Why an early RESP start should be a top priority

Even if money is tight, a risk-free return of 20% is too good to pass up.

Pira Kumarasamy 29 September, 2017 | 5:00PM
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The Who's classic-rock song, The Kids are Alright, doesn't quite ring true today in a world of soaring tuition costs and dismal savings. A recent poll sponsored by CIBC found that students on average say they expect to spend nearly $14,000 annually on their education. The poll also found that two-thirds of students don't have a registered education savings plan (RESP) to help them with the cost.

These findings might not be shocking, but they do indicate that a shift in priorities is needed in order to get ahead of the savings game. Starting early is the best -- if not only -- course of action to make the rising cost of education feasible for the next generation of scholars. For those in the millennial generation, however, it's not so clear-cut.

Shrishma Dave is one such millennial.

"When you have a young child, you feel like you have the luxury of time," she says. "There are many more pressing priorities right now and it does get tough to manage finances while starting a family."

With a 16-month-old child, Dave recognizes the benefits of the RESP and plans to contribute early, but recognizes that it's not easy for many young people with the budget challenges that they face.

Why invest in an RESP?

Millennials with growing families might wonder why they should start saving in an RESP when they have a whole host of financial priorities including child-care costs, mortgage payments, life insurance and rising grocery bills, to name a few. The argument for moving it to the top of the priority list, however, is compelling.

"When it comes to investment planning, it's always important to start early," says Tony Salgado, director at CIBC Wealth Strategies Group. "With an RESP, you not only benefit from tax-deferred compounding growth, you also benefit from grants received from the government."

The government's matching program makes the RESP the clear winner for parents looking to save for their child's education. It gives families the opportunity to grow their savings by a risk-free 20% in the first year, up to a maximum contribution limit of $2,500. Additional incentive is given to families with net income below $90,563. Depending on where you park your funds, this means potential investment growth, plus a guaranteed 20% rate of return in the year of contribution. Even if you were willing to accept high risks, you'd be hard-pressed to find that type of return in today's markets.

How should you get started?

As the old personal-finance adage goes, pay yourself first. My husband and I made it a priority to meet the $2,500 threshold for the maximum government matching benefit the year our son was born. We did this by setting up automatic payments out of our biweekly income. This made it a painless process, and we no longer feel the hit to our paycheques.

"Start with priorities and budgeting," says CIBC's Salgado. "You need to look at your necessary costs compared to your unnecessary costs. You might not need to jump into a whole plan, but start with a simple budget."

It's not necessarily avocado toast that's keeping you from saving for your child's education, but once you examine your wants and your needs, there are sure to be areas you can trim. For instance, my husband and I almost convinced ourselves that we needed a $500 toy Ferrari for our son but ultimately decided that the money served him better in his RESP.

Where should you invest?

The type of investments you choose will largely be based on personal preference. As a millennial investor, however, it's important to note that your time horizon is relatively long. If you have the stomach for it, you can afford to take some risk with the investments you choose.

When your child is in diapers, you might want to weight your portfolio heavily in equities. Once he or she is closer to the point of cap and gown, fixed income would be a better bet to preserve income.

No matter what you decide to do, think about your tolerance for risk and your time horizon before deciding where to invest. If you're going to run for the hills every time your portfolio dips a few percentage points, a portfolio heavily weighted in equities might not be right for you. Keep in mind that even the most conservative of portfolios will include the initial 20% return that comes with government matching.

How much should you invest?

Salgado notes that there's no rule that works for everyone. The most obvious choice is to invest up to the maximum $2,500 annual limit for which the government will provide grants. The main benefit beyond that amount is the tax deferral feature, which essentially means that interest and dividend income and capital gains are not taxed within the plan. Withdrawals are taxed in the hands of the student, who is likely to have to pay very little or no tax on them.

Another thing to keep in mind is that an RESP can be opened for each subsequent child. There's also a family RESP option, which allows you to save for additional children in one account and allocate the amount that you choose for each child. Speak to your advisor about the pros and cons of each option and choose the one that works best for your family.

The options for saving money though RESPs are more abundant than ever, and it's important to stay informed and start early to enjoy growth over time. Putting in the work now means less stress for both you and your child down the road. In other words, the kids might actually be alright.

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About Author

Pira Kumarasamy

Pira Kumarasamy  Pira Kumarasamy is a financial writer who writes for Morningstar on personal-finance topics, with an emphasis on issues affecting the millennial generation. She holds a bachelor of arts, economics and accounting from Wilfrid Laurier University.

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