Opinion mixed on RESP change

The proposed tax deduction for registered education savings plans (RESP) has sparked controversy among advisors. Some are worried students will not be able to bear the tax consequences when they withdraw money from their RESPs, while others feel this new bill does nothing to help lower-income families.

The legislation, which is currently being reviewed by the Senate, is light on details. What is known is that if the bill were to pass, it would allow parents to contribute up to $5,000 per child and then deduct the amount from their income tax. The spanner in the works is that the federal Conservative government has vowed to diminish the bill’s cost — estimated at $900 million by some sources — which means the final outcome may be very different from the current program.

Currently, the bill would allow tax deductions on the RESP contributions in addition to the Canada education savings grant (CESG). The CESG gives parents who have contributed more than $500 to their child’s plan up to 20 cents for every dollar above that, up to a contribution of $2,500. A representative from the office of Liberal MP Dan McTeague, who authored the private members’ bill, said there was an intention to have the proposed changes included for the 2008 tax year.

One thing the bill did not make clear is who will bear the tax burden when money is taken out of the RESP.

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“Mr. McTeague, who I’ve spoken to, suggested that the intent is when the money is pulled out, it would be taxable as income of the student. To me, that’s a little unclear in the drafting of the legislation,” says Peter Lewis, vice-president of operations for the Canadian Scholarship Trust Company. “One way or another, the money will be taxed when it comes out.”

Gena Katz, executive director of the tax group at Ernst & Young, believes it’s logical that the student, rather than the parents, takes on the tax burden.

“To me, it would be sensible that it would be the child. The parent is likely taxed at a much higher rate,” she says.

Katz also notes that if planned properly, the tuition tax credits, which if not used can be carried forward to other years, can also help to minimize the income tax burden of the student.

Karen Diamond, a CFP and vice-president of Winnipeg-based Diamond Planning Limited, believes the tax burden transferred to the students would be too great. Diamond has two children currently attending university, and she says they each make about $13,000 a year from the work they do during their four-month summer break. Combined with what they take out of their RESPs, this puts them at a marginal tax rate that will require them to pay a relatively sizable tax bill, given their financial means.

“At the university level, it is not unusual for kids to be making incomes in excess of the personal exemption just through summer and part-time jobs,” she says. “If they would also have to include not just educational assistance payment income but also the principal portion of the savings plan in their incomes, it is quite possible that even with the tuition and education credits, they might end up having to pay tax — maybe a lot of tax if they are going away to school and need living expenses covered by the RESP.”

For example, Diamond says that if one of her daughters were to need $10,000 from her RESP, her tax bill would be in the vicinity of $1,400. Now, with the extension of the RESP timeline that allows a student access to it until the age of 31, it becomes a more attractive funding opportunity for professional graduate programs, like law school or MBA programs, which cost tens of thousands of dollars in tuition alone.

Diamond says if her daughter were to withdraw $25,000 from the RESP, she would be left with a $5,380 tax bill.

Katz says Diamond’s scenario is possible, but she still believes the tuition tax credits and the lower marginal tax rate of the student should offset most of the tax cost.

Another point of contention by a number of advisors is that the proposal does not actually motivate more middle-income Canadians to contributing to an RESP.

“Making it tax deductible — does that make lower-income families more inclined to contribute?” Katz asks. “I’m not sure it will make them save for exemptions.”

Another advisor wrote in an e-mail to Advisor.ca that he would rather see the extra tax dollars this will cost used to directly fund education for lower-income families.

“More fundamental to my objection to RESPs is simply that the program targets the wrong students. This is in reality a program for students whose parents/grandparents are in the top quartile of income earners. Just this past week, one of my clients withdrew her deductions for her daughter’s plan due to financial difficulties,” he wrote. “I would like to see my tax dollars supporting underprivileged students with grants and no-interest loans.”

Lewis, on the other hand, does believe that the proposed changes if passed would encourage more Canadians to contribute.

“Since they introduced it, there hasn’t been as significant a change to the RESP landscape as this one,” he says. “Any change that puts more money back into pockets of taxpayers will drive usage of that particular investment vehicle. I would suggest that if this change goes through, there will be more families who will take advantage of this.”

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com

(03/10/08)

Mark Noble