Author: Craig Allison

Registered Education Savings Plan (RESP)

Many Canadians have heard of the RESP and plenty of us probably had one when we went to post-secondary education. It is a very important and powerful savings plan and is one of the big three registered plans in Canada along with the TFSA and RRSP. 

As the name of the account makes clear, an RESP is a savings plan for education. Specifically this is for post-secondary education which includes college, university, trade school etc. 

It is a tax-sheltered account where contributions grow tax free. The contributions are not tax deductible. Lifetime contributions are limited to $50,000 per child with no annual maximum.

Government benefits

The significant benefit of the RESP is the Canada Education Savings Grant (CESG) which is a 20% federal government match on annual contributions. The government will only match the first $2,500 of contributions each year unless you are catching up for past years, then the match would apply to the first $5,000 in contributions that year. No match will be provided for annual contributions above those limits. The lifetime maximum CESG each child can receive is $7,200. If you don’t exceed the annual maximums you need to make $36,000 in contributions to receive the full $7,200 lifetime CESG.

The Canada Learning Bond is an income-tested government payment of up to $2,000/lifetime. Eligibility depends on family income and number of children. Review this link to see the eligibility criteria. 

When can I start?

You can begin contributing to an RESP for your child in their first year. If you contribute the $2,500/year you will have received the full CESG before the end of your child’s 15th year.

What if I haven’t contributed yet?

As mentioned you can catch up on CESG by contributing up to $5,000 a year and still get the 20% match. Your child can continue to get the CESG up until the year they turn 17 but there are some special rules. 

To receive the CESG between ages 15 and 17 the RESP contributions by December 31 of the year the beneficiary turns 15 must either:

  • Total at least $2,000
  • Have had annual contributions of at least $100 in any 4 previous years. 

Withdrawals

When it comes time to withdraw, the contributions are not taxable but the earnings and the grants would be taxable income when withdrawn. These would be taxable on the beneficiary’s (student) tax return. In many cases the student will not end up paying taxes because they will have low income and tuition tax credits to offset any income taxes from the RESP withdrawals.

What if my kids don’t end up going to post-secondary education?

If the funds are not used by your child there are some other options:

  • The RESP can be transferred to a sibling fairly easily. Although the grants may need to be repaid. 
  • Contributions can be withdrawn tax free but the grants would need to be repaid and there would be taxes charged on the earnings in the plan. 
  • The contributions and earnings could be transferred to the beneficiary’s RRSP (if they have contribution room). 
  • The contributions and earnings could be transferred to the beneficiary’s Registered Disability Savings Plan (RDSP) if the beneficiary qualifies for one.  

Keep in mind that RESPs can stay open for up to 36 years so you do not have to close it if your 18 year old child decides they don’t want to go to school. They could always change their mind. 

Conclusion

The RESP is a great tool in saving for your loved one’s post-secondary education. Receiving a 20% return on your investment as soon as you contribute is incredibly powerful in accumulating funds. Coupled with the tax-free growth in the plan, the RESP becomes an extremely compelling investment vehicle.

If you have any questions or would like a projection for your RESP, please do not hesitate to call or email us.

October 2021 Quarterly Investment Update

China Rises

For years we have been tracking China’s rise as the world’s political, military and business superpower. This summer we learned that 2021 China’s spending on Research & Development will exceed $500 billion and for the first time ever will exceed R&D spending by the United States (Source: Bank of America). We believe China will be to the 21st century what America was to the 20th: the world’s superpower. The growing importance of China is why we work with investment managers who are located in China and have in-depth, local knowledge on how best to invest there.

A Cautionary Tale

On August 31, the criminal fraud trial of Elizabeth Holmes (former CEO of Theranos) began. The story of Theranos is a cautionary tale on the importance of investing in things that are well-understood while eschewing investments that seem too good to be true. Theranos was a high-flying health-care company founded by Holmes in 2003. It claimed to have technologies that would make blood tests widely available at a fraction of the cost. Theranos embodied a wonderful promise that enabled its value to grow to $10 billion (USD) by 2013. Unfortunately for their clients and investors, the technology never delivered as promised, patients were harmed, and many investors lost their savings when the value of the company collapsed. When we see stories like Theranos, we are reminded of why we work with investment managers who research and understand the businesses we invest in so we can avoid these situations. 

