Optimizing Your RESP Contributions

Much of finance is like sex. Action now, with consequences later – many of which cannot be undone. Some people figure that out faster than others. Hopefully before getting an unwanted rash.

In this post, we will deal with one of those consequences – having to save for educating the fruit of your loins. We recently reviewed the Registered Education Saving Plan (RESP) as a means for doing that. This post will be focused on how to optimally contribute to your RESP to get the most out of it.

Fear not, fellow nerds, I have made an Excel-based RESP calculator to help us.

There are three main factors to optimize in building up your RESP:

  1. Front load as much as possible, while making sure that you won’t exceed the $50K lifetime contribution limit.
  2. Spread out contributions of at least $2500/yr over at least 15 years before your progeny turns 18 to maximize the Canada Education Savings Grant (CESG). To do this, you need to start as early as possible.
  3. Choose your investment mix to optimize returns for your level of risk tolerance.

The effects of Front-loading your contributions to your RESP

Let’s look at three scenarios for making contributions. All three have $50000 in lifetime contributions, the same CESG, and assume the same investment return of 7% with 2% inflation for a real return of 5% annually.

 RESP ARESP BRESP C
Strategy$2500/yr from birth$16500 first year, then $2500/yr for 13yrs, then $1000.$2500/yr for 11 years, then $15000 once, then $2500/yr for 3 more.
CESG Money$7200$7200$7200
Investment Income$38852$58500$42627
Total Value at Age 19$96052$115701$99827

As you can see by comparing A and B, front-loading your contributions and then spreading the rest out results in an extra 18K due to the longer period for investments to grow tax-free. It will also be taxed in the little hands of your offspring when it comes out (ie likely little or no tax) compared to your marginal rate.

Situation C is actually mine with my original clone. I did not realize the optimal strategy until researching this for the blog. It is not too late, I can still make an extra 3K by making a larger contribution this year. It also isn’t as bad as it seems because that money not put into the RESP was left invested in my CCPC. So, I made money on it, but it was not tax-free growth and it will be taxed in my hands rather than my daughter’s hands when I access it.

A valuable lesson in this. I have had four professional advisors in two different firms, none of whom pointed this out to me. It pays to learn about and mind your personal finances, even if you have an advisor.

The effects of spreading out your contributions to maximize your CESG

You generally only get a maximum of $500/yr CESG, but you can get $1000 if you did not get any CESG the previous year. Let’s plug in a few more scenarios into the RESP calculator.

 RESP ARESP BRESP DRESP E
Strategy$2.5K/yr from birth$16.5K first year, then $2.5K/yr for 13yrs, then $1K$50K contribution in year of birth$35K contribution at age 11, then $2.5K/yr for 6 years
CESG$7200$7200$500$4000
Investment Income$38852$58501$77100$14649
Total Value at age 19$96052$115701$127611$68649

We have already seen that front-loading RESP B beats a totally spread out contribution like in RESP A.

However, if you had the money sitting around or gifted from a wealthy relative to put $50K in at birth, you may end up with slightly more money (RESP D), even though you miss out on the CESG. This is because of the power of compound returns. In our scenarios, we are assuming a 7% return on our investments. If you realize lower returns, then this advantage for D can disappear. For example, a 4% return would have both strategies pretty much even.

One big decider between strategy B and D is most likely to be whether you can access the big wad of money to put $50K in the first year. If you get it as a gift or find it in the crack of your couch – great. If not (which would be most of us!),  to access that kind of cash could cause you to pay alot of tax which you would need to factor into the equation.

The CESG is a guaranteed 20% return the year it is put in. That seems a pretty good deal to me. Like everything else in investing, risk and return are related and you need to balance them in your planning.

What the heck happened to poor RESP E – Well, that family of nerds got an Atomic Wedgie from the Trudeau Gang. How can this be???

Credit: Rockstar Games.

The parents of RESP E are professionals and have a CCPC. They kept the money that they were saving for Mini-me’s enrollment in Evil Medical School as retained earnings in their CCPC. They invested that, after paying the paltry 15% small business tax rate and were planning on paying their kidadult via dividends when it was time for them to go to school. Their genetically engineered clone could have received $35K/yr whilst paying only $750 in taxes.

Unfortunately, effective 2018, they are no longer able to pay their kidadult dividends unless they actually work over 20h/week in the CCPC. Now, they are stuck trying to save using an RESP and may never make up for the lost tax-free investment time or CESG money depending on their timelines.

This is a good example of “political risk” from concentrating your portfolio in one type of account. The government can unilaterally change the rules as they did in this case. They are likely to do so again, as they seek more revenue in the future. All we can do is operate under the current rules, but when there are multiple strategies with similar results, it may be wise to spread out your risk amongst different options as long as it is part of a cohesive overall plan.

6 comments

  1. Great post. Found you through GreaterFool website.

    It is a lot easy to set aside $3K per year than it is to come up with $50K up front, especially if they have a mortgage.

    My plan is as follows: $5K initial contribution and then $3K per year until age 15. Total contribution: $50K. Total CESG: $7,200. My calculations suggest that portfolio will hit just over $100K by the time the kid is 18.

    1. Thanks! That seems like a good plan and slightly better than what we have done to this point. We definitely could not have come up with $50k when we first had kids and I like the more gradual optimizing the CESG approach better anyway. We still had huge student debt at the time. We put in 5k the first year for our first kid and then 2500/yr for each kid when we had our second. We are better off financially now about a decade later and will make some top ups now that I examined the math better writing this article. Thanks for visiting!

  2. i liked this post a lot and just came back to reread it
    was reading a few comments on the canadian couch potato blog on the new Vanguard 1 fund solutions and a commenter made a comment similar to yours about trying to maximize total value of RESPs
    wondering if you could comment on comparing the Mawer balanced fund and the similar Vanguard 1 fund ETF….would this be VBAL? in terms of how much value this Mawer fund now has in your opinion

    1. Thanks Elmer. Canadian Couch Potato is better for comparing specific funds than I am and had this to say about VBAL. The VBAL looks to be more passive with a lower fee of 0.22%. Mawer is actively managed with a higher fee (~1%). That is a relatively low fee for a managed fund, but is the manager going to be able to consistently outperform enough to make up for that fee over the long-haul? I don’t know. It is like predicting the weather to me. I did do a comparison of active versus passive managed funds in general which showed passive generally wins.

  3. Great look at this issue! Would you consider adding in the consideration of where the $50k for front loading comes from – cash from Grandpa vs dividends from Corp, probably the two most likely sources of funds for many of us? Of course, there’s also the financial planning issue of it probably not being a good idea to put $50K in a RESP just to squeeze out a few more $s in 18 years time, when you have student loans that need taking care off now.

    1. Thanks Grant! Great points. I have been thinking that I should revisit this one with the recent interest in it. Where the money comes from is key. A gift is one thing, but taking money out of a corp and getting taxed on it is entirely another. Also, if a gift or you just happen to have the money at a personal level, one would also need to consider the alternatives about where that money could be held for a fair comparison. Competing priorities if you do have the money is a key issue for most people. When we started our RESPs, we had loans which took precedence. We are now looking at doing a lump sum top up (without losing any of the potential grant) since we are in an entirely different financial position and our timeline/returns still make it worthwhile. Rational or not, I also psychologically have a hard time turning away a guaranteed government grant – the money flows the other way so often.

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