Why RESPs Should Be Kept Simple

October 22, 2012

In the last couple of weeks I’ve received two questions from readers who were trying to figure out the right strategy for their children’s education savings accounts. Both were smart questions that stemmed from things they had read on this blog, and I was eager to help. But as I thought about how to respond, I began to worry about the danger of making some investing goals too complicated.

The first question came from Karen, who had opened an RESP for her nine-year-old. Karen had read my post on bond duration, where I explained that investors should try to match the duration of their bond fund to their time horizon. She wondered if XBB (which has a duration of about seven years) would still be suitable once her child was 11 or 12. If not, what’s the best way to shorten your bonds’ duration as your child approaches university age?

The second came from Bryan, who has an RESP for his five-year-old and a second child on the way. His brokerage, TD Waterhouse, allows only family RESPs, which means he can only open a single account for both children. Bryan read my post about choosing an appropriate asset allocation for an RESP according to your child’s age and wanted to know how it would work when you had two beneficiaries of different ages.

In both cases, it’s possible to create a spreadsheet and a formula to work out the optimal strategy. But the question is, how far do you want to go with this?

Can’t get no satisficing

More than half a century ago, the psychologist and economist Herbert A. Simon coined the term “satisficing” to describe the process of making a decision that is good enough, as opposed to “maximizing,” which seeks the perfect solution. When it comes to RESPs—and other investing goals, for that matter—it pays to be a satisficer.

Remember that RESPs are medium-term investments: even if you open an account when your child is an infant (and most parents do not) you are not likely to have more than 18 years before you start drawing it down. It may grow fairly large over 18 years (although I would argue it makes little sense to contribute more than $36,000, at which point the government grant is maxed out), but by that time virtually all of it should be in cash, GICs, or other safe, low-return instruments. A significant percentage of your RESP may be in equities when your child is young, but that is when the account will be smallest, so your rate of return is not likely to have a large effect during these early years. And, of course, a significant portion of the growth in RESPs is likely to come from the 20% government grant.

All of these factors mean the amount you contribute to an RESP will typically have a far greater impact than your investment returns. Here’s an example: if you contribute $167 a month beginning the year your child is born and ending the year she turns 18, you’ll collect the maximum grant ($7,200) and wind up with about $56,200 assuming an annualized return of just 3%. If you contribute $100 a month, you would need a return of about 8.5% to end up with the same amount. So are you better off trying to come up with an extra $67 a month, or trying to triple your investment returns?

Simple isn’t settling

To return to the readers’ questions, I would suggest Karen use XBB for her bond holdings now. Starting when her child is 11 or 12, she can gradually move some of the money to cash until the proportion reaches 80% to 100% by the time her child starts university. For Bryan, I would just opt for an allocation that is close to what one might use for the oldest child—even a straightforward 50% equity, 50% fixed-income blend would be fine until the oldest reaches high school, after which I would start dialing down the risk. But there are several other strategies that would work just as well—and none of them require a spreadsheet with complicated formulas.

Karen and Bryan were asking the right questions, and I certainly don’t mean to suggest  investors shouldn’t care about the details of their strategy. Indeed, one of the frequently misunderstood ideas about “satisficers” is that they have low standards and are happy to settle for mediocrity, which just isn’t true. My point is simply that it’s possible to adopt an RESP strategy that is low-cost, broadly diversified, easy to implement, and fully capable of meeting your goal, even if it is less than optimal. More important, there is a lot of evidence that satisficers tend to be more content, less paralyzed during the decision-making process, and less likely to be plagued by regret—and those qualities are almost certain to make you a better investor.

{ 40 comments… read them below or add one }

Paul G October 22, 2012 at 9:06 am

About RESPs, are you aware of the Universitas funds and do they make sense to you ? I looked into them for some of my godchildren and they seemed decent enough for mutual funds, but I’d love to have a second opinion.

I wonder if they’re good enough to call this choice “satisficing”…

Canadian Couch Potato October 22, 2012 at 9:23 am

@Paul G: I did not know anything about Universitas specifically until you mentioned them. It seems to be quite similar to other group RESPs, though with a little more flexibility (the ability to invest in equities, for example). In general, I think these plans are too inflexible and the fees are too opaque. I think people are better off simply opening an RESP account with a discount brokerage and setting up a monthly contribution to a single balanced fund.

This post from Mike Holman is helpful:
http://www.moneysmartsblog.com/group-pooled-scholarship-resp-plans-differences/

Kiyo October 22, 2012 at 9:40 am

According to Wikipedia, you need to contribute $2500/year to max out the CESG, not $2000. Below link seems to confirm this.

