Where does the introduction of TFSA to our savings options leave the RESP? Contributions to both TFSA and RESP are made with after-tax dollars and both offer the benefit of tax-deferred growth. RESPs have the advantage of attracting the CES Grant of at least 20% but the grant and all the growth within the RESP is taxed upon withdrawal, albeit at the lower rates that beneficiaries tend to pay when attending university. But RESPs have strict restrictions and face heavy penalties if the beneficiary does not attend school. If you discount the initial matching grant, the TFSA is superior to the RESP due to its flexibility.
So, the question boils down to whether the CESG makes up for the main drawback of a RESP, namely the penalties involved if a child does not attend college or university. You’ll have to determine for yourself the chances that your child will get post-secondary education but consider this statistic: among young Canadians aged 18 to 21, about 60% attended an university or college and almost two-thirds went to some kind of post-secondary institution.
If there is a very high chance that at least one child will attend University, the RESP wins out over the TFSA due to the CES Grant depending on the time horizon and the tax rate on withdrawals. I ran the calculations using the following assumptions: $36K is contributed to a RESP over 14.4 years to get the maximum grant of $7,200. The same $36K is contributed to a TFSA over the same time frame and both accounts earn a 6% rate of return. The CESG and the growth within the RESP is taxed at the lowest level of 15%, a rate that is likely overstated because students tend to receive tax deductions for tuition, education and text books. After 18 years, the RESP has a roughly 10% advantage over the TFSA. If the tax on RESP withdrawals is lower at 10%, the RESP has a 13% advantage after the 18th year. You can play around with different scenarios using this spreadsheet.
The calculations confirm my suspicion that it is more profitable to save for your child’s education in a RESP by contributing just enough to get the maximum CES grant. But it now makes no sense to contribute the maximum 50K allowed to a RESP over time. It is better to channel any contribution that doesn’t receive a matching grant into a TFSA instead.
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25 responses so far ↓
1 MillionDollarJourney // Feb 28, 2008 at 10:42 pm
Another great post CC, thanks for doing the math and sharing the spreadsheet. You are becoming the TFSA guru!
2 Four Pillars // Feb 28, 2008 at 10:45 pm
Interesting post.
One of the items in the recent budget that is important for RESP accounts is the fact that you don’t have to collapse the account until it’s been around for 35 years vs 25 years currently. This gives a lot more parents who have kids not attending school the opportunity to collapse the RESP when they are retired which lowers the tax hit from the collapse.
In this post I did a comparison of RESP vs non-registered account and concluded that if the child did not go to school and the parents were retired when they collapsed the RESP account then there was only a small disadvantage to the non-registered account. This disadvantage is more than made up by the fact that the RESP account ended up way ahead if the kid did go to school.
http://www.four-pillars.ca/2007/11/16/resp-a-comparison-to-non-registered-accounts/
3 George // Feb 29, 2008 at 9:13 am
One thing I’ll note about the StatsCan data - the 60% number you quote is a point-in-time number - it’s the number of 18-to-21 year-olds attending university or college at the time the survey was completed. There are plenty of 18- and 19-year olds that take a year or two after high school to “find themselves” before attending post-secondary education. A good chunk of the 40% not attending post-secondary schooling when the survey was completed will pursue higher education in some way within a few years afterward.
How many people do you know that enter the job market nowadays with nothing more than a high school education - no trade school, no college, or university? There aren’t very many that I’ve seen, especially among middle- and high-income families.
4 Canadian Capitalist // Feb 29, 2008 at 11:04 am
Mike: The government can’t stop tinkering with RESPs, eh? Fortunately, all the changes so far have been improvements. I think the CESG is a huge advantage to RESPs and if chances are very high that kids will go to university, it is almost certain that a RESP will come out ahead of other options as long as there is a match.
George: I agree with you. For families with well-educated parents and high incomes, it is a virtual certainty that kids will go for a higher education.
5 TonyR // Feb 29, 2008 at 12:41 pm
It also depends on how much of your kids’ education you want to pay. There’s something to be said for them paying for a part of their education. More of the people I know whose parents paid the whole shot wasted a year or two compared to those who paid for at least part of their education.
