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RESP Primer – Just The Rules You Need To Know

Canadian Capitalist — Thu, 05 May 2011 01:51:30 +0000

It costs a lot of money to put a child through University these days and Registered Education Savings Plans offer one of the best ways to save for a child’s education. In today’s post, Mike Holman, the blogger behind the Money Smarts Blog and author of The RESP Book (available on Amazon) explains the basics of RESPs.

RESPs (Registered Educational Savings Plans) have been around for a long time. Most people don’t have the slightest clue how these accounts work until they have kids – at which point, they need a crash course. This article is that course.

What is an RESP?

RESPs are special investment accounts where the government will deposit a 20% grant (or more) based on the amount of your contributions. RESPs are intended to be used for educational purposes and there could be penalties if the child doesn’t go to post-secondary education. RESP accounts are tax-sheltered so all earnings inside the account are not taxed. Any investments that are eligible for an RRSP are also eligible for an RESP. GICs, stocks, bonds, ETFs are all eligible.

Where do you sign up for an RESP?

Most financial institutions and financial advisors offer RESPs, but the easiest RESP solution is to visit your local bank branch and set one up. Bring your SIN card as well as the child’s SIN card and birth certificate.

Be careful of scholarship or pooled RESP plans. These are typically sold by salespersons who earn large commissions. If someone calls you or is willing to come to your house to discuss an RESP, you can be sure it’s a scholarship RESP. These have high fees and restrictive rules.

RESP Account rules

Subscriber – The person who sets up the RESP account. There can be one or two subscribers. The subscriber does not have to be related to the child.
Beneficiary – Any children named to the account who will eventually receive payments from the RESP.

There are two types of RESP accounts – individual and family plans.

An individual plan means there is only one beneficiary on the account. A family plan means there can be more than one beneficiary. Family plans make it easier to share RESP money between siblings or even cousins. Some RESP accounts have annual fees, so reducing the number of accounts can save money.

Multiple accounts can be set up for one beneficiary. It is critical that the subscribers of the accounts communicate so that contributions which are ineligible for the RESP grant aren’t being made.

Contribution Rules

No tax receipt is issued for contributions to an RESP account.
Every child accrues $2500 worth of "grant eligible" contribution room per year starting in 2007. Only $2000 worth of contribution room is accrued in years prior to 2007.
Any contributions made in excess of the "grant eligible" contribution room are allowed, but won't receive any grant.
All "grant eligible" contributions will receive a 20% grant. This grant might be higher for lower income families or in Quebec.
Each year you can contribute up to two years worth of contribution room – one for the current year and one for missed contributions from previous years.
Maximum amount of grant per child is $7,200 for their lifetime.
The last year a child can receive a grant is the year they turn 17, subject to certain conditions.
A special grant known as the Canada Learning Bond is available for low-income families and no contribution is required. See the Canlearn page for qualifications.

Withdrawal Rules

Student must attend a qualified post-secondary educational facility as determined by the government. This rule is quite reasonable in that it encompasses trade schools and pretty much any kind of training. Here is a description and list of eligible institutions.
Only $5,000 of non-contribution money can be withdrawn in the first 13 weeks. There is no withdrawal limit on contributed money.
Contributions can be withdrawn tax-free. Everything else is taxed in the hands of the student. You can direct your financial institution whether you want to withdraw contributions or earnings.
To withdraw money from an RESP account, you just need to show proof of enrollment at a qualified institution. You can then spend the money on whatever you want (books, tuition, booze etc.) since you don't have to show receipts for anything. Don't be shy about taking more money out of the RESP than required.
Only the subscriber can request withdrawals. The beneficiary has no control over the account.
If the child doesn't go on to post-secondary education, the account can be transferred without penalty to a sibling. Otherwise the account can be collapsed and there will be penalties on the non-contribution
portion of the RESP account. Those penalties can be avoided by transferring the non-contribution portion of the RESP to an RRSP.
RESP accounts don't have to be closed until their 36th year. There is plenty of time for the child to use the money.
In a family account, ensure that no beneficiaries are paid more than $7,200 in grant money or the government will take the extra grants back.
Reduce the amount of equities in the account as the child gets closer to school.

Conclusion

There are a lot of RESP rules and the different RESP phases can be confusing. The good news is that you don't need to learn the withdrawal rules when you are setting up your account. And even the contribution limits are not that relevant if you aren't maxing the contributions. It's not hard to get an account set up and then learn more about RESPs later on.

