Unlocking the power of education savings is often a complex task, but with the right strategies, a Registered Education Savings Plan (RESP) can be a game-changer for Canadian families planning their children's future. In this episode, Ben Felix, Dan Bortolotti, and Mark McGrath take a deep dive into the mechanics of the RESP, covering everything from optimal contributions and grant maximization to tax-efficient withdrawals and asset allocation. They discuss critical factors like the Canada Learning Bond (CLB) for low-income families and the intricacies of group RESPs, noting how pooled plans, though easy to join, can financially penalize those who don’t stay the course. With the RESP’s unique 35-year lifespan and its flexible range of education options, this in-depth conversation brings clarity to a valuable tool often overshadowed by its complexity. Tune in to discover practical strategies that could transform how you fund education, optimize your investments, and make the most of Canada’s RESP benefits.
Key Points From This Episode:
(0:03:00) Overview of the Registered Education Savings Plan (RESP) in Canada.
(0:04:33) Discussion on contribution limits and government grants for RESPs.
(0:07:15) Explanation of the Canada Learning Bond and provincial grants.
(0:10:00) The flexibility and complexities of family RESPs.
(0:12:51) Contribution strategies: front-loading vs. maximizing grants.
(0:17:54) Optimal RESP withdrawal strategies and timing.
(0:28:11) Asset allocation strategies within an RESP, including glide paths.
(0:43:45) Dan's critique of the RESP system and suggestions for improvement.
(0:55:37) Discussion on the inadequacy of RESP incentives for low-income families.
(1:04:26) Positive observations about RESPs and their benefits.
(1:09:19) Listener feedback and appreciation for the podcast hosts.
Read the Transcript
Ben Felix: This is the Rational Reminder podcast, a weekly reality check on sensible investing and financial decision-making from three Canadians. We are hosted by me, Benjamin Felix, and Dan Bortolotti, Portfolio Managers at PWL Capital. And Mark McGrath, Associate Portfolio Manager at PWL Capital.
Mark McGrath: And I thought you were going to introduce yourself as Chief Investment Officer now?
Ben Felix: I'll tweak that for the next intro, Mark.
Mark McGrath: Thank you.
Ben Felix: Yeah. No problem. I got to keep you happy.
Mark McGrath: Thank you.
Ben Felix: Welcome to episode 329. Today, we do a deep dive on the RESP, the Registered Education Savings Plan in Canada. This is one of those episodes where the topic is pretty Canadian. We have those from time to time because we are in fact Canadian. But we do go through some what I think are pretty interesting optimization scenarios. Even if they don't have direct corollaries to whatever country you may be in, I think there's still some interesting stuff in there.
We also talked about asset allocation as it relates to time horizon for this account type. And we have an interesting sort of philosophical discussion about government savings programs and incentives at the end. Hopefully, our non-Canadian audience still finds the discussion useful. But disclaimer upfront, it is a pretty Canadian topic.
And then we do hope you stick around for the aftershow where we have a bit of a meatier discussion than usual for an aftershow because there was this discussion in the Rational Reminder community that just blew up. It was really interesting to watch actually. A couple of people started really go on out of topic and then a bunch more people chimed in. Larry Swedroe was in there with a bunch of posts. It was neat to see. I think it's up to almost 340 posts on that topic now. But it kicked off in the Sunil Wahal episode discussion. It was all about expected returns. What is an expected return? What determines an expected return? Anyway, a bit of not a recap. But some comments on that discussion in the aftershow.
Mark McGrath: Yep. I think the aftershow might be as long as the main topic.
Ben Felix: No. It's not going to be that long.
Mark McGrath: We will have the same audience, I'm sure.
Dan Bortolotti: Yeah.
Ben Felix: Yeah. Yeah. I did want to mention that if you're enjoying the podcast, we would love it if you told one person about it that maybe doesn't already listen. I mean, hopefully doesn't already listen. That would kind of defeat the point if they already did. You maybe pick an episode that you think might be useful to that person and share it with them. But the audience that we have is a huge part of why we keep doing the podcast. And I think it makes the whole ecosystem more interesting when we have all these audience members who are engaging with the content. We hope that keeps growing. And, yeah, if you could share it with someone that has not listened before, we would appreciate it. All right. Ready to go to the episode?
Mark McGrath: Yeah, ready to go.
***
Ben Felix: We're talking about optimal education savings withdrawals and asset allocation. In Canada, we have this account called the RESP, the Registered Education Savings Plan. It's existed since 1974. And I don't think it's changed a ton over that period, Dan, that you're going to talk about later.
Dan Bortolotti: Yeah. Exactly. Maybe since 1974. But not really much since 1994.
Ben Felix: Yeah.
Mark McGrath: There's been some. I was actually looking into this yesterday. I think the only change that I noticed – we're going to get into this. But there used to be no limit on contributions prior to something like 1989. And then they started adding all these caps to it. And the caps haven't changed much since which I think is what you're referring to.
Ben Felix: Yeah. As the name of the account suggests, it's intended to help with funding post-secondary education costs. The definition of post-secondary education is very broad. The way that it works is contributions to the account are made with after-tax dollars. And then there are matching grants that get paid into the account when certain contributions are made. Not on all contributions. There are some limits. And we'll talk about that in a second.
And then inside of the account, just like with other account types like an RSP or a TFSA, once you put money in there, you can invest it most of the time. Depends where you open it, I guess. But if you open it at a brokerage, you can invest in stocks or whatever inside of the account. And the benefit of the RESP is that all of the growth in the account is tax-deferred. Grants too. I mean, that's part of the benefit. But for investing, the benefit is that the growth is tax-deferred.
And as long as the beneficiary enrols in post-secondary education, qualifying post-secondary education, that growth is taxable to the beneficiary when it's withdrawn. If it's a parent funding the account, stuff is growing tax-deferred in the account. And then if the child enrols in a qualifying program, the growth is taxable in the child's hands, which is pretty beneficial in a lot of cases.
Mark McGrath: Well, it's one of the only income-splitting tools we have, right?
Ben Felix: Yeah. Definitely. I think one of the common misconceptions with RESPs is that you buy a RESP from the sales organizations that chase you down in the hospital right after you've had a child. And that's happened to me. With someone who has a little bit of financial knowledge, seeing it happen in real-time was pretty interesting. But you're like, "You just had a baby." And they come in with a folder that has information. And part of that information is like, "Sign up for this thing."
Dan Bortolotti: How long ago was that, Ben? When was your child born? Because I know that was definitely the case 25 years ago. But I'm saddened to hear that it's still happening.
Ben Felix: Well, most recently, my youngest kid is four. As recently as that.
Dan Bortolotti: That's pretty shameful.
Mark McGrath: It's funny. Because my daughter's 18 months now and I was actually hoping this would happened to me. Because I've heard so many people – and it didn't happen with my son. Totally, yeah. And just so I could roast them in the hospital. But why they shouldn't be doing this to me when my wife's just given birth. But it never happened.
Ben Felix: It might have changed. I seem to remember there might have been a legal case. I don't know. I can't remember. But I have a feeling that it might have changed more recently. That is a common misconception that that's what a RESP is. But a RESP is just an account type. That is one way of accessing the account type is through these things called group RESPs or pooled RESPs. They've got a bunch of downsides that I think we'll comment on a little bit later.
You can open this account any time after the birth of to the beneficiary. You need a social insurance number to do it. And then the person opening the account is called the subscriber. They legally own the account. That's important for a bunch of reasons. Usually, a parent or a guardian. It could be a spouse.
Mark McGrath: It could be anyone with an individual RESP. There's no restriction on who you can open it for. There are different types, which we'll get into as family RESPs and individual RESPs. But most commonly, yes, it's going to be parents or grandparents opening it for children.
Ben Felix: Yep. And then there's a lifetime contribution limit, $50,000 per beneficiary. That can go in at any time. There's no annual limit on contributions. But where it gets interesting is that there are grants. When you make a contribution, you receive grants in certain cases. And those have an annual cap. You get 20% of the contributed amount up to a maximum of $500 per year. That's $2,500. Contribution gets the max grant for that year.
And then if you keep contributing, you don't get more grants. If you have unused grants, you can mop up one past year of unused grant at a time. Then the total lifetime amount of grant is $7,200. And there are some programs where you can get a little bit of an accelerated grant if you have an income below a certain threshold but your lifetime grant amount is still the same. Do you want to explain the Canada Learning Bond, Mark?
Mark McGrath: Sure. Yeah. To there's a Canada Learning Bond which is for children of what the government considers to be low-income families. It's not a matching contribution. It's basically just a deposit by the government. It does require a RESP to be open in order to receive it. But you don't have to make a contribution. It's effectively a free deposit from the government for those under certain income levels. Do you know what the income level is?
Ben Felix: For the bond?
Mark McGrath: Yeah, for the Canada Learning Bond. I don't have it offhand.
Ben Felix: Not off the top of my head. No.
Mark McGrath: Okay. We can look it up after. But different provinces also have grants. I'm in BC and we recently, like in the past 10 years or so, introduced something called the BC Training and Education Savings Grant I think it is. And so, that is for children who are older than 6 years old to get it. It's just an application. As long as they're six or over, I think. It's a free $1,200 deposit to the RESP, which is a great incentive. I think Quebec has one. I think, Ben, you looked at this. Or, Dan, maybe you looked at this. And Alberta and Saskatchewan used to have them but they've discontinued them. Is that right?
