How to save for post-secondary education

In this episode, listen to how to save for your child's education using a Registered Education Savings Plan (RESP).  

I talk about how to set up an RESP,  what happens when you deposit money, what does the (federal) government grant look like, what are the tax implications of your deposits.  I also talk about investment considerations, when joint ownership of the account makes sense and when it doesn't and the planning considerations that I talk to clients about as they are making deposits to their RESP.

Next episode- How to withdraw money from an RESP

Useful links: 

information on the government grant (Canada): https://www.canada.ca/en/services/benefits/education/education-savings/savings-grant.html    

information on U.S. citizens, tax treatment of RESP plans (parents and children): https://www.bdo.ca/BDO/media/Misc-Documents/Tax-Consequences-for-US-Citizens-and-Other-US-Persons-Living-in-Canada.pdf

information about 529 accounts (U.S.): https://www.savingforcollege.com/intro-to-529s/what-is-a-529-plan#:~:text=A%20529%20plan%20is%20an,programs%20and%20student%20loan%20repayments.

information about costs of post-secondary education in the European Union: https://education.ec.europa.eu/news/tuition-fees-at-european-universities 

Transcript

Sara (00:05):

Welcome to Season 2 of Sara makes Sense.  In this season, most of my episodes are going to focus on how: how do you manage your income and expenses? How do you use things like RESPs and our RSPs and TFSAs? And how do changes in the economy in policy, in the world, in your career… How do they affect you? That's what we're focusing on this season. If you've got anything that you'd like me to cover, you can always email me at ask@saramakessense.ca  

Sara (00:53):

Today, I'm talking about how to save for post-secondary education.  As a society, we start this question young.  “What do you want to be when you grow up?” We ask that to anyone over the age of two. Some of us have a clear answer to that question from an early age. And then we go and do that thing. Some of us have a harder time answering that. Some of us surprise ourselves. I'm in the ‘surprised myself’ category. Lots of us have to figure out how to pay for the education that we need to land in the career that we want. 

I'm Sara McCullough. And in this episode of Sara makes Sense, in this season of how to episodes, I'm talking about how to save for post-secondary education. I'll speak mainly from the perspective of saving for your own child's education. 

There are some variations that you may have questions about. Maybe you want to contribute to your grandchild's education, or a niece or a nephew. Maybe you're thinking about your own return to school as an adult. For more specifics, including an outline for my U.S. listeners on 529 savings plans, check the show notes for links to blog posts on the variations and for links to more information.   This episode will focus on saving for education in Canada. My next episode will focus on using the savings to actually pay for education. I often dedicate a whole meeting with my clients on how to withdraw money from savings once their child is ready to attend school.

In Canada, the most common way to save for your child's education is to use a registered education savings plan, an RESP. So let's talk about the basic features of these plan that make it an often really good option to save for education. 

Sara (02:47):

The registered part tells you a couple of things. One of them is that the growth in the account, the investment growth (once you make deposits) the investment growth in these types of accounts is tax deferred. So if you put in a hundred dollars and you make $8 in investment return, you don't have to pay tax on that $8 until the money is withdrawn to pay for education. So that's the R in our RESP.

The second feature about this account that makes it a really great savings option is that the federal government will contribute up to 20% of the money that you contribute. They will match that amount to a maximum grant amount of $500 a year. So if you, as the account owner put in $2,500 in a calendar year, the government will deposit an additional $500. So now we're up to $3,000 in a year. 

Sara (03:50):

The other advantage to this type of account is that when the money is withdrawn, the investment gains and the grant money are actually taxed to the child, not to the parent.  Generally speaking, students are in a really low tax bracket. And by low, I mean, a large number of them don't pay any taxes at all because they've got the offsetting deductions of their tuition costs. So to be able to save this money and have the growth taxed to the child, not to the parent, is a really great option. 

What you do need to know as the parent, as you're contributing that money, unlike your own RRSP for your own retirement, the money that you deposit into an RESP is not a tax deduction for you in the year that you make it. So to go back a little bit to that, our RSP,  our own retirement savings, if we put $2,500 into our retirement savings account, that 2,500 will be subtracted off our taxable income. 

Sara (05:03):

And so it lowers the income tax that we're going to pay in the year that we do that.  

When you put 2,500, or any amount that you put into your child's RESP for education, there is no tax deduction for that. The good news is it's not taxable to anybody when it comes back out. When we talk about the tax advantages of an RESP we mean two things: we mean the tax deferred growth in the investments that you choose. And we mean that, that growth, when it is taxed is taxed to the child who is in the lowest or the non income tax bracket. The other advantage of an RESP to save for your child's education is that it does give you a clear savings pattern, a clear savings destination. And I find for a lot of families, that's really, really important. 