Looking a bit closer, it looks like you are referring to the lifetime maximum, not the yearly maximum, so I guess 2k/year is enough.

http://www.canlearn.ca/eng/saving/CESG/brochure/cesg.pdf

Robb October 22, 2012 at 9:56 am

I agree that it’s best to keep things simple in your RESP. If you want to maximize your returns, focus on increasing contributions to $2,000 – $2,500 a year to get all the CESG money. Tough to beat a 20% guaranteed return.

I use the TD e-series funds and contribute $100 a month for each of our kids. If I want to boost returns, I’ll double that amount to take full advantage of the grant money.

Michael James October 22, 2012 at 10:02 am

I have a theory that most advice is followed by the wrong people. Your advice is perfect for someone who is agonizing over whether his RESP should be 23% or 24% Canadian large caps. Unfortunately, this person will likely keep agonizing. The couple who have no RESP at all might try to justify it by saying that their finances are “good enough”. It’s tricky trying to get the right people to listen.

Canadian Couch Potato October 22, 2012 at 10:14 am

@Kiyo: Yes, I was referring to the lifetime maximum CESG. If you contribute $167 a month from birth, you get $400 a year times 18 years = $7,200.

@Robb: I agree the number one priority of an RESP investor should be to max out the available grant money. I realize there are many competing priorities when you have young kids, and most people won’t be able to get the full CESG, but that’s clearly a more important decision than the precise asset allocation.

@Mike: Fair enough. Although I hope I didn’t imply that opting out of an RESP altogether is a “satisficing” option. That’s clearly the worst possible decision. I was thinking more along the lines of your blog post (linked above) where you suggest that GICs are adequate if you want to keep things simple.

Michael James October 22, 2012 at 10:30 am

@Spud: That’s a different Mike, but that’s OK — all Mikes will eventually band together to take over the world :-) I don’t think you implied anything that is incorrect. I’ve come to realize that the tendency for people to choose advice they like is very powerful. If readers can use your words to justify what they want to do, many will. This adds a major writing challenge for writers who really want to get through to the right readers. Many other blogs consist of fluff designed to tell readers what they want to hear. You’ve set yourself a more difficult task.

Canadian Couch Potato October 22, 2012 at 10:34 am

@Mike: Duh, sorry. I had Mr. Holman on my mind as I wrote about RESPs. If it makes you feel any better, I got an email last week addressed to Ram. :)

Danno October 22, 2012 at 11:47 am

Great advice, and I think very true. I have a not-quite-2 year-old and we have been filling her RESP since she was born. When I started, I created a fairly simple chart which started at 70/30/0 equity/bond/cash and gradually took me into bonds, and finally into mostly cash by the time she will be 17-18. I bought 3 simple ETFs (I used XIU, XSP, XBB) in a discount brokerage, and each year I will put in new money and buy more, to bring the distribution back to target.

So far, 2 years in, and I have stuck to my spreadsheet. :-) We’ll see if I can maintain discipline for the next 16! I have since learned a few things, largely from this site, and realize now that in hindsight, I may have done some small things differently. Perhaps picked some different ETFs (maybe XIC rather than XIU, maybe used XWD….etc). But I think the point of this article is that, frankly – it probably ain’t going to make much difference.

Marc October 22, 2012 at 1:31 pm

I was about to post my thoughts about converting the XBB into a GIC ladder in the teenage years instead of cash (to get extra money from interest) and then it dawned on me that it would be proving the whole point of your article – trying to “maximize” return using a more complicated strategy — when just converting to cash is the simplest solution and (at least given current interest rates) almost as good as GICs.

Canadian Couch Potato October 22, 2012 at 1:42 pm

@Marc: A GIC ladder that is timed so one GIC matures just before the child starts each year of university may be a great solution, and not too difficult to set up. But you’re right, compared with just gradually moving to cash, the difference in returns is likely to be very small.

Marc October 22, 2012 at 4:40 pm

Right, not to mention that (at least with my broker, RBC DI) the minimum purchase amount for each GIC in a registered account is $3500, there not may be enough in the fixed-income category to do a full 5-year ladder.

RJ October 22, 2012 at 8:19 pm

I simply consider my RESP along with my TFSA, and RRSP as part of my total portfolio and monitor my target allocation based on all accounts. Because my TFSA is the most easily used for short term goals I keep my fixed income there and my RESPs (for young children are 100% equities).

When my children get closer to needing the money I will have a higher allocation to fixed income because I will be older, but I may still be holding mostly equities in the RESPs. This does not concern me because I can always sell the equity holdings in the RESP and buy the same equity holding in my TFSA when I go to withdraw from RESPs in the future.

