How Can I Tax-Efficiently Withdraw Money from My Child's RESP?
You've diligently saved in your RESP for years. Now, your child or close family member is getting ready for school in the fall and it's time to think about taking money out of the RESP account to pay for education.
So, how do you withdraw money from the RESP in a way that makes sense from a tax standpoint?
What's in the RESP Box?
Before diving into the question, let's review what's "in" the RESP box. 3 components:
Contributions you have made to the RESP. A common contribution strategy to an RESP is a $2,500 per year contribution which maximizes the government grant portion (more on this portion in a moment).
These are the matching grants that the government put into the RESP every year while you were making principal contributions. Unless you are considered a low-income family, it is likely that these grants have been $500 per year for each year that you contributed $2,500.
Growth on the contributions and grants is the third and final component of what's "in" the RESP box right now.
How are these items taxed?
contributions can be withdrawn by the subscriber (the person funding the RESP account) at any time with no tax consequences as long as the beneficiary (ie. your child or loved one) is attending post-secondary school. Since RESP contributions are made with after-tax dollars (there are no deductions from income when you invest in an RESP), it stands to reason that those deposits shouldn't be taxed when they are withdrawn. These are officially referred to as Post Secondary Education (PSE) Withdrawals.
Grants and Growth
Grants and growth are taxed in the hands of the beneficiary of the RESP. Since students are generally in a much lower tax bracket than their parent contributors, this ends up being a very good income splitting strategy for people who save in RESP's. In fact, in many cases, students who are receiving grant and growth income have low enough incomes and enough other tax credits that the growth and grants that come to them as income will attract zero or very little taxation. For tax purposes, these are also referred to as EAP's (Educational Assistance Payments). For the rest of this post, we will use this name to describe taxable withdrawals of grants and growth in the hands of the student.
So, what's the right strategy for withdrawing from an RESP? Let's illustrate with an example
Your Student Goes to University
Let's say that your child will have the following financial situation in their first year of University
1. They will have a part time job that will pay them $7,000 in the calendar year
2. They will have tuition payable of $10,000
3. They will have no other income
How much money can they take out of EAP's? (remember, growth and grants) before they need to pay any income tax? We can use an income tax calculator to run a simple scenario:
1. They will get the personal exemption, which means their first $13,229 of income for the year is tax-free
2. They will get the tuition tax credit, which they can apply to any taxes owing on income over and above the personal exemption
So, after you back out their part time income of $7,000 for the year, that leaves at least $16,229 of "room" in your child's tax free "bucket" that can be filled with EAP withdrawals from the RESP before your child needs to pay any federal income taxes. ($13,229 + $10,000 - $7,000).
So When Do You Use Up Principal Contributions?
It makes sense to use up the low/no-tax bucket room for your child when you know they have the room. Your child may end up getting a co-op job or an internship that may push them into a higher tax bracket during the latter part of their university education. In this scenario, you are best to leave principal payments until future years of RESP withdrawals.
1. Speak to your advisor and get an understanding of the sizes of each of the RESP elements in your RESP box. These are not apparent on your statement, so you are going to need to make sure your tracking on these is accurate before you put any withdrawal strategy in place
2. Work with an advisor to estimate the most tax-optimal way to draw down on those assets, taking into account you and your child's unique situation.