Demystifying RESP drawdowns for educational purposes

As the academic year progresses, it’s important to reflect upon registered education savings plans (RESPs) and how they can be used as a tool to support the education of students. While the students are focusing on their studies, their parents (or grandparents) may have some decisions to consider when drawing down RESP savings through educational withdrawals.

Our previous article (RESP withdrawals: Basic rules and strategic considerations) explained in detail the different types of withdrawals from an RESP. In this article, we delve into some strategies for withdrawing for educational purposes, ensuring the student’s journey toward their educational goals is not only academically enriching but financially savvy as well.

Let’s begin with a primer on RESP taxation. 

RESP taxation

The RESP can generally be divided into three buckets for tax-reporting purposes: contributions, grants, and growth. A withdrawal for an RESP beneficiary’s educational purposes can include amounts from all three buckets.

Amounts withdrawn for education purposes are collectively referred to as education assistance payments (EAPs) and are comprised of: the Canada Education Savings Grant (CESG) and other provincial grants (collectively referred to as “grants”), and growth on both contributions and grants. The entire amount of an EAP is taxed to the beneficiary in the year received at their marginal tax rate.

Unlike a registered retirement savings plan (RRSP), RESP contributions are not deductible from the subscriber’s taxable income. Because the contributions have previously been taxed, the contributions can always be withdrawn by the subscriber tax-free (though adverse non-tax consequences may ensue for non-educational withdrawals).

When EAP conditions are met, the subscriber can also choose to withdraw the contributions, referred to as post-secondary education (PSE) withdrawals. PSEs are not taxable and do not incur any adverse tax consequences (as with a non-educational withdrawal of contributions).

For more information on the tax rules and other considerations, please refer to our Tax & Estate InfoPages titled “Registered education savings plans (RESPs)” and “Registered education savings plans (RESPs) – Frequently asked questions”, accessible through our website’s Tax & Estate Resource Centre.

Should you withdraw grants and growth first?

As explained earlier, EAPs are the combination of grants and growth, which are taxable to the beneficiary when withdrawn. As a student, the RESP beneficiary is often in the lowest income tax bracket, so a shrewd RESP draw-down strategy maximizes the use of EAPs as soon as possible. Any income inclusion by the beneficiary may be lightly taxed or perhaps not subject to income taxation at all, as the beneficiary may claim certain personal tax credits. This may be especially true in the first year or two of enrollment, as earned income generally increases with age. Special consideration needs to be given to co-op students who may earn a considerable amount in a short period of time and sometimes within eight months in the same calendar year. Contrast that to students in their final year of enrollment that are employed full-time for eight months in their final tax year of school. Given the variability in students’ income and therefore tax position, the subscriber should pay close attention to the income earned, forecasting wherever reasonably possible and using that information to devise an EAP funding strategy. That could mean, for instance, taking EAPs in three tax years instead of five. Of course, the optimal timing for withdrawals highly depends on the RESP beneficiary’s personal situation.

There is an added incentive to use as much of the EAP first, as grants can only be used for education purposes. This is an important restriction to keep in mind because any grants not used for the beneficiary’s education cannot be paid to the subscriber and must be returned to the government when the RESP is eventually collapsed. This is further complicated by the fact the subscriber is not permitted to redeem from the grant portion only. A prescribed formula dictates that the RESP administrator redeems EAPs as a blend of growth and grants.

An educational withdrawal may consist of both EAP and PSE. The tax merit of a PSE drawdown strategy is discussed next.

Or should you withdraw contributions first?

Recall that educational withdrawals from contributions are referred to as PSE. While there are risks associated with deferring EAPs, subscribers can specifically request that contributions be withdrawn first. This strategy might make tax sense if the RESP beneficiary is in a higher tax bracket due to part-time employment or is operating a successful business while in school. In this case, it could be beneficial to redeem PSE first and then EAP in later years, when the beneficiary may be in a lower tax bracket.

A PSE-first strategy may also make sense depending on the income tax dynamic among beneficiaries in a family RESP. A family RESP can have multiple beneficiaries who are blood-related to the subscriber. An attractive feature of a family RESP is that unused grants can be shared among beneficiaries as long as each beneficiary does not exceed the lifetime grant limit (currently $7,200). Note that the $7,200 lifetime limit applies to the federally funded CESG and not provincial grants.

One strategy available to family RESPs is to make PSE withdrawals for higher-income beneficiaries and EAP withdrawals for lower-income beneficiaries. For example, let’s assume Beneficiary A is in a higher income tax bracket due to an internship while Beneficiary B is in a lower income tax bracket. If Beneficiary B has not fully utilized their $7,200 CESG lifetime limit (meaning the cumulative amount of CESG paid to Beneficiary B and taxed in their hands is lower than $7,200), it may make sense to allocate more EAP to Beneficiary B and more PSE to Beneficiary A. This way, the overall tax burden on the RESP payments may be reduced or eliminated because PSE would not be taxable to Beneficiary A, who would have paid higher taxes on an EAP received. The type of payments made to each beneficiary in a family RESP may need to be reviewed each year based on their tax bracket changes.

That said, taxes should not be avoided at all costs. It is still better to receive a relatively lower after-tax amount than to return the grants to the government (recall that grants can only be used for educational purposes). Also remember that leaving grants in the account may mean leaving growth in the account as well, due to the prescribed formula for EAPs. If grants and growth are left unused, the subscriber may be forced to return the grants to the government and redeem the growth with a penalty tax (unless rolled over to the subscriber’s RRSP). The non-educational withdrawal of growth is called an accumulated income payment (AIP) and is further explained in our previous blog post as well as our Tax & Estate InfoPage titled “Registered education savings plans (RESPs)”.

RESP educational withdrawal requests with Invesco

We have identified the two types of educational redemptions: EAP and PSE. Now, how do you communicate your approach to the RESP administrator (e.g., Invesco)? Invesco has prepared an RESP Educational Withdrawal Form to assist with this.

Under Section B – Withdrawal Information, the subscriber’s first direction is to indicate whether the withdrawal request is for the full account or a partial withdrawal.

If a partial withdrawal is indicated, Section B provides two choices in specifying whether grants/growth (EAP) or contributions (PSE) are to be redeemed from the RESP. The subscriber is permitted to redeem from both at the same time. The intent is to provide Invesco with the total redemption amount first, then how much from EAP and/or PSE.

For example, if an RESP subscriber, Jane Doe, is requesting a total withdrawal of $9,000, she could designate $3,000 as EAP and $6,000 as PSE. In this case, the tax outcome for the beneficiary is that $3,000 is taxable, while $6,000 is non-taxable.

Careful planning for EAPs from a tax perspective means more hard-earned investment dollars can be put toward the ever-increasing cost of post-secondary education — and hopefully less student debt upon graduation.

For a more in-depth discussion of RESPs, please contact Invesco’s Client Relations department. Additionally, please refer to Invesco’s Tax & Estate Resource Centre for a variety of bulletins related to RESPs, such as “Registered Education Savings Plans (RESPs)”, “Registered education savings plan (RESP) helpful hints and strategies”, “Registered Education Savings Plan – Frequently asked questions”, and “Registered Education Savings Plans (RESPs) – Quick Reference Card”.