Money talks: Alphabet soup – RESP accounts: part 2
by Arnold Machel
“A good person leaves an inheritance for their children’s children…” – Prov. 12:22
Last month we talked about how great RESPs are. This month we’ll go over what happens if the funds can’t be used, how the money gets withdrawn and how it should be invested while it’s in the plan.
As a backdrop, be aware that even though the funds in the account are just one big lump sum, the government views each dollar to fall into one of three categories: grant, growth or contributions.
In the event that none of the children ever attend post secondary the grant money (and only the grant money) must be given back to the government.
The original contributions can be taken back by the contributor without tax. The growth component may be rolled into one’s RRSP (subject to having sufficient room) or may be withdrawn and be subject to income tax plus a 20 percent penalty tax.
In reality, it rarely comes to this, but when it does we always attempt to avoid the penalty tax.
Withdrawing the money is fairly easy. All that’s needed is proof of enrollment in an eligible institute – and the list of eligible institutes is a very long one. There are a few decisions that need to be made at this point though. As mentioned, grant and growth, when withdrawn, attract tax. Contributions do not. But the grant will have to be paid back should the children ever suddenly stop attending. So strategically it makes sense to withdraw as much grant/growth as one can each year but attempting to keep the child’s income below the threshold at which tax would be triggered. This is always a balancing act and can be a bit of a guessing game, but it is worthwhile trying to get it right.
Family Plans are generally favourable as they make it easy to manipulate the withdrawals of grant, growth and contributions for each child, especially when plans are not fully maximized. For example, imagine that Mr. and Mrs. Brown have contributed to an RESP for their children, Charlie and Sally, but could not afford the $72,000 required to maximize the plan. Imagine that they were only able to contribute $20,000. The government would have added $4,000 (20 percent) and let’s just assume that the plan has doubled in size to $48,000. They will be able to allocate all the grant and growth to Charlie if they wish. In fact, if they are concerned that Sally will never make it to post secondary they are able to use all the funds for Charlie.
The only restriction (that doesn’t apply in this case) is that regardless of how much grant is in the plan, no one child can be allocated more than $7,200 worth of grant. In other words, Mr. and Mrs. Brown can choose what to allocate to whom so long as they do not allocate more than $7,200 in grant to either child. Since there isn’t that much grant in the plan, they may allocate it however they wish.
It can all get a bit complicated, but don’t worry, that’s what your adviser is there for.
Investments in the plan may be GICs, mutual funds, etc., but when investing in the plans be sure to understand that unlike RRSP funds, not only do RESPs generally have a shorter time horizon, the withdrawals are generally a much larger part of the plan than with RRSPs.
Upon retirement we generally convert RRSP money to a RRIF and then take a tiny amount (relative to the whole plan) out each year as we need our money to last a long time. Not so with RESPs. For a single child we usually take out 20 – 30 percent per year so that in 4 – 5 years it’s completely empty – longer if multiple children are part of the plan, but the same principle holds. The plan is drawn down at a much faster pace than our retirement funds.
With a shorter time horizon and a quicker draw down, it’s important to ensure that the funds are made relatively conservative some time prior to the children needing the money. The last thing anyone wants is to see their funds drop in value significantly just as they need to take money out.
As I mentioned last month, RESPs are one of the great gifts that the government has made available to parents (and grand-parents) across this great nation.
Get one started for your child or grandchild today.
Arnold Machel, CFP® lives, works and worships in the White Rock/South Surrey area where he attends Gracepoint Community Church. He is a Certified Financial Planner with IPC Investment Corporation and Visionvest Financial Planning & Services.
Questions and comments can be directed to him at firstname.lastname@example.org or through his website at www.visionvest.ca. Please note that all comments are of a general nature and should not be relied upon as individual advice. The views and opinions expressed in this commentary may not necessarily reflect those of IPC Investment Corporation. While every attempt is made to ensure accuracy, facts and figures are not guaranteed.