TFSA versus RESP
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.