Tax Managed Strategy 9
When most people think of registered education savings plans (RESPs), they think of an educational savings plan for children. Did you know that RESPs are a great savings plan for adults too? In fact, self-funded RESPs are a smart investment for individuals who are planning on going back to school (i.e., for a change in career or retirement studies), or can even be used as an income-splitting tool.
It’s a common misconception that RESPs are only useful for parents saving for their child’s postsecondary education. With a little financial savvy, an RESP can provide an effective means of funding an adult’s education and it can also provide an income-splitting opportunity as well.
Generally, investments that qualify for a registered retirement savings plan (RRSP) qualify for an RESP. Unlike RRSPs, however, contributions to an RESP are not tax-deductible, which allows the contributor to withdraw their original contribution at any time on a tax-free basis. In addition, you’re not forced to withdraw the funds from the RESP at age 71, like an RRSP, and incur an income inclusion. This provides some deferral against income-related clawbacks like Old Age Security.
RESPs for adults — 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 total over the life of the plan.
You can invest in a wide array of investments, including mutual funds and segregated fund contracts, and the investment can compound tax-free until withdrawn. You can withdraw your contributions at any time without penalty. However, the RESP has a limited life — it must be terminated within 36 years of its initiation.
What are the rules for withdrawing funds?
You can withdraw your contributions at any time free from taxes. Once you’ve enrolled in a qualified post-secondary institution, you can begin receiving educational assistance payments (EAP). An EAP is a distribution to a beneficiary of the RESP’s accumulated investment income, as well as the Canada Education Savings Grant (CESG) and other government incentives, where applicable, which are taxed in the beneficiary’s hands in the year of receipt.
For a beneficiary to qualify for an EAP, they must be enrolled in a post-secondary program at a qualifying educational institution in Canada for at least three consecutive weeks. A full-time program requires at least 10 hours of work or instruction per week; a part-time program requires at least 12 hours of work or instruction per month. For an educational institution outside of Canada, the course must last at least 13 consecutive weeks.
The amount of EAP is limited to the lesser of $5,000 ($2,500 for a part-time program) and the amount of the actual expenses for the first 13 consecutive weeks, with no limit on the amount of the EAP afterwards. In addition, you would be eligible for the tuition tax credit (15 per cent of eligible tuition fees).
Individual RESPs allow adults to be both the subscriber (contributor) and beneficiary. Although RESPs for adults aren’t eligible for government incentives, such as the Canada Education Savings Grant (a qualified 20 per cent top-up paid by the Federal government), they still represent one of the few investments that allow assets to grow on a tax-deferred basis, which is particularly valuable if you don’t have any RRSP or tax-free savings account (TFSA) contribution room.
What if I don't go back to school?
If you 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 represents the investment earnings in the RESP and not your original contributions (or government grants, where applicable).
Unlike the EAP, which are withdrawals of the investment earnings after you have enrolled at a qualifying post-secondary institution, an AIP withdrawal is subject to a tax of 20 per cent (12 per cent federal plus 8 per cent provincial for residents of Quebec) in addition to the taxes payable when taken into income.
It’s important to note that the RESP must be terminated 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 into your RRSP or to a spousal RRSP. This will allow you to avoid the 20 per cent additional tax while generating a tax deduction from the contributions made to the RRSP. If you’re going to contribute an AIP payment to an RRSP or spousal RRSP, the contribution must be made in the same tax year or within the first 60 days of the following year in which the AIP payment is received. If the RRSP deduction isn’t claimed within the same tax year, the 20 per cent additional tax will apply.
How can I use an RESP to split income?
The opportunity for using an RESP to split income arises if you decide not to attend a post-secondary institution.
If you name your spouse¹ as a joint subscriber to the RESP and your spouse has contribution room left in an RRSP, the AIP can be transferred to your spouse’s RRSP regardless of who made the contributions to the RESP. This option is particularly attractive if your spouse is in a lower tax bracket since the taxes paid on the eventual withdrawal will be reduced.
If you don’t have a joint RESP, you may still be in luck. If the RESP allows for joint subscribers, simply add your spouse as a subscriber and then transfer the AIP to your spouse’s RRSP (assuming that your spouse has sufficient RRSP contribution room).
Are there other ways to avoid the 20 per cent additional tax?
If neither you nor your spouse has contribution room left in your RRSPs and you still want to avoid the 20 per cent additional tax, you’ll have to go back to school. If you find yourself in this situation, try finding a qualifying post-secondary program with minimal costs and that lasts for more than 13 consecutive weeks. This will allow you to withdraw more than the initial $5,000 limit described earlier. Once the 13 weeks have passed, the $5,000 limit no longer applies, allowing larger EAP withdrawals to pay expenses. That said, you’ll still have to claim EAP payments as income during the year they were withdrawn.
- Individuals seeking to return to post-secondary education
- Individuals seeking additional tax-deferred investment opportunities
- Individuals who have a spouse in a lower marginal tax bracket and are interested in income splitting
To take advantage of income splitting:
- Complete an education savings plan application (individual plan) with mutual funds or a segregated fund contract.
- Make sure your spouse is named a joint subscriber to preserve the ability to split income.
Investment options with Manulife Investment Management
Manulife Investment Management provides a range of investments and services.
Mutual funds can help meet your specific financial needs throughout your life. Whether you’re just starting out, accumulating wealth, or are nearing/in retirement, mutual funds offered by Manulife Investment Management, can provide you with solutions to help build a portfolio that meets your needs.
Segregated fund RESP contracts
For conservative investors looking to grow their wealth but also concerned about helping to minimize risk potential, segregated fund contracts may provide an ideal solution. The appeal of these contracts is the combination of the growth potential offered by investment funds and the unique wealth protection features of an insurance contract.
Through segregated fund contracts, investors can help limit their exposure to risk through death and maturity guarantees, as well as the estate planning benefits — all from a single investment. These contracts may be ideally suited for investors concerned about the effects of market volatility.
1 Spouse includes a common-law partner as these terms are defined in the Income Tax Act (Canada).
The commentary in this publication is for general information only and should not be considered investment or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation. Manulife Funds are managed by Manulife Investments, a division of Manulife Asset Management Limited. Any amount that is allocated to a segregated fund is invested at the risk of the contractholder and may increase or decrease in value. Commissions, trailing commissions, management fees and expenses all may be associated with mutual funds. Please read the fund facts, as well as the prospectus of the mutual funds before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. The Manufacturers Life Insurance Company is the issuer of the Manulife Segregated Fund Education Savings Plan insurance contract and the guarantor of any guarantee provisions therein. Manulife, Manulife Investment Management, the Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.