Firm Bulletin: Helping RESP consumers avoid withdrawal mistakes

As students head to college or university, financial services firms can expect visits from parents and students planning to make Registered Education Savings Plan (RESP) withdrawals, but this process is not straightforward and can have consequences that many consumers do not expect. In recent years, we have seen many cases where costly RESP withdrawal mistakes could have been avoided. The purpose of this bulletin is to alert firms to these risks and identify actions to avoid them.

The process for accessing RESP funds typically involves filling out paper-based forms at the financial institution. These forms include options that are often confusing for consumers to consider and it is easy for both the consumer and a firm representative to make costly mistakes if making decisions without a good understanding of the consumer’s circumstances and the product features.

There are two types of payments options that can be made when RESP funds are withdrawn, and these are selected by the consumer at the time of withdrawal. These are:

• Post Secondary Education (PSE) payments, which come from the contributions to the RESP. These are not taxed on withdrawal (since tax has already been paid by the contributor).
• Educational Assistance Payments (EAP), which include the federal and provincial education savings grants and all earnings on contributions and grants. These are taxed as income of the student in the year they are withdrawn.

Importantly, if the beneficiary of an EAP does not pursue a qualifying program, all grants must be returned to the government (although there is a 35-year window to make use of the funds), while original contributions and earnings can be returned to the consumer (earnings are then taxable).

Given the different tax treatment for PSE and EAP payments, the option selected for the withdrawal of funds can have real consequences for a family or a student if they are not understood and handled properly. Some firms want to avoid providing – or being seen as providing – tax advice. However, helping consumers better understand the education savings plan as a product and the consequences to them of different withdrawal choices is important to ensure consumers are able to receive the full benefit of the program.

Examples of avoidable RESP errors

RESP errors can often be avoided if consumers are provided with clear information about the impact on their personal circumstances of the withdrawal decisions they make. Examples of complaints we have heard include:

• A consumer had a family RESP for her four children. She began withdrawing from the plan in 2009 as her children started to attend university. Each year she would sign a form pre-filled by her advisor, instructing the withdrawal to come from PSE – the non-taxable payment. The consumer only realized there was a problem with her withdrawals when her youngest child remained in school. At that point, all that remained in the plan was taxable EAP including more grants than the youngest child could realistically withdraw for eligible programs. Her other children were now employed and so she would have to return the unused grant to the government.
• The eldest beneficiary of a family RESP stopped going to university after their third year due to a disability. On their advisor’s recommendation, all the consumers’ withdrawals ($35,000 in total) had come from PSE. Because no EAP was withdrawn, and it was unlikely the child would ever be capable of attending post-secondary education before age 35 (the end of the plan in his case), the consumer would be required to return all the government grants they received but had not withdrawn to that point.
• A consumer withdrew funds from an RESP following their advisor’s general advice to withdraw from the EAP first to ensure all grants were received. There was no clear conversation between the consumer and the advisor about the tax consequences of the different withdrawal types. However, the beneficiary had earned significant income that year from an internship and suffered unnecessary tax consequences because the full EAP was taxable as additional income while the PSE would not have been.

A challenging time for families

As RESPs provide funds typically to be used in the relatively distant future, most consumers focus their efforts on maximizing savings, returns and government grants. Any conversations or disclosures that might have occurred at the opening of the account about tax treatment of EAP or PSE are often long forgotten.

Families with a member attending post secondary school for the first time are usually distracted by grades, gaining acceptance into schools and a myriad of other concerns. There is a lot of uncertainty around this process, including the costs, that are often unknown until the school year is about to start.

When it comes time to withdraw, families face deadlines to provide the proof required to release the funds and to meet school payment schedules. It is usually a busy and stressful period where the rules for withdrawals and their impacts are seen as a technical consequence and secondary to the immediate need for access to funds to make education payments.

Even families who have made withdrawals in the past may face very different situations each year as family circumstances change. For example, a student who is in an academic program one year and a co-op program the next would likely benefit from different withdrawal strategies each year.

How firms work with clients through this challenging period can make a big difference for their clients and avoid costly errors.

