RESP savings strategies: lump sum or periodic?

It’s no secret that the cost of post-secondary education in Canada is on the rise. And for that reason, you may be wondering about the best savings strategy when it comes to contributing to a registered education savings plan (RESP) for a child.

An RESP is a tax-sheltered investment plan. Unlike a registered retirement savings plan (RRSP), the contributions aren’t tax deductible; however, the investment growth compounds tax free until withdrawn and the contributions can be returned to you as the subscriber without tax consequences. The remainder goes to the beneficiary (e.g., a child or grandchild) and is taxable to them as income when it’s withdrawn for a post-secondary education program. In other words, it’s only the growth and any government grants that would be taxable in the hands of the beneficiary.

The lifetime contribution limit on all RESPs is $50,000 per beneficiary, which is in addition to the Canada Education Savings Grant (CESG) limit of $7,200.¹ The CESG is paid into an RESP at a rate of 20% of your contributions, up to an eligible annual maximum contribution limit of $2,500 or up to $500 per year in CESG funding.²

Considerations

If you have $50,000 available to invest for a child’s future education needs, it may at first seem like a good idea to contribute this full amount to the plan immediately to take advantage of the tax-deferred compounding available in the RESP.

Keep in mind that contributing the lifetime limit in the first year of a beneficiary’s life will result in the loss of CESGs in subsequent years, since only $500 of the CESG will be paid into the plan in the first year. Therefore, a decision needs to be made whether the tax benefits of having the funds in the RESP will outweigh the grants that are subsequently lost.

The following example demonstrates the differences when contributing the full $50,000 to the RESP as a lump sum in the beneficiary’s first year of life compared to a strategy that combines a lower initial contribution with subsequent annual deposits.

Here’s how it works

Joe and Wanda are looking at different ways to contribute to their newborn grandson Gabriel’s RESP, and at the same time maximize the total amount available to him for his future post-secondary education needs.

Let’s look at two options that are available:

Option 1 – $50,000 RESP deposit

Under this option, Joe and Wanda deposit the entire $50,000 into an RESP in year one and receive the $500 maximum CESG for that year only.

Option 2 – $16,500 RESP deposit with subsequent annual contributions

Under this option, Joe and Wanda deposit $16,500 into an RESP in year one, $2,500 in years two through 14, and $1,000 in year 15 to generate the maximum CESG each year. These annual deposits are funded by investing the remaining $33,500 in a non-registered investment in year one and withdrawing the annual RESP deposits from this investment.

Assumptions

Annual rate of return: 6%

Taxable portion of return (non-registered): 20%

Tax rate on investment income (non-registered): 25%

What it looks like at year 18:

At the end of 18 years, Option 1 results in an RESP value of $144,144. Since the full $50,000 was contributed to the RESP, this produces a higher RESP value compared to the ending $125,844 RESP value of Option 2. However, Option 2 results in a higher total investment value amount since the remaining non-registered investment that funded the annual RESP deposits equals $29,816—for a total of $155,661.

And as shown above, Option 2 also results in the maximum lifetime CESG of $7,200 being received over 18 years.

In the end, Joe and Wanda decide that it’s more beneficial to receive the maximum grants outlined in Option 2, as this will leave them with the highest total investment value to fund Gabriel’s post-secondary education.

Ideal candidates

• Individuals with at least $50,000 and looking to contribute to a child’s post-secondary education
• Individuals who want to maximize the total amount available from their investments and CESG

Take action

• Complete an Education Savings Plan Application for mutual funds or segregated funds from Manulife.
• Speak to your advisor about an investment strategy that works with your tolerance of risk.

1 Certain provinces also provide provincial incentives and/or grants in addition to the federal CESG. 2 The maximum annual CESG grant is $1,000 on a $5,000 contribution if the beneficiary has adequate grant carry-forward room available. Depending on your net family income, you could receive an extra contribution of 10% or 20% on the first $500 per beneficiary for a child’s RESP each year. 3 Assumes that any taxes on realized gains from withdrawals, as well as potential annual income distributions, are paid out of the investment annually