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Smart Ways to Withdraw from RESPs: Take Advantage Of Low Marginal Tax Rates

First Posted: September 11, 2009

By Bennett Gold LLP, Chartered Accountants

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You've been building savings for your children's education in a Registered Education Savings Plan (RESP) and now the time has come.

The tuition bills are arriving and your kid is headed off to college or some other institution for a post-secondary education. It's time to make some informed decisions on how you're going to start withdrawing from the plan.

First, you need to understand how the money is distributed in your plan. Generally, RESPs are split into three components:

Capital, which is the total after-tax money you put into the plan.
Government funds from the Canada Education Savings Grant (CESG), the Canada Learning Bond, the Alberta Centennial Education Savings Plan and Quebec Education Savings Incentive. These funds are each tracked separately in the account.
Accumulated earnings from capital gains, interest and dividends.

Understanding the distinctions is key to your tax planning. Capital withdrawals aren't taxable because you paid taxes on the money when you earned it. Funds in the latter two compentns are collectively known as Educational Assistance Payments (EAPs) and are taxable in the year they are withdrawn.

Although EAPs are taxable, you can follow a strategy that will eliminate tax liability. That's because the accumulated income and grant money are taxed at the student's generally lower rate. As students are unlikely to have much taxable income, they usually won't pay any tax on the withdrawals.

Nevertheless, be sure your children keep track of money they earn during the summer or working part-time during school. That income will be added to the taxable money withdrawn from the RESP. The plan's administrator will issue a statement to the beneficiary for the amount of grant and income funds withdrawn during the year.

EAPs are taxed as ordinary income, which means they do not benefit from the dividend tax credit or the 50 per cent exclusion of capital gains. On the other hand, if necessary, students can use their personal exemptions as well as tuition and education tax credits to help lower tax bills. Note: You cannot claim a capital loss in an RESP.

In the first 13 weeks of an educational program, a full-time student can take out only $5,000 of income and grant money. If you need more, you can mail a written request to Human Resources and Skills Development providing proof of the additional costs. Taking more of the earnings and grant money lets you leave income-earning capital in the plan to continue growing. Make your request as early as possible. The response will affect your withdrawal strategy.

After the first 13 weeks, the number and frequency of EAPs is unlimited for full-time students. If, however, the plan's beneficiary takes a 12-month hiatus, the $5,000 maximum will again apply when the student returns to school.

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