We have been contributing to a registered education savings plan for our two granddaughters since they were born. Some stocks we chose – such as Alphabet (GOOG) and Facebook (FB) – have produced large gains and the RESP is now worth about $500,000. Our problem, if you can call it that, is we will likely never be able to withdraw all the money while our granddaughters – who are entering their first and third years of university – are attending school. Any advice?
First, congratulations. Your granddaughters are fortunate to have such skilled investors looking after their postsecondary financial needs. But, as you indicated, your success has created an unusual challenge: Now that you have amassed a small fortune inside the RESP, what’s the best way to get the money out?
Let’s go over some RESP basics before we dig into the details.
Contributing to an RESP is relatively straightforward. You deposit some cash, and the federal government contributes an additional 20 per cent in the form of the Canada Education Savings Grant, which provides up to $500 per child per year. (Additional incentives are available for families with modest incomes and those living in certain provinces.)
But when it comes time to start withdrawing money, things get a little more complicated.
When a beneficiary starts postsecondary school, there are two types of RESP withdrawals the subscriber (the person who opened the RESP) can make: a refund of contributions, and an Educational Assistance Payment (EAP).
A refund of contributions consists of funds that the subscriber originally deposited into the account. These withdrawals are tax-free and can be paid to the subscriber, or to the beneficiary.
EAPs work differently. They consist of government grants and investment earnings such as dividends, interest and capital gains that have accumulated in the account. EAPs are taxed in the beneficiary’s hands, which is usually an advantage because students often have minimal income and – thanks to various tax credits – pay little or no tax.
But there are rules regarding the size and timing of EAPs. In the first 13 weeks of a full-time program, the maximum EAP is $5,000. (You’ll need to give the financial institution, or “promoter,” proof of enrolment to make the withdrawal.) After that, there is more flexibility, but if the subscriber exceeds a certain EAP threshold he or she may be asked to justify that the withdrawal is for education expenses.
For 2020, the “annual EAP threshold limit” – which is indexed to inflation – is $24,432. According to the federal government, “we consider all legitimate EAP requests below this threshold to be acceptable. We do not expect promoters to assess the reasonableness of each expense item as long as the conditions permitting an EAP are met.”
For EAPs that exceed the annual threshold – which includes the initial $5,000 – the financial institution may ask for receipts or other documentation to prove that the money is for education-related expenses. The institution would typically forward this information to the Canada Revenue Agency, which could open an investigation, although when I called the CRA to inquire about my own situation – I have a son starting university this fall – I was told it is rare for the CRA to challenge an EAP approved by a financial institution.
It’s important to withdraw all of the grants and earnings from the RESP while the beneficiary is in school. If the student graduates or drops out and funds are left in the account, any remaining grants will have to be repaid and the withdrawal of the remaining income – called an Accumulated Income Payment (AIP) – will be taxable to the subscriber, who will also face an additional 20-per-cent tax.
The subscriber can defer the income tax – and avoid the additional 20-per-cent penalty – by rolling up to $50,000 of the AIP into a registered retirement savings plan if sufficient contribution room is available. The subscriber can also make an EAP for up to six months after the child has stopped going to school.
For modest-sized RESPs, draining all of the funds probably won’t be an issue. But for exceptionally large RESPs, it may be necessary to make withdrawals that are larger than the annual EAP threshold limits, which could require the subscriber to justify the withdrawals by maximizing expense claims.
Mike Holman, author of The RESP Book, says there is wide latitude in what constitutes an education-related expense. “Pretty much anything goes. If a student is living on their own, any living expenses should count,” he says, including tuition, rent, food, furniture, computers, clothing and car expenses.
“For a student taking an expensive course such as engineering in an expensive city like Toronto, I think it would be very easy to spend way over the EAP limit on legitimate expenses. If it were me, I would try to increase the expenses as much as possible” to justify the EAP, Mr. Holman says.
“Bottom line is that the grandparents should talk to a tax expert, the financial institution and the CRA to try to get a sense of what is allowed and how to go about doing it.”
E-mail your questions to firstname.lastname@example.org. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.