RESPs and Taxes

You may have heard that famous quote “nothing can be said to be certain, except death and taxes.” But are taxes certain with RESPs? In most cases “no” when managed strategically. Let’s have a look at some answers to common questions about RESPs and taxes.

Are my RESP contributions tax deductible?

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

Is RESP income taxable?

Your earnings stay nice and cosy within your RESP where they can grow tax-free until they are withdrawn. This means you can continue to contribute and receive 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When it comes time to withdraw, the grants and income generated in the RESP are taxed (not your contributions) and are withdrawn by your student, not you. This means the income is taxed at the student’s rate, which usually means no tax or low tax.

What exactly is taxable?

When it’s time to withdraw, a typical RESP contains funds that were accumulated by: Contributions made by you (not taxable), investment gains (taxable) and government grant income (taxable).

When your contributions are withdrawn, that money is returned to you tax-free. After all, you already paid tax on that money when you made it. Only the new money—the grants and investment gains—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 or “EAP”). After all, the whole purpose of the investment is for their 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 When RESP earnings are withdrawn by the student to pay for education costs, they are taxed based on the student’s income, which usually means the tax rate is quite low.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, it is best for the student to withdraw an EAP (government grants and investment gains) in their early years of post-secondary school, so they can claim those earnings while their income is quite low. If the EAP is withdrawn in later years, the student may need to pay substantial tax, since their income is more likely to be higher (they might have a paid internship or higher paying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 contributions later. Of course, every situation is different and our RESP experts are here to help you along the way.

How is RESP income reported on a tax return?

Embark will send the student a T4A slip for the year that EAPs were received. The student includes the EAPs as income on their income tax return for the year.

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 own 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”). In addition, withdrawing your contributions may also result in the government clawing back grants that it had previously contributed to your RESP, so it is wise to be aware of such implications.

What are the tax implications if I overcontribute?

If RESP contributions to a beneficiary exceed the lifetime limit 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.