2-04: RESP Withdrawals
Oh boy, what a headache it can be to understand how to withdraw from Registered Education Savings Plans.
Contributing? No problem, here’s ten million blog posts about the rules and how to make them work for you. Oh yeah, and an episode of this podcast from season one.
Withdrawing? Mostly crickets.
So today, we’re talking about that magical time when your child, a wee baby the last time you checked, has chosen some kind of post-secondary program that needs paying for, and some or all of the money is coming from the RESP.
These accounts aren’t like other investment accounts, where there’s just one number–the balance–you have to worry about.
RESPs are accounts that have other accounts inside of them…kind of like Russian nesting dolls. And you can’t just take the money out and hope for the best…well, you can, but it’s likely to result in the government getting money that could have been yours, if only you knew how to get at it.
Notional accounts
Inside your RESP are three “notional” accounts; that is, three different pots of money that aren’t really separate accounts, but are tracked by your financial institution until there aren’t any dollars left. You can ask them for a statement that shows how much is in each one anytime you’d like - it’s great practice to do so just before you make your first withdrawal, and before every withdrawal after that.
The first pot contains all of the money you contributed over the years. This money is never taxed when you withdraw it. The second pot contains all of the money the government contributed, in the form of Canada Education Savings Grants or Canada Learning Bonds. The third pot is all of the investment income earned on your and the government’s contributions. These last two pots of money are the ones with the complicated rules about withdrawals that can trip people up.
Why are these different pots of money important? It’s so the government can make sure the right people are paying tax on the right amounts.
Types of withdrawals
The next thing to understand is that there are two different kinds of withdrawals from an RESP: withdrawals you make when your child can prove they’re in an eligible program, and withdrawals you make when they can’t.
When your child can show proof of enrollment in a program that’s eligible for RESP funding, you are allowed to take out Educational Assistance Payments (or EAPs), which come from the government grants and investment income inside the account according to a strict formula calculated at the time of the withdrawal, and Post Secondary Education payments (or PSEs), which come from your contributions.
You won’t be asked for receipts, since the money can be used for a huge range of things necessary to live through however long it takes to get a post-secondary education, not just tuition.
Educational Assistance Payments are taxable income for your child. Post Secondary Education payments are not.
If your child doesn’t enroll in an eligible program within 35 years of when you opened the RESP, or if you used some of the money but not all of it, you can still withdraw the pot of money holding your contributions. You won’t pay any tax on it.
The pot of money holding any grants can go to a sibling, if they don’t already have the maximum $7,200 any one beneficiary can get. Otherwise, it goes back to the government, along with any bonds in the account.
Then there’s the accumulated investment income. If you withdraw it directly from the RESP, it will be added to your income for that year when you file your taxes, and you’ll pay an additional 20% penalty tax on top of your marginal tax rate. Yikes.
You can avoid this extra tax if you transfer the accumulated income to your child’s Registered Disability Savings Plan, if they have the contribution room and are the right age, a sibling’s RESP, if they have contribution room available, or up to $50,000 of it to your own RRSP, if you have room.
Strategic thinking
The goal of most RESP withdrawal plans should be to not lose any grants and bonds, and to pay the least amount of income tax.
This last one is usually easier than you might realize, because your child is likely not earning enough money as a student to break out of the first tax bracket, and they’ll have tuition tax credits to cut down on most, if not all, of any tax they do have to pay.
But it’s easier to lose out on grants and bonds, because not all kids stay in eligible programs long enough to withdraw the full amount received, and the formula that governs how much of any Education Assistance Payment comes from grants vs how much comes from accumulated income doesn’t allow pure grant withdrawals.
So the way to think strategically about withdrawals goes is this:
Calculate how much money is available in grants, bonds, and accumulated income, and divide it by the number of years your child will be in school, if all goes as planned. Divide the amount of your contributions by this same number of years.
For example, if you think your child will be in school full time for two years, and the RESP has $20,000 in grants, bonds, and accumulated income, and $15,000 in contributions, you’ll end up with $10,000 per year from the first pot, and $7,500 per year from the second pot.
In their first year, you’ll withdraw $10,000 in EAP and $7,500 in PSE. You’ll only be able to withdraw $8,000 of EAP in the first 13 weeks of enrollment, so you’ll have to make a second withdrawal later in the school year to get the last $2,000. In their second year you can just make one EAP withdrawal and one PSE withdrawal.
If your child is going to be in school part-time, the math changes a bit, because part time students can only withdraw $4,000 of EAP in any 13 week period.
This gives you the best chance of getting all of the grants and bonds out of the RESP and smoothing out the income tax your child pays while they’re in school (if they pay any at all).