Education Savings
By Troy Peart : In today’s increasingly competitive work force, a post secondary education has become a progressively more important factor in determining one’s career path. The global trend of outsourcing routine roles to less costly jurisdictions (like India) has amplified the need to differentiate oneself via their education. Unfortunately, the cost of a post secondary education has been increasing much more rapidly than the overall rate of inflation which has made the process of getting a post secondary education more challenging.
Funding one’s education can basically come from any combination of 3 sources: 1) Savings – RESPs, trust accounts or otherwise 2) Loans – either government or from another source or 3) Current/Future cash flow that usually comes from parents or students employment income throughout the year. The options utilized usually are determined by one’s personal circumstances. Having said that, as a result of the matching government contributions and income splitting opportunities present in RESPs; most individuals that have the foresight to plan for their children’s education utilize RESPs as one of their key solutions.
While the financial industry has been fairly effective of explaining all of the advantages of contributing to an RESP, very little has been communicated about how one can or should pay out these funds. Consequently, this month’s article will be focusing on how best to make redemptions from RESPs. Basically, there are 4 types of RESP withdrawals methods available: refund of contributions, education assistance payments (EAPs), accumulated income payments (AIPs) and payments to a designated educational institution in Canada.
As the name implies, a refund of contributions is simply the subscriber having their principal returned to them. While there are no tax consequences involved in receiving one’s principal, if the beneficiary is not attending a qualifying post secondary educational institution, the government payments associated with that original contributions will have to be returned.
An EAP is an amount paid to a beneficiary from an RESP, including Canadian Education Savings Grants (CESG) and income (but not principal) to help finance the cost of a qualifying post secondary education. During the first 13 weeks of attending a qualifying program full time, a maximum of $5,000 ($2,500 if part time) can be withdrawn in the form of an EAP. After these first 13 weeks, the withdrawals only have to be “reasonable” and are not governed by any maximums. There is also no restriction on how any of the funds can be used. EAP payments are taxable income to the beneficiary (student) and most students pay very little if any taxes at all because of their limited time to work and substantial tax credits for education. Consequently, this is usually the most effective form of withdrawals for students attending a qualifying educational institution.
An AIP is generally a payment made to the original subscriber of an RESP. These payments resulted from the growth that accumulated in the RESP and can only be made if the beneficiary is not going to pursue a qualifying post secondary education and if the subscriber is a Canadian resident. AIPs are fully taxable unless rolled over into an RRSP; assuming that there is sufficient RRSP contribution room. It is however important to note that there is a 20% tax on AIP payments in order for the government to be able to recoup the CESGs that were intended for educational pursuits.
If an RESP has to be collapsed while investment income remains in the plan and the plan does not qualify for an AIP; the remaining funds will need to be paid out to the designated educational institution that was included on the original RESP application. As the proceeds will be going to an educational institution, this institution will be responsible for any potential taxation.
On the surface, redeeming funds from an RESP seems like a straightforward task, however, this is often not the case. Professional advice should be utilized to ensure that one maximizes the benefits of their RESP while avoiding potential pitfalls.
Troy Peart BBA, CFP, CFA can be emailed at troypeart@shaw.ca. Your questions comments or suggestions for future articles are encouraged.
