Preface: Part 3 of this Guide is WRONG
I’ll leave it up as a memorial to the facts that (1) I can be incorrect and, as I say in the article, (2) you should always seek professional advice. You can only earn a maximum of a $1,000 CESG (Canada Education Savings Grant) in a given year. That’s stupid, for the reasons mentioned in Part 3. Adjust your plans accordingly, although it’s likely impossible to predict your child’s academic path when they’re aged 10. There’s other good advice in Parts 1, 2, and 4. Enjoy!
RESP Guide, Part 1: do Registered Education Savings Plans (RESPs) help or hurt kids?
Before I tell you how to effectively use the subsidized savings vehicles known as RESPs (and in a way that nobody recommends, because they all want to take your money), I should preface my brief RESP Guide with a clarification:
I don’t believe in RESPs.
No parent owes his or her child a free ride through university. My parents didn’t pay for any of my $23,000+ in tuition and fees. They didn’t even buy my books or pay my rent. They did buy two laptops as gifts (not at the same time) and that’s about it. They could have easily afforded much more. But I didn’t expect free money and I’m not complaining. Far from it.
Further, a free ride in university can sabotage a student’s success. Having to pay one’s own way instills independence. I was much more motivated. Sure, I partied once a week, but I didn’t drink every night. If I hadn’t gotten academic scholarships (over $30,000 worth), I would have probably gone into debt. I worked during the summers. Instead of being infantilized by reliance on my parents, I became an adult.
If you’re not faced with limited resources, you won’t make economically-sound decisions. I went to Trent University, largely, because my grandparents lived in the city and I could stay with them. If my parents had given me a blank cheque, I would have been more likely to pursue my love for writing with a B.A. in English or something equally frivolous. I might have gone to school in BC. Or maybe I would have taken a year off. Scarcity forces a person to think rationally. If you’re not faced with limited resources, you’ll do dumber things. Why do you think the federal government is always so incompetent?
RESP Guide, Part 2: can you afford to contribute to an RESP?
OK, so my bias has been clearly stated. You still want to pay for Junior’s formal education.
Should you contribute? My answer is decisive: only if you can afford it (and you probably can’t).
- Do you have consumer debt? If so, you can’t afford RESP contributions. Consumer debts include anything other than a mortgage. HELOC? Consumer debt. Car loan? Consumer debt. Side note: it is stunning that there are people with student loans who are saving for theirs kids’ educations. That’s hardcore money-stupidity. Quit reading this article and work on paying off your debt.
- Do you have a sufficient emergency fund? A sufficient emergency fund is equal to your net income for six months. It is fully liquid, i.e. 100% cash. It’s fully segregated from any other savings (e.g. separate from retirement savings and any planned spending accounts).
- Do you have a fully funded retirement account? In other words: do you and your partner/spouse have ZERO contribution room remaining for your RRSPs and TFSAs? If you have any contribution room remaining then, no, you do not have a fully-funded retirement account. It is an opiate to some people to plan for their kids’ futures – it allows them to ignore the critical need to plan for their own futures. If you don’t have a fully funded retirement account and you’re researching how to save in RESPs, you are one of these delusional persons. Stop reading this article.
- Are you on track to have your mortgage fully repaid by the time your oldest child turns 15? If not, then no, you can’t afford it. Focus on getting debt free! When you’re mortgage free, you’ll have a lot more flexibility to help your kids.
RESP Guide, Part 3: How should you, the parental rose among thorns, contribute to an RESP?
Ask yourself a question:
What’s the biggest unique benefit of an RESP?
If you think it’s tax treatment, you’re wrong. RRSPs allow money to grow tax free just like an RESP. The difference is that an RRSP gives you a tax break up-front. An RESP doesn’t.
When you withdraw money from a TFSA, it’s tax-free. Money withdrawn from an RESP, on the other hand, is still taxable. When a student receives RESP money for an eligible education expense, it’s taxable in the hands of the student. “But Joe! Students are poor so they won’t pay taxes!” You’re probably right. But RESP withdrawals can adversely impact the student’s ability to get needs-based scholarships or (as a last resort) government loans.