Dan Bortolotti: Yeah. That's right. A couple of other provinces have had them. And I think what they've realized is they were really quite small. They would throw in a few hundred dollars. And I'm sure they felt that the cost of the administration didn't merit it. It wasn't really adding enough value. Just to backtrack on the BC one, if I remember correctly, you have to apply for it when the child is older than six but younger than nine.
Mark McGrath: Yeah. Good point. Yeah, there's a window.
Dan Bortolotti: There's a bit of a window in there. And I know for our clients here, we put their birthdays in the calendar. That pops up as soon as they turn six. And then we reach out and apply for the grant for that reason. Because if you forget and your kid is over nine, you miss the opportunity.
Mark McGrath: It's weird, isn't it?
Dan Bortolotti: It is strange.
Mark McGrath: Why pick a three-year window arbitrarily between six and nine? It's still a decade before they're actually going to use the money for anything. It just seems like an odd way to administer that.
Dan Bortolotti: Well, these plans are so complex. It is just par for the course that the provinces add their own level of complexity onto them.
Mark McGrath: Yeah. Fair enough.
Ben Felix: We have federal grants, matching grants. You have to make a contribution. We have a bond, which you get based on your income level. But it's not contributory. You don't have to make a contribution. But you have to have an income below a certain level. And you have to open the RESP account to get it. And then two provinces, BC and Quebec, have additional grants. Are those matching grants? They're contributory?
Mark McGrath: The one in BC is not.
Dan Bortolotti: No. I mean, the BC one is definitely not. You just have to have an RESP open.
Ben Felix: Okay.
Mark McGrath: Yeah. And to be clear. The CLB, the Canada Learning Bond, it's not a huge – I mean, it's money. But I think it's $500 for the first year. And then $100 per year after that up to age 15 as long as you continue to qualify from a family income perspective. At the most, you're getting $2,000 over 15 years, which obviously for low-income family is going to have trouble saving for education. It's money. But it's not huge. Dan, you're going to get into this later. But the cost of education is high. And $2,000 is not likely to be the difference between somebody being able to achieve post-secondary education and not.
Ben Felix: Yeah.
Dan Bortolotti: Agreed.
Ben Felix: Another nuance with a plan is that blood relatives or legally adopted relatives can share what's called a family RESP. Beneficiaries have to be under 21 to be added to a family plan. But with a family RESP, it's the same deal. You get access to the same grants per child. And while the use of grants is limited per child, you can only withdraw up to $7,200 of grant per child. Any excess earnings in the account, that's earnings on contributions and earnings on grants, that part can be distributed to any one child within a family plan. With a family that has multiple children, the family plan I think is generally just a little bit more flexible in terms of how the money can be used to fund education for the kids.
Dan Bortolotti: More flexible but more confusing.
Ben Felix: More confusing.
Mark McGrath: More complex, for sure. Dan, did you have a family plan for your kids? You said they're grown up –
Dan Bortolotti: No. We had individual plans.
Mark McGrath: Interesting.
Dan Bortolotti: But we manage virtually all family plans for our clients because they're easier administratively. But we do this every day for people who are trying to manage their own RESP. Trying to keep track of how much contributions, grants, and growth is allocated to each child. And the plan is not that straightforward. It definitely takes a little bit of experience to be able to manage those competently.
Ben Felix: Yeah. That's a good point.
Mark McGrath: Ben, you got four kids. You presumably got a family RESP.
Ben Felix: Yeah. We have it set up as a family plan.
Dan Bortolotti: Yeah. I'm pretty sure you can manage the complexity, Ben.
Mark McGrath: It's tricky.
Ben Felix: Yeah. My PWL adviser that helps me with all that stuff can manage it.
Dan Bortolotti: Yeah, there you go.
Ben Felix: Okay. We have the stuff going into the account. We have contributions. We have grants. We have bonds. We have investment returns, which are not being taxed but will eventually be taxed in the hands of the beneficiary. And all of those individual notional accounts, I guess you could call them, that exist inside of the RESP, they actually matter quite a lot for how it comes out, how the money comes out of the account.
If the beneficiary enrolls in a qualifying educational program the grants and growth are paid out as what are called education assistance payments, EAPs. Those are taxed in the hands of the student. Now for a student who has probably a low income, probably some tuition tax credits, they're not going to pay much tax on those withdrawals.
However, if they have a high-paying co-op job or something like that, they could end up paying a lot of tax. We'll walk through some withdrawals. A little case study later. But you do have to be a little bit cautious of the timing of withdrawals of the taxable portion of the RESP.
Mark McGrath: This isn't a problem anymore because of the new tax on split income rules. But it used to be where – again, I primarily worked with doctors. And most of them have corporations. And you used to be able to add your children as shareholders of your corporation at least in BC. There are bylaws per province. But in BC, you would have children subscribing for shares of the corporation on their kids. And then when they turn adults, you could just pay them dividends. You could just split income from your company. It doesn't matter if they work there or anything. A lot of physicians had set up their corporations to pay dividends to their adult kids for school. You used to have to manage the taxes on the REPS a lot more intricately because they had this other taxable income. That opportunity is largely gone away. But now to your point Ben, everyone's got about $15,000 of tax-free income they can earn per year. You stack on the tuition tax credits. And it's often possible to get a lot of that RESP money out with little to no tax.
Ben Felix: And then the contributions that you put in there, the grants and the growth are taxable, those are EAPs. The contributions are PSEs. I find all the names to make this whole thing just like that much more complex. There all these ridiculous acronyms for the types of withdrawals that are coming out that just the structure of the withdrawals is complicated enough. But then we have these acronyms for them too. It's just like, "Man, this is ridiculous."
Mark McGrath: Not only that. But the acronyms both kind of mean the same thing, don't they? Education assistance payment or post-secondary education payments.
Dan Bortolotti: Yeah. Distinguish between contributions and growth. They both essentially are synonymous. Yeah.
Ben Felix: Yeah. It makes no sense.
Mark McGrath: Yeah. Taxable and tax-free.
Ben Felix: But it actually matters for how useful the account is. It doesn't make the account useful. That's what I mean. But for it to be useful, you have to properly manage all of these different notional accounts inside of the account.
Okay, you can make contributions to the RESP until 31 years after it was first opened. And then you have until the 35th year after the plan was first open to use the funds before the account expires. And that would have implications for how the money comes out as well. And if it's not used to fund post-secondary education, then there are another set of implications.
The contributions you put in there still come out tax-free. That's nice. The grants are repaid to the government. And then the excess, which is the earnings on the contributions and the grants, you can transfer some of that to your RESP if you have room. You don't get additional room to put it in there. And as long as all remaining beneficiaries are at least 21 years old and the plan has been open for at least 10 years. It's not like super simple. Like, "Hey, you can just do this."
Mark McGrath: And it's a $50,000 cap per subscriber, I believe, on what you can roll over into an RESP which is actually really interesting. And favours jointly-owned RESPs. My wife and I are both joint subscribers on our kids' RESPs. That gives us $100,000 of potential growth that could be rolled into RESPs. If you're a single subscriber, then you only have 50,000 for the family that can be used that way. It's a pretty high cap. $50,000 of growth. But still.
Ben Felix: Yeah, for sure. If the beneficiary doesn't go to school or if they have a disability and don't use the RESP, the earnings can, in certain cases, be rolled into an RDSP, a Registered Disability Savings Plan. And then if you have to take the money out – you can put it into an RRSP if you have room. Up to $50,000 per subscriber. You can put it into an RDSP if certain conditions are met. But if you can't do either of those things, then the excess amount, the earnings have to come out at your tax rate plus a 20% penalty, which is basically to account for the growth from invested grants. You earn the money on grants that you had to pay back. You also had this tax shelter growth benefit. There's a penalty applied to, I guess, an account for that.
Mark McGrath: Yep. It could be a lot of tax. That's like 73.5% I guess would be the top tax in BC.
Ben Felix: Yup.
Dan Bortolotti: Yeah. But as we've talked about, these are pretty theoretical. It's extremely rare for a parent to be put in a position where they have to do this. There are enough other exit strategies that that's really the last resort.
Mark McGrath: And I think you can just donate the money too. I've never seen it. But I believe there's a clause that says you can also just donate that money to a registered educational institution of some kind. Presumably, there's no tax to you. I don't know if you get any sort of tax credits or anything like that.
Dan Bortolotti: You don't get a tax – I've seen it happen once. And you don't even get a tax benefit.
Ben Felix: Jeez. These accounts, it seems unnecessarily complex. But it is what it is. But because they're complex and because they have all these funny little features, it turns out to be a pretty fun optimization problem to play with. If you've just had a child and you have $50,000 that you could invest in a RESP account, keeping in mind that 50,000 is the lifetime maximum contribution limit, should you dump that $50,000 into the RESP and invest it? Or should you contribute it gradually over time to maximize the matching grants?
Just keep in mind, if you do 50,000 once, you get one year of matching grant. But there's a cap for that year. And now you're done. You have no more contribution room. So you give up a bunch of grants. Or you could contribute gradually over time to get all the grants. Yeah. It's kind of fun to play with.
