Author: Mike Holman

One of the drawbacks with RESP accounts, is that it is very difficult to predict exactly how much money your child will need as a student.  Studying out of town is much more expensive than living at home.  A four year University program is far more expensive than a 9-month cooking course.  Your child might do one year of a post-secondary program and then run off and join the circus.

If you are a diligent saver, contribute the maximum amount to an RESP account and things don’t work out as planned, it is pretty easy to end up with extra money in the RESP account when the student has finished.

Why is excess money in your RESP a problem?

When contributions are withdrawn from an RESP, there are no taxes applied since the money has already been taxed.  When non-contributions (ie grants, capital gains, interest payments dividends) are withdrawn from an RESP they are considered income in the hands of the student.  If the child is not eligible to receive payments from an RESP which would be the case if they quit school then the non-contribution payments are taxed in the hands of the subscriber (account owner) along with a 20% penalty.  Needless, to say it is far more preferable to have the money be taxed in the hands of the student.

Here is a more complete description of the RESP withdrawal rules.

This is why financial institutions will always default any withdrawal request to EAP, if you don’t specify otherwise  It is generally in your best interest to withdraw the non-contributions first, followed by the contributions.  This of course, has to be balanced by the fact that the student might pay tax if the EAP amounts are large enough.

A reader question

Reader Lance wrote in with an interesting question (at least it is interesting for someone who likes RESPs as much as I do).

Is there is a limit to how much one can withdraw from an RESP once the beneficiary starts post secondary education. Let’s take an extreme example. Say you really managed to do well performance wise, and your contributions, grants, and returns have totaled $300K. You have one child and they intend on staying at home while completing a four year degree. Assuming that total education needs are reasonable, say under $15,000 per year, are you allowed to take out more as you know you aren’t going to exhaust the $300K? Can you take out $75,000 per year?

I’ve read that you have to have documentation supporting your requirements when you go to your bank/financial institution when you first start taking out RESP money.

The analysis

The federal rules state that to get an EAP payment (educational assistance payment), proof of enrollment at a qualified institution must be provided for each withdrawal.  This is the type of payment made to the student when attending school.

The guidelines also state that the promoter (financial institution) shall:

• Verify whether the amount requested covers valid educational expenses which will help the beneficiary further their education.
• The RESP Promoter’s organization may have established guidelines or policies with respect to acceptable educational expenditures.
• Only $5,000 EAP can be with withdrawn in the first 13 weeks.

Those rules can be found on this page on the HRSDC website.

EAP – Education Assistance Payment.  These are non-contribution payments made to a student enrolled at a qualified post-secondary educational facility.

AIP – Accumulated Income Payment.  This payment is made when collapsing an RESP account, usually because the student decided to end their schooling.  The payment is made to the subscriber and is taxed in their hands along with a 20% penalty.  The 20% RESP withdrawal penalty can be easily avoided however.

Do you need to provide receipts when withdrawing from an RESP account?

To answer your second question, first – No, you do not have to provide receipts or answer questions about how the money will be used.  You just have to provide proof of enrollment. 

Can you withdraw whatever amount you want from your RESP account?

If you do end up with a $300,000 RESP, then your financial institution might be a problem when requesting withdrawals.  I would suggest just keep after them, if there is any resistance.

The real problem with doing an excessively large RESP withdrawal is that the CRA reserves the right to audit any EAP payments after the fact, so if you do an abnormal-sized EAP payment, then they might come calling.  If the CRA decides that your EAP payment was in fact an AIP payment, then the taxes and penalties will be quite severe.

In Lance’s case, if the account was $300,000 and there were $36,000 worth of contributions, then the total EAP amount would be $264,000, which works out to $66,000 per year.

The reality is that there are no solid guidelines as to what the money could be spent on, so theoretically a student could buy a fancy new car for example, since that car would be used to get to school.  Maybe the student could buy a condo if there was a huge amount in the RESP.  Not sure how that would fly with the CRA though.

If you do end up in this situation, then I would consult a tax expert to determine the best course of action.  On the one hand, it would be nice to save on the 20% penalty and extra income taxes, on the other hand you wouldn’t want the CRA to levy the 20% penalty and taxes after the fact, along with a potential fine.

This situation might be more common that you think.  If you have good-sized RESP accounts for three kids and two of them don’t want to go to post-secondary education, then you can transfer their RESP money (minus the grants) to the third child who will end up with a very large RESP.

