Mindful family

 

A blog about mindful living, health, parenting and money.

We often hear how post-secondary education is becoming so expensive and kids have to assume so much debt just to get enough education for a decent job.  We both got through university assuming our financial costs and came out into the workforce with some debt.  It was not crippling since we had worked as much as we could during university. We faced comparable tuition costs as kids do today. We paid approximately $5,000 a year in the last year of our undergraduate program 10 years ago. According to a CBC Analysis in 2019 the average Ontario university tuition is $6,160 and the average college tuition is $2,768. According to Statistic Canada, Ontario is very close to the Canada wide average. When adjusting for inflation, we were probably in the same boat as kids are today.  And with advances in technology and more social pressure for free post-secondary education across our society, we can’t imagine that tuition costs will outpace inflation anytime soon. If anything we believe they could start decreasing. 

 

Although we got through our four-year undergraduate programs as well as a through graduate and accounting certification programs (CPA for Danielle, MBA for Reggie) on our own financially, if we can provide some financial assistance to our kids at no costs to ourselves we will take advantage of it. In this article we will explain how you can also save a large amount for your children’s education without sacrificing any of your own funds in the long term. We will show you how the Canadian government gives you the tools to pay for a 4-year undergraduate degree or 3-year diploma program for free.  Yes for FREE! 


 

What is an RESP?

 

A Registered Education Savings Plan (RESP) is an investment account available to Canadian parents (or other relatives or friends of a child).  The government contributes 20% or $500 per year of the first $2,500 contributed by the account holder.  Ex: You contribute $2,500 per year and the government will provide a grant of $500 each year.  The total lifetime grant contribution by the government is $7,200. 

 

There are many ways to manage an RESP account through your bank or financial institution. There are also some financial companies that specialize exclusively in group RESP programs and they will try to entice parents to join them at baby or parent trade shows. I would advise against these companies as they generally operate the RESPs differently than a bank would and they seem to charge higher management fees. They may also offer less flexibility.  To keep it simple just open your account with whatever bank you do most of your business with. For us it’s with RBC. 

 

Once your money as well as the government grants are in an RESP you can manage it in many different ways. You can keep it in a high interest savings account, but high interests savings rates are pathetically low right now.  You can invest it in a variety of mutual funds depending on your risk preference. You can even invest it in a balanced Index following ETF (exchange traded fund) like we do. Regardless of the option you choose, you should just aim for long-term growth as this is money that you are investing for eighteen years or more. This means that you shouldn’t use it to buy and sell individual stocks short term (even though you could do that as well) just because you got a good tip.

 

Now that we got the basics of what an RESP account is and how we can open one and manage it, we will move on to how to gift your child a FREE EDUCATION. 


 

 

Step 1: Maximize the grants and the growth 

 

If you contribute $2,500 per year into an RRSP for 15 years (in the 15th year, you only need to contribute half), then you will take full advantage of the $7,200 grants from the government. 

 

If your contributions and the grants are properly invested (even conservatively) they can grow substantially over the course of the child’s life. 

 

A good example would be RBC’s Target 2030 Education Mutual Fund which has generated average returns of almost 6% per year over the last five years.  This type target fund is designed to be a little bit more aggressive in the early years and more conservative in the years closer to when the money is needed (in this case it would be 2030).  So assuming you were invested in a fund like this with similar returns, you may expect an average of 5% return over an 18 year period.  

 

At the end of 18 years your $2,500 annual contributions (for 14.5 years) plus the government grants will have grown to: $80,144*

 

*To come up with this number I used a future value calculator. I calculated the future value of annual contributions of $3,000 for 14.5 years at 5% interest. And then took that amount and calculated the future value of 3.5 additional years with no annual contributions but still at 5% growth. 


 

 

Step 2: Pay for your child’s education

 

Now you take the $80,144 in this account and subtract the $36,000 you contributed. This will leave $44,144 to use to cover all your children’s educational expenses

 

Now you're probably thinking “well $44,144 won’t be worth the same in 18 years”. So we have to bring it back to 2020 dollars.  If we examine the inflation rate in Canada over the last 20 years the average is between 1.5-2% per year.  So after accounting for a safe 2% rate of inflation per year, the present value of our account at the end of 18 years would be $30,907. 