Mark McGrath: Have you seen clients do that? I've had one client do that. Dump 50 grand in day one. This would have been 2016 or so. And so, in hindsight, that looks really, really good.
Ben Felix: It probably worked out.
Mark McGrath: Yeah. 100%. I think he went 100% into VEQT. 100% global equity. It's worked out very, very well for him. But I think most people aren't in a position to do that. That's the only one I've seen do it.
Ben Felix: Yeah. Interesting.
Dan Bortolotti: We do a hybrid strategy very frequently where we put in the 14,000 lump sum. That's the difference between the maximum contribution and the maximum amount that you need to collect the lifetime maximum grant. You put in 14,000 the year the child is born and 2,500 every year going forward. You get the maximum grant and you get extra compounding on that original 14,000. I don't know if it's optimal. But it's certainly a strategy to make intuitive sense. Yeah.
Ben Felix: Oh, it is. It's optimal then. We're going to talk about that exact strategy.
Dan Bortolotti: Sorry about that.
Ben Felix: It's okay. Optimal is hard to define here. But I think that is probably overall when you consider a bunch of different stuff, that's probably the optimal strategy. We'll talk through a couple different examples here. If we assume that other registered accounts are maxed out. TFSA is maxed out. RESP is maxed out. While this $50,000 is waiting to be invested in the RESP, it's invested in a taxable account. Taxed at the highest rate in Ontario in these examples.
I've got one little mini case here from Aaron Hector, who's a financial planner that we know pretty well. He's brilliant. But he did a post on exactly this where he looked at a 7% return as his base case. And he did look at a couple different scenarios. But 7% return is the base case. And he actually found that a four-year funding plan was optimal, which is interesting. That was putting in 42,500 in the first year. And then following that with three years of $2,500 contributions to make up the room. It's even a different hybrid than your example, Dan. And then he looked at a bunch of different return scenarios.
And in general, in his return scenarios, what you see is higher returns make front-loading look better. Like your example, Mark, of dumping the 50,000 in. Just getting great returns. That's going to look better than getting grants. Then if you have lower returns, the grants are more attractive because they're obviously guaranteed. You get those regardless of how low your returns end up being.
In Aaron's example with a 7% return and a bit of variation around that, he kind of finds a front-loading looks pretty good. I did a model pretty similar to Aaron's. I did this last year. I posted it on Twitter. But I added a Monte Carlo simulation because I wanted to see the distribution of comes for the different strategies. I didn't do exactly what Aaron did. Aaron did a bunch of different variations of the multi-year funding. I just did the $50,000 or the one you mentioned, Dan, where you do the 14,000 up front and then rest after that. And then I looked at the terminal wealth at age 18.
With a 7% return, similar to what Aaron found, I also found that front-loading makes a lot of sense if you get a guaranteed 7% return, which you can't get right now. But when I ran it through the Monte Carlo, what I found is that the median ending wealth was lower for the front- loaded strategy and the standard deviation of final after-tax wealth was much higher for the front-loaded strategy. My take on this is that once you adjust for risk, I think it's pretty hard to argue against getting all of the grants.
Yes, you can show that front-loading makes a lot of sense if you can get a really high return. But because returns are not guaranteed, I think it's pretty hard to say that it doesn't make sense to go for the grants unless you're really risk-seeking, I guess.
Mark McGrath: Yeah. I mean, the grants are a hedge against the worst outcomes effectively over time. It's the difference between investing $2,500 a year and 3,000 per year over that time frame. If you get lucky with your returns, like the client that I had, great. But if you had done this, I don't know, going into 1999 or something where we faced two massive bear markets within a decade, those grants in hindsight would probably have been really, really useful to be allocated. I think it just improves the worst-case scenarios by getting the grants. We did the same thing with our kids. We did that exact strategy that Aaron described where we put in the 14,000. I mean, not everybody can do this, of course. I respect that. But in my mind, the best strategy is to try to get the additional $14,000 in as soon as possible. And if it takes five or seven years to do that, that's fine. But you've got time on your side to some degree by allowing that money to compound. If you can't do it year one, that's fine. But try to spread it out. But you can contribute more than the $2,500 per year that you need to get the grants.
Dan Bortolotti: Yeah. And you make a good point though, Mark. That you want to get that unassisted contribution as they call it. That $14,000. That you don't obtain a grant. You don't want to put that in when your child is 13 or 14. I mean, you can. But I just think that it's not worth it at that point. You might as well either try to get it in early. And if you don't have the funds available, just get in the 36,000 that you need to get the maximum grant.
And as we'll talk about a little later, that's going to be enough for a lot of people. That's going to get you very close to the full amount that you would need to fund a four-year undergrad education in many cases.
Mark McGrath: For sure.
Ben Felix: Yeah. We do that $14,000 front-loading strategy. We do that for clients all the time, like you guys do, Dan. And we call it RESP super-funding. That's our nickname for it.
Dan Bortolotti: Okay. If you have non-registered funds available, it's a great idea.
Ben Felix: Yeah. Totally. Okay. The other side of the RESP that I think gets typically less attention than optimal contributions, which even itself is a pretty niche topic, but even less attention is paid toward withdrawals. We mentioned some of the nuances around the different types of notional accounts that exist inside the RESP. But there's this question of, "Okay, you do this. You find the optimal contribution strategy and you end up with a big pile of money in your RESP. Now what do you do?"
Aaron Hector did another post on this. And I did ask Aaron for permission to talk about these posts for the record. And he was totally cool with it. The two types of post-secondary withdrawals, there's the EAPs, the educational assistance payments, which are taxable. And that's from your investment returns and your grants. Taxable to the beneficiary assuming they're enrolled in a qualifying post-secondary education program. And they are fully taxed as income. There's no idea of dividends, or capital gains, or whatever. It's all 100% taxed as income.
And then we have the PSEs, the non-taxable withdrawals. Those acronyms still just drive me – they just drive me nuts. And you have a choice. You can choose between taking out EAP or PSE. There are some limits on the EAP. It's limited to $8,000 in the first 13 weeks of enrolment in a full-time program or $4,000 if it's a part-time program. And then after the first 13 weeks, there is still a limit, which is kind of interesting.
If you stay under the limit, your financial institution is not expected to assess the reasonableness of the expenses. And if you go over the limit, then your financial institution may ask questions about is this a reasonable educational cost? That limit for 2024 is $ 28,122.
Mark McGrath: That's really interesting. Because it's up to the promoter. It's up to the financial institution to determine whether it's reasonable at the end of the day to make those –
Dan Bortolotti: Well, it does raise the question though. First of all, what's reasonable? Second of all, if you just happen to have very high investment returns in your RESP and you have no choice but to withdraw these larger EAPs, what is the consequence if you try to take a $40,000 EAP and the limit is 28 and you can't generate receipts showing that you spent $40,000 for your child's education? I've never seen that happen. I'm just curious as to what consequences there would be. Can the financial institution say, "Yeah. Sorry. We're not allowing you to withdraw your money because you exceeded the limit that we've set."
Ben Felix: I don't actually know. That'd be an interesting question to ask somebody that runs one of these programs at a financial institution.
Dan Bortolotti: If anyone knows, leave a comment.
Mark McGrath: Yeah. And I think CRA can audit these. Even if a financial institution says it's reasonable, the CRA does have the right to audit all of these. Even if you took out 40 grand – let's say your financial institution says it's reasonable. In theory, CRA can audit your transaction. And then you would have to submit further proof of that.
And then CRA does maintain – I don't know if it's CRA or the ESDC. But they maintain a list of expenses that are considered reasonable versus not reasonable. And so, something that's interesting is rent. To live on campus. Housing is a reasonable expense. But not down payments on property. And this is just with respect to the EAP limit. This taxable limit.
I've actually seen a case where somebody took out the full amount of PSE, their non- taxable contributions that they've made, and they use that to buy a condo on campus and then charge their child rent using the EAP withdrawals as rent for the condo. And then when they finished university, they just gifted them the property. I think there's creative ways around it. But it's a problem that I think very few people will end up facing. And the three of us have never seen a case, I guess, where somebody's needed to make a withdrawal in excess of $28,000 per year, I guess, that limit. Right?
Ben Felix: Per year. Yeah.
Mark McGrath: Per year. Yeah.
Dan Bortolotti: Yeah. I mean, I think we've come close to that. I mean, it's not that unusual for if you supercharge your RESP and you earn healthy investment returns for 18 years, you could end up with well over $100,000 in an RESP. And that might require you to take out $28,000 in a year. That's not an extraordinary amount. But, certainly, we have never been challenged for taking too large of an EAP.
Ben Felix: Neither did we.
Mark McGrath: And it can happen if you have multiple kids and then one doesn't go to school. That growth has to be spread out amongst the other children so that larger amount of growth the more kids you have. Ben, if two of your kids don't go to school, you're going to have all this excess growth that has to be distributed to the two that do go to school.
Ben Felix: Yeah. I hope they all go to school.
Mark McGrath: I have a feeling your kids are going to go to school, Ben.
Ben Felix: I hope so. We'll see. It's also so broad though what qualifies as post-secondary programs. It can be trades. It can be beautician school. There's a huge list of qualifying programs.
