At some point in Grade 10 or 11, it’s time to drain the risk out of an RESP.monkeybusinessimages/AFP/Getty Images
This is exam time for parents using registered education savings plans to help their children pay for a postsecondary education.
Top grades go to parents who have lowered the risk level in their children’s RESPs as they progress through high school, while still generating some growth to cover tuition costs for the years ahead. Thanks to high interest rates, it’s never been easier to achieve this delicate balance.
As much as high rates are a burden on borrowers, they’re a gift to savers and people investing for goals like retirement and a child’s postsecondary education. Virtually risk-free returns of 5 per cent or more can be locked in for terms of one through five years, and you can get similar returns on cash kept safe and liquid for anytime use.
A quick overview of RESPs: Investments in the account compound tax-free, while the beneficiary student pays any applicable taxes on withdrawals. Contributions receive a 20-per-cent match from the federal government that tops out at $500 per year and $7,200 lifetime. In addition to colleges and universities, RESPs can be used for trade apprenticeships and various training schools.
A back-to-school refresher on RESP withdrawals
RESPs for babies and young children can be invested aggressively, with 70, 80 or even 90 per cent of the assets in the stock market. But at some point in Grade 10 or 11, it’s time to drain the risk out of an RESP. The goal is to make an RESP impervious to mayhem in financial markets around the time it’s needed to pay postsecondary bills.
A thought for parents of a student going into Grade 11: Set up a five-year ladder of guaranteed investment certificates maturing in August, when tuition bills start coming due. This money would be covered by deposit insurance and thus pretty much bulletproof.
Here’s how to set up the GIC ladder, which means equal amounts of money invested in terms of one through five or fewer years:
- Check the GIC inventory at your online broker, or ask your adviser or bank/credit union representative.
- Use 5 per cent as a rough target for minimum annual return for each term.
- Confirm the GIC issuers you select are members of Canada Deposit Insurance Corp. – which covers eligible accounts for up to $100,000 in combined principal and interest – or credit union deposit insurance plans.
- If a child is in Grade 12 or already in a postsecondary program, shorten the ladder to as long as needed. For example, consider a student who is heading into a four-year university program and has already paid tuition for the year ahead. A three-year GIC ladder in an RESP would secure the next three years of costs.
It’s a good idea to keep some cash in the RESP of a postsecondary student so surprise expenses can be covered. Here, again, high rates can produce a strong return with no risk.
One option for cash sitting in an RESP is an investment savings account, which is basically a savings account packaged like a mutual fund and generally covered by deposit insurance. Rates for these products range from 4.55 to 5 per cent and you can buy them through any broker with no commissions. The advantage of these accounts is that money is readily accessible, while GICs are locked in.
Rates around 5.3 per cent are available from high-interest savings account exchange-traded funds, which you buy and sell like a stock. Commissions for this type of trade range from zero to $9.99, depending on which broker or trading app you use. HISA ETFs hold their money in bank savings accounts, but are not covered by deposit insurance.
Another way to put high rates to use in an RESP, and in other investing accounts, is to pair GICs with equity funds or individual stocks to create a balanced portfolio. An RESP for an infant might go as follows: 20 per cent in GICs and 80 per cent in an ETF tracking stock markets in Canada, the United States and the rest of the world. An example of this type of ETF is the Vanguard All-Equity ETF Portfolio (VEQT-T).
Bond funds and individual bonds are the usual way to diversify stocks, and it’s possible they will generate a better total return of interest and capital gains in the next few years. But bonds fell hard in 2022 – an alarming development for people who hate surprises. GICs give you a safe hedge against stocks, with no drama.
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