My recent column in MoneySense offers suggestions for parents who want to use the Couch Potato strategy in a Registered Education Savings Plan (RESP).
Investing in an RESP presents some added challenges compared with a retirement account. First, the time horizon is usually shorter: even if you start contributing to an RESP when your child is born (and most parents don’t), you’ll start tapping the funds in no more than 18 years.
The account size is also much smaller. You’re not allowed to contribute more than $50,000 to an RESP, and most parents won’t ever hit that maximum. If your RRSP account isn’t that large now, we’re hoping it will be before you’re ready to retire.
For these reasons, I suggest that RESP investors use index funds rather than ETFs: something simple like the Global Couch Potato (assembled with TD e-Series funds) is all the diversification you need. That advice is echoed by Mike Holman, Money Smarts blogger and author of The RESP Book, whom I interviewed for the column.
There is one other idea in the article that I’d like to expand on. As your child approaches university age, it’s important to gradually decrease the risk in her RESP. You can invest in stocks when she’s a toddler, but by the time your child is 18, all of your RESP money should be in fixed income and cash, so you’re certain it will be there when you need it. Imagine if your teen was getting ready for Frosh Week in September 2008 and her education savings were in an all-equity fund. You could have lost half of your RESP and put your kid’s university plans in jeopardy.
Adjusting your RESP asset allocation
Here’s my strategy for dialing down the risk in an RESP. Until your child is nine years old, you can keep as much of her RESP in equities as you want. For example, Mike Holman’s children are two and four years old, so his RESPs are 100% stocks for now.
After that, consider this formula: Subtract your child’s age from 18, then multiply by 10. That’s the maximum percentage of an RESP that should be in equities. My 13-year-old’s account is split 50-50, while my 16-year-old’s is only about 20% stocks. Here’s a year-by-year breakdown:
| Your | Maximum % |
Minimum % |
| child’s age | equities | fixed income |
| 8 or younger | 100% | 0% |
| 9 | 90% | 10% |
| 10 | 80% | 20% |
| 11 | 70% | 30% |
| 12 | 60% | 40% |
| 13 | 50% | 50% |
| 14 | 40% | 60% |
| 15 | 30% | 70% |
| 16 | 20% | 80% |
| 17 | 10% | 90% |
| 18 or older | 0% | 100% |
I stress that these are maximum stock allocations. Depending how early you start and how much you’re able to save, you may not need to take any equity risk at all. Thanks to the generous 20% government grant on RESP contributions, $200 a month starting when your child is six will grow to $50,000 by the time she’s 18 if you earn a modest 5% annually. That may not be achievable with an all-bond portfolio today, but it has been in the past and will likely be possible again in the future as interest rates rise.
{ 42 comments… read them below or add one }
Dan
I’m somewhat concerned the time period is too short for major exposure to equities. If you do go with major exposure, I think you got to also consider the state of the market. If the market crashes during the early stage of the RESP, then jumping into stocks in a big way could pay off. If the market is in a euphoric phase during the early stages of the RESP, then the payoff will more likely be disappointing.
I did the unthinkable and put much of the money into mutual funds. This was with my now long-gone financial advisor. The funds have not made it back to even (AIC and the like). Now that I’m running my own portfolio I’m doing fine but the resps sadly are not where they should be. Also the bank people have hinted the paperwork is a bit of a pain when withdrawing, especially at a loss. Oh well.
My kids are turning 1 in January. We started their RESP a few months ago. Our starting allocation was 60% equities (XIC and CDZ), 5% real estate (XRE), and 35% fixed income (split between CLF and a 5 year GIC ladder). By the time the kids turn 18, we expect to have 5% in equities (all CDZ), 5% in real estate (XRE) and the remaining 90% split between CLF and the GIC ladder (obviously reduced to a one year GIC). We are in a position to max out the contributions so I’m sticking with ETFs. I also anticipate more contribution room will be unveiled in the future. I’m probably guilty of having too many ETFs but I can’t seem to shake the feeling that using only one equity ETF or one fixed income ETF for example would be putting my eggs in one basket. I’m wary about the bureaucracy surrounding RESPs but the government grant of 20% makes it a no brainer. However, completely agree with earlier posts on this topic that RRSP should be prioritized over RESP. One more thought – an alternative way for parents who own a small business to ‘fund’ their kids’ university is to make them shareholders in the corporation and to pay out retained earnings through dividends.