Sara (06:09):

We all have a lot happening day to day, year to year, and it can be hard to really clarify what money is going to pay for what, and when I do review meetings with clients, we often end up having to go over that in a lot of different areas. So from a big picture planning conversation, often people will say to me, how am I going to pay for this again? How am I going to pay for my car? And sometimes I will say to them, remember this account that you started over here, that one is the one that's going to pay for the car. And so one of the advantages of an RESP is that it gives you a clear savings amount.  That this is money that is clearly earmarked for your children's education. And so, as they get older, and you're talking to them about what they want to do as they're choosing schools, as the costs are becoming a little bit more clear, you have a clear place to start when you're thinking to yourself, “how are we going to pay for this?” Or when you're talking to your child's other parent, or your partner, or your spouse, “how are we going to pay for this?” This account is your starting point. And so I find it again, has that real clear definition, and really we don't go into that account for any other purpose. Unlike sometimes our other savings accounts, or sometimes even our own our, our RSP for our retirement. We do use those accounts sometimes for a purpose that we didn't initially intend.  This RESP account, I would say probably 98% of the time, really that money once it goes in, it stays in and is used for education. So I think that is an advantage when we look big picture about how are you organizing your day to day money, really, so that it's not taking up too much of your time and energy, and that you're not worried. 

Sara (08:22):

So this again, gives you a clear “here's the money”, “here's the amount”.

The disadvantages to these accounts?  There's really only one. The child has to attend some form of post-secondary education to get the money. And even that one, in 2022, is not really a big disadvantage. When these accounts first started, they had a very narrow list of institutions that really counted as post-secondary education. And I think what one of the really great changes that Canada has made to these types of accounts is that we allow now for a very broad definition of postsecondary education.  At the launch of these accounts, postsecondary meant university only. And today that is certainly not the case.  It means university college, trade programs, all kinds of things that really allow the beneficiary of these accounts to pursue training or education in a career that they want to be in. 

Sara (09:35):

So yes, your child has to go, but for the most part, once that money goes in, you will be able to use it to help support your child's education, training and career decisions. So that covers one of my most common questions about RESP accounts, “what if my son or daughter doesn't go?”. 

And the other thing about these accounts, that again, is a little bit different from the initial setup is in a family with more than one child, you're going to set up your RESP as what's known as a family plan. So you're going to have one account. All of your children are going to be named as beneficiaries of that account. And so you've got these pooled resources.  

The deposits, though, will be tracked to a child. So when you make a deposit, you're going to tag it to the child. And again, this is part of the registered piece of the account. And it's important because the government grant is tracked per child. And I mentioned earlier that there's a $500 a year maximum grant payable per child, or per beneficiary. There's also a lifetime maximum per beneficiary. So in this family plan setup, all of your children can be named on the same account. The maximum amount is really focused on the grant. So that child has a $500 a year grant maximum, a $7,200 lifetime grant maximum. And so that's going to be tracked, but otherwise you can pool the money, which does a couple of things. It makes it easier to invest. If you have two or three children, rather than having two or three smaller accounts, you've got a bigger pool of money for investing, and there is often over time, an advantage to that. So that's a good thing. 

Sara (11:56):

The other advantages of this family plan really come on withdrawal. And today we're talking about how to save for education. The next episode of Sara makes Sense, I'm going to talk about the mechanics of how to withdraw from these accounts. So when your child or your children are ready to go to school, how do you get this money back out? And what do you need to be aware of? So again, today we're focused on the how to save. And so you will, if you've got more than one child, have a family plan.

One of the common misperceptions about RESPs often comes out as a statement from my clients. And what they say is, “I'd like to max fund this RESP.”  I've mentioned a couple of times that government grant, and this really is what motivates most of us to do this type of account. 

When we talk about ‘max funding’, often parents are aiming for that $2,500 per child to maximize the government grant of $500 a year. And that's great, but that doesn't actually make it clear about what the max funding amount is. And let me explain that a little bit more. I've said earlier, the $500 maximum grant a year, $7,200 per beneficiary over the beneficiary’s lifetime, if you do the math on that, that translates through to, if you deposit a total of $36,000 for a single child that will get you the maximum government grant of $7,200 per child. So that's a maximum amount. If we're talking about max funding, maybe that's the amount you're going with. There is another maximum amount associated with RESP accounts that most of us, we may know it, but we may not fully connect it. Maybe we didn't sit down and do the math. 

