This article, Choosing an RESP – Advice for New Moms (and Dads), first appeared May 3, 2010 on Walletpop.ca.
Investment knowledge is a handy thing. I always knew it would be useful but I never imagined that it would help me in my early days of new parenthood too.
It took years for any financial advisor to look twice at my family with the thought that we might make good clients. Have a baby, though, and just watch at all the salespeople who suddenly come out of the woodwork.
Unfortunately, most of these salespeople aren’t in the business of providing retirement or cash flow planning. They’re not going to help me make the most of my RRSP (Registered Retirement Savings Plan) contributions, they can’t tell me a thing about life insurance and they won’t know anything about wills or estate planning for my parents.
All they want is to sell me on their RESP (Registered Education Savings Plan) programs.And man, let me tell you, some of their programs are downright confusing. I know how to read most financial paperwork but I was completely stymied by the prospectus documents from a few of the different trust and savings plans.
Putting money into an RESP hopefully means giving your child a leg up in the future. It also lets you claim free grant money for your child – the government matches 20 per cent of your contributions, up to $500 each year. If your child doesn’t go to school, you need to give the grant money back but you get to keep whatever it earned during the time it was invested.
Do Your Homework
When you’re presented with the opportunity to buy into an RESP program though, no matter how good the sales pitch may sound, try to do your homework. Ask a lot of questions. Investing something is better than nothing, but impulsively buying into the first program presented to you can leave you regretting the decision later on in life.
Like investing in your RRSP, there are a lot of things you can buy to put into an RESP for your child. Mutual funds are probably what you’ll be directed into if you visit a bank or investment advisor but you can also purchase GICs, segregated funds, individuals stocks and so on. You have a lot of choice.
The trust programs all seem to invest in long bonds, mostly issued by government entities. The relative safety of government-issued bonds and the fact that you’re virtually guaranteed to get all of your money back in the end is one of the selling points scholarship trust salespeople will continually emphasize.
“It’s a bit of a red herring,” says Mike Holman, author of The RESP Book. “You can get that same investment (without any additional restrictions, rules or fees) at any investment company. You don’t have to buy a junior mining stock. You can get bonds there too.”
Avoiding Risk Can Be Risky
In fact, being completely and blindly risk-adverse carries its own set of risks. Interest rates are ridiculously low right now. With a time horizon of 18+ years to work with, there’s a good chance a quality balanced fund will do a better job of generating earnings “People get scared about mutual funds,” says Zena Amundsen, client service specialist at planning firm, Tyler & Associates. “But even a basic, so-called low-risk fund will give you four per cent.”
Financial planner, Rod Tyler agrees. “They (the trusts and savings plans) tend to get sold to people, but not with a great deal of explanation about how much money it might ultimately cost to achieve something,” he says. “I meet a number of people who’ve bought them. They do get some benefit from them but seldom do they ever come close to the funding that’s required.”
Planners also say it can be difficult to adapt the plans to meet a client’s needs as life circumstances change. Those suffering a financial setback can find themselves paying penalties if they withdraw from the plan or cancel monthly payments. If circumstances have changed for the better, the funds can rarely be moved around to invest in a better quality product. Adding to the plan is a confusing exercise as well.
“I started with one but now I can’t stop because the fees to get out right now would be crazy,” says Amundsen. “When our daughter was about seven we wanted to start increasing our monthly contributions. It turns into this bizarre unit though, so it’s almost like we had three accounts. It’s beneficial if you start from day one with the maximum monthly contribution – that’s great. You’re getting the biggest bang for your buck for the longest time. But as soon as you’re in halfway (after seven years, for example), it’s a lot more expensive to buy in.
To make up for the lack of performance and the hefty enrollment fees, some trusts say they’ll return all fees to you if and when your child actually does go off to school. (Remember, though, that 18 years from now the same dollar value likely won’t buy as much.)
To sweeten the pot even further, some pay survivor benefits as well. “This makes it sound like you’re getting something extra. You are, but you’re also giving up a lot of freedom,” says Holman.
Some Plans Are Built On Assumptions
It’s a little like buying an insurance policy – the plans are built based on the assumption that some people are not going to see things through until the end. If they cancel out of the program or if their child does not go into a qualifying post-secondary program, the grants are paid back to the government, and their investment, less fees, are paid back to the parents while the interest earned by their assets gets put back into the pool to be paid out as a bonus to those who are still in at the end.
“It’s a lapse subsidy,” says Tyler, who describes the concept in insurance terms: If a person with a life expectancy of 82 purchases a life policy and pays their premiums over the years but then lets the policy lapse at age 70, “by definition, if enough of us do that, those who do keep their policies through until claim time are being subsidized by our premiums. I think the trusts still have an element of that to them.”
Kate McCaffery is a freelance writer in Toronto, Ontario. Visit mccaffery.ca/kate2.0/ for more information.
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