Mark McGrath: It's almost anything. The qualifiers at the program has to be at least three weeks in length. I had a client once and they had a child that was going to take a two-week bartending course. It was a couple thousand-dollar course. It was two weeks in length. But then there was a one-week study period. And then there was a final exam.
From start to finish, from the day you start that program to the day you write the exam is 3 weeks, even though there's actually two weeks of instruction. And ESDC maintains a list of qualified educational institutions. If you're ever curious about a program as to whether it would qualify for a RESP withdrawal, you can just go look that up. And it's not just Canadian institutions by the way. You can use this for institutions outside of Canada.
Anyways, of course, we look it up. The bartending school is not on the list of approved schools. And I was able to call ESDC and say, "Hey, here's the scenario. And the program is two weeks. But there's a one-week study period and then the exam. Can we make a RESP withdrawal?" And they approved it.
Anytime I get people saying like, "Oh, well, it's so restrictive. And what if my kid doesn't go to school?" I'm like, anything they do to further themselves and any kind of career path is likely to qualify for a RESP withdrawal. You just don't really have to worry about it. If they become a rockstar and never go to school, okay, that's one thing. But I've yet to see a scenario where we couldn't find something for them to do for a month to get the RESP money out.
Ben Felix: Yeah.
Dan Bortolotti: That's very encouraging. I'm really happy to hear that they're that flexible about what they consider to be post-secondary education. And it's not this narrow-minded college, or university, or – that's it. That's a good story.
Ben Felix: Okay. Now thinking about how to withdraw properly or efficiently matters because we have this mix of taxable and non-taxable amounts inside of the account. We have limits on withdrawals. Certain limits like we were just discussing. And then we have this issue where once the beneficiary is no longer enrolled, it's much less efficient. Because you have that penalty, tax. The grants have to be paid back. You really want to get this right. Not to mention stuff like tuition tax credits while the kid is enrolled in school.
What Aaron did in his post here is he looked at a case where an RESP has $50,000 of PSE. That's $50,000 of contributions and $150,000 of EAP. That's grants and growth. We've got a $200,000 RESP account. And Aaron just maps out what should you take out, and when, and what does it actually look like?
In the fall semester of the first year of enrolment in a qualifying post-secondary educational institution, Aaron shows taking $15,000 out as a non-taxable PSE. And he's going to put that in the TFSA and the FHSA, the First Home Savings Account of the student. And then he suggests taking out $8,000 as an EAP. That's the taxable amount. And that's the limit for the first 13 weeks of enrolment. And that's going to pay for whatever educational costs and stuff like that.
Then in December of that year, now 13 weeks have past, Aaron suggests taking out $2,122 which is the balance to get to that EAP threshold, the 28,122 for the year. And that's it for that year. And then in January, the first winter semester of the first year, we have $15,000 taken out as a PSE again. And that goes again into the TFSA and the FHSA. And then a $28,122 EAP or whatever the maximum amount happens to be in that year. And he does the same thing. Cycles through a couple more times. Eventually, the PSE is all used up. There's a final EAP for the 28,122.
But then there's an interesting piece at the end where, in Aaron's case, there was still a chunk left of EAP. The students done their program now. There were still a bunch of EAP left, I think it was $9,000 or something, that couldn't come out under that $28,122 limit. Aaron's like, "Okay. Well, this is a bit of a problem because now we would have to be able to justify the expense."
In his case, what he does is use it to purchase a vehicle which would qualify as an excess for an excess EAP withdrawal as long as a student is using it for transportation to and from school. Interesting little point in there. And so, in Aaron's case, the student ends up, they've paid for a good chunk of their education cost. They've also got a maxed out FHSA. And they've shovelled $35,000 into their TFSA. Yeah. I think it's an interesting case.
And I think it ties into asset allocation for RESPs which we're going to talk about a little bit later. Because in this case, a bunch of the money that was in the RESP has now gone into other investment accounts that could be used for long-term investments as opposed to spent on education costs.
Dan Bortolotti: Yeah.
Mark McGrath: Yeah, that's really interesting.
Dan Bortolotti: A lot of moving parts in here. I guess the one thing that jumps out to me is that your contributing to the FHSA, presumably in years where your income is very low, probably don't want to deduct those contributions and carry that deduction room forward.
Ben Felix: Yeah. Totally.
Mark McGrath: The FHSA, for people who aren't familiar, is the new First Home Savings Account. It combines the benefits of RESPs and TFSAs in some ways. When you contribute to that account, you can use that to reduce your income. Like a RESP, you can contribute to it. But you don't have to use that income deduction in the year you contribute. Ben, to your point in those low-income years, you probably don't want to use that deduction. Carry it forward to a year when you have a higher income rate.
The other thing is that limit, that $28,122, that’s indexed to inflation, I believe. That's one of the few things that is actually indexed to inflation with RESPs. Because I remember looking at that number a few years ago, and it was something like 24,000. It has obviously gone up. And I assume it's indexed as CPI, the Consumer Price Index. But Aaron's example I don't think obviously accounted for growth on any remaining investments or any investment income.
There would be like maybe residual income built up in the plan because you're going to leave it in a savings account of some kind maybe as this is happening. But on the flip side, that EAP limit is also going up by inflation each year. Very fascinating scenario. But, Dan, to your point, quite complex.
Dan Bortolotti: Yeah. I sometimes like to start with the simple scenario where you assume that the RESP is just going to be withdrawn in order to pay for school-related costs and not used to fund these other accounts. And one of the strategies that we will often consider is, try to get those EAPs out as early as possible. Obviously, you don't want to load up the student with income that's eventually going to be taxable.
But the reason for that is if the child finishes a year or two of school and then drops out and doesn't go back, and we all know this happens frequently, you might end up in a position where you have to pay back those grants and face all of those penalties that we talked about. If you get all the EAPs out, and at the end all you have left is contributions, you can take those out anytime even if the child no longer is enrolled in school. And I have seen this happen. Experienced it with clients. It's not a zero-risk strategy. I would say as far as possible, up to the limit where you're pretty confident that students not going to pay any taxes, get those EAPs out in the first couple of years if you can.
Mark McGrath: Yeah. And not only that. But, I mean, I've got clients who have students that enter co-op programs in year three and four and they make $25,000 $30,000. The probability of having other sources of taxable income I find goes up in the later years of a program. You want ideally, from just a pure tax perspective, less EAPs withdrawn in later years than in earlier years, right?
Dan Bortolotti: Exactly.
Mark McGrath: Crazy. It's a super interesting topic. There's a few other fun things about RESPs that we didn't cover. Before we get into some of the other stuff, I mentioned quickly they can be used for qualifying programs outside of Canada. That's another thing that I find people who are maybe weary or concerned about RESP usage. They don't realize that. You can use them for certain educational programs outside the country, which is great.
There are over-contribution penalties to be aware of. And this can get hairy when you've got multiple RESPs for one beneficiary. I've seen cases where grandparents open an RESP for a child, for their grandkid. The parents also open one. Both are contributing. The beneficiary is the one that has those limits. That 50,000 lifetime limit and the $7,200 grant limit is per beneficiary. Not per plan.
If you've got multiple RESPs with the same beneficiaries, it's very difficult to strategize properly to optimize the way that we've explained here. And you can run into situations where you inadvertently over-contribute to the plan. You have to be careful. And if you do, there's a 1% penalty per month, much like a RESP and a TFSA, on any excess contributions.
The difference – and I don't know why this is. But somebody actually pointed this out to me on Twitter last year. With a TFSA, for example, the moment you over-contribute to a TFSA, the penalty applies for that month. Even if it's in there for an hour, in theory, you have to pay that month's penalty on the TFSA over-contribution. With an RESP, that's not the case. The RESP, they actually look at the month end. As long as you've withdrawn the excess contribution before the end of the month – which just brought up a really ridiculous strategy that I would never recommend to anybody. But I guess, in theory, you could just, the second day of the month, invest the money in the RESP, take it out on day 28, not pay the penalty, and put it in on the first or the second of the next month. Don't do this. It just occurred to me. Don't try this at home.
But for whatever reason, reading the tax forms for RESP over-contributions, the wording is such that as long as the excess amount is withdrawn before the end of the month, there's no 1% penalty. Just to further complicate things, they've made even the over-contributions on this plan different from the rest of registered plans. Yeah. And I think that's it. And then I just had that anecdote about the client of mine. They used it for a bartending school, which I thought was really interesting.
Dan Bortolotti: I'll jump in here. You had mentioned, Mark, about sometimes grandparents will open RESPs for their grandkids. That's a strategy we've been asked about it. I tend to discourage it. And the reason is that, unfortunately, the chances of a grandparent passing away before their grandchild has completed university is not remote.
And if you are the subscriber of a RESP and you pass away, transferring that asset is not as straightforward as it is from any other account types. And so, what I typically suggest in this situation is talk to your child, the parent, and say, "We would like to fund an RESP for our grandchildren. We encourage you to open it up." I don't know. Make it a holiday gift or something. You can fund it. But open it up in the parents' name as far as possible. That also solves the problem that you had mentioned about parents and grandparents perhaps both opening RESPs and accidentally over-contributing. It's much cleaner if the parent is the subscriber. Preferably, both parents as joint subscribers if possible.
