Can You Claim an RESP on Your Taxes?

You may have heard the famous quote “Nothing can be said to be certain, except death and taxes.” But are taxes certain with money contributed to your Registered Education Savings Plan (RESP)? In most cases, “no” when managed strategically. Let’s have a look at some answers to common questions about RESPs and taxes.

How Are RESP Earnings and Government Grants Taxed?

TFSA and RESP contributions are not tax-deductible, although we can understand why you might think they are (RESP sounds a lot like RRSP). The benefits are a bit different, with the key draw being the free money you get from government grants.

Your earnings, which is a form of investment income, stay nice and cosy within your RESP where they can grow tax-free until they are withdrawn. This means you can continue contributing and receiving the benefits of government grants + compound growth without worrying about paying tax.

When it comes time to withdraw, the grants and income generated in the RESP are taxed (not your contributions) and are withdrawn by your students when they enter post-secondary education, not you.

This means the income is taxed at the student’s rate, which usually means a lower tax bracket or none, given that they will be in school most of the time.

What exactly is taxable?

When it’s time to withdraw, a typical RESP contains funds that were accumulated by:

1. Contributions made by you to your child’s RESP (not taxable)
2. Investment earnings (taxable)
3. Government grant income, like the Canada Education Savings Grant, Canada Learning Bond, and other grant money available through provincial governments, is taxable.

When your contributions are withdrawn, that money is withdrawn tax-free. After all, you already paid tax on that money when you made it. Only the new money—the grant money and investment earnings—are taxed.

And while you might be tempted to think that all this new money is yours, the reality is that only the student can withdraw the government grants and investment gains (that withdrawal is called an Educational Assistance Payment “EAP”). After all, the whole purpose of the investment is for their post-secondary education.

Students typically pay little or no tax on RESP withdrawals. When RESP earnings are withdrawn by the student to pay for education costs, they are taxed based on the student’s income, which usually means the tax rate is quite low.

In most cases, the student should withdraw their taxable educational assistance payments (government grants and investment gains) in their early years of post-secondary education, so they can claim those earnings while their income is quite low.

If the education assistance payment is withdrawn in later years, the student may need to pay substantial tax, since their income is more likely to be higher (they might have a paid internship or higher paying summer or part-time job).

For that reason, it’s usually best to withdraw EAPs first and your RESP contributions later. Of course, every situation is different, and our RESP experts are here to help you along the way.

Understanding the T4A Slip for RESP Withdrawals

When you withdraw money from your child’s RESP, government grants and investments are considered income. Let’s break this down a bit further below:

1. Who receives the T4 slip?

Embark will send the student a T4A slip for the year that EAPs were received. The student includes the EAPs (consisting of government grants and investments) as their taxable income on their income tax return for the year.

2. How to use your T4 slip when filing your tax return

• Students will use their T4 slip to report their income on their personal tax return (T1).
• They’ll add the income under line 13000, or “other income.”
• If you’re using tax software, it will automatically provide your child with a step-by-step guide on what to do and enter next.

3. T4 slip lines

• Box 042 will show your Educational Assistance Payments (EAPs).
• Box 028 will show scholarships, bursaries, and grant money.
• Most of the time, only 042 will be filled.

4. What to say to your tax preparer

When you’re getting your taxes ready, tell your preparer the following:

• The T4 belongs to the beneficiary, not the RESP subscriber.
• Only the amount listed in box 042 needs to be reported as “other income.”
• Remember, if your child has multiple T4 slips, provide all of them.

What are the tax implications if I withdraw for non-educational purposes?

In some cases, a subscriber may want or need to withdraw money from the RESP for non-educational purposes. While the subscriber may withdraw their contributions without being taxed, the withdrawal of any income earned from an RESP is taxed (that withdrawal is called an Accumulated Income Payment or “AIP”).

Accumulated Income Payment (Taxable Income)

Let’s say your beneficiary decides they don’t want to pursue post-secondary education. What happens with the education savings you’ve been growing in a registered education savings plan all these years? As a subscriber, you can make an RESP withdraw the investment income you’ve gained through your RESP contributions.

However, because your investment income has been tax-sheltered within the RESP account, your RESP withdrawals will be considered taxable income on your tax return, which is subject to your province’s marginal tax rate, plus an additional 20% tax penalty (12% in Quebec).

