Ask Lisa: How can I make the most of my RESPs for my children?

Dear Lisa,

My partner and I opened up an RESP when each of our three children were born – we set up small monthly contributions and haven’t thought much about it since. There was no strategy or plan behind what we did, we just knew RESPs were good for education savings but truth be told, I don’t really understand how they work or if they were the right choice. For example, what happens when I start to withdraw money? And are there strategies I should know about to make the most of the RESP?

Now, 12 years later, in the beginning of another school year, these questions are top of mind. Post-secondary education seems that much closer, and I’m worried we won’t have enough savings to cover the costs of schooling. My parents paid for my school expenses so I never had student loans or had to worry about how much it cost. They’ve offered to help with our children’s education costs which takes a weight off my shoulders, but I can’t help but feel like my partner and I should’ve been able to plan for this ourselves. I’m feeling really disappointed in myself to be in this position – that I haven’t prioritized saving the way my parents did. I used to think they needed to lighten up and have more fun with their money… but I’m starting to see it differently.

What advice would you give to someone in my situation? How can I best prepare for these looming expenses, and how can I set my children up to have better savings habits than myself?

 

-Need Some Education

 

Dear Need Some Education,

First off, don’t be too hard on yourself about your financial regrets. Yes, it’s important to take responsibility for your role in creating your financial reality, but what’s more important is what you’re going to do about it – and finding a way to feel good while you do it!

You’re probably right that your parents needed to lighten up and have more fun with their money… just not in the way you had thought. Enjoying money is a function of your thoughts and feelings, not just the actions you’re taking. Consider how the following thoughts make you feel:

When spending freely …

“There’s more where that came from!” versus “I’m so irresponsible with money.”

When saving regularly …

“I love watching my bank balance grow!” versus “I’m so worried I won’t have enough.”

Spending money can feel really fun; but so can saving. On the flip side, both actions can bring on feelings of guilt and lack. It’s all in your thoughts.

Your parents obviously have good savings habits, but if their words and behaviour showed you that being financially responsible is hard work or based on fear, then it’s no wonder you didn’t develop those habits yourself. I encourage you to take this opportunity to decide that being financially responsible feels good, and to choose thoughts that support this position.

Once you clean up your beliefs and feelings around money, you’ll be much better equipped to help your children adopt healthy financial habits. Show them not only the behaviour you want them to model, but how much fun it can be while you do it!

Now let’s get to your technical question: what you need to know and what you need to do to make the most of Registered Education Savings Plans (RESPs) and the Canadian Education Savings Grant (CESG).

 

What you need to know

About RESPs

  • Contributions are not tax deductible, but investments inside the account grow tax-free (similar to a Tax-Free Savings Account)
  • Maximum lifetime contributions (deposits) of $50K, no annual limit
  • Funds can be used to pay for costs related to school (e.g. tuition, books, transportation)
  • Withdrawals are considered taxable income to the recipient

While there’s no immediate tax benefit to you for contributing to an RESP, it’s still a great vehicle for optimizing your family’s financial situation. The fact that your investments grow tax-free means there’s more money available to your child when it’s time to pay for post-secondary education. Said another way, every dollar in taxes saved is another dollar that can stay invested and grow over time. Plus, it’s very likely that the taxes your child will pay on the income they receive from the RESP will be minimal, since they won’t likely be earning much other taxable income while attending school.

You can visit the Government of Canada website for more information on RESPs.

About the CESG

  • All Canadian residents with a valid social insurance number and RESP opened in their name are eligible for the grant
  • Matches 20% of your annual contribution, up to a maximum grant of $500 per year; lifetime limit is $7,200
  • Additional grants are available for lower income families
  • Your RESP provider will request the CESG on your behalf, and after filling out an application, the amount will automatically be deposited into your RESP account

What I love about this grant is that it’s kind of like a guaranteed return of 20% on your investment. Considering the stock market returns an average of 6-8% per year, it’s a pretty sweet deal. Don’t leave free money on the table by missing out on this grant!

You can visit the Government of Canada website for more information on the CESG.

 

About the pitfalls

There really aren’t many, but we should consider what happens if your child does not attend a qualified university or college. First, any grant money received would be returned to the Government of Canada. Fortunately, this won’t cost you out of pocket and leaves you no worse off. Second, you will have to pay taxes on any investment earnings that have accumulated within the account. That said, you may be able to reduce your tax bill by transferring the money into a Registered Retirement Savings Plan (RRSP) if you have room, so again, you might not be left worse off.

One big caveat to mention here: there are some group plans that work quite differently. These plans offer higher annual returns and potential “bonuses,” in exchange for forfeiting not only the grant but also your contributions if your child does not attend post-secondary school. In my opinion this isn’t a risk I’d be willing to take to earn a few extra dollars in investment income. Make sure to read the fine print and ask questions about how your plan works!

Now that you understand the pros and cons of RESPs, we can talk a bit about a strategy to make the most of your savings for school.

 

What you need to do

Since the unique benefit of the RESP is the CESG, contribute enough annually to max out this grant. Beyond that, consider saving the remainder of your cash in a TFSA to hedge your bets, so to speak. You’ll have the money growing tax-free, same as if it was held in a RESP, but you’ll also have the benefit of flexibility – that is, you won’t have to pay any additional taxes or forfeit your savings in case your child doesn’t continue their education.

 

Most importantly…

This strategy assumes that you have extra room in your TFSA that you’re not using for retirement savings — which brings me to perhaps the most important point of all. You didn’t mention anything about saving for retirement in your question, but I would bet my lunch money that if you’re feeling disappointed that you haven’t prioritized saving like your parents did, that feeling probably extends to your retirement savings as well.

Your retirement savings plan should be in place BEFORE your children’s education savings. Much like on airplanes where we’re instructed to put on our own oxygen mask first, you have to look after saving for yourself before you can responsibly save for your children. My advice for how you can best prepare for the cost of post-secondary education is to get your own personal finances in order, starting with your retirement plan.

Here’s what that might look like: Figure out how much of your after-tax income you can reasonably save (ideally around 20%). Calculate how much of that needs to be used to fund your retirement (hire a professional if you need help with this). Allocate whatever is left over for your children’s education.

It might turn out that it’s not realistic for you to cover the entire cost of schooling and save for your retirement, but maybe that’s not a bad thing. Involving your children in planning and saving for school might be just the education they need to learn the savings habits that you wish you had developed.

 

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