Sara (14:08):

Every child, every RESP beneficiary has a lifetime maximum of $50,000. So as a parent or grandparent, or just really great family member, you can deposit $50,000 per child, but you will only get grant on $36,000. Okay. So when you're saying, or when you're thinking, “I'd like to max fund this RESP”, it's important that you're aware of which maximum amount are we talking about? All right. And again, there's no wrong answer here. There is the answer that works best for your family. And in my opinion, it's important that you have an answer to that question so that you're not surprised down the road, or if you're in a co-parenting situation. If you and your child's co-parent are separated and your separation agreement says, “we agree to max fund the RESP” again, it's important that you clarify either in the agreement or between each other, what did we mean by maximum funding? 

Sara (15:26):

And so, as your planner, it's important for me to understand what your goals are for this account. When you say that you want to set up this account and you want to help your child with their education costs, I'd like you to think about: is it important for you to fund a hundred percent of the costs? Do you want to fund some of the costs? Is it important to you that the child contributes to their education costs? And that's going to really shape my advice on whether you have enough, because that's another frequently asked question in my office  Usually around, you know, the preteens, when your child is in the preteens, “Do we have enough for education?” Well, let's back up and look at what your goals are. And then I can start to give you some answers with numbers attached on here's what you have, and here's potentially an excess.  That does happen, believe it or not. 

Sara (16:40):

And we'll talk about how to work with that in the next episode, when I talk about withdrawing from the account. And that's also, again, when we can talk about what are your goals, how are the withdrawals going to happen? And how do you really pass on your values to your child about education, about adult responsibilities, about your feelings towards money? One of the other frequently asked questions is “I haven't started an RESP yet. And so I've missed some years now.” Previously in this episode, every time I've mentioned the government grant, I've talked about an annual maximum. The good news is the government does understand that sometimes we miss years, or sometimes, you know, we, we have to catch up or we have the ability maybe to catch up in years after the child's a little bit older. 

Sara (17:49):

So maybe once you're through those daycare costs that we talked about in a previous episode of Sara makes Sense where I covered the cost of having a baby, maybe some of that cash flow that is a little bit more available once your child's through the really intense daycare years, maybe now you're ready to start an RESP account. And so we've talked about that lifetime maximum grant of $7,200. We've talked about the lifetime maximum of RESPs of a total of $50,000. And so we do have some flexibility here in how the money goes in and what the government will match with grant. And so the grant maximum is $500 a year. As a contributor, you put in$ 2,500, the government gives you $500. If you have years that are available as catch up years, as in your child was on this earth, but you didn't contribute to an RESP. 

We can catch up one year at a time. So if it's 2022 and you have a five year old and you have money available, you can put in $2,500 for this year, the government will give you a $500 match. You can also put in $2,500 for those previous five, four years that you didn't contribute. All right, do you see how that works? So we're going to use those four years, one year at a time. So the government will let you catch up again to a maximum, all right. So if you've got a 10 year old, we can't do the current year and the previous nine years, even though that still falls in the child's lifetime maximum, the government kind of says, well, whoa, whoa, we're, we're not doing that much all at once. We will do one year at a time for catch up. So if you've got some years where you didn't do deposits and you now have the ability to do that, it's entirely possible to plan out your deposits so that you are going to catch up one year at a time. 

Sara (20:16):

The other thing you need to know, and that's important when you're planning out how to save for your child's education. We just talked about how to catch up. If you have more dollars available when your children are either preteens or mid teens, the rules for depositing change around the time that your child turned 16. So you can add money to an RESP until your child is 18. Those are the rules. If you put $36,000 in two days before your child turns 18, you will not get any grant. In fact, for that, you've got the money in. You will get no government grant. The last year that the government pays grant to a child is the year in which they turn 17, but your deposit behavior in the year that they are 16 matters. Okay? So this is, this is a funny distinction in the rules that sometimes tangles people up. 

Sara (21:30):

So if you are a sporadic depositor to your RESP, that is entirely okay, whatever works for your family. And however you can get it in there is great, but as your child is getting older and approaching that mid teens, I really recommend that you meet with a planner and really start to schedule out what do your deposits look like? Particularly in the year your child has turned 16, because if you don't have either enough money in that year, or a scheduled monthly deposit amount, grant will not happen when your child turns 17. And again, I'm gonna put some links in the show notes to the exact wording around this rules. I'm going to do some examples on my blog, because this is a tricky one. So if you're in a situation where your ability to save is happening, when your child is getting older, again, it is still possible for you to do this. 

