It is common for U.S. parents who live in Canada to open and hold a RESP (Retirement Savings Plan) account for their children. This type of account allows money that is deposited into the account to increase on a tax deferred basis. However, this type of account is not considered to be a tax deferred plan for U.S. tax purposes. They are not treated with the same tax deferment as RRSPs are.
The RESP Income Can Be Taxed In The United States
Any income that is earned through a Retirement Savings Plan is taxable to the depositor or subscriber. In many instances, this is the parent. It will be taxable on the return for the current year. It is also important to understand that if the account receives a grant from the Canadian Government, such as the Canada Education Savings Grant (CESG), this income will also be taxable under U.S. law. This means that all returns, interests, dividends and gains must be reported on your yearly U.S. tax return. Agencies can explain more details in Canada at Heritage RESP.
Additionally, if there are other holdings in the account such as mutual funds, these may be considered PFICs, and this would require additional disclosure.
Citizens of the United States will have to pay taxes on this account even though they will not be required to do so for Canadian purposes. The account will also be subject to double taxation. It will be taxed once for the parents, and it will be taxed again by the Canadian government when the beneficiary (student) withdraws the money from the account.
Other Consequences To Opening A RESP Account
Although opening this type of account ensures that funding will be available for your child when they are ready to start college, there are negative consequences because of the tax implications. For example, the Internal Revenue Service considers these accounts to be a type of foreign trust. The subscriber will have to file several forms for any account they withdraw from or contribute to.
If a subscriber fails to comply with the filing of these forms, they could face severe fines and penalties.
One alternative would be for subscribers to transfer these accounts to a non U.S. citizen. It is common for a non U.S. relative to become a subscriber. However, the transfer would not affect the current tax year so the U.S. subscriber would still need to pay taxes. They would begin to see relief going forward.
A Retirement Savings Plan is a way to ensure your child has financial security when they are ready to start college. Speak with a tax expert so you will understand how this type of account affects your tax returns.