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When to Put Money in RRSP

I have come up with a relatively straight forward heuristic on how to figure this one out.

heu·ris·tic adjective
enabling a person to discover or learn something for themselves.”a “hands-on” or interactive heuristic approach to learning”

Google Dictionary description

It is a simple trickle down or waterfall decision tree. Many times I get asked this question, or see it float by in other sites.

Personal Finance Waterfall

Where to Put Money Heuristic

  1. Pay off debt , it has the highest guaranteed pay back today.

    I mean all debt except perhaps your mortgage. A mortgage is your biggest debt, so my view is investing elsewhere, and not paying down your mortgage is a mistake. I have been told my opinion is very “old fashioned”.
    • This lowers your risk in life and gives you choices.
  2. Put money in your TFSA.

    My opinion is that this is a good place to put your money. How you invest it, is up to you. It should be within your Risk tolerances. Whether you want to buy stocks, Index Funds, ETFs or mutual funds is up to you. Do this in a trading account. In a trading account you can buy all those savings vehicles. In a Mutual Fund account, you usually can only buy Bank or Insurance company (read high MER) funds.

    TFSA until you reach your limit. You find that in your My CRA Account (limit as of start of current year).
  3. Do you have Kids? If you do, maybe it is time to think about an RESP? This could be, before (2). The Registered Education Savings Plan will help your child’s future. You may decide you don’t want to do this, so you could skip this step.
  4. Do you have a disabled loved one? Before step (1) you might want to think about an RDSP. A Registered Disability Savings Plan will help their future a great deal.
  5. Time to use your RRSP. It will lower your tax levels, so you should reinvest the money you get back into the RRSP, until you have no RRSP limit left.

    Sometimes you can’t use your RRSP, if you are lucky enough to have a Pension. This is a tragedy of riches, so don’t complain to your friends about it, or they might kick you in the shins.
  6. You have reached savings nirvana. If you are at this point where:
    • All your debt is paid off
    • Your TFSA limit is reached
    • Your RRSP is full
      You are now at the Zen level of life.

At this point in your life you have choices that most folks don’t have. Your Risk level should be quite low. Your stress level (due to money) should be non-existent.

This is your goal. Being out of debt, with money in the bank means you are financially in the right place. You can do what you want.

Am I Done ?

If you somehow get back into debt, restart the process. You did it once, you can do it again. Maybe create (say after step (1)) an Emergency Fund, in case something bad happens.

Is this easy? No, however, it is a good heuristic.

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RESP Only For the Rich ?

TL:DR : Rich folk are using RESPs much more than the poor, which is counter to whom it was supposed to help.

Stats Canada came out with a very telling survey titled, Why are Lower-income Parents Less Likely to Open an RESP Account? by Aneta Bonikowska and Marc Frenette. The findings are worrisome in that it points to the fact that the RESP seems to be a program mostly used by the rich(er) parents.

A telling quote from the Executive summary.

The results suggest that differences in wealth remain the single most important factor behind the gap in RESP participation by family income, even after accounting for differences in parental education and literacy, numeracy and financial literacy.

Why are Lower-income Parents Less Likely to Open an RESP Account? The Roles of Literacy, Education and Wealth

Many lower income families are unaware that even if the put no money into the program, it can grow with the Canada Learning Bond. This can add up to almost $2000 (over the life of the RESP).

The claim that this is a Financial Literacy issue is a bit of a stretch, but possible. I think it is that Lower Income families are not aware of the CLB and other benefits (which I suppose is Financial Literacy). My guess is tellers at banks will not offer to set up an RESP for a “No Star” customer. The Up Sell would be reserved for “good” customers.

A Graphic from Stats Canada Report about RESP and Lower Income Families
A Graphic from Stats Canada Report about RESP and Lower Income Families

Conclusion

I guess the question is simple, if Canadian Parents are barely making ends meet, will they put money aside for their kids’ post-secondary education? This report concludes, No.

I think I agree, but I’d really like to know how to change that.

Ways to Fix This?

  1. Banks need to market this program to lower income families, and point out that there is Free money to be had. The Canada Learning Bond is that free money. I really doubt many banks will do this, unless they could make money doing it.
  2. Expand the Canada Learning Bond, so that there is more money for lower income families.
  3. Maybe a Government run RESP program, that is set up for lower income families?

Read more about RESPs, Click Here! The page is being revamped, so come back soon.

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As most of my readers know I rarely have Guest Posts, but this article is very much in theme for my site. Read about the author at the end of this lengthy tome. Also remember there is lots of info on the Registered Education Savings Plan on this page.

Guest post for Canadian Personal Finance Blog 

Many parents have concerns about the cost of post-secondary education in Canada. They worry about how they will pay for their child to go to a university or trade school to expand their job opportunities.

This situation leads many families to set up Registered Education Savings Plans (RESPs). These accounts are one of the best ways you can invest in a child’s future. They allow you to make contributions that the government will partially match. And, this money can grow, thanks to interest.

