First off, I would like to thank frequent commenter Mike for suggesting this topic. Though I have set up a self-directed RESP for my boys, I had not researched scholarship plans in detail. The little I did read about them suggested that I should stay away. Nothing that I learned while researching this post made me change my mind.
How do these plans work?
In a Group RESP plan, contributions are pooled together and invested in fixed income instruments. For an overview of how a Group RESP plan works, you can refer to pages 25 to 32 of this prospectus.
What are the fees involved?
You should keep in mind that there is no such thing as a free lunch. Scholarship plans are heavily promoted at doctor’s offices throughout the country. They also employ agents to sell their products. Guess whose pocket these expenses come out of?
In a typical plan, you’ll pay an enrolment fee of $200 per unit. If you enrol your newborn in a group plan, you are agreeing to invest $105 for each unit every year. The enrolment fee may be refunded to you, in portion or in full, when your newborn enrols becomes a qualified student. Note that you won’t receive any earnings on your enrolment fee.
You will also pay depository charges, administration fees, trustee fees, custodian fess and investment fees. These fees alone (excluding the enrolment fee) add up to more than 0.60% of total assets.
What are the advantages of a Group RESP?
When a contributor withdraws from a group plan, only the initial investment (less enrolment fee) is returned. The earnings on the investment stay within the plan and is shared by children who become eligible to receive payments. If the earnings boost from forfeited income were much larger than the total fees, you would benefit from a Group RESP.
What are the drawbacks of scholarship plans?
Lack of Flexibility: For most people, saving for their child’s education should have a lower priority than saving for their retirement or paying down their mortgage. If money is tight (a job loss or unexpected emergency), you should be able to skip a contribution to the RESP. Your flexibility is limited if you originally signed up for a regular contribution schedule. Also, you’ll derive full benefit from the program only if your child attends a four-year degree program.
Returns: You should keep in mind that scholarship plans are invested in low-risk and low-return assets like T-bills, bonds and mortgages. The return you should expect from scholarship plans will be similar to what you can get from bonds (around 5% currently) plus the earnings on capital of members who dropped out less plan expenses. It is extremely difficult to say how much the fees add up to and since it is not obvious, you have to assume that you will be left with more if you invest on your own. Also, note that fully one-third of returns are “discretionary payments” and around 12% was due to “attrition”.
Are there better options available?
In my opinion, you should carefully consider the alternatives and decide for yourself if they are better. I have a RESP set up for our kids with TD eFunds. There is no RESP administration fee and I am able to invest in one of the lowest cost mutual funds available. It gives me flexibility (I can decide to contribute or skip entirely. Remember, most people have other priorities like saving for a retirement and paying off their mortgage) and control (my kids are very young, so the portfolio is heavily tilted toward equities. If your kids have five years or so till university, you should be invested in bonds or GICs). In contrast, you have to keep contributing to a scholarship fund or you lose your membership. You also don’t have control over where the money is invested. It makes no sense that an infant’s college fund should be invested entirely in bonds.
Is there any drawback to self-directed RESPs?
Yes there is. Though it should take you an hour or so to set up and fifteen minutes every year to monitor, it is entirely your responsibility to do so. You should also be disciplined enough to take appropriate risks. You should not invest 100% of a 15-year old’s college savings in the latest investment fad.
What should I do if I have already enrolled in a Group RESP?
It makes no sense to stop contributing to a scholarship plan because only your contributions less fees are returned to you. You lose the earnings on your contributions as well as the matching grants provided by the government. The longer you have been contributing to a plan, the more important it is that you continue to do so.