Sara (22:32):

It's just going to take a little bit more planning and a little bit more discipline on your part. All right? So that really talks you through how this account starts, what it looks like, whether you've got one child or multiple children. And again, this account really has three parts to it, your contributions, which while they are not tax deductible to you in the year that you make them, they do come back out to your child tax free. All right, because from the government's perspective, you've already cleared the tax on that money. That's the first part of this account. The second part of this account is the government grant. So every time you make a deposit that triggers a government grant.  It usually lands in the account about four to six weeks after you do the deposit.  Grant has both the annual maximum and the lifetime per child, or per beneficiary maximum. 

Sara (23:32):

And it is taxable to the child when it comes back out. Because again, from CRA's perspective, nobody's really paid tax on that money. That's the second part of the money inside an RESP account. The third part of the money inside an RESP account is the investment growth. So very much the same as your registered retirement savings plan, your tax free savings account. You have a really broad range of investments that are available to you inside the RESP. So once you make the deposit and get the money in there, you've got to make a choice on what are you doing with that money? Is it in cash? Are you putting it in bonds, stocks, mutual funds? Again, the range of investments is as broad as it is within your own RRSP or your own TFSA. So those are the three distinct parts of the money flow inside an RESP. 

Sara (24:40):

And on the withdrawal side, that investment growth again is taxable to your child in the same way that the investment returns inside your RRSP are taxable to you when you make a withdrawal in your own retirement. Because again, CRA has never taxed that money, but the tax deferral part is valuable to you. And it becomes more valuable. The earlier you start the account, just because we've got more time, we've got more time for those investments to compound on themselves. So it's that snowball up idea, right? Time does often benefit you in this situation. Hopefully that gave you a really good sense of how to get a registered education savings plan started for your family. I'm going to wrap up this episode with just a few things that I look at when I'm planning for my clients and helping their children when education is a goal. 

Sara (25:47):

And so, again, some of the things that get discussed in my office specifically related to RESP plans.  In my opinion, it's really important that there is joint ownership of these plans. Generally joint between the parents sometimes joint between grandparents. I have seen situations where sometimes an RESP account is owned only by one parent or only by one grandparent. Often when we talk about how did this come to be? It's just a convenience thing. There was only one of us available to go in and sign the papers that day. So this is what we did. I completely understand.  Where I think joint ownership is important is in the case of losing the account owner before the child goes to school.  Even if your will has clear instructions on what should happen with this account and who should take over ownership of this account, the reality is administratively, it's very difficult to change ownership. It's very difficult to have an account like this with no owner. Again, even when we have clear instructions and a will about who is to take over, in my experience, because remember this is a back office administrative function, and it's not just the back office of the investment firm that you're working with. It's also the division of the government that is tracking the grant. These accounts, it is difficult to get them to a new owner with all of the information intact and correct. So wherever possible, I do recommend that there is joint ownership on these accounts. And even when I am working with my families who are separating and divorcing, if at all possible, I recommend that as you are moving from spouses or partners to co-parents, that you still retain joint ownership of this account. And there's a whole conversation that we can have about how to make that work for both of you. 

Sara (27:57):

But I do believe if at all possible it is important that those accounts stay in joint ownership. Having said all that, <laugh> where I have recommended against joint ownership or where my clients who work with me actually don't have an RESP is if you are a U.S. citizen. So when I've got a parent, who's a U.S. citizen that is when we have single ownership. And the reason for that is that U.S. citizens have to file taxes in the U.S.. They have to file with the IRS, even if they've never lived there. And the United States does not recognize our RESP accounts as tax sheltered education savings accounts, even though they have their own plans, they do not for whatever reason recognize this as an equivalent. They do not consider it tax sheltered. And so if you are a parent and a U.S. citizen, you will actually have to report on and pay tax on the gains in that account annually. 

Sara (29:06):

And so often it's just not the best way for you to save for your child's education. Or again, that is a situation where we would not put you as joint owner of the account. The other thing that from a planning perspective is really important is the investment considerations for an account like this.  In my 20 years of advising, and especially when I was managing money directly in the first part of my career, I often find that clients have very different risk tolerance for this account versus their other accounts. I generally speaking, find parents are less willing to see a loss in this account than their own accounts. And I think that's reasonable. I talked at the beginning about one of the advantages of this type of account is to give you a really clear answer for ‘how are we gonna pay for our kids' education’. 

