Saving for your child's eduction - RESP vs. the Tax Free Savings Account

From my CBC radio national column, August 20, 2009:

While they're trolling the malls looking for new backpacks and back-to-school clothes, parents need to remember that they need to prepare for life after high school.

The back to school scramble. It's a dance parents know all too well. But between trips to the mall, I'm reminding moms and dads that they need to squeeze in some time to think about how
they're going to pay for their child's post-secondary education.

But with all the demands on family budgets this year in particular, isn't it asking too much of parents to take on another financial burden ?

I sympathize that this is a difficult time for many people, but when you consider that one year of university including tuition, books, room and board costs approximately $12,500 or $50,000 for a four year degree, you should really try to put some money away-even if it's less than you would like.

What's the cost?

It's amazing how much your savings can build over time. And that's important when you consider how much the cost of education is expected to grow. The Bank of Montreal estimates that the cost of a degree could grow to close to $100,0000 by 2021.

The other thing to realize is that there are a variety of options to consider when you're deciding on the best way to save. So even if you can't manage to set aside money this year, there's nothing stopping you from drawing up a long-term plan that you can start putting into place
next year when your financial situation is a little better, let's say.

What are my options?

Let's start with the obvious one-the RESP, or Registered Education Savings Plan. Basically, it's a tax shelter allowing you to save for your child's education. When I say shelter, what I mean is that the amount you put into an RESP grows tax deferred until your child takes it out for their
schooling. The idea is that the tax won't be much as it's taxed in their hands and they're not earning much income at that stage.

You can contribute up to $50,000 per child over the life of a plan and there is no longer an annual limit.

There's no tax deduction as there is with an RRSP, but there is a government grant

The government will provide 20% on the first $2,500 contributed each year to an RESP, up to $500 a year ($7,200 to your child's resp in a lifetime).

Is there another option that exists?

Something else you should think about is a tax-free savings account. With the tax-free savings account (TFSA), you can put $5,000 a year and not pay tax on its growth or what it returns. You need to keep in mind though that the account holder must be at least 18 years old, so you
can't start an account for a small child.

One big advantage though to this account is that there's no restriction with how the funds are used, unlike an RESP, which must be used for educational purposes.

So a tax-free savings account might make sense if you wanted to say purchase a condo or house to use while your child's at school, for example - this account would offer that flexibility. But of course, you'd be forgoing the guaranteed 20% grant from the RESP.

Many advisors suggest maxing out the RESP contribution first because you're guaranteed the 20 per cent minimum from the government grant and then if you're able to save more, allocate it to the TFSA.

What kinds of investments are eligible for RESPs?

Just as with an RRSP, most investments are eligible, such as GICs, mutual funds and more. If you wish to purchase individual stocks and bonds for your child's RESP, you will need to open a self-directed account. Check with this financial institution to see what options exist for your plan.

Are there any that you would recommend in particular? Or to stay away from?

Time is of the essence with an RESP. If you're starting when your child is say at the age of two, you have time to be a bit more aggressive. If they're much older, you'll need to reduce or eliminate exposure to equities or more risky investments.

Remember, as with your own investments, it's essential to understand the risk level you should take or not for your child's RESP.

And you should review your investments over time...you don't want to be moving in and out of stocks or mutual funds willy-nilly, but don't feel like you have to stick with an investment for 20 years if it's not working for you.

What happens if my child doesn't end up going to college or university ?

Any money the government added to the RESP will have to be paid back. But income generated from that money remains within the plan. There are also rules about what happens to the money that grew tax-free. You can transfer up to $50,000 to your RRSP - or your spouse's - if you have the contribution room.

A final word of advice

Remember that it's essential that you as a family survive first, then save for your kids next. During your child's early years, there's a great deal of debt and demands on your savings. So although yes, it's ideal if you can start early, don't feel that you can't catch up as your children are older and your debts are reduced.

Lastly, an effective strategy could be to invest in your RRSP and use the tax refund that it generates to then invest for your child's education.