Class is now in session for parents who have set up registered education savings plans for their kids.
Good move, that. RESPs are a must-have savings vehicle for parents because they're tax-sheltered and they qualify for a federal government grant of up to $500 per child a year, with a lifetime maximum of $7,200. But it's not enough to simply start a plan and contribute money every year.
Parents must also learn to manage their RESP investments over the years, just as they'll have to adjust their registered retirement savings plans (RRSPs) later on in life. The guiding principle for both RESPs and RRSPs: At some point you will have to switch from trying to build up your savings to protecting what you've already earned.
You may already understand this if you have an RESP that was hit hard by the recent stock market plunge. Properly run, the RESP of a child approaching college or university in the next year or two should have had only minimal exposure to the stock market.
Early on with an RESP, you can go in one of two directions. The first is to invest aggressively to take advantage of the fact that you'll likely have as many as 18 to 20 years until your child will start drawing from the plan to pay for postsecondary schooling.
"For a young child, you can afford to have more of an aggressive asset mix," said Charley Tsai, vice-president of wealth planning support at TD Waterhouse. "We think as much as 90 to 100 per cent equities."
David Shymko, an investment counsellor in Vancouver with Macdonald, Shymko & Co., also said he believes that parents can afford to invest aggressively in the early years of an RESP. However, he has found that parents of young children often struggle to find the money for RESP contributions and are thus very protective of the money they contribute to RESPs.
"They're squeaking out this money and, by God, they want to be confident it will be there," he said.
A more conservative approach is suggested by Norman Raschkowan, chief investment officer at Mackenzie Financial. His reasoning starts with the fact that RESPs can be kept open for a maximum of 35 years. In that light, someone setting up an RESP is like a 55 year old with an RRSP who for planning purposes expects to live until age 90, or an additional 35 years.
The RRSP investor would keep a large portion of his or her portfolio in bonds as opposed to stocks, and Mr. Raschkowan thinks parents setting up RESPs should do likewise.
"If you're starting off with an RESP, then you'd be looking at something like 45 per cent as a minimum equity exposure, and I probably would not go much beyond 65 per cent," he said.
Mr. Raschkowan suggests that you ratchet down the stock market exposure in the plan every three years so that you end up with no more than 25 per cent of the mix in equities when a student begins university, and the rest in bonds and GICs.
Retirees typically keep a minority portion of their savings in the stock market, but TD's Mr. Tsai isn't enthusiastic about this idea for RESPs of students attending college or university. "Personally, I would be very conservative with this investment, and the conservative view on this would be no equities."
There are actually two types of RESPs, one set up for a single child and also a family plan that can have multiple beneficiaries. Mr. Shymko said it can make sense to keep stock market exposure in a family plan where there will be a lag of several years before one sibling follows another to college or university.
His suggested mix of investments for a plan with one beneficiary in school and others to follow is one-third in the stock markets, one-third in fixed income and one-third in cash, which could be money market funds, Treasury bills or high-interest savings accounts that can be held in investment accounts.
With individual RESPs, Mr. Tsai suggested having enough cash on hand to cover one or two years of school and putting the rest in GICs.
For example, the RESP for someone in a four-year program could have enough cash on hand to cover the first two years' worth of expenses, with the rest evenly divided between a three-year and a four-year GIC. Alternatively, you could simply set up a ladder of GICs with terms of one through four years.
Note: The most you can withdraw from an RESP in the first 13 weeks a student is enrolled in a postsecondary program is $5,000 of the income generated by the plan's investments and federal grant money. These funds are referred to as an "educational assistance payment" or "EAP" when withdrawn, and they're considered distinct from the contributions made to the plan.
It's possible to withdraw extra funds from an RESP when a student starts school by dipping into the principal (remember, that's distinct from the grant money and investment income).
But Mr. Shymko said he has found that students sometimes drop out early on in their first year, or their circumstances change. This argues against making a large upfront withdrawals from RESPs.
With self-directed plans held through an investment adviser or an online brokerage firm, you can use pretty much any type of security for an RESP, including stocks, exchange-traded funds and mutual funds. For stock market exposure, Mr. Shymko likes to use stocks and ETFs that pay dividends and other forms of income. He prefers GICs for fixed income, but he sometimes uses bonds because they can be bought and sold before maturity.
When buying fixed income for an RESP, Mr. Shymko suggests arranging for bonds or GICs to mature in July so as to have cash ready and waiting to pay tuition and other costs that will mount up in the lead-up to September.
Rob Carrick