Beware of the RESP Tax Trap: How to Minimize Your Child\’s Tax Liability

If you\’re a parent in Canada, you\’re probably familiar with the RESP (Registered Education Savings Plan). It\’s a popular investment vehicle that allows you to save for your child\’s post-secondary education while taking advantage of tax-deferred growth and government grants. However, there\’s a potential RESP tax trap that parents should be aware of when it comes time to withdraw funds from the plan. In this article, we\’ll discuss the RESP tax trap and share some strategies for minimizing your child\’s tax liability.

What is the RESP Tax Trap?

The RESP tax trap arises from the way withdrawals from the plan are taxed. When your child attends post-secondary school and withdrawals are made from the RESP to pay for their education, the money is taxed as income in the student\’s hands. This means that your child will need to pay taxes on the amount withdrawn at their marginal tax rate, which could be significantly higher than your tax rate.

Why the RESP Tax Trap Matters?

The problem arises when parents have contributed a significant amount to the RESP, and their child receives a large sum of money upon graduation. If your child is in a high tax bracket, they may end up paying a considerable amount of taxes on the withdrawals, which could result in a substantial reduction in the amount of money they actually receive.

Strategies to Minimize Your Child\’s Tax Liability

To avoid the RESP tax trap, here are some strategies that you can use:

1. Spread out the withdrawals

One option is to spread out the withdrawals over several years to minimize the tax hit in any given year. This can help to ensure that your child\’s tax liability remains low and manageable.

1. Transfer some of the RESP funds to an RRSP

Another option is to transfer some of the RESP funds to an RRSP (Registered Retirement Savings Plan) in your name. This can be done as long as you have available contribution room, and the transfer is done before your child turns 21.

1. Keep your child\’s income low

You can keep your child\’s income low during their post-secondary studies by having them take out student loans and using the RESP funds to pay them off after graduation. This will allow your child to take advantage of the basic personal exemption and other tax credits, which will reduce their tax liability.