Within the group of various tax deferred/free savings initiatives provided by the Canadian government to its residents, the Registered Environment Savings Plan (RESP) is like the black swan of the programs; In the sense that it tends to be overshadowed in popularity and familiarity by its other well-known cousins – the RRSP and the TFSA.
But we have known since elementary school that black swans turn out to win the beauty contest, eventually.
For instance, the RESP is one of those rare gems, and I am talking rubies and sapphires here, where in the government contributes to this saving plan on your behalf to top up the contributions you have already made. Repeat: the government is giving you money at almost no cost to you.
The RESP works something like this (simplified):
Open the RESP account at a bank or financial institution;
- Contribute annually to this account subject to annual contribution limits;
- Watch the government pay in to this account annually subject to limits (typically 20%)
- Roll-back on the recliner, rub you hands and keep and that smug look on your face. You did good.
Your contributions to RESP Canada are not tax-deductible and when your beneficiary (typically your child) withdraws it for tuition, it is generally taxed at the low rate. But to make up for this lost benefit, the government provides the annual contributions – typically at 20% of your contributions. This is on top of any interest earned through the specific banking or financial institution’s account.
If the RESP was a mutual fund, it is like having the fund offer you guaranteed return of ++20% per year with one of the lowest MER (Management Expense Ratios) to boot on top of that. Black swan or White swan? You decide.
All the major banks and most financial institutions offer RESP accounts. The two most common offerings are GICs and Mutual Funds. There are benefits and risks with each so it is important to have a discussion on your financial goals with your planner before opening the account.
In general, the GIC offers the lowest risk and your return (the bank or institution’s interest offering) but the rates can be dismally low that prevents maximal growth potential. At the least, your GIC rate must beat inflation rate otherwise this option is essentially moot.
Mutual funds can help with the maximizing the growth part, but Canadian mutual funds are notorious for having one of the highest MERs. Plus, your investment could fall in accordance with the fund performance. The key is selecting the right fund that balances growth, security and low MER. This is where discussions with your planner becomes critical.
In terms of timing of RESP contributions, it is critical to start contributions the earliest you are eligible. Even a difference of a few years between contribution start times makes a huge difference in the growth of the savings amounts over the life of your beneficiary.
Take a look at this chart below that highlights the impact of starting the contributions early.
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