Consider the options fully when picking RESP
Eighteen years ago, a young couple set up a Registered Education Savings Plan for their newborn son. Over the next four years, they invested a total of $10,000.
Both of them worked for a start-up technology company that was publicly traded. They had faith in the future of the business so they invested all their contributions in shares of the firm. The average cost of the stock over the period was $0.18 per share. The software developed by the company turned out to be highly successful and the stock soared. The firm was eventually taken over and the RESP received shares of the acquiring company in exchange for the original stock. Today, the plan is worth well over $2 million.
The son will start university at an Ivy League school this fall. He’ll fly business class to the city, live offcampus in a luxury apartment, do his homework on a top-of-the-line computer, and have a generous allowance for books, school supplies, campus activities and more. After he earns his degree, he plans to go on for a master’s, perhaps at Oxford or Cambridge.
He can do this because RESP rules do not place any limit on which universities students may attend or the level of degrees they may attain. Educational assistance payments (EAPs) may be used at any qualified school in the world, provided the plan beneficiary is enrolled on a full-time basis for not less than 13 consecutive weeks.
Getting back to our wealthy student, his parents are encouraging him to spend as much of the money in the RESP as he can because they have no other children who can benefit from it. He has to pay tax on any EAP withdrawals but it will be at a rate much less than his parents pay. Average tuition at Harvard for the 2016-17 academic year is $59,550 (U.S.).
Any money that is left in the plan after he obtains his final degree will be subject to tax at a rate that many would consider usurious — the parents’ marginal tax rate plus a 20-per-cent penalty. In Ontario, that would work out to a maximum rate of 73.53 per cent this year.
Of course, these people are in an incredibly fortunate position.
Very few parents will see their RESPs grow to anything like this amount. But even people with much smaller plans can still be hit with a huge tax bill if the beneficiaries don’t go on to post-secondary education.
Consider a family with two children that opened a plan years ago to send both youngsters to college. Both parents contributed, so they were the plan’s subscribers. The family budget was tight but they scrimped and saved. The mutual funds they purchased did well and the plan was boosted by the Canada Education Savings Grant, which provides a maximum lifetime contribution of $7,200 per child.
Unfortunately, neither child went on to college. The son dropped out of high school after Grade 10 while the daughter chose to go to work and earn money as soon as she received her high school diploma. The parents were left with an RESP worth $95,000 with no one to spend it on.
They were allowed to withdraw their original contributions tax-free, which was only reasonable since they had been paid with after-tax dollars. After that, they ran into problems.
First, all the government grants they received over the years had to be repaid. The money that remained after that could be withdrawn as an accumulated income payment (AIP).
AIP payments are subject to two different rates — the regular mar- ginal rate plus the 20-per-cent penalty mentioned earlier (12 per cent for Quebec residents). The unfortunate patents were shocked when the saw the potential tax bill and tried to figure out a way around it.
There is one possibility. If the plan subscriber has RRSP contribution room available, he/she could transfer the remaining cash in the plan directly to the retirement account. Of course, it will be taxed when the money is withdrawn from the RRSP but at the taxpayer’s marginal rate, with no penalty. The lifetime limit on this kind of transfer is $50,000 per subscriber. But what if the RRSP has been maxed out?
If the subscriber is still earning income, the solution is to stop any more contributions to the retirement plan and wait a few years before winding up the RESP. That should provide the room needed for the transfer. Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters. BuildingWealth.ca
RESP rules do not place any limit on which universities students attend or the level of degrees they may attain