RESPs Part 4: Withdrawing Funds

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The whole purpose of setting up the RESP in the first place is to fund your own or your children’s education. One of the major benefits of investing inside an RESP is that the funds get to grow tax free. However, unlike the RRSP account, contributions don’t get a tax refund. That makes the RESP account special when the funds are taken out of the account.

Before understanding the withdrawal rules you need to understand the differences between contributions, Educational Assistance Payments (EAPs) and Accumulated Income Payments (AIPs).

Contributions – This is the money that you contribute into the RESP.

EAPs – These are withdrawals made against gains made in an RESP to the beneficiary. This includes the government grants, interest income and any capital gains you might from investing within the RESP account.

AIPs – These are withdrawals made against gains made in the RESP to the subscriber.  This includes interest income and any capital gains you might from investing within the RESP account. Grants are not eligible to be paid to the subscriber.

Now that we’ve established the differences in payment types, now it’s time to determine whether the educational institution qualifies for RESP withdrawals. This means one of these two conditions need to be met:

  • The student must be enrolled in a qualified educational program that requires at a minimum 10 hours a week while attending
  • The student must be enrolled in a specified educational program that that requires at a minimum 3 consecutive weeks and must require at least 12 hours a month while attending

If you are unsure as to whether your program or course is qualified, then it’s possible to contact the CRA and ensure that you qualify. Otherwise, the penalties of withdrawing your money may apply.

Tax On Contributions

This is the easiest form of withdrawing from your RESP, that’s because contributions that are withdrawn are not taxed at all. Since contributions don’t generate any kind of tax refund, the withdrawn amount is also not taxed.

Since the subscriber is the owner of the contributions, she is free to do as she wishes with the original contribution amount. In fact, the subscriber can decide not to give money to the beneficiary if she chooses not to do so.

You can almost treat contribution amounts as money sitting in a chequing account that generates no interest.

Example:

  • You’ve contributed $10,000 over the lifetime of the RESP. After grants and investment gains the RESP now sits at $15,000. This means $10,000 can be withdrawn from the RESP as contributions and no tax will be paid on it.

Tax On EAPs

gradWhen money is taken out of the RESP by the beneficiary and the money represents grants or gains from investment, the money becomes taxed as income for the student receiving the money. This might seem bad, but in reality a student can write off their tuition against this income and therefore will most likely be exempt from paying any income taxes at all.

It’s only at the point of withdrawal that funds in the RESP are acknowledged by the CRA to belong to the beneficiary.

In order to dissuade individuals from cheating the CRA, there is a maximum of $5,000 that can be withdrawn in the first 13 weeks of starting a qualifying program. $2,500 if you are enrolled in a specified program. This means if the student drops out before the end of the first term, they can’t withdraw the remaining gains from the RESP. I guess there’s more incentive to continue school.

If the costs exceed the threshold of $5,000, that’s where contribution withdrawals are important to make up any shortfall. After the 13 weeks has passed, then the student can withdraw as much as they like so long as they don’t drop out of school.

Example:

  • You’ve contributed $10,000 over the lifetime of the RESP. After grants and investment gains the RESP now sits at $15,000. In first year of university your child

Tax On AIPs

If the beneficiary of the RESP decides to not attend post secondary education, then the funds existing inside the account stays with the subscriber.

In this specific case when gains are withdrawn from the account AIPs get taxed at the subscriber’s marginal tax rate. This essentially becomes additional earned income for the subscriber.

In addition to being taxed on the amount withdrawn there is additional 20% tax on top of the gains as well. This makes withdrawing investment gains from the RESP really expensive if the beneficiary doesn’t attend school, so be sure they are not going before collapsing the account.

Essentially, the RESP account should only be used for investment purposes if you plan on saving for education. Even though gains are allowed to be tax free while in the account, the withdrawal penalties make it inferior to the TFSA or RRSP as a long term investment account.

Example:

  • You’ve contributed $10,000 over the lifetime of the RESP. It has grown to $15,000 but your child does not attend university.

    You decide to close the account and withdraw everything.$10,000 does not get taxed as it is contributions. The remaining $5,000 is taxed at marginal rate say 35%. On top of that, there is another 20% tax as well.
    This means of the $15,000, you get $10,000 + $2,250 = $12,250.

Summary

The main purpose of the RESP account is to save for post secondary education. Depending on the situation you may fall into just remember the rules which may apply to you:

  1. Contributions can be withdrawn without taxation or penalty.
  2. Money from grants or capital gains withdrawn by the beneficiary is taxed as income.
  3. Money from capital gains withdrawn by the subscriber is taxed as income and penalized with an additional 20% tax.
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