How to Cash out an RESP Tax-Efficiently
At this point, you should be familiar with RESPs, how they work, and their key components.
Now, you need to know how to cash out an RESP tax-efficiently. This knowledge will give your child the maximum amount of money they need to pay for post-secondary education. Here are a few key things to know:
The Importance of Filing Taxes
Generally speaking, even if they are full-time, students should file taxes in Canada.
Students are often eligible for tax credits like tuition. These credits can be enough to reduce the amount of tax they have to pay. They may even be enough for the student to get a refund.
Students, of course, must file taxes if they receive any taxable income. Taxable income includes the money they get from a part-time job, and, yes, you guessed it, taxable EAPs.
Basic Personal Amount
Most students will end up claiming less than the “basic personal amount” as their income. Income less than the basic personal amount is tax-free.
Currently, the basic personal amount in Canada is $12,069. As long as the student claims less than $12,069, even if the income is taxable, they won’t have to pay any taxes.
You should keep this basic personal amount in mind when withdrawing money from an RESP. This limit will prevent your child from having to pay taxes on EAP payments.
The Importance of Taking out All EAP Money
Depending on your situation, it is in your best interest to request all EAP money before the student graduates. If you don’t, you may have to return the grant and income money to the government.
A Scenario
To help solidify these concepts, here’s a scenario:
Let’s say Mom set up an RESP account for Caitlyn, her daughter. To keep things simple, we’ll assume that Mom contributed the maximum amount an RESP allows ($50,000).
So, the account has $50,000 of Mom’s own money. The government matched the maximum of $7,200 through the Canada Education Savings Grant. Over the years, the income growth on Mom’s contributions and the grants totaled $20,000.
Caitlyn now has $77,200 available for post-secondary education expenses. $50,000 of it will be in the form of non-taxable PSE payments. $27,200 (government grants plus the income growth) will be in the form of taxable EAP payments.
Mom and Caitlyn must determine how to get the money out while minimising the tax they have to pay.
The First Year
Let’s say Caitlyn needs $4,000 to cover expenses for her first year. The family must determine whether to request EAPs, PSEs, or a combination of the two.
Technically, Mom could withdraw the entire $50,000 in PSE payments whenever she wants. This money is non-taxable and ready to spend on educational expenses.
However, Mom decides that it’s better to leave the $50,000 in the RESP. The money will continue to grow until the family needs to withdraw it.
Mom decides to request the maximum amount of $5,000 in EAPs. Even though Caitlyn only needs $4,000, this smart move helps the family use up the EAPs.
Even better news? Caitlyn won’t have to pay taxes on it as it is below the basic personal amount of $12,069. (Know that this is only applicable if Caitlyn doesn’t have other taxable income that would push her over this threshold.)
Mom gives Caitlyn the $4,000 she needs to pay for books, tuition, etc. Mom holds on to the remaining $1,000 for future expenses down the line.
The Second Year
Let’s say that tuition and book costs remain the same throughout Caitlyn’s four-year program. Caitlyn will need another $4,000 for her second year.
However, Mom wants to take out $15,000. Caitlyn will use $4,000 of it for tuition books, and $11,000 will go toward a new car.
Technically, Mom could request the $14,000 entirely as EAPs. (Remember that, in most cases, there are no limits on EAPs after the first 13 weeks of school.)
However, this wouldn’t be the smartest move. Caitlyn would have to report her taxable income as $14,000, which would put her above the basic personal amount of $12,069. With that amount, she would have to pay taxes on the EAPs.
A better idea would be to split up the EAP and PSE payments. Mom should request, say, $10,000 in EAPs and $4,000 in PSEs. Caitlyn won’t have to pay taxes on the PSEs as PSEs are non-taxable. She won’t have to pay taxes on the $10,000 as it is below the basic personal amount.
The Third Year
Again, Caitlyn will need at least $4,000 and wants to cash out $14,000. Things get interesting this year as she gets a job at a bookstore.
At the bookstore, Caitlyn makes $6,000 per year. She’ll have to report this as taxable income.
If she wants to remain below the basic personal amount, Caitlyn should not take out more than $6,069 in EAPs. This situation means that the family should not do what they did the second year (request $10,000 in EAPs and $4,000 in PSEs).
Instead, Mom requests $6,000 in EAPs and $8,000 in PSEs. This allocation puts Caitlyn at $12,000 in terms of taxable income. Because this is below the basic personal amount, she won’t have to pay tax on it!
The Fourth Year
For her final year, Caitlyn needs at least $4,000.
So far, the family has cashed out $21,000 out of the original $27,200 of available EAP funds. They want to cash out the rest to avoid it going back to the government.
So, Mom requests $6,200 in EAPs. Caitlyn quits her job, meaning she will need additional funds to help cover expenses. So, Mom seeks an additional $3,000 in PSEs.
At the end of Caitlyn’s schooling, she has used all EAP funds. She still has $35,000 available in PSE funds.
What to Do with Leftover Funds?
Having leftover funds can be tricky. It’s best to withdraw as much as possible when the student is still in school.
If you have leftover funds, your options include:
- Transferring the money to a retirement account
- Adding another student as a beneficiary so that they have access to the funds
- Withdrawing the funds at a penalty
What If the Beneficiary Doesn’t Go to School?
If the beneficiary doesn’t go to school, your options are similar to those for using leftover funds. You can transfer the money to a retirement account or another beneficiary, etc. Some options will have higher tax penalties than others.
However, you should keep in mind that an RESP can stay open for 36 years. It will be available for your child if they decide to pursue additional education later in life.
Talk to Your Accountant
As a parent, you should understand the importance of using the RESP withdrawal rules to your advantage. This knowledge will allow you to minimise taxes and get the most money possible for your child’s education.
Keep in mind that every family’s situation is different. You’ll want personalised advice when it comes to your RESP withdrawal plan.
I recommended talking to your accountant. They will analyse factors like your child’s income, how much money they need for school, how much is currently in the RESP, etc. Then, they’ll advise you on requesting EAPs and PSE payments (when to claim them, how much to request, etc.).
A professional account will help you minimise taxes and get the money to which you’re entitled. They’ll also help you determine the best course of action for using any leftover funds.
Summary
As confusing as the RESP withdrawal rules are, it’s a good problem to have. Through dedication and responsible financial planning, you could build a post-secondary education fund for your child. We hope this guide helps you determine the best way to cash it out!
Chris Muller’s Bio:
Chris is a personal finance writer with a background in banking and investments. He started a digital marketing business that focuses on freelance writing, content marketing, and SEO — all while working full-time and playing dad to two kids. You can check out his blog – Money Mozart to read more.
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.