Another scenario might be if you have a decent-sized RESP account, let’s say $100k and the kid quits school after one year.  You can still do the EAP withdrawals for 6 months after that, but again, will the CRA do an audit if the payments are too large?

What would Mike do in this situation?

Well, as a dedicated passive, low-cost investor, it is extremely unlikely that I would end up with an excessively large RESP account based on investment returns alone.  I do have two kids however, so it is possible that if one doesn’t go on to post-secondary education then the money would get transferred to the other child which might make for a very large RESP.

I wouldn’t worry too much about the CRA, if I am taking extra money out of the RESP that I know isn’t going to be used for education.

Here’s why:

1. The withdrawal rules were changed in the 2008 budget to allow EAP withdrawals (payments for school) for up to 6 months after the student is finished or quits school.   Why would the government introduce a rule like this, unless they were trying to encourage people to get all the extra money out of their RESP?  Obviously, if the child is no longer enrolled in school then any withdrawals are not going to be used for educational purposes, yet the government went out of it’s way to allow this.
2. Create some expenses.  In Lance’s case, he asked about a student that lives at home.  Well, how about charging them rent?  Charge them for food, tv time, parking fees, utilities, companionship fees etc etc etc.

Please keep in mind that this should not be taken as advice – I’m only saying what I would do.  Please see a qualified tax accountant if you want real advice.

One of the drawbacks of opening up an RESP account to save for your child’s post-secondary education is that if the child ends up not attending post-secondary education or quits early, then there are some penalties applied when the RESP account is collapsed.

How the penalties and taxes are applied if your RESP account is collapsed

When the account is collapsed then the following happens:

1. Any RESP grants paid into the account are removed and sent back to the government.
2. You can withdraw all your original RESP contributions without any taxation or penalties.
3. Anything left in the account is taxed at your marginal tax rate plus 20%.   This part of the withdrawal is called the Accumulated Income Payment (AIP).

How to avoid the RESP 20% penalty

All you have to do is contribute the accumulated income amount to your RRSP or your spouse’s RRSP.  By doing this, you can avoid the 20% extra penalty and you will defer any income taxes that would have been due on the payment.

Here are the conditions necessary to be able to contribute the accumulated income amount from the RESP to an RRSP:

• Subscriber is a resident of Canada.
• Payment has to be make to only one subscriber of the plan.
• Plan has been open for at least 10 years and each individual who is or was a beneficiary, is over 21 years of age and not eligible for an educational assistance payment (EAP).

But I need the money!

No problem, contribute the AIP amount to the RRSP, wait until the following year and then withdraw the same amount from your RRSP.  Assuming your marginal tax rate is unchanged between the time of the contribution and withdrawal then the amount of income tax paid will be the same as if you hadn’t contributed the AIP to the RRSP in the first place.  And there is no 20% penalty!

What if my spouse and I don’t have any RRSP contribution room?

Good problem to have!.  Assuming you are still working then you can just wait to collapse the RESP until the following year.  Reduce your RRSP contributions appropriately so that you will have enough room next year to contribute the accumulated income portion of the RESP.    In this case you are really only saving the 20% penalty since you are reducing your normal RRSP contribution by an amount equal to the AIP, but saving 20% is still very worthwhile.

Unfortunately, if you are too old to make rrsp contributions, then this plan won’t work.

My son just quit University after one year and there is still money in the RESP – do I have to pay a penalty to withdraw?

If you collapse the RESP account then the penalties and taxes will have to be paid.  However, the 2008 budget allowed for EAP withdrawals up to 6 months after the child stops going to school.  EAP withdrawals are when you withdraw the accumulated income from the RESP.  These will be taxed in the hands of the student and won’t incur any penalties.  If you are in that situation then just empty the account out as soon as possible.  This strategy can only be used if the student starts post-secondary education.

From the RESP Promoter User Guide:

 

Six Month Grace Period

Budget 2008 introduced a six-month grace period for receiving an EAP to provide more flexibility for a beneficiary to access RESP savings. Under this measure, an RESP beneficiary is eligible to receive an EAP for up to six months after ceasing to be enrolled in a qualifying program, provided that the beneficiary would have qualified while still enrolled.

Check out my RESP rules guide for more information on RESP rules and how to set up an RESP account.