Editor's note: This article is part of Morningstar's August 2015 Focus on Education Savings special report.
Financial advisors routinely sing the praises of contributing to a Registered Education Savings Plan, the government-sponsored program to encourage Canadians to save for their children's post-secondary education. And, no wonder! RESPs offer tax-deferred savings, and an annual RESP contribution attracts a Canada Education Savings Grant of up to $500 each year until a child turns 17. Subscribers in some provinces also receive provincial grants. Modest-income families may be eligible for additional government money.
The withdrawal side of RESPs receives less attention, even though there is much to consider. How much advanced planning is necessary in order to access RESP funds? What is the process for withdrawing the money? How much can be withdrawn each year? Which educational programs qualify for RESP payouts? What happens if my child does not pursue post-secondary education?
RESP withdrawal strategizing begins with researching and selecting the right plan and provider. Since drawing down an RESP is far in the unknown future, the plan you choose should be as flexible as possible.
A family RESP is usually the most flexible, says Matt Sears, a Certified Financial Planner and consultant at T.E. Wealth in Toronto. You can designate any or all your children or qualifying relatives as beneficiaries, and you decide how to divvy up the funds.
A plan provider should offer numerous withdrawal options so that when it is time to access the funds, there will likely be a payout structure that suits the beneficiary's needs. Sears notes that group RESPs are the least flexible and have strict rules on withdrawals.
When an RESP beneficiary begins high school, the plan subscriber (usually a parent) should re-read the RESP provider's rules and begin to prepare for the eventual withdrawal of the funds.
This is the right time to let the plan beneficiary know which post-secondary educational programs qualify for RESP withdrawals so she can factor RESP eligibility into her choice of program. Details on qualifying programs are posted on the government's RESP website.
"Once a beneficiary reaches high school, subscribers should focus on de-risking RESP investments," says Sears. "Plan holdings should become increasingly conservative as the withdrawal phase approaches."
By the time the beneficiary is ready for post-secondary schooling, the plan should hold enough cash to cover withdrawals for at least the first year of schooling. The remaining funds should be held in low-risk, liquid investments such as cash or GICs with maturities timed to provide cash for withdrawals in subsequent school years.
The federal government sets the general rules for RESP withdrawals. The process for a particular RESP depends on the rules established by the plan provider. To ensure that withdrawals will proceed smoothly, a subscriber should check the rules of her plan when the beneficiary is ready to apply to a post-secondary program.
Invariably, to withdraw RESP money, the subscriber will need to fill out a form and provide official proof that the beneficiary is enrolled in a qualifying program. She may also need to provide receipts to verify that the student spends the funds on allowable educational expenses. (Click here for more practical details on withdrawing from RESPs.)
Withdrawal of RESP funds requires some planning in order for you to maximize the benefits and minimize tax owed.
Subscriber contributions used to pay for qualifying expenses can be withdrawn at any time, and there is no tax due. Students can receive up to $5,000 in Educational Assistance Payments (EAPs) i.e., the investment earnings and government grants portion of an RESP, during the first 13 weeks of attendance. After that, EAP withdrawals for qualifying expenses are not restricted.
In general, EAPs should be accessed first because any unused grant money must be returned to the government.
A student must claim all EAPs received as income on her tax return. Given the available basic personal, tuition, education and textbook tax credits, many students will not pay tax on their EAPs. Co-op students may need to reduce EAP withdrawals in school years when they earn income from co-op work.
What happens to the RESP if a beneficiary chooses not to continue her education after high school? If it's a family plan, other beneficiaries may be able to use the funds.
Keeping an individual plan open for several years is advisable as the beneficiary could change her mind. (Plans can stay open for up to 36 years.) If it is certain that the beneficiary will not pursue post-secondary education, it may be possible to change the beneficiary, or transfer all the funds to another RESP.
If it's time to close an RESP and funds remain, any unused government grants must be returned and contributions go back to the subscriber.
The fate of the investment earnings portion, known as the Accumulated Income Payment or AIP, will depend on the plan. Investment earnings in group RESPs are normally forfeited to the group's funding pool. An individual or family plan subscriber who is a Canadian resident will receive the AIP if certain conditions exist -- either the RESP has reached the end of its mandated life, or all beneficiaries have died, or the plan is at least 10 years old and all beneficiaries are over 21 and not in school. Income tax plus an extra 20% fee are due on the AIP amount.
In certain circumstances, the 20% penalty is avoidable. If the student is the beneficiary of a Registered Disability Savings Plan, a rollover of the remaining RESP earnings to the RDSP may be possible. Similarly, a subscriber can transfer the AIP to her or her spouse's Registered Retirement Savings Plan if there is sufficient RRSP contribution room.