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Kevin Greenard: The benefits of a disciplined RESP approach

It’s essential to start planning for the costs of education early and take a disciplined approach to RESP contributions to take advantage of the full benefits.

Parents (and grandparents) want the best for their children and grandchildren, including a good education. In today’s competitive job market, a college or university degree is more important than ever and will likely become even more necessary in the future. That’s why it’s essential to start planning for the costs of education right now and take a disciplined approach to RESP contributions to take advantage of the full benefits.

The benefit of deferral

Parents or grandparents who have set up an RESP for their children or grandchildren should employ a strategy 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 an 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. An RESP can be set up when a child or grandchild is born.

If a parent or grandparent (the “subscriber”) opens an 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 and compounding period of an RESP is 35 years, at which time the plan must be collapsed. The compounding period therefore is between 18 to 35 years, for those that contribute early on.

The key to get the benefit of the above deferral is to contribute early. Don’t wait until your child is a teenager before contributing to an 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 BC 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.

Greenard Group’s regular contribution strategy

Every year is important when it comes to contributing to an RESP. The typical strategy we map out for subscribers is to contribute $2,500 each year for the first fourteen years of their child’s/grandchild’s life, and $1,000 when the child/grandchild is 15. Making 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. If there is any unused grant room from a previous year, the maximum annual CESG can be up to $1,000. The lifetime maximum grant is $7,200 per child. The strategy noted above has annual contributions of $2,500 for 14 years ($2,500 x 20 per cent = $500 CESG each year x 14 years = $7,000) and a $1,000 contribution in the 15th year ($1,000 x 20 per cent = $200 CESG). This contribution schedule enables the subscriber to claim and obtain the maximum CESG of $7,200 per beneficiary.

Greenard Group’s regular contribution strategy illustrated

The below example illustrates the power of compounding growth. If contributions are made in line with the regular contribution strategy shown above, then assuming a five per cent rate of return compounded annually, the RESP plan value would be worth $76,499 in the year the child/grandchild wants to attend post-secondary school. With the power of tax-sheltered, compounded growth, the initial RESP contributions of $36,000 have more than doubled when also adding in the CESG received.

   
   
   

Year

Opening balance

RESP contribution

Grant received

Total

Investment Income (assuming five per cent rate of return)

Closing balance

Year 1

0

2,500

500

3,000

150

3,150

Year 2

3,150

2,500

500

6,150

308

6,458

Year 3

6,458

2,500

500

9,458

473

9,930

Year 4

9,930

2,500

500

12,930

647

13,577

Year 5

13,577

2,500

500

16,577

829

17,406

Year 6

17,406

2,500

500

20,406

1,020

21,426

Year 7

21,426

2,500

500

24,426

1,221

25,647

Year 8

25,647

2,500

500

28,647

1,432

30,080

Year 9

30,080

2,500

500

33,080

1,654

34,734

Year 10

34,734

2,500

500

37,734

1,887

39,620

Year 11

39,620

2,500

500

42,620

2,131

44,751

Year 12

44,751

2,500

500

47,751

2,388

50,139

Year 13

50,139

2,500

500

53,139

2,657

55,796

Year 14

55,796

2,500

500

58,796

2,940

61,736

Year 15

61,736

1,000

200

62,936

3,147

66,082

Year 16

66,082

0

0

66,082

3,304

69,387

Year 17

69,387

0

0

69,387

3,469

72,856

Year 18

72,856

0

0

72,856

3,643

76,499

Greenard Group’s optimal contribution strategy

While $36,000 of RESP contributions attract the CESG, the lifetime maximum a subscriber can contribute to an RESP is $50,000. The excess $14,000 ($50,000 - $36,000) does not receive the grant. However, the funds can be contributed and benefit from tax-sheltered compound growth. With the Greenard Group’s optimal contribution strategy, $16,500 is contributed in the first year ($2,500 regular RESP contribution to attract the CESG plus $14,000 excess contribution). For the next 13 years, $2,500 is contributed to receive the $500 grant. In the fifteenth year, the final $1,000 is contributed to receive the remaining $200 of eligible grant money.

Greenard Group’s optimal contribution strategy illustrated

Let’s see what the optimal contribution strategy looks like as illustrated below, assuming a five per cent rate of return compounded annually, similar to above, but with the key difference of contributing the additional $14,000 in year one:

Year

Opening balance

RESP contribution

Grant received

Total

Investment Income (assuming five per cent rate of return)

Closing balance

Year 1

0

16,500

500

17,000

850

17,850

Year 2

17,850

2,500

500

20,850

1,043

21,893

Year 3

21,893

2,500

500

24,893

1,245

26,137

Year 4

26,137

2,500

500

29,137

1,457

30,594

Year 5

30,594

2,500

500

33,594

1,680

35,274

Year 6

35,274

2,500

500

38,274

1,914

40,187

Year 7

40,187

2,500

500

43,187

2,159

45,347

Year 8

45,347

2,500

500

48,347

2,417

50,764

Year 9

50,764

2,500

500

53,764

2,688

56,452

Year 10

56,452

2,500

500

59,452

2,973

62,425

Year 11

62,425

2,500

500

65,425

3,271

68,696

Year 12

68,696

2,500

500

71,696

3,585

75,281

Year 13

75,281

2,500

500

78,281

3,914

82,195

Year 14

82,195

2,500

500

85,195

4,260

89,455

Year 15

89,455

1,000

200

90,655

4,533

95,187

Year 16

95,187

0

0

95,187

4,759

99,947

Year 17

99,947

0

0

99,947

4,997

104,944

Year 18

104,944

0

0

104,944

5,247

110,191

Contributing the additional $14,000 early on results in a significant increase in the plan value of $33,693 ($110,191 - $76,499). Taking out the extra $14,000 contributed shows that it resulted in $19,693 of extra income ($33,693 - $14,000).

How to invest RESP funds

Now that we have mapped out the strategy of contributions, the next decision is to determine 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 and/or Guaranteed Investment Certificates (GICs). If you open the account up at a full-service investment firm then you could explore a variety of lower-cost options outside of mutual funds, including individual shares, especially once the account gets built up.

Investing in individual common shares can be another good option. We 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 analyse 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 readily accessible money market is a prudent move.

Kevin Greenard CPA CA FMA CFP CIM is a Senior Wealth Advisor and Portfolio Manager, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the TC. Call 250.389.2138, email greenard.group@scotiawealth.com, or visit greenardgroup.com.

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