An RESP is a great tool for young families to incrementally start saving for their children’s education. However, a question many parents are asking these days is what if my child decides to forgo university, what happens to their RESP?
There are a few options available to parents in this situation. You can transfer the funds into another child’s RESP without penalty, withdraw the funds, or transfer it to your RRSP.
First off, you can keep an RESP account open for up to 35 years. So if your child after secondary school decides not to pursue higher education (either university, local colleges, or trade schools) there is no rush to absolve the account of funds. In fact, it is advisable that if your family can afford to do so, to keep the funds in place so your child will have the financial flexibility to go back to school in the future.
Why should you transfer your RESP into your RRSP?
The short answer: tax savings. When you decide to close your RESP because your child chose not to use the funds, this is what you can expect. First, the grants contributed by the Canadian government to your RESP must be returned. Grants from the Canada Education Savings Grants (maximum total of $7,200) can be wholly transferred to another child’s RESP, but grants from the Canada Learning Bond must be returned. The principle amount you paid can also be freely withdrawn or transferred without penalty. What is left is called the Accumulated Income Payment (AIP).
This is the portion of the RESP where taxes and penalties will be incurred. If you were to withdraw your AIP, you would have to pay your current marginal income tax rate PLUS an additional 20 per cent penalty. As you can imagine, this can be costly, especially if you have the maximum ($50,000) in the account. However, if you were to transfer this AIP directly into your RRSP, you could avoid paying the 20 per cent and defer the tax. If you need the money sooner, you can transfer the AIP into your RRSP, then withdraw from your RRSP later on. This way you can still avoid paying the 20 per cent penalty.
No room for an RRSP?
The maximum contributable amount for your RRSP is either 18 per cent of your earned income or a fixed amount set by the government every year (2016: $25, 370). If you have no room in your RRSP, the best course of action is to reduce or abstain from your RRSP payments until you can fit in the AIP appropriately. Of course with this method you will just be saving the 20 per cent penalty as you will be paying income taxes on what you do not contribute to the RRSP.
What if my child decides to drop out of post-secondary school?
This happens all the time; a child decides to drop out of school and pursue something else. However, before you do anything with the RESP, remember that you can have the account opened for a total of 35 years so it may be best to wait and see if your child will need the funds later on.
If you are certain your child will not need the funds, it’s best to have your child assume control of the money. Make sure that during the six-month grace period after your child leaves school that they continue to receive Education Assistance Payments (EAP). These funds will accumulate with no penalties and is the best way to withdraw funds from the RESP. For parents whose children have been out for more than six months, having them withdraw the funds as a beneficiary can also save on taxes. This is because the money they withdraw will be taxed in their tax bracket.
When faced with how to handle large sums of liquid assets, like in the case of an unused RESP, it’s important to educate yourself and understand what can be done in your particular situation. Online resources are informative, but contacting an RESP professional is the best way to help save your family time and money.