Having more money than you need normally is a good thing. But when it comes to unused funds in a registered education savings plan, you may be penalized for not using the money in the plan for its intended purpose: to pay for a beneficiary’s post-secondary education costs.
However, through proper planning, you may be able to retain most if not all of the income accumulated within an RESP – even if the money is not all used to fund education.
The assets within an RESP generally come from three sources:
· Capital (from your contributions)
· Canada Education Savings Grants
· Investment income (earned on both grants and capital)
Assuming the student-beneficiary enrolls in a qualifying post-secondary institution, you will want to ensure he or she receives Education Assistance Payments from the RESP that are at least equal to the amount of the CESGs and investment income accumulated within the plan.
Education Assistance Payments are taxed in the student’s hands at his or her tax rate. Thus the student’s taxable income for a calendar year has an impact on how these payments can be most effectively structured. You can opt to pay out only the CESG and income to the student, and then cut into the capital if necessary. Note that the RESP contributor or the beneficiary may withdraw the plan’s capital tax-free.
As long as the student’s income from the RESP and other sources doesn’t exceed the basic federal personal tax credit amount – which basically exempts the first $11,474 of income from taxation – he or she should not have to pay tax. This, in turn, will also allow the maximum tuition credit to be transferred to the parent’s tax return.
The maximum Education Assistance Payments that can be made to a student initially is $5,000. After he or she has completed 13 consecutive weeks in a qualifying post-secondary program, there is no limit to the amount of payments that can be made, assuming the student continues to provide proof of enrollment at a qualified institution.
While large Education Assistance Payments can be made, bear in mind that the tax authorities reserve the right to audit these payments. For example, they could rule that a large Education Assistance Payment was in fact a strategy to close an RESP, and tax and penalties applicable when an RESP is closed could apply. So make sure the student’s educational expenses justify the amount paid out.
First off, there is a grace period which allows Educational Assistance Payments to be made up to six months after the student stops going to school.
Regardless of whether the intended beneficiaries have gone on to post-secondary education, once they have all reached age 21, and assuming the RESP has been in place for at least 10 years, the account may be closed. Should you do this:
· Any unused grants must be returned to the federal and Quebec governments.
· Income tax must be paid by you at your own tax rate on accumulated income (on grants and capital) that remains in the plan.
· You also must pay a 20% penalty on that excess income.
An RESP can stay open for up to 36 years, so think twice about closing the plan if there is a chance any its beneficiaries might register for a post-secondary program in the future.
Regardless of when you decide to close the RESP, you should work with your financial advisor on some careful tax planning to ensure you pay little or no tax on excess income in an RESP.
- First, consider transferring up to $50,000 of excess income in the plan to your registered retirement savings plan (RRSP), or a spousal RRSP. However, you must have sufficient unused contribution room to do this.
- If you don’t have RRSP contribution room, work with your advisor to identify a taxation year in which your income will be lower, and close the account at that time.