When your child goes off to university, you can request payments from their RESP. These funds will help them pay for their education. 

Keep in mind that cashing out an RESP can be tricky. You’ll want to keep tax considerations in mind to maximize the funds your child receives. 

This guide will help you understand the tax considerations when withdrawing money from an RESP. 

What Is an RESP? 

You’ve been making payments to your child’s RESP for quite some time now. But, you might not be familiar with how it works other than that you make regular contributions.  

Let’s begin by defining some terminology. 

RESPs are accounts set up by subscribers (usually the child’s parents). Subscribers make regular contributions to the account. You can set up an RESP through most financial institutions. 

When the child (the beneficiary) goes to college, the subscriber may request RESP payments. The child uses these payments to help fund their post-secondary education. 

These conditions are how RESP works in a nutshell. But, it gets a little more complicated. Below, we describe the three major components of all RESP accounts. 

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Contributions

The subscriber saves money by making regular contributions to the account. Keep in mind that each RESP is different. Some require a minimum deposit. Some require you to deposit specific monthly contributions, whereas others let you make contributions whenever you want. 

Currently, there is no annual contribution limit. Over the lifetime of the account, however, the maximum you can contribute is $50,000. Just be mindful of how much you’re contributing to your child versus your own retirement. I love how Bridget Casey from Greedy Rates puts it when she says to “never sacrifice your own long-term financial security when saving for your kids.”

Grants

Grants are one of the significant perks of RESPs. They provide families with money that the recipient does not have to repay. 

The Canadian government matches a percentage of your contributions via grants. The Canadian Education Savings Grant (CESG), for instance, will match your contributions (see specifics here).

Additionally, there are other national and provincial grants available. For instance, the Canada Learning Bond (CLB) provides money to low-income families without the need for any contribution. 

Income

Income is yet another great perk of RESPs. 

RESPs are comparable to investment accounts. The contribution and grant money have the opportunity to grow. You can invest the money in stocks, mutual funds, bonds, etc. to earn extra income. 

When you have an RESP, you must determine how you want to invest your contribution and grant money. Some families choose to navigate the investment process themselves. However, a financial advisor is usually the best way to make smart investment decisions. 

Important note: RESPs are tax-deferred accounts. The grants and income money are tax-free until withdrawn. This exemption allows it to grow at a much faster rate. 

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Types of Payments

When you cash out an RESP, you’ll get the money as two separate payments: 

Post-Secondary Education (PSE) Withdrawal

PSE payments consist of the contributions the subscriber made. 

Keep in mind that contributions do not qualify for a tax credit. When you put money into an RESP, you are using post-tax dollars. 

This stipulation means that when you withdraw PSEs, no one has to pay tax on them. You request for PSE payments to transmit either directly to you or your child. Then, the student will use the money to pay for books, housing, tuition, and other relevant expenses. 

There is no limit on when you can request PSEs. You can request however much of your contributions whenever you want. 

Educational Assistance Payments (EAPs)

Unlike PSEs, EAPs consist of the money from grants and income. They aren’t your contributions, so they must transmit directly to the beneficiary. The beneficiary will have to report EAPs as taxable income. 

In the first year of schooling, there are EAP limits. See here for exact specifications. But generally speaking, students have a limit of $5,000 in EAPs for their first 13 weeks of schooling. After that, there are no EAP limits. 

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MER : A Worm in the RESP Money Tree

The RESP can be like a Money Tree for parents (and children) wanting to save for  post-secondary education.   If you invest your money you can get:

All of this free money is there for the asking. Truly it is like having a Magic Money Tree, however, as with all orchards, you can lose some of your fruit due to  worms.

In this case the worms can be:

  • High MER (Management Fee) Mutual Funds, many of the time they are hidden under the guise of Balanced Funds.
  • Badly performing Mutual Funds, usually pushed by an “Investment Person” who is making money on the purchase.
  • Very low interest paying saving devices (e.g. Bond Funds, Money Market Funds, GICs and HISA).

These financial worms chew into the potential growth of your RESP. Remember that most RESPs can have about a 23 year lifespan. The government stops adding money after the child turns 18, but  the  money  can continue to  grow for  a while after that, unless the  worms get in there.

When I opened my kids’ RESPs (more than 23 years ago), I didn’t know much about investing, so I spoke to my Canada Trust “Investment Person”. This person warned me that this was a short-term investment, where I didn’t want to risk losing money, so I should put the funds in safe Mutual Funds. I didn’t know so that is what I ended up getting was a small amount in a Balanced Mutual Fund (MER 2.8%) a larger amount in a Bond Fund (paying 1.2%) and a Money Market Fund (which paid 0.9%).

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As time passed, I learned more about investing, and started looking at my TD Mutual Funds (CT had been bought by TD), and saw the High MER I was paying. I read about the E-series Funds from TD, saw they had low MERs, so I went to TD to ask how to  transfer to  these Mutual Funds. You would have thought I was about to fall into an abyss, the way the investment person reacted, but I was not to be dissuaded. I got all the needed forms and changed the RESPs so that I could purchase the E-series funds.

