As post-secondary education costs skyrocket, especially for students who must live away from home, it's never too soon to start saving for one of the most important gifts you can give your children.
If your kids are still babies or preschoolers, planning for their post-secondary education might seem a bit premature.
Besides, you may be thinking summer and part-time jobs will fund their continuing education. Or perhaps they'll be among the few extremely bright students who earn scholarships.
The reality, though, is that the cost of post-secondary education is now so high that most students need financial help from their family in addition to their own income.
Even if your children or perhaps grandchildren are very young, it's not too soon to think about putting money into a savings vehicle such as a registered education savings plan (RESP).
How Much Will Your Kids Need for University?
According to Statistics Canada, university tuition increased an average of 8.1% per year between 1990-01 and 2002-03, with the average 2004-05 tuition fees for a Canadian undergraduate being $4,172.
When you include expenses such as books and transportation, a university student living at home today needs between $7,000 and $9,000 per year. Add in living expenses like rent, utilities and food for a student living away from home and the annual cost rises to between $10,000 and $12,000 minimum.
Projected increases in tuition and living expenses put costs for a 4-year university program 18 years down the road at about $65,000 for a student living at home and $135,000 if he or she moves away. That's a lot of money, but channeling savings through an RESP can make the pot grow faster.
Although RESP contributions are not tax-deductible, the income compounds on a tax-free basis year after year.
As well, the federal government kicks in a Canada Education Savings Grant (CESG) of 20% of what you contribute, up to a maximum of $400 per child per year and to a lifetime maximum of $7,200 per child.
When RESP funds are withdrawn to pay for post-secondary education, the income portion is considered the student's income and is taxed at his or her lower or nil tax rate.
You can contribute up to $4,000 per child per year, with a maximum lifetime contribution per child of $42,000. If you miss a year, or can't contribute as much as you would like, you can always catch up later.
RESPs come in 2 basic categories:
- Pooled scholarship trusts
- Self-directed accounts
Pooled Scholarship Trusts
Pooled scholarship trusts invest only in fixed income securities such as bonds, T-Bills and GICs. While these investments are low risk, they also typically provide lower returns.
Plan managers have full control over your investment and make all investment decisions. Self-directed accounts offer more investment flexibility.
The pooled category can in turn be divided into 2 subgroups: individual and group plans.
With pooled individual/family plans you decide what contributions you make to the RESP, and your contributions are pooled with those of other investors. With pooled group plans, on the other hand, you adhere to a schedule of set payments, which are used to buy plan units.
When your child attends a post-secondary institution (it doesn't have to be a university), pooled trusts usually make a fixed number of payments. Their size depends on the fund's return on investment, administrative expenses, and the number of investors who have dropped out of the plan along the way.
If your child doesn't attend post-secondary school, a pooled individual/family scholarship trust will return your contributions less enrollment, administration, management, depository and trustee fees. Since there was no tax deduction on contributions when they went into the plan, they come out tax-free.
Your plan earnings (accumulated interest) can be rolled into your RRSP if you have RRSP room, or withdrawn. Since earnings have been tax-sheltered, they are taxable in your hands when withdrawn. You must also repay all CESG money to the government.
With pooled group trusts, you forfeit your plan earnings and get back only your contributions minus the numerous fees. You end up getting back less than you contributed. Other investors in the plan will benefit if your child does not go on to higher education, or if you drop out of the plan, because in both cases your earnings and CESG money remain in the pool.
Some people like pooled group RESPs because they simply make their payments and don't need to spend time worrying about their investment. If you're considering this type of RESP, read the plan prospectus carefully before you invest, and know what happens if you miss a payment or terminate the plan.
Also check out the qualifications of your investment representative, as well as how the salespeople are paid. Several provincial securities commissions have issued warnings about possible inappropriate practices including misrepresentation of fees and returns, limited financial knowledge, and lack of compliance with securities regulations.
You can set up a self-directed RESP account, the other main type of RESP, at most financial institutions.
Depending on your risk tolerance, plus the return you hope to get, you can opt to invest in mutual funds, stocks, corporate or government bonds, GICs and T-bills.
You can make your deposits on a regular basis or in annual lump sums; whichever works for you. When your child starts post-secondary school, you decide payment size and frequency.
If your child does not attend a post-secondary school, you'll recover your contributions to a self-directed RESP. Your earnings can be rolled into your RRSP if you have contribution room available, or withdrawn with tax consequences. You must repay the CESG.
A real advantage to a self-directed account is your ability to maximize your investment income through strategies that are not available with pooled scholarship trusts.
You can invest in equities, which traditionally have performed best over the long term. You can also invest in foreign markets, which gives you access to some of the best returns possible.
You can adjust your asset allocations over the life of the RESP in similar fashion to how you'd deploy retirement savings.
That is, when a child is very young, you can invest aggressively for the greatest long-term return. When your child is mid-way through school, you can switch to investments with a more moderate risk level. Finally, in the last few years of high school when you've built up the savings, you can switch to conservative investments to keep the capital safe.