Strategies for Tax-Efficient RESP Withdrawals

If your child is planning to start post-secondary studies this year, congratulations! It’s an exciting life transition and also a critical time to educate yourself about strategies for Registered Education Savings Plan (RESP) withdrawals. Smart planning means your student may be able to pay for their education from the RESP with minimal tax owing.

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There’s no question that a Registered Education Savings Plan (RESP) is an important savings vehicle in an era when higher education is a valued commodity and tuition costs are rising. The RESP is[JE1]  the only financial instrument that tops up your contributions by up to 20% through the federal Canada Education Savings Grant (CESG)  –– or more, in some provinces –– and empowers your contributions to grow on a tax-deferred basis.

Your child should pay little – or no – tax on RESP withdrawals

You can withdraw your contributions from the RESP on a tax-free basis and use them for any purpose, including assisting the beneficiary (the student) in school.  You should wait to start withdrawing from your contributions until the beneficiary has enrolled in post-secondary education though, because if you make a withdrawal from contributions prior to that time, the withdrawal will cause a claw-back of CESG.

You can direct a withdrawal of the RESP income and CESG by way of an “Educational Assistance Payment (EAP)”.  EAPs are taxable to the beneficiary (the student), not the contributor (you). This is advantageous because most students are in a low tax bracket, often with unused personal credits, so there’s usually no (or very little) tax owing.

Depending on your student’s plans for the future and the possibility of earning income during their post-secondary years (for example through a paid internship or working for a family business), it makes sense to sit down with your IG Wealth Management Consultant now to do in-depth tax planning before the student makes their first withdrawal.

How much money will your student need during their post-secondary years?

In addition to tuition, RESP withdrawals can be used to pay for any expense related to post-secondary education: books, residence, living expenses, even trips home. Proof of enrolment at an accredited institution in an eligible educational program is usually all that’s needed as documentation.

Start by sitting down with your student, at least six months before they start university, and calculate how much their education will cost, all-in. You may want to allocate those funds equally over the years they’ll be an undergraduate, or hold some back for graduate school.

Keep in mind that tuition and living expenses vary by institution and program. For example, an engineering program will charge higher tuition than a general arts program at the same institution, because of the long-term earning potential it offers.

The ABCs of RESP taxes

An RESP is made up of three components, each with different tax implications:

  1. Contributions
    • Your RESP contributions can be withdrawn tax-free.
  2. Government Grants, including CESG
    •  Grants are taxable as Educational Assistance Payments (EAPS).
  3.  Income Earned on Investments
    •  Income earned on investments within the RESP is taxable as Educational Assistance Payments (EAPs ).

Case Study

Let’s say a family has opened an RESP at birth for a child who is now 18 years old and planning to major in engineering and go on to graduate school. That’s six years of university education, with potential opportunities for paid internships.

On the advice of their IG Wealth Management Consultant, this family contributed a total of $36,000 to their child’s RESP over 15 years[1], enough to receive the full Canada Education Savings Grant of $7,200.

At an average rate of return of 4.75%[2], the RESP funds available to their child would be $74,322. Here’s how their tax plan might look:

 

Contributions by parent

Investment income earned on contributions

Government grant (CESG)

Amount in RESP after 18 years

$36,000

$31,122[3]

$7,200

Taxation at withdrawal

No tax owing

 

Taxable to the student

Taxable to the student

Tax strategy

Use this amount when student’s income is higher (for instance, during a paid internship in 3rd or 4th year)

Access this portion early in student’s university years, when their income is low.

Access this portion early in student’s university years, when their income is low.


Keep the RESP growing

It’s important to set a time horizon for your student’s educational goals, and an asset-allocation strategy with the potential to keep your RESP investment growing. That way, if your student plans to go on to graduate studies, medicine, MBA or law school, the RESP will continue to provide funds to cover expenses.

If post-secondary school starts soon, meet with your IG Wealth Management Consultant to optimize tax planning for RESP withdrawals.

 

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