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The MER on Group Scholarship Plans

September 9th, 2008 ·

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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19 responses so far ↓

  • 1 Charles // Sep 9, 2008 at 2:59 am

    Well strictly speaking, if you walk down the street you’ll be able to open a TD Mutual Funds account, and then you’ll need to print out forms from the Internet and mail them in to gain access to e-series funds :) Cause they don’t want to deal with e-series funds in person.

  • 2 Million Dollar Journey // Sep 9, 2008 at 7:10 am

    Great post CC. Perfect timing as I was in the process of doing more research on the Canadian scholarship trust. The validity of this program seems to be a hot topic.

  • 3 George // Sep 9, 2008 at 7:41 am

    CC, thanks for doing the math on these plans. The issue of nominal vs. real returns is one that is truly confusing to most investors, but it is a point that has to be made.

    The return of the enrollment fees in nominal terms is the equivalent of depositing $1200 in a bank account for almost TWENTY YEARS and then getting nothing back but the original $1200 - not a penny of interest. Hardly a good deal, if you ask me.

    The other issue you don’t mention with regard to the Group RESP plans is that, on top of the high fees, they also have extremely low returns. The returns are “enhanced” by a survivor’s bonus (the people still in the plan after X years get a share of the money lost by the people who cancelled the plan over those years). Personally, though, I don’t like the idea of my kids’ college fund earning returns based on moneys lost by other parents trying to save for their kids.

    I’ll keep my self-directed RESP. I’ve been perfectly happy with it, and I’ve made several changes (both up and down) to the contribution rates over the past few years - none of the changes have required more than a 5-minute phone call to the bank. Try doing that with a CST or other Group RESP plan.

  • 4 Canadian Capitalist // Sep 9, 2008 at 8:13 am

    Charles: Yes, you’re right, of course. When I opened a TD Mutual Funds account, the rep didn’t even know what e-Series funds were.

    FT: Good luck with the CST prospectus — it should be a fun read :)

    George: Good point. I’ve made it on other posts and didn’t repeat it here. It makes no sense to me that a very young child is 100% in fixed income assets. Though, the prospectus mentions that 25% is of the portfolio is invested in index-linked notes.

  • 5 Rob // Sep 9, 2008 at 8:55 am

    Beyond the math of the higher MER is the less-quantifiable factor that these scholarship plans are all calculated based on full, non-interupted participation in the plan. Life doesn’t work that way; however and financial circumstances do change despite the scholarships implied assertation that one can always plan out - with perfect certainty - the next 17 years of their life.

    If you later want, or more importantly need, to suspend contributions or cancel the plans, you can pay dearly.

    Again it is hard to quantify this element, but lack of flexibility can sometimes be much more costly than anything else.

    My advice - avoid these plans like the plaque.

  • 6 Chuck // Sep 9, 2008 at 9:41 am

    We’re dissatisfied Heritage plan members. The plan when we enrolled was supposedly investing in safe interest bearing investments. However when I review the annual reports, I’d be able to get better returns putting the money into ING. The difference is much more than just the 0.56% management fee taken from the porfolio.

    Thankfully money was tight when we opened my daughters plan so only a small amount goes there. I wised up 2 years later and opened a family efund RESP at TD CT.

  • 7 Canadian Capitalist // Sep 9, 2008 at 10:35 am

    Rob: I concur with your observations that there are much better alternatives. The report released last week (mentioned in the post below) shows how important flexibility is: 3.2% of plans were cancelled or terminated in a single year, which would imply that a significant percentage of plan subscribers are giving up early.

    http://www.canadiancapitalist.com/2008/08/26/interesting-report-on-resps

    Chuck: The expenses of these plans are front loaded because unlike a mutual fund that charges a MER every year, the enrolment fee has the biggest impact in the initial years. Your TD RESP is likely to do much better than any group plan out there.

  • 8 Traciatim // Sep 9, 2008 at 11:05 am

    Rob, I agree. Everyone should avoid these funds like the plague. I am a sucker of the CST group RESP for my daughter. I have a TD E-Funds RESP for my son. Our family recently had to stop contributions to the RESPs while my spouse starts a business after going to school herself. Very suddenly my enrolment fees of the plan are no longer on my statement (as expected, and according to the agreement with CST) making the balance drop by $2100.

    The TD account, we simply logged in online and stopped the pre-authed payment plan. No harm, no foul. When we want to start back up I just re-start the deductions and we’re on our way again.

  • 9 Rob // Sep 9, 2008 at 5:59 pm

    Traciatim - that’s too bad and a story I have unfortunately heard many times before.
    I don’t know how much you had in the fund and what percentage therefore $2100 represents, but I’ll bet it is high. $2,100 dollars - robbery, and nothing else.

    As a financial advisor, I could make a fortune marketing this garbage because it is a very easy sell, but I don’t because it is crap. The people selling this stuff should take a long hard look at themselves in the mirror.