And think about this: if a child saved money for education in his own name, why would it need to be in a tax-sheltered account?? If he simply saved his RESP money in a taxable high-interest savings account he probably wouldn’t pay taxes because his income is negligible. Then he could just use the RESP strategy that I lay out later in this article.
The financial industry’s labeling of RESPs as “tax-advantaged” or “tax-sheltered” is one of the grandest scams in Canadian personal finance. And that’s coming from the same financial services industry that brought us the Canadian housing bubble.
The biggest benefit of an RESP is the Canada Education Savings Grant (CESG). On every dollar you put into an RESP, the government adds twenty cents. The maximum CESG is $7,200 per child (I realize there are certain bonuses for parents with lower incomes. I don’t consider these “income-tested” grants in my analysis; all the more reason that you should always speak to a financial professional and never take my advice). The $7,200 CESG maximum means that you stop receiving grant money after you’ve contributed $36,000 per child.
The CESG is a 20% rate of return! Crazy! But it may not be as amazing as it sounds. It’s important to note that the one-year return on your money is only 20% if you deposit the capital, receive the 20% CESG, and remove the money at the end of the first year.
Huh?
Let’s say you invest $1000 into an RESP. You put it in an RESP savings account that pays 2% a year (good luck finding that). Your first year return including the CESG would be a whopping $224, or 22.4%! Inconceivable!
But let’s say your kid doesn’t go to university at the end of the RESP’s first year. He waits another year. In the second year, you’d only earn $24.48 on the total invested capital (the original capital + the CESG + the first year’s interest). Suddenly, your annual return is only 12.42%. Not exactly impressive. Add a third year? 9.1%. It continues to decline in this fashion. The CESG subsidy means your investment returns become less impressive as time goes by.
Now let’s imagine that you use an RESP the way that you’ve been told to by Canada’s banksters. You run down to your branch and open an RESP on the day your child is born. You put the money in an actively-managed fund. The fund syphons off a solid 2 or 3% of Junior’s returns every year for their Management Expense Ratio (MER). Despite egregious management fees paid to “financial Gandolphs” (as Adina calls them — you should really read the article she wrote yesterday), these clowns can’t even beat the market. Some years you might earn 5%. Other years you might earn nothing. And let’s hope you didn’t start saving for Junior’s education in the year 2008, or Junior is headed for Trent.
Hence the CESG is the biggest RESP benefit because it’s a large risk-free return. This benefit is significantly eroded by time and risk.
(BTW, I was kidding, Trent is a good school).
If you invest in an RESP early (and probably before you’ve met all of the criteria in Part 2), you’re eroding the benefit of the risk-free, instant 20% CESG return. To outweigh the corrosive effect of time, you’d need to get a very high rate of return. To get a high rate of return, you’d need to take bigger risks – especially in today’s markets. Bet big with your retirement funds when you’re age 28. Don’t gamble with your 10-year-old’s educational savings.
OK, that all makes sense. Now ask yourself a second question:
What’s the biggest risk of saving in an RESP?
It’s the risk that your kid won’t go to post-secondary or goes to university and drops out. Then you stand to lose all of the CESG money and possibly more (I won’t get into penalties here; suffice it to say they suck), rendering the whole savings endeavor pointless.
Getting the most value out of an RESP now becomes a simple question: how can a parent optimize the risk-benefit relationship?
Don’t use RESPs the way you’ve been told. Save late, not early.
Maximize the benefit by getting all of the free grant money you can. And do it as late as you can.
Minimize the risk by only saving when you’re reasonably confident your child will actually attend post-secondary — then save the money over the least amount of time possible while minimizing investment risk. Remember: we’re after the 20% risk-free subsidy, not capital gains or dividends or 1% savings account interest.
Here’s an example of how you might go about maximizing the benefit while minimizing the risk of an RESP:
When your daughter turns 15, assess her first year in highschool. Did she get good grades? Is she hanging out with the right crowd? If so, start saving $1,500 a month specifically earmarked for her education. Can’t save $1,500 a month? Well, you probably didn’t answer the questions in Part 2 honestly. Or you made the mistake of having kids within 2 years of each other. Adapt this plan as best you can.