Ethical Investing, ESG and Greenwashing

We continue to cast a skeptical eye on so-called “green” mutual funds and ETFs.  Investors are increasingly concerned about how their investments are impacting the world and the future – and we think this is a good thing. At the same time, investment companies are using investor sentiment as an opportunity for profit without really helping the environment (this is a process called “greenwashing”). Helping the environment is a complex endeavour and serious solutions are needed. TransAlta, a Canadian power company, is in the process of converting from coal to natural gas power generation. This conversion will reduce the company’s annual carbon emissions by 30 mega tonnes which represents 14% of the target carbon emission reduction for Canada (Source: Edgepoint). We believe a typical “green” investor would be disinclined to invest in TransAlta, yet it is difficult to find a company that will contribute as much to the reduction in Canada’s carbon emissions moving forward as TransAlta.

We believe that investing continues to be a nuanced and complex endeavour where simplistic solutions are counterproductive.  We agree that making the world a better place through our investments is a good thing – and affixing simple labels to investments and/or people does more harm than good. 

Welcome Garrett Boekestyn

We are pleased to announce a new addition to our team. Garrett Boekestyn joined us earlier this year, and his expertise in tax and financial planning will continue to strengthen our service.  You can review his bio along with the rest of the team on our updated website.

TFSA vs. RRSP

One of the first questions when Canadians begin saving and investing is:

What account do I use, the RRSP or the TFSA?

The RRSP has a long history and Canadians have used it for their retirement investing for decades. Meanwhile the TFSA is the new(er) kid on the block and is quickly gaining in popularity. While the choice between RRSP and TFSA comes down to your particular situation there are some general principles that can inform your decision. 

A brief description of each account:

The RRSP (Registered Retirement Savings Plan) is intended for retirement savings. Any contributions made to the plan are deducted from your taxable income. The growth and earnings accumulate tax-free. Withdrawals are considered income and are taxable. 

The TFSA (Tax Free Savings Account) is intended to be more flexible and used for other savings goals in addition to retirement. The contributions are not deducted from taxable income and withdrawals are not considered income and therefore not taxable. As with the RRSP, the growth and earnings within the plan accumulate tax-free. 

Both of these accounts can hold the same types of investments including stocks, bonds, mutual funds, ETFs and more.

General guidance on your choice

The general guidance on when to use each account is based around your current and future tax brackets. If you are paying taxes in a higher bracket when contributing than when withdrawing the RRSP makes the most sense. If your tax bracket will be the same or higher when you withdraw the money then the TFSA makes more sense. Here is a quick example:

In the first comparison, there is more money after-tax when using the RRSP. This is due to the lower tax rate when the funds were withdrawn. In the second comparison you would have more after-tax money available if you had saved within the TFSA. The tax rates don’t affect the results of investing in the TFSA but they have a large impact on the RRSP results. 

Keep in mind the benefit of the RRSP is dependent on contributing more than you would in the TFSA (the tax deduction allows you to contribute more to the RRSP).

Additional RRSP features:

The Home Buyers’ Plan allows RRSP account holders to withdraw up to $35,000 for a home down payment without paying immediate taxes. Keep in mind this is only available if you are considered a first-time home buyer purchasing a qualifying home. More information and rules about the HBP can be found here.

You are allowed to withdraw the money out under the HBP without paying taxes but you must repay the funds over a 15 year period starting the second year after the year you withdraw the funds. If you don’t make the repayments, 1/15th of the amount withdrawn will be added to your income each year starting at the first required repayment year.

There is a similar plan called the Lifelong Learning Plan that allows you to withdraw up to $20,000 ($10,000 per year) to fund the pursuit of your education and repay it over a 10 year period. More information can be found here. 

Flexibility of the TFSA

The TFSA is a much more flexible savings vehicle as it allows you to withdraw funds without worrying about the tax consequences. This can be great for emergencies, large purchases and in your retirement. Since TFSA withdrawals are not considered income they also do not affect eligibility for federal income-tested benefits and credits, such as GIS and OAS clawback.

Withdrawals from the TFSA are added back onto the contribution room the next year. This is not the case with the RRSP as withdrawals do not affect contribution room. This allows you to withdraw money from the TFSA and then reinvest that same amount back into the TFSA in the future.

Conclusion

The TFSA should be the first stop savings vehicle for investors unless they are in a high tax bracket now and expect to be in a lower one when the funds are withdrawn. The flexibility of the TFSA and ability to withdraw without worrying about taxes makes it a more useful vehicle. 

On the other hand, if you have trouble leaving your savings alone, maybe the tax payment on RRSP withdrawals will stop you from withdrawing and spending your savings. 

If you have questions about your specific situation please send us an email or give us a call.