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Lack of flexibility a big problem with Scholarship RESP Plans

Canadian Capitalist — Tue, 02 Nov 2010 03:24:54 +0000

In The RESP Book (review here), Mike Holman points out the reasons why parents should avoid Scholarship / Pooled / Group RESP plans:

Very, Very expensive. There are large upfront sales fees paid to the salesperson, which are paid from your contributions, and very high ongoing fees. They have restrictive rules that can mean getting less money out of the plan if the child doesn’t go to school.

In my opinion, the biggest and loudest complaints arise from the lack of flexibility in Scholarship RESP plans. First, a lot of parents sign up without fully realizing that they are committing to contributing regularly to their child’s RESP and if they miss contributions all they might lose the Government grants, earnings on their contributions and initial enrollment fees. By contrast, a parent can choose to skip a contribution or two to a RESP held at a bank or discount broker and resume contributions at a later date.

Some parents stick with the contribution schedule until their child is in University and then find out that Group RESP rules are more restrictive than Government rules that deal with RESP withdrawals. One parent found out that his child does not qualify for payments because he switched to another program in the same University. Another found out that her child does not qualify for payments because of a strike at the University. Or heaven forbid, a child should fall ill and miss a significant chunk of the year.

Group RESPs would probably work well if life follows a carefully scripted plan. Unfortunately, stuff happens and then we find out that Group RESPs were not such a great idea after all.

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Book Review: The RESP Book

Canadian Capitalist — Mon, 01 Nov 2010 04:41:34 +0000

Compared to Registered Retirement Savings Plans (RRSPs) or even the relatively new Tax-Free Savings Accounts (TFSAs), Registered Education Savings Plans (RESPs) are a low priority for the mainstream financial institutions. The reason is quite simple: relatively speaking RESPs are small fry for the big financial institutions. While Canadians hold more than $600 billion in their RRSP accounts (2005 figures from The Wealth of Canadians report by Statistics Canada), the total value of RESP accounts is just $26 billion (2009 figures from the Canada Education Savings Program – Annual Statistical Review 2009). This mismatch is also reflected in books: a number of RRSP books are published every year but to my knowledge, there are no books covering RESPs.

Mike Holman who writes the Money Smarts Blog has filled this gap by penning a valuable resource on RESPs. The author starts off by explaining the unique and sometimes complicated rules governing RESPs. He then talks about the main reason RESPs are the best way to save for a child’s education for most people: the various grants available from the Federal Government and additional grants that Alberta and Quebec residents may be eligible for from their provincial governments. The final chapters deal with how to open a RESP account and how to invest the contributions and grants.

To be honest, most of the information available in the book can be found scattered between Government websites, newspaper articles, blog posts and forum discussions. But frazzled new parents will likely appreciate that the author has put everything together in one slim volume. And hopefully most readers will take the author’s advice and open a self-directed or bank RESP. Or at least opt for a Group RESP after carefully considering other options available to them.

The RESP Book: The Complete Guide to Registered Retirement Savings Plans for Canadians is available from Amazon.ca for $15.99. It should be noted here that a review copy was provided by the author. I should also mention that I’ve personally known Mike for many years and consider him a friend. You can find links to more reviews of The RESP Book on the Money Smarts Blog. The Globe and Mail recently published an excerpt from the book.

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Cost of a Future University Degree: $92,369

Canadian Capitalist — Thu, 29 Oct 2009 00:45:03 +0000

Parents could be forgiven for going into sticker shock after reading press reports on the release of a TD Economics Report titled The Future Cost of a University Degree. Media reports gave prominent coverage to the headline numbers: an average cost of $137,013 for an undergraduate degree for a student living away from home and $101,426 for a student living at home. The Globe and Mail called it That’s one pricey piece of paper. The Financial Post headlined its column University degree may cost $100K in 18 years. Both papers incorrectly noted that these were “inflation-adjusted projections”.

