Registered Education Savings Plans (RESP’s) are a very popular and useful way to help a loved one pay for their post-secondary education.
In many cases the beneficiary of the RESP, a child or close family member, graduates high school and uses the funds in pursuit of a college diploma or a university degree. But sometimes life changes and the beneficiary of that RESP account no longer needs the money for their education. This situation leaves the RESP holders wondering - what else can we do with this RESP account?
In this post, I offer some alternatives for families that are faced with this question.
Background on the RESP account
Before we dive into the alternatives, here is a brief summary on how an RESP account works and the different components of the plan.
An RESP is an education savings program set up specifically to assist with saving for a child’s post secondary education. The person who sets up the plan, typically a parent or other close family member, is known as the subscriber. The financial institution that holds the RESP account is known as the promoter. The child who the RESP account is set up for is known as the beneficiary.
A subscriber can contribute up to $50,000 per beneficiary during the lifetime of the plan. Contributions to an RESP also attract a special bonus from the government known as the Canada Education Savings Grant (CESG). This grant is designed as an incentive for Canadians to save for a child’s post-secondary education, and it is awarded based on contributions made to the plan. The lifetime maximum CESG per beneficiary is $7,200.
Contributions are made with after-tax money, which means that you do not receive a tax deduction when you contribution like you do when you contribute to an RRSP. Contributions grow tax-sheltered inside of the plan until the time of withdrawal. Investment growth and government grants are taxed in the hands of the beneficiary at the time of withdrawal provided that they meet certain criteria at that time (more on these criteria below). This achieves the effect of tax-efficient income-splitting with the beneficiary. It is common for the beneficiary to have low or no other income when they are attending post-secondary education. Therefore, low or no tax may need to be paid by the beneficiary as a result of the withdrawal of grants and growth. Withdrawals of RESP contributions are not subject to tax.
RESP contributions and grants can be invested at the discretion of the subscriber in an array of different investments including GIC’s, ETF’s, and mutual funds.
Again, this is a very high level summary of how the RESP account works, its components, and the different roles. Check out this page at the Government of Canada website for a more detailed description.
RESP funds withdrawn - No school
Consider you are in a situation where you have an RESP account and your child has decided not to pursue a post-secondary education. You would like to get the money out of the RESP and use it for another purpose.
Given that the plan has likely been open for a few years and that the investments inside of the account have grown, you will have three different types of money in that account by now - contributions that you made, grants from the government, and investment growth on the contributions and grants. This is important because each of these are treated differently when you make the withdrawal.
Contributions - Contributions are paid back to you with no penalty or income tax consequences. Recall that these contributions were originally made with after-tax dollars. It would be unfair to charge you with taxes now that you are simply retrieving those contributions from the RESP account.
Grants - Grants are paid back to the government. Since the purpose of the grants is to help fund the beneficiary’s post-secondary education, it is reasonable that the government will want that money back in this case.
Growth - Contributions that you made and grants from the government have likely attracted investment growth while invested in the RESP. Provided that the beneficiary of the RESP is over 21 and not pursuing a post-secondary education, and the plan has been in place for at least 10 years, this growth can be withdrawn from the plan. The amount of growth inside of the plan is subject to regular income taxes when it is withdrawn from the RESP in this circumstance. On top of that, a withdrawal of investment growth is subject to an additional 20% penalty tax. This may seem harsh. But, consider that the government wants to avoid people using the RESP as a tax-sheltered savings vehicle when they have no intention of using the funds for a beneficiary’s post secondary education. While this was not your intention when originally setting up the funds, they need to make sure that they structure these rules in a way that covers off this situation.
There are some opportunities to avoid this scenario, however.
- If you are the subscriber to the RESP plan and you or your spouse have RRSP contribution room available, you can roll up to $50,000 of growth directly into your RRSP. This will allow you to defer the regular income taxes and avoid the additional 20% penalty tax on that withdrawal.
- You can also transfer an RESP from one beneficiary to another beneficiary, provided that the beneficiaries are sibblings, that the receiving beneficiary is under the age of 21.
Programs that the RESP can be used for and time limits for the RESP
When I am asked about how to treat RESP’s that may go unused, it helps to talk about the wide range of situations where the RESP can be used. It’s very common to assume that the RESP must go unused if your child goes to trade school, goes to school out of the country, or takes a few “gap years” between high school and their eventual post-secondary education.
Fortunately, this is not the case. The RESP can be used for a wide range of post-secondary education programs, and it can remain open for a long time.
Keep in mind, at this point we are referring only to investment growth and government grants. Recall that contributions can be withdrawn without penalty at any time. Now we are establishing situations where investment growth and grants can be paid out to the beneficiary and taxed in their hands, as the RESP is designed to work.
The criteria for of RESP grants and growth, also known as Education Assistance Payments or EAP’s, to be paid to the RESP beneficiary are:
- The beneficiary must be enrolled in a full-time qualifying educational program at a post-secondary educational institution; or
- The beneficiary is enrolled in a specified educational program (usually part-time studies) at a post-secondary level that lasts 3 consecutive weeks, and that requires the beneficiary to spend at least 12 hours per month on courses in the program
The list of institutions and programs that meet these criteria in Canada is quite lengthy, and you can review it here. Universities, colleges, and other educational institutions outside of Canada that offer post-secondary level courses can also qualify.
Furthermore, RESP’s must be closed by the end of the 35th anniversary year that the plan is open. So, if your child is considering a few gap years between high school and post-secondary education, there is still a lot of time for them to use the RESP funds as intended.
In summary, if your child is considering any type of post secondary eduction, even if they plan to take some gap years between high school and the beginning of their studies, there is a good chance that they can still qualify to use up the government grants and growth in the RESP account as intended.
When RESP’s are opened, parents often assume that their kids will graduate high school and move straight to college or university. But, life changes and kids may decide to take different paths when the time comes. The good news, as it relates to the use of RESP’s, is that the program is designed to adapt to these changing situations. If you have questions about your RESP alternatives, please feel free to contact me or to set up a brief meeting to discuss it further.
Photo by Drahomír Posteby-Mach on Unsplash