The day that your daughter turns 17, you should have $36,000 saved up (more including interest, but only earmark $36,000 for the RESP). Remember? $36,000 is the magic number required to get the maximum grant of $7,200! But don’t put it in the RESP yet. Wait to deposit it until the last possible month.
If she messes up royally, don’t put the money in her RESP. If you do, you’ll probably only live to regret it. Sure, she doesn’t get $7,200 in free money. At least you’ll still have your $36 grand. Tough love at its finest.
If she’s a thriving young adult, deposit the money and you’ll enjoy an instant, risk-free return of 20%. Well, she’ll enjoy it. Six months later she goes to university, and you just beat the system.
Note that there are a bunch of ways to adapt my idea to your specific situation. As I alluded in my example, it’s best to space kids apart by at least two years (I know, I know. Kids aren’t clockwork. Tell me about it, I dare you). Perhaps you could match your child’s own educational savings dollar-for-dollar. Some programs are inexpensive or short and wouldn’t require a $43,200 RESP for a full ride.
Best advice of all: get your kid into an apprenticeship during high school (make sure it’s a useful trade) and she probably won’t even need your money for college. As a graduation present, give her money for a job search trip to Northern Alberta.
RESP Guide, Part 4: Are you considering a Group RESP plan?
Don’t. That is all.
Interesting article. I never thought of RESPs like that. My parents had RESPs for me and my siblings. When I got myself a parttime job and had way more money than I could spend (Oh I tried to spend it all LOL) and I was solid in my choice to go to school I started dropping 2K at a time into the RESP. At the time it was a great idea (probably because I was 16 & 17 when I did it so it wasn’t sitting there) but I agree with you Joe that it is still a good idea for students to find a way to pay their own way. I don’t think I was the best student (major understatement lol) and I really think a bit of responsibility would have bettered my management of things in school.
Yeah, apparently my article is flawed insofar as the strategy is impossible — there is an annual limit on the CESG of $1,000. Still, I highly agree with your experience that parents don’t owe their kids a free ride and it can be harmful.
This is a timely post for us, since we have been putting money into a RESP for our son since he was born. To be fair, it’s only the $100 UCB we get from the government every month. But we are now deciding to up our contribution. This post is making me have second thoughts but … my perspective differs from yours in a crucial way.
My parents always made it clear that they would pay for my university, while at the same time expecting me to do well enough to qualify for scholarships. They covered the shortfall, and I believe they would have covered it even if it had been higher. With that said, they pretty much straight up told me that they would not pay for a BA of any sort. I wanted to pursue an English degree too, and they categorically said “no” – unless I wanted to pay for it on my own. I wasn’t that adventurous. Also, my parents did not otherwise subsidize my lifestyle, beyond paying for shelter and food. No car (I didn’t drive anyway), no fancy clothes, no parties. No crappy grades, or falling behind on my work either. I wasn’t coddled, and I don’t think my ability to be financial responsible or independent was impaired by the extra time I spent at home. If anything, I learned how to be accountable. It’s sometimes easier to be accountable to others (especially people you love & respect) than to yourself. That is, provided your parents have the backbone to be authority figures and look out for your long-term welfare. It’s actually a tougher balance than either cutting your kid off entirely, or keeping them in suspended adolescence indefinitely.
So, yes, I do want to help my kid(s) with their tuition (should it be required) … now, I just gotta figure out the best way to do it, LOL!
p.s. That should be “Gandalf” not “Gandolph” … I wouldn’t want people to think I don’t know my Tolkien …
lol re: Gandalf v. Gandolph — I’d edit it, but the post is clearly so fundamentally flawed anyway (per the fact that CESG is apparently limited to $1k a year. The gov’t literature (I read a pamphlet for this article) is so implicitly misleading. Ridiculous.
It’s pretty awesome your parents were so supportive. But I think it’s pretty clear that you were the kind of good kid to whom I’d recommend giving money (IF a parent is going to give money at all).