July 2021 Quarterly Investment Update

Crowds Slowly Building Again

The long-anticipated 2020 Summer Olympics will finally take place starting on July 23 in Tokyo. Crowds around the world are slowly building again as the organizers announced that 60,000 fans will be allowed into Wembley Stadium for the Euro Cup finals in July (Source: The Guardian). Foo Fighters, an American rock band, played to a full-capacity audience at Madison Square Garden on June 2. In a sign of what may be to come, attendees had to show proof of vaccination in order to gain entry to the concert.  

Strong Investment Returns Tempered with Higher Inflation

The value of the businesses in your mutual fund portfolios generally increased over the quarter. In our view, these higher values are to be greeted with caution because at the same time the values of our investments were increasing the prices we pay for things was also increasing. Year-over-year inflation in Canada was 3.6% in May (up from -0.4% a year earlier) and 5% in the United States (Source: Trading Economics, Statistics Canada, U.S. Bureau of Labour Statistics). The US Federal Reserve, who had previously indicated that they would leave interest rates alone until the end of 2024, now suggest that interest rates will be lifted twice in 2023 (Source: Economist).  If our main objective is to maintain and grow purchasing power over time, these inflation numbers remind us that this is not an easy task.

It Pays to be an Owner

Oil prices are up by over 53% since the start of 2021 (Source: Yahoo Canada Finance).  It should come as some consolation for you to know that when we invest in Canada through Canadian equity mutual funds, we benefit from these higher prices through ownership of energy businesses such as Enbridge, TransCanada, Canadian Natural Resources and Suncor.  Another reminder that ownership is a good thing – and potentially takes some of the pain away when the price of gas creeps up above $1.30/litre.

April 2021 Quarterly Investment Update

Finding Risk in Unlikely Places

Bond prices were significantly down over the first quarter and we believe this is important. We were again reminded how fragile our global supply chains are when a ship named MV Ever Given ran aground in the Suez Canal blocked over 12% of global shipments.  If it isn’t a pandemic, it’s something else that is reminding us that financial risk is everywhere. We are well-served to understand and manage (versus avoid) risk. 

Why Lower Bond Prices is a Big Deal

A decrease in bond-prices is important because bond prices represent the value of money we lend to others. From January 1 – March 31, the iShares Core Canadian Long-Term Bond Index ETF (this serves as a proxy for the value of long-term bonds in Canada) was down 11% (Source: Morningstar).

The graph below shows that interest rates have been more-or-less declining and bond prices have been more-or-less rising since 1981. Since 1981 it has made sense to borrow as much as we possibly could to buy assets that go up in value as the cost of borrowing goes down. The decrease we have seen this year is the first major pullback in bond prices in a generation. How much further bond prices decline and how much higher yields rise is anyone’s guess.

What Do We Do About It?

We want to remain vigilant as the investing landscape changes around us. What causes bond prices to fall and what does it mean? Bond prices often fall when investors require a higher rate of return on the money they lend to others. In many cases they require a higher rate of return when they believe the cost of things will go up. Why, for example, would I lend you my lunch money for 2% this year when I think the price of food will go up by 3% over the same timeframe? Lenders worldwide are expecting prices to rise at a greater rate in the future and have already priced higher interest rates into bond valuations.  

What can we do about this? Here are three ideas:

1. Be prepared for declining home values. I am concerned about the number of Canadian households with high mortgages and how they will manage when interest rates increase to 3%, 4% or 5%. I’m interested to know what will happen to the market value of my house when the pool of potential buyers is faced with higher mortgage payments. It is difficult for me to imagine a scenario where housing prices rise in the short to mid-term.

2. Keep our lending short-term. With a bond we receive a promise from borrowers to repay within a specified timeframe. Lending money to others for a longer timeframe in a period of rising inflation is risky. This is because borrowers typically don’t increase what they pay simply because inflation has gone up. With a bond they agree to pay you whatever they agreed to pay you, not a penny more. This is why we prefer to lend our money to others on more of a short-term basis. This strategy is reflected in the portfolios we manage for you. 

3. Invest in businesses that have the ability to increase the price of the goods and services they produce. These businesses are able to generate higher profits for investors. This is why we use mutual funds that invest in businesses that are industry leaders and have the ability to thrive while prices are rising. 

A Word About ESG Investing

ESG stands for “Environment, Social, Governance” and it is a hot sector in the investing marketplace. The above image shows the explosive growth in ESG assets since 2015. The promise of ESG is that we can use our investment dollars to nudge businesses to be more environmentally aware, socially conscious and better corporate citizens. We have not embraced ESG investing because we believe it is difficult to fulfill the promise that ESG investing makes. 

An opinion piece published in USA Today on March 16 by Tariq Fancy, former head of sustainability at BlackRock, the world’s biggest asset manager, tends to support our concern. Click here to read his article.