mother and daughter on a beach / Ustyl359

This article appears in the November 2021 issue of Advisor’s Edge magazine. Subscribe to the print edition, read the digital edition or read the articles online.

Last month I discussed how students can benefit from financial planning. Now, let’s look at this in action.

Case study: Anne

Anne was born in P.E.I. where she was raised by her mother, Marilla, who is your client. Marilla saved $2,500 per year in an RESP over Anne’s life, maximizing the Canada Education Savings Grant (CESG). As Anne headed off to university in Newfoundland, the RESP was worth $79,974.

You estimate that Anne’s four-year program will cost $59,291, including inflation. Luckily, her RESP assets are greater than this cost.

After explaining how education assistance payments (EAPs) work, including taxation, you offer to structure the annual withdrawals to make sure a large portion isn’t left over when Anne finishes school. Marilla pushes back, thinking the annual withdrawals should equal costs. For simplicity, Marilla wants the breakdown to be 50/50 EAP and tax-free post-secondary education (PSE) withdrawals.

You wrap up the meeting by gathering data about Anne’s other income sources and the RESP breakdown (contributions, grant and growth) so you can present an alternative plan in a follow-up meeting.

The initial numbers

With Anne’s time horizon (four years), RESP assets ($79,974), other income sources ($7,800 summer employment and $1,275 in scholarships) and annual education expenses, you run an analysis with total RESP withdrawals equal to annual expenses.

Table 1: Annual expenses and withdrawals

Year of study Annual cost EAP PSE
1 ($14,364) $7,182 $7,182
2 ($14,666) $7,333 $7,333
3 ($14,974) $7,487 $7,487
4 ($15,288) $7,644 $7,644

Next, you review the RESP account breakdown before and after withdrawals.

Table 2: RESP breakdown

Contributions CESG Growth Total
Before Year 1 $42,500 $7,200 $30,274 $79,974
After Year 4 $12,854 $2,118 $13,073 $28,045

Anne has no siblings or cousins, so she can’t share her leftover basic CESG balance. Further, CESG can only be withdrawn via an EAP and that payment must maintain the ratio of CESG and growth in the RESP (excluding contributions) before the withdrawal. In short, if Anne and Marilla want to fully utilize the CESG, they would need withdraw all of the remaining EAP of $15,191 no later than six months after Anne completes her studies.

This is a problem for Anne. Her taxable income averages $16,386 in her first three years of study. She will receive tax refunds in those years thanks to the basic personal amount, Canada employment credit and the refundable Canada Workers Benefit. The extra EAP in Year 4 spikes her projected taxable income to $31,887 and her taxes payable to $4,532. If we fully utilize her tuition tax credit and most of her provincial education amount in that year, her taxes payable would be reduced to $0.

The proposal: higher withdrawals, lower taxes

In your followup meeting, you present Anne and Marilla with the results of Marilla’s proposed approach and the Year 4 dilemma. You propose increasing the annual withdrawal amount to $21,250 ($10,625 in EAPs, $10,625 in PSE withdrawals) to bring your EAP balance down to $1,109 at the end of Year 4. In either scenario, the annual EAPs are not enough to cover all of Anne’s costs so some tax-free PSE withdrawals need to be taken.

While Anne’s taxable income is higher in each of the first three years ($19,677 per year), she is still in a small refund position using the same tax credits as before. However, with the extra EAP of $1,109 in Year 4, her taxable income increases to $20,786 and her taxes payable end up at $223. To reduce this balance to $0, Anne only needs to use $895 of her tuition tax credit.

Finally, the annual PSE withdrawals would reduce the RESP contribution balance to $0 by the end of Year 4. The recommended annual PSE withdrawal is more than is needed, but Marilla receives these amounts tax-free. If these funds aren’t needed immediately, they can be contributed to Marilla’s RRSP or TFSA, or to Anne’s TFSA, subject to contribution limits.

As you can see, with planning, clients can maximize an RESP’s benefits and minimize taxes.

Curtis Davis, FCSI, RRC, CFP, is senior consultant for tax, retirement and estate planning services, retail markets at Manulife Investment Management.