RESP Deposits: Watch Out For Penalty Taxes

If making an RESP contribution is part of your year-end tax planning discussions, be sure to understand the expensive tax consequences of an excess contribution. A subscriber who contributes more than the limits allow will face a penalty tax of 1% per month on the excess amount, imposed under the Income Tax Act S. 204.91(1).

Last week, the contribution limits were covered in Knowledge Bureau Report.

In addition, clients and advisors should discuss the potential end results of any RESP investment before it is actually made: what happens when a student goes to school and needs the deposits, and what happens if no one uses the funds for their intended purposes.

Beneficiary Does Become a Student. If the beneficiary begins post-secondary education, the beneficiary is eligible to receive Education Assistance Payments (EAPs). These amounts are withdrawals from the plan to aid with the costs of the student’s education. The amounts are taxable to the beneficiary (as other income on line 130). Contributions may be returned to the subscriber or paid to the student with no income tax consequences.

The maximum amount of EAPs is $5,000 until the student has completed 13 consecutive weeks in a qualifying education program at a post-secondary educational institution. Once the 13 weeks have been completed, there is no limit to the amount that may be withdrawn from the plan. However, if, for a period of 12 months, the student does not enroll in a qualifying education program, the 13-week period and the $5,000 limitation will be imposed again.

No One Uses the Funds:  If the beneficiary does not attend post-secondary school by the time the student reaches the age of 21, and there are no qualifying substitute beneficiaries, the contributions can go back to the original subscriber, under certain circumstances. However, the income earned in the plan over the years will become taxable to the subscriber, and the income is subject to a special penalty tax of 20% in addition to the regular taxes payable. Such income inclusions are called “Accumulated Income Payments” or AIPs. Form T1172 Additional Tax on Accumulated Income Payments from RESPs must be completed.

As an alternative, if the subscriber has unused RRSP contribution room, AIPs can be transferred into the subscriber’s Registered Retirement Savings Plan (RRSP), up to a lifetime maximum of $50,000. If amounts are transferred to an RRSP, Form T1171 Tax Withholding Waiver on Accumulated Income Payments from RESPs may be used to reduce or eliminate tax withheld on the AIP.

Additional educational resources include EverGreen Explanatory Notes and Distinguished Advisor Workshops (DAW) 2017.

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