Planning for education costs is something that should start soon after the birth of the child, because it can be a very long process. As parents and guardians, we want to see our kids getting the best possible education, but at the same time don't want to have to get a 2nd mortgage on our homes to do so; or even worse, we don't want to have to choose which child goes to post-secondary and which doesn't. Often what we see is the student taking up a part-time job during the school year to help pay for costs; but this usually leads to added stress and also to lower grades due to less time committed for studying.
Just as there are several different options when saving for our own future, there are a few different strategies that can be used to fund the child's post-secondary education. I will discuss just the 4 main strategies that are most often used and discuss the pros and cons of each. The 4 main strategies used are: RESPs, Insurance (Universal Life or Whole Life Policy), Open (Non-Registered Savings) and Trusts. In this post I will discuss the first of the 4.
What is an RESPs?
An RESP is a Registered Education Savings Plan. Similar to the RRSP, it is 'Registered' with the government and there are certain limitations to how it is used and what it can be used for. An RESP is a government sponsored initiative to help families save for post-secondary education. The contributions are made be a subscriber and has one or more beneficiaries designated to it. Here are some of the pros and cons about RESPs:
Pros:
- income earned grows tax-sheltered and tax-deferred
- can designate more then one beneficiary
- can get government sponsored 'bonuses' --> Canada Education Savings Grant (CESG), Canada Learning Bond (CLB), Other provincial sponsored programs
- when funds are withdrawn, it gets taxed at beneficiaries tax rate (I see this as a 'pro', since, in most cases the child's tax rate is very low or even 0)
- You can transfer the RESP from one child to another
- You can carry forward the unused grant room (maximum of $1000 for the next year)
- RESP can be transferred into an RRSP (max of $50,000 -- given that you have room in your RRSP to transfer that much) if it is not used
- No annual contribution limit
Cons:
- Lose any growth and must return grants back to government if child does not go to post-secondary education
- If you invest in the market, there is no guarantee in the amount of return you get
- If you invest in something like a GIC, you might not earn enough return to meet the needs
- RESP plan fees might eat away at your savings and growth
- No tax deductions
- If RESP is not used and there is no room for contribution in your RRSP, then funds are to be withdrawn as INCOME and taxed at MTR (maginal tax rate) [only growth is taxed]
*note: principal invested can be withdrawn at any time without paying taxes because it is invested with after-tax dollars
Other Points:
- Beneficiary must be Canadian resident and have a SIN (Social Insurance Number)
- Maximum lifetime contribution limit of $50,000
- Maximum lifetime CESG of $7,200
- Maximum annual CESG of $500 (20% of contribution up to $2,500)
- RESP can only be used to fund education at a Qualifying Post-Secondary Institution that is approved by the Government of Canada
- CESG stops when child turns 18
- Maximum CLB of $500 initially, and $100/year up to the time child is 15 years of age
- Can only qualify for CLB (Canada Learning Bond) under certain circumstances [must be under National Child Benefit initiative -- i.e. for low-income families]
I know this probably must have confused some of you (although I tried very hard to keep it simple); RESPs do have a lot of rules and regulations about them.
What I would recommend is putting a maximum of $2,500/year into an RESP so you can get the maximum $500 (20% of contribution) grant, and any additional funds to be invested in some other instrument; such as a TFSA or UL policy.
When investing into an RESP, you have 2 main choices in how you go about doing that. You can get a scholarship plan or have a self-directed plan.
Scholarship Plan
Scholarship Trust Funds guarantees that your child will receive specific benefits once the funds are needed. Usually the money is put into GICs or Bonds or the like - the investment decision is completely up to the Company and you have no choice over where the investments are allocated. These are considered 'pooled plans', where all the the investors are pooling their money together into one bucket depending on the birth year of their child (i.e. all children of a certain birth year are placed into one pool). However, if some subscribers leave (stop paying into the plan), they leave most (or all) of their money into that pool, and then the money gets split among the remaining clients. The entire basis of this type of plan is that they know approximately 40% of clients will not live out the full life-time of the plan, thus, being able to split more money among less people.
