I bought your RESP book and have been a long-time reader of your blog. I have a question I’m hoping you can help me with, but it you don’t have time I totally understand.
My question is this: at what point is an RESP ‘big enough’ that we should discontinue contributing to it?
We have two kids (7 and 5) and have an RESP self-directed family plan. We’ve contributed to it faithfully since shortly after our kids were born, and the balance now tops $37000. We’ve been contributing $2600/year/child to the plan to maximize the CESG grant.
Assuming that we want to fund about 90% of both children’s undergraduate (or trade school) studies, plus around 50% of any post-graduate work, at what point is the fund large enough to cover those costs without further contributions?
Estimating how much you should save for a expense that is far in the future is quite difficult. To estimate accurately, you need to know how much you will contribute to the account, the investment return and of course, the future cost of whatever it is you are saving for.
Saving for post-secondary education costs has all those difficulties plus two really big extra variables – you don’t know what kind of education your child will do and you don’t know if the child will live at home or on their own.
Will they do a four year degree? One year program? Will they live at home or be on their own?
Traditional retirement planning where you estimate contributions, rate of return, future withdrawals is a good model to see if you are in the ball park for retirement planning. However, it’s not hard to figure out that you should be able to get by with a retirement income that equal or less than your pre-retirement income. At the same time, unless you are very high income – you likely will need some minimum portion of your working income – say 40% just to have a minimum standard of living.
If you run some models using a replacement income ratios of between 40% and 75%. You can get a reasonable idea of how much you need to save to somewhere in that range.
Related: Different types of retirement scenarios (lots of great comments)
The problem with educational costs is that the range of scenarios is greater. Your child could end up doing a one year program and live at home. Let’s say this costs a total of $10,000. On the other hand, your child could do a four year program and not live at home. This might cost $80,000.
Needless to say the difference between $10,000 and $80,000 is so large, it pretty much negates any kind of other variables that you might consider when estimating how much to save.
Related: University costs might not be as bad as you think
At least with retirement planning, as you get older and closer to retirement, things become clearer. Factors like inflation and future contributions become less important because there isn’t much time before retirement.
With educational planning, it’s possible to not have any idea what the child will do until they go and do it. Yes, it would be nice if they are committed to a specific educational path, but for some kids – that’s not realistic.
RESP financial model
I did a rough RESP model on his situation and it appears that there should be about $53,000 available for each child in today’s dollars when they attend school. This should work out to about $14,000 per year for a four year program.
If you assume a worst case scenario of $20,000 per year of educational costs, and George wants to cover 90% – that is $18,000. According to my rough model, there will be a deficit of about $4,000 per year (in today’s dollars).
This is quite manageable. If the student can contribute a bit more and cut some costs, the deficit should be eliminated.
What is the solution?
My advice to George is to contributing enough to get the maximum grants ($7,200) per child. It sounds like this shouldn’t be a problem for George, but for anyone else – just contribute what you can. Every little bit helps.
If you start early and have good returns, the RESP should have a lot of money by the time the child goes to school.
It sounds like George doesn’t want to overcontribute to the RESP which is a valid concern. However, I would remind him that all contributions can be returned to the parents without any tax issues, so there is no penalty if the contribution amount ($36,000 per child) isn’t necessary.
The other thing to keep in mind is that withdrawals from the non-contribution portion of the RESP (EAP) is taxed in hands of student. Students are likely to have little or no marginal tax rate, so again, it isn’t a big deal if some of the non-contribution money doesn’t get used for educational purposes.
Whatever you do – make sure you take out all the non-contribution money as an EAP even if the student doesn’t need it for education.
Read this article for more withdrawal details: 8 Things You Need to Know About Withdrawing Money From Your RESP Account