“Past behaviour is the best predictor of future performance.” That’s a mantra in HR. If your kid is a screw-up at age 17, it is improbable that his or her life course will suddenly change. People often pull up anecdotal evidence to the contrary “I was a B student in highschool and became an A+++ student” and vice versa, but the truth is that behaviour is more hard plastic than rubber. I had a 94.3% average in highschool and my cumulative in university was 93.5%. Talk about statistically validating the grades at geographically disparate locations. And then I write terrible advice like today; hopefully it’s an outlier predicated on bad information!
Hi Joe, I hate to shoot a hole in your plan (because I agree with most of it), however you can’t wait that long and still get the full benefit of the CESG. According to my buddy Mike Holman, who literally wrote the book on RESP’s:
“You can catch up basically one year of contributions each year. For example if you haven’t contributed for the first five years, the following five years you can double your maximum contributions (assuming you have the money), so you could put in $5,000 and get $1,000 worth of grants and use up your unused contribution room. What you can’t do is contribute $20,000 in one year to try and get the grants from the previous 5 years. Once your child reaches the age of 10 then you start to run out of time if you want to catch up and max out the grants.”
It’s wise to pay off your consumer debt and get your own savings plan under control, and then only contribute what you can afford to your RESP. We only contribute $100 per child, but we’re also executing a plan to pay off our mortgage in 10-15 years while maxing out our TFSAs.
LOL you are totally right. http://www.hrsdc.gc.ca/eng/learning/education_savings/publications_resources/promoter/tools/infocapsules/11.shtml
I was thrown off by the statement that the “Annual RESP Contribtuion Limit” is “unlimited” up to the $50k cap. You’re right that, to max out the benefit, you need to start the year the kid turns 10.
Which is, might I add, exceptionally stupid. Clearly it’s not about empowering parents to make INFORMED decisions. It’s about forcing them to save early, to ramp up the risk of CESG non-collection. The “20%” subsidy is thus even more misleading and a quixotic, risky rate of return. So I guess one needs to make your assessment at, what, age 10? Ridiculous.
Anyone can start an RESP for a child, it doesn’t have to be the parents. I know some people who do this for gifts. They are past the stage where they enjoy buying clothes and toys for kids. If you’re going to give a gift anyway when the kid is born, birthdays, holidays etc. why not do something that will last more than a year or two?
As for the risk, I think there are some options if the child doesn’t go to post-secondary. I haven’t looked into it as I don’t have kids and haven’t given one as a gift. The money can be moved into an RRSP (any grants are lost), and I think the money can be switched to a different child but I’m very hazy on those details.
Good points.
There’s definitely an option to transfer it to another child; in fact a person can start a “family” plan in the first place. Problem is, I see this as a very ineffective way to risk pool b/c the risk of a child not attending, or going into a very expensive program, is spread amongst who? 3 kids at best?
As you note, the grants are lost if you move it to an RRSP. But it’s WAY worse than that. You lose RRSP contribution room. That’s straight-up stupid, because unlike an RRSP, the RESP didn’t give you a tax break up front. So you’re losing the grants and RRSP contribution room. It’s such a government money-grab that it disgusts me.
There’s also the possibility of cashing out the RESP rather than transferring to an RRSP. In which case you also get dinged by lots of taxes and probably lots of fees.
The “pooling” option is kind of risky but better than nothing. The RRSP or cash-out options are just brutal.
“Scarcity forces a person to think rationally.”
Maybe that’s why I did fine, despite my parents paying for my education in entirety. I always told myself that I had no money, to the point of graduating with over $30k in the bank.
On marks…my university admission average was somewhere around 92-24%, but my average in university was in the low to mid 80s, which was a pretty good average for my major and school. University was way harder than high school, so I think I did pretty well.
I know of people who have used the RESP to help fund their retirement, once they were certain that their kids were going to college. That’s kind of sketch.
