Taking Risk in an RESP

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 (short-term bonds, GICs or 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 child’s age Maximum % equities
Minimum % 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 much 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.

124 Responses to Taking Risk in an RESP

  1. wheredoistart February 3, 2015 at 2:37 pm #

    Mr. Potato, We have all of our RESP cash for our daughter (currently 20 months old) in the RBC Target 2030 Education Fund. Thoughts? Should we be riskerier?

  2. Canadian Couch Potato February 3, 2015 at 2:53 pm #

    @wheredoistart: Looks like that fund is over 70% equities. I don’t think anyone needs to get riskier than that.

  3. wheredoistart February 3, 2015 at 3:03 pm #

    Thank you for your quick reply. It’s also managed by RBC and the MER is 2.03%, I went in to my appointment thinking, i’ll direct invest and do it on my own (mostly inspired by your blog and a savvy uncle). When I left I was in a fund with a high MER and not direct investing and even more confused… Is there anything I can do?

  4. Canadian Couch Potato February 3, 2015 at 3:50 pm #

    @wheredoistart: I’m not going to defend 2% MERs, but don’t be too quick to bail. Remember that in a small account the fee impact is relatively small in dollar terms: $100 on a $5,000 account, for example. If setting up this account encouraged you to start saving and collecting the CESG grant, don’t beat yourself up. At some point in the future, if you are comfortable investing on your own, then you can certainly lower that fee with a DIY portfolio. But for now you have 20-month-old who is probably taking up a lot of your time. 🙂

  5. Andrew March 27, 2015 at 8:43 am #

    My daughter is in year 17 and my son is in year 15, I want to start rebalancing my funds into the fixed income side. Any comments on using 1-5 year laddered government bond etfs to fulfill my fixed income objectives?

  6. Canadian Couch Potato March 27, 2015 at 8:51 am #

    @Andrew: Once a child is 15 or so, I would keep all of the fixed income assets (which should be close to 100% of the RESP) in cash or laddered GICs. Any bond ETF can fluctuate in value and is not appropriate when you need the money is needed imminently. In any case, the yield on short-term government bonds is lower than that of GICs (and in some cases, even lower than cash) so there’s really nothing to be gained by using an ETF.

  7. Andrew March 27, 2015 at 11:38 pm #

    Thanks for the comments. If interest rates start sneaking up over time, what are your thoughts of a laddered bond fund instead of VAB etf or ZAG etc?

  8. Canadian Couch Potato March 29, 2015 at 8:44 pm #

    @Andrew: The laddered structure isn’t really a factor: the key idea would be to use bonds with shorter maturities (such as VSB) if you are concerned about rising rates.

  9. Tyler May 7, 2015 at 9:43 pm #

    Hi There,

    Thank you for the valuable information. I’m planning on following your advice for my 4 month old daughter.

    Now I just went to TD and they told me the e series funds are not available for RESPs. I haven’t read through all the comments to see if this was already answered but just wanted to know if the advisor was pulling my leg or not.

    I’m assuming the Royal Bank index funds would suffice.

    Thank you,

    Tyler

  10. Canadian Couch Potato May 7, 2015 at 11:14 pm #

    @Tyler: The e-Series funds are definitely available for RESPs. However, the e-Series funds are only available to self-directed investors, so your advisor is not able to offer them because they don’t pay him a fee. If you need the services of an advisor, then you would need to pay more for that. If you want to manage the account on your own, then you can open a self-directed e-Series RESP at the branch or through TD Direct Investing.

  11. Tyler May 9, 2015 at 2:48 pm #

    Thanks for the quick reply,

    But of course I forgot to click the notify by email and missed it until now. The guy I talked to was an investment consultant and obviously didn’t do his homework.

    I ended up going with RBC, but even they weren’t on the ball. I asked if the RBC index funds were available for RESPs and she assured me they were, but then she setup an account for me that wasn’t self directed and wouldn’t have access to them. When I question her about it she proceeds to tell me that I never asked for a self directed account, which I didn’t know I needed. After a couple phone calls and sitting on the phone with someone from the investment department they finally got it setup. They sure do everything in their power to sell you mutual funds.

    I haven’t yet sat down and done the math but I don’t think I’m going to lose much by using the RBC funds instead of the TD e series ones.