Let us set the record straight. The report makes it clear that, eighteen years from now, a four-year degree would cost an estimated $92,369 in 2009 dollars for a student living away from home and $68,373 for a student living at home. An undergraduate degree currently costs $77,132 and $51,763 respectively. In other words, an university degree would cost about $15,237 more in 2009 dollars for a student living away from home, not the $60,000 you would have inferred from media reports. Granted, the actual increase isn’t exactly petty change but it can be planned for in advance:

Assuming an annual rate of return of 6.8 per cent on a balanced growth portfolio, the annual contribution to an RESP needed to cover the future cost of an undergraduate degree is $2,475 for students living away from home and $1,725 for students living at home. Alternatively, parents may wish to use a Tax Free Savings Account (TFSA) to ease the burden on saving. The annual contribution to a TFSA would need to be $2,900 for students living away from home and $2,150 for students living at home.

So, take a deep breath and relax. Yes, a university degree might become an even more expensive proposition but it is an investment that will still produce satisfactory returns in the form of a higher paycheque. You can plan for it in advance but if you are unable to cover or save for the increase, students can pitch in through summer jobs or co-op terms.

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How to invest periodically in a TD e-Series Funds RESP Account

Canadian Capitalist — Mon, 09 Mar 2009 03:33:02 +0000

Reader Tim managed to jump through the hoops to set up a TD Bank e-Series Funds RESP account for this two children and has the following question:

My plan is to invest approx $100 to each of the 2 plans every two weeks in order to qualify for the maximum government match. I want to take advantage of dollar cost averaging but the problem is that there seems to be a minimum of $100 investment for each of the funds. I was hoping to diversify between 4 e-funds but it would seem I have to invest more money or invest less often in order to do that.

As I tend to invest a lump-sum amount into our kids’ RESP, I don’t have experience with investing regularly in a RESP. But I think Tim can invest regularly by setting up a Pre-authorized Purchase Plan for the TD Money Market Account. A Pre-authorized Purchase Plan (PPP) allows investors to invest as little as $25 on a regular basis — from as often as every week to as infrequent as once a year. The PPP can be set up for purchasing $100 of the TD Canadian Money Market fund for each of the two accounts. Every other month (or so), the account should have enough contributions plus CESG payments in the money market fund to switch into other e-Series mutual funds. Use this automatic rebalancing spreadsheet to figure out how to divvy up the holdings in the money market fund.

Another option is to set up a PPP for each of the e-Series mutual fund in your portfolio. If you are planning on purchasing four e-Series funds, you’ll set up a contribution of $25 (the minimum required for a PPP) for each fund for a total of $100. The CESG is deposited into the account in a money market fund and can be used to rebalance the portfolio, say once every year. Note that all the PPP purchases made on the same day in one account show up as one transaction in the chequing account. I’d like to hear your opinion if you have set up a RESP account and invest in it regularly.

[Note: The original post incorrectly mentioned that each mutual fund purchase via a PPP is treated as a separate chequing transaction. Thanks to readers who pointed out the error in the comments.]

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Your Turn: Setting up RESPs with Altamira

Canadian Capitalist — Mon, 10 Nov 2008 05:50:30 +0000

Despite charging some of lowest fees, the TD e-Series mutual funds may not be suitable for everyone because TD Bank RESP accounts are not set up to receive the enhanced Canada Education Savings Grant available for lower income Canadian families. Reader TS who had RESP accounts at TD sent the following note (slightly edited) about moving the accounts to Altamira (posted with permission):

After some initial confusion, I set up one family RESP account for each of my three children with Altamira and added the other two as beneficiaries. The Altamira rep was very helpful with the paperwork and even caught what looked like a mistake on my part in the transfer from TD (it wasn’t a mistake as I had transferred one kid’s amount to another on purpose to make the amounts deposited in the new accounts more proportional to the kids ages), but I was impressed that she caught it.

So overall I was pleased with Altamira, and very happy my kids will be able to receive the additional grants for which we are eligible. We have other business with Altamira and I have been happy with them because although their index fund MERs are a bit higher than TD (most are 0.5% I think), I find their online system, phone system, and monthly reports much easier to read/use. I don’t know what it is with TD as I find their reports much harder to read and track, and when I make trades within my account, it always seems harder than it should be. I know you’ve had good experience with them, and overall I am still pleased, but I am glad that I only have to call them a couple of times a year.

One more thought: Overall the RESP process just doesn’t seem that easy. My local TD banker told me that many people are missing out on all the free government money (here in Alberta each kid is eligible for $500 for just being born!) because they don’t ever set up an account. I am fairly good with numbers and have a decent investment understanding and I still found it a lot of work and confusing, so I think the government isn’t succeeding in getting the money to families who could really use it in the future. I hate seeing people miss out on good things like this. It would be interesting to know how many people do not get the grants for which they are eligible.

