College funding for children is constantly on parents’ minds, as the cost of tuition continues to skyrocket with no end in sight. That has heightened parents’ and grandparents’ desire to maximize college savings, by utilizing financial tools such as the Registered Education Savings Plan (RESP) in Canada. But what happens if circumstances change and the family relocates to the U.S.? Or what if your son or daughter attends a university in the U.S.? How might your current RESP planning be impacted, and what strategies should you implement to overcome potential hurdles? This article speaks to these concerns while providing insightful examples to help you navigate the complexities of college savings in a cross-border context.
Case Study Scenario #1: The RESP subscriber remains in Canada and the beneficiary attends a Canadian post-secondary education institution.
This is the simplest circumstance to dissect, since the RESP was designed for this specific scenario. As contributions, government grants, and earnings within the RESP accrue, buckets of income are formed. There are various withdrawal strategies available, based upon the beneficiary’s tax status, the number of remaining siblings who will attend college, and the subscriber’s utilization of accumulated income payments (AIP) to fund their RRSP (up to certain thresholds). For more information surrounding the basic mechanics of the RESP please read Cardinal Point’s article: Cross-Border Transition Planning – RESPs.
As post-secondary educational costs are realized, the taxation of RESP withdrawals is as follows:
- Original contributions (used for Post-Secondary Education or PSE) are non-taxable
- Grants and investment earnings (Education Assistance Payment or EAP) are taxable to the beneficiary and subject to certain withdrawal restrictions
Depending on the beneficiary’s part-time employment opportunities, it’s possible that they may owe taxes on some portion of the EAP bucket.
Case Study Scenario #2: The RESP subscriber is a U.S. resident and the beneficiary attends college in Canada.
In this scenario, the RESP is susceptible to annual taxation in the U.S., reported on the subscriber’s U.S. tax return and disclosure as an “other” foreign financial asset. This is due to the U.S. view of the RESP, which sees it as a standard taxable brokerage account. The subscriber needs to report any realized capital gains and/or dividends and interest income on their U.S. tax return. For this reason, some families transfer RESP subscribership duties to a close friend or family member who is a Canadian resident and not a U.S. taxpayer. There are pros and cons to this strategy, but it does alleviate the U.S. tax reporting issues for the U.S. subscriber.
Assuming the beneficiary attends a higher education institution in Canada, the same income taxation results detailed in Case Study #1 apply. But there is one exception. There would be no benefit gained by the student transferring a portion of their education credit to the U.S. parent (unless the U.S. parent had Canadian-sourced income and was required to file a Canadian tax return themselves). All RESP withdrawals are taxable to the beneficiary who then includes the T4A EAP distributions on their T1 as a Canadian resident. Keep in mind that each Canadian resident has access to annual basic personal amounts (BPA). This is a non-refundable tax credit that can be claimed by all individuals to provide a full reduction from federal income tax to all individuals on their taxable income up to the BPA. This is an important detail for Canadian resident students to note when withdrawing EAP while attending colleges and universities in Canada.
Case Study Scenario #3: Both the subscriber and beneficiary are U.S. residents, and the beneficiary plans to get their post-secondary education at a U.S. institution.
In both the second and third scenarios, it would have been necessary to open the RESP while both the subscriber and beneficiary were Canadian residents. Now let’s assume that the subscriber has not shifted their RESP duties to a Canadian resident and continues to report the annual RESP income on their U.S. tax return. All income, inclusive of capital gains within the RESP, needs to be converted to USD and reported and taxed in the U.S., which can lead to increased tax liability and tax preparation costs. Furthermore, if the aggregate total of the maximum market value of all foreign (non-U.S.) financial accounts is greater than $10K USD (a very low bar), an FBAR/FinCEN 114 disclosure report needs to be electronically filed. The taxpayer may also need to include a Form 8938 (higher thresholds) with their U.S. tax return. It’s debatable whether the RESP is considered a foreign trust, but recent IRS Revenue Procedure 2020-17 suggests that Forms 3520/3520-A are no longer required for RESPs.
From the beneficiary’s perspective, any income withdrawn from the RESP needs to be allocated to a specific bucket (PSE vs EAP). In the case of PSE, this is seen as a non-taxable return of capital to the subscriber. These payments represent after-tax contributions to the RESP. If withdrawals include EAP, then as a non-resident of Canada grants need to be repaid to the Canadian government and any earnings necessitate a 25% non-resident withholding tax payable to CRA on behalf of the beneficiary. But the beneficiary does not need to report the EAP on a U.S. tax return, since the account is only taxable to the subscriber.
Tax-related information is a powerful and essential tool to help you strategically plan optimal methods of navigating Canadian assets such as the RESP, RRSP, LIRA, and TFSA. As cross-border financial planners we are in a unique position to examine the intricacies of complex cross-border wealth management scenarios, including those regarding your RESP within Canada or the U.S. Although we only explored three commonly experienced scenarios, there are many other possibilities. To unpack your specific circumstances and learn applicable solutions and strategies, please contact Cardinal Point.