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The up-and-down bouts of volatility in financial markets this year are a vivid study in contrasts for all investors, including students and parents who may be saving for postsecondary education in a registered education savings plan (RESP).
“If you’re starting out now and you have 18 years ahead of you, in a sense, you want this volatility because it brings opportunity. The market is on sale right now,” says Erik Wachman, financial adviser with WWH Financial Group at Assante Financial Management Ltd. in Mississauga.
“The other extreme is that you have a child who’s 17 and going to postsecondary next year. If we had to pull out of those funds and the investor didn’t de-risk over time, you’re potentially down 20 or 30 per cent.”
Those clients might have to take out money at a loss, he adds.
Indeed, today’s market is a clear-eyed warning for many do-it-yourself (DIY) investors about the risks that can build if they’re not taking the same diligent approach as a professional adviser.
“It’s all personal preference; there’s no right or wrong answer,” adds Per Homer, wealth management adviser, also with WWH Financial Group at Assante Financial Management. But with “the do-it-yourselfer, the concern is about discipline.”
Both advisers say investment choices should “de-risk” a portfolio away from equities into more conservative vehicles the closer clients get to the time the funds will be needed, especially when that money is earmarked for something as important as a child’s education.
They point to an investment product such as target-date funds as an example.
Target-date funds such as Fidelity Investments Canada ULC’s ClearPath Portfolios group of funds or RBC Global Asset Management Inc.’s RBC Target Education Funds reallocate holdings over time from stocks to fixed-income and short-term investments based on a targeted year, such as Fidelity ClearPath 2025 Portfolio.
Utilizing bonds close to withdrawals
A caveat to consider is that this year’s volatility in bond markets has hit even these conservative-leaning products, which have posted year-to-date declines. However, as the funds head closer to their targeted years and into shorter-term holdings, they should recover.
Brenda Akins, associate portfolio manager and investment adviser at Kozak Financial Group with CIBC Wood Gundy in Calgary, says that by the time the student or beneficiary is set to make their first tuition payment, the majority of the funds should be in principal-protected assets.
“This money has to be safe,” Ms. Akins says. She prefers directly purchasing bonds dated to come due in the subsequent years that the student would need the money.
“We would generally set up a ladder for investments to mature in the anticipated years that the student would be withdrawing the money,” she says.
There are select investments that can potentially achieve both higher returns and principal protection, says Kaif Lalani, financial adviser with Hudson Wealth Management Group at Raymond James Ltd. in Toronto. He likes a product such as equity-linked principal protected notes, “to get the market exposure desired while protecting 100 per cent of the downside if a market decline occurs close to the date when capital is needed.”
How to withdraw from RESPs tax-efficiently
With September here, just as important as the RESP’s asset mix is a plan for withdrawals.
“There’s going to be a lot of tuition paid in the next several weeks,” says Michelle Connolly, senior vice-president, advanced wealth planning at Wellington-Altus Private Wealth in Toronto.
“The one thing many Canadians and clients don’t understand is there’s a big choice as to how you withdraw.”
RESPs consist of two primary “buckets,” one taxable, the other not. The taxable portion consists of two sources of money – investment returns and what’s been contributed by the government, chiefly through the Canada Education Savings Grant, or the 20-per-cent annual top-up on the first $2,500 contributed to the account (up to a lifetime maximum of $7,200). Together, these two sources of funds fall under the term educational assistance payment (EAP).
The second non-taxable component are the original contributions made over the years by “subscribers” such as parents or anyone else who has funded the RESP. These funds can generally be withdrawn at any time, tax-free.
Ms. Connolly stresses that students and beneficiaries withdrawing funds to pay for tuition or other related costs should look to draw down the EAP portion of their accounts first before touching the original contributions, which can be accessed later in a postsecondary student’s time in school or even after they’ve left for the work force.
The reason is quite simple – full-time students don’t earn much and are taxed accordingly. By withdrawing the taxable EAP money early in a student’s school years, they are limiting their taxation. Yet that critical, money-saving distinction can be overlooked by RESP holders and even some pros, she notes.
“I want to build the awareness that there is a choice – you tick the box that the withdrawal is an EAP or a combination of EAP and [principal],” she says. “It makes absolutely no sense to just draw down principal when the beneficiary has little to no income.”
It’s a really important part of the RESP that some clients sometimes don’t think about, Ms. Akins of CIBC Wood Gundy adds. She ensures that accessing the EAP first is built into a client’s plan well before the time comes when a beneficiary will need the money.
“For our clients, we start planning pretty early. I always make a joke, ‘Your kid is 2, you don’t have to tell me where they’re going to university,’” she says.
“But as soon as the child gets to about Grade 10, we would sit down with them as part of our annual review and make a plan for systematic withdrawals that make sense tax-wise and also to drain the account in an efficient manner.”
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