Transfer RESP funds to an RRSP if beneficiaries don’t attend post-secondary

Maroney on Money for September 22, 2001

Last week I reviewed the basic rules surrounding Registered Education Savings Plans (RESP) – plans that, up until the past several years, were generally shunned by financial planners. As promised, this week I’ll review why, in my opinion, RESPs deserve a second look.

One of the big fears parents, grandparents etc. have in setting up an RESP is that junior, no matter how gifted, may choose not to attend a post-secondary institution – after all, Bill Gates dropped out of university and it doesn’t appear to have done him any harm.

Up until 1998, failure of the RESP beneficiaries to pursue a post-secondary education could cause the forfeiture of all the plan income earned over the years, returning only the original capital to the subscriber (i.e., the person who set up the RESP). This meant that the original capital contributed to the RESP earned absolutely no return and, in fact, lost purchasing power, during the life of the plan – not a good situation. The thought of all named beneficiaries to the plan opting to forego additional schooling thereby forcing the subscriber to attend post-secondary against his or her wishes turned many an RESP investor away.

A potential, and possibly partial, solution to this problem was introduced for 1998 and later years. These new rules permit RESP subscribers to transfer up to $50,000 of RESP income to the subscriber’s RRSP (or their spouse’s RRSP) during their lifetime. This solution may only be partial since it is quite possible that RESP income may exceed the $50,000 cap in which case the subscriber will be taxable on the difference.

To take advantage of this option, the subscriber or their spouse must have sufficient RRSP contribution room available in the first place – transferring RESP income to an RRSP uses up RRSP contribution room, unlike, say, a qualifying retiring allowance, that does not impact on existing RRSP contribution room. For example, if a couple has combined RRSP contribution room of $40,000 and the RESP income is $50,000, the amount to be included in the subscriber’s income will be $10,000 ($50,000 less $40,000) after having used up all of the couple’s RRSP contribution room.

Obviously, to take maximum advantage of this option, RESP subscribers will need to undertake some planning if it appears that there will be no RESP beneficiary willing to attend a post-secondary institution. This planning may entail, for example, foregoing RRSP contributions in one or more years to ensure the maximum RRSP contribution room is available when the time comes.

The attractiveness of RESPs was further enhanced in 1998, with the introduction of the Canada Education Savings Grant (CESG). The CESG is a program whereby the federal government will provide a grant to an RESP equal to 20 per cent of the first $2,000 contributed to an RESP each year that the beneficiary is 17 years of age or less. At its maximum, the CESG will add $400 to an RESP each year or a maximum of $7,200 (18 x $400 per year) until the year the beneficiary turns 18. The CESG is one of those rare government handouts that is available to taxpayers regardless of their income level, so if you qualify, don’t miss out on the opportunity.

Given the lifetime RESP limit is set at $42,000 per beneficiary, it makes sense to contribute no more than $2,000 per year to stretch out the number of years the CESG can be earned. A $2,000 annual contribution will provide for the maximum 18 years of CESG (a total of $7,200) if contributions commence in the year the beneficiary is born; by contrast, a $4,000 annual contribution will cap out at 10.5 years ($42,000 divided by $4,000) of CESG resulting in a total grant of only $4,400 (11 x $400 per year).

Note that the grant received does not come into play in calculating either the annual ($4,000) RESP contribution limit or the lifetime ($42,000) RESP limit – the CESG is over and above both of these amounts.

As an added bonus, unused CESG grant room can be carried-forward to future years. For example, assume in one year a $1,500 RESP contribution is made earning a $300 CESG (20 per cent of $1,500) - $100 less than the $400 maximum. In a following year, the $100 CESG shortfall can be made up by contributing $2,500 to an RESP thereby earning a $500 CESG. In this case, the total CESG earned over the two-year period is $800 which works out to the $400 maximum allowed for each year.

Special rules exist for beneficiaries in the years they become 16 or 17. In order to receive the CESG in these years one of two conditions must be met: a minimum of $2,000 of RESP contributions must be made in respect of the beneficiary before that beneficiary turns 16 years of age; or a minimum of $100 in annual RESP contributions must have been made for the beneficiary in any four years before the beneficiary attains the age of 16. The lesson to learn here is to start your RESP as soon as you can and chances are you won’t have to worry about these special rules that can work to deny the CESG.

In a situation where the beneficiary does not pursue post-secondary education, you can expect to repay the CESG funds received, however, there is provision to add a replacement beneficiary. Surprisingly, there is no need to repay the income earned by the CESG funds in the plan where this situation arises. The logic here is that the income earned by the CESG will be included in income and taxed when withdrawn so there is no need to seek repayment. This also eliminates the need to calculate just what that CESG income amount is in the first place.

Taken together, the ability to transfer RESP funds to an RRSP if beneficiaries don’t attend post-secondary and the CESG top-up, make the RESP an investment product worth considering.

Jim Maroney is a chartered accountant with Andrews Brown Maroney in Maple Ridge.