6 Canadian Capitalist // Feb 29, 2008 at 3:01 pm
TonyR: Good point. The flip side is that education is so expensive these days that it is a huge burden to graduate out of university with tens of thousands of dollars in debt. The nice thing about RESPs is that you can withdraw the contributions for personal use and use the earnings and CESG for education. That way, the parent can control how much of their kids’ education they want to finance.
7 MillionDollarJourney // Feb 29, 2008 at 5:36 pm
I will be encouraging my kids to participate in paying for their own education (without loans). That’s what I did, I worked through University, and picked a program with “coop” so that I could pay my own way through.
8 TonyR // Feb 29, 2008 at 6:15 pm
Good points. I paid all of costs, including housing and needed student loans to do it. I’d argue with the student activists until I’m blue in the face that they still have it good. Would anyone here pass up a $20k investment that gave you a $10k payment (ie. starting career salary vs. McJob salary) in year 5 and continues at an increasing rate every year for the next 40 years? Would you borrow the money to do it? I maintain that my student loans were the best investment I ever made and will never be rivaled.
9 TonyR // Feb 29, 2008 at 6:37 pm
I made myself curious so I punched some rough numbers into excel yielding a very rough IRR of 42% for my education, including loans and interest and high McJob salary estimates. Factoring lost income during school years, it dropped to 19% BUT I still have 2-3 decaded to collect the “dividends”. My point is ‘get an education’, hopefully without loans but don’t let the need for a loan stop you….
My $.02
10 Elliott Russell // Feb 29, 2008 at 10:44 pm
Wow great post. I don’t have kids but when i do this is something to keep in mind. I’m not that familiar with all this tax stuff, *laughs* lucky i have blogs like this to learn from!
Thanks again
11 Elliott Russell // Feb 29, 2008 at 10:48 pm
Sorry i just read MDJ and Tonys comment about paying for your child’s schooling. Personally i am going to make them pay for it themselves. Even though i have almost 60k in student loan debt it was a wonderful learning experience.
That said, i do think that when they do graduate and get employed that i would then pay for half of it (I would not let them know this ahead of time) and then later i would like to be able to give them the other half to put down on their mortgage.
Just thoughts
12 Riscario Insider // Mar 1, 2008 at 7:40 pm
Why assume that a child won’t get higher education? If they don’t, I’d feel that I failed in preparing the child for success in later life. In that context, the numerical analysis of using an RESP becomes almost irrelevant.
An RESP can be a motivational tool. You show the child that you have faith that they’ll go to university and have been setting aside money to help cover the costs. That said, we contribute just enough to get the maximum CES grant.
13 CanadianInvestor // Mar 2, 2008 at 4:53 pm
Handy and neat little spreadsheet CC (I especially like the fact you have taken into account the fact that only the income in an RESP is taxable when withdrawn, not the contributions, a fact that many people forget). Though I would add consideration of the RRSP possibility - i.e. Yes, put all the first $2500 into the RESP, then maximize the TFSA or your RRSP if you expect your tax rate to be lower in retirement than while contributing. As your spreadsheet can show, at a tax rate of 0%, which is where many if not most students would end up, the advantage of the RESP is 20% all along, exactly the amount of the CESG. Moral of the story, when the government offers you part of your money back, take it!
People should note that your spreadsheet is correct only up to contributions of $2500 since the max CESG is only $500 at a rate of 20% of contribution.
14 Qcash // Mar 4, 2008 at 3:58 pm
CC
Keep in mind that the TFSA can be set up at any time (after you turn 18) and if you put $5000 per year and don’t have kids until you turn 25 and they don’t go to school until they turn 18 and you can put back the money you take out as the contribution room is revolving, the TFSA may be the better option.
However, I would argue that anyone setting up their financial portfolio should include all three vehicles in their portfolio.
The TFSA should be set up as soon as you turn 18 and can save, but aren’t in a high enough tax bracket to warrant the use of RRSPs.
