As most of my readers know I rarely have Guest Posts, but this article is very much in the theme for my site. Read about the author at the end of this lengthy tome. Also, remember there is lots of info on the Registered Education Savings Plan on this page.
Guest post for Canadian Personal Finance Blog
Many parents have concerns about the cost of post-secondary education in Canada. They worry about how they will pay for their child to go to a university or trade school to expand their job opportunities.
This situation leads many families to set up Registered Education Savings Plans (RESPs). These accounts are one of the best ways you can invest in a child’s future. They allow you to make contributions that the government will partially match. And, this money can grow, thanks to interest.
When your child goes off to university, you can request payments from their RESP. These funds will help them pay for their education.
Keep in mind that cashing out an RESP can be tricky. You’ll want to keep tax considerations in mind to maximize the funds your child receives.
This guide will help you understand the tax considerations when withdrawing money from an RESP.
What Is an RESP?
You’ve been making payments to your child’s RESP for quite some time now. But, you might not be familiar with how it works other than that you make regular contributions.
Let’s begin by defining some terminology.
RESPs are accounts set up by subscribers (usually the child’s parents). Subscribers make regular contributions to the account. You can set up an RESP through most financial institutions.
When the child (the beneficiary) goes to college, the subscriber may request RESP payments. The child uses these payments to help fund their post-secondary education.
These conditions are how RESP works in a nutshell. But, it gets a little more complicated. Below, we describe the three major components of all RESP accounts.
Contributions
The subscriber saves money by making regular contributions to the account. Keep in mind that each RESP is different. Some require a minimum deposit. Some require you to deposit specific monthly contributions, whereas others let you make contributions whenever you want.
Currently, there is no annual contribution limit. Over the lifetime of the account, however, the maximum you can contribute is $50,000. Just be mindful of how much you’re contributing to your child versus your own retirement. I love how Bridget Casey from Greedy Rates puts it when she says to “never sacrifice your own long-term financial security when saving for your kids.â€
Grants
Grants are one of the significant perks of RESPs. They provide families with money that the recipient does not have to repay.
The Canadian government matches a percentage of your contributions via grants. The Canadian Education Savings Grant (CESG), for instance, will match your contributions (see specifics here).
Additionally, there are other national and provincial grants available. For instance, the Canada Learning Bond (CLB) provides money to low-income families without the need for any contribution.
Income
Income is yet another great perk of RESPs.
RESPs are comparable to investment accounts. The contribution and grant money have the opportunity to grow. You can invest the money in stocks, mutual funds, bonds, etc. to earn extra income.
When you have an RESP, you must determine how you want to invest your contribution and grant money. Some families choose to navigate the investment process themselves. However, a financial advisor is usually the best way to make smart investment decisions.
Important note: RESPs are tax-deferred accounts. The grants and income money are tax-free until withdrawn. This exemption allows it to grow at a much faster rate.
Types of Payments
When you cash out an RESP, you’ll get the money as two separate payments:
Post-Secondary Education (PSE) Withdrawal
PSE payments consist of the contributions the subscriber made.
Keep in mind that contributions do not qualify for a tax credit. When you put money into an RESP, you are using post-tax dollars.
This stipulation means that when you withdraw PSEs, no one has to pay tax on them. You request for PSE payments to transmit either directly to you or your child. Then, the student will use the money to pay for books, housing, tuition, and other relevant expenses.
There is no limit on when you can request PSEs. You can request however much of your contributions whenever you want.
Educational Assistance Payments (EAPs)
Unlike PSEs, EAPs consist of the money from grants and income. They aren’t your contributions, so they must transmit directly to the beneficiary. The beneficiary will have to report EAPs as taxable income.
In the first year of schooling, there are EAP limits. See here for exact specifications. But generally speaking, students have a limit of $5,000 in EAPs for their first 13 weeks of schooling. After that, there are no EAP limits.
So for clarification the Parent’s post-tax money goes in, and the child pays tax on all the money that comes out. So does the original contribution get taxed a second time when they withdraw or is it only the income generated that’s taxed? (I know the parent’s don’t pay tax when it comes out but the students still do, and they are most likely in a lower tax bracket….)
The money that is taxed (in the Students hands) in the RESP account are:
1) Grant Money
2) Learning Bonds
3) Growth of the original money
The money put in by the parents (or by anyone really) were After Tax money, so it is not taxed again.