April 18, 2021 | Bringing up Baby

When people have babies they’re swimming in expectations, obligations and hormones. Those are the prime days of vulnerability. The insurance guys descend, prey on emotion and walk off with nice commissions on needless policies. Realtors have a field day selling people debt and deeds even though the kid would be a happy renter. But perhaps most heinous are the baby vultures, shamelessly peddling college funds to parents of newborns.

Now, don’t mistake. Money for uni is hugely important. School costs a ton, especially if your spawn ends up being a dentist or, like David, a PhD earner. And the thing called an RESP is a valuable tool for getting there. But, but, but. Beware. A good idea can twist into a costly trap.

“When my daughter was born, my father started an RESP with Canadian Scholarship Trust (CST), which is one of those mutual fund outfits you rightly decry,” says David, a 40-ish academic in BC. “He made the initial contribution and then I made regular contributions for several years until July 2019.”

It was that year that I wanted a closer look at the return on my investment. It was going “up” so it looked fine (of course it would! I was contributing monthly!). But when I calculated it, it seemed to be an annual rate of return of 2%. Remember, this is for the 10 years that started from the bottom of the GFC to the heady days of the Trump years. I asked them to show me their calculations but they never replied. That’s when I decided I needed to transfer my contributions to my self-directed account. I would have done it earlier but I did not realize I could also open an RESP in a self-directed account. I suppose the banks don’t advertise it a lot so you’ll buy their mutual funds instead.

Well, what a nightmare it has been to transfer those funds because CST doesn’t want to make it easy to lose their money. The charges are outrageous. So with a $4613.69 penalty on an approximately $26K balance, is it worth it? I’m pissed at the low returns, the high MERs, and my bank’s incompetence in handling the transfer, which has cost me at least a year of good returns. Thanks for you all you do. Feel free to share my story to your readers. Certainly a cautionary tale with real figures for those who invest in mutual funds.

When David asked for the transfer, the company initially rejected it, writing: “We want to make sure you understand the impact this will have on your child’s post-secondary education savings. Transferring your child’s RESP to another institution may have a significant effect upon your current savings and the amount of money you will have to help finance their post-secondary dreams.”

You bet. The hit for David was almost 18% – and that came after a decade of returns below the prevailing inflation rate and during a bull equity market. This is what happens when you’re talked into an RESP with an outfit that charges high fees, misinvests and erects a costly barrier to exit – just like those DSC (deferred service charges), which create a mutual fund prison for unwary investors.

Are we pregnant? Then this is what you need to know about Junior’s college fund….

The Registered Education Savings Plan is a tax-sheltered way to grow money and the government pays you to have one. Woo-hoo. Once a kid has a SIN you can start. Contribute $2,500 a year and the feds will give you a $500 grant – which is the easiest 20% you’ll ever earn. The lifetime contribution limit is $50,000 and you have over 30 years to put the funds in. The most the government will chip in is $7,200 by the time the child hits 18.

The contributions and grants swell within the RESP tax-free, which means they should be in growth-oriented assets like equity ETFs. (Way too many helo parents choose brain-dead GICs and do their kids a huge disservice – or sign up with the wrong provider.)

When university starts money can be taken out and given to the child. Contributions are tax-free, while the grants and growth are taxable in the student’s hands. But since most college kids have no taxable income, there’s nothing to pay. If the kid becomes a TikTok star and eschews school, contributions to the RESP can be taken back, the grants have to be repaid, and the growth can go into an RRSP, if you have the room and the plan’s been in place for a decade or more.

Remember that anyone (called a subscriber) can open an RESP for a child (called the beneficiary) – not just parents. Missed grants can be carried forward one year at a time. There’s no limit to the size of annual contributions – but the max is fifty grand in total (and only $2,500 a year qualifies for the grant). Beneficiaries can be changed if your kid turns out to be a stinker. Family plans give more flexibility, since funds can be shifted between offspring. All plans have to be wound up after 35 years.

In short, if you procreate, do this. Tax-free growth. Forced savings. Free grant money. What’s not to like? Just ensure the self-directed RESP is hosted somewhere that offers the ability to hold low-cost, growthy ETFs. That could be an online brokerage, robo outfit, or your family advisor. No vultures.

Garth Turner April 18th, 2021

Posted In: The Greater Fool

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