Registered Education Savings Plans are all about helping kids get a post-secondary education. But for anybody with a RESP and children ready to start school,
The economic turmoil caught many parents off guard, experts say, as many focused on getting contributions into the plan and didn’t look at its allocation.
“In an RESP, you are very time sensitive in terms of when you need the money,” says Peter Lewis, vice-president at Canadian Scholarship Trust Foundation. “They were in investments that were far too high risk for the time period they have left before they’re going to need to start using the money, so they end up taking a hit.”
Lewis says the recession served as “a major wake-up call” to many parents that they have to have a good, sound long-term plan for their RESPs.
“The sad fact is that they weren’t paying attention (to their investments).”
FEDERAL CASH BACKS RESPS
RESPs have been a mainstay investment for parents for many years.
The beauty of an RESP contribution is that the value of the investment brings an immediate return: the federal government’s Canada Education Savings Grant — launched in 1998 to help offset the increasing costs of post-secondary education by supplementing Canadians’ educational savings — will match annual RESP contributions by 20, 30 or 40 per cent depending on the family income to a maximum of $7,200 over the life of the plan.
“Any one child can receive up to $7,200 — and this is free money,” explained David Ablett, director of tax and estate planning at Investors Group. “ Because these grants are invested and placed into an RESP on an on-going basis, they generate investment income, just like the contributions do.”
Choosing the right mix of investments depends on how long the parents have to save — that is to say, how old the child is — and their risk tolerance, and experts say parents need to educate themselves to support ‘ their childrens’ future prospects.
Ablett suggests parents think of their RESPs as they would their retirement savings.
In general, the idea is the same for RESPs and RRSPs: The closer you get to retirement — or in this case, school — the less you want to invest in stocks and the more you want to be in safe instruments such as government bonds.
CHANGING INVESTMENT STRATEGIES
“When you’re starting an RESP for a new-born child, you have to think to yourself that the investment time horizon you’re looking at would be between 18 and 22 years,” says Ablett. “So in that situation, I think you need to have a significant equity component in your RESP.”
Ablett says that while equities may carry a certain level of risk, they also offer the greatest growth potential. “If all your holdings for safety sake is money-market type instruments or GICs, you just don’t have that earnings potential there.”
Once they start high school and the time horizon to university is shorter, then it’s time to look at more secure money-market options, he advises. When the child is to start his or her post-secondary schooling in three years or less, the portfolio should be free from largely liquid assets, and parents should shift away from equities and into ultra-safe investments.
REDUCING THE RISK
There are alternatives out there for people who want to limit their risk exposure.
Some analysts suggest purchasing target-date funds, also known as life-cycle funds, which are diversified investment vehicles that have a specific target end date. Some also offer a guaranteed amount at maturity.
Meanwhile, Lewis’s Canadian Scholarship Trust Foundation offers group plans that guarantee the capital of an individual’s investment.
“We are a specific type of securities in the investment world (that) mandates us to protect and preserve the capital that’s invested,” Lewis says.
“We’re invested in a way that means that the capital’s going to be there when your child’s ready to go to school and you’re going to get a stable return over time,” he says, noting that it has no equity exposure.
“We’ll never give you a 20 per cent return, but we’ll also never give you a negative return.”
CST’s annual return has been averaging about six per cent, and Lewis is keen to point out that his funds have been unaffected by the economic downturn.
He does admit his funds aren’t for everyone. “I’m not going to say that ours is the right one for every family. It’s clearly not.
“Some families are interested in taking a little bit more risk with their money and are looking at equity funds where you’re looking at higher growth,” he says, “But if you’re looking for a simple option, ours works for most families.”
Build an RESP first
As for the enormously popular Tax-Free Savings Accounts in which many Canadians have been parking their money, the financial experts say it isn’t that attractive of an investment option for a child’s education.
“Even though the TFSAs have a lot of advantages, we still think parents should be using the RESP — if only to maximize the grants,” Ablett says.
“We also believe the RESP is the best way to save for the post-secondary education for your child,” Lewis agrees.
There are a number of strategies parents can use with a TFSA in combination a RESP.
Once parents have invested the maximum contributions needed to qualify for the $7,200 grant, then Lewis suggests parents put any additional money into a TFSA.
Another option, Ablett says, is to park the money in a TFSA first and to wait and make sure the child is likely to go on to post-secondary education. (RESPs face heavy penalties if the beneficiary does not attend school.) “And then at that point, you can switch over and put some money away in the RESP, to ensure you get the grants.”
Savings always pay off
“We are strongly recommending parents look at the Tax Free Savings Accounts as a way to supplement the RESP,” Ablett says.
Lewis says that despite these difficult economic times, a savings program for a child is a must.
“If you’ve lost a lot of money and your child’s two years old, you still got a period of time to recover,” Lewis says.
“But it certainly underscores the importance of families staying on top of their investments and understanding what the risks are and making sure they’re comfortable with those risks.”
Ablett adds: “The main point is that we certainly think the RESP should be the cornerstone of building savings for a child’s education.
“I think if there’s one area that parents are willing to invest in, it’s in the child’s education. I think parents understand the need to make sure there are funds available if they do go to school.”