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How to Avoid an RESP Tax Trap: 4 things to get right

Canada's registered education savings plans can be used to save and invest for post-secondary education tax-free. The trick is to minimize tax and clawbacks when withdrawals are made.

When your kids approach college or university age, here are 4 things you should do with their RESP: Stop contributions, adjust your asset allocation, structure withdrawals to minimize taxes, and deplete the RESP at the right time.

Contributions are eligible for up to 20% in “Canada Education Savings” grants when you contribute up to $7,200 per child per lifetime. Withdrawal of "contributions" is tax-free if you do it right while your kids (the "beneficiaries") are attending post-secondary education. Grants and income are taxable in your kids' hands. Tracking the balances in each bucket, contributions, grants & income, can be tricky due to the fact that statements generally do not show them.

It is best to invest wisely while your RESP funds are in it, and then minimize potential taxes and clawbacks once you withdraw them.

4 key things you should do:

  1. Maximize grants without over-contributing

  2. When you're close to drawing funds, adjust asset mix

  3. Make tax-efficient withdrawals

  4. Near the end of university, deplete RESPs

EAPs should be drawn early to ensure they are used, but also over enough years to be offset by tax credits. It is important to note that taking EAPs too soon could have tax implications. Withdrawals from contributions have no tax consequences, so you can top up your kids' funding needs each year.

In the first 13 weeks of post-secondary schooling, you can withdraw only $5,000 from EAP funds, but usually there are few restrictions thereafter.You must show proof of enrollment but no receipts, although you may be asked to show that very large EAP withdrawals over $20,000 in a year are used to further your kids' education.

Using 2023 figures, here's how much EAP money you can withdraw without paying federal or provincial income taxes: Start with the basic tax credit everyone receives ($15,000 for federal taxes). Add a tax credit for tuition paid (we'll assume $9,000 for a full-year at school), subtract income (we'll assume $7,000 from a summer job), offset partly by EI, CPP, and employment tax credits ($1,465 federally).

You can withdraw roughly $18,465 in EAP money without your kid paying any significant income tax in 2023 ($15,000+$9,000-$7,000+$1,465). You can also transfer up to $5,000 of unused federal tuition credits to a parent if your kid's gross income is low. In this case, no federal tax would be due, but you may have to pay a small amount of provincial tax because of differences in provincial tax practices in some provinces.

Until next time,

Christine Walters

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