    Tyler

  12. Jennifer Webster May 15, 2015 at 2:55 pm #

    Hi, I had a question about RESP’s. As I receive the CESG and the additional CESG I cannot transfer the RESP’s to TD e series. They can only do RESP’s for CESG, if you get the additional or the low income Canada Learning Bond you can’t use the TD e series (and retain these two extra grants).

    So what do you suggest? Tangerine doesn’t have RESP.

    Thank you for your time,
    Jennifer

  13. Canadian Couch Potato May 15, 2015 at 5:01 pm #

    @Jennifer: In this case I think it’s better to stay where you are and collect those extra grants. Even if you pay somewhat higher fees on your funds, you are likely to come out ahead. Do you have access to other index funds at your current RESP provider?

  14. Casey June 3, 2015 at 11:59 am #

    Q#1: I just read above that e-series RESP accounts are available (which is the main answer I was looking for). I currently have an e-series TFSA account (no other accounts with TD) and am considering an RESP account for my daughter. I recall the set up process being a bit of a hassle the first time, but I knew what I needed to ask for the second time when we went in to set one up for my husband. Would setting up the RESP be the same as we did for our TFSA? We went in, opened a money market TFSA and then sent the paperwork in to have the account converted to e-series. There is an application that can be sent in for existing account holders, but I do not see RESP as an option on it.

    On another note, my income tax advisor suggested not investing in RESPs because of the lack of flexibility and tax implications, and that Ontario Savings Bonds are a better option. Given the 20% CESG and low rates of even long-term government bonds, I’m having a hard time seeing the math on this one. I understand that RESP income is taxed in the child’s name, and therefore there may not be any parental transfer potential and tax savings, but I still don’t think it adds up to what an e-series RESP could earn. If anyone can shed some light on this, I’d appreciate a second opinion.

  15. Canadian Couch Potato June 3, 2015 at 12:32 pm #

    @Casey: The account-opening process should be similar, although an RESP tends to involve a little more paperwork in order to apply for the CESG. The rep at your branch will walk you through the process.

    There may be factors in your situation that I am not aware of, but I cannot think of a situation where Ontario Savings Bonds would be a better choice for education savings than an RESP. The worst-case scenario with an RESP is that you need to pay back the grants and the income earned on the account if the beneficiary does not attend post-secondary school, and you are unable to name another beneficiary, and you are unable to roll the income into an RRSP (in this last case, the grants would be repaid). That rarely happens: a lot of things need to go wrong.

    RE: “I understand that RESP income is taxed in the child’s name, and therefore there may not be any parental transfer potential and tax savings.” Actually, the fact that the grants and income can be taxed in the child’s hands is a significant opportunity for tax savings via income splitting. Since the child will claim this income during a year when she has little or no income, she will likely pay no tax on it. I would ask your advisor to be more specific about his objections. You’re welcome to post them here for follow-up.

  16. P July 11, 2015 at 9:00 pm #

    Hello ,
    My baby is only 1 year old right now, still 18 year to go to university. Per Mike Holman’s asset allocation, the RESP should be 100% in equity , no any fixed income until 9 year old. Other financial blogs/articles give similar recommendation, e.g. 80% equity, 20%fixed income for age 5 or less.
    I understand 18 years is mid to long term , should take some risk, but can it take that big risk?

    If an ordinary 47-year old man who looking for proper asset allocation for his RRSP , and would retire at 65,i.e. 18 years later. Most blogs/articles would recommend 50-60 % equity, 50-40% fixed income.

    The man’s RRSP investment time frame is same as my baby’s RESP, assume same level of personal risk preference for 2 plans. why the asset allocation are so different?? The basic investing conditions ( tax free growing , time, investment product,etc) of 2 plans are exactly same, just purposes are different, one for education, one for retirement. Both should have similar asset allocation in my mind.

    Could U pls explain? tks!

  17. P July 11, 2015 at 10:26 pm #

    Hello again,
    Just some other thoughts about RESP Vs RRSP asset allocation.
    I assume a RRSP is for a 47 years old man who will retire at 65, a RESP is for a 1 year old baby who will go to university at 19. so both plans have 18 years to invest.

    1st,How will people withdraw from RESP? most will withdraw when kids studying in university, about 4 years period, 4 years is short, so most people will move most RESP money to GIC/cash when kids begin in university to avoid market ‘s up and down.