Mark McGrath: Yeah. That's a great point. Because unlike other registered plans, RESPs are subject to probate. They go through the will of the subscriber. If you have an RESP or a TFSA and there's a named successor or a named beneficiary, it bypasses the estate on death. That's not the case with a RESP, even though it's also a registered plan. And so, if you haven't named a successor subscriber to that plan in your will, your executor effectively takes ownership over the plan and needs to find somebody to take it over. And if there's nobody suitable, the executor could just decide to distribute the money. Pay the penalties and deal with it. I haven't seen it happen. But to your point, it can get really messy with the estate too.
Dan Bortolotti: Yeah. And think about if the grandparent were to pass away, say, just before or just after the child is enrolled in post-secondary education. By the time you get all this sorted out, it's quite possible that the child could be in third, fourth year by now. And it's just really messy. It's so much cleaner if you can just arrange it so that the parents are joint subscribers whenever that's possible.
Mark McGrath: For sure. Could you open a joint account with the grandparents? The parents and the grandparents? Would that help solve it? RESP with parents and grandparents?
Dan Bortolotti: You can have joint subscribers on an RESP but they have to be spouses. This is another interesting point. This has come up with us before we've had clients where the parents are separated and they were joint subscribers. And even though both parents of the beneficiary, they cannot be joint subscribers once they are no longer spouses.
What we had to do was sever it. One parent became the subscriber, and they just had an agreement. Fortunately, it was an amicable separation and they were just able to say, "Okay. Your name is on it as the subscriber. But I will be as supportive as I can. Contribute some amount for the contributions, etc."
Mark McGrath: Interesting.
Dan Bortolotti: Adds yet another wrinkle into an already fairly complex plan.
Mark McGrath: Yeah. Well, I've got one where the parents are divorced but each of them maintains a RESP for the beneficiary. It was joint. They separated. But one of the spouses wouldn't give up their control over the RESP or both, I guess. And so, there's actually two RESPs. But I only deal with one of the separated spouses. And so, I have absolutely no view and neither does she on what's going on in her ex-husband’s RESP for their kids. And now the kids are going to university. And so, it's becoming very difficult even for us as advisers. Where do we take the money from?
Ben Felix: Yeah. Crazy. How many downstream implications there are with RESP planning in estates and the family law stuff? One important nugget in there that we can maybe be explicit about is that if you want a RESP account to go to somebody else as opposed to be distributed, it's really important to have a successor subscriber named in your will. Because that's not something that you can do on the account like with other registered account types. And that's something that I've seen missed many times for people who have a RESP and are getting a will done. It's, for whatever reason, common to be overlooked throughout that process. Asset allocation. Do you want to talk about that other –
Mark McGrath: Yeah. No. I think that's good. I think we've probably picked it apart as much as we should for now.
Ben Felix: Okay.
Mark McGrath: Right. Yeah. Yeah.
Ben Felix: Well, Mark, you've made the point a few times. It's not as restrictive as it seems. And it's a lot easier to use than it seems. And whatever, whatever. But that argument is used. I've seen it used at least in one case when people are trying to recommend permanent insurance instead of an RESP. That flexibility argument is often used where someone will say don't contribute to an RESP. Contribute to a whole life policy because it's whatever. You get tax-free growth, which is not true. And then you don't have all these restrictions at the end of the plan like you do with the RESP.
But, yes, there are restrictions on the RESP. But they're not that bad. They're relatively easy to manage. I don't think it's a big deal. And we have modelled that recently. Jason Pereira and I, for a project that we're working on, we modelled whole a life insurance.
Mark McGrath: You and who? Sorry.
Ben Felix: That joke is so ridiculous.
Mark McGrath: Well, it's my favorite joke.
Ben Felix: This guy's named Jason. I don't know. You probably haven't heard of him.
Mark McGrath: Yeah. Some guy.
Ben Felix: We have this project where we're looking at different cases for permanent insurance. And one of the ones we looked at is RESP versus whole life policy. And because of the grants mostly, there's just no way that a whole life policy can match an RESP unless you make some extreme assumptions about what happens at the end of the RESP plan. All of the gains being given back, for example, which obviously wouldn't look very good. But that's not a realistic case either. Anyway, that was just a digression.
Asset allocation for RESPs. It's another thing where it's surprisingly complicated for what should be a relatively simple account. We've talked about how the money's got to come out of the RESP for it to be tax efficient in a pretty specific time frame while the student is enrolled in qualifying post-secondary education.
I think one of the things that leads to people doing is thinking about their account's asset allocation as being tied very closely to when their child is going to go to school. And I think that can make sense if the funds in the RESP are going to be completely used to fund education costs. If you need the money in the account, and it will be spent and given to an educational institution when the child is enrolled, then sure. It should follow some kind of glide path. Because you're really matching liabilities with that account. No one liabilities.
Dan Bortolotti: I mean, that should be the assumption for most people, I think. We're going to talk a little bit about this. If you happen to be quite well off and are well able to fund your kids' post-secondary education and are just using the RESP as a tax shelter, then you're right. But I think it's fair to say that that's not necessarily the majority of people. And for most people who are opening a RESP for the reason that it was presumably intended, I think you should probably go into it with the thought that there should be some kind of glide path where the asset allocation gets more conservative as you approach high school graduation.
Ben Felix: Yeah. I think that makes sense in general. I just think that it's not the only way to think about it. And in our sample where, PWL, we tend to deal with fairly affluent families, the second case where they maybe have other wealth or income to fund education costs, then the asset allocation doesn't necessarily need to be directly tied to the education costs. But I agree that, in a general case for the average person, yeah, it still makes sense.
Justin Bender at PWL has a great post on this where he just shows walking through that glide path where RESP starts out at 90% equity and then decreases into, incrementally shifting into bonds and eventually shifting into cash the years before the student is enrolled. And so, I think that makes a lot of sense. But then as I mentioned with Aaron's example. In that case, some of the money was going into the TFSA and the FHSA which, depending on what the money is going to be used for, could continue to be in long-term investments. I think that could change the asset allocation target for the RESP account. Because, again, it's not actually being spent and withdrawn. A little bit more volatility wouldn't be as big of a deal. Yeah. That's all my thoughts on RESP asset allocation.
Mark McGrath: In a standard case, would you actually get more conservative year-by-year? I haven't read Justin post in quite a while. But does he go year-by-year? In my mind, I would probably go without looking at it 100% equity up until they're 14 or 15 a few years before I started a glide path. You wouldn't start a glide path from age five and start getting more conservative at that point.
Ben Felix: In Justin's example, that is what he shows. But that's not the only way to do it. I think just, conceptually, you're wanting to get more conservative over time.
Dan Bortolotti: I personally would go more conservative earlier than that, Mark. Our nature, I think. But I don't think it needs to be done on a year-by-year basis. You're 30% stocks this year and 25 the next year. And I think that's overdoing it. But it's funny. Because when we talk to clients about this, I tend to not recommend the 100% stock allocation even early on. Or if it is, it's only for the first six or seven years. I wouldn't go all the way to 14 just because – especially if they're not front-loading it, if they're going to put in that $50,000 when the child's born, maybe. But if you're just adding $2,500 a year plus the grant, your investment returns are not really driving very much at that point because the dollar amounts are so small. It's your contributions and the grants that are really the most important factors. And so, if you just use a balance portfolio is probably the least volatile way to do it. But, again, that's just a stylistic thing. I wouldn't argue that that's the only way to do it.
Mark McGrath: Interesting. We talk to clients about risk tolerance. And we use a risk tolerance tool that, Ben, you and your research team built. But RESPs have always not confused me but been an interesting conversation with clients. Because it's like whose risk tolerance matters the most for the RESP? And, obviously, it's the parents. But their timeline is constrained. And at the end of the day, if this really is going to fund the child's education, even though you're the owner of the account and the child's too young to have a risk tolerance per se. But the risk tolerance conversation, which usually is the constraint on how aggressive you can be with a portfolio, becomes really fascinating in those cases.
Dan Bortolotti: Yeah. The time horizon there is more important than the client's temperament.
Mark McGrath: I'm triple-leveraged NASDAQ in my RESP issue. Start my glide path early. TQQQ. Although, I did find – this a total digression. But there's a 5x leveraged NASDAQ ETP. I don't know if it trades in Europe or something. I couldn't find it in Canada. But this thing exists. It's a 5x NASDAQ.
Dan Bortolotti: That's a good RESP vehicle, I would say.
Mark McGrath: There you go. RESP.
Dan Bortolotti: Are you going to allow me to climb on my soapbox for a minute here?
Ben Felix: Let's do it then.
Dan Bortolotti: Yeah. Okay. This was actually one of the geneses of this discussion that we had was I have a number of issues I think with RESPs. And there's no question they have a lot of benefits. We've just cataloged them. If you're a parent who can afford to contribute to them, you absolutely should. I did for my kids. I don't regret it at all. The problems I have are just a little bit more about the structure of them and some of the government incentives. I just want to make a few constructive criticisms and hopefully somebody out there is listening.
Let's start with the first one that I hope the objective of the RESP program was to assist families who would otherwise have been unable to afford tuition. And, therefore, increase the number of low-income families who are able to send their kids to school. If that is in fact the objective of the program, it's mostly failed. And the research seems pretty clear. There's been a number of reports on this. RESPs are predominantly used by well-off families. Most of whom would have probably been able to send their kids to school and assist them financially without the government's help.
