With the ever-rising costs of post-secondary education, saving for a child’s future is a top priority for many families.
At the basic level, both Registered Education Savings Plans (RESPs) and Tax-Free Savings Accounts (TFSAs) boast a number of fundamental benefits. The former offers tax advantages, income splitting, and contribution matching by the federal government, and the latter offers tax-free growth, anytime withdrawals, and a carry-forward of contribution room. The real strategizing, however, exists beyond the surface level in the growth potential within each.
A simplified approach to RESPs
With the ever-rising costs of post-secondary education, saving for a child’s future is a top priority for many families. And given the fact that the maximum lifetime contribution amount for RESPs is $50,000, but the current cost estimate for a four-year post-secondary program is approximately $80,000 (tuition, living expenses, books, etc.), the question becomes how to maximize growth in the most effective, time-efficient manner possible.
Unfortunately for some individuals, there is a lot of untapped potential within their RESPs, and this can often be based on uncertainties around asset allocation. With a number of options to consider (equities, mutual funds, bonds, to name a few), and the time-consuming nature of trying to strike the right balance between risk and growth, the investing process can become complex and confusing, especially given the shorter time frame — unlike RRSPs where the investments have decades to grow. This is where target date funds can come into play as an ideal, convenient strategy.
On the highest level, target date funds are asset mixes managed to a specific time horizon. What makes them such an attractive option for RESPs is the fact that investors simply have to choose the fund with the target date that aligns with the year their child would likely begin post-secondary education, and the asset mix is designed to evolve in a way that capitalizes on that time frame. Specifically in this regard, the RBC Target Education Funds provide an ideal option based on structure, purpose, and impact — these funds are customized to meet the dates relevant to your child’s post-secondary education timeline, they rebalance automatically, and they provide the reassurance that the rest is taken care of, eliminating a need for year-to-year management.
As part of the sophistication within these funds, the focus in the earlier years is progressive growth, and then as the target date becomes closer, there’s an asset mix shift to preserving capital via lower equity exposure (see Figure 1). And while this strategy may be similar to what some individuals aim for by self-directing their RESPs, the added value of funds such as RBC’s Target Education Funds is that the complexity of planning and management is taken out of the hands of the investor and put into the hands of expert portfolio managers who select the funds, monitor the portfolios, and adjust the asset mix for you.
For those who are very conservative in their investment approach, GICs are another alternative. The tradeoff with that option, however, is that it’s more difficult to build capital in a low-interest-rate environment. Ultimately, you want to ensure sufficient investment growth to keep pace both with inflation and the rising costs of post-secondary education, so it’s important to focus on growth of capital, not just on the preservation of that capital.
Figure 1 - Asset mix becomes more conservative over timeSource: RBC Target Education Funds Brochure (22056 (03/2015))
Take TFSAs to the next level
While a recent Ipsos poll conducted on behalf of RBC noted an increasing popularity in the TFSA program (46 percent of Canadians would choose a TFSA over an RRSP if they could only choose one),1 as a whole, TFSAs are still somewhat misunderstood among some individuals, specifically around what can be held in them. While the name suggests that it is a savings account, a TFSA can in fact be utilized for investments including GICs, bonds, stocks, and mutual funds. Therefore, a shift in focus to using it more as a longer-term investment vehicle opens up a range of options that can positively impact the growth potential.
In this regard, a key strategy to consider is investing in funds that are properly diversified to deliver consistent and reliable returns, and it’s here that options such as RBC’s Select Portfolios may be worthwhile, as they offer broad global exposure to both bonds and stocks, which is important in today’s more volatile market environment. As part of this option, there are five RBC Select Portfolios offered based on risk tolerance, each of which is monitored and actively rebalanced with a focus on tactical adjustments to capitalize on short-term opportunities while still keeping long-term strategic allocation at the forefront.
For both RESPs and TFSAs, an advisor is the ideal resource to discuss some of the finer intricacies relating to investment strategies, as well as identifying the best options based on personal risk tolerance and short- and long-term goals for the contributions made.
TFSA yearly contribution limits
While the federal government has reduced the 2016 annual TFSA contribution limit back to $5,500, those who didn’t capitalize on the 2015 limit of $10,000 can still utilize it. Thanks to the contribution carry-forward rules, any unused contribution room accumulates each year.