@DM: I’m a bit confused as to how or why you could have your RESP in four ETFs and five GICs if you just opened it a few months ago. While there is no annual contribution limit (you could put the whole $50,000 in at one time if you wanted), contributing more that what you need to get the 20% grant doesn’t seem like the optimal strategy. I’ve assumed here that most RESP contributors will spread out their contributions to maximize the grant. This works out to approximately $200 a month if you start when your child is a baby.
I also had my RESP with a previous advisor who put the funds into equity mutual funds. I am now with a discount online brokerage. Based on your model i should be at 80% fixed income. I am wondering what my fixed term options are. I am not with TD.I prefer to not set up another RESP account. Trading fees for bond etfs would eat up profits for small annual contributions. I am thinking i have to live with the low GIC rates offered by my broker.
@JR: Why not just use a bond index fund, like RBC’s (which is all government bonds) or TD’s I-Series fund (which is government and corporates), which can be purchased through any online brokerage?
@CCP, I have twins. I made lump sum contribution of $2500 x 2 = $5000 and recently received grant of $500 x 2 = $1000. So I had $6000 to play with. Only bought first rung in GIC ladder as minimum purchase was $1000. Used remaining $5 k to buy four ETFs. I prefer $5 k annual lump sum contributions and annual rebalance as opposed to monthly contributions because I want keep trading costs minimized. While I sometimes question the value added of including GICs in such a small portfolio, they are safe and the yields are better than govt bonds owing to lack of liquidity.
@DM: Thanks for clarifying. As long you’re not paying more than $9.95 per ETF trade, $1,000 purchases may be reasonable (1% trading cost). I do wonder, however, if you could keep things a lot simpler and cheaper by just using a balanced mutual fund for the first few years. Slicing and dicing individual ETFs and GICs with $5,000 (or even $15,000) is not likely to provide any meaningful benefit, and may just add costs.
Sorry — I don’t mean to sound critical. Just trying to simply things for a dad with one-year-old twins!
We set up an RESP in this manner when we had our girl a year ago. We have a TD eseries portfolio set up and we contribute $208.33 each month automatically ($2500, the maximum yearly amount that the govt will match, divided by 12). We will rebalance the portfolio once per year at no cost. When she is 18 that will be $45,000 total in contributions, plus interest. The govt will stop matching our contributions once we get to $36,000 in contributions (because the total maximum lifetime grant is $7200). Can you keep contributing past the 18 year old mark if you want to take advantage of the full $50,000 contribution limit?
@Dave: You can contribute past age 18, but I would think twice about this: after you stop receiving the grant money, the only benefit of an RESP is tax-sheltered growth, and you may be able to do this in a TFSA with far fewer restrictions about how and when you can take the money out.
Mike Holman discusses several issues like this in his book, which you may find useful.
I see your point. However, in our case we have decided to make our TFSA’s a long term growth fund which will supplement an early retirement. So, we have it set up as part of our long term retirement portfolio (in addition to RRSP and pension at work).
It seems that the best strategy to take full advantage of the $50,000 limit is to then up your contributions earlier in your child’s life (obviously assuming you have the funds available to) in order to take advantage of tax free growth over a longer time frame. Perhaps if someone could afford to do it, they could contribute about $300 per month. Then, by the time you reach the end of the government contributions (around age 14) you will have also reached the $50,000 limit. Now you can stop saving for your kids education and start splurging a bit more on other things.
Great post and good timing.
I have just been in the process of opening up an RESP account at TD waterhouse and working out the stock/fixed income mix has been my main dilemma.
I have read a number of investing books and they do a good job of explaining the stock/fixed income mix for retirement portfolios.
