Jamie Golombek: Here’s a strategy that ideally permits all funds in an RESP to be withdrawn tax-free or at minimal tax cost
Author of the article:
Sep 04, 2020 • • 5 minute read
Forex Article content
Driving my daughter back to university this past week gave us some quality time together to review the ins and outs of the RESP that was established nearly two decades ago for her and her siblings. Sure, she always knew that funds were set aside to help with tuition, books and accommodations, but she was unaware of the potential tax bill that may be associated with RESP withdrawals, if not properly managed.
Let’s briefly review some RESP basics and how withdrawals are taxed, and then suggest a withdrawal strategy that minimizes a family’s tax liability and, ideally, permits all the funds in an RESP to be withdrawn tax-free or, at minimal tax cost.
What is an RESP?
An RESP is a tax-deferred savings plan that allows parents to contribute up to $50,000 per child toward saving for post-secondary education. The addition of government money in the form of Canada Education Savings Grants (CESGs) can add $7,200 per child to the plan. Combine that with income earned and gains realized in an RESP but untaxed over the course of their childhood and, depending on investment returns, you may have a small fortune accumulated in an RESP by the time the student begins their post-secondary studies.
When considering RESP withdrawals to fund post-secondary education, the first thing to remember is that contributions you made to an RESP, which were not tax-deductible, can generally be withdrawn at any time, tax-free. These are referred to as Refunds of Contributions (ROCs).
Any other funds coming out of the plan for post-secondary education are referred to as “educational assistance payments” or EAPs. This includes the income, gains and CESGs in the RESP. When these are paid out, they are taxable to the student receiving the funds.
How to withdraw funds in 2020?
The question many parents have been asking this past week is whether they should withdraw ROCs or EAPs to pay for the student’s education. While at first glance it might seem attractive to only withdraw ROCs, since they are simply non-taxable, if the goal is to minimize the family’s taxes over the student’s course of studies, we may wish to trigger some income in the form of EAPs to fully utilize the student’s annual basic personal amount.
For 2020, the enhanced federal basic personal amount is $13,229. That means that a student can have income from all sources up to this amount before paying any federal taxes. That’s where things get a bit complicated, especially when the student had employment or investment income in 2020, and may have also received the Canada Emergency Student Benefit (CESB) or the Canada Emergency Response Benefit (CERB), both of which are taxable.
Forex Article content continued
While every family’s situation is different, let me posit one strategy for RESP withdrawals. According to Statistics Canada data, the average cost of a year of undergrad studies at a Canadian university for the 2019/2020 academic year, including a room in residence and a meal plan, was around $20,000. Let’s say the student is living away from home and requires this amount from their RESP.
For starters, the student should calculate their income for 2020, including any CESB and CERB amounts received. This income would be deducted from the basic personal amount of $13,229 and the difference would be the amount of EAPs that can be received tax-free in 2020. Note that both Manitoba and Nova Scotia have provincial basic personal amounts slightly lower than the federal amount, and as a result, there may be a bit of provincial tax on the EAPs in those two provinces as the student’s income approaches the federal amount of $13,229.
Next, assuming the student needs more funds for school than the tax-free basic personal amount, should the balance come from taxable EAPs or from tax-free ROCs?
In the past, some have suggested the student could continue to receive additional EAPs to be sheltered by the amount of their non-refundable tuition credit. The federal government, along with most provinces other than Alberta, Saskatchewan and Ontario, provide a non-refundable credit for the cost of tuition fees paid at the post-secondary level. The tuition credit, however, can always be carried forward, indefinitely, for use in a future year, against the student’s future income. Alternatively, with the student’s consent, up to $5,000 of the current year’s tuition, less the amount claimed by the student, may be transferred to a (grand)parent’s, spouse’s or partner’s tax return.
As a result, it may make sense to draw on ROCs to fund the balance of the student’s educational funding from the RESP, and then allow a parent or spouse to claim the $5,000 tuition transfer credit against their own taxes payable. Note that since it’s a credit, it’s worth the same to a parent or child, provided they are both taxable in the year. The student can then carry the balance of the tuition credit forward for use in a future year. The tuition credits carried forward never expire and will always be available to the student to use against tax payable even after they complete their studies.
If, by following this approach and withdrawing mostly ROCs, there are still some funds left beyond the original RESP contributions when the student graduates, the student is permitted to receive EAPs for up to six months after ceasing to be enrolled in a qualifying program, the tax on which could then be offset by claiming the tuition carried forward.
Sarah is attending university away from home, with an estimated annual cost of $20,000, of which $7,000 constitutes tuition. She made $4,729 in part-time and summer employment in 2020, and received two months’ of CESBs at $1,250 each, for a total 2020 income of $7,229.
Using the above strategy, she would ideally receive $6,000 ($13,229 – $7,229) in EAPs to utilize her full 2020 federal basic personal amount. The balance, or $14,000, would come from ROC payments, which can be received tax-free. Sarah could then transfer $5,000 of her tuition to her parents, leaving a carry forward of $2,000 that can be used in a future year.
Jamie Golombek, CPA, CA, CFP, CLU, TEP is the Managing Director, Tax & Estate Planning with CIBC Private Wealth Management in Toronto.
Real Life. Real News. Real Voices
Help us tell more of the stories that matterBecome a founding member
Subscribe to the newsletter news
We hate SPAM and promise to keep your email address safe