Are RESP Withdrawals Taxable? A Look at the Tax Rules

Registered Education Savings Plans (RESPs) are specialized savings vehicles designed to support future education costs. These plans allow funds to grow without immediate tax implications, providing a structured approach to saving for post-secondary studies. Understanding how withdrawals from these plans are taxed is important for anyone considering or already utilizing an RESP. The tax treatment varies significantly depending on the type of withdrawal and its intended use.

Components of an RESP and Withdrawal Categories

An RESP consists of three distinct financial components. The first component is the contributions made by the subscriber, which are the funds deposited into the plan using after-tax income. These contributions are not tax-deductible. The second component is the earnings or growth generated from investments held within the RESP, which accumulate tax-deferred.

The third component involves government grants. Two primary federal grants are the Canada Education Savings Grant (CESG) and the Canada Learning Bond (CLB). The CESG provides a matching contribution of 20% on the first $2,500 contributed annually, up to a maximum of $500 per year, with a lifetime limit of $7,200 per child. The CLB offers additional support for low-income families, providing an initial $500 and then $100 annually until the child turns 15, up to a lifetime maximum of $2,000.

When funds are withdrawn from an RESP, they fall into specific categories. Educational Assistance Payments (EAPs) are for a beneficiary’s post-secondary education expenses. Accumulated Income Payments (AIPs) are withdrawals of earnings and grants when the beneficiary does not pursue eligible education. A Return of Contributions (ROCs) refers to the withdrawal of the original contributions made to the plan.

Taxation of Educational Assistance Payments

Educational Assistance Payments (EAPs) are funds paid from an RESP to a student for post-secondary education. These payments are composed of accumulated investment earnings and any government grants received. When an EAP is issued, it is considered taxable income to the student beneficiary.

Despite being taxable, EAPs often result in little to no tax payable by the student. This is because students typically have minimal other income during their studies, placing them in a low tax bracket. Students can often utilize various tax credits, such as tuition and education credits, to offset any tax liability on the EAP amount.

The original contributions made to the RESP are not included in EAPs and are not taxed when withdrawn for educational purposes. These contributions are considered a return of principal, as they were made with after-tax dollars. The focus of taxation for EAPs is solely on the portion representing the growth and government incentives.

There are specific limits on EAP withdrawals during the initial period of study. During the first 13 consecutive weeks of enrollment in a qualifying full-time program, EAPs are limited to $8,000. For part-time studies, this initial limit is $4,000. After this initial period, the amount of EAP that can be withdrawn must be reasonable to fund the student’s educational needs.

Taxation of Non-Educational Withdrawals

Withdrawals from an RESP not used for eligible post-secondary education have different tax consequences. Accumulated Income Payments (AIPs) are distributions of investment earnings and government grants when the beneficiary does not pursue qualifying education. AIPs are taxable to the RESP subscriber, who is the individual who opened and contributed to the plan.

AIPs are subject to the subscriber’s regular income tax rate, plus an additional federal penalty tax of 20%. This additional tax applies because the funds grew tax-deferred within the RESP but are not being used for their intended educational purpose.

An AIP can be made if the RESP has been open for at least 10 years and all beneficiaries are aged 21 or older and not pursuing post-secondary education. Other conditions include the 35th anniversary of the plan, or the death of all beneficiaries. To avoid the additional penalty tax on AIPs, a subscriber may roll over up to $50,000 of the AIP amount into their Registered Retirement Savings Plan (RRSP), provided they have sufficient RRSP contribution room. This rollover defers taxation until funds are withdrawn from the RRSP in retirement.

In contrast to AIPs, a Return of Contributions (ROCs) involves the withdrawal of the original funds deposited by the subscriber. Since these contributions were made with after-tax dollars, they are not taxable when withdrawn. The subscriber can receive these funds tax-free.

Reporting RESP Withdrawals and Tax Implications

Reporting RESP withdrawals for tax purposes is a structured process that ensures proper accounting for taxable amounts. For any taxable RESP withdrawals, specifically Educational Assistance Payments (EAPs) and Accumulated Income Payments (AIPs), the RESP provider will issue a T4A slip. This slip details the amount that needs to be reported on an individual’s income tax return.

The beneficiary of the RESP is responsible for reporting EAPs as income on their tax return. Conversely, the subscriber of the RESP is required to report any AIPs received. The T4A slip includes specific box numbers to identify these taxable amounts, guiding the individual on where to enter the information on their tax forms. Refunds of contributions are not reported on a T4A slip because they are not considered taxable income.

The overall tax efficiency of an RESP is realized when funds are used for eligible educational expenses. By having EAPs taxed in the hands of the student, who often has little to no other income, the effective tax rate on the RESP’s growth and grants is minimized or eliminated. This strategy allows savings to grow tax-deferred within the plan and then be withdrawn with minimal tax impact, maximizing funds available for education.