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The MER on Group Scholarship Plans

Canadian Capitalist — Tue, 09 Sep 2008 04:43:45 +0000

Ellen Roseman’s recent column and blog post on group scholarship plans generated a lot of comments, including the following from a group RESP seller on how the fees of group RESPs stack up against bank mutual funds:

Banks promote their family of mutual funds as the investment vehicle for just about anyone who wants to save for their child’s education with average MER’s of 2.65%. Go to a bank and ask to see for yourself, like I have. By the time junior is off to college or university, the total fees paid by the family to the bank is about 300% higher than with scholarship plans and that’s before we even calculate the erosion of compounding interest by this annual fee that is charged.

While I’ve never been a fan of high-cost mutual funds, the claim that the MER on group scholarship plans works out to 0.9% can only be justified with a lot of fuzzy math. At first glance, it doesn’t sound unreasonable: the Canadian Scholarship Trust, for instance, charges an administration fee of 0.5% and a portfolio management fee of 0.10% to 0.30% on plan assets. There are some miscellaneous fees such as depository fees and trustee fees that we’ll ignore for the purposes of this post. The total administration and portfolio fees, roughly, totals 0.90%.

The typical sales pitch is that though there is a steep enrolment fee charged initially, it is refunded partly or in full. But attention must be paid to the details — the enrolment fee refund is in nominal dollars, without any adjustment for growth and inflation. A promise to repay $200 eighteen years in the future is only worth $83 in today’s dollars at a 5% discount rate. This is a real cost that must be accounted for in calculating the MER of group scholarship plans.

I constructed a spreadsheet with the following assumptions: (1) A rate of return of 5%. (2) Annual contributions of $105. (3) An enrolment fee refund over 4 years. A self-directed RESP earning 5% would total $3,101 after 18 years. The group scholarship plan would deduct an enrolment fee of $100 from the first year’s contribution and $50 from the second and third years. At the end of 18 years, the plan should add back the present value of four future enrolment fee refund payments. The difference between the rate of return of the self-directed RESP (5%) and group scholarship plan is a fair estimation of the impact of enrolment fees:

At full refund, the group plan earned a return of 4.05%.
At a 50% refund, the group plan earned a return of 3.75%.
At no refund, the group plan earned a return of 3.4%.

So, the total impact of all the fees on a group scholarship plan is of the order of 2.15% (1.25% for the impact of the enrolment fees and 0.9% for other fees). While that compares favourably with high-MER mutual funds, it is certainly not 3 times cheaper. And parents have a much better option than having to choose between Tweedledee and Tweedledum: they can walk down the street to a TD Canada Trust branch and open a RESP account and invest in TD e-Series mutual funds for a total cost of less than 0.5%. Now, that is more than three times cheaper.

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Interesting Report on RESPs

Canadian Capitalist — Tue, 26 Aug 2008 23:09:40 +0000

After reading Rob Carrick’s article in the Globe and Mail on a study commissioned by the Federal Government on Registered Education Savings Plans, I went looking for the report. Fortunately, it is available online (Update: The report referred here is no longer available online. Contact me with request for industry_practices.pdf if you need a copy), provides a wealth of interesting information and explains various RESP options available to parents in a clear and straightforward manner. As Mr. Carrick has highlighted the shortcomings in the design of group RESP plans in his column, I am going to focus on interesting tidbits in the report:

Participation in RESPs is low: only 35.2% of children aged 0 to 17 years received a Canada Education Savings Grant.
The Canada Learning Bond provides $500 for low-income families to establish a RESP account and allows for an annual contribution of $100 thereafter but the participation rate is a miniscule 8%. The CLB program has paid out a paltry $24 million to date.
The biggest “complaint” against RESPs offered by banks and brokerages is that they are not “vigorously” marketed.
It is shocking that 3.2% of group RESP plans were cancelled or terminated in 2006. Even more shockingly, 1.9% of group scholarship plans were closed by the group RESP vendors and subscribers paid the price: “When the group scholarship provider closes a group plan, the subscriber can reclaim the contributions, and these are then returned net of fees and without the investment income. Closing also means the grant and bond are repaid to the government, and these cannot be earned back later if new contributions are made for the same beneficiary.”
The report notes two benefits of group scholarships: the mandatory contribution schedule may force some people to save for their child’s education and the proactive marketing of these plans may result in higher participation in RESPs.
Corporate governance of scholarship trusts leaves much to be desired and there is no disclosure of executive compensation.
The criticism that scholarship trusts have high fees is justified. The report notes that in 2006, some 20% of gross contributions went towards fees. Granted some of the enrolment fees may be refunded but the present value of the refund is quite small.
If a group RESP subscriber is unable to continue contributing, they can transfer to an individual savings plan instead of terminating the program and keep the principal, grants and income. Termination, on the other hand, will result in refund of contributions less the enrolment fee. The report points out that 1.9% of plans were terminated even when a better option is available.