Your RRSP should be set up as soon as you have income levels which push you into higher tax brackets.
Your RESPs should be set up as soon as baby one arrives.
Q
15 moneygardener // Mar 4, 2008 at 5:08 pm
It is amazing how quick your child’s S.I.N. arrives in the mail with the online registeration. I think I had my son’s within 2 weeks of his birth.
16 Jordan Clark // Mar 4, 2008 at 7:56 pm
Is it possible to withdraw money from a RESP to pay the tuition for private elementary or high school? Or is it limited to post secondary alone?
Cheers, Jordan
17 Traciatim // Mar 4, 2008 at 8:36 pm
Hey Jordan, I believe the purpose is for post-secondary but there is some leeway in there for a specified program:
The student is enrolled full time in a qualifying educational program at a post-secondary educational institution (this includes students attending an institution and those enrolled in distance education courses, such as correspondence courses) or;
The student has attained the age of 16 years and is enrolled part-time in a specified educational program.
I very much doubt that they meant private school by this, but it wouldn’t hurt to give the CRA a call and ask if the age works out. Though I’m fairly certain that they will inform you the funds are intended for post-secondary education only.
18 Jordan Clark // Mar 6, 2008 at 6:04 pm
I just read a new Federal bill has passed to change RESPs to be tax deductible like RRSPs. I wonder if they allow a carry forward of existing contributions.
http://www.reportonbusiness.com/servlet/story/RTGAM.20080306.wresp0306/BNStory/Business/home
Let’s hope the senate approves it.
19 Weekend Reading - March 7, 2008 | Million Dollar Journey // Mar 7, 2008 at 6:32 am
[...] Canadian Capitalist answers a few questions regarding the TFSA as to where to invest your money. Is the TFSA better than a RESP or RRSP? [...]
20 JMP // Mar 8, 2008 at 12:12 am
tax-free-resp.blogspot.com
Show your support
21 Political Football with RESPs // Mar 13, 2008 at 6:41 am
[...] In most instances, a RESP beats out other alternatives - it is better than a RRSP, it will be better than the TFSA and it is certainly better than saving in a taxable account. Bill C-253 introduced by MP Dan [...]
22 Daniel Goertzen // Mar 26, 2008 at 9:46 am
One advantage of the TFSA approach is that you can get tuition deduction carryover to the parent. Consider this [extreme] scenario:
- Save for education in a TFSA
- Child has no income.
- For example’s sake, say all eduction expenses are deductable (tuition, books)
- Since child has no deduction room, parent can get the whole deduction at MTR (say 40%).
If I got all that straight (perhaps I didn’t) then TFSA could be better than RESP. Of course that situation is extreme, and the child will probably have some sort of income, and not all of the child’s expenditures will be deductable.
Thoughts?
23 Canadian Capitalist // Mar 26, 2008 at 10:42 am
Daniel: The education expenses (tuition, education amount and textbook credit) are not tax deductible. You just get a tax credit which would result in a 15% reduction in taxes payable and hence is worth the same whether it is taxed in the parent’s hands or the child’s. The 20% grant provided to a RESP just makes it better than the TFSA for saving for a child’s education.
24 Traciatim // Mar 26, 2008 at 11:09 am
CC, having said that, it still would be a good idea to consider using, not to replace but to supplement the RESP. Contribute the max to the RESP to get any CESG the government is offering and then put the rest in to the TFSA to ensure the minimum amount is taxed for the child when in school to allow the deductions to make taxes owed 0.00, and then transfer the rest to the parent.
Though not quite as nice as Daniel had thought, it still is a decent strategy, and worth thinking about if you are making enough contributions to an RESP to put in more than the CESG match tops up.
25 Canadian Capitalist // Mar 26, 2008 at 1:23 pm
Traciatim: I concur and that’s what I plan to do personally. Contribute enough to get the maximum match for a RESP and any thing over and above that goes into the TFSA. As an added bonus, the TFSA account offers flexibility rather than tied to a specific purpose.
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