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investor clinic

Several readers sent in questions following last week’s column about registered education savings plans. Let’s get right to them.

I am considering starting an RESP for my two grandchildren. Can I open an RESP for both children together?

Yes, you can open an RESP for both grandchildren. This is called a family RESP, and the requirement is that the beneficiaries must be directly related to you (the RESP subscriber), by blood or adoption. This could include children, grandchildren, great-grandchildren or even siblings, but it excludes nieces, nephews, aunts, uncles and cousins.

One big advantage of a family plan is that the RESP’s investment earnings can be shared among the beneficiaries. Canada Education Savings Grants (CESG) can also be shared, but only up to a maximum of $7,200 a child. This flexibility will come in handy if, for example, one child’s educational expenses are higher than the other’s, or if one beneficiary decides not attend postsecondary school.

Where is the best place to open an RESP?

You can open an RESP with a bank, credit union, mutual fund company or brokerage firm. Going with your bank is probably the easiest option, and works well for most people. However, for the greatest flexibility, I recommend opening a self-directed RESP with a discount broker. This will allow you to purchase everything from low-risk guaranteed investment certificates to individual stocks and exchange-traded funds that offer the prospect of higher long-term returns. (More on this in a moment.)

I would steer clear of group RESPs, also known as “scholarship” plans, in which your money is pooled with contributions from others. As financial author Mike Holman warns in The RESP Book – a great resource if you’re just starting to learn about RESPs – group plans have “very high ongoing fees” and “restrictive rules that can result in getting less money out of the plan” if the child doesn’t go to a postsecondary school.

What should I invest in?

Assuming you open an RESP in the year the child is born, you’re looking at about 18 years before he or she starts postsecondary school. That’s a long time for investments inside the RESP to grow and generate income. For that reason, I believe it’s prudent to tilt the asset mix toward equities in the early years. If you’re comfortable owning individual stocks, I suggest focusing on conservative, blue-chip companies such as Canadian banks, utilities, power producers, real estate investment trusts, telecoms and infrastructure companies. (See my model Yield Hog Dividend Growth Portfolio for specific examples). An RESP is no place for speculating.

If you don’t have the time or knowledge to monitor a portfolio of stocks, you could choose a couple of low-cost index exchange-traded funds – one tracking the S&P/TSX Composite Index, for example, and the other the S&P 500. Dividend ETFs are also a good choice. Tip: If you use a discount broker that offers free ETF trades, you will be able to invest your annual RESP contribution – and the 20-per-cent matching CESG grant of up to $500 a child each year – without paying commissions.

Around the time the child is starting high school, consider moving some of the RESP’s assets into lower-risk investments such as guaranteed investment certificates and high-interest savings accounts. The last thing you want is to have to sell stocks or ETFs during a market slump to fund your child’s education.

My son has decided not to pursue a postsecondary education and I will be collapsing our RESP. The plan has a current value of $110,000, of which $50,000 consists of my contributions, $7,200 is from CESG grants and the remainder is investment earnings. If I withdraw my $50,000 of contributions and transfer $50,000 of the remaining amount to my RRSP, I’m left with $10,000. If my marginal tax rate is 35 per cent and there is an additional penalty tax of 20 per cent, am I correct that my tax would be 55 per cent of $10,000, or $5,500?

No. You’re forgetting something: Because your son has decided not to attend postsecondary school, your financial institution will return all CESGs to the government. After subtracting $7,200 of grants, withdrawing $50,000 of contributions and transferring $50,000 of your accumulated income (the maximum allowed) to your RRSP, you will be left with $2,800 of income in the RESP. Upon withdrawal, this will be taxed at your marginal rate, plus 20 per cent, leaving you with about $1,260 after tax.

Keep in mind that, in order to withdraw accumulated income from an RESP, several conditions must be met. The RESP must have been open for at least 10 years, the beneficiaries (or beneficiary, in your case) must be at least 21 years of age and not enrolled in postsecondary school. What’s more, in order to transfer amounts to your RRSP – a good option since it defers income tax and avoids the 20-per-cent penalty tax – you or your spouse must have sufficient RRSP room available.

Another option is to leave your money in the RESP in case your son changes his mind and decides to attend college or university at a later date. RESPs don’t have to be terminated until 35 years after they were opened, so there’s no rush.

RESP withdrawal rules are complex, and penalties can be severe in some cases. Before you make any decisions, discuss the details with your financial institution to avoid any unpleasant surprises.

E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.

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