Getting the maximum grants requires $2,500 in annual and $36,000 in total contributions. Another $14,000 can be invested in the RESP without matching grants to reach the $50,000 contribution limit.stockstudioX/iStockPhoto / Getty Images
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Building a nest egg for post-secondary schooling can be challenging for parents as tuition and living expenses creep higher. Although a tax-sheltered registered education savings plan (RESP) is a popular way to build assets for higher education, investment strategies can differ among financial advisors.
“The features of an RESP are great, but they haven’t really kept up with inflation,” says Benjamin Felix, chief investment officer and portfolio manager with PWL Capital Inc. in Ottawa.
“Still, the matching grants are pretty generous,” he says, and only the investment growth and grants – not the contributions – are taxable in the hands of the student when they’re withdrawn.
The federal government gives a Canada Education Savings Grant totalling 20 per cent of contributions to an annual limit of $500 and a lifetime limit of $7,200.
Getting the maximum grants requires $2,500 in annual and $36,000 in total contributions. Another $14,000 can be invested in the RESP without matching grants to reach the $50,000 contribution limit.
Children from low-income households may get a Canada Learning Bond of up to $2,000 without making any contributions. (Provinces such as British Columbia and Quebec may provide more funding.)
RESP investing depends on how much parents can contribute and their tolerance for risk, Mr. Felix says.
“If they have more than enough to maximize the grant-matching contribution, it starts to get interesting,” he notes.
One strategy he uses is called “super-funding” the RESP. In a baby’s first year, parents can contribute $2,500 to get the grant as well as a lump sum of $14,000, he says. “Each year after, they make the $2,500 matching contribution [for the grant].”
The RESP gets the maximum benefit of tax-deferred growth by adding that lump sum early, he adds. “That gives the nicest combination of deferred growth and relatively safe returns from grants.”
If there’s more than one child, “those dollars can be pretty significant,” he says. “Having a family RESP also allows the investment growth portion to be distributed among other children.”
One potential pitfall is when a student with income from an internship gets hit with a big tax bill by withdrawing money from the grant and investment gains within the RESP, he says.
A strategy to reduce that tab, he says, could be a mix of taxable withdrawals stemming from grants and investment growth, and non-taxable withdrawals from contributions.
For an RESP, Mr. Felix typically invests in low-fee Dimensional Fund Advisors mutual funds, which track the market but emphasize factors such as company size and value. Another option is using some Vanguard or iShares asset-allocation exchange-traded funds ETFs.
Investors could also use a glide-path strategy by investing 100 per cent of the money in an equity ETF, if it fits with their risk profile, and then reducing that equity exposure by 5 per cent or more every year or few years to invest in a fixed-income ETF, he says. “You would do that to a point at which you’re in a pretty conservative portfolio when you need the money.”
Ross Ferrier, portfolio manager and branch manager with Commerce Valley Financial Group at CIBC Wood Gundy in Thornhill, Ont., advises clients to try to contribute $2,500 annually for the grant.
“I usually don’t tell people to put more money into an RESP than what’s required for the maximum grant,” Mr. Ferrier says, and how it’s invested will depend on their risk appetite.
He typically buys Canadian bank stocks for equities in an RESP.
“I favour bank stocks because, historically speaking, their returns tend to be more predictable and their dividends don’t get cut,” he says. “They have demonstrated a history of growth.”
For fixed income, he likes CIBC structured notes linked to different market indexes, but says these securities are available at any bank.
“The one we use in the RESP is called the auto-callable step-up note, which is very similar to [a] strip bond,” he says. “The earned interest is very predictable.”
The term is usually for up to seven years, “which is good for an RESP because you are probably looking beyond seven years, and it is also a liquid investment,” he says.
The note can be sold but otherwise it “steps up” yearly with an interest rate increase – unless it beats a certain hurdle and is called by the bank.
“You then get the principal returned and interest,” he says. “It is not advisable to sell before a call unless in a profit position.”
Because the RESP already benefits from grants, the focus is growing the capital safely, he says.
If a client is risk-averse, “I might introduce them to the auto-callable note right away.”
Devin Cattelan, a portfolio manager at Verecan Capital Management Inc. in Aurora, Ont., says clients who can contribute more than $2,500 yearly per child should instead put the extra funds into a tax-free savings account (TFSA) if there’s room.
Alternatively, he says stashing that cash in a taxable, non-registered investment account.
“We are big on having flexibility because life changes and things come up,” Mr. Cattelan says.
For RESPs, he recommends clients invest in his firm’s actively managed equity and fixed-income pooled funds.
For example, Verecan Global Equity Fund holds securities such as Mawer Global Equity Fund, iShares MSCI Minimum Volatility Canada Index ETF XMV-T, and stocks such as Generac Holdings Inc. GNRC-N and Shopify Inc. SHOP-T.
Verecan’s Majestic Select Partners Global Income Fund holds fixed-income investments such as PIMCO Monthly Income Fund and BMO Aggregate Bond Index ETF ZAG-T.
Because there’s a long runway after a child is born, he typically starts with 80 to 100 per cent of an RESP in the equity fund depending on the client’s risk tolerance, and gradually adds more bond fund exposure over time.
Beginning in grade 12, he sets aside what he calls a “cash wedge,” with money going into a high-interest savings account or a guaranteed investment certificate.
“The idea is to have the funds available for higher education costs without taking on the volatility of the markets,” but some clients are still comfortable with the pooled funds, he says.
A pitfall when saving for higher education costs is not opening an RESP early when the children are young and then trying to play catch-up later, he says.
A student may miss out on the $7,200 in grant money because parents can only double their contribution in any year to $5,000, which would provide $1,000 in grants, he says.
For example, if only $10,000 were invested in an RESP in the two years before a student goes to university, that account is only eligible for $2,000 in grant money.
The power of compound growth is also lost, Mr. Cattelan says. “If you are only a few years away from when the funds are needed, you’ll have to be less aggressive in terms of the investment strategy.”
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