Baby bucks

Andy Seliverstoff photo

Swimming in hormones, Jimmy opened the door to a knock. On the stoop was a trustworthy-looking guy with a briefcase. Twenty minutes later Jim and his wife owned not only a brand new baby, but an RESP. The wrong kind.

The baby vultures sometimes hang around maternity wards. They read the birth notices. They follow social media. They’ve even been known to spirit lists of new moms from hospitals. Their job is to mine the same overwhelming new-parent obligation that makes people load up on foolish amounts of life insurance when they give birth. They sell RESPs not as open-ended and flexible investment accounts, but rather as locked-in programs with fat initial payments, high fees and dubious outcomes.

So Jimmy fell for it. Don’t you.

A registered educational savings account is a good thing. It can provide a guaranteed 20% annual return. The government gives you money. Gains are tax-free. And after two decades it can finance junior’s tortuously-expensive journey through dental college. Got kids? Then you need an RESP.

Grace does, plus questions:

“In a recent blog post, you mentioned a family that had two kids and a family RESP, and that it was best to have that kind. Could you explain why? My husband and I have three kids and as they were born, we set them each up with an investment account RESP with ETFs and stocks.

“Also, I had until recently thought I would fund each to the maximum contribution amount, but am now thinking to only fund each up to the point of receiving the maximum $7,200 grant. That is, continue to contribute $2,500 per kid per year until they each max out their grant amount, then just oversee their accounts and keep reinvesting the dividends they receive in cash. I’d rather direct money to TFSAs and non-registered accounts to have flexibility in having/using those as needed, rather than have RESP rules dictate how those funds are used. The RESPs seem to be on the right track. 8 year old has $43k, 6 year old $30k and the baby (just started her account!) $3k+.”

Good points, Gracie. Maybe it’s time for a small recap of why an RESP is a cool thing – so long, of course, as you avoid any ‘providers’ whose plans come with an initial fee, poor investments or exit restrictions. The best RESP is a self-directed one which you open with your bank, credit union or financial advisor, then stuff with the appropriate assets.

The basic idea is simple: this is a savings plan for kids. All gains made within it are untaxed. You contribute on behalf of the little beneficiary, and the government will chip in an annual grant. There’s a lifetime limit on your per-child investment ($50,000) and an RESP can exist for as long as 35 years before it must be collapsed.

The grant is called a CESG, equal to 20% of the first $2,500 contributed annually to a max of $500, as Grace mentions. The lifetime grant total is $7,200 up to age 18 and unused portions can be carried forward one year. Of course, if you put in $50,000 all at once, you’ll miss a portion of the grant money, but the larger amount of principal will enjoy more investment growth.

By the way, an RESP does not need to be for your own child (or adopted). Grandkids, nieces, nephews or family friends also qualify – but they must be Canadian residents (not citizens) and have a SIN. Low-income families can also apply for a government bond payment worth $100 a year to age 15.

How does money come out?

With proof that they’ve enrolled in a post-secondary school, kids can take RESP funds out for education, pretty much tax-free. Original contributions are not taxed, and the grants and growth are considered taxable income in the hands of the student. Since most children don’t have employment income, taxes are nil.

However if a kid raids an RESP to buy a Camaro, the grant money is repayable, up to 20% of the withdrawal. And if the beneficiary throws her life away by becoming a rockstar and earning a billion annually, you can fold the growth portion of the RESP into your own RRSP, or take it as taxable cash after paying a 20% penalty.

However (and to Grace’s question) with a family plan the money can largely be moved to another child, for him/her to spend on schooling. Family plans can have multiple beneficiaries, all connected to you by blood or adoption. They’re flexible, since a portion of the overall pot can be attributed to children in differing amounts, accounting for their ages (more to the older ones with less time for growth). Family plans also cut down on account fees, since all of your brood can be covered by one.

Naturally, all RESPs should have growth-oriented assets in them, since the time horizon is usually a decade or two and school costs keep rising. Don’t make the mistake of thinking your precious, special spawn needs safe widdle GICs. You’ll come to regret that decision. Be wary of bank mutual funds with their insidiously-high MERs. And make a point of kicking any baby vulture off your doorstep, no matter how addled your brain might be.

