By planning backwards, you can better prepare for the impact your child’s decision not to pursue post-secondary education could have on your hard-earned RESP money. (Photo: 123RF)
Canadian parents save and budget for years to put money into their children’s RESPs for college.
For parents who think well and have high hopes for their children, managing emotions is part of the equation. When children drop out or drop out of school, parents also face the financial consequences of that decision. One of these consequences is to consider what they can do with the money allocated to their children’s university studies.
An important part of financial planning is knowing where all that RESP money goes when it’s not being used for its intended purpose.
Because RESPs are specifically designed to encourage saving for children’s education, they come with a number of restrictions on access to these funds. So before you decide to cash out your RESP savings, here are a few options that can reduce the penalty you have to pay if you break the bank.
Wait and see it coming
One of the things you can do is do nothing. Don’t rush to dive into your education savings just yet. Your child may change their mind in a few years and decide to go back to school. You can have peace of mind knowing that an RESP can be opened for a period of 36 years.
Additionally, an RESP is not limited to strictly funding university and college education. Maybe your child decides not to become a doctor or an engineer, but instead to become a plumber, do an apprenticeship or attend a hairdressing school, for example. These types of programs can also qualify for the RESP.
Transfer money to a sibling’s RESP
If you are certain that your child will not use the money, you can transfer it to another child’s RESP. A transfer from one RESP to another may be tax-free as long as the allowable contributions are not exceeded. But beware: If this child receives the transfer amount over the age of 21, tax penalties may apply. You may also be asked to repay government contributions such as the Canada Education Savings Grant and Canada Learning Bonds.
For more flexibility, it may be a good idea to open a family RESP plan and enroll all your children in it. That way, if one kid spends more money on college than another, everything comes from the same pot. The advantage of a family plan over an individual RESP is that it saves on annual fees and eliminates duplicate paperwork.
Certain conditions may be attached to these family RESP plans, particularly where grants have been paid into an RESP, so it is always advisable to consult a financial professional before entering into any arrangements.
Transfer funds to an RRSP
One of the least known things about RESPs is that you can transfer up to $50,000 of earned income to your or your spouse’s RRSP. Instead of closing the RESP account and taking on the taxes associated with the earnings, you could consider transferring the money to your RRSP account, provided it doesn’t result in over-contributions.
But there are some conditions, for example, one cannot make this transfer until the children or the beneficiaries have reached the age of 21. The government wants us to focus on our children’s education first and wants to make sure the RRSP has been around long enough.
Liquidate the RESP
Sometimes closing an RRSP account is not the only choice. This is the last option and the least desirable because of the penalties one has to pay if one closes this account without having used it for educational purposes.
If you liquidate your RESP, you get back all of your contributions – the capital – with no tax penalty, but any accumulated growth is taxed, an additional 20% penalty must be paid, and any government grants must be paid back.
This is to prevent account holders from using an RESP as a tax-deferred vehicle for purposes other than funding education.
Using a TFSA to supplement the RESP savings
Saving in a Tax-Exempt Savings Account (TFSA) combined with an RESP is an effective way to minimize taxes, regardless of when the money is withdrawn. Begin putting money aside in an RESP as soon as you exhaust the $7,200 free grant from your RESP.
The TFSA is much more flexible to use and once your child turns 18 you can contribute to their own TFSA without penalty.
The smaller the RESP, the smaller the tax burden on withdrawal, as TFSA money continues to grow tax-free and can be used for all types of expenses, including education.
Of the $7,200 grant limit, the government grants a maximum of $500 per year if you contribute at least $2,500 per year yourself. In about 14½ years you will receive the full scholarship amount. After that, you might do well to contribute to the TFSA within the available contribution space and let your savings grow tax-free.
When it’s time to withdraw, withdraw the funds from the RESP first, then let the TFSA savings continue to grow. This gives you extra money to fall back on later if the need arises.
By planning backwards, you can better prepare for the impact your child’s decision not to pursue post-secondary education could have on your hard-earned RESP money.