Kevin Greenard: What happens if your child doesn't attend post-secondary education?

Kevin Greenard

Registered Education Savings Plans (RESP) are still relatively new. Originally started in 1998, they were slow to gain traction because of some of the unreasonable rules on the account application. One of the initial rules required the subscriber to name, on the application, the post-secondary institution that the child would one day attend. If the beneficiary did not attend the named qualifying post-secondary institution (i.e. college or university) then the growth, interest, dividends and capital gains went to the educational institution that was designated on the RESP contract. The good news is that the Canada Revenue Agency soon afterwards changed the regulations and significantly modified the RESP rules.

In 1998, the maximum time period in which an RESP could remain open was 25 years. This too has changed to a more reasonable time frame. The rules say that you have until the end of the 35th year after the plan was first opened (or 40 years if the beneficiary has a disability) to use the funds before the RESP expires.

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If you have a child that is attending post-secondary education, we encourage mapping out a plan to remove 100 per cent of the funds in the RESP. In some situations, we have seen only partial withdrawals and funds still left in an RESP after the child has finished their education. If six months have passed, you are no longer able to utilize your proof of enrolment to pull the funds out. The end result of leaving funds in the RESP would be similar to an RESP reaching the 36 year point or a beneficiary not going to a qualifying institution.

Accumulated Income Payments (AIP)

An Accumulated Income Payment is a payment made up of earnings on all contributions made into the RESP – both capital contributions and incentives that have not been paid out as Educational Assistance Payments (EAP). To qualify for an AIP, all children named in the plan must be at least 21 years old and not be eligible for an Educational Assistance Payment. As well, the subscriber must be a Canadian resident; and the RESP must have been opened at least 10 years ago.

An AIP is triggered as a consequence of leaving funds in the plan and you have reached the 35th year of the RESP being open or if you have decided to collapse the plan earlier and there are still funds in the income or grant portion of the plan. The taxation consequences of an AIP are not favourable. When RESPs first originated, if the beneficiary did not pursue post-secondary education, the subscriber would receive back their original capital contributions, but any income and grants earned during the plan’s life would be entirely forfeited. The rules have eased slightly and currently only the CESG must still be repaid to the government. All of the income earned in the plan will be included in the subscriber’s taxable income in the year the plan is collapsed or in the year it expires. On top of the regular income taxes paid on this income, an additional 20 per cent tax is levied on all the income earned on the account since inception.

There are certain times when the conditions for an AIP may be waived by the CRA. If the beneficiary of the RESP suffers from a severe and prolonged mental impairment is one example. If the beneficiary of an RESP is deceased then we would also request from CRA that the conditions of the AIP be waived.

If the beneficiary you originally contributed the money for chooses not to pursue post-secondary education, there are only a few options to minimize the tax consequences triggered from an AIP. Below, we have outlined the different options to avoid this unfavourable outcome.

RESP withdrawals

The first step in preventing an AIP is to withdraw any excess money that you can while the beneficiary is still in school. Sometimes parents will wait, thinking that their child may continue for a masters or doctoral program. My recommendation is to pull the funds out over the short term and put any excess money into the child’s Tax Free Savings Account or cash account.

Replacement beneficiary

The first article in our RESP series, “Tips when opening up a Registered Education Savings Plan”, published on August 28, 2020, highlighted the benefits of opening a family RESP plan. One benefit is that RESP contributions made into a family plan can easily be used by any of the beneficiaries should one beneficiary decide not to attend post-secondary education. If an individual plan has been opened, however, there is still the ability to designate a new beneficiary if the new beneficiary is a sibling. The assets can be transferred from one plan to the other without triggering the repayment of the CESG, or the 20 per cent tax levy consequences highlighted above. A couple of things to note are that the sibling receiving the funds must be under the age of 21 and they cannot exceed the lifetime grant of $7,200. Let’s have a look at an example. John (19) and Jane (21) are siblings and their parents and grandparents have been contributing to each of their RESPs over the years. The breakdown of their RESP now is as follows:

 

  Jane RESP John RESP
Capital $25,000 $15,000
Income $10,000 $6,000
Grant $5,000 $3,000

 

If John decides not to pursue post-secondary education, the parents (subscribers) can name Jane as the beneficiary of John’s RESP. In this case, since the combined grant equals $8,000, $800 of the grant will need to be repaid when the plan is collapsed ($8,000 - $7,200 lifetime grant = $800).

