RRSP vs. RESP: Which should I prioritize? A question I have often asked myself. This time, a long time friend was the one to bring it up. Let me take your through some of the key differences of each to better help you make your own decision.
Should I prioritize contributions to an RRSP or should I choose to max out my children’s RESP first? This can be a fairly long and complex article, so I will do my best to summarize and possible do a deeper dive in the near future.
the answer?: IT DEPENDS!
Let me walk you through the key advantage of each strategy. Think of what situation you are in, and how this might be advantageous for you.
- RESPs provide an automatic 20% return upon investment, this is quick free money and is a good addition to the principal amount for more compound interest. however, your RESP contribution is after tax at whatever tax rate you face in the year of contribution. Secondly, the government grant portions (EAP) can be taxed on your children’s income (much lower tax bracket than you) when they withdraw.
- Your children must attend an approved post secondary school to reap the maximum benefit of the program.
- Where RRSPs really make sense is into the years of peak income. The more money you can spare from a 40% income tax bracket to instead, funnel that income into say a 20% tax bracket in the retirement years. The advantage is only maximized if you are diciplined enough to re-invest your tax refund immediately to take the compound interest on the full amount. If you are like me however, the tax refund is usually repurposed for paying bills or discretionary spending.
See below an exert of an article published Here in moneysense.
“There are parents who have enough money to max out their retirement accounts and save for their kids’ university education. And then there are the rest of us who need to set priorities.
Over the past 20 years or so, my wife and I have contributed regularly to our RRSPs, but only after putting money aside for our kids’ education. Today our daughter is halfway to a bachelor’s degree, and our son is just about to enter his first year of university. We expect both to graduate with zero debt.
Not everyone will agree with our decision to put our kids’ education ahead of our retirement, but here’s our reasoning: We expect our kids to cover part of their university costs with summer jobs and co-op placements, because they need to have skin in the game. But unless they can swing summer jobs as investment bankers, that won’t be enough: Tuition plus room and board adds up to at least $15,000 a year. Without our help, they’ll leave university with diplomas and debt, and they may feel pressured to accept the first jobs that come along, even if they are unrelated to their fields of study. That defeats the whole purpose of investing in education.
There are also good financial reasons to contribute to RESPs, even at the expense of retirement savings. The government tops up your contributions with a 20 percent grant, to a maximum of $7,200 per child, depending on how much you deposit each year. (For low-income earners, there are even more generous incentives.) But to collect all that free money, you need to open an RESP by the time your child is 10 and make all the contributions by the end of the year she turns 17. The RRSP window is much wider.
Our kids were born while we were in our twenties, so we won’t even be 50 when they’ve finished their degrees. That will leave us at least a decade of peak earning years to supercharge our RRSPs. If we’re short on cash as retirement looms, we should be able to work an extra year or two. And if we’re really strapped, we can always move in with our kids.”
In conclusion, there is no right or wrong answer. It depends on your financial situation, your desired goal, and the timeframe in front of you. As you will hear from me alot in future posts, alot of it revolves around tax exposure and fees. Both investments have the ability to provide healthy growth for a good future growth. The remaining question is, which method is most tax efficient for you and your family. The essential realization is: Either way, I am saving for a better future!