Collapsing an RESP when your child does not attend post-secondary school, has significant penalties. So, are there other withdrawal options to avoid paying the collapse penalty tax?
There are a number of options for collapsing an RESP if your child decides that they don't want to attend a post-secondary education.
One option is to 'collapse' the RESP account. When you do this, any contributions can be withdrawn without penalties or tax. However, all grants are returned to the government.
The real kicker is that the remainder of the accumulated income (interest, dividends and capital gains) is taxable at your personal marginal tax rate PLUS an additional 20% penalty tax!
Are there more attractive strategies than the collapse option? Yes.
RRSP Transfer – Assuming you have room, the remainder of the accumulated income can be transferred to your RRSP or your spouse’s RRSP. The income tax is deferred and there is no 20% penalty tax.
Wait – RESPs do not have to be terminated until 35 years after they are created. Therefore you can afford to wait until your child comes to his or her senses.
Transfer to Sibling – You are allowed to transfer the remainder of the accumulated income to a sibling. The sibling can be part of a family RESP or can have an individual plan but the $7,200 lifetime grant still applies.
Donation – technically one can donate the remainder of the accumulated income to a qualifying educational institution. For tax purposes, it is considered a gift and not a donation so a tax receipt will not be issued.