Dear Nancy Woods,
We recently had our first and possibly only grandchild born. I want to start an RESP for her. My question for you is, does it make more sense to contribute a lump sum and forgo the government grant (CESG) or do I make annual contributions and take the governments free $500? Signed Bill
I did some calculations with regards to your question and found interesting results. I compared making a lump sum contribution to an RESP that foregoes most of the CESG versus making a lump-sum contribution at the beginning, investing the difference in a non-registered account and transferring just enough to the RESP each year to maximize the CESG payment.
The lifetime maximum amount you can contribute for a child into an RESP is $50,000. Assuming a rate of return of 5 per cent for 17 years, and that the child starts a post secondary school education at age 18, if you contributed the full $50,000 to the RESP upfront, that amount would have grown to over $121,000 by the year your grandchild starts his or her post secondary education.
Whereas, if you make a lump sum contribution of $16,500 the first year and $2,500 the following 14 years, you would end up contributing the same $50,000. Contributing the largest amount upfront while still maximizing the CESG received, provides for a greater opportunity for tax deferral by having the funds grow tax-free in the RESP for 17 years. Again assuming a 5 per cent rate of return, the total education fund (the RESP plus your non-registered account) balance would grow to around $119,000.
In contrast, if you do not currently have $50,000 to contribute to an RESP, and instead can only contribute $2,500 annually to receive maximum CESG of $7,200, the RESP alone would be worth approximately $86,000. Since the CESG lifetime maximum is $7,200 it would take 15 years of contributions to reach it. Please note that this option only contributes $42,500 to the RESP.
As you can see there is a slight benefit resulting from the power of tax-free compounding even though you are sacrificing the CESG. However, this result differs with the rate of return assumption. The lower the rate of return, the more beneficial it is to make periodic contributions.
So my short answer is, if you have the cash and are not too conservative in your risk assumptions, it is better if you can to make a lump sum contribution to a newborn's RESP and forgo getting the CESG from the government.
Please note that it would be rare that new parents would be able to fund their child's RESP with $50,000 as an initial and final contribution, but it would be an excellent way for a grandparent to pass on an inheritance to a second generation.
Nancy Woods, CIM, FCSI, is an associate portfolio manager and investment adviser with RBC Dominion Securities Inc. To ask her a question, send an e-mail to email@example.com or visit her web site at nancywoods.com