With my oldest child turning 11 this year, my mindset and strategy for our family RESP is starting to shift from accumulation and growth to a more balanced portfolio.
This has many similarities to retirement planning but on a smaller scale. In your younger years, there is a focus on growth, but as retirement approaches, a shift from offense to a more balanced approach typically occurs.
In both scenarios, you want to get the most out of your portfolios to pay for stuff, which usually means withdrawing from those portfolios in a tax-efficient manner.
Here is a brief outline of how RESPs work:
- Deposits are made with after-tax dollars (ie. not tax-deductible);
- The federal government provides 20% match funding for your deposits called the Canada Education Savings Grant (CESG);
- The maximum free money (CESG) per year is $500, which means that a $2,500 contribution would result in a total of $3,000 added to the RESP. The maximum lifetime CESG is $7,200, which will get maxed out after approx 14.4 years of contributing $2,500/year.
- If you are a little late getting started, here is how to catch up on your RESP contributions.
- When it comes time to withdraw, portfolio growth and CESG withdrawals are taxable but reported under the student’s income tax. So the withdrawals will likely face low taxation.
A Deeper Dive into RESP Withdrawals
You can choose how the money withdrawn from an RESP is categorized. To elaborate:
- A withdrawal of CESG and investment growth from an RESP is considered an Educational Assistance Payment (EAP). EAPs are taxable to the student.
- A withdrawal of RESP contributions is called a Post-Secondary Education Payment (PSE). PSEs are not taxable and can go to either the subscriber (ie. parents/grandparents) or the student.
- A maximum of $5,000 EAP withdrawal during the first semester of schooling (13 weeks). After that, there is no maximum EAP (up to the amount in the RESP). PSE can be withdrawn at any time.
Tax Efficient RESP Withdrawals
As you can see from above, some withdrawals are taxable while others are not. With any withdrawals that are taxable (ie. EAP), a T4A will be provided to the student.
With the basic personal amount of $10.5k in Ontario, this means that an Ontario student can earn up to $10.5k annually without paying any income tax.
You’ll need to determine other income the student has, but it’s likely wise to withdraw the full $5k EAP in the first semester. After the first semester, you can work out the withdrawals to stay under the basic personal amount.
The secret is to get the EAP out of the account while the student is attending post-secondary. Note that the PSE can be withdrawn tax-free and without penalty.
In my 2019 RESP update, the balance of my 11 year old’s RESP was around $49k. Let’s fast forward to University age, and assume that the portfolio grows to $80k.
The $80k RESP balance would be made up of:
- PSE: $36,000
- EAP (CESG: $7,200 Growth: $36,800): $44,000
Inspired by Retire Happy, I created a chart summarizing the RESP withdrawal plan.
|Year||Tuition Room/Board||Part-Time Income||EAP||PSE|
This example assumes that the student doesn’t work part-time and it shows a tax-efficient way to get the EAP money out of the account over 4 years.
In another scenario where the child decides to attend a local university and live at home, the student would have some extra money to spend while paying little or no tax. The best part? We would get our contributions back!
|Year||Tuition Room/Board||Part Time Income||EAP||PSE|
To summarize, RESP withdrawals are separated into two components – the EAP (CESG and investment growth) and the PSE (contributions).
The EAP is the taxable stuff that can face a penalty if not used up. To maximize RESP withdrawals, strategize to use up the EAP while staying in a low tax bracket (or under the basic personal amount) before dipping into the PSE.