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 – saving to educate the fruit of your loins. We recently reviewed the Registered Education Saving Plan (RESP) as a means for doing that. This post focus on how to optimally contribute to your RESP to get the most out of it.

Fear not, fellow nerds, I have made an online 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.

Effects of Front-loading 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. That likely means 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. That money not put into the RESP was left invested either in my CCPC or my spouse’s taxable account. So, we made money on it. However, it was not tax-deferred growth like in an RESP.

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

Households with an annual income over 92K can get a maximum of $500/yr CESG. Those <46K/yr can get up to $600/yr, and those in between can get $550/yr. You can also make up for a previously missed year. For example, you can get $1000 if you did not get any CESG the previous year. The lifetime maximum remains $7200 regardless of household income levels. A lower income family can simply accrue the CESG more quickly.

Let’s plug 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$25K contribution at age 13, then $5K/yr for 5 years
CESG$7200$7200$500$5000
Investment Income$38852$58501$77100$13604
Total Value at age 19$96052$115701$127611$68604

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 have the option of a huge upfront lump sum contribution. This approach could end up with slightly more money in the RESP (RESP D), even though you miss out on the CESG.

This is because of the power of tax-sheltered 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. The other factor to consider is that if you have $50K and don’t put it all in the RESP at once, it will be growing in your regular account. The effects of that are variable based on the returns and tax drag. Complex enough, that it will be a separate post. However, as a rule of thumb, never turn down risk-free money that the government gives you.

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 a lot 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 little prodigy via dividends when it was time for them to go to school. They could have received $35K/yr whilst paying only $750 in taxes while enjoying the increased flexibility of a CCPC.

Unfortunately, effective 2018, they are no longer able to pay their adult offspring dividends unless they actually work over 20h/week for the corp. Now, they are stuck trying to save using an RESP. They can never make up for the lost tax-free investment time. They can make up some of the CESG money by contributing $5K/yr to get a maximum of $1K CESG/yr until the end of the year that their child turns 17. Those starting the RESP after age ten will miss out on some CESG.

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.

14 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.

  4. Great post, the power of compounding wins another one.
    I was wondering if you’ve ever considered the advantage of using Informal Trusts for investing any windfalls from grandparents or the Canadian Child Benefit. If one can trust your future kids at 18, it seems like it offers more flexibility in how the money is used? Allowing one to give money to the kids without strings attached?

    1. Hi Stevie. An informal trust can be particularly useful if you fund it via CCB (which we don’t get anymore if high income) or an inheritance since all income would be attributed to the beneficiary (minimal or no tax). Outside of CCB or inheritance funding, interest/dividends are attributed to the donor (interest or dividends from re-investment and capital gains are not). The main benefit compared to RESP is not needing to withdraw the money in a prescribed way and the amount of money being limited only by how much is available. It simply becomes theirs at age 18 (although an IFT funded via a Will can set out other parameters in most provinces). The money cannot be taken back and the trustee needs to be different from the contributor. The main benefit is also the main drawback – you would need to be happy that they can use the money for whatever they want – whether funding an education or trips to Vegas. Thanks for bringing it up – warrants a full post I think!
      -LD

  5. Great post! I was just wondering if you could explain why the up front 50K did worse than the gradual (16.5 + 2.5K + 1K) approach in this brochure I saw from Manulife? Really appreciate all the content on here!!!

    https://repsourcepublic.manulife.com/wps/wcm/connect/1036890e-d51b-464f-a629-389fac6086b3/inv_trs_mk2874tms.pdf?MOD=AJPERES&amp%3BCACHEID=ROOTWORKSPACE-1036890e-d51b-464f-a629-389fac6086b3-lWVqIeN&fbclid=IwAR3Jrg-WG0zfiUdv0o5H8tUNVYOdoanPPcvCN_WqsaQVaXXgMTPnwxAO-Ks

    1. Hi Bran,

      Excellent question and I am glad you brought this up. It has been on my todo list to do a follow-up article to this one that specifically looks at the lump sum issue. This current article compares RESP contribution strategies to other RESP contribution strategies. However, the more relevant comparison if you have a $50K lump sum to invest is RESP vs taxable account. That is what the Manulife comparison is doing.

