Friday, January 9, 2015

5 RESP Strategies


UPDATED: Please also read my followup article here


I am not a tax professional. You should consult one prior to making investment decisions with tax implications. The documentation from CRA details that contributions can be returned to the subscriber for RESP's when the child is in school, but ensure you fully understand the rules on this most complicated investment account.

RESP Strategies

In Canada, a Registered Education Savings Plan (or RESP) is a government sponsored type of account to save for your child's education. Fortunately, I've just been blessed with a daughter, so the need for this has become more important.

Note: this article assumes your family income is over $87k, and so excludes the Additional Canada Education Savings Grant.

Note2: I am not a tax professional, so do your own checking or consult a professional. This information is for entertainment only (and how entertaining it is!!!).

If you don't feel like reading this list of 4 strategies, you may jump straight to my Google Doc Spreadsheet which allows you to play your own What-If games with RESP savings. From the File Menu select "Make a Copy" to make your own version you can edit.

Option 1 - Do Nothing!

Doing nothing is definitely one option. You may for financial reasons be unable to contribute to an RESP. Some people feel that a child should completely pay for their own education to feel involved in it. Others may feel that college or university is not for their child. There is some truth that by not having any income, a child will be eligible for more bursaries, loans or other assistance from the government when applying to university or college.

Just be aware, if you don't take one of these other strategies, you are tacitly choosing the Do Nothing approach.

I personally do not favour this, since because I have an 18 year head start on my daughter, I can save for her education without much difficulty. Since I am fortunate enough to be able to do so without much pain, I choose to.

Option 2 - Max Out Government Matching As Early As Possible

With the Canada Education Savings Grant, the government will match 20% of annual contributions, providing up to a maximum of $500 per year, for a total of $7,200.

With this strategy, you contribute $2,500 starting in the year the child was born, and each year until the year the child turns 15. The benefits of this are:

  1. You get the full $7,200 matching money
  2. You get the matching money as early as possible, so it has more time to grow

 Assuming you contribute until your child is 17, with 5% investment return, the account will be worth $93,552.

Factoring in the time value of contributions (don't worry if the math gets fuzzy here) the total portfolio return is 294.89%

Option 3 - Max Out Contributions, but still get Government Matching

There is a limit of $50,000 that can be contributed to the RESP. There is also no limit to how much you can contribute each year, so theoretically you could contribute $50,000 right after your child is born. The downside to this, is you would get $500 matching in year 0, but no further matching since you wouldn't have any contribution room left for year 1, to get the $500 available in year 1.

So, with this strategy, you can contribute up to $3,500 per year and still get the full $7,200 of matching. The benefits of this are:

  1. You get the full $7,200 matching money
  2. You get the matching money as early as possible, so it has more time to grow
  3. IF you're worried about the cost of university, you have the extra $1000 per year vs the $2500 strategy, which grows tax free, and was put in as early as possible.
  Assuming you contribute until your child is 15 (you hit the $50k limit at age 14), with 5% investment return, the account will be worth $106,588. Note that you're only contributing $5,000 more than the $2,500 approach but because you're doing it earlier, you have $13k more in the account. The difference would be even greater with a higher investment return than 5%.

Factoring in the time value of contributions (don't worry if the math gets fuzzy here) the total portfolio return is 288.99%. This is lower than the $2,500 because you're putting in more of your own money versus having a 100/20 ratio of your money to government money.

Option 4 - $50K Right Away!

If you somehow had a spare $50k lying around, you could contribute the whole thing in year 0. You would only receive $500 of matching, but would have more time for your money to compound tax-free.

The benefits of this are:
  1. You never worry about making another contribution
  2. The money has the maximum time to grow
With 5% return, this works out to $127,611 in year 18.

Factoring in the time value of contributions, the total return is a measly 255.22%, considerably lower than the other two.

Option 5 - Get Max Government Matching Then Stop

This approach lets you maximimze the ratio of government money to yours. The total account return is 301.83%, but the value is quite a bit lower. This approach is ideal if you have other places you need to put your money. It is the most efficient, but again, that depends on what you would do with the money otherwise. If you were in a high tax bracket, invested the money in your own name and had to pay tax on the gains, and gave that to your child for schooling, then you should opt for the original Option 2 instead.

Key Takeaways

If you contribute $2,500 per year in the early years... you get the matching money early with the most time for your money AND the matching money  to grow.

If you contribute more than $3,500 per year ... you are going to lose out on some of the $7,200 in matching money.

1 comment:

  1. The optimum might actually be somewhere between Options 3 and 4. One can front load contributions in the year baby is born to the tune of $16,500 and yet still get the full $7,200 grant. In other words, contribute $16,500 in year 0, $2,500 in years 1 to 13 and the final $1,000 in year 14 for a total of $50,000. That person would then receive 14 grant payments of $500 and a last one of $200 for a total of $7,200.