29.6.12

Be Your Own Investment Manager: Part 9 - Saving for Education (RESPs)

By Ed





Schools out for Summer, so why am I going back to the personal finance books?  Well, if you are a parent, June means that your kids are one year closer to being done with public provided school, which also means you have one year less to save to pay for the next step.  Sending the kids to university or college has very nearly become an assumption amongst parents.


Even if your son or daughter won't be going to a traditional classroom after high school, there is a world of Trades, Arts and other programs out there to help them find their calling (and hopefully a paying career).  Again, all of these will cost money.  So how are you planning to pay for it all?


The Registered Education Savings Plan (RESP) is the single best vehicle we, as Canadians, have to save money for our children's education. 


It is the mythical "Free Money" button you can press.  Interested in how they work?  Read on.




I am not going to go into all the reasons on why you should save - we have all heard about the costs of going to school and how tuition goes up faster than the rate of inflation.  All I want you to care about is that even if you haven't started saving yet, every drop helps.  
  • You may not be able to pay for all of their post-secondary schooling, but getting them started is great.
  • It will also mean borrowing less money, which is a much nicer way to start life.  
  • If nothing else, it shows kids that you value education (which it turn, has shown to improve their performance - in fact, your efforts may actually matter more than theirs or their schools.  Talk about pressure). 


Like RRSPs, RESPs are not really just one investment.  You can choose pretty much anything going (stocks, mutual funds, GICs, plain-jane Savings Account) and fill in paperwork to call it an RESP.  This will give you some tremendous advantages over just having the money socked away.   

 

What are those advantages?  Here is the list:

 

Free Money!  
  • For every dollar you contribute, the Federal Government tops it up by 20% with something called the Canada Education Savings Grant (CESG).  Depending on your income, you may get up to a 40% top up.  Check out the Revenue Canada scale to see how much you'll get and the maximum yearly limit (sorry, the free money does have a cap - $500 (20% of $2500) for most of us).  But do you know any investment that offers a risk-free, 20% return in the first year?  Neither do I.

Tax sheltering: 
  • Several months back we talked about how awesome compound interest (read that post here) is and that in order to get those growth advantages, you need to leave the money untouched.  RESPs help you do this by tax-sheltering the growth your money earns over the years.  The lifetime maximum for contributions is currently $50000; there is no cap on growth (other than your own risk/return tolerance).

Freedom to choose how it is spent: 
  • As long as your kid goes to some sort of educational institution (the list is here and crazy-long; it includes Canadian and international schools), the money is yours to direct.  With each withdrawal, you will have to do a little paperwork to prove junior really still does go to school, but once withdrawn, tuition, computers, housing, food, transportation are all options.

Money is taxed as income to your child: 

  • Apart from your original contributions (which were already taxed when you earn them), income taxes need to be paid on the CESG and Growth portions of the RESP.  These will be taxed on withdrawal in the hands of the beneficiary (in other words, your kid).  Since students' income levels tend to be low (likely lower than yours anyhow), the tax they pay will be negligible.  

Missed a year?  Or 10?  You can catch up!
  • If you don't contribute enough to get the maximum CESG in a given year, it carries forward.  If you find yourself with more ability to contribute in future years, you can catch up (to a maximum of one year every year).  For example, if you could only contribute $1000 a year for the first 5 years of an RESP but then find yourself with more income, you could "catch-up" for 5 years with an additional $1500 a year and still get CESG (this would be in addition to the normal yearly maximum of $2500)

 

So, if you are a cynical sort you are likely asking, "How do I pay for this free lunch?".  Critical thinking is good, especially in investing (ask John Elway), but the drawbacks to RESPs are few and far between. 

 

 

A shortlist of things to consider:

 

If Sally or Timmy don't go to school, can I get my money back? 

  • Yes - you can get your money back.  Think of the RESP money as three parts:  1) Your Contributions (money you paid tax on already and put into the plan) and 2) CESG (the Free Money) and 3) Growth (investment return) portions.  You get back the money you put in (tax-free), the government gets back what they put in (only fair) and whatever is leftover (the Accumulated Income) gets taxed as income to you, plus an additional 20% penalty.  Given that it was growth that occurred on money that was 20% free in the first place, this is likely fair too.

There will be paperwork:

  • Beginning with getting a SIN (Social Insurance Number) for your baby as early as possible, there will be forms when you contribute and forms when you withdraw.  There is no getting around this.  If you're paperwork adverse, this might be a good argument for getting an actual financial planner or bank to help you.  If you can suck it up, you can save that extra commission portion and invest it.

What if Timmy or Sally chooses a school not on the list? 

  • There is apparently a provision for getting alternative programs approved (by contacting CanLearn).  But, what I would like to suggest is that if your chosen school isn't on the list, there probably is a reason.  I hate to cast dispersions, but your chosen school may not, in fact, be worth paying for.

This is only an RESP primer; to hopefully convince you to get the ball rolling if you haven't already. 

Interested in doing more reading? 

Super RESP link/article master list from RetireHappyBlog.ca


So, schools out for summer, but with apologies to Alice Cooper, it is not out forever and it fact will cost you a boatload of money someday. 


Not a catchy metal song, but more valuable as a personal finance plan. 

 

Leave a comment below and I will try and field whatever questions you have.  Are you already using an RESP to save for your kids future? 


Keep reading...


The "Be Your Own Investment Manager" Series:


Part 1: Best Time to Start
Part 2: How Much and How Often to Invest
Part 3: Invest in Your Debt?
Part 4: Risk and Return
Part 5: Mutual Funds
Part 6: Simple Investment Options
Part 7: Saving for Retirement (RRSPs)
Part 8: The Colour and Psychology of Money
Part 9: Saving for Education




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