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Whether it's an RESP in Canada or an ESP in the U.S., which account is the most tax efficient?
Q: Many Canadian residents who belong to “cross-border” families (both Canadian and U.S. citizenship or permanent residency status) with children are uncertain about how to best save, in the most tax efficient way possible, for our children’s future university educations. This is somewhat further complicated by not knowing what side of the border our kids will ultimately choose to attend university in the future. Both countries have tax-advantaged education savings plans (RESP/CESG in Canada, 529s and ESPs in the U.S.) but it appears that each of these does not enjoy the tax-deferred status in the other country. How would you advise such families to structure their education savings for greatest tax and grant benefit and versatility?
—Mark
A: Excellent question Mark. For U.S. citizens, green card holders and U.S. residents, Canadian Registered Education Savings Plan (RESP) accounts are rarely a good option. In addition to the IRS not recognizing the tax-deferred status of the account, they are set up as trust accounts, which will require the filing of foreign trust forms with the U.S. tax authorities. In addition, if your RESP account is invested in mutual funds, it is another layer of complexity because they are classified as passive foreign investment companies (PFICs) taxed in a complex and unfriendly way by the IRS.
A 529 plan, the U.S .equivalent of RESP accounts, are a great idea for people only dealing with U.S. taxes and, as long as the Canadian school has a U.S. FAFSA (Free Application for Federal Student Aid) number, the withdrawals can be tax-free.
Unfortunately, there is no one-size-fits-all solution when you are a cross-border family. We do not suggest either vehicle if you are subject to tax in both countries because of the different tax treatments in each country. If you live in Canada, one option may be for family members who are not subject to the US tax rules to set up and contribute to an RESP account for your children – even if your children are US citizens.
If you live in Canada, one option may be for family members who are not subject to the U.S. tax rules to set up and contribute to an RESP account for your children—even if your children are U.S. citizens.
One thing is certain: Each situation should be reviewed by a tax specialist proficient on both sides of the border to discern the optimal solution for saving for your children’s college education—taking into account the specific details of everyone’s unique situation.
Cleo Hamel is a Senior Tax Specialist with American Expat Taxes in Calgary
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