With the school year nearing its end, families with high school graduates are starting to turn their attention to September, when they’ll send their kids off to university. While parents are naturally concerned about where their kids will live or what they’ll eat if they’re going to school away from home, the biggest worry may be around how to actually pay for those pricey classes.
Fortunately, those who have been saving diligently in a Registered Education Savings Plan (RESP) should have enough money to cover most if not all of their costs, but after saving for so many years, many aren’t sure how to properly withdraw those funds. And withdrawing can be more complicated than many people think. Here’s how to remove, and use, those RESP dollars.
What does your child want to do?
The first place to start is to determine how much schooling your university-age child may need. An RESP can be used for 35 years from the day it’s opened, so you don’t have to be in a hurry to liquidate its assets. If someone wants to do a four-year undergrad, then use the money within four years. If your child wants to go to medical school, consider spacing it out over several years. “You don’t have to use it all right away,” says Sara Kinnear, director of tax and estate planning at Investors Group.
You may also want to hold off on withdrawing, or not take out as much, if your child has other sources of income earmarked for education. Maybe they’ve received some scholarships, or have saved money from a summer job they’d like to use. If the ultimate goal is to pay for your child’s entire education, then, depending on how much has been saved and what the child wants to do, you may need to tap into other financial sources. “You have to ask yourself, ‘what resources do we have available and what expenses can we afford?’” she says.
Pay attention to tax
Removing funds from an RESP also involves some tax planning. There are three types of money in an RESP – the money you put in (“contributions”), government grants and bonds, and the income or gains generated from your investments. While family contributions can be withdrawn tax-free, grant money and plan income are taxable to the beneficiary, says Kinnear.
Since many 18-year-olds aren’t making a hefty salary they won’t have to pay much, if any, tax on the taxable portion of withdrawals. However, if your child took the year off to work and made money, or if they’re in medical school residency and starting to earn a decent living, the taxman may come calling.
Fortunately, you can designate the type of funds you’re withdrawing. If you think your child will earn a salary before they’re finished using their RESP, then it could make sense to use the income and grant money first in years when they’re in a lower tax bracket, says Kinnear. If not, then it may not matter what type of income is removed.
Balancing short and long-term investing
Investing can be tricky during the withdrawal phase. You’ll need some money immediately, but if your child is planning on going to school for several years, you’ll also need to continue growing those savings.
Any immediate withdrawals should be transferred into short-term investments like Money Market Funds or Guaranteed Income Certificates (GICs), which are investment products that don’t fluctuate in value, says Kinnear. For instance, in Grade 12, move the money you’ll need in year one into short-term investments. Then in year one, move year-two money into short-term investments, and so on. By doing this you’re ensuring the money you’ll need now won’t be impacted by market ups and downs.
Funds that may not be needed for a few years can stay invested a mix of mutual funds, stocks and bonds. “You’ll want to become more conservative the shorter the time horizon,” she says. “But if your child is in a program that lasts, say, eight years, then you can be more aggressive with some parts of your money.” She suggests talking to a financial advisor to know how much risk you should take on.
Child not going to school?
What happens if your child decides not to go to school at all? Kinnear recommends waiting as long as possible before making non-educational withdrawals from the plan in case the child changes their mind. Parents can also transfer or allocate funds from one sibling to another, but the total Canada Education Savings Grant (CESG) that is paid to the new child via Educational Assistance Payments (EAPs) cannot exceed $7,200 per child.
If, in the end, you decide to withdraw from an RESP for purposes other than your child’s education, you should know that the grant money will be returned to the government. As for the income or growth within the RESP, it will be taxable to you, the subscriber of the plan, and could be subject to penalties.
Clearly, withdrawing isn’t as easy as straightforward as it may seem. Talk to an advisor to determine the best approach for your family.
The Canada Education Savings Grant and Canada Learning Bond (CLB) are provided by the Government of Canada. CLB eligibility depends on family income levels. Some provinces make education savings grants available to their residents.