Tuesday, 16 June 2009

RESP: Maximizing Withdrawal Benefits

You've had an RESP for long time, you've made lots of contributions, got Canada Education Savings Grants (CESG) and perhaps an Alberta Centennial Education Savings Plan Grant if you live in Alberta. You have a family plan with two or three kids as beneficiaries. The kids are young adults and it is now time to take the money out. Here are some thoughts on getting the maximum benefit from the RESP.

Note the best source of information - the Human Resources and Skills Development Canada Promoter Tools. HRSDC is the horse's mouth and the information is detailed and precise with helpful tables and examples. Skip their consumer info pages if you really want to know how things work. The Canada Revenue Agency has a good FAQ on RESPs. Other government sources like CanLearn, Financial Consumer Agency of Canada and Service Canada serve up really basic baby pablum type info which in some cases is misleadingly general. I would also warn people off CRA's IC93-3R, as the copy I found on the CRA website is dated 2004 and is out of date. CRA's RC4092 is better.

1) Wait till the child/beneficiary is in a qualifying educational program before removing any funds. You (the subscriber) are allowed to take out your contributions (actually, anyone's contributions since, as far as HRSDC and plan promoters are concerned, the subscriber becomes the owner of the contributions, not the beneficiaries, nor the aunt, uncle or grandparents who may have deposited money). But taking money out early means you will have HRDSC asking for the corresponding CESG back.

The list of qualifying institutions is vast, not just university or college, so there is no excuse. The minimum length for a program is three weeks. Send them to the Kanine Klipping All Breed Grooming School in Saskatoon (check the list under K). The travel expenses can count as education expenses since there isn't anything more detailed about the requirements for expenses than to further post-secondary education.

2) Remove the CESG (and Alberta grant, if applicable) once the student is enrolled in a program by requesting the Promoter (discount broker if an self-directed RESP; complete list is here at HRSDC) to make an Education Assistance Payment (EAP). Once the student is enrolled, i.e. eligible for the EAP, you can also ask for contributions back, even if you have not requested an EAP. Your contributions always come back tax-free no matter who they go to, you, the student or anyone else (makes sense since you paid tax on that money before contributing and did not get a tax deduction or credit when making the RESP contribution). When the RESP has made money, some of the EAP will consist of CESG and some from interest, dividends or capital gains but the source of the return is lost and all the EAP is considered other income and taxed in the hands of the student at the student's marginal rate .... which should be minimal or zero due to low income and lots of deductions. It's probably best in most cases to remove only what is needed each year of a study program to even out the student's taxable income flow and allow the remainder to continue growing tax-protected.

You do not get to choose the proportions of CESG and profit removed in an EAP. You state a total desired withdrawal and there is a mandated formula that pro-rates the amounts. There is no withholding tax on withdrawal, unlike on RRSPs.

An EAP with earnings passed to a no-tax child achieves income splitting, a big tax benefit as the profits that you could have made in a taxable plan would have been taxed at your much higher marginal rates.

After the first 13 weeks of study, during which time only $5000 in EAP can be paid to a full-time student, the only limit to EAP without hassle is the informal $20,000 (2008 dollars that will be inflation-indexed) limit that CRA has told RESP providers it will not question in paragraph 6(i) of its RESP FAQ. Part-time studies are a bit more complicated in restricting an EAP to $2500 in each 13 week period preceding the EAP (see example worked through on this HRSDC page). There is an option to obtain more as an exception by having your RESP provider write to the folks at HRSDC. All the EAPs are only supposed to be paid for legitimate education expenses but receipts and strict lists of acceptable vs unacceptable expenses are not provided so I would guess most RESP providers will be quite cooperative when you ask for an EAP amount.