One of the disadvantages of a scholarship plan is that it offers very little in the way of flexibility. The monthly investment is determined by the company, based on your child’s age. Once committed to a plan, you must meet all monthly payments until your child goes to post-secondary education. If the regular payments are missed, then the plan is terminated and all (or most of the) previous contributions are lost. Some companies will allow you to start contribution again after you stopped (within a certain timeline - maybe 6-12 months), but they require you to pay back all missed payments + interest.
One big thing to look out for is that some scholarship trust funds do not allow you to choose the university or college; instead they determine from a list of schools where your child can attend and in some cases what expenses will be covered. So, if you are considering to use this type of plan, please make sure you fully understand which schools/institutions your child will be allowed to attend.
Another issue of concern is the drastically high fees that are involved by being with these plans - these fees are actually used to pay the salespersons commission. Usually the first 2 to 2.5 years of your contributions are gone towards covering Membership and/or Administrative fees, and if you were to stop contributing or opt out of the plan, you lose all (or most of) those dollars put in for those fees.
So, if you are considering to go into this plan, you should definitely think twice. The lack of flexibility, lack of transparency and lack of success for most clients are a few reasons people might stay away from this type of plan. You have to ask yourself, if approximately 1 out of every 2 people don't make it all the way through, what are the chances of you making it all the way through?
Self-Directed Plan
In a Self-Directed RESP, the contributor has the flexibility to determine how much to invest and how often. They also have the control to determine how and where the funds are to be invested. If managed properly, the investment can enjoy substantial gains.
With this plan, the student has the option to choose which university or college to attend and has flexibility to determine how to spend the funds on educational related expenses, such as tuition, schoolbooks and even living expense. If the RESP is not used for post-secondary education by the intended child, then it can be used by another member in the family or rolled over into an RRSP (or spousal RRSP), after all grants have been returned back to the government.
With self-directed plans, as compared to scholarship plans, there's generally the opportunity to earn a lot more growth in within the plan, if managed properly. This is where the importance of having a knowledgeable and experienced Advisor by your side comes in.
As you can see, RESPs are not too complicated, but still require a little bit of research before choosing the right one. When thinking about opening an RESP make sure you ask all the necessary questions and have all the information you need to make the right choice for you and your family. The last thing you want is the stress of having a shortfall in your child's future dreams. Make sure you do your homework and be very careful of RESP agents. Many will push the scholarship plan because it pays a LOT more but usually the first 2-2.5 years of your contribution go straight to fees.
I hope you have learned some good things from this post, and please consult your financial advisor before making any decisions on how to invest for the future of your children. If you have any questions, please do not hesitate to contact me!
Cons:
- Lose any growth and must return grants back to government if child does not go to post-secondary education
- If you invest in the market, there is no guarantee in the amount of return you get
- If you invest in something like a GIC, you might not earn enough return to meet the needs
- RESP plan fees might eat away at your savings and growth
- No tax deductions
- If RESP is not used and there is no room for contribution in your RRSP, then funds are to be withdrawn as INCOME and taxed at MTR (maginal tax rate) [only growth is taxed]
*note: principal invested can be withdrawn at any time without paying taxes because it is invested with after-tax dollars
Other Points:
- Beneficiary must be Canadian resident and have a SIN (Social Insurance Number)
- Maximum lifetime contribution limit of $50,000
- Maximum lifetime CESG of $7,200
- Maximum annual CESG of $500 (20% of contribution up to $2,500)
- RESP can only be used to fund education at a Qualifying Post-Secondary Institution that is approved by the Government of Canada
- CESG stops when child turns 18
- Maximum CLB of $500 initially, and $100/year up to the time child is 15 years of age
- Can only qualify for CLB (Canada Learning Bond) under certain circumstances [must be under National Child Benefit initiative -- i.e. for low-income families]
I know this probably must have confused some of you (although I tried very hard to keep it simple); RESPs do have a lot of rules and regulations about them.