In addition to withdrawing your RESP contributions as an AIP, all government incentives that it had previously contributed to your child’s post-secondary education will be clawed back, meaning you don’t get to keep this money as your own, so it is wise to be aware of such implications.

RESP and Tax Benefits for Parents and Students

Saving for your beneficiary’s post-secondary education is challenging. But, at the end of the day, RESPs offer some great tax advantages that will allow you to maximize your savings over time:

Tax-free growth and compounding

As we mentioned, RESPs grow tax-free, preventing you from paying RESP tax until the money is withdrawn from the account. This allows for compound growth, which maximizes the long-term value of your RESP. Ultimately, parents will benefit from this tax deferral, as the accumulated earnings can grow more efficiently over time.

Tuition tax credits offset RESP tax

When the student beneficiary withdraws their education assistance payment (including investment earnings and government grants), they won’t be taxed as highly, given their likely lower tax bracket. Students can also use their tuition tax credits and other deductions to offset any liabilities they may have that calendar year.

Tax-efficient withdrawal strategies

To minimize taxes, Canadian families can use the following strategies:

• Withdrawing EAPs gradually over the years to keep students in a lower income tax bracket.
• Timing withdrawals strategically to align with tuition credits.
• Transferring unused RESP funds to another child’s account.

Transferring unused contributions to a registered retirement savings plan (RRSP)

If the RESP provider does not have another child to transfer RESP money to and their beneficiary has decided not to attend a post-secondary institution, they have the option of transferring their investment gains to their RRSP to avoid heavy taxation.

Note that the following rules apply:

Only investment funds can be transferred

Only your original contributions and gains can be withdrawn and transferred tax-free. Your grants must be returned to the government.

You must have contribution room in your account

You can transfer a maximum amount of $50,000 from your RESP to your RRSP. You also must have sufficient RRSP contribution room for that tax year to ensure the transfer is eligible for a tax deduction on your income tax. Doing so will defer your taxes until retirement when the savings are withdrawn and taxed at a lower bracket.

Eligibility requirements

To be able to transfer savings from your RESP to your RRSP, the RESP account must be open for at least 10 years. The beneficiary must also be at least 21 years of age and not currently enrolled in a post-secondary educational institution.

Keep contributions separate from accumulated income payments

When withdrawing funds from your RESP account, request that the withdrawal only include the contributions, especially if your student has minimal income for the year. Because you already paid taxes on your contributions, you won’t need to pay again when withdrawn. Additionally, manage how much money in accumulated income payments is withdrawn to avoid bumping your student into a higher tax bracket.

FAQs

What are the tax implications if I over-contribute?

If RESP contributions to a beneficiary exceed the lifetime maximum of $50,000, you will be required to pay tax in the amount of 1% per month on your share of the over-contribution until it is withdrawn. For more information on over-contributions and associated tax penalties, visit the Canada Revenue Agency website.

How does the taxation of RESP earnings differ from principal withdrawals?

RESP principal withdrawals, which are the contributions made to the account, are tax-free, given that they were contributed with money that was already taxed. In contrast, investment gains and grants when withdrawn as EAPs are taxed as taxable income for the beneficiary. To optimize tax efficiency, beneficiaries should withdraw their EAPs gradually and use tax credits to offset any potential tax liabilities.

Can RESP withdrawals affect a student’s eligibility for tax credits or benefits?

RESP withdrawals can affect a beneficiary’s eligibility for tax credits and benefits, but it is very minimal. Tuition tax credits aren’t affected, which means students can use them to offset EAPs. But, EAPs will count as taxable income, which can impact their eligibility for tax benefits.

Do I pay tax on RESP gains?

Yes, you will pay tax on the investment income (capital gains, dividends, and interest), but only when you withdraw this income as an accumulated income payment. Remember, RESPs are tax-sheltered, meaning your contributions grow tax-free while the funds remain in your account. Only when you withdraw the funds will they be taxed at the marginal tax rate.

Note that even when you withdraw the funds, the money will be taxed under your student’s name. Because they have minimal income while in school, they’ll be subjected to lower taxes.

How to report RESP on tax returns?

To report your RESP withdrawals on your tax return, ensure you receive a copy of your T4 slip from your RESP provider. Look for box 042–this shows you the amount of money you’ll need to report on your taxes. When filling out your tax return, take the amount from box 042 on the T4 slip and enter it on line 13000, known as “other income.”