3) If the child doesn't go on to any sort of post-secondary studies, transfer the earnings of the plan to your RRSP. Up to $50,000 of earnings can be transferred if there is RRSP contribution room and as long as your are under 71, when one can no longer make any contribution to an RRSP. A transfer to an RRSP is better than taking earnings as an Accumulated Income Payment (AIP) into your own income since you will pay tax at your normal rate plus a 20% surcharge. AIP does not include your contributions, which you can withdraw without tax. It is also better than another possibility, which is to give the AIP money to an educational institution, since such a gift does not even qualify for a charitable donation receipt.

4) Include all your children in a family plan - and you can add them later if they are under 21 - so that the CESG can be shared amongst the siblings. CESG paid into a family plan RESP may be used by any beneficiary of the RESP to a maximum of $7,200 per beneficiary. It doesn't have to be the same child under whose name the CESG was obtained. Nor does the CESG or the EAP have to be shared equally amongst the beneficiaries, which can be a boon if only one child goes on to further studies. How you maintain fairness in the family is your personal matter unaffected by this flexibility in the rules.

Plan providers are supposed to keep accounts of contributions and track how much CESG is paid out to each beneficiary. My provider insists that it will prevent an EAP that would try to take too much CESG out for a particular beneficiary in a family plan - e.g. if two beneficiaries had $10,000 in CESG between them, only $7200 could be taken in EAPs by either one. But I would double check and track the CESG for each child just to be sure because if an over-wthdrawal happens, HRSDC will ask for the extra CESG back from the beneficiary.

An interesting aside is that only blood relatives can share a family plan. Blood relatives includes parents, brothers and sisters, children, grandchildren and great grand-children and onwards, but not nieces, nephews, aunts, uncles, cousins. A grandparent can start a plan too, so your parents could start a plan where CESG is shared amongst your children and their cousins. The sharing only applies to the basic CESG, not the extra supplement of $50 or $100 per child given to lower income earners (see this HRSDC page). If it is not a sibling-only plan, the additional CESG is not given.

5) If the RESP has a loss then don't close it even if the children have finished their education and all the CESG has been used up with EAP. There is no hurry to close the RESP since a plan now may stay open for 35 years. That gives time to recoup any investing losses tax-free! Here's how this works. First, a loss exists when "the fair market value is less than the total of assisted contributions, unassisted contributions, the CLB, the CESG, and the Alberta Grant accounts in the RESP." (on this HRSDC page) There is no need for messy accounting on interest or dividends received from investments being considered as earnings, it is simply whether the market value is less than "book value". When one also notes that contributions can be made for a beneficiary up to his/her age 30 and up to 31 years after plan opening, that can even allow further contributions to be made. Such contributions can gain profit tax-free up to the point all the losses have been recouped, at which point everything can be withdrawn tax-free as a return of contribution. The rules allows you to make up your investing misfortune (or stupidity) tax-free.

On top of that, when a withdrawal is made and the RESP is in a net loss position, the rules consider that the contributions are what suffered the loss and any EAP comes purely out of the CESG, so that liability goes away faster. But the book value of contributions doesn't disappear, it just doesn't figure in the calculations of the CESG and EAP. Below is a simple spreadsheet to illustrate the calculation.

In the example, the $15,000 loss is such a large deficit to make up with only $35,000 remaining in the RESP account following the withdrawal (which conveniently consumed all the CESG, unlike the profit example), that a new contribution of $10,000 is made to make it more feasible to recover the loss. Of course, new contributions must remain within the $50,000 lifetime maximum permitted for each beneficiary.

A tricky point that caused me needless extra phone calls is the fact that HRSDC only tracks CESG and the contributions related thereto. This means their records only go back to 1998 when CESG started. RESPs existed long before that. The RESP provider is obliged to record all contributions and pass this along with other essential data (like when your plan was opened) to another provider if there is a transfer. HRSDC will provide the subscriber with a written table of all their CESG plus contribution per beneficiary records upon request - phone 1-888-276-3624. If you make contributions after the kids get beyond 17, the maximum age to receive CESG, then HRSDC isn't interested and only your plan provider will keep that data (nor does Canada Revenue Agency keep any data on contributions or CESG).

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