There are some obvious reasons for that. Obviously, well-off families have more funds available for RESP contributions. But it's not just that. Another reason is that lower-income families may have less financial literacy. And they may just simply be unaware of RESPs. They might face barriers to opening the plans. They might be less comfortable dealing with investment firms or banks. And, therefore, those programs may not be getting to the people who need them the most.
One encouraging thing I was noticing that Ontario has now tried to address this issue by asking parents specifically if they would like to be referred to a RESP provider as part of their newborn registration service. This is when you have a baby, you apply for the birth certificate and the social insurance number. And at that time, they will offer – if you want. Without any sales pressure. Because they don't have any vested interest.
They will introduce you to a RESP promoter. Either one that you choose, so you can go to them and say, “Hey, I would like to open a RESP with such and such an institution.” The government will then reach out to that financial institution and then invite them to contact you directly. This is how they put it on their website. It says, “You can consent to be contacted by a RESP promoter of your choice to learn about and to start to open a RESP if you decide to and to request the Canada Learning Bond and/or the Canada Education Savings Grant for your child. The service is quick and easy and puts the RESP promoter that you choose in direct contact with you to assist you to start saving early in a RESP for your child's education after high school.”
I think that's a pretty useful nudge. I don't know how successful it's been, but I like the idea, and I would encourage other provinces to consider the same sort of thing. But I want to look at another issue with RESP accessibility. Ben, this is one that you touched on in your introduction, and that is that RESP providers are sometimes what are called group RESPs or pooled RESPs. These include a few different companies; Children Education Funds, Canadian Scholarship Trusts, Heritage Education Funds. There are a few others.
Now, if there is a benefit of one of these plans is that they don't require you to work with an intimidating financial advisor like Mark or someone here at PWL, and you don't need to have any investment knowhow. You just need to sign up. You subscribe basically. You make monthly contributions. You get all the bonds and grants that you're eligible for. They do all of that administration for you, and they administer the funds. In theory, that's a benefit.
The problem is these plans have really been widely criticized for being aggressively marketed to new parents. Ben, you mentioned in – I've heard these stories for years, of course, of them going into hospital maternity wards and pressuring new parents to sign up. But even more problematic, I think, is the way they're structured because these pooled plans are designed so if you subscribe and then you decide for whatever reason to cancel, the penalties are very high. A lot of your money ends up staying in the plan, and it subsidizes people who don't drop out. Not surprisingly, the people who are most likely to drop out after subscribing tend to be low-income families, simply because they can't afford to continue the contributions that they had committed to.
Here's a paragraph from a report about this problem. It says, “Redistribution of earnings on contributions from subscribers who exit the plans early to those who stay to maturity is integral to the design of group plan RESPs. There are concerns that low-income subscribers may be more likely to exit these plans prior to maturity or prior to their beneficiaries accessing the full complement of payments.” This is a pretty heartbreaking report, I think, because it's like a survival of the fittest approach to education. I mean, this hardly advances the goal of fairer access to education when it has presumably lower-income families contributing dropping out, not benefiting from it, and then their money going to higher-income families who keep subscribing right to maturity. This is a problem for me. I don't like the way that those plans are structured for that reason.
All right, so then the next problem with RESPs I want to address is the inadequacy of the incentives for low-income families who participate because there are some promising plans. We've talked about the Canada Learning Bond, for example. Again, just a reminder, if you're a qualifying low-income family, you can get up to $2,000 without making any contributions yourself. You get $500 just for opening the RESP, and you get another $100 annually until the child is 15. If you continue to qualify, the government even chips in 25 bucks to help cover the cost of opening the account. It’s lovely.
We can all agree $2,000, which, by the way, has not increased since 2004, is not even enough to pay for a single semester of an undergraduate program. I'm not really sure that this meaningly improves the prospects for post-secondary education for any child in a low-income family. They might open the RESP. They might get a couple of thousand dollars, but that's not likely to make an otherwise unobtainable goal any closer to reality.
More than that, too, there's a significant obstacle in that receiving the Canada Learning Bond requires you to actually open an RESP. That might sound simple for our listeners, but families with lower financial literacy are going to have more difficulty with this step. It's not necessarily as straightforward as those who are more financially savvy might think. There have been critics of the CLB program who have suggested that low-income families would be better served if financial assistance for education wasn't tied specifically to the RESP program. There's different ways you could do it. The federal government could deposit the entitlement into some kind of notional account. This could be administered alongside the Canada Child Benefit, which is another income-tested benefit. There are alternatives.
Mark, I did want to say, when we were prepping for the show, you had pointed out that in the current federal budget, there was a proposal for something that might help.
Mark McGrath: Yes. This was budget 2024. Starting in 2028, 2029, the proposal that all eligible children born in 2024 or later would have a RESP plan automatically opened for them. If they were eligible for the Canada Learning Bond payments, that would be automatically deposited into their accounts. I believe it's done or proposed in such a way that if the child attains the age of four and they don't yet have a RESP, then they will automatically open one for them. It does step in the right direction, for sure. At least it's going to get some of that Canada Learning Bond money that people would otherwise qualify for that they don't know about or they don't have the financial literacy to go and open an account themselves. That will partially solve it.
I mean, there's four years there where they're not going to be getting it and then those cases. I don't know what institution is going to end up administering all of these. I don't know how that money is going to get invested if at all. I believe just it'll probably end up sitting in cash or in a savings account of some kind. But at least they are thinking about the concerns that you've raised to some degree, Dan.
Dan Bortolotti: Yes. I mean, these are at least good ideas. We'll see what the execution is actually like. Anyway, so that's the Canada Learning Bond. We've also mentioned that the CESG grants or the standard grants, the matching grants on your contribution, will get topped up for low-income families who have RESPs. But I see this benefit as pretty problematic as well. I mean, so here's how it works. When you contribute $2,500 to an RESP, you typically get a grant of 20%, $500. However, lower income families also get what's called additional CESG. Instead of the usual grant of $500, they would get $600.
Again, that's nice, but here's the problem. To qualify for that full top up, your net family income can't be more than $55,867 in 2024. That number changes with inflation. If your family income is greater than that but not more than $111,733, you still get some additional CESG, but it's only 10%. On that $2,500 contribution, your grant would be $550 instead of $500. If it's over that $111,733, you get no additional grants. It’s also important. As Ben pointed out, these additional grants, yes, they can be obtained with smaller contributions if you qualify. But lower income families are not able to collect any more grant money over the life of the RESP. The maximum lifetime grant any child can receive is still $7,200, including the standard amount and the additional CESG. That’s important. You're not getting any additional money. You're just getting it with lower contributions.
Mark McGrath: These are tens of dollars that we're talking about. To your point, a family with an income of, say, $55,000 or even under $111,000, they might not be maxing out in RESP. If they're getting a 10 or 20 percent bonus on a $1,000 or $1,500 contribution up and above the grant that they would already get, we're talking like $30 a year in some cases. It's really meaningless at the end of the day.
Dan Bortolotti: Pretty trivial amounts. Even with the trivial benefit, I mean, let's look at these very low-income thresholds. Households earning less than $55,000 a year cannot be expected to direct any meaningful amount of savings into an RESP. It's very unlikely that they're going to be contributing that $2,500 and collecting the whole additional $100 in grants. Most people in Canada, most families are going to have a pretty hard time just paying the rent and putting food on the table at that point. So you have to be really low-income in order to benefit from these. If you are, you probably don't have $2,500 to put into an RESP.
I mean, at the risk of getting hate mail from seniors, I'm going to put my neck out here and say the government is removing this very modest benefit from families with a combined income of less than $56,000. But it continues to pay Old Age Security benefits to seniors until their individual incomes, not household incomes, exceed $148,000 in 2024. I'm just putting it out there that maybe RESP grants could be calculated on the basis of income and reduced or even eliminated for families who don't need them but with thresholds that are more in line with those used to claw back Old Age Security.
I don't know. I don't have the answers here, but I'm suggesting that maybe if you earn $200,000 a year, you don't get any RESP grant. But if you earn $50,000 a year, you get a very generous RESP grant. So then the grant money is going to the families who really need it and not just acting as an additional tax-sheltered account for families who don't really need it.
Mark McGrath: Interesting. Your number there on the Old Age Security, 148,000, that's the point at which the last dollar of OAS gets clawed back.
Dan Bortolotti: Exactly. At that point, you're still getting some OAS. You're not getting the full amount but yes.
Mark McGrath: Does that number presume you took it at age 65?
Dan Bortolotti: Yes. I don't think it matters the age you took it. It matters the age you are. If you're over 75, that threshold goes up because your Old Age Security is 10% higher.
Mark McGrath: Yes. I'm just thinking if you defer it, and this is also something that Aaron Hector pointed out to me once upon a time, but if you defer it because your OAS is higher, you can actually have more taxable income before the entire amount gets clawed back because it gets clawed back at 15 cents per dollar. The higher your OAS, the higher the income you can actually have before it all gets clawed back.
My point is that if you were to defer OAS, that ceiling is not necessarily 148,000. It could be 160,000; 170,000. You got a couple that's 340,000; 350,000 dollars of household income, and you might still get a penny of Old Age Security. To your point, Dan, people with $55,000 of household income are losing these tens of dollars of benefit on their RESP. I mean, come on.