Sara (30:11):

And when you have an RESP, you can say, oh, right, the money in that account, that's its job. So often we are not tolerant of volatility in these accounts, or we're less tolerant. And so again, I think that's an important conversation to have with your investment advisor is reviewing this account, not as just a big part of your savings or a big part of your investment strategy. I think it is important to break it out and to say specifically, talk about how would you feel if this account declined by 10% or by 25%, because your answers there may be very, very different than your answers. If the advisor is asking you about your own, RRSP your own TFSA, a or any of your other investments, all right. And I think that's a reasonable thought process. The other time that the investment choice becomes really important is when we look at the realities of the timelines of these accounts.  Any investment that involves risk takes time to hit a target rate of return and the riskier it is, the longer it will take to hit it. 

Sara (31:38):

And by risk, I just mean how much does this investment jump around on a regular day, what's considered normal behavior for this investment. So any type of stock or equity investment can take five to eight years to hit a target rate of return. And there's really good reasons for that, which I will cover in another episode, but that target stock rate of return of roughly six to 7% per year, it can take you five to eight years to hit that seven, six to 7% rate of return a year. And what that means is you could put the money in and you see 2% minus 10, minus 12 plus five. That's not an overall six. When you add up those numbers and divide by four that's low, but then it's that fifth year that the investments do really well. And it almost backfills all those other years where your return missed. 

Sara (32:40):

Okay. So that's what I mean when I say stocks can take five to eight years to hit a target rate of return. So looking at not only the timeline that you have to build up this account, but looking at the realities of how this account is going to come apart, these accounts generally speaking, when you save the money, if you've been able to start early, you might have had 18, 19, 20 years to save the money, but then it's going to come back out in a two to four year period. So what that means is: I think it's important to start looking at the volatility in the account up to five years before the child attends school. And then once they really are getting any closer than five years, I think it's important that you understand how much are we exposing to that $5,000 may not be $5,000 when my child gets accepted. 

Sara (33:42):

How much of that as a parent, are you willing to leave on the table or is it important for you to really have a solid number available to you? So that's where the investment considerations inside an RESP account are actually very, very different than the investment considerations, particularly in our RRSPs. So when we think about the RSPs for ourselves, we have decades to save in there. So that stock market cycle of five to eight years, we can actually take advantage of that, that can work in our favor. And even when we retire and we stop putting money in and we start drawing; some of that money, we still don't need for decades. And so again, we still have the ability to take advantage of that stock market cycle, and we still have the ability to tolerate from, and actually even benefit from market declines, post retirement. 

Sara (34:43):

And again, that's a whole other episode, and that's often an entire meeting conversation with my clients who are approaching retirement is often, our timeline just stops. The reality is most of us have decades of retirement.  With the RESP, the reality is you probably don't have decades. Your child is not gonna be in school for decades. And if they are, you're probably gonna ask them to pay for it at some point <laugh>. And you can only have this account open until the child is 35. So not decades. And again, realistically, your child is probably going to do potentially a two year college program, a four year university program. So we're taking these accounts apart very, very quickly. And so that changes the investments that make sense to go in there. 

And I've already mentioned the other part to me, that's really important for planning for these accounts: 

What are your goals? What do you not only want to be able to do for your child, but teach your child or pass to your child? Because every time we do something financially that the child is aware of, sometimes even when they're not aware, we are passing our goals and our values, not just about money, but about education, about independence, about building or being motivated. And so all of those things can actually play into the planning, the goals and the behavior around a registered education savings plan. And I think it's an amazing thing. When you can have that as part of the planning conversation with your advisor, because then it makes it easier for you to talk to your kids about money, why you've done what you've done and what is possible financially for them 

Sara (37:05):

In life, we all have pieces scattered here and there. As you're planning to meet this moving target that is “paying for my kids' education”, you're going to need both the practical mechanics of how your savings and withdrawing can happen and the best option to meet your goals as a family, because education is only one of a big number of goals. We all have other goals and your education piece should work together with your other pieces. From time to time, we need someone who can cut through the noise. Someone who not only gets to know you as a person, but can also really show and make sense of your financial plan. And I'm not talking about just the numbers. I'm talking about explaining what the numbers mean for you and the values that help to drive those numbers. This relationship, this plan, it belongs to you, not your planner. I'm Sara McCullough. Thank you for listening to Sara makes Sense. 

Disclaimer:The information in this podcast is intended for general information and illustrative purposes only for advice relevant to your specific situation. Meet with a qualified financial planner, lawyer, or accountant before making any changes to your situation. Sara's designations and licensing include certified financial planner, registered financial planner, certified divorce financial analyst, chartered divorce financial specialist, and holding an insurance license.