Crossing the RESP finish line

Ruth Saldanha: We're catching up today with Jason Heath, the fee-only financial planner at Objective Financial Partners, to talk about the RESPs and also more importantly, what to do when we withdraw. But before that, just let's hop in with Jason. Welcome.

Jason Heath: Thank you.

Saldanha: Tell us to start with, what is the best place to invest funds for an RESP?

Heath: Well, I think, one of the important recommendations I'd make to people is to avoid group plans, scholarship plans. They tend to have fairly high fees. They tend to be fairly inflexible. And I think compared to more traditional options like an individual or a family RESP, the extent to which you could grow your child's education savings isn't quite there. So, avoid group plans for sure. Stick with a more traditional RESP.

I think the other thing is what you are investing in. When you have a young child, who might be 15 or 20 years away from needing the money, I think that subject to your own risk tolerance, you can take a lot of exposure to stocks and to risky assets. You've got a long timeframe before you are going to need the money and that's probably the way to grow the assets the most. But once you get within about five years of needing the RESP money, so, typically, when a child has started high-school, I think, it's time at that point to start to reduce the risk. Unlike an RRSP for retirement that might be drawn down over a 30-year period, an RESP might be gone in a few years. So, once you start to get close to needing the money, you can't take the same risks because it might be drawn down to zero at a point when stock markets are otherwise down. So, aggressive early, more conservative later on from an investment strategy perspective.

Saldanha: The thing with RESPs though is right at the start, you already know the time that you have to withdraw, right? So, what are some of the pitfalls that someone should think about at the time of withdrawal? Is there anything to keep in mind at the time? And what should one look for when you are looking to withdraw the RESP?

Heath: Well, when you are taking withdrawals from an RESP, you need to decide whether you are going to take a principal withdrawal or whether you are going to take an education assistance payment or an EAP. So, with an RESP balance at any given time there's the principal, your original contributions and then there's everything else, which is grants from the federal and the provincial government, growth on the investments. The principal comes out tax-free. The other stuff, the education assistance payments comes out on a taxable basis. So, it's important to try to balance the way in which you are drawing it out. The tax payable and the income goes to the beneficiary, to the child. So, especially in the first couple of years when they may not be working, that's a good time to try to access the taxable amounts and hopefully get them out when they are tax-free.

Saldanha: Are there any tips that you would be able to provide in terms of tax planning at the time of withdrawal? You did mention that it's best to kind of withdraw at the start when the child isn't earning, so that they get into the lower-tax income. But is there any other tip that you can think about in terms of tax implications?

Heath: Yeah. I think ideally making sure that you use all of an RESP by the time a child is done their post-secondary education. Most people have no problem with that because they have got a small RESP and they have got lots of education costs for a child. But particularly, if someone has a medium or a larger-size RESP and particularly if they only have one child who may or may not finish a full four-year post-secondary program, you don't want to be left with RESP monies that have been unused. There can be negative tax implications from having leftover money in an RESP.

Saldanha: In case we are in that odd situation where you do have some money left over, what can a child use that money for apart from tuition?

Heath: Beyond tuition, nothing really. If a child is not in qualifying post-secondary education, you can't – well, I shouldn't say you can't pull the money out, but you can't pull the money out in the same way as if they were enrolled. So, if a child has finished post-secondary education or hasn't gone, the principal can come out tax-free. The government grants from the federal, and potentially provincial governments need to get paid back to the government, and the growth can be withdrawn but it's taxable to the subscriber, to the parent, to the grandparent. Not only is it taxable, it's taxable at their regular tax rate, plus a 20% penalty tax. So, it can be really punitive. If they have RRSP room, they can transfer up to $50,000 into an RRSP. So, there are a couple of ways to deal with a large RESP balance left over after post-secondary is finished. But the best thing, I think, is to try to plan ahead and use it in the most optimal way in the first place.

Saldanha: Great. Thank you so much for being with us today, Jason.

Heath: Thanks for having me, Ruth.

Saldanha: For Morningstar.ca, I'm Ruth Saldanha.