It's September and with that, a new school year is upon us, albeit an unusual and distanced one this time around. For parents with children taking their first steps towards post-secondary education this month is an exciting time and for many, it can also be a financial milestone. Congratulations if this is you! Now that you've done the hard work of saving the money, it's time to think about how to use it towards your child's education. Which brings us to the question - how do you withdraw money from an RESP? And how can you make the most of those withdrawals?
As a refresher – an RESP is an account that can be opened as soon as you have a SIN number for a newborn child. Individuals can open and contribute to an RESP account and are known as the subscribers of the account. One of the key reasons RESPs are great is the fact the government will also contribute funds known as the Canada Education Savings Grant (CESG). The government will match 20% of contributions, up to a max contribution of $2500 per child per year. This means the max the government will provide in a year per child is $500 (20% x $2500).
A subscriber can contribute more than $2500 in a year; they just won't receive additional grant money for the year. The lifetime max the government will contribute in the form of grants is $7200 per child and the lifetime maximum a subscriber can contribute is $50,000. Once the money is in the account, you can choose to invest it in a variety of investments and these investments can grow tax-free. Tax is paid only when you withdraw money from the account and only a certain portion gets taxed with the idea that the tax is attributed to the beneficiary of the account, typically a child or grandchild. The idea is that little to no tax will be paid given the fact the beneficiary has little to no income at the time.
There are several rules as it relates to withdrawing money from an RESP and some of them make it seem fairly complicated. Let's take a look at the nuts and bolts of withdrawing money from these accounts and how to do it in an efficient matter. The individual who opened the account, or the 'subscriber', is the only person authorized to initiate the withdrawal from the account. Funds inside RESP accounts are broken out into two different classifications; funds will either be classified as Post-Secondary Education Payments (PSE) or Education Assistance Payments (EAP). These classifications become important when money is withdrawn from the RESP account as each classification receives different tax treatment.
PSE represents the contributions that were made by the subscriber and were done with after-tax dollars. No taxes are paid when funds come out of the account that are classified as PSE.
The EAP portion includes money provided by the government in the form of the CESG and other grants AND any investment returns earned on all the funds inside the account. The financial institution you deal with will have a record of the breakdown of these components and when you withdraw you'll be asked which of the classifications you'd like to withdraw from and how much.
Because PSE is made up of after-tax contributions by the subscriber, this can be withdrawn by the subscriber at any time without incurring tax and can be used either the subscriber or the beneficiary. But hold up before you go running to pull out all this money tax-free first. The EAP portion is made up of government-provided funds and the tax-free returns that were earned on all funds held inside the account. When the EAP portion is withdrawn it is taxed, though it's in the hands up the beneficiary/student who again pays little to no tax due being in the lowest tax bracket. Initially, there is a $5000 maximum of EAP that can be withdrawn in the first 13 weeks of schooling. After the 13 weeks, there are no restrictions on how much money classified as EAP can be withdrawn. What should you withdraw first? PSE or EAP?
At Endeavour, we often recommend to our clients focus on getting this EAP portion out of the RESP first. However, rushing to get all of the EAP portion out as quickly as possible can put the beneficiary in an adverse tax situation defeating one of the core purposes of using this account. A balanced and planned approach is the most optimal. When done successfully the beneficiary will pay little to no tax on the EAP portion while the subscriber can continue to have their after-tax contributions represented by the PSE compounding for them tax-free inside the account.
Sometimes post-secondary just doesn't work out. Sometimes individuals just don't end up using the entire account. In either case, the RESP will need to be closed and the funds remaining have to go somewhere. The subscriber will receive any PSE tax-free as these were the subscriber's after-tax contributions. The EAP portion however is made up of government grants and accumulated investment earnings on the funds inside the account.
When closing out an RESP, subscribers are required to pay the government grant portion back. The subscriber is however able to withdraw the portion of the EAP that is made up of investment earnings known as Accumulated Interest Payments (AIP). This portion of EAP can be withdrawn but is taxable to the subscriber as income and comes with a 20% penalty as well! The less EAP and the more PSE leftover at the less you have to pay back and the more you get to keep after tax. It is worth noting that you are allowed to transfer up to $50,000 into an RRSP if there is an unused contribution room available at the time.
Although an RESP account is fairly straight forward when it comes to contributions. Withdrawing can be anything but. By ensuring you understand the withdrawal rules and how the funds are classified, you can ensure the money you've worked hard to save has the greatest possible impact.
- Brandt Butt, Investment Advisor, CIM
Brandt Butt is an Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.
This information has been prepared by Brandt Butt who is an Investment Advisor for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.
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