How to use an RESP to save for Retirement

Saving can be complicated. Once you’ve overcome the temptation to spend, there are a few savings plans that it can be confusing to prioritize which ones to focus on. Most personal finance articles debate whether to prioritize saving in your RRSP or TFSA account first. But if you’ve got kids and you live in Quebec, I argue that you should be contributing to your RESP first!

In today’s blog, I’ll explain why you want to top up your RESP contributions before your RRSP when it comes to saving for your retirement. As always, stay tuned until the end to catch all the caveats to this strategy.

When you’re thinking about saving money, the allure of a big tax refund often makes us want to save in our RRSP first. After all, who doesn’t like taking a vacation, or starting a spring reno with a big tax refund?

If you can’t afford to do both, contributing to an RESP will give you a bigger bang for your buck. Why? Because an RESP combines some of the advantages of both an RRSP and a TFSA. Let me explain.

How an RESP Works

In Quebec, an RESP attracts matching grants of 30% on up to $2,500 worth of contribution per child per year. That’s almost as much as the tax refund you’ll get on an equivalent RRSP contribution. What’s more, since the grants are inside the RESP, you can’t spend them like you would your tax refund! So right off the bat, you are encouraging better habits already.

Like a TFSA though, the funds come out of the RESP virtually tax free. That’s because the growth and grants come out in your child’s name during university, when they’re not likely to be earning anything else. The original contributions can come out in your name, also tax free, because they were after-tax dollars when you put them into the plan in the first place.

So, if you contribute every year in a way that maxes the grants you can receive, that means contributing a total of $36,000 to the RESP over 15 years. You’ll accumulate $10,800 in grants over that period. If the investments earn 5% per year on average, you’ll also accumulate about $40K in growth by the time your child is 19 and ready to go to university. That adds up to about $86,000 to put your child through university.

RESP Balances after 18 years (5% return)

If you decide that you want to fund your child’s entire university tuition and living expenses, then you’ll have accumulated about enough to do that. But what if they stay at home while going to university, or if you agree to split the cost with your child? Quebec tuition is still very inexpensive!

RESP and Retirement

So where does the retirement savings piece come in then? If your children don’t use all the money that has accumulated in the RESP for their education, you can take out the amounts you originally contributed, tax free, and use them to bump up your RRSP at that point. If you do that, you’ll still have around $50K to pay for your child’s education.

Now, a few caveats apply here:

1. Your child must pursue his or her schooling for at least two semesters after high school. Whether university, trade schools or CEGEP, any of these options will allow the grant and growth to be withdrawn from the RESP in his or her name.
2. You must withdraw all the grant and growth money from the plan in your child’s name first, before then withdrawing the original contributions in your own name.

Essentially, you can think about this strategy as a no interest loan from your retirement savings to the RESP for the better part of 20 years. Those funds will earn more than in the RRSP because of the amplifying effect of the grant. Now, if you can afford to max out the RESP and your RRSP, great! You should be doing that. But if there’s a choice, the RESP wins.

After 20 years, you put the original contributions ($36K) back into your RRSP to grow towards your retirement. You’ll get the tax deduction then, when you’re more likely to be in the top tax brackets anyways.

I hope this has helped you reframe the way you think about saving in your RESP as opposed to your RRSP!