Saving for Your Kids Education
There are few prouder moments as a parent than seeing your child go off to college or university. And although I am just beginning my journey as a parent, I believe it is never too early to start planning for life’s major milestones.
In Canada, post-secondary tuition can cost anywhere between $7,000 - $23,000 per year, depending on the school and program. That means that if you have a child in 2021, the inflation-adjusted cost of post-secondary education (tuition alone) could be anywhere from $40,000 - $130,000 by the time they turn 18! And that doesn’t even include living costs if your child plans to study away from home. For most of us, this might seem like an overwhelming figure, especially when there are other goals that we are also focused on, like building a nest-egg for retirement or starting a business.
The good news is that by starting early and contributing consistently, you can take advantage of two major benefits – maximizing government grants, and the power of compounding. Let’s take a look at two strategies using a registered education savings plan (RESP) to optimize your kids’ education savings:
The Slow & Steady Method - Maximizing Government Grants
An RESP is a registered account and a great investment tool set up by the Canadian government to help parents, grandparents or guardians fund a child’s post-secondary education. The way it works is that every child who is a named beneficiary on the plan is able to receive a 20% grant (CESG) per year (up to $500) for every dollar that is contributed to the plan. By contributing $2,500 per year per child, you will maximize the amount of the grant (totaling $3,000 per year). Another great benefit of an RESP is that it is a tax-deferred investment vehicle, meaning that your savings in this type of account can be invested and will grow tax-free until it is withdrawn, at which time it will be taxed at the hands of the beneficiary (your kids/grandkids). Assuming that they are a student and not making a lot of money, the taxes will be quite low (if any at all).
Assuming an annual rate of return of 6%, let’s take a look at how beneficial this strategy can be if government grants are maximized annually:
Annual RESP Contribution = $2,500
Annual CESG (Canada Education Savings Grant) = $500
Annual Rate of Return = 6%
Contribution period = 18 years
Total RESP Contributions/Principle = $2,500 x 18 = $45,000
Total CESG received = $7,200 (this is the maximum lifetime grant that you can receive per child)
Using a financial calculator with the above assumptions, by the time your child turns 18 they will have approximately $97,000 available in the RESP to use towards their education - $52,200 of which consists of principle and grants, and the remainder consists of the return on your investments.
* Important to note:
Although the above scenario assumes the grant-maximizing contribution of $2,500 from the year the child is born until they turn 18, if you are not able to make this contribution in a given year, you can carry-forward the grant room up to $1,000. For example, if you are not able to make any contributions in 2021, you can contribute up to $5,000 per child in 2022 and receive a total up to $1,000 in grant money.
The above scenario assumes that only $45,000 in total contributions are made ($2,500 for 18 years). However, the grant-maximizing contribution total is $36,000 per child and the life-time contribution maximum per child is $50,000. No grant will be received for the additional funds contributed, as the lifetime grant limit per child is $7,200. The advantage of making additional contributions is to benefit from tax-deferred growth.
The Upfront Method – Maximizing the Power of Compounding
Another effective yet less common strategy is to fully fund your child’s RESP the year they are born, and take advantage of compounding to see those savings almost triple in 18 years! While you won’t be able to maximize the Canada Education Savings Grant, you’ll more than make up for it with the power of compounding.
Let’s take a look at an example of investing the maximum allowed contribution of $50,000 the year your child is born for 18 years:
Initial RESP Contribution = $50,000
Total CESG received = $500
Annual Rate of Return = 6%
Years of Growth = 18
Using a financial calculator with the above assumptions, your child will have approximately $144,000 available in the RESP to use towards their education - $50,500 of which consists of principle and grants, and the remainder consists of the return on your investments, which have continued to grow tax-free.
When it comes to saving for your kids’ education, there are a number of strategies that might work best for you – depending on your specific circumstances. The most important thing to remember is that by starting early, your contributions will go a long way in funding your child’s future.
Carolina da Silva is a Marketing Specialist with Raymond James Ltd. Information provided is not a solicitation and although obtained from sources considered reliable, is not guaranteed. Raymond James advisors are not tax advisors and we recommend that clients seek independent advice from a professional advisor on tax-related matters. The view and opinions contained in the article are those of the author, not Raymond James Ltd. Raymond James Ltd., member of Canadian Investor Protection Fund.