For me the simplest thing is to look at all of my invest-able assets on a portfolio basis and I am only using RESP as a means to get the CESG and allow for virtually tax free growth (it is of course taxed in my kids hands).

Que October 22, 2012 at 8:28 pm

Speaking of keeping RESPs simple, has anyone had experience with getting an EAP from their broker/bank, ie your child is in school and you are trying to get the CESG (grant) and investment income out of the RESP?

I am particularly interested in someone that has experienced this with a family account. Did your broker/bank tell you how much of the EAP was CESG and how much was investment income?

The reason I ask is my broker says they won’t tell me what the CESG portion is (who knows why?!?!), and I am trying to calculate how much investment income can go to each child, without going over the max 7200 CESG payout to each child.

Thanks for sharing any of your experiences.

Canadian Couch Potato October 22, 2012 at 8:51 pm

@RJ: That’s fine in your specific circumstances, but for those whose RESPs and RRSPs have different horizons (which is most people) the asset allocation should be a separate decision for each account.

@Que: That’s absurd behaviour on the part of your brokerage: they have to tell you this information in order for you to make an important tax decision. I just did this earlier this year, and my brokerage gave me a detailed breakdown of contributions, growth, and grant money (albeit it was an individual account, not a family plan).

One idea would be to contact the federal government’s CESG administrators directly at 1-888-276-3624. They will be able to tell you how much CESG has been paid out to each of your child. You may also tell them about your brokerage’s refusal to disclose this information and ask for a suggestion.

Que October 23, 2012 at 4:51 pm

Thanks Dan,

You are right, I called CESG administrators directly at 1-888-276-3624, and they confirmed that the Bank/Broker has to confirm what amount in the EAP is from growth and what is from CESG. I will have to forward this information onto the not so helpful customer service at Questrade.

The government administrators also said only clients that have Family RESPs at more than one broker should have to worry about this, since if you are only dealing with one broker, it’s their responsibility to make sure you don’t remove more than 7200 CESG per beneficiary. They also confirmed, that the broker should adjust the EAP to 100% investment gains (growth) and 0% CESG, once a beneficiary has reached their 7200 CESG limit.

Mike Holman October 25, 2012 at 1:05 pm

Thanks for mentioning my article. I agree about simplicity. I’ve gotten a few interesting emails from people with really complicated investing strategies for their RESP. Totally unnecessary.

If someone comes up with a winning investing strategy – use it on their (presumeably larger) RRSP and get more benefit.

@Que – Dan is right. The financial institution has to tell you how much grant is included in every EAP.

If they give you any trouble, just point this part of the RESP promoter guide to them:

http://www.hrsdc.gc.ca/eng/learning/education_savings/publications_resources/promoter/tools/guide/3-2-3.shtml#_3-3

In particular:

“•Inform beneficiaries, in writing, of the amount(s) of incentive(s) they are receiving with each EAP, and the obligation of beneficiaries to repay any CESG and CLB portion of an EAP to which they are not entitled to, including any portion of an EAP attributable to CESG that exceeds $7,200.”

“Incentives” refers to the grant or CESG.

Unfortunately you were misinformed about the CESG payout limit on family accounts. You are allowed to take out as much non-contribution money as you like for one beneficiary. Any grants in excess of $7,200 are returned to the government.

Greg October 25, 2012 at 10:26 pm

I treat my kids RESP completely separate from everything else. Entirely invested in Mawer Balanced Fund. It is the only non index fund I own and placing 100% of the amounts there for the first few years is so easy.

Cody October 27, 2012 at 2:09 pm

For family’s with lower income there is one thing to keep in mind. When it comes time to withdraw RESP’s if your child is eligible for OSAP problems arise. The amount of RESP’s withdrawn for each semester is dollar for dollar taken away from the child’s OSAP amount. Now you say 20% grant on RESP’s is a no brainer but wait. if eligible for max OSAP you get ~20-30% grant if not more and if your child has a disability including but not limited to a learning disability witch are very common the grants work out closer to ~50%. Personalty I had a learning disability and graduated from University with an Engineering Degree and ended up giving my RESP money I saved from a young age to my brother because it did not make mathematical sense for me to claim it and wish I had just invested it outside RESP’s. Just thought I would point it out to keep in mind RESP’s are not the best bet sometimes.

Darren October 27, 2012 at 3:53 pm

You state “I would argue it makes little sense to contribute more than $36,000 at which point the government grant is maxed out”.

Could you please clarify? Is it not true that the return on the extra contributions will be taxed at the student’s lower rate?