Another thing they seem to discuss is that if you are looking at short term investing (under 5 years) you should stay away from equity exposure. Given this from the above plan it looks like there would be a 50% exposure to the equity market 5 years before you lock in any gains or losses.
I am a little confused with this. Am I missing something. Would people suggest putting your housing deposit in equities if you planned to buy in 5 yrs time?
I also wanted to congratulate you on a great website. I have found the information and discussion here very informative and it has helped me make the transition from my financial advisor to working things out myself.
Del
I’m thinking of just switching to 100% GICs or high interest savings account when the kids are around 9-10.
@Del: You ask a great question. There are some important differences between saving in an RESP and saving for a down payment on a house:
1. In most cases, you’ll spend an RESP gradually over four years: when your child enters university at age 18, you only need about one quarter of the money. Whereas you need 100% of a down payment on the day you buy your home.
Some people make a similar mistake when they consider their retirement portfolio: you might stop working at 65, but you’ll be drawing on your retirement savings until you die, which could be another 30 years or more. If you’re 40 years old, your investing horizon is not 25 years: it’s more like 55 years. Therefore, you don’t want to be 100% fixed income on your 65th birthday.
2. For most families, a small decline in an RESP account when a child is 15 or 16 years old (and with the suggested allocation above, the drop is unlikely to be more than 10% or so) would amount to a couple of thousand dollars. This would be inconvenient, but it is unlikely to jeopardize a child’s education plans: there would be several years to adjust.
Finally, I stress again that the suggested allocations in the post are maximum equity exposures. It is perfectly reasonable to save all of your RESP money in savings accounts or GICs if you do not want or need additional risk.
Thanks for the reply.
Yes that does make sense with the difference in a house deposit and a RESP.
It also makes sense with the difference in how the money is going to be withdrawn. Currently I have Two children (10 & 8) in a family RESP of $12,000. Who knows how long it could take to withdraw the money I didn’t start university until I was 26.
Given this I was going to use a short term bond mutual funds/ ETF for the fixed income part of the portfolio instead of GIC or money market. After thinking about what you wrote it could take a decade for both of them to draw down the account.
On the subject of using a mutual fund or ETF I was thinking of using both. TD waterhouse have recently changed their policy so households with $50,000 can get $10 trades.
I discussed my plan with them of doing monthly contributions to mutual funds and then transferring it to an ETF once a year. They said this was fine as long as I didn’t take out the funds that were deposited in the last 90 or 30 days depending on the fund. They also said that you didn’t need to meet the mutual funds minimum deposit requirements if you are doing the monthly deposit plan. Lets just see if it works in practice.
I asked them of the above because of what I read in the documentation they sent to me about frequent trading and mutual funds.
Does it make sense to look to Vanguard ETF’s for U.S. and international components of a RESP? Assuming one would make lump sum payments of $2500 annually and trading fees of $9.99 in an all stock simplified portfolio of 1/3 CDN, 1/3US, 1/3 EAFE would you still suggest the TD series index funds?
@Mike: In my opinion, in an RESP, where the total balance is likely to be small, ETFs are not worth it, especially if you’re paying USD/CAD exchange fees when you buy them. Any savings you get from the lower MERs are likely to be eaten up by the other costs.
@Del: This two-part post may be useful as you implement your plan:
http://canadiancouchpotato.com/2010/09/14/dollar-cost-averaging-with-etfs-part-1/
http://canadiancouchpotato.com/2010/09/15/dollar-cost-averaging-with-etfs-part-2/
Dan,
Great article! I recently set up an RESP account using the Global Couch Potato model with TD e-Series funds, but wasn’t sure about how best to adjust the asset allocation as my daughter approaches her university years. Your recommended formula for dialing down the risk is that last piece of the puzzle I was looking for!
I’m also using the Global Couch Potato model with TD e-Series funds for my RRSPs and I’m wondering if there is any rule of thumb that you might recommend for adjusting allocation over time in this type of account. I’ve seen formulas out there that suggest making the % of equities equal to 100 minus your age. I’ve also seen the same formula recommended using 110 and 120. Maybe there’s another formula worth considering? I’d appreciate any input you could provide on this.
