Understanding the tax consequences of RESP withdrawals
By Gerry Vittoratos, UFile
Registered Education Savings Plans (RESPs) are a great vehicle to save money for your children’s post-secondary education in a tax efficient way. This article will explain the tax treatment of withdrawing from this plan.
Basics of RESPs
Before we get into the tax treatment of RESP withdrawals, we need to understand certain fundamental concepts of the plan.
Contributions to the plan are made by a subscriber (parent of the child or children) to a promoter (financial institution) for the benefit of the beneficiary (child or children). The plans can be individual plans (single beneficiary) or family plans (multiple beneficiaries).
Contributions into the plan are not tax deductible; however, the earnings within the plan accumulate on a tax-free basis. The contributions and accumulated earnings can stay in the account for up to 35 years after the plan is established.
The lifetime contribution limit per child is $50,000.
Canada Education Savings Grants (CESGs)
Apart from the tax deferral of earnings, another major benefit of contributing to the RESPs is the Canada Education Savings Grant (CESG). In simple terms, the CESG is an additional amount the Federal government adds to every dollar contributed into the RESP. The basic grant is 20% of the current year contributions up to a maximum of $500 per beneficiary. This translates to a yearly contribution maximum of $2,500. The lifetime CESG is $7,200. An additional grant of 10% or 20% is given to low income families. The table below summarizes the grant amount:
|CESG||Family net income of $47,630 or less||Family net income of more than $47,630 but less than $95,259||Family net income of more than $95,259|
|Basic CESG on the first $2,500 of annual RESP contributions||20% = $500||20% = $500||20% = $500|
|Additional amount of CESG on the first $500 of annual RESP contributions||20% = $100||10% = $50||Beneficiary is not eligible|
|Maximum yearly CESG depending on income and contributions||$600||$550||$500|
|Lifetime maximum CESG for which you may qualify||$7,200||$7,200||$7,200|
Source: RC4092 guide
Depending on the province you live in, you can get an additional grant on top of the CESG.
Canada Learning Bond (CLB)
On top of the CESG above, the Federal government provides an additional amount for low-income families in the form of the Canada Learning Bond (CLB). The difference with the CESG is that fact that no contribution is requires to get the CLB; it is deposited directly into the RESP account. An initial payment of $500 is made for the first year the child is eligible; then $100 is deposited for each additional year of eligibility, up to age 15, for a maximum of $2,000. For 2019-2020, the income eligibility threshold is $47,630 for up to 3 children and increases for every additional child.
Tax treatment of withdrawals
Now to the question at hand: what is the tax treatment of these withdrawals?
Since the contributions do not benefit from a tax deduction (in other words, after-tax dollars were contributed), the contributions can be withdrawn tax free to the subscriber (parent or grandparent of the child or children) or beneficiary (child or children). These are called “refund of contributions”.
Education Assistance Payments (EAP)
Payment of the Canada Education Savings Grant, Canada Learning Bond and accumulated earnings are called Education Assistance Payments (EAP) and are payed to beneficiaries (children). These payments are taxable in the tax return of the beneficiary.
In order to receive an EAP, the recipient must be enrolled in a qualifying educational program, which is an educational program at post-secondary school level, that lasts at least three consecutive weeks, and that requires a student to spend no less than 10 hours per week on courses. The recipient must also be at least 16 years old.
Although the income received by the student is taxable, remember that it is likely that this student has little to no other income to declare while attending school full-time; therefore, these payments will be subject to a low income tax rate.
Accumulated Income Payments (AIPs)
These are payments made from Canada Education Savings Grant, Canada Learning Bond and accumulated earnings to subscribers (parents). These are possible under 3 conditions:
- the payment is made after the year that includes the 9th anniversary of the RESP and each individual (other than a deceased individual) who is or was a beneficiary has reached 21 years of age and is not currently eligible to receive an EAP (see above)
- the payment is made in the year that includes the 35th anniversary of the RESP
- all the beneficiaries under the RESP are deceased when the payment is made
In this case, the income will be taxed in the subscriber’s tax return (income tax rate based on all income), and an additional 20% tax is added as well. Subscribers can reduce both the income tax and the additional 20% by transferring the AIP into an RRSP, provided the subscriber has enough contribution room to do so. The limit of this transfer is set at $50,000.
Gerry Vittoratos is the national tax specialist at tax software provider UFile, which has been helping millions of Canadian taxpayers file smart for the past 20 years.