Every year, the return to school season provides a reminder that the education of children involves a substantial expense on parents. This is all the more true when contemplating the cost of postsecondary education, where the outlay for each term may be several thousands of dollars. Fortunately, the registered education savings plan (RESP) provides a tax-sheltered environment to save for this goal, and also offers substantial grants. 

What people don’t always realize, though, is that this tool is based on a principle that is just as vital as those grants: compound returns over time. In fact, the RESP offers an ideal opportunity to rediscover the importance of compounding and also to explain it to your kids as a way of introducing them to the basics of investing. 

The RESP in brief 

The RESP is a savings plan that allows you to contribute up to $50,000 over the plan lifetime to save for your children’s postsecondary education.  

An RESP offers two big advantages. First, it makes you eligible for the Canada Education Savings Grant (CESG), which can amount to at least 20% of your annual contribution, to a maximum of $500 a year or $7,200 over the plan lifetime. Second, it provides a tax-free environment for your savings to grow over many years, right up until they are withdrawn. Other grants are also available depending on your situation and your province of residence. Quebec, for example, has the Quebec Education Savings Incentive (QESI), amounting to 10% of your annual contribution up to a plan lifetime maximum of $3,600.

Maximize the grants… 

The following graph illustrates a strategy where you would be seeking to maximize the CESGs that you would receive: with an annual contribution of $2,500, you would receive a $500 CESG every year (or $600 a year for families with household income below a certain threshold) until you reached the lifetime limit of $7,200. After 18 years, including your contributions plus the grants, and assuming an average annual return of 5%, you would end up with a little over $90,000 at your disposal. Other grants are also available depending on your situation and your province of residence. Quebec, for example, has the Quebec Education Savings Incentive (QESI), amounting to 10% of your annual contribution up to a plan lifetime maximum of $3,600. 

… or maximize the returns? 

But now let’s look at another scenario. Suppose you already have $50,000 and you invest the whole thing in an RESP right at the start. In this case, you would receive a $500 grant in the first year only, since you wouldn’t be making any contributions in subsequent years. However, after 18 years, if we use the same 5% return assumption, you would have thousands of dollars more than in the first scenario. 

How is this possible? Compounding. 

The RESP: a teaching tool 

Essentially, compound returns are returns that accumulate, year after year, on top of the returns of previous years. So your investment tends to grow not in a linear way, but exponentially.  In this case, the compound returns obtained over the years on a much larger initial amount compensate for the lack of annual grants. 

Of course, not many parents have $50,000 available to invest all at once in an RESP. But regardless of the amount invested, compound returns remain the very cornerstone of any long-term wealth accumulation strategy, such as the one that can be used in an RESP. And that’s why it could be a good idea, when the time comes to talk to your children about their RESP, to introduce them to this fundamental concept of finance. That way, they can understand how important it is to start saving early, and to be disciplined about it, because they will see the effect for themselves once they begin their postsecondary education. 

When to talk to your kids 

It’s generally recommended that children be introduced to money matters gradually, in accordance with their age and developing interests. 

For example, before the age of five, it’s not very likely that they will understand the value of money. But the closer they get to adolescence and eventually adulthood, the more they will be able to understand complex concepts such as the value of things, borrowing, interest, returns and investing. As soon as they are able to understand these types of concepts, you could let them know about their RESP, what it’s for – and the important lesson they can draw from it.  

And to decide on the best way to optimize both your grants and your returns in an RESP, talk to your advisor!