Thanks!
Kirk
To Mike’s point regarding using US ETF’s in an RESP portfolio, another disadvantage is that they’re also subject to the 15% withholding tax. Only RRSP’s are exempt from that tax, if I’m not mistaken.
@Kirk: The rules of thumb about the equity portion of your RRSP are all reasonable. Your choice depends on how risk averse you are, and the rate of return you think you need. Unfortunately, there are no hard and fast rules here.
@Rajesh: You are correct that US ETFs are subject to the 15% withholding tax on dividends if held in an RESP. It’s important to note, however, that Canadian funds holding US stocks also pay this tax, so there’s no getting around it if you want to hold foreign equities in an RESP.
@CCP:
you mentioned in response to DM that you didn’t think that contributing more that the minimum amount to maximize the government grants was the optimal strategy for an RESP. Care to elaborate? If the maximum contribution is $50,000, and you need to contribute $2,500 per year to get the $500 government contribution, is there any value in contributing the remaining balance up front and taking advantage of the time value of money? For example contributing $16,500 in year one and $2,500 for the next 13.4 years>
@PeterT: I haven’t thought through the optimal strategy, but your idea sounds fine if you happen to have $16,500 in cash in year one. You will be able to take advantage of tax-sheltered growth for many years, which is great. My advice applies more to people who have already received the maximum grant when their child is still a few years away from university. At that point, I would suggest that any additional savings be held outside the RESP for added flexibility.
@ PeterT: Personally, I would open a TFSA for the child (though I’m not sure that’s allowed) and contribute the $5000/yr maximum over the 3+ years it would take to eat up the $16500 contribution. Given the increased bureaucracy of withdrawing from an RESP relative to the timeliness required of education costs, I would want sufficient funds to cover the first expenses in a more ‘liquid’ vehicle. Once the EAPs from the RESP come through, I would try to replenish the TFSA as needed.
The TVM benefits I would gain from contributing the full 16500 in year one compared to spreading it out over 3+ years I would gladly trade in order to have a little more control over the disposition of those funds at the time they are needed.
@AKA & PeterT: A couple of things to clarify. You can’t open a TFSA in a child’s name — account holders must be 18, so the account would have to be in the parent’s name. If you’re considering opening a TFSA to save for a child’s education, and you have not opened one before, then you will have $15,000 of contribution room as of January 1, 2011. So there may be no need to spread that $16,500 over three years.
@CPP:
How about using the RESP in your personal overall asset allocation instead?
You will probably need to help your kids to finance their education anyways, whether the RESP investments performed well or not. If, for example, you don’t have enough RRSP room for all your savings, and have some assets in non-registered accounts, it may be more tax efficient to maximize fixed income inside registered accounts like RRSP, TFSA , AND RESP.
@Jas: I would not recommend that. RESPs are quite restrictive in terms when they allow you to access the money, so they really should only be used for the specific goal of funding a post-secondary education. If your child ends up deciding not to go to university, you may be faced with some significant penalties. The government has done it’s best to make sure RESPs are not simply used as tax shelters for the the wealthy.
@CCP: Thanks for your answer. Suppose you have already invested the maximum of 50k inside your child RESP and you would like to invest even more money towards your child’s education. Would it make sense to keep fixed income and international equities inside the RESP, and put canadian equities inside a non-registered account?
I understand that if you child doesn’t go to university it might be a problem, but it is always possible to transfer the RESP to another children in the family (assuming you have have more then one!)
@Jas: That sounds fine.
I see a lot of people on the forum are using TD Waterhouse to set up their RESPs. They charge a $50 annual fee except for accounts over $25 000. Is it worth the fee to have a self directed RESP with access to E-series funds?
@Brodie: Chances are you’ll save more than $25 in MER compared with other options, so it is likely to be worth it. (There aren’t many RESP options that have no account fees on small balances, so you’ll likely pay something similar no matter you do.)