What I would recommend is putting a maximum of $2,500/year into an RESP so you can get the maximum $500 (20% of contribution) grant, and any additional funds to be invested in some other instrument; such as a TFSA or UL policy.
When investing into an RESP, you have 2 main choices in how you go about doing that. You can get a scholarship plan or have a self-directed plan.
Scholarship Plan
Scholarship Trust Funds guarantees that your child will receive specific benefits once the funds are needed. Usually the money is put into GICs or Bonds or the like - the investment decision is completely up to the Company and you have no choice over where the investments are allocated. These are considered 'pooled plans', where all the the investors are pooling their money together into one bucket depending on the birth year of their child (i.e. all children of a certain birth year are placed into one pool). However, if some subscribers leave (stop paying into the plan), they leave most (or all) of their money into that pool, and then the money gets split among the remaining clients. The entire basis of this type of plan is that they know approximately 40% of clients will not live out the full life-time of the plan, thus, being able to split more money among less people.
One of the disadvantages of a scholarship plan is that it offers very little in the way of flexibility. The monthly investment is determined by the company, based on your child’s age. Once committed to a plan, you must meet all monthly payments until your child goes to post-secondary education. If the regular payments are missed, then the plan is terminated and all (or most of the) previous contributions are lost. Some companies will allow you to start contribution again after you stopped (within a certain timeline - maybe 6-12 months), but they require you to pay back all missed payments + interest.
One big thing to look out for is that some scholarship trust funds do not allow you to choose the university or college; instead they determine from a list of schools where your child can attend and in some cases what expenses will be covered. So, if you are considering to use this type of plan, please make sure you fully understand which schools/institutions your child will be allowed to attend.
Another issue of concern is the drastically high fees that are involved by being with these plans - these fees are actually used to pay the salespersons commission. Usually the first 2 to 2.5 years of your contributions are gone towards covering Membership and/or Administrative fees, and if you were to stop contributing or opt out of the plan, you lose all (or most of) those dollars put in for those fees.
So, if you are considering to go into this plan, you should definitely think twice. The lack of flexibility, lack of transparency and lack of success for most clients are a few reasons people might stay away from this type of plan. You have to ask yourself, if approximately 1 out of every 2 people don't make it all the way through, what are the chances of you making it all the way through?
Self-Directed Plan
In a Self-Directed RESP, the contributor has the flexibility to determine how much to invest and how often. They also have the control to determine how and where the funds are to be invested. If managed properly, the investment can enjoy substantial gains.
With this plan, the student has the option to choose which university or college to attend and has flexibility to determine how to spend the funds on educational related expenses, such as tuition, schoolbooks and even living expense. If the RESP is not used for post-secondary education by the intended child, then it can be used by another member in the family or rolled over into an RRSP (or spousal RRSP), after all grants have been returned back to the government.
With self-directed plans, as compared to scholarship plans, there's generally the opportunity to earn a lot more growth in within the plan, if managed properly. This is where the importance of having a knowledgeable and experienced Advisor by your side comes in.
In contrast to the Scholarship plan, you can start and stop contributions and also increase/decrease contributions as you so choose. There is no penalty for doing these, and no heavy loaded up front fees (i.e. Membership/Enrollment Fees that Scholarship Plans have) associated with these plans. This means, that all your money will be directly going towards your plan - the only "fee" associated with this plan is the MER (management expense ratio) of the fund that you put it in. This is nothing uncommon from any other mutual fund/seg fund/stock investment that you buy, as every investment you pay some sort of fee -- Scholarship Plans also have an MER associated with the investment within the plan, which is charged on TOP of the Membership/Enrollment Fee.
I hope you have learned some good things from this post, and please consult your financial advisor before making any decisions on how to invest for the future of your children. If you have any questions, please do not hesitate to contact me!
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