It’s interesting you bring up grades (and that unlike most bloggers, you’re so candid and willing to share your own). I’ve been called out (in private) by another blogger re: citing the grades I achieved in University. I’m not trying to brag about being smart (this very article had a massive flaw that Robb from Boomer and Echo pointed out). Good grades might demonstrate a person’s inherent intelligence. Fair enough; it’s pretty tough to drive 150 MPH in a Honda Civic. I mean it as proof of my willingness to work hard (perhaps this ties in with wisdom, time management skills, or whatever, too) and thus an explanation for my scholarships and personal success to date. Grades are just a proxy, since it is much more difficult to show any externally demonstrable examples of hard work post-graduation with the exception of perhaps a solid employment history. Don’t get me wrong, the grades are irrelevant after school is out (unless you’re headed for a PhD in a few years). It’s all about the Benjamins and achieving your definition of success. And on those benchmarks, you’re doing very well. Your hard work earned you a position that is very lucrative, while your ‘scarcity mentality’ got you there without going into debt. If I could choose to be endowed with either university scholarships or the ability to work hard, then I’d choose the latter in a heartbeat.
Yeah, the RESP => RRSP transfer is scary. If you have the contribution room, it means you were choosing kids’ education over your retirement security (which as I discuss is a stupid thing to do). Further, you completely lose the biggest benefit of the RRSP, which is a tax rebate. You don’t get one with RESPs. Not only is it sketch, it’s just straight-up stupid.
Oh no, I meant that they would pull money out of the RESP as their kids were going to college and then they wouldn’t pay for their kids’ college with the money.
that’s horrible! Although I kinda lol’d cause that’s an epic troll move. But stupid insofar as they should have just contributed to an RRSP and gotten the tax break… what a dumb thing to do hahah
I agree that if you’re ensuring your children have somewhere to live, something to eat, and something to wear you don’t owe them much more in terms of physical/financial things and giving too much more could be dangerous. However the RESP doesn’t have to be a gift. It’s been 6 months since I read the book but from what I remember you own and control it until you decide to distribute the cash.
What our kids don’t control is the potential time in the market. If I could have invested $2500 when I was born, gotten a 20% bonus, and then let it grow for 18 years and transferred it to another account at a time when I paid virtually no taxes on the gains, I might well have taken that deal. But it was another 8-10 years before I started to think bonds were really cool so I didn’t have that choice.
So our plan is to put in a little as early as possible ($2500 this year, we’ll see after that), and let it grow in appropriate investments for the time-frame. If it averages a 5% real return that will grow to 2.89x the amount contributed. And then in 18 years it will still be our cash, so we can decide what needs to be done to earn the money. I would guess that doing something equivalent to the amount of the original contributions would be a reasonably good lesson about work/investing/taking-good-deals-while-they-last (do $1000 of work this month, get $2890 next month). But we have time to think about that.
We’ll be using a family plan to make distributions more flexible and reduce the risk. We could just combine this with our general investments and not have the risk of cancelling the plan, but I think the 20% bonus + low-tax withdrawals gives it a slight advantage, in addition to not (initially) using up valuable contribution room in regular retirement accounts.
That is an important consideration: it remains your money to give out as you see fit. As I noted, the family plan doesn’t mitigate the risks a ton but I agree that it does at least allow you some flexibility (including the flexibility to pick which child gets more money, or which child doesn’t deserve any at all — a lovely dinner conversation courtesy of the federal government to be sure). I think I’m going to spend the next 15 years encouraging my daughter to enter a well-paid trade like becoming an electrician. No dolls, just tool toys.
Or computer science! Encourage your daughter to go into computer science or engineering
lol good point, I’ll keep that in mind. Robots will probably form an increasingly large part of our lives, too, so I’ll also add robot design/maintenance to the list.
That’s always a good way to go, and many real tools can double as fun toys which could be a better investment than traditional education. I played with (low-voltage) electronics components and eventually programming which ended up being useful. A friend’s 8-year-old suddenly started welding things recently. I don’t know if that’s more promising or scary! (apparently it is with proper equipment and supervision so it’s not quite like the memories I first thought of)
Your kids can use tuition and books as a tax deduction. This can be carried forward to future years to offset their first year or two of income. This was a nice break for me when i was starting out. But then again i paid for my own education by working PT, so i had the moral right to claim it. But i suppose this benefit would actually be lost if it was instead used to offset the income of the resp withdrawls. Fair enough, they should eat the tax if their education is paid for.
I, too, enjoyed the tuition credits. Paying little or no tax for the first year after grad is a huge boon.
My parents wanted me to give them my credits — they didn’t pay for my tuition or books, house me during university, etc. so I thought it was a pretty unreasonable request.