How to best withdraw funds from a large RESP with minimal tax

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Every year around this time, I am inundated with questions about strategies for tax-efficient withdrawing funds from a Registered Education Savings Plan (RESP). Given the bull market of the past decade, some parents have noticed that there are substantial funds in their RESPs and are wondering if there are any strategies that could be used to withdraw those funds with minimal tax (or, in some cases, zero).

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Before we get into a strategy, let’s review the basics of RESPs. An RESP is a tax-deferred savings plan that allows parents (or others) to contribute up to $ 50,000 per child to save for post-secondary education. Adding government funds in the form of Canada Education Savings Grants (CESGs) can add up to $ 7,200 per child to the plan.

Combine this with the income earned and gains made in an RESP, but not taxed during your children’s childhood, and depending on the performance of the investments, some RESPs can reach a pretty penny by the time they leave the door for start their post-secondary education.

Funds withdrawn from the RESP take one of three forms: Return of Contributions, Education Assistance Payments, and Accumulated Income Payments.

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The first thing to remember when considering withdrawals from an RESP to fund post-secondary education is that the contributions you, as a subscriber, made to an RESP, which were not tax deductible, may generally be withdrawn at any time, tax free. This is called refund of contributions (ROC).

All other funds from the post-secondary education plan are called Educational Assistance Payments (EAPs). This includes income, earnings and the CESG in the RESP and is taxable to the student when paid.

If all of the RESP beneficiaries decide not to pursue post-secondary studies or have completed such studies, and there are still funds left in the RESP beyond the initial contributions, you, as the subscriber of a resident RESP Canadian, may be eligible to receive Accumulated Income and Growth as an Accumulated Income Payment (AIP). Any remaining CESG must be repaid.

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To be eligible, an AIP can only be made after the ninth calendar year following the year in which the RESP was opened and only if all current and former living beneficiaries of the RESP have reached the age of 21 and are no longer eligible for EAPs. You can usually also receive an AIP in the 35th year of the plan – the maximum length of time an RESP can generally remain open.

The problem with AIPs is that they are subject to potentially heavy taxation. First, AIP is taxed like ordinary income at your marginal tax rate. But to compensate the government for the fact that no tax has been withheld on the income / growth of the RESP for a period of up to 35 years, the government imposes an additional 20% tax penalty on top of your rate. usual tax. For a high-income (grand) Ontario parent, this could translate to an effective tax rate of 73.53% on any AIP.

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You may be able to transfer up to $ 50,000 from AIP to your RRSP if you have unused contribution room. In this case, the additional 20% tax penalty will not apply.

Once an AIP has been paid, the RESP must be fully wound up by the last day of February of the following year. Any remaining income / growth can usually be directed to a designated educational institution, although donation credit is not available.

This brings us to the question of how best to withdraw funds from a large RESP in order to minimize any income / growth left behind upon the completion of a children’s post-secondary education and potentially subject to an effective tax rate of up to $ 73. . percent.

Intuitively, it might seem worthwhile to only withdraw ROCs, as they are simply not taxable. But if the goal is to minimize family taxes while the kids are in school, you are probably better off creating income each year in the form of EAPs to fully utilize the student’s annual basic personal amount (EPS). and other credits.

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The enhanced federal EPS is $ 13,808 for 2021. This means that a student can have taxable income from all sources up to that amount before paying federal taxes. The student must calculate their estimated income for 2021, including any part-time and summer income. This income would be deducted from the basic personal amount of $ 13,808 (plus other credits) and the difference would be the amount of tax-free EAPs that can be received in 2021. Please note that students in Manitoba and Nova Scotia may owe due to their respective provincial tax rates.

That said, there is no requirement that the money withdrawn from the RESP be used specifically for tuition, books, etc. As long as the child is enrolled in a qualifying post-secondary program, “reasonable” EAPs may be paid to the student. and the student can then choose to use the funds to pay for rent, food or any other expense that helps the student to pursue post-secondary education.

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For 2021, the Canada Revenue Agency will allow each beneficiary of an RESP to receive up to $ 24,676 in EAPs without having to demonstrate to the RESP provider whether such a withdrawal request is reasonable.

In addition to claiming the BPA, students can claim a non-refundable tuition tax credit at the federal level and in all provinces other than Alberta, Saskatchewan, and Ontario. New data released by Statistics Canada shows that Canadian students enrolled full-time in undergraduate programs will pay, on average, $ 6,693 in tuition fees for the upcoming 2021/2022 academic year.

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If we assume a federal tuition credit of $ 6,700 combined with the EPS of $ 13,800, we get a total of federal credits of $ 20,500. In other words, a Canadian undergraduate student with no other income in the year could receive approximately $ 20,500 in EAPs in 2021 and pay no taxes. If the student had part-time or summer income, this amount would be reduced accordingly.

Given the “reasonable” EAP limit of nearly $ 24,766 in 2021, the student could then receive an additional $ 4,176 and pay only minimal tax on that EAP, at marginal rates ranging from $ 20. percent (Ontario) to 27.5 percent (Quebec), if the student’s total income in 2021 remains in the lowest provincial bracket.

Taking funds out of RESPs that have accumulated income and substantial growth at these lower rates is better than being forced to take out an AIP years later at rates that can exceed 70 percent.

Jamie Golombek, CPA, CA, CFP, CLU, TEP is Managing Director, Tax and Estate Planning at CIBC Private Wealth Management in Toronto. [email protected]

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