 

Today that $30,907. Would cover an average 4-year university degree in Ontario ($24,640) with money left over for books and incidentals. On the college side, this amount could easily pay for a 3-year program plus incidentals, books and residency costs (if your child decides to study out of town). 


 

 

Step 3: Pay yourself back

 

In this step you take your money back. As per the RESP rules, you can withdraw all the principal payments you made with no taxes or penalties. That is because those $2,500 contributions were made with after-tax dollars already so they have already been taxed by the government. You can do this even before you decide to close the account but if you don’t need the money right away, you could leave it in the RESP until your child is done with their schooling.  In case you decide you want to help them further down the road. An RESP can stay open for 35 years. 


 

So by using just the grant and growth portion of the RESP account you could pay for your child’s entire university or college education.  I realize that there are other related expenses (such as housing and transportation) but just paying for their tuition will give your children a huge financial advantage starting their post-secondary education.  Contrary to the common thinking these days, we don’t think parents should feel obligated to pay for all of their children’s post secondary education.  Teenagers and young adults can work during their summers or after school and save up.  They are in fact going to study to get a job that will generate their future income so they should have a financial stake in it as well. We both gained tremendous financial knowledge by being financially responsible for our entire post-secondary education. Being financially responsible is one of the best lessons you can teach your children and they won’t learn it [as well] if all their education and living expenses are paid for.

 

You will have essentially paid for your child’s entire education by lending them money for 18 to 22 years at 0% interest.  That in itself is a nice gift and makes this not entirely “free education” however, if you were otherwise investing $2,500 per year in a high interest savings account you wouldn’t be missing out on much. The average high interest savings account at most big banks in Canada currently pay 0.05% per year.  $2,500 invested in such an account will generate $1.25 per year.  So your $36,000 interest free loan to your child spread out over 18 to 22 years will have lost you about $200 in compounded interest. Even if interest rates rebounded a little and you could conceive a 1% return on your savings, your opportunity cost would still be under $5,000. A small price to pay for a post-secondary education. This strategy can work like a forced-savings plan that will give you a very nice gift once your children are out of the house. The $36,000 per child that you will pay yourself back with can be used to retire a year earlier or to take a trip around the world. 


 

 

Other Considerations

 

A few other things to consider regarding RESP (We hope to write other articles on these subjects in the future):

 

  • To follow this strategy you will have to withdraw from your RESP from the grant (government) portion or the growth portion of the RESP account and leave the principal balance in the account.  These amounts are tracked separately. Grants can only be withdrawn for educational purposes (so if there are any left in the account when it is time to close it, they are forfeited). The growth portion is taxed and can be penalized if you need to take it out under your name once the account is closed.  But as we mentioned earlier, the principal balance can be withdrawn with no taxes or penalties.  Consult with your financial institution when it comes time to withdraw funds. 
  • In a scenario where you were planning to use all the money in the account for your child’s education (i.e. no plan to withdraw your principal) then you may be more strategic in how you withdraw funds.  Because the growth/grants portion of withdrawals will be taxed in your child’s name, you may aim to reduce their tax burden and may use principal money in some years if they have other significant income (above the basic personal amount in your province).
  • Regardless of what you decide to do with your RESP it is important to have a withdrawal plan.
  • If your child doesn’t go to school or does not need any of the RESP money (because of grants or scholarships), then you could still benefit from all the growth accumulated in the account.  Although all the government grant portion has to be returned, up to $50,000 of the growth can be transferred to your RRSP account if you have room.You can keep an RESP open for up to 35 years.  So if you anticipate this to be the case, you should have a few years to accumulate some RRSP room to continue sheltering this money and avoid paying a penalty on it upon closing the account. 

 

Final Thoughts

 

When deciding how to plan for your child’s education it's also important to consider the financial assistance options out there because there are a lot more than people might think.  The OSAP (Ontario Student Assistance Program) has a calculator that estimates how much you are eligible in grants and loans.  A quick estimate based on our household income (which is quite low) showed that if each of our children started a 4-year university degree today they would be eligible for $7,000 in grants alone each year.  We also tested the calculator using a hypothetical family with only two dependents and with a family income of $100,000 and the grant portion available from the government was still $2,000 per child. There are a lot of financial options available (with a good chance that there will be more in the future). There is also the chance that the post-secondary industry changes drastically, or that we live in a country where post-secondary education is free. All these scenarios may mean that an RESP is not required in the future or even today. 


 

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