Thoughts About RESPs

For well over a decade now, funding a Registered Education Savings Plan (RESP) has been the preferred method for those people who wish to plan and pay for their children’s and / or grandchildren’s education. Officially created in 1974, the popularity of the RESP really took off when then Minister of Finance Paul Martin introduced the Canada Education Savings Grant (then a new government program) to incentivize families to self-select as education funding partners for the young people in their families as part of the 1998 Federal Budget.

The problem that Martin had to grapple with is that education falls under provincial jurisdiction in the Constitution, but provinces would happily receive federal transfers that were earmarked for education and (since children can’t vote) would sometimes divert that money to build hospitals, repair roads and various other non-educational priorities. Applying the principle of “there’s only one taxpayer”, Martin’s policy people concluded that if they could find a way to go over the premiers’ heads to get to those citizens (each a citizen of Canada and of their respective province), they could cut out the provincial middleman and financially help those families who self-identified as making education funding a priority, it would be a laudable advance. Accordingly, the Canada Education Savings Grant (CESG) was created to offer pro-rated matching funds for families that were doing their bit in advance.

While it has been tweaked a bit over the years and while there are a few wrinkles that make the CESG even more attractive to low-income families, the main point about the CESG is this: the federal government will match up to 20% of all contributions up to $2,500 / child / year. Accordingly, a $2,500 RESP contribution will attract a $500 CESG payment – typically at the end of the month following the month of the contribution (31 to 60 days later). Essentially, it’s a 20% guaranteed return on investment if you assume that the grant money is invested the same way as the initial contribution.

The thing about RESPs is that many families don’t always make annual payments (or are late in setting up RESPs in the year their child is born because they have too much going on), so catching up can pose a few modest challenges. To begin, people can catch up by paying for up to one year of missed payments at a time. Let’s say your child was born in 2015 and that you haven’t contributed to an RESP to date. You could put in $5,000 in 2017 and apply half of that money for the previous year (2016). In a few months, you’d receive $1,000 of free grant money from our friends in Ottawa. Then, in 2018, you can contribute a further $5,000 (half to be used in 2018 and half for the most recent unused contribution year of 2015) and again, you’d get $1,000 a few weeks after the contribution. From that point forward, making annual $2,500 contributions would maximize your child’s CESG eligibility. Grants are paid until the year in which your young scholar turns 17 – and the proceeds can be used to fund any post-secondary education you can think of (chef’s school and mechanic programs apply).

Many people are less than careful about the investment choices made within an RESP. In essence, anything that is eligible to go into an RRSP or TFSA can also be purchased in an RESP. As a general rule, I usually recommend putting contributions (and grant money) into equities until age 9 or 10 and then putting all new contributions into income-generating alternatives thereafter. Your children may be much younger than you, but their time horizon is typically much shorter. They’ll need the RESP money for school long before you need your RRSP money for retirement (in most cases). I know it sounds odd to start “being more conservative” for an eleven-year-old, but that’s the reality of prudent RESP management. People should be able to set aside $70,000 to $90,000 using reasonable growth assumptions (i.e. provided they are not unduly prudent or hopelessly unlucky) and, depending on the program and whether junior stays home, that amount ought to be just about enough to pay for a four-year undergraduate degree.

Note that the lifetime CESG limit is $7,200 and that the RESP also has a lifetime maximum contribution limit of $50,000. Of this $50,000 lifetime contribution limit, only $36,000 would qualify for the 20% CESG grant before maximizing the separate $7,200 grant limit. Still, for wealthy people who are more concerned about long-term tax deferred-compounding (and this is especially sweet if there has been a significant market pull-back), putting in a lump sum of $50,000 right after your child has been born can potentially lead to having a truly massive RESP balance come frosh week.

Now there are other related considerations that many people intuitively ask about…

Q.        Do I get a deduction for any contributions?

A.        No, but withdrawals are taxed in the child’s hands, so there is often no tax associated with             withdrawals (in this respect, RESPs are a lot like TFSAs).

Q.        Can I set up a family RESP if I have more than one child?

A.        Sure. It might save you on trustee fees and it might provide greater flexibility of one study (for instance) goes on to graduate school while another does not.

Q.        Can people have more than one RESP?

A.        Sure, but contribution limits are capped as noted earlier and monitored (cross-referenced) using the child’s social insurance number (a pre-requisite to account-opening).

Q.        Can other people contribute to RESPs?

A.        Sure. For instance, I often encourage grandparents to help their adult children out by funding some or all of their grandchildren’s educations. There can be complications regarding third party cheques, however. It might be easier for grandparents to give the money to their children so that the children (i.e. parents of the grandchildren) can make the deposit.

Q.        What do the proceeds have to be spent on?

A.        No one asks. If junior has established enrollment in a post-secondary educational program and provided proof, if junior wants to spend the money on fast women and slow horses (and squander the rest), that would be his prerogative.

Q.        What if junior doesnít go to school like we want him / her to?

A.        An alternative beneficiary can be named. However, if the subscriber does not name a new beneficiary, the following terms will apply once the plan is closed:

            i) Capital: The subscriber may recover the original capital (contributions).

            ii) Grants: Must be reimbursed to the government.

            iii) Gains: The subscriber may, under certain conditions, receive the accumulated income payment.

All told, RESPs are a wonderful and flexible way for most middle-class families to help their children out.

For more information, please feel free to visit CRA’s website at: http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/resp-reee/menu-eng.html

John De Goey is a portfolio manager with Industrial Alliance Securities Inc. (IAS) and the author of The Professional Financial Advisor IV. The views expressed are not necessarily shared by IAS. Industrial Alliance Securities Inc. is a member of the Canadian Investor Protection Fund.