Two weeks ago my son, Winston, started school. Junior Kindergarten can be stressful when the teacher gives you a question that you're not able to answer correctly.
This week, Winston's teacher threw him a curve ball: "Winston, what kind of job does your daddy have?" she asked.
When my wife, Carolyn, picked up Winston at the end of the day, his teacher approached Carolyn and told her about Winston's response to that question. Turns out I'm a "sax" specialist (not a tax specialist). That's right, I'm officially a musician.
Move over Kenny G. The problem, of course is that "sax" specialist is too close to "sex" specialist for my liking. And with my luck, that would end up being the very piece of information that makes it home to the other parents.
Regardless, I have full confidence in my son's ability to pass JK. He'd better; he's got a registered education savings plan (RESP) to take advantage of 14 years from now. Speaking of RESPs, now is a great time to revisit the value of these plans.
I don't want to scare you into setting aside money for the education of your kids. But I do think that you should be aware of how much it's likely to cost to send that little bambino to university for four years. This year, the cost of one year of university where your child lives away from home is about $14,100, according to Human Resources Development Canada. And that's pretty consistent with other calculations, including those I present in my book Winning the Education Savings Game.
If we assume a rate of inflation of 5 per cent for tuition (which is a fair figure given that tuition has increased by 4.6 per cent annually on average over the past 25 years but at a 9-per-cent clip annually through the 1990s), and 3 per cent for other costs, four years of university will cost $114,800 in 18 years if your child lives away from home. If your child lives at home, the total cost can be expected to come in at around $75,100.
I was contacted this week by a financial adviser who was frustrated that a number of his clients immediately lost interest in RESPs when they found out that there is no tax deduction available for a contribution to these plans. I've heard the same comment from Canadians in the past. People would rather put money into their registered retirement savings plans because there's a tax deduction available.
This line of thinking is all wrong. Yes, you've got to save for your retirement as your first priority. But don't mistake a contribution to your RRSP as an alternative to a contribution to an RESP. These plans serve entirely different purposes. No, you may not get a deduction for contributing to an RESP for your child. But make no mistake, those education costs will have to be paid somehow. And your RRSP is not the vehicle for that purpose.
Want a compelling reason to contribute to an RESP? Just take a look at the rate of return you've earned on your own portfolio over the past couple of years. Not exactly worth writing home about, I bet. What if you were offered a guaranteed 20-per-cent rate of return on the first $2,000 you invest each year -- regardless of how equity markets perform.
Most people would jump at it -- I know I would. This is precisely what an RESP offers. The first $2,000 contributed to an RESP each year for an eligible child will attract a Canada education savings grant (CESG) worth 20 per cent of that contribution. Talk about a no-brainer.
How much does that CESG really help? Consider this: If you invest $2,000 annually in an RESP for a child, receive $400 (20 per cent) in CESGs annually on those contributions, and earn a 7-per-cent return annually, that RESP will be worth $81,600 by the time the child is 18.
If you didn't receive the CESG and simply invested the $2,000 annually over that same period, you'd need an annual return of 8.87 per cent to arrive at that same $81,600 after 18 years. The CESG will effectively increase your rate of return by 1.87 per cent annually over 18 years in this example.
If you're one of the many Canadians who likes an RRSP for the deduction, consider this: Make a $5,000 RRSP contribution. This will give rise to a refund between $1,750 and $2,100 if you're the average Canadian. Use that refund to contribute to an RESP for your child and reap another $400 from the government.
Tim Cestnick, CA, CFP, TEP is author of Winning the Tax Game 2002 and Winning the Estate Planning Game. He is managing director, Tax Smart Services, at AIC Ltd.
Only GlobeinvestorGOLD combines the strength of powerful investing tools with the insight of The Globe and Mail.
Discover a wealth of investment information and and exclusive features.