I changed my investment mix, to be more like my other Index Fund portfolios, while still holding all grant money in safe(r) funds (i.e. Money Market funds). I didn’t want to lose the grant money, so I figured they were safe in a Money Market fund (which is wrong, Money Market funds can lose value too).

I lost a great deal of possible growth during that time, to High MER funds and badly chosen Mutual funds as well.

Don’t let the worms eat away at the growth of your RESPs.

BCM 2020

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RESP withdrawals and Taxes

Understanding the tax consequences of RESP withdrawals

By Gerry Vittoratos, UFile

Registered Education Savings Plans (RESPs) are a great vehicle to save money for your children’s post-secondary education in a tax efficient way. This article will explain the tax treatment of withdrawing from this plan.

Basics of RESPs

Before we get into the tax treatment of RESP withdrawals, we need to understand certain fundamental concepts of the plan.

Contributions

Contributions to the plan are made by a subscriber (parent of the child or children) to a promoter (financial institution) for the benefit of the beneficiary (child or children). The plans can be individual plans (single beneficiary) or family plans (multiple beneficiaries).

Contributions into the plan are not tax deductible; however, the earnings within the plan accumulate on a tax-free basis. The contributions and accumulated earnings can stay in the account for up to 35 years after the plan is established.

The lifetime contribution limit per child is $50,000.

Canada Education Savings Grants (CESGs)

Apart from the tax deferral of earnings, another major benefit of contributing to the RESPs is the Canada Education Savings Grant (CESG). In simple terms, the CESG is an additional amount the Federal government adds to every dollar contributed into the RESP. The basic grant is 20% of the current year contributions up to a maximum of $500 per beneficiary. This translates to a yearly contribution maximum of $2,500. The lifetime CESG is $7,200. An additional grant of 10% or 20% is given to low income families. The table below summarizes the grant amount:

CESG Family net income of $47,630 or less Family net income of more than $47,630 but less than $95,259 Family net income of more than $95,259
Basic CESG on the first $2,500 of annual RESP contributions 20% = $500 20% = $500 20% = $500
Additional amount of CESG on the first $500 of annual RESP contributions 20% = $100 10% = $50 Beneficiary is not eligible
Maximum yearly CESG depending on income and contributions $600 $550 $500
Lifetime maximum CESG for which you may qualify $7,200 $7,200 $7,200

Source: RC4092 guide

Depending on the province you live in, you can get an additional grant on top of the CESG.

Canada Learning Bond (CLB)

On top of the CESG above, the Federal government provides an additional amount for low-income families in the form of the Canada Learning Bond (CLB). The difference with the CESG is that fact that no contribution is requires to get the CLB; it is deposited directly into the RESP account. An initial payment of $500 is made for the first year the child is eligible; then $100 is deposited for each additional year of eligibility, up to age 15, for a maximum of $2,000. For 2019-2020, the income eligibility threshold is $47,630 for up to 3 children and increases for every additional child.

Tax treatment of withdrawals

Now to the question at hand: what is the tax treatment of these withdrawals?

Contributions

Since the contributions do not benefit from a tax deduction (in other words, after-tax dollars were contributed), the contributions can be withdrawn tax free to the subscriber (parent or grandparent of the child or children) or beneficiary (child or children). These are called “refund of contributions”.

Education Assistance Payments (EAP)

Payment of the Canada Education Savings Grant, Canada Learning Bond and accumulated earnings are called Education Assistance Payments (EAP) and are payed to beneficiaries (children). These payments are taxable in the tax return of the beneficiary.

In order to receive an EAP, the recipient must be enrolled in a qualifying educational program, which is an educational program at post-secondary school level, that lasts at least three consecutive weeks, and that requires a student to spend no less than 10 hours per week on courses. The recipient must also be at least 16 years old.

Although the income received by the student is taxable, remember that it is likely that this student has little to no other income to declare while attending school full-time; therefore, these payments will be subject to a low income tax rate.

Accumulated Income Payments (AIPs)

These are payments made from Canada Education Savings Grant, Canada Learning Bond and accumulated earnings to subscribers (parents). These are possible under 3 conditions:

  • the payment is made after the year that includes the 9th anniversary of the RESP and each individual (other than a deceased individual) who is or was a beneficiary has reached 21 years of age and is not currently eligible to receive an EAP (see above)
  • the payment is made in the year that includes the 35th anniversary of the RESP
  • all the beneficiaries under the RESP are deceased when the payment is made

In this case, the income will be taxed in the subscriber’s tax return (income tax rate based on all income), and an additional 20% tax is added as well. Subscribers can reduce both the income tax and the additional 20% by transferring the AIP into an RRSP, provided the subscriber has enough contribution room to do so.  The limit of this transfer is set at $50,000.

Gerry Vittoratos is the national tax specialist at tax software provider UFile, which has been helping millions of Canadian taxpayers file smart for the past 20 years.

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