Yes, puppies are so much easier.

Beer & cigarettes

DOUG  By Guest Blogger Doug Rowat

Unfortunately, I have many difficult conversations with clients regarding their retirement plans. As you might expect, some clients want to live a retirement lifestyle far beyond their means or retire far sooner than their investments will allow.

We’re transparent regarding the long-term investment returns that clients should expect from us: roughly 6% annually in the form of a balanced and globally diversified ETF portfolio. Naturally, such returns cannot be guaranteed each and every year and, with the Government of Canada 10-year bond yield (the risk-free rate) below 2%, such returns mean accepting some capital market risk. However, this targeted rate of return is still a reasonable assumption for future financial planning. So, if a client is unable to meet their retirement goals under such investment growth expectations, one (at least) of three things has to happen. They’ll have to: 1) earn more (thus save more), 2) spend less (thus also save more) or 3) downgrade their retirement lifestyle expectations.

Steps can be taken to find a more desirable and better paying job, of course, but this rarely happens quickly and can cause a lot of personal upheaval, so we’ll set this option aside for now. And, at least initially, we’ll also be optimistic and try and preserve our clients’ retirement lifestyle expectations—this lifestyle is, after all, what they’ve been working their whole lives for. So, the most immediately actionable option is to start spending less.

The average Canadian household forks out $86,070 a year on expenses. Naturally, there’s not a lot of wiggle room for many of these costs (health care or public transportation, for instance), but some of this spend falls clearly into the discretionary category. The below table contains a select list of expenses (selected by me). I’ll highlight the difference it could make to your retirement savings if you’re able to make some sacrifices in each of these areas. The median age in Canada is about 40, so we’ll use this assumption for our calculations, along with an age-65 retirement date. We’ll also apply that 6% annual growth rate to the extra money saved each year.

Canadian yearly household spending

Source: Statistics Canada, Turner Investments, 2017 data

First, restaurants and clothing. Could you eat out less often? Go to less expensive restaurants? Substitute lunches out instead of dinners? Skip desserts and alcohol? Do you need that expensive coat, suit or handbag? Could you repair or alter clothing rather than buy new? Avoid impulse clothing purchases and wait for sales? If you could trim even $1,000 off this almost $6,000 combined total yearly expense, it would result in roughly $58,000 in additional retirement savings.

Second, private transportation and recreation equipment. Canadians spend only about $1,300 annually on public transportation versus more than $11,000 on private transportation, so this ratio remains significantly out of balance. Also, do you need brand new golf clubs? And, be honest with yourself, are you actually going to become a serious kayaker or paddle boarder? If you could trim $1,500 off private transportation and $200 off recreation equipment costs per year, it would result in roughly $99,000 in additional retirement savings.

Finally, smokes, booze and gambling. Needless to say, you should quit smoking, and buying a few less cases of beer each year wouldn’t hurt either. And the odds of winning the Lotto 6/49 main draw are one in 14 million. A total of five hundred bucks saved per year across these categories would translate to more than $29,000 in additional retirement savings.

If you implemented all of these cost reductions at once across all of these categories, you’d have more than $186,000 in additional retirement savings. That’s meaningful and could result in a more fulfilling or much earlier retirement. Also, for our free-spending millennial readers, it’s worth noting that if you implement these cutbacks at age 30, instead of 40, it results in almost $378,000 of additional retirement savings. Suddenly, your retirement becomes a whole lot sexier.

Obviously, I’m not the first person to highlight the importance of trimming expenses to build wealth. David Bach in his book The Automatic Millionaire, for instance, famously mentions the Latte Factor. If you spend, for example, five bucks a day on a Starbucks latte, you’re forgoing more than $105,000 in investment savings over 25 years. Still, I write this blog to highlight that reaching retirement goals isn’t the sole responsibility of your employer, the government or your financial advisor—it requires personal sacrifice on your part as well.

Here’s the Statcan link to the complete household spending list:

Go trim some more fat.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.