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Quick Tip: Catch up on RESP Contributions

Canadian Capitalist — Thu, 03 Jul 2008 02:59:09 +0000

While chatting with a friend, I found out that it is not common knowledge that if you didn’t contribute to a Registered Education Savings Plan (RESP) in previous years, you can catch up on contributions and possibly still get the lifetime maximum Canada Education Savings Grant (CESG) of $7,200 that your child can receive. It’s hardly surprising — for many families paying down debt or saving for retirement takes priority over saving for a child’s education. If you missed contributing to a RESP, it may not be too late to catch up on past contributions and get every dollar of the CES grant.

First, a quick primer on CESG rules: (1) Starting in 1998, the CES grant accumulates every year for a child until she turns 17. The basic grant room is $400 per year from 1998 to 2006 and $500 from 2007. (2) The maximum CES grant that a child can receive in a calendar year is $1,000 provided grant room is available. (3) The lifetime CESG is $7,200.

As you can deduce from the rules, in every calendar year, you can catch up for roughly one more year of missed contributions. For example, let’s say no RESP contributions have been made so far for a child born in 2000. The total CESG room for the child is $3,800 ($400 for the years 2000 to 2006 and $500 for 2007 and 2008). If a RESP account is set up for the child and $5,000 is contributed to it, the child will receive a grant of $1,000 and have the remaining $2,800 carried over to future years. In this example, it will take another 6 years to bring the grant room down to zero.

Globe and Mail columnist Rob Carrick has written a couple of articles on RESP catch-up contributions available here and here. Note that the CESG rules are slightly different now.

[Update: You can find the unused grant room for your child by calling Service Canada at 1-888-276-3624. You'll need the child's Social Insurance Number.]

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Still Sour on Group RESPs

Canadian Capitalist — Thu, 01 May 2008 02:52:04 +0000

The more I learn about group RESPs, the less I like them. In the comments thread on an earlier post on Group RESP plans, a reader referred to the prospectus for the years 2000 to 2007 filed by the Canadian Scholarship Trust filed with SEDAR. I was initially excited to lay my hands on so much information – at last, I could compare past results of Group RESP with a self-directed RESP that holds fixed-income securities and make an apples-to-apples comparison between the two for a number of time periods in the past. The results would be interesting and hopefully conclusive.

Alas, it was not to be. While it’s possible to find out contribution information or EAP (education assistance payments that is made over four years to eligible students) information, it is hard to obtain both for the same plan. For instance, consider the 2007 prospectus. The Group RESP plan marketed by Canadian Scholarship Trust is called “Group Savings Plan 2001″. The contribution schedule is available in the prospectus and tells us that buying one unit for a newborn would cost $105 per year, for a 1-year old $115 per year etc. The oldest child that can be enrolled in the plan would be 12-years old for a contribution of $1,100 per year. While, the prospectus mentions that EAP of $600 was made for the 2006 year, the “Group Savings Plan 2001″ was offered only in 2006 and 2007, which means the oldest child enrolled in the plan in 2006 will be eligible for EAP in 2012. The Group plans offered in years 2000 to 2002 was called the “Optional Plan”, in years 2003 to 2005 was called the “Group Savings Plan”. So, it’s nearly impossible to tell how the plans have performed over the years.

The defendants of Group RESPs point out that the portfolio is invested in an “ultra-safe” manner. But, guess what? According to the prospectus for the “Group Savings Plan 2001″, about one-quarter (24.8%) of the assets is invested in index-linked notes. A fair comparison of group plans with self-directed RESPs, going forward, would be a 75% bond and 25% equity mix. I’m convinced more than ever that a self-directed RESP invested in a diversified portfolio in a low-cost manner is more flexible and almost certain to outperform any pooled RESP plan available today.

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