The untapped potential of education savings

Any parent with children heading off to university knows that post-secondary education is an expensive business. This fall, students attending a first year arts program at a typical Canadian university can expect to pay upwards of $10,000 for tuition, fees, room and board. Now, take that first year cost, factor in inflation, multiply by four, and you get some idea what it costs to attain the most basic of bachelor’s degrees.

While RESPs have been available since 1972, Canada Education Savings Grants (CESG) started in 1998, and Canadians have responded to this obvious savings need by sheltering $25.9 billion in assets in RESPs, according to Human Resources and Skills Development Canada. That’s a more than six-fold increase in tax-sheltered savings for education since 1998, and it almost makes you think Canadians have gotten the RESP message.

Truth is they haven’t, and this opens a very significant opportunity for you to help clients. Consider that Human Resources and Skills Development Canada (HRSDC) reports that at the end of 2009, there were 6.78 million Canadian children eligible to receive the Canada Education Savings Grant (CESG), a federal grant designed to supplement the money Canadian families put into RESPs. When you factor in the lifetime RESP contribution limit of $50,000 per child, this implies a potential RESP market of $340 billion for financial advisors, an amount roughly 13 times the size of existing RESP assets. Admittedly, few people will take full advantage of the maximum lifetime limit, (the average RESP account balance is currently just under $4,000), but clearly these figures point to an enormous untapped market for education savings.

You’ll truly be doing clients a favour by encouraging them to take advantage of RESPs. While the government grants are an obvious reason to open RESPs, there are also significant tax deferral and income splitting opportunities with these plans, not to mention yield potential. Given the various incentives provided by both federal and provincial governments, the guaranteed return on investment from RESPs can reach 20% or more (read on for more details). What other encouragement should Canadian families need to make the most of their RESP opportunities?

The ABCs of RESPs

Before getting into the finer points of RESPs and government incentives, it’s worthwhile to review the basics of these savings plans. In essence, RESPs are special savings accounts designed to help save for a child/beneficiary’s post-secondary education. They are registered by the federal government, providing tax-deferred savings growth until the beneficiary enrolls in a post-secondary program. Beneficiaries are normally the children or grandchildren of the account holder, but technically, there is no specific relationship required between contributors and beneficiaries. Since 2007, there has been no annual limit for contributions to RESPs, but there is a lifetime limit on contributions to all RESPs for each beneficiary of $50,000. RESP contributions are made with after tax dollars – meaning there is no tax deduction for making an RESP contribution as there is for an RRSP.

There are three fundamental benefits of an RESP:

• Tax deferral – the income from (non-deductible) contributions made to the plan is not subject to tax as it is earned. Income therefore accumulates more rapidly in the plan than it would in the hands of the contributor;
• Income splitting – amounts paid out of the RESP for post-secondary education are taxed in the hands of the beneficiary who, typically, will have a lower tax rate than the contributor; and
• Incentive grants – The federal government provides a grant covering a specified percentage of the contribution. The Quebec and Alberta governments also provide incentives respectively called the Québec education savings incentive (QESI) and the Alberta Centennial Education Savings Plan (ACES).

Grants 101

Basic Canada Education Savings Grant (CESG)

Ottawa will provide a Basic CESG annually for children who have had RESPs opened for them, up to an including the year in which they turn 17. Depending on net family income the basic grant can be up to $200 on the first $500 saved each year in a child’s RESP, and as much as $400 on the next $2,000. The higher a family’s income, the lower the grant, and in all cases there is a lifetime limit of $7,200. Special rules apply to children between the ages of 15 and 17. A total contribution of at least $2,000 must be made by December 31 of the calendar year in which the child turns 15, and there must have been contributions of at least $100 in each of the previous four years.

An additional incentive, called the Canada Learning Bond, was introduced in 2005 to help modest income families save for their child’s post secondary education. This provides $500 for the RESP of a child born after 2003, with an additional $100 a year to age 15, with a maximum of $2,000.

At the provincial level, the Alberta Centennial Education Savings Plan (ACES) helps Alberta parents start saving for their children’s post-secondary education. Unlike the Basic-CESG and Canada Learning Bond grants, the $500 one-time ACES Grant is not exclusive to low or middle income families. All Alberta residents are potentially eligible if they fulfill four requirements:

• The child must have been born on or after Jan. 1, 2005;
• The child’s parent or guardian must be a resident of Alberta at the time of application and must be ordinarily present in Alberta;
• The child must be named as a beneficiary of an RESP account; and
• The grant application must be received within six years of the child’s date of birth.

Additional $100 ACES grants are available for Alberta children who turn 8, 11 and 14 in 2005 or later. To be eligible, these children must be attending school.

The Québec education savings incentive (QESI) takes a slightly different approach. It allows for a refundable tax credit that is paid directly into a RESP opened with a financial provider that offers the QESI (Fidelity is one). Each year, RESP accounts can receive an amount equal to 10% of the annual net contributions paid into it, up to a maximum of $250. And as of 2008, any benefits accrued during previous years can be added to the basic amount, up to a maximum of $250.

And like other grants, child beneficiaries must meet certain conditions to qualify for the Québec education savings incentive (QESI). They must:

• Be less than 18 years old;
• Have a social insurance number (SIN);
• Be resident in Québec on December 31 of the taxation year; and
• Be the designated beneficiary of the registered education savings plan (RESP).

A simple case study

One strategy is to contribute enough to an RESP to maximize the government grant. Typically, this would result in an annual $2,500 contribution for each child to obtain a $500 CESG. However, even if parents are only able to contribute a more modest amount of their own money to an RESP, they can still save a significant amount of money for a child’s post-secondary education by making use of basic federal and provincial incentives.

Consider for example parents who receive the Universal Child Care Benefit of $100 every month until the child reaches the age of six. They could arrange to have that money automatically invested in a mutual fund within their child’s RESP. By contributing the UCCB every month for six years, they will have saved $7,200. And remember the CESG that provides a grant of 20 cents for every dollar invested? That will add up to another $1,440 in savings over the same period. The QESI will add another $720 in savings in that timeframe. So after 18 years of investing in a mutual fund that earns a consistent 7% per annum return, the parents in our hypothetical example could have saved $26,553 – right on time for their child to head into the realm of higher education.

Educate clients about RESPs

Clearly, though, saving for higher education is a multifaceted endeavour. Obviously, your clients should take advantage of publicly available benefits. Such incentives are, in effect, free money. But ultimately, their success will be primarily based on the efforts they make to contribute to RESPs for their children. And when you consider the tax-deferral and income-splitting benefits that arise from RESP investments, it just makes sense to make those contributions.

We know the potential of the RESP market is far greater than current numbers indicate. We also know that contribution growth slowed to a near trickle last year in the wake of the recession. You undoubtedly have clients with children who lack RESPs. By alerting them to the advantages of these savings plans, you will not only help them but your overall business as well.