With clients packing their children off to school, September presents a good opportunity for advisors to start a discussion about registered education savings plans.

If your clients have been diligently contributing to RESPs over the years, they may need advice about making withdrawals to finance their children’s education. Or if a child is not interested in higher education or intends to travel for a year, your clients will need to understand the alternatives.

According to Sara Kinnear, senior tax specialist in advanced financial planning support at Investors Group Inc. in Winnipeg, advi-sors should start having the RESP withdrawal conversation around the time children begin to decide whether they will pursue post-secondary studies.

“At this point, advisors will need to have a more in-depth conversation,” she says, “about whether the child will be continuing studies or if the plan should take another route, such as being transferred to another child’s RESP or to an RRSP.”

Wayne Rothe, senior financial advisor at Berkshire Investment Group Inc. in Spruce Grove, Alta., agrees. Advisors have to make sure clients are aware of every possible outcome and that planning is done well in advance.

“The average client is not going to have it sprung on them right before the start date that a child isn’t going to go to [post-secondary] school right away,” says Rothe. “Most parents have a good idea whether the child will be going on to university or a post-secondary institution by the time the child is in Grade 9 or 10 — so it should be put into their financial plans pretty early.”

THREE COMPONENTS

It is also important that clients understand the three components of RESP contributions and what each component does, says Rothe. The first component is the client’s own contributions, which can be withdrawn at any time without penalty. The second is the Canadian education savings grant (CESG); the maximum any beneficiary can receive is $7,200. The third is the growth of the investments in the RESP.

The second and third components make up the income earned in the plan, also called the “educational assistance payment.” The government grant and the growth are both taxable income.

So, what if a plan beneficiary decides not to continue education after high school? In that case, the subscriber (the person making the contributions) can transfer the money to the beneficiary’s sibling’s RESP if that child has decided to continue his or her education after high school. Or, if the beneficiary is just putting off post-secondary education, the money can remain in the plan while he or she takes time out to work or travel. RESP accounts can remain open for up to 26 years; in special cases, plans may remain open as long as 31 years.

But if your client decides to withdraw the money rather than put it toward the beneficiary’s education, he or she faces restrictions. For starters, the client will have to repay the CESG paid into the plan. To withdraw income earned on the investment, the plan must have been open at least 10 years, and the income may be subject to a 20% penalty tax.

To avoid the penalty taxes, the subscriber can transfer the money to their own RRSP but only if the beneficiary is 21 or older and is not going to school. The subscriber must be a resident of Canada and have contribution room.

“The plan is designed this way to give students a chance to change their minds,” says Kinnear. “Advisors should make sure clients are aware of these criteria before they decide to withdraw.”

It’s at this point that advisors can discuss alternative withdrawal options. They may advise clients to stop making RESP contributions and look ahead at how much RRSP room they will have, so they can transfer the money into their RRSP when the RESP matures.

Or your client can let the RESP withdrawal be taxed in the hands of the child. That transfers the tax obligation from the parent to the child, who may not have taxable income for that year or may be taxed at a much lower rate than the parent.

Rothe says that when discussing RESPs with a client, he often starts by getting a rough idea of what the child’s income and tax rate will be at withdrawal time. The contributions and EAP growth can be withdrawn in any order the beneficiary and subscriber choose, and good planning can reduce or eliminate taxes.

@page_break@MINIMIZING TAXES

“The client wants to do the best job possible in minimizing taxes for the child,” says Rothe. “If a child decides to drop out after a year or two and there is taxable or restricted money — government grants and growth — left in the RESP, it can become a problem.”

It’s often best to withdraw the taxable money first, when the child is in school and has a low income and will pay little or no taxes on the funds. The money remaining in the account will be contributions, which can be withdrawn tax- and penalty-free, regardless of whether the beneficiary is in school.

Those clients who are withdrawing from an RESP for educational purposes should submit their withdrawal documents early, Kinnear says. Proof of enrolment and a redemption form are usually required and must be signed by the subscriber or the beneficiary.

Kinnear advises contacting the financial institution that holds the RESP to find out what documentation it requires for withdrawals. Also, find out what the educational institution offers as proof of enrolment.

Some schools require full payment before they issue proof of enrolment, and most banks want proof of enrolment before they release payment, Kinnear says: “It can be a catch-22 situation.”

There are no limits on the amount of the contributions that may be withdrawn, but the maximum payment of EAP to a beneficiary is $5,000 for the first 13 consecutive weeks of enrolment in the qualifying educational program. Beneficiaries can then receive larger EAP amounts after those first 13 weeks. For courses shorter than 13 consecutive weeks, the maximum withdrawal is the tuition paid plus $300 a week.

The student can start receiving money from the RESP as soon as he or she is enrolled in a qualified post-secondary educational program.

For more information about RESPs, visit www.hrsdc.gc.ca. IE