Canadian Couch Potato October 27, 2012 at 5:28 pm

@Darren: Yes, there is some potential tax advantage to contributing to an RESP after the grant has been maxed out, but in my opinion it is offset by the lack of flexibility. Once you have maxed out the CESG, it probably makes more sense to save any additional funds in a TFSA, where the growth is also tax-free and there are no restrictions on withdrawing the funds. If you pile $50,000 into an RESP and your child ends up not going to university, or if your child earns other income during the years when you’re making withdrawals, you may run into added taxes or penalties.

Sustainable PF November 3, 2012 at 6:34 pm

We have maxed out each of the first 2 years of lil’ SPFs CESG. 20% is virtually impossible to beat especially over a decade and a half of consistent return. After that I plan to split things 50% equity 50% bonds until the little guy is about 8 then I will start shifting out of equity into a more heavy bond holding.

Trevor January 10, 2013 at 12:25 pm

Could anyone give some examples of their RESP portfolios and how the plan changes over time? Currently I have all of my 2 year old son’s RESP at RBC in an index fund with an MER of 0.71%. because I’m jumping full steam into all of this I’m starting up a TD investment account and plan on moving all my money into indexing and as such, I may as well move my son’s RESP over for the substantially lower fees.

Any advice would be appreciated.
Thanks!

Canadian Couch Potato January 10, 2013 at 6:04 pm

@Trevor: An RESP portfolio might be equal amounts of Canadian and US equities, plus a bond fund and cash. Not sure if you’ve seen this post, but this is my suggestion for altering the asset allocation as the child gets older:
http://canadiancouchpotato.com/2010/11/05/taking-risk-in-an-resp/

As this post suggests, don’t sweat the optimal mix: there isn’t one. The magic RESP formula is: cheap + simple + fully funded.

Trevor January 10, 2013 at 6:07 pm

Thank you Mr. Potato!

Your blog is excellent. I plan on buying your book in the next few days as my way of saying thanks.

Cheers.
Trevor

Canadian Couch Potato January 10, 2013 at 6:08 pm

@Trevor: Please, just call me “Potato.” :) Glad you’re enjoying the blog, and hope you like the book.

Danno January 10, 2013 at 6:41 pm

It sounds like CCP already gave you the best advice, but in case you were interested in what someone else like you was doing, here’s what I did.

My daughter is two and we started her RESP as soon as she was born. I opted for ETFs because I use a discount brokerage and knew I could keep the fees down. I am at 70/30 equity to start, because I just wasn’t comfy with going 100 percent stocks. The equities are allocated roughly split between US, Canada and International equities. I elected to use currency hedged funds (well at least in the US case – you just about don’t have a choice in the Intl case), knowing that there would be a drag/cost, but because the time horizon was shorter, and I didn’t want the currency risk, knowing that in just 9-10 yrs it’d already be time to be getting out of equities. I intend to follow a ramp down of equity into bonds and cash similar to that described in the article above.

Trevor January 11, 2013 at 12:33 am

Thanks Danno – sounds like we are in a similar situation. My son is just 2.5 and we’ve maxed out the RESP ($7500) and have had it all in an RBC index fund (0.71) for the last 6 months. It’s done fairly well.

Based on the advice of this blog I’m actually moving ALL of my investments (RRSP,TFSA, investing account, sons RESP) to TD bank to start doing a full couch potato strategy. I have to many accounts with too many institutions – it’s ridiculous.

I think that I’ll likely follow the schedule above – thanks for the advice. Lots of choices.
Cheers.

Trevor January 12, 2013 at 5:56 pm

I just went to TD bank and opened up a TD waterhouse account and am in the process of moving all of my financials (including my son’s RESP). My plan until he is six is to have all in:

TD Canadian Index 30%
TD US Index 40%
TD International Index 30%

The increase in US is for no other reason than my child is also American. USA! USA! ;)

Thanks for all the help. Now that I feel that is checked off now I just need to figure out what to do with my RRSP, TFSA and investment accounts. Nice to have one put to bed for a year at least.

Craig January 19, 2013 at 10:25 pm

We’ve just recently opened a family RESP at TD and converted it over to the e-series following the steps you described. Took some time to process but worked out fine in the end.

I have 2 year old twins and we have $10K (current year + 1 previous year) saved outside the RESP. My plan is to following your Global Couch Potato option 2 with 60% equity 40% canadian bonds. We have a long timeline and hopefully will continue to have the luxury of maxing out the grant each year.

My question is whether we should invest the full $10K all at once or set up an monthly preauthorized payment and invest the month over the next 3 months.

Any comments?