Possible solutions

Practical, quality training is vital
Some of the problems we have seen stemmed from representatives not fully understanding the details of the product and the rules that apply. All firms should consider providing representatives with an appropriate refresher training session each year regarding RESP withdrawal rules in preparation for the upcoming school term.

Offering RESP product information is not tax advice
If firms are concerned about their representatives giving tax advice, have representatives explain more clearly how the product works, the limitations and rules that apply, as well as how the grants get paid out (or not) under different withdrawal scenarios. By providing facts about how the product works, representatives can help families make more informed decisions based on their personal circumstances and avoid costly errors. At a minimum, raising the fact that there are tax implications that families need to understand and decide upon before making a withdrawal should be discussed each time a client seeks to access their RESP funds.

Provide timely, proactive communications to consumers
Firms should also consider helping consumers holding RESP accounts by being proactive in their communications. This includes:

• Having a system to initiate contact with RESP holders based on the age of the beneficiary (e.g., 17). This should include a summary of the approximate taxable and non-taxable portions then available in their RESP account.
• Adding messages to statements about seeking tax advice when considering withdrawals.
• Suggesting meetings to discuss withdrawal plans months in advance of tuition deadlines.
• Connecting consumers to information available through government websites, such as the Canada Revenue Agency.
• Creating a tip sheet for consumers using common scenarios that describe the impacts of different decisions. We’ve provided two samples below.

Examples of good planning

Scenario 1
A family’s son is enrolled in a full-time, two-year diploma program in a local college and works part-time hours as a cashier. They have a RESP worth $15,000, which includes $10,000 of non-taxable capital, $2,000 of grants, and $3,000 worth of investment earnings. The parents would like to withdraw $7,500 for each year of the two-year program.

The parents should understand that:

• There is a pool of $5,000 that will be taxable as income to the student. If there are tax questions, they should speak to an accountant.
• The government grants can only be withdrawn when the student is enrolled in an eligible program. If they drop out and do not re-enroll, the grants could ultimately be lost.
• $10,000 can be withdrawn without tax consequences and enrollment is not necessary to withdraw it.

The parents consider income tax consequences and decide to withdraw $5,000 as an EAP payment and $2,500 as a PSE payment in their son’s first year. This will remove all the grant money from the RESP while the son is enrolled and has a low income. The remaining $7,500 PSE can be withdrawn in year two of his program or later, even if the son changes his educational plans.

Scenario 2
A student is enrolled in the second year of a sciences program. She estimates that she will need approximately $10,000 for tuition, materials and other expenses. For the upcoming academic year, she plans to spend the winter term (January to April) working in a co-op program and to have a job through the summer. Her RESP is currently worth $33,000 ($22,000 in contributions, $4,400 in grants, and $6,600 in earnings).

She and her parents meet with the representative, who explains the different options, including:

• That $11,000 can be withdrawn as EAPs (grants and earnings) and will be taxable as income so she should consider her expected earning over the course of her educational program.
• Grants of $4,400 can be withdrawn only when she is enrolled in an eligible program and may be lost if they don’t get used for education.
• That $22,000 can be withdrawn as a PSE during her program or withdrawn afterwards and withdrawals and will not be taxable.
• Both PSE and EAP withdrawals can be made at the same time, but they do not need to withdraw all the money required today. If there is proof of enrollment, more can be withdrawn later.
• They may want to consult with a tax specialist before deciding on a withdrawal.

After the explanation, the family decides to withdraw $4,000 in EAP for this calendar year and will make a $5,000 PSE withdrawal in January 2020 to minimize the daughter’s taxes. By doing this, they expect she will pay little to no tax on the EAP for 2019. In 2020, when she is expecting income form her internship, they will make a $5,000 PSE withdrawal which is not taxable. The family also understands that some of the government grants and earnings will remain in the RESP, but they are confident she will qualify to withdraw them in later years.

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Canada’s provincial and federal education saving programs offer students important and meaningful financial support. But the products and rules are complicated, and consumers are often unprepared for these complexities. Canada’s financial services industry plays a critical role in supporting consumer confidence in these programs and their effectiveness. With some extra effort, firms can ensure all families and students get the most of what the programs were intended to offer.