Summer school for RESPs

If you’ve been saving for years for your child’s post-secondary education, and they are now ready to pursue higher learning in the fall, it’s not unusual to feel a little lost regarding how best to use that money.

That’s because the main savings vehicle for post-secondary learning, the Registered Education Savings Plan (RESP), is often complicated to unwind.

“There are definitely some unique aspects to taking out money from a RESP,” says Anthony Maros, senior private banker at BMO Private Wealth in Winnipeg.

Unlike a RRSP (Registered Retirement Savings Plan) where every withdrawal is taxable because all contributions are made with after tax money (hence the deduction on contributions), RESPs involve taxable and non-taxable withdrawals.

In one bucket, Canada Education Savings Grants, the Canada Learning Bond (for low-income families) and investment growth are taxable. These are called educational assistance payments (or EAPs).

Notably, these monies are generally taxed in the hands of the beneficiary (the student). In turn, taxes owing are often low. Some students pay no taxes at all. That said, many students get part-time and summer jobs, which can increase their tax exposure.

In the other bucket are the contributions by the subscriber (often parents), which are not taxable.

That’s because those contributions are made with after-tax money, says Peter Lewis, president and chief executive officer with CST (Canadian Scholarship Trust) Savings Inc. in Toronto.

“So that money can’t be taxed again.”

Lewis adds unwinding can feel complicated because of these two streams and trying to manage the level of taxable income to ensure as much money goes toward tuition, books and other related costs (which can include living expenses) and as little money as possible goes to the Canada Revenue Agency.

“The general advice that I give to parents is start with the taxable portions.”

Lewis explains the capital contributions can come out at any time as required. Often, parents use them to top up funding for costs exceeding the basic amount before income taxes start.

Parents and students should also be mindful of other nuances, including that grant money must be proportional to the income withdrawn. “If pull out $50 of income, for example, I’m required to take out $5 in grant.”

What parents and students should not do is withdraw all the money at once for a four-year degree, which would lead to paying more taxes than necessary, says Helen He, vice-president of retail investments at Scotiabank in Toronto.

“It’s important to think about pacing withdrawals so that they last through the duration of the schooling, rather than taking a one-time sum up front and depleting it early,” she says.

The feds have other rules that can be missed and lead to more taxation — like one regarding how much EAP can be used in the first semester when first drawing on the plan, Maros says.

“It is $8,000 in the first 13 weeks for full-time students,” and $4,000 per part-time students.

No limits apply after that first semester, he adds.

Withdrawing from the RESP also requires a shift in the investment strategy for assets still held in the account. Presumably, parents would de-risk the plan’s investment a few years before the first year of school arrives. More capital should be sitting in cash, guaranteed income certificates (GICs) and bonds, He says.

“A lot of families use a laddered approach,” she adds, noting this strategy involves holding enough cash to pay for costs for the first year. Then second-year costs are held in a one-year GIC, maturing in time for use in Year 2.

Year 3 costs are in a two-year GIC, and Year 4 in a three-year GIC.

Any money in the account exceeding those sums could be held in a dividend-oriented fund in case the beneficiary plans to attend school beyond four years, she adds.

“The other thing that parents should be aware of is that the RESP provider will require documentation that the child is attending post-secondary to release the money,” Maros says.

With proof of enrolment, the student should have the funds in their account within three days or less, he adds.

“I usually recommend clients start thinking about drawing funds from the plan after the August long weekend,” he says, adding a financial adviser can help build a tax-efficient income stream.

At the same time, your financial institution will provide all the necessary documentation to the CRA tracking the taxable and non-taxable portions.

“We issue a T4A in the name of the student, which makes the whole tax filing process a lot cleaner,” Lewis says.

The financial institution should also keep track of attribution for contributions and grant monies in a family RESP, where multiple beneficiaries (children) are involved, he adds.

If it all sounds overly bureaucratic and, in turn, complicated, you’re not wrong, Lewis says. The RESP could be more user-friendly — and a strong case can be made to exclude all RESP monies used for education from taxation.

“I would love to see it as tax-free, but it’s not, so we live with the rules as they are,” Lewis adds, noting attending post-secondary ultimately serves the greater public good.

Until that unlikely day the federal government changes the rules, the only tax-free option for parents to fund post-secondary learning is the Tax-Free Savings Account (TFSA). Then again, parents and children would miss out on the grant money that comes with an RESP.

The Canada Education Savings Grant — offering an annual maximum of $500 per $2,000 of contributions, with a lifetime grant maximum of $7,200 in grants per student — is what makes the RESP such a powerful savings tool.

It’s just too bad all the rules around withdrawals can make it overly complicated to manage when it comes time to use it.

Joel Schlesinger is a Winnipeg-based freelance journalist

joelschles@gmail.com