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

National Post


Each year around this time, I’m inundated with questions about strategies to tax-effectively withdraw 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 RESP and wonder if there are some strategies that could be employed to withdraw those funds with minimal (or, in some cases, zero) tax.

Before delving into a strategy, let’s walk through the RESP basics. An RESP is a tax-deferred savings plan that allows parents (or others) to contribute up to $50,000 per child toward saving for post-secondary education. The addition of government money in the form of Canada Education Savings Grants (CESGs) can add up to $7,200 per child to the plan.

Combine that with income earned and gains realized in an RESP, but untaxed over the course of your kids’ childhood, and, depending on investment returns, some RESPs may grow to a tidy sum by the time they head out the door to begin their post-secondary studies.

Funds withdrawn from the RESP take one of three forms: refund of contributions, educational assistance payments and accumulated income payments.

The first thing to remember when considering RESP withdrawals to fund post-secondary education is that contributions you, as the subscriber, made to an RESP, which were not tax-deductible, can generally be withdrawn at any time, tax-free. These are referred to as refunds of contributions (ROCs).

Any other funds coming out of the plan for post-secondary education are referred to as educational assistance payments (EAPs). This includes the income, gains and CESGs in the RESP and are taxable to the student when paid out.

If all the beneficiaries under the RESP decide against pursuing post-secondary education or have completed such education, and there are still funds left in the RESP beyond the original contributions, you, as a Canadian-resident RESP subscriber, may be entitled to receive the accumulated income and growth as an accumulated income payment (AIP). Any remaining CESGs would have to be repaid.

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

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

You may be able to roll over up to $50,000 of AIPs into your RRSP if you have unused contribution room. In this case, the additional 20-per-cent penalty tax will not apply.

After an AIP has been paid, the RESP must be completely collapsed by the last day of February of the following year. Any remaining income/growth may generally be paid to a designated educational institution — though a donation credit is not available.

This brings us to the question of how to best withdraw funds from a large RESP to minimize any income/growth from being left over at the end of the kids’ post-secondary studies and potentially being subject to an effective tax rate of up to 73 per cent.

Intuitively, it might seem attractive to only withdraw ROCs, since they are simply non-taxable. But if the goal is to minimize the family’s taxes during the kids’ studies, you’re probably better off creating some income each year in the form of EAPs to fully utilize the student’s annual basic personal amount (BPA) and other credits.

The enhanced federal BPA is $13,808 for 2021. That means a student can have taxable income from all sources up to this amount before paying any federal taxes. The student should 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. Note that students in Manitoba and Nova Scotia may owe a bit of provincial tax due to their respective provincial tax rates.

That said, there is no requirement that the money taken out of the RESP be specifically used towards tuition, books, etc. As long as the child is enrolled in a qualifying post-secondary program, “reasonable” EAPs can 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 assists the student to further their post-secondary level education.

For 2021, the Canada Revenue Agency will permit each beneficiary of an RESP to receive up to $24,676 of 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 federally and in all provinces other than Alberta, Saskatchewan and Ontario. New data released by Statistics Canada show that Canadian students enrolled full time in undergraduate programs will pay, on average, $6,693 in tuition for the upcoming 2021/2022 academic year.

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

Given the “reasonable” EAP limit of nearly $24,676 in 2021, the student could then receive an additional $4,176 and pay only minimal tax on this EAP, at marginal rates ranging from 20 per cent (Ontario) to 27.5 per cent (Quebec), if the student’s total 2021 income stays in the lowest provincial bracket.

Getting the funds out of RESPs that have substantial accumulated income and growth at these lower rates beats being forced to take out an AIP years later at rates that could exceed 70 per cent.