This post is part of the Big RESP Series. See the entire series here.
See the previous post on Individual and Family Plans
I did an analysis of some different resp and non-registered account scenarios (child goes to school or not) in order to determine the different amounts of money that would result from each scenario. The idea was to try to see how well the resp does in the different situations compared to putting the money in a non-registered account. Thanks to the Money Gardener for the idea.
The spreadsheet showing all the calculations is here. Basically it’s an account with $150/month contributions into an equity security. In real life an investor might switch to a more conservative portfolio later on but I decided to keep it simple for this example.
The equity return is 0.5% per month which works out to just over 6% per year, it also gets a 2% dividend at the end of each year. The dollar figures were calculated at the 18 year mark which is when the student would normally be going to school.
The average tax rate on the withdrawal of the subscriber who is working is 40%, subscriber who is retired is 15%
- RESP account – student uses the money for school. This scenario is the typical “hoped for” scenario where the student uses the money to go to school. I assume that the student doesn’t pay any income tax on this money. All dollar figures are future dollars.
- RESP account – subscriber collapses plan before retirement. If the child doesn’t go to school then the subscriber will pay the marginal tax rate on the income in the account.
- RESP account – subscriber collapses plan during retirement. In this case the student doesn’t go to school but since the subscriber is retired they have a lot more flexibility with respect to income tax rates. Keep in mind that the plan doesn’t have to collapsed until the 26th year of it’s existence so there is time to do this option even if you are working when the child decides not to go to school.
- Non-registered account – money is withdrawn before retirement. For non-reg accounts since the money is always taxed to the owner of the account it doesn’t matter whether the child goes to school or not – the taxation is the same.
- Non-registered account – money is withdrawn during retirement. In this case the capital gains paid by the account owner will probably be less than when they were working.
Amount of $$
|1||RESP account – student uses the money for school.||
|2||RESP account – subscriber collapses plan before retirement.||
|3||RESP account – subscriber collapses plan during retirement.||
|4||Non-registered account – money is withdrawn before retirement.||
|5||Non-registered account – money is withdrawn during retirement.||
If the child goes to school then the RESP account is the clear winner with a total of $87,556. The non-reg account would only provide $66,953 or $62,284 depending on if the account owner is retired or not. This is not surprising considering the 20% grant available to the resp as well as the zero tax drag during the accumulation phase.
If the child does not go to school then the results are dependent on if the subscriber is working or retired when the plan is collapsed. If the subscriber is retired then there is not much difference between the resp ($64,039) and non-reg account ($66,953). If the subscriber is working, then the non-reg ($62,284) fares quite a bit better than the resp ($51,870).
If your child goes to school then the RESP account will have about 30% more money than the non-reg account. If the child does not go to school then the non-reg account will have 5% more money than the resp if the subscriber is retired, if subscriber is working then non-reg account will have about 19% more.
Bottom line is that if you are an older parent (like me) and are pretty sure that you’ll be retired (or can control your income) by the time the resp plan is 26 years old then the resp is the winner hands down. If you are a younger parent then the choice is not so clear, although there is a big upside (30%) to the resp, there is also a significant downside (19%) if the child doesn’t go to school.
Things to think about
Commander T pointed out that if you transfer the non-contribution portion of a collapsed RESP to your rrsp (if you have the contribution room) then you can avoid the 20% penalty. I personally don’t plan to have this much room, but this is a great strategy if you can do it.
One strategy to think about if you are a younger parent is to wait a few years before starting the resp account since that’s when the clock starts ticking on the age of the account. If the child doesn’t go to school then collapsing the resp plan when you have no other income will reduce the income tax considerably. Most younger parents have mortgages, rrsp room so waiting a few years to start the resp is probably a good idea anyways.
How many kids? Having two or more kids will improve the odds that the resp money will get used since you can transfer between beneficiaries. This generally only works if the older child doesn’t go to school or they are very close in age.
Establishing a trust for your child is another method of funding their education and saving taxes. The reason I didn’t get into trusts here is because I consider them a completely different animal compared to non-reg accounts and RESPs. Unlike RESPs and non-reg accounts where the parent owns and invests the money and controls the account all the way through the process, with a trust you give the child the money and will never get it back. My problem with this is that if the kid doesn’t go to school then I don’t want him to get any of the education money since he probably doesn’t need it. This is not to say I wouldn’t help him out if he needed it. The other problem I have with trusts is that it might encourage the child not to go to school. Think about it, if you are 18 and have a trust account with $50k in it and you have a choice between going to school or buying a fancy sports car or travelling the world for a few years – which would you choose?