The smartest and most far-sighted parents rush to open an RESP for their offspring when they leave the hospital, the newborn in their arms. But what should they do when their paths diverge?
Posted at 6:30 a.m.
It would be heartbreaking if ex-lovers who had been responsible by accumulating thousands of dollars in a registered education savings plan (RESP) were suddenly being negligent. That would, in fact, be reckless!
Very often, parents who leave each other on good terms are tempted to do nothing. Everyone will continue to contribute their share to the RESP, as in the good old days, they tell themselves. But if one of them does not keep his promise, or goes bankrupt or dies? This is where it gets complicated and this is precisely what we want to avoid.
Before going any further, it should be noted that we are talking here about individual and family RESPs, and not these group plans offered by organizations such as Kaleido (formerly Universitas) or the Heritage Education Fund, for example. Let’s also recall the operation of this investment vehicle which remains quite misunderstood.
Basically, the RESP allows you to grow money tax-free and get government grants. Ottawa adds an amount equivalent to 20% of your contributions, and Quebec, an amount equivalent to 10%. Each slice of $100 entitles you to a gift of $30, which undoubtedly exceeds the performance of your best mutual fund. Families with low incomes can get more 1. Of course, there are annual and lifetime caps.
When the beneficiary (child) enters post-secondary education in a qualifying program, contributions made by the subscriber(s) (parents) may be withdrawn. The same is true for government grants and investment income, under other terms. But in both cases, the money can be used by the parent to do whatever they want: pay for their child’s education, renovate their kitchen or buy a car.
Create two new RESPs
The couple who separate but who decide to maintain the RESP with two subscribers for their child take unnecessary risks, judge Antoine Auger, financial planner at Vignone & Associés, affiliated with IG Wealth Management.
If the parents do not always pay the same amount each year, the separation of contributions, performance and subsidies will be risky to calculate 10 or 15 years later. Another pitfall: how to deal with the ex who decides to withdraw funds before the start of his child’s post-secondary studies because of financial problems?
And if a parent goes bankrupt, “creditors could come and dip into the RESP,” warns Hélène Marquis, regional director, tax and estate planning at CIBC Private Management.
To avoid these situations, Antoine Auger systematically suggests opening two new RESP accounts – one in the name of each parent – in which the accumulated money is distributed according to the contributions paid (say 50-50). Then the original, empty RESP is closed, with no tax implications.
Even if spouses say they get along wonderfully, we don’t know what life has in store for us. “We separate so that it is clear and to sleep well at night,” says the expert.
This is especially useful when the child prefers the school of life to qualifying study programs. It is therefore wise to transfer the return obtained to the RRSP of the subscribing parents to avoid paying income tax. “So we want to be able to follow who put how much and when,” notes Mr. Auger.
Note that the RESP is not part of the family patrimony, unlike the registered retirement savings plan (RRSP).
Condemned to agree
Whether we use this strategy or favor the status quo, we are still forced to agree.
Because the subsidies are granted to the subscriber… the fastest. If Mrs. pays $2,500 into the RESP at the beginning of January and Mr. decides to do the same in February… the grants will go entirely to Mrs.’s account. And if the gentleman’s contribution has caused an overage in the account, costly penalties await him. We have to coordinate!
Before making a payment, it is therefore best to contact the Canada Revenue Agency to find out if subscriptions have already been made in your child’s RESP. Especially if the ex is not collaborating too much or the memory is lacking. It is quite common for grandparents to open RESPs, which adds a layer of complexity during separations.
Some would say that the grants are for the child anyway and it doesn’t matter if they grow into an account or two. That is not exactly correct.
The beneficiary is the person who will have to declare on his taxes the sums withdrawn (grants and return). But nothing prevents the money in question from being paid into the parent’s bank account. From then on it can be used for anything. Dad can use it to pay his child’s school fees, or to travel. Mind you, it’s no different if the sum is passed on to the child who, too, could use it to take it easy in the sun.
Eventually, the exes will also have to agree on the disbursement strategy.
Plan everything in writing
To protect yourself, an amicable divorce or separation agreement (ideally ratified by the court) should address the issue of the RESP: amount that will be contributed annually by each, consequences if the promise is not respected, restrictions on the account to prevent one of the parents from emptying it without the consent of the other, access to statements, etc.
An information document produced by TD Bank 2 also suggests establishing who will be responsible for paying taxes or penalties, if any, and imposing restrictions on who can be named in a will as a successor subscriber in the event of death.
One of the problems is that “lawyers and judges don’t know that!” “, laments M.me Marquis. In her career, she has seen a divorce decree so badly written that the RESP had to be dissolved. She has also witnessed numerous bickering “in dysfunctional or blended families” which resulted in deregistration of the account. This causes an unfortunate loss of subsidies which should in theory benefit the children.
When this happens, the capital is withdrawn tax-free, while the return – up to $50,000 – can be transferred to an RRSP. Otherwise, the amount is added to taxable income and a 20% penalty is imposed by Quebec (8%) and Ottawa (12%). It is therefore doubly taxed. Warning !
A single manager
One of the solutions proposed by M.me Marquis is the opening, after a separation, of a single new RESP account in the name of one of the parents and to transfer there all the sums accumulated by the couple (it is not allowed to withdraw from an RESP the name of a subscriber). A parent will then become solely responsible for the rest of things.
The other spouse would then have to apply for financial compensation. The amount can be negotiated in the divorce or separation agreement. In this way, we avoid having to agree on each side on the amounts to be paid and the dates for doing so. We’re making life a lot easier.
But it’s not perfect either. We can judge that this causes a certain inequity for the parent who no longer contributes to the RESP. Suppose son, at age 23, needs a good amount of money to study away from home in an expensive program. The parents agree to split the bill. One pays his share with the RESP and the grants and the other with his savings only?
In a case of parental alienation, for example, the parent who contributed to the RESP could also use the sum for his own benefit only, thus depriving his child of the subsidies that were intended for him at the start.
Another option is for each parent to manage one child’s RESP, assuming the couple has two. But there too, we take the risk that one of the children ends up with a higher amount than the other and that this causes conflicts.
To complicate matters even more, each financial institution sets its own disbursement rules, some are more demanding than others in terms of the invoices to be submitted, so it is important to be well informed about what is allowed.
As we can see, the RESP is a very judicious enrichment tool. But it is important to put as much energy into managing it after the breakup as during the good years of the relationship.
For information about a specific child’s RESP (Ottawa): 1-888-276-3624
For information on how RESPs work and tax rules (Ottawa): 1 800 267-5565