Craig

Canadian Couch Potato January 19, 2013 at 10:31 pm

@Craig: Congrats on setting up the RESPs. In my opinion, dollar-cost averaging a lump sum is usually not the best strategy:
http://www.moneyville.ca/article/973952–why-a-lump-sum-investment-beats-a-little-every-month

Linda September 5, 2013 at 7:19 pm

My son is in his second year at University and I am wondering if I should pull out his money invested in his RESP to get all of the grant money out and reinvest it. One concern, if he doesn’t continue to school, yes I can pass it onto our daughter and if she doesn’t continue I can transfer unused to RRSP, but I don’t have a lot of room. In order to get my son’s maximum grant money out, I have to take out $16,000.00. Since he didn’t have any income this year and will have to pay tax on the grant money, he won’t be over the amount. It’s around $3,500.00 in Grant money left. We have already put in for OSAP for this year, 2013 so I would have to notify the government as he has already received OSAP. Wondering if I should take out the grant money in January because even if he gets a job he won’t make that much over the summer. Then it could be used in the fall. More I take out though, less OSAP he will receive, but at least the grant money is all out of there and can be reinvested. Any thoughts on this?

Thanks:)

Canadian Couch Potato September 5, 2013 at 7:41 pm

@Linda: I can’t advise you on your specific situation, but in general it may be a reasonable strategy to withdraw money from an RESP and hold it in a TFSA so it grows tax-free until you need it. That also makes it much easier to access: no more RESP withdrawal request forms to fill out. forms to fill and it is much easier to access when you need it. It sounds like you understand the tax implications: that would be my biggest concern with withdrawing a lump sum in one calendar year. One idea might be to withdraw half now and half in January to spread it over two calendar years if necessary.

The one thing I’m not clear on is why you you can’t just reinvest the grant money inside the RESP?

Linda September 28, 2013 at 7:16 pm

The reason I wanted to get the lump sum out was so that I could get as much grant money out that the government has contributed for each year we have contributed. If my son decides not to go back to school he could lose all of the government grant contribution. Also he has put in for OSAP loans which he has already received and this would affect what he has received for 2013. He would have to let OSAP know he has received more money from his RESP if he goes this route. He has had no income in 2013 but hoping he will next year and he will have to pay more tax on the amount withdrawn in 2014 from RESP if he has income. Sounds like a good idea to take out more in 2013 and readjust OSAP. In January 2014 take out as much money as we can for 2014, and wondering about putting it in a TFSA. Once it’s out of the RESP and put into a TFSA wondering how this affects OSAP for 2014 or take it all out in 2013 and put in a TFSA? It’s now in a TFSA not RESP which the government looks at for lending money for OSAP. We are investing the OSAP as we get it and hoping not to use it, but you never know. Education is so expensive.

Shauna January 25, 2014 at 12:33 am

We are currently co tributing 400 a month to our sons resp. We have a family plan and have been contributing for the last 3 years. Our sons are 6 and 3. We have most of it in equities and little in cash. We are moderate to high risk right now I’m just wondering when we should reduce risk as well as if we are contributing enough?

Marc January 25, 2014 at 1:18 am

@Shauna: I started out in a similar situation – just ETFs for the first several years (XIC and XWD). What I’ve done since then is keep the existing equities as-is — i.e. I’m not buying any more, just letting what I have grow. All new contributions now go into high interest savings fund until the end of the year, when I convert it back into cash and buy a 5 year GIC. This way, over time the percentage of my portfolio that is equities will gradually go down (since regular contributions should outpace the returns on equities). So as time goes on and they get closer to needing the money, the portfolio should automatically keep going towards a “safer” asset allocation with fewer (relative) equities and more towards GICs/cash. At least – that’s the plan! :)

Canadian Couch Potato January 25, 2014 at 12:07 pm
Shauna January 25, 2014 at 5:34 pm

Thanks I will have a look at the article!

Natasha April 4, 2014 at 8:26 pm

I’m new to RESPs as we moved back to Canada three years ago and are just starting an RESP for our two children: 7 and 5 year olds.

From reading your articles and comments, it seems a 50/50 balance of a Canadian equity ETF (VCN or XIC) and possibly XBB would be a start for now (of course decreasing the equity portion according to your formula on risk). (Btw we are with Questrade which has n0 fee on ETF purchases). Would it make any sense at all to use VSB or VSC instead of XBB for our older child in a few years?

Canadian Couch Potato April 5, 2014 at 11:03 am

@Natasha: XBB is now the most expensive of the broad-based bond ETFs: VAB and ZAG are both considerably cheaper. You may indeed find that a short-term bond ETF such as VSB is less volatile and therefore more appropriate for an RESP.

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