      How that analysis turns out actually depends on the tax drag of the funds invested in the taxable account, your marginal tax rate, and the rate of return. In the Manulife analysis, they use a portfolio that is only giving off 1.2%/yr of the 6%/yr as taxable income. That would be assuming a portfolio that gets almost all of its return from capital gains (which is tax deferral and very efficient, but riskier). A 60:40 stocks:bonds portfolio would likely give off 1.2%/yr from the bonds alone if they pay a measly 3% interest. Dividends would be on top of that as would be any realized capital gains. That would be about 2-3%/yr as tax-exposed income. The second part is at what rate that is taxed at. The Manulife analysis uses a tax rate of 25%. Looking at tax rates on interest and dividends, that probably corresponds to an income in the $40-70K/yr range. Put together, the tax drag on their model is about 0.3%/yr. Tax drag on the same portfolio putting off the more likely 2.5%/yr income and taxed at top marginal rates would have a tax drag in the 1.3%/yr range. That 1%/yr compounded tax drag could make a difference in the outcome of the analysis. I will have to circle back and run the analysis in detail. Should be interesting.
      -LD

  6. Thanks for the educational experience as always.

    I have also been debating the pros and cons of in-trust investment accounts for children versus inter vivos trust versus personal investment account. (Once the RESP has been maxed)

    Assuming our children are decent humans beings (at least financially astute), then in-trust investment account would seem to be better and lower cost. You can effectively income split as capital gains are attributed to your children and if you can hold out until they are 18, then you can take advantage of their lower tax bracket.

    For those with a spouse of similar income or who are frugally minded (I’m not ashamed to be confused with a penniless student as I carry the same mindset and embarrassingly sport the same attire and haircut ), there may be excess money after RESP, RRSP, and TFSA have been optimized.

    What are the considerations of personal investment account versus in trust investment account versus inter vivos trust?

    With use of non dividend paying stocks eg Berkshire or Swap based ETF (still available on European markets), it is foreseeable to have a diversified portfolio that generates only capital gains.

    1. Hey George. We have thought about an in-trust account and it can be done as a way of income-splitting. If capital gains oriented, it can be efficient. Even with income, only the “first generation” of investment income is attributed to the high-income contributor. Income earned on that income is attributed to the beneficiary. The main issues, from my limited understanding, are that you need to be fully prepared that it is their money to spend how they want and a layer of complexity. We have been able to effectively enough income-split with my wife’s investment account and building a tax-efficient portfolio that we aren’t going to bother. We will likely simply start gifting money to our kids as they (and we) get older. My attire helps me blend in with students also – my thinning hair with white-patches are starting to give me away though 😉

      On a separate note, the European synthetic-ETFs that I have been able to find all pay distributions. The physical non-distributing ones (accumulating) basically function as dividend-reinvestment and tax is due on the dividends. I haven’t found a synthetic accumulating ETF (like our swap-ETFs under siege). Happy to learn of some if you have found any.
      -LD

      1. Dear Loonie Doctor,

        I had presumed that the European swap- based ETFs described as accumulating and which do not report regular distributions are similar to the (beloved) Horizon ETFs and please correct me if I am mistaken. If there are distributions, given the swap-based tracking, would the distributions be considered capital gains instead of traditional dividends?

        Using the European ETF screener (https://www.justetf.com/) and searching for swap-based ETF with low MER and high fund size, the following ETFs stand out. (Just be cautious about the listing exchange as the ticker can vary and the currency – sometimes in GBP, EUR or USD)

        1) Amundi MSCI Europe UCITS ETF – EUR (C) (https://www.justetf.com/uk/etf-profile.html?listId=first&isin=LU1681042609&from=search)
        Benchmark: MSCI Europe
        MER: 0.15%
        Key Investor information: https://www.justetf.com/servlet/download?isin=LU1681042609&documentType=KID&country=UK&lang=en

        2) Invesco MSCI Emerging Markets UCITS ETF (https://www.justetf.com/uk/etf-profile.html?listId=first&isin=IE00B3DWVS88&from=search)
        Benchmark: MSCI Emerging Market
        MER: 0.29%
        Key Investor Information:
        https://www.justetf.com/servlet/download?isin=IE00B3DWVS88&documentType=KID&country=UK&lang=en

        3) Invesco S&P 500 UCITS ETF (https://www.justetf.com/uk/etf-profile.html?listId=first&isin=IE00B3YCGJ38&from=search)
        MER: 0.05%
        Key Investor Information:
        https://www.justetf.com/servlet/download?isin=IE00B3YCGJ38&documentType=KID&country=UK&lang=en

        4) Xtrackers Barclays Global Aggregate Bond UCITS ETF 2C (USD hedged) (https://www.justetf.com/uk/etf-profile.html?listId=first&isin=LU0942970285&from=search)
        MER: 0.20%
        Key Investor Information: https://www.justetf.com/servlet/download?isin=LU0942970285&documentType=KID&country=UK&lang=en

        1. Hey George. I honestly don’t know the answer and found it really hard to find. My guess is that it would count as “other income” same as interest or foreign dividends. Only guessing though.
          -LD

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