    2nd,How will people withdraw from RRSP? most will withdraw from retirement (65 years old) to final farewell ( ave. life 85 years old ) , total about 20 years, it is quite long period, 5 times longer than RESP’s 4 years. There is no sense to move most RRSP money to GIC or bond when retiring at 65, especially for the part of money prepared for 2nd half of the retire life, which is 10 years away from beginning. Because of the long investment time period, RRSP should can take more risk, more aggressive than RESP, enjoy stock market’s up and down.

    However, Mike’s asset allocation for 1 year baby’s RESP is 100% stock, and common recommendation for 47 year old man’s RRSP is only 50% stock, which is more conservative than RESP, not more aggressive. This two look not quite logical for me. I am quite puzzled.

  18. Canadian Couch Potato July 12, 2015 at 12:09 pm #

    @P: Your logic here is pretty much right on: an important difference between retirements savings and eduction savings is that the latter is usually depleted in four years or so, whereas retirement savings needs to last for decades. Your retirement portfolio is also likely to be much larger.

    For these reasons, it rarely makes sense to take a lot of risk in your RESP, since your investment returns are not likely to be a huge factor: the biggest drivers are your contributions and the grants. The 80% to 100% guideline is a maximum amount. It’s probably wise to be more conservative than that.

  19. Casey September 30, 2015 at 12:46 am #

    Thank you for shedding light on my question above regarding resp vs. savings bonds. I’ve opened an resp for my daughter and am having it converted to e-series, and I am happy about this decision. I just have one last matter to take care of that I was hoping you might be able to give some info on. To be as brief as possible, I withdrew about $11,500 from an RRSP under the HBP back in 2007 and have repaid about $7500. I am an Ontario teacher and have been advised that RRSPs are not the best investment vehicle when a substantial pension is in place. This is why I started my e-series TFSA back a few years ago. I am currently on maternity leave for all of 2015. Would it be wise to withdraw the RRSP money (which was in GICs, but is now sitting in cash doing nothing), take the tax hit now at the lower income and get some of it into my e-series RESP (I intend to only contribute enough to get the max grant) and the remainder into my e-series TFSA? Is there a way to take the tax hit now for the $4000 that has not been repaid? The RRSPs are not at TD, so I want to know what exactly I want to do before talking to an advisor at the bank. Thank you.

  20. Canadian Couch Potato September 30, 2015 at 11:44 pm #

    @Casey: I can’t give you advice about withdrawing money from your RRSP without knowing all the details of your situation. But in general, you can simply choose not to repay the outstanding HBP balance. Each year the minimum required repayment will just be added to your income and you’ll pay tax on it. You cannot choose to take all of the outstanding amount as income in a single year:
    http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/hbp-rap/rpymnts/menu-eng.html

  21. Yanira November 10, 2015 at 8:19 am #

    Earlier this year I opened an RESP eSeries account for my daughter at TD. I have modeled after the eSeries balanced portfolio on this site. Based on this article perhaps the portfolio should be the agressive one based on the fact that’s it has 90% equity and 10% fixed income?

    Does that sound right?

  22. Huy Tran April 13, 2016 at 10:25 am #

    Hello,

    I’m looking at opening an RESP for my daughter. She is a newborn so I’m getting started early. I’ve decided to either go with the TD E-Series or just go with Questrade and do a Couch Potato ETF portfolio. I read that you recommend going with Index funds rather then ETF’s because of the commissioning fees associated ETF’s. I see the article was written in 2010 and I’m not sure when Questrade had implemented free ETF buys but would you still recommend TD E-Series for RESP even though Questrade now offers free ETF buys but still charge commission to sell?

  23. Canadian Couch Potato April 13, 2016 at 10:45 am #

    @Huy: It’s true that Questrade offers commission-free ETFs, but I would not recommend this option for an RESP. An RESP is going to be quite a small account for many years (you shouldn’t contribute more than $2,500 a year), so building a diversified portfolio with ETFs will not be very efficient. The TD e-Series funds are likely to be a simpler option.

  24. DLG April 15, 2016 at 2:42 pm #

    To start, my wife and I love the Coach Potato site and discussions. Got us to look and invest in ETFs in our TSFA and RRSP. Quick question re: RESP allocation. We have $18K in idle cash in our kids RESP that we’d like to find a home for. The RESP already have positions in ZCN and WCP (not great performance). Like to allocation a significant portion of this idle cash (say ~80%) to ETF’s exposed to some decent dividend equity positions the with price appreciation and some income and the remaining 20% into more riskier higher return potential equitys (stocks or ETFs). Comments much appreciated.

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