When most people think of registered education savings plans (RESP’s), they think of a savings vehicle to help fund a child’s future college or university education. But savvy investors can benefit from the plan as well. In fact, self-funded RESPs can be a great investment for adults who are planning to go back to school, and they can even be used as an income-splitting tool.
How Do They Work?
By opening an individual RESP and naming yourself both the subscriber and the beneficiary, you can contribute up to $50,000 over the life of the plan. A variety of investments can be held in an RESP, including mutual funds and segregated fund contracts, and the investments can grow tax-free until you make a withdrawal. This is valuable if you don’t have any contribution room in your Registered Retirement Savings Plan (RRSP) or Tax-Free Savings Account. However, an RESP has a limited life – it must be closed within 36 years of being opened.
Unlike RESPs for children, RESPs for adults are not eligible for government incentives such as the Canada Education Savings Grant.
Contributions can be withdrawn from the RESP at any time, tax-free. Once you have enrolled in a post-secondary institution, you can begin receiving Education Assistance Payments (EAPs). An EAP is a payment made to the beneficiary from the RESP’s accumulated investment earnings, as well as any applicable government incentives. The payments are taxed in the beneficiary’s hands in the year of receipt. In order for a beneficiary to qualify for an EAP, he or she must be enrolled in a post-secondary level program at a qualifying educational institution for at least three consecutive weeks – and correspondence classes count. In addition, you would be eligible for the tuition tax credit.
Not Going Back to School?
If you’re over 21 and don’t enroll at a qualifying post-secondary institution, and the plan has been open for more than 10 years, you can qualify for an Accumulated Income Payment (AIP). An AIP is a payment made from the investment earnings in the RESP; however, it does not include the original contributions, nor government grants where applicable.
Unlike the EAP, an AIP withdrawal is subject to a penalty tax of 20 per cent (12 per cent federal tax plus eight per cent provincial tax for residents of Quebec), in addition to regular income tax. It is also important to note that the RESP must be closed prior to March 1 of the year after the first AIP payment is made. If you have contribution room left, you can transfer up to $50,000 of AIPs into your RRSP or to a spousal RRSP. This will allow you to avoid the 20 per cent penalty tax, while generating a tax deduction from the contributions made to the RRSP.
Using an RESP to Split Income.
Those who do not attend a post-secondary institution can use the RESP to split income. If your spouse is named as a joint subscriber to the RESP, and has contribution room left in his or her RRSP, the AIP can be transferred to your spouse’s RRSP regardless of who made the contributions to the RESP. This is beneficial if one spouse is in a lower tax bracket, since the taxes paid when the funds are withdrawn will be lower.
Speak to Your Advisor.
Whether you are interested in going back to school, looking for additional tax-deferred investment opportunities or thinking about income splitting, it might be worthwhile to consider an RESP. Speak with your advisor or tax specialist to find out if an RESP is right for your situation and your financial goals.
(To avoid the penalty tax, the AIP must be contributed to an RRSP or spousal RRSP in the same year it is received, or within the first 60 days of the following year, and must be deducted in the same year received.)
(A spouse or common-law partner as defined by the Income Tax Act (Canada).)
©Manulife Spring 2018