While back to school is looking different this year, the benefits of contributing to a Registered Education Savings Plan (RESP) have not changed. Parents and grandparents, who have set up a RESP for their children or grandchildren, are still encouraged to stay the course with making planned contributions. Ensuring the matching grant money is received, obtaining the long-term tax deferral, family income splitting, and years of compounded growth are all key elements that make a RESP successful.
One of the main attractions for RESP accounts is the ability to receive grant money for qualified contributions which we will discuss below. Another main feature is that both the contributions and grant money received can be invested for further growth. The compounding of investment returns should far exceed the grant money if the RESP is invested appropriately early on. A RESP can be set up when a child or grandchild is born.
If a parent or grandparent (the “subscriber”) opens a RESP when a child (the “beneficiary”) is born, and that same child begins their first year of university at age 18, then the funds will have the ability for compounding growth for 18 to 22 years. The maximum deferral of a RESP is 35 years, at which time the plan must be collapsed. The range therefore is between 18 to 35 years, for those that contribute early on.
The key to get the above deferral is to contribute early. Don’t wait until your child is a teenager before contributing to a RESP. Let us compare the deferral within a Registered Retirement Savings Plan (RRSP). For example, you can begin contributing as early as age 19 to an RRSP in B.C. and can keep 100 per cent of these funds tax sheltered until age 72, at which time you must begin small withdrawals - typically done over a 15 to 20 year period. The deferral of compounded growth for RRSP accounts is between 53 to 73 years – significantly longer than an RESP. We encourage parents and grandparents to contribute early on for RESP accounts to take advantage of the compounded growth, as well as to receive the grant money sooner.
Every year is important when it comes to contributing to a RESP. The optimal strategy I map out for young parents is to contribute $2,500 each year for the first fourteen years of their child’s life, and $1,000 when your child is 15. Doing the contributions early each year allows a greater amount of time for the value of the RESP to grow. If coming up with $2,500 as a lump sum is difficult, then we suggest setting up a Pre-Authorized Contribution (PAC) of $208.33 every month (assuming only one child). Automating this with your Portfolio Manager will help ensure you keep with the plan.
Apart from the rising cost of education, the government provides the Canada Education Savings Grant (CESG) for contributions made up until the end of the calendar year in which the child turns 17. The basic CESG provides a grant of 20 per cent, up to an annual maximum of $500 per child. The lifetime maximum grant is $7,200 per child. The plan noted above has annual contributions of $2,500 for 14 years ($500 CESG each year x 14 = $7,000) and a $1,000 contribution in the 15th year ($200 CESG). This contribution schedule enables the subscriber to claim and obtain the maximum $7,200 per beneficiary.
Now that we have mapped out the strategy of contributions, the next decision is to decide how to invest the money. The RESP account will have your contributions and the CESG all in one account. These funds can be invested in a number of different ways depending on the financial institution you are dealing with. If you open the account up at a bank or credit union then you’re likely investing primarily in mutual funds. If you open the account up at a full-service investment firm then you could explore different, lower-cost, options outside of mutual funds, especially once the account gets built up.
Investing in individual common shares can be another good option. I feel that the RESP can be a fantastic learning opportunity to teach children about finances and investing. Every year you can sit down with your kids and discuss what to do with the current contribution money. You can analyze companies and weigh the pros and cons of different investment choices. Over time, you can teach your kids how they can track the RESP investments.
The initial priority should be setting the savings discipline and obtaining all available CESG grant money. As the beneficiaries get closer to needing the money (i.e. going to University) then shifting some or all of the investments into something more conservative to reduce risk generally makes sense.
Next week, we will discuss the strategy of how to utilize RESP funds for post-secondary education.
Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director, wealth management, with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138. greenardgroup.com