In this series of articles we’ve looked at a number of topics around RESP accounts:
- Basic concepts of RESPs
- Scenarios for funding an account including maximizing grants and contribution limits
- Projected outcomes when withdrawing from the account to fund post-secondary education
One important observation is that even under the best scenarios, an RESP may not fully fund a post-secondary education including tuition, fees and living expenses. So its important that families still explore other ways to fund a child’s education including part-time work for the student, co-op/internship jobs, scholarships/bursaries, etc. This lack of ability to fully fund education is a function of the increasing costs of post-secondary education and the fact that the Government of Canada has not adjusted lifetime contribution and grant limits since 2007. One could also argue this is intentional and that an RESP is not intended to fully fund an education but merely help.
Despite these points and given the rules around grants and contributions today, an RESP is still one of the most effective ways to save for a child’s education. The grants represent a guaranteed return on your investment that you can’t find elsewhere. And the tax advantages of withdrawing investment returns in the hands of the beneficiary can be significant.
Our Personal Story
Early in our personal finance journey and our children’s lives, we did start contributing to a family RESP. The contributions were small at first but over time we increased them as our family income grew. This journey was very much the inspiration for the scenarios we analyzed in Part 3.
One of my personal “aha” moments around RESPs was realizing that funding our childrens’ education was effectively a future liability and using an RESP was the best way to save against that liability. Even if we couldn’t hit the maximum contribution limit we should at least try to maximize the grants. Because this realization came late (and only after we could afford it), we never did get the maximum grants for our first child. But I’m happy to say we did for our second and we’re on our way to maximizing both the contribution limit and grants for our last two children. Overall we’ve saved enough that each child will be able to get enough each term from the RESP to pay for their tuition (adjusted over time for inflation). I think this is a good example of a sub-optimal result that has still put our family in a good financial position.
From the very beginning we made our contributions through regular pre-authorized transfers from our main banking account to the family RESP. Setting up regular automatic contributions fits many our our foundational personal finance principles. Once we had set this up, we just increased these automatic contributions over time as we could afford to do so.
Handling Multiple Accounts
We also had grandparents and great grandparents that saved in separate RESPs. Although this hasn’t became a problem for us, this can complicate tracking the overall contributions and grants for each child. If you’re not careful with multiple accounts you could over contribute which triggers tax penalties.
A useful tip to manage this is that you can get detailed information on contributions and grants from the Canada Educating Savings Program office. It requires a good old fashioned phone call to 1-888-276-3624 but I’ve found it very easy to just call them up and get details for each child once a year. In hindsight, if we had arranged with our relatives to just contribute to the plan we were managing, that would have simplified things.
Our Asset Allocation
In the early days of our family RESP account we used TD Direct Investing as our brokerage since TD was also our primary bank. Back in the early 2000s, there weren’t as many great options as there are today for low cost diversified funds but I followed the TD e-series mutual fund model portfolio from the great Canadian Couch Potato. This gave us a portfolio of four relatively low cost mutual funds that worked out to a 75% stock / 25% bond allocation. Every time we contributed I’d buy whatever fund was most off it’s target allocation as a form of constant re-balancing.
Eventually I switched all of this to a simpler and lower cost asset allocation exchange traded fund (ETF). In our case, I picked XGRO which is an 80% stock / 20% bond asset allocation ETF from iShares. Many similar funds exist from other ETF companies such as VGRO (Vanguard) and ZGRO (Bank of Montreal). The exact fund isn’t that important as they all have the same overall asset allocation and similar fees. But picking an 80/20 fund gave us almost the same asset allocation as our prior TD e-series portfolio.
We stuck with this single asset allocation ETF up until a few years ago when we had to start withdrawing from the RESP. In hindsight we should have been changing the asset allocation slowly over time. Fortunately things worked out OK since markets have been very good for many years now. That was pure luck though and not because I am a brilliant investor.
Now that we’re deep into the decumulation phase of our family RESP account we have a completely different approach to managing the assets. We track the 2-year forward looking withdrawal plan for all our children and keep that amount in a high-interest savings ETF (the appropriately named CASH ETF). This acts as a “cash wedge” of funds for the next two years. The rest of the account I keep in XBAL which is a 60% stock / 40% bonds asset allocation ETF. Over time the cash portion will increase or stay the same and I will sell XBAL to top up the cash wedge.
Making things Personal for Your Family
In order to run the projections we explored in in this series of articles we made many assumptions that may or may not apply well to each family’s personal situation. Ultimately these scenarios are just thought experiments to get a feeling for how accumulation and decumulation can work for an RESP account.
With that in mind and after sharing our own personal story above, let’s explore some areas that you might want to think about when personalizing an RESP strategy for your family.
Contributions
Contributions will of course be very personal based on what your family can afford to save. But the scenarios we explored demonstrate that earlier is better to take advantage of compounding and it’s important to try to maximize both the contribution limit and grants.
Even if you can’t maximize contributions for all your children, focus on how to maximize the government funds. The big one is the CESG, but depending on your income level this can also include the additional CESG and Canada Learning Bond (CLB) as described in Part 1. This is essentially “free money” that the government is offering up to help fund a child’s education.
Asset Allocation
The asset allocation glidepath used in our scenarios can be endlessly personalized. As described above in our own personal story, we have taken a different approach to asset allocation especially during decumulation. As with any investment asset allocation decision you should consider your own tolerance and capacity for volatility and risk.
Withdrawals
Your decumulation (i.e. withdrawal) plan is also going to be very personal. It will depend on your childrens’ needs, your investment returns and again how much risk you might be willing to take. Since the amount of money you can withdraw will also depend on your investment returns it can be a moving target.
Another important aspect of a withdrawal plan that we have not explored in depth is tax optimization. As described in Part 1, there are withdrawals taxed in the hands of the beneficiary (EAP) and withdrawals that are not taxed at all (PSE). You can optimize the amounts of each type of withdrawal based on the beneficiaries expected taxable income. For example, if a student has two co-op work terms in one year they will have higher taxable income that year so you could take out more (or all) of the withdrawals as a PSE payment to avoid additonal taxes. Conversely maybe your child only has a part-time job in the summer for one year and so you can take out more as an EAP without significant (or sometimes any) taxes.
In Conclusion
RESPs are an interesting microcosm of personal finance. They require considerations that are applicable to other areas of personal finance including retirement planning such as accumulation, asset allocations, decumulation, tax optimization and navigating government regulations. And unlike retirement planning which has an indeterminate time horizon, RESPs have a much more well defined timeframe. Sure there might be uncertainty in when and for long your child goes to university but it’s still a more well bounded timeframe than a 30+ year retirement.
And as with any area of personal finance, we can take these considerations into account when we plan for the future and plan for your own personal situation. So whether your child is just about to be born or already packing for college I encourage you take sometime to think intentionally about your RESP plans. And if you need it, we can help.