RRSP contributions

If the beneficiary does not wish to pursue post-secondary education, up to $50,000 of RESP income can be transferred to the subscriber’s, or the subscriber’s spouse’s, RRSP as an RRSP contribution. This effectively counteracts the inclusion of RESP income in the calculation of your own taxable income. The CESG must still be repaid to the government and the original capital contributions can be withdrawn tax-free. It is also worth noting that the $50,000 RESP income transfer is a lifetime amount for each subscriber, rather than $50,000 per beneficiary. Most importantly, this option is only available to you if you have sufficient RRSP contribution room. If you have a child that is not planning on attending post-secondary education, we might recommend pausing RRSP contributions leading up to the expiry of the RESP to ensure you have sufficient contribution room.

Enrolment in a qualifying program

You may recall from last week’s article “Utilizing RESP funds for post-secondary education” that other than valid proof of enrollment, and a form signed by the subscriber, withdrawing funds from an RESP is pretty straight forward. In the context of this week’s article, what this means is that only proof of enrollment is required to withdraw the funds, and there is no requirement for the beneficiary to actually pass the course they are signed up for.

Let’s revisit the case of Mr. and Mrs. Miller from last week’s article. Mr. and Mrs. Miller have an 18 year old daughter whose RESP has a market value of $83,900 as of August 31, 2020. This is comprised of $36,000 in capital contributions to the RESP, $7,200 in grants/incentives, and income of $40,700. Let’s assume the Millers are in a 30 per cent income tax bracket, and have no RRSP contribution room. Should the Millers’ 18 year-old daughter, Miss Miller, not wish to pursue post-secondary education, the potential monetary consequences of this would be $27,550 to the Millers. This is broken down as follows:

- $7,200 in CESG that must be repaid;

- $12,210 in regular income taxes (30 per cent of $40,700) as a result of the $40,700 AIP being included in taxable income in the year the plan dissolves; and

- $8,140 in additional taxes levied (20 per cent of $40,700) on the income from within the RESP.

For fun, let’s look at if the Millers were in the top tax bracket in BC, which is 53.5 per cent. The monetary consequences of this would then be a whopping $37,115 ($7,200 CESG, $21,775 in regular income taxes, and $8,140 in additional taxes levied). If the Millers were in the top tax bracket, they would be paying back more than the $36,000 in capital they originally contributed.

This then leaves the question of why Mr. and Mrs. Miller would pay back anywhere from $27,550 to $37,115 when their daughter could register in a qualifying course online for, say, $3,000? With a bit of foresight and planning, unfavourable tax consequences can be minimized if your child decides against pursuing a post-secondary education

RDSP transfer

As mentioned earlier, you are able to waive some of the conditions for an AIP repayment in the case of severe or prolonged mental impairment. In this case, you have the option of rolling over the AIP to an RDSP provided that the beneficiary of the RESP and RDSP are the same. To qualify for the rollover, the beneficiary must meet the existing age and residency requirements in relation to the RDSP contributions as well as one of the following:

- The beneficiary is, or will be, unable to pursue post-secondary education because he or she has a severe and prolonged mental impairment.

- The RESP has been in existence for more than 35 years.

- The RESP has been in existence for at least 10 years and each beneficiary under the RESP has attained 21 years of age and is not eligible to receive educational assistance payments.

When a rollover occurs, first the contributions to the RESP will be returned to the subscriber. The income that is being rolled over will not be subject to regular income tax or the additional 20% tax.

Although the intentions of opening an RESP are that the beneficiary will go to school in the future, that is not always the case. As mentioned above, there are a few different strategies for pulling out funds from an RESP when the beneficiary decides not to pursue post-secondary education, and it is always best to speak with an advisor to help you map out a plan that is best for your specific scenario.

Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director, wealth management, with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138. greenardgroup.com

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