Dan Bortolotti: It's just a yawning gap, I think, between those two thresholds and something that just really jumps out to me if you want to get money in the hands of families who need it. Let’s face it. RESPs funding education is an investment in the future. It's not just a handout. It's something that benefits everybody to have a more educated populace and workforce. Look, I've spent a lot of time ripping on RESPs and their flaws. I want to end with some more positive observations because, as I said, I love the idea of them. Just because they have some structural limitations, it doesn't mean they're accounts that people should avoid.
Let's start with the first one. If you are able to take advantage and you contribute that $2,500 annually, and lots of middle-income families can do that and do that on a regular basis, and you max all the government grants, that RESP really does become a pretty significant asset. Even with modest investment returns, it's quite realistic. We see it all the time for parents to save 75,000; 80,000 dollars or even more by the time their child starts university. That is likely to cover most of an undergrad degree, I think, depending on what course you take, of course, or whether you live at home or what your needs are for room and board. But that is certainly a very good start. I have worked with many parents who are really pleased to achieve that goal for their kids.
The first time you have a child graduate high school and they look at that RESP and they say, “Do you think that's going to cover their education?” I'm able to say, “Yes. If not all of it, certainly the bulk of it.” They're very proud of that financial goal, and they should be. They're definitely a boon for people who have the means and the savvy to use them to their full potential. We did for both of our kids. They were a huge help in paying for their education. I think big picture, they're very useful accounts.
I want to say, too, I think it's important, even though I've been complaining about how the RESP program has not really improved over the last 20 years or so. This contribution limit is basically the same as it was. That lifetime maximum grant has been $7,200 it seems like forever. There's been no indexation on any of these limits. But I think it's worth noting that one of the reasons for that and one of the reasons that the government has clearly stopped improving the RESP program is because governments have introduced other policies that have improved access to education; tuition freezes, more generous financial assistance for low-income families. They are, in many ways, doing the right thing. As a result, Canada actually now leads all G7 countries with almost 60% of its workforce holding bachelor's degrees or higher. We are doing a lot of things right. Just not convinced that RESPs can take too much credit for that.
Mark McGrath: Yes, that's fair. I think the only thing that I can remember is, was it this budget or last year, they actually increased. We talked about the EAP limit in that first semester of being $8,000 for full-time school and $4,000 for part-time school. It actually used to be $5,000 for full-time and $2,500 for part-time. This isn't really a big deal, but they recently increased the amount that you could take out as a taxable withdrawal during the first 13 weeks. Not a big deal but it's some minor improvement to the withdrawal plan.
Dan Bortolotti: Actually, that $5,000 limit in the first 13 weeks was pretty limiting. I know that for a lot of times, we would have preferred to be able to take more. I think it seems clear to me that the primary reason that that limit's there is so people don't game the system by enrolling their child in a program, withdrawing all of the grants and growth, and then dropping out six months later. You could still gain the system, but it's just a little harder now with that cap.
Mark McGrath: Yes. Great. Very valid points and criticisms, Dan. In my experience, I've never seen a situation where a RESP ended up being a bad tool. In hindsight, I think people worry about some of the restrictions that we talked about that are mostly overblown and are concerned about withdrawal strategies and what if their kids don't go to school. I've not once in 15 years come across a scenario where with the client, we looked at the RESP when their kids were about to go to university and went or even of university age and went, “Oh, boy. This was a really, really bad idea in hindsight.” I'm just curious if either of you have come across bad experiences with clients and RESPs.
Dan Bortolotti: I had one that just happened to us last year. Again, this was not something that I think in hindsight we could look back and said, “Well, we shouldn't have done it.” But we did run into one of the limitations that we couldn't overcome. That was we opened the RESP for the family. They have two kids. We contributed the max every year. I think we even did the supercharge 14,000, and then the family moved out of Canada. Just for the record, you don't have to collapse in RESP if you move out of Canada. But if the child is not a resident of Canada, they cannot claim those benefits.
They said, “The chances of our kids going to post-secondary school while they're moving back to Canada and becoming a student there was remote,” so we just agreed we would have to collapse the RESP, and the usual things happened. We got the contributions back. We had to repay the grants to the government, fine. But then all the growth on the investment we could not withdraw. The reason was the plan had not been open for 10 years. You'll remember that one limitation we talked about. Because of that, we had to just make a donation to a post-secondary education. They were very grateful for the donation. No tax receipt was issued.
Worst-case scenario, they got back their contributions. They definitely lost a few years of investment growth. It was some opportunity cost. I mean, what do you do? When you ask a family, “Would you like to open a RESP do you think? Is there any chance that someday years from now you might move out of the country?”
Mark McGrath: Yes. Or your kids might move out of the country.
Dan Bortolotti: Hindsight, I don't think there's anything we did wrong. But just to let you know, there can be situations where you end up disappointed that you have to dissolve the plan.
Ben Felix: Very interesting. All right, I think that's it for RESPs. We go into the after-show.
Mark McGrath: Sure. Sounds good.
Ben Felix: I don't watch any content. Cameron always has content that he talks about. I don't know. Do you guys watch any shows or anything that were good?
Mark McGrath: Shows? No.
Ben Felix: You guys are like me.
Mark McGrath: Yes. Who's got time for shows?
Ben Felix: Cameron does. “Did you watch this?” I'm like, “No, I didn't watch that.”
Mark McGrath: Of course not. He doesn't have young kids anymore. That's why he's got all the time in the world.
Ben Felix: Yes, maybe. Okay, so no content. That's pretty funny.
Mark McGrath: No. I'm reading a Star Wars book.
Ben Felix: Oh, okay. Nice.
Mark McGrath: Yes. Star Wars isn't actually based on a book. But in between two of the movies, I don't remember which ones now, but there was this lull where there was not a lot of Star Wars content coming out. I think Lucasfilms, their licensing company, said, “We need to put out some Star Wars stuff, but we're not going to put out a new movie.” They went and found a publisher to find an author to write books in the Star Wars universe. It’s cool because it has all the characters from the original movies. There’s just a totally different timeline and story for them. I can't remember what it's called; Heir to the Empire, Heir to the Throne, something like that. But, yes, I read fantasy novels at night before bed, and that's about all the content I consume these days that's not financially related.
Ben Felix: Well, there you go. That filled the content slot.
Mark McGrath: There you go. Somebody got to do it.
Ben Felix: We got a review here. It's related to Dan, which is nice. It says, “Thank you, Dan. Wow, it's so refreshing to hear Dan Bortolotti’s voice again. The CCP podcast was one of the first pieces of content that got me into sensible financial advice, and hearing him again is like a warm comforting hug. Please don't let him leave.” Sorry, Dan. You're stuck.
Dan Bortolotti: Uh, oh. Well, I always like to be able to offer warm hugs, so.
Ben Felix: Super nice. That was the only review, though. We always appreciate reviews. We have 1,234 ratings on Apple Podcasts now, which is, I mean, pretty crazy. I used to think it'd be crazy if we got to 100 with an average rating of 4.9 stars. We've got 1,200 ratings on Spotify with an average five-star rating. If you're listening and have not yet left a review, we would love to hear from you. It's always nice to read those. It really is.
I also had someone reach out to me on Twitter. I sent this to you, Dan. They said, “Hi, Ben. Great work on the Rational Reminder Podcast. I just wanted to say that Dan is awesome. He really adds value to the podcast, well-spoken, mature, and sensible. Thank you.”
Dan Bortolotti: Thank you.
Ben Felix: Also, very nice.
Dan Bortolotti: I strive to be all of those things.
Ben Felix: You know, you are. Listening to some of your comments when we're doing the RESP episode, it's like it's a really sensible way to think about that.
Dan Bortolotti: It comes from, I think, being a background as a communicator as opposed to in the financial industry. I have a little different perspective to a lot of these things, I think. Sometimes, it's helpful. Sometimes, it resonates with listeners, readers, clients.
Ben Felix: Yes. More than sometimes I would estimate. But, yes, I agree.
Mark McGrath: Yes. It's great. Lots of positive comments for Dan. Hey. Nice.
Ben Felix: You got a bunch of positive comments when you started, too, Mark.
Mark McGrath: But no longer. All good.
Dan Bortolotti: These will dissipate very quickly I'm sure.
Mark McGrath: It's great to have you, Dan. I think it adds a lot to the conversation, for sure.
Dan Bortolotti: Thank you. It's definitely nice to be back in it, for sure.
Ben Felix: Yes. I know it's good. Okay. I did want to comment on this discussion in the Rational Reminder Community that unfolded over the last couple of weeks on expected returns. What is an expected return? What determines expected returns? Do value stocks have higher expected returns? That was a big part of the discussion. It’s in the Sunil Wahal episode, if people want to check it out. When I last checked, it was up to 313 posts, but that was a while ago. It's probably more now.
I'm not going to go over the whole discussion because some of it's like, man, just a lot of text, walls and walls of text. Maybe think of that meme. I don't know if you guys ever see that meme that's like a screenshot of someone texting and it says, “I ain't reading all that. I'm happy for you, though, or sorry that happened.”
Mark McGrath: Yes. Top five meme.
Ben Felix: That's how I felt trying to keep up with this thread. It was just like, “Man. On the weekend, too, people are writing these essays. Wow, I'm impressed.” I don't mean to be disrespectful of the efforts people put into that conversation, but it's just like, “Man, it's a lot of text.”
