Tuesday, December 18, 2007

RESPs: The Quality of Investments Matters

An RESP is a Canadian tax-advantaged savings vehicle for funding a child’s education. I’ll leave most of the details of RESPs to others and focus on one aspect: the actual investments bought with RESP money.

Back when my children were very young, I looked into RESPs and was disappointed to find that there were severe restrictions on how the money could be invested and what the money could ultimately be used for. For the plans I investigated, investments were restricted to mutual funds with MERs over 2%, and the rules for how the money could be used were more restrictive than was required by law.

When the Canada Education Savings Grant (CESG) came along, things were looking up. The government was going to match 20% of RESP contributions (up to a maximum amount). Surely this would make up for the high fees charged by the mutual funds, right? Not so fast.

Costs due to MERs accumulate year after year, but the 20% CESG is only added to each RESP contribution once. So each dollar that goes into an RESP becomes $1.20 because of the CESG, but then gets multiplied by 98% each year because of the 2% MER. At this rate, it takes 9 years for the MER to eat up the entire CESG. This is a problem for a child who won’t need the money for more than 9 years.

RESP rules and the available plans have changed significantly over the years. As you try to understand all of the rules and tax implications, don’t lose sight of the fact that the actual investments are important. Good investments outside an RESP are likely to generate more money for your child’s education than bad investments inside an RESP. The best results would come with good investments inside an RESP.

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