  • 10 Traciatim // Sep 9, 2008 at 9:49 pm

    @Rob, it was about 28% of the value as I last saw it, which is a huge chunk for us. I doubt that I can catch up payments at this point since it’s been about a year now. I’ll call them when we’re ready to go again and see what my options are. If there is no way to get back on track I’ll just close it up and open a new TD E-Funds account, or whatever sounds good at the time that’s cheap.

    Lets face it though, I was 22 and financially illiterate when i signed up. I just had a daughter and the CST sales pitch was in our info pack from the hospital. My parents couldn’t afford to pay for my schooling and I wanted to be sure I could help with my daughters so I figured I was doing a good thing.

    I guess a lot can happen in 18 years. Please, for anyone reading, steer far clear of group RESP providers.

  • 11 Al // Sep 10, 2008 at 7:53 am

    It was via the hospital that we got on a list for a group RESP (Heritage I think.) I wonder why the hospitals do this? We got a cold call and set up the appointment to hear about their products. I didn’t know the difference between the group plans and other RESPs at the time. The sales pitch was good for what it covered, but it left out some info that I wanted. After reading the material the rep left I wasn’t going to sign up. The RESP company was an NPO, but the sales force was a private for profit entity. After reading and rereading I finally managed to piece together that the upfront fees were 20%. And I realised what George did, the only way to come out ahead with these things is if other people drop out. There’s not enough vulture in me for that to be appealing.

  • 12 A Lap Of The Blogs : WhereDoesAllMyMoneyGo.com // Sep 11, 2008 at 10:25 pm

    [...] Canadian Capitalist examines the claims about just how low the costs are on Group Scholarship Plans. [...]

  • 13 Weekly Dividend Investing Roundup - September 13, 2008 » The Dividend Guy Blog // Sep 13, 2008 at 7:02 am

    [...] fees will always [...]

  • 14 squawkfox » Crutches, Magpies, and Tomatoes Oh My! // Sep 20, 2008 at 11:22 pm

    [...] The MER on Group Scholarship Plans : Canadian Capitalist [...]

  • 15 RESP // Sep 21, 2008 at 8:50 am

    Interesting article.

    I agree with whats been said by most other comments. Avoid group plans like death.

    Self directed, if you know what your doing is the best way to go.

  • 16 D.H. // Mar 18, 2009 at 8:07 pm

    The last post on here appears to be Sept 10, 2008. I wonder how all of you and your self directed RESP’s did in Q4 of 2008? That 30% chunk of change missing from your kids RESP probably hurt a little . . . Heritage, as an example, returned 5.23% in 2008. I like the fact that I dont have to worry about managing my money. I view my RESP as an 18 year investment. Why would I stop paying all of the sudden?

  • 17 George // Mar 18, 2009 at 8:39 pm

    My self-directed RESP did just fine in 2008. It dropped by about 18%, but that’s to be expected during a down market. I fully expect to gain back the losses and then some over the next 18 years or so. A self-directed RESP invested in bonds would have all of the advantages you like in the Heritage plan without any of the drawbacks.

    It isn’t reasonable to compare different investments based on a single short time period, especially if the different investments are for long-term objectives like post-secondary education.

    As to reasons why you might stop contributing to an RESP over the next few decades, I would think that a job loss, disability, or some other major medical issue would all be good reasons to suspend contributions, at least temporarily.

    With a pooled RESP plan, you lose the flexibility to halt contributions if your life circumstances change.

    I wouldn’t sign a contract for a cell phone or my TV service that obliged me to pay a fixed amount for 15+ years - why would I sign up for an investment that does exactly that?

  • 18 Traciatim // Mar 18, 2009 at 9:14 pm

    D.H. I agree with George, likewise my index fund RESP for my son hasn’t gained money over the past year which is an unfortunate symptom of a bad year for stocks. Similarly my group RESP plan is down my enrollment fees since we stopped paying in to the kids plans for my spouse to go back to school and then start her own business.

    With my self directed plan I simply logged in and click on my pre-auth payment plan and hit cancel. It cost us 2 grand of lost enrollment fees from my group plan.

    I also assume you will be back posting about your 4-5% return (2% in CST where I am) when stocks have a good year sometime in the next 15 years and return 15% in a 12 month period?

    18 years is an awful long time to tell someone you can pay a certain amount of cash. I’ve learned that a lot can change in 18 years and would far rather have the flexibility of a self directed plan, using whatever low cost investments that your comfortable with.

  • 19 Canadian Capitalist // Mar 18, 2009 at 10:33 pm

    D.H.: Like George and Traciatim point out, I’d be really in trouble if my kids had gone to University in 2009. Fortunately, they are only 3 and if my calculations are correct, I’d be needing the money in 15 years, not tomorrow. I’m perfectly willing to live with fluctuating portfolio values in return for the possibility of earning higher returns.

    BTW, that Heritage return, is that net or do scholarship plans still report make-believe returns hoping the tooth fairy would pay the innumerable fees?

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