Anyway, a lot of the discussion was around how cash flow growth affects expected returns. Instead of trying to recount the whole discussion or even give my views on what people were saying because there's just so much going on in there, what I did is took one post from one community member who I think is generally very, very sensible and well-informed. I'm just going to take some of the points that he made. We linked to an AQR presentation on this topic that shows the price of a stock equals its expected cash flows discounted back to today's dollars at a discount rate that is equal to the expected return. I mean, that's it. That's fundamental asset pricing theory, discounted future cash flows.
Then he makes the comment that if two companies, A and B, have the same expected cash flows and company a has a lower price than company B, then company A, definitionally, mathematically, it's an equality, has a higher expected return, higher discount rate. That must be true, just the way that the math works. Now, that's true, whether expected cash flow growth is zero for company A and B or if it's 10% for both companies. Cash flow growth does not affect that.
Then he also makes a comment that when cash flow growth gets included in the equation, the stock's price mathematically can be simplified down to expected return equals expected cash flows over price, plus expected growth. That's like the Gordon growth model for stock valuation that people may have heard of. This poster was saying that's where some of the confusion comes in because now we have growth as one of the terms in the equation. How does that affect expected returns?
Using that same example, if two companies, A and B, have the same expected cash flow, and maybe we can put the equation in the video, so people can see what I'm talking about because it's probably hard to think about. If two companies, A and B, have the same expected cash flows, so the same initial cash flow and the same expected cash flow growth into the future, and company A has a lower price than company B, then company A, again, must have a higher expected return, a higher discount rate. That's true, regardless of the growth assumption. It's the same in both cases. He's basically saying, mathematically, it must be true that cash flow growth doesn't somehow magically change expected returns.
One of the challenges, though, I think, is that in those equations, we're assuming that cash flows and cash flow growth are no in quantities. But in reality, it's really hard to disentangle cash flow expectations and discount rates and expected returns when we're looking at stock prices. For example, does Nvidia have a high relative price because of insanely high cash flow expectations? It still has a high discount rate, which is possible, and therefore still a high expected return. Or does it have reasonable cash flow expectations and a really low discount rate, meaning a low expected return? It's really hard to say what's going on there.
But then you have papers like Fama and French’s ‘The Anatomy of Value and Growth Stock Returns’. It's an older paper, so there's always that this time is different argument. But they break down the average returns of value and growth stocks into dividends and then three sources of capital gain. It's like where are the returns actually coming from for these different types of stocks. The three sources of capital gain are growth in book equity from earnings retention, convergence in price-to-book ratios, which is mean reversion, coming from mean reversion in profitability and expected returns. Then the third source of capital gains is upward drift in the price-to-book ratio during the period in their sample.
They find that the capital gains of value stocks trace mostly to convergence. That's price to book rises as some value companies become more profitable, and their stocks move to lower expected return groups. They become growth stocks, for example. Growth in the book value of equity is not meaningful for value portfolios but is a large positive factor in the capital gains for growth stocks. Then for growth stocks, convergence is negative. Valuation ratios fall because growth companies do not always remain highly profitable with low discount rates.
They also showed that in the year after stocks are allocated to value portfolios, growth in book equity is on average minor for large-cap stocks and negative for small-cap value stocks. It’s basically saying that value stocks don't do a lot of equity-financed investment. A large average capital gains of value stocks show up as increases in the price-to-book ratio. Then in contrast, companies invest heavily after they're allocated to growth portfolios. On average, the growth rate of book equity actually exceeds the growth rate of the stock price. That means that price to book declines after stocks move to the growth category, and the positive average rates of capital gain of growth portfolios trace back to increases in book equity that more than offset that declines in price to book.
As I'm reading this, I'm realizing it's probably way too nerdy. We did an episode in this a while ago. Basically, there's this convergence that we see in valuations for growth stocks. Once a stock becomes a growth stock, there tends to be convergence back down to a lower valuation at some point. That has a big impact on the returns of growth stocks, and then it's the opposite for value stocks. Once a stock becomes really cheap, it tends to do a little bit better at some point in the future. That's one of the reasons that we see historically that there's been a value premium.
Yes, as it relates to expected returns, you look at that. You look at what has happened in the past. You see a stock with a high price and ask that question. Does it have a high expected return and really high cash flow expectations? Or does it have a low expected return and reasonable cash flow expectations? It's still really hard to disentangle that, but I think it is interesting to look at that anatomy of what actually tends to happen with gross tocks, which suggests that they probably don't have high expected returns, unless this time is different, unless companies are different now and whatever, whatever. That argument is always there, and we can't know, obviously, if this time is different. Anyway, that's it. Expected returns or discount rates, the end.
Mark McGrath: Yes. But what does this mean for my 5x leverage Nasdaq position? That's all I really care about. I didn't hear anything you just said. Just tell me what to do with it.
Ben Felix: It probably has a low expected return. This was the point of discussion. This was the point of contention in this community discussion is do high-price stocks have low expected returns. The argument is that, well, today's companies, they've got such incredible cash flow expectations because it's a winner-take-all environment and so on and so forth. Therefore, we can have high-price stocks that still have high expected returns. Is that true? I mean, if you look at the past, that has not been true. Companies with high prices –
Mark McGrath: Like the long past. But I guess over the 10 years or so, the most recent 10 years, it feels like it.
Ben Felix: Over the last 10 years, valuations have just gone up.
Mark McGrath: Yes. So maybe it is different. All right, I'm sticking with my Nasdaq position. Thanks, Ben. Thanks for talking me through that. Yes, perfect. We're sorry that happened to you.
Ben Felix: Oh, yes. I felt like I had to say something about that discussion because it became such a thing in the Rational Reminder Community.
Mark McGrath: Cool.
Ben Felix: Yes. That's it. We did talk about ‘The Anatomy of Value and Growth Stock Returns’ and another related Fama and French paper called ‘Migration’. Both of them just look at why has there historically been a value premium. Why have growth stocks underperformed and value stocks underperformed relatively speaking? When you dig into the actual components of what drove that. That's episode 140. We talked about that, but I still don't know the answer. Do value stocks have higher expected returns than growth stocks? Or do the differences in valuations predict differences in expected returns when we don't know what cash flows are? It's a pretty interesting question.
Dan Bortolotti: But there is no answer.
Ben Felix: No, there's no answer. All right, that's it. As always, let us know what you thought of the episode. It’s, again, a bit of a different thing where we covered a relatively Canadian topic and talked through some different kinds of stuff like Dan's soapbox segment. That's a new thing. I don't do much soapboxing.
Dan Bortolotti: Thanks for letting me get off the leash on that one. Sorry. It's been bubbling up for a long time, so.
Mark McGrath: We were talking after we recorded the last episode about maybe doing a series on the different types of accounts in Canada like RESPs and tax-free savings accounts and non-registered investment accounts, registered disability savings plans. Again, very, very Canadian content. I'm very curious to hear what listeners think about this episode because that will probably inform our decision on whether we do deep dives on the other account types as well.
Ben Felix: Yes, yes. Definitely appreciate the feedback. I got some other stuff cooking, too. I just wrote a video that we can talk about in the podcast, too, on what's related to actually what we were just talking about. Can you pick winning industries? Can you identify which industry is going to perform well in the future before the fact?
Mark McGrath: Can I? Because I bought marijuana stocks in 2017, so I personally cannot but –
Ben Felix: You're hilarious, man. You do all the stuff that the silly average investor does.
Mark McGrath: Most of my portfolio is totally hands-off. You got to scratch the itch a little bit. Got to have some fun.
Ben Felix: I don't have that itch but –
Mark McGrath: No, you don't. I know you don't. You're a cyborg. You wouldn't have that itch.
Ben Felix: I'm glad you do it, I guess.
Mark McGrath: I do it for all of us, Ben.
Dan Bortolotti: I want to get really crazy. I’ll buy a three-year GIC.
Mark McGrath: Oh, three years.
Ben Felix: Three years, Dan?
Dan Bortolotti: Three years.
Ben Felix: Oh, my goodness. That is nuts.
Dan Bortolotti: Yes.
Mark McGrath: Wow.
Dan Bortolotti: Leveraged, 5x. I'm not sharing that strategy with anybody, though. I'm keeping it to myself.
Mark McGrath: Yes. I hope you don't get margin called. You've got no liquidity on that, Dan.
Ben Felix: The price doesn't move. I think you're good, right?
Mark McGrath: That's true, yes.
Dan Bortolotti: No volatility. I got it figured out.
Mark McGrath: Oh, it's not a market link, too. I see. I hope but –
Dan Bortolotti: No.
Mark McGrath: Nice. Okay, anyways.
Ben Felix: All right, I think that's good for the episode. But, yes, I'm repeating myself. Definitely interested in feedback on the topic. We do have some more traditional topics that we can do in future episodes like picking winning industries one. I've got something cooking on gold, too. There's been some interesting research that's come out on gold since the last time we covered that topic. Working on that. Working on a few other things, too. All right.
Dan Bortolotti: All right. Thanks, everyone.
Ben Felix: Anything else for you guys?
Mark McGrath: No, that’s it. Thanks.
Ben Felix: Awesome.
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