. But it can also pay for a student’s indirect costs such as rent, meals, computer equipment, office furniture, transit fares and any other living expenses.
EAP withdrawals can only be made penalty free until six months after your child has stopped being enrolled in a post-secondary institution.
An RESP can be left open for up to 36 years. However, any EAP remaining when it is closed must be repaid to the government. You can transfer up to $50,000 of the investment earnings portion to your RRSP if you have contribution room or you may withdraw funds as taxable income in your hands.
Given these restrictions, it’s important to keep track of how much EAP remains in the plan and get it out before your children finish their post-secondary education.
Once you have withdrawn all the EAP, I advise clients to quickly close the RESP. By closing the plan, you recover any of your contributions that are left and avoid having more investment income and capital gains build up, which count as EAP with all that implies.
What to do with the money left over when you close your RESP? Your original intent was to save it for the kids’ future, so you might want to keep it in case they return to school in the future. Or you could put it into their tax-free savings accounts (being careful not to exceed their contribution limits). Another possibility is to use the money to top up your or your spouse’s RRSPs. It’s up to you.
An RESP is an excellent vehicle as long as you keep your eye on the rules when helping your kids with their education and winding down your plan.