Consider an RESP/TFSA combo to maximize value and flexibility
Whether your child is a month old or starting high school, you might be thinking about just how much their post-secondary education is going to cost and how on earth you’re going to pay for it. Using a combination of an RESP and a TFSA, and investing regularly, will get you a long way.
A Maclean’s study from 2018 showed that the average total cost of university in Canada was about $20,000 a year for students living away from home and about $9,300 for students living at home. Doing some quick math and adding in some inflation gets you to a number of about $100,000 for a four-year degree.
This number varies a lot depending on what your child ends up doing: College, university or another program? Humanities or dentistry? B.C. or Nova Scotia? Also, you might not be paying for the entire cost. Bursaries, scholarships, part-time work, help from grandparents, and student loans can help too.
The point is, it’s very hard to know how much this will cost you – and how do you save for an unknown expense? One way is to use a two-pronged approach: using both an RESP and a TFSA.
Getting the most free money you can
Using an RESP – Registered Education Savings Plan - is a worthwhile way to save for post-secondary education. Not only is there good potential for tax savings, but the program also pays out a grant, which is free money from the government.
You are allowed to contribute up to $50,000 per child over the lifetime of the plan, but should you?
If you knew for sure that your newborn was going to be a dentist then the answer is probably yes. A dental student needs more than the average tuition, like over $60,000 more, so you’d need to use every tax-advantaged savings opportunity you could get.
But you might not know what your child will do after high school until, well, after high school. If your child doesn’t do any post-secondary education, and you don’t have another beneficiary who can use the money, the benefit of investing in the RESP is eliminated: you will give back the grant money, pay tax on the investment gains as if all the gains were interest income (meaning fully taxed as regular income) and pay a 20% penalty. (There’s also the option to roll some of it into your RRSP, if you have the room.) Plus, there are restrictions on how long you have to wait to get the money out to use for something else. The government is serious about making the plan strictly for education.
Is this a disaster? No, but it’s not ideal either. What if you hedged your bets? Use the RESP to get the maximum government money you can with the minimum required contributions, and use your TFSA for the rest. For each child that’s named as a beneficiary on the RESP, you’ll need to contribute $36,000 to get the maximum grant of $7,200 (20% of what you put in). And you need to spread it out over time – you can’t just dump $36,000 into the plan when your child is in grade 10 and get all the grant money. Ideally, you’d put in $2,500 a year and get $500 a year from the government.
How far would this take you towards your savings goal? If you contributed $36,000 evenly over the years, and assuming you can get a 5% return on your investments inside the RESP, you’d end up with a little over $70,000 after 18 years, which gets you well along the path towards a four-year university degree. You can play around with the numbers with an online RESP calculator like this one.
A TFSA provides maximum flexibility
Once you’ve planned your RESP savings to get all the free money you can get, but you want to save a little more, you can top up the education savings using your TFSA. Using a TFSA gives you lots of flexibility: you can use the money for education, but if your child doesn’t need it, there’s no hassle - just use it for something else. Anything else. Like an empty-nester trip to Venice, landscaping the backyard of your dreams, or for retirement.
The limitation of this strategy is that the annual TFSA contribution room isn’t very high. It’s $6,000 for 2022. (If you’ve never contributed to a TFSA, though, you’ve got $81,500 of room.) Offsetting this limitation is a great feature of the TFSA: even if you take money out, you don’t lose the contribution allowance. This means if you use some TFSA money to pay the landlord of the student house, you’ll be able to replace it the following year.
What’s the tax implication? When your child takes money out of the RESP, they pay the income tax on the investment gains. Even if they are working part-time, they will most likely be in the lowest tax bracket and pay 20% (as of 2022) income tax. If this money were sitting in your regular, non-registered investment account, you would have to pay the tax on the gains, and you might be in a higher tax bracket than your child, like 30% or more.
Taking money out of the TFSA will cost you and your offspring nothing in taxes. That’s the “tax free” part of the TFSA.
A few parting thoughts
First, be sure to invest the RESP money. Simply making a contribution to the account isn’t good enough because the interest you’ll earn is a pittance compared to inflation. You should consider the stock market and/or GICs depending on how old your kids are.
Second, it’s ok if you have a lot of money in the RESP, more than the cost of tuition and residence. Your child can use the money for anything – yes, anything – so long as they are registered in school. Groceries, rent, a new laptop, going to the movies, beer, and new shoes are all on the table.
Lastly, if you are late in starting your RESP contributions, you can still recover at least some of the government grant by catching up one year at a time. Contribute more than $2,500 and you’ll get the grant money from one prior year. But don’t wait – if you don’t start to contribute by the time your child is 9, you’ll never fully catch up on the government grant.