Last month, White Rock Senior Wealth Advisor Dave Lee explained how Registered Education Savings Plans (RESPs) work, and how to optimize your contributions. This month you’ll learn the rules surrounding RESP withdrawals, and strategies to consider.
“The government tracks three ‘buckets’ of money within every RESP: capital contributed, grant money from the government, and all growth. The distinction between these buckets is largely meaningless during the accumulation phase, but each bucket has different characteristics when you start pulling money out,” Dave says.
- Contributions: Money contributed to the plan can be withdrawn tax-free.
- Grants: Grant money from the government is taxed to the student when it’s withdrawn for education. If it is not used for a qualifying training program the grants are forfeited but the income earned on them remains in the RESP. Grant money can be shared among siblings in a family plan RESP with a maximum of $7,200 of grant money withdrawn for each child.
- Accumulated Income/Growth: The interest, dividends and capital gains earned on both the contributions and grant money (as well as the growth on that growth) is lumped together and taxed on withdrawal to the student. If unused, this is taxed to the subscriber, plus there is a 20 percent penalty tax on any unused funds.
“I generally advise my clients to withdraw the grants (bucket two) first, because if you don’t end up using that money it will go back to the government — that’s like a 100 percent tax!” Dave says.
Next, withdraw accumulated income (bucket three) because students generally have low incomes and likely won’t pay any tax. Dave suggests withdrawing the capital (bucket one) last because any unused funds can be pulled out without tax or penalty.
“If you have a family plan RESP, a child with expensive tuition can use a sibling’s money. There are no limits on how much is shared from buckets 1 and 3, but there is a $7200 lifetime cap on using CESG for any one child,” Dave says.
From RESP to RRSP
There is a 20 percent penalty on accumulated income that isn’t used for education and training, but Dave says there’s one trick subscribers can keep up their sleeve — if they plan ahead.
“You can roll income from an RESP into an RRSP, provided you have contribution room. You’ll ultimately pay income tax on that money when you withdraw it in retirement, but you’ll avoid paying the 20 percent penalty,” he says. “That’s why it usually makes sense for parents to be the subscriber, even if a significant portion of the money is coming from grandparents. Grandparents are likely to be over 71 by the time it’s discovered that the grandkids aren’t going to use the money, which means they no longer have an RRSP they can contribute to.”
And remember, BC children between the ages of six and nine are also eligible for an additional $1,200 grant for education — you just need to remember to apply! Enjoying these articles? Visit www.dave-lee.ca/publications to read more. Have a question? Contact Dave at 604.535.4743 or firstname.lastname@example.org.
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