Brodie – if all you want are TD e-series funds, then you can open up a TD Mutual Funds RESP (not TD Waterhouse) with no annual fee. You open the account up like a regular RESP and then mail in a form to convert it to an e-series account.
There is lots written about paying into RESPs but very little about the bureaucracy in getting one to pay out. I showed up at my Financial Institution with my son`s University invoice and discovered that this was not sufficient information to pay it from the RESP in his name. The process cannot begin without a Certificate of Enrollment being produced by the academic institution (I wonder why the Government thinks that I would be providing a University thousands of dollars for my son`s tuition if he was not enrolled). This then requires a visit by my son to the University Service Centre (during final exams) where you discover that producing this document can take up to a week. The Financial Institution then needs paper work and several days to pay out from the RESP. The result is either a late tuition payment (with University fees) or going overdraft with Financial Institution fees waiting for the transfer of your funds. Of course, the University does not communicate any of this when they send out their invoice. The Universities, Financial Institutions and Revenue Canada need to move into the current century and get together and stream line this process for the betterment of all concerned.
My son was born in 2012 in Alberta. I am very much interested in setting up an RESP with TD to buy TD e-series mutual funds; however, I understand that the Alberta Centennial Education Savings Grant (CESG) is not available with TD e-series funds.
Is it possible to set up an RESP through TD e-series for the bulk of the investments, and then a smaller mutual fund/etf account with an Alberta CESG promoter?
@Krista: It is certainly possible to have two RESPs set up for the same child. You just need to be careful that your combined contributions do not exceed the maximum. (It’s similar to having two RRSPs or two TFSAs.)
Hi Dan,
Hope you don’t mind explaining the asset allocation risk from a slightly different angle. This is something I’ve been wondering about for a while for my kids’ RESP’s.
For retirement planning, it’s not generally advised to be 90% in equities within 9 years of retirement. My understanding is that would be considered too high a risk. Yet the risk of doing this seems to be much less than with an RESP because in retirement you’ll use only a small percentage of your savings per year, and your retirement is spread out over a much longer time. Just wondering why it would be Ok to take this much risk with an RESP where you need to spend the funds so much sooner. I’ve read your point about your table above representing maximum allocations, and how you have to account for how much you’ve already saved, but is 90% equities within 9 years high risk or ‘desperate’? I don’t mean to argue the point, I just want to understand it better so that I’m not being too conservative with my kids’ RESP’s.
@Pat: I’m not sure I understand your point: do you feel my suggestions are too conservative or too risky?
@CCP: I’m wondering if they’re too risky.
Thanks, Pat. Remember, the recommendations above are for the maximum equity allocation, so they may well be too risky for some people. I’m inclined to agree with you that RESPs should err on the side of conservative, since your rate of return won’t make that much of a difference over the course of 10 to 15 years with small amounts of money. Your contributions are much, much more important.
But it’s also important to keep in mind real dollar amounts here. When a parent is nine years from needing their RESP, how much money are they likely to have in the account? Most will have just a few thousand dollars (remember, the lifetime maximum is $50K and very few people ever hit that limit). So any losses at that stage are unlikely to jeopardize a child’s education plans. That’s not quite true if you lose half your RRSP nine years before retirement: that might force you to work longer, etc.
Thanks Dan. On a somewhat different topic, another blog I was reading recommended eventually moving to all cash (and money market funds I think) by the age of 18. Is that really necessary? Is there a risk in being 100% in bonds during the time your child is in university? Would a 100% allocation to the TD e-series Canadian bond fund be Ok while your child is in university?
@Pat: Yes, there is definitely risk in keeping 100% of your RESP savings in a bond fund when your child is at university. A bond fund can lose money over a period of two, three, even four years, if interest rise sharply.
One strategy at this point would be to use a ladder of three or four GICs, with one maturing each summer before the academic year begins. But I generally agree with the advice of keeping 100% in cash once your child starts school. At that point, your goal is preserving capital, not growth.
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