I always think of early September as the real “New Year’s”. All across the country, children and young adults went back to school, at different times, over the past few weeks. September 14th was the first day back for our daughter who is in Grade 12. Like most other aspects of life in 2020, high school looks different this year. In early September my older daughter moved to Hamilton, and is attending McMaster university online (she didn’t want to live at home any longer). No residence, classes online, and restrictions on gatherings; it doesn’t look much like my first year of university, which, mind you, was a long time ago.
What hasn’t changed though, is how we should be planning to save for our children’s eventual post-secondary education. The best method is a Registered Education Savings Plan (RESP).
Whether your child attends university, college, or trade school, there are definite benefits to contributing to an RESP. The biggest one is free money! Ok, not quite free, as you have to contribute to get it, but it feels like free when the government is putting money into your investment account.
There are three sources of funds into an RESP:
- Your contribution – up to $50,000 per child lifetime
- Government Grant – everyone gets the Canada Education Savings Grant (CESG – a maximum of $7200), and lower income households may get additional money, called the Canada Learning Bond.
- Investment Growth on the above.
When you withdraw money out of the RESP, as our family did just last week, the income (CESG, Growth) is taxed in the student’s hands. This is usually an advantage as students, especially in the early years of school, will very likely have a lower income tax rate than you the parent. Your contributions are never taxed upon withdrawal; only the free government money and growth, as your contribution were made with after tax dollars.
The standard operating procedure is to contribute $2500 per child per year, as this is the maximum amount you can contribute and receive the 20% CESG annually. You contribute $2500, the government adds $500 (20%), and the total for the year will be $3000! You can contribute monthly, annually, or anywhere in between.
If you didn’t start soon enough, you are allowed to catch-up an additional $2500 per child per year. $5000 + $1000 (20% CESG) = $6000. So as long as you don’t wait too long, you can still collect all the free money. Of course if you wait too long, you may also miss out on tax advantaged growth. Here are three different examples highlighting the power of compound growth.
START EARLY – $2500 per year in January, 4% investment return, over 18 years = $74,813. This assumes you max out the government grant about age 14, but continue to contribute $2500 per year until age 17.
LUMP SUM EARLY – $45,000 in year one (which is age zero by the way), 4% investment return, by age 18 (which is year 19) = $95,862. This assumes you only get one year of CESG so the total investment is $45,500. Note, you are actually allowed to contribute up to $50,000 ($106,396 at age 18) but I wanted to compare $2500 x 18 = $45,000.
START LATE – $5000 per year starting age 9, 4% investment return, over 9 years (you can only get the CESG until they are 17) = $63,397.
In Start Early and Start Late you maxed out the $7200 CESG, but ended up with less. The sooner you start the better. Even though you invested the same amount in each scenario, $45,000, the outcomes are drastically different.
When the student attends post-secondary school you can draw out any amount you want, although there are restrictions about how much of the CESG and Growth you can draw down in years 1 and 2. Usually we can get the taxable portion out of the RESP and into your hands over those first two years. After that, most of the withdrawals will be your own contributions and are not taxable. This is a fairly simple process, although wait times get a little longer in late August and early September. Don’t wait until the last minute.
In the worst case scenario, where your child never attends any post-secondary institution, an RESP can stay open for up to 36 years in case they change their minds. With a Family RESP, funds can be shared amongst siblings, so if one attends longer (graduate school as an example), you can still utilize all the savings, grant and growth. If the account needs to be wound up there is a “penalty” of 20% on the growth in the portfolio. Your original contributions can be returned to you, and the CESG portion has to go back to the government.
There is truly very little downside, unless you feel your child will never ever, not in a million years, attend any sort of training or educational facility after high school. While I agree there is always that possibility, it is fairly small in this day and age, and is outweighed by all the benefits of an RESP.
Start early. Save monthly. Invest wisely (that is a whole other conversation).
For more information, check out the Government of Canada website, which is actually quite good – https://www.canada.ca/en/employment-social-development/services/student-financial-aid/education-savings/resp/info.html.
Happy New Year!
It's Not Rocket Science 