How it works
The RESP operates a little bit like a pension. There is an annual contribution amount that the federal government will contribute to in grant money to pay for tuition in the future. For every year that you make a contribution, you will get a deduction in your income tax. Also, the private contributions and grants will accumulate interest over the years, so it is always a good idea to make the contributions as early in the child's life as possible.
Let’s say you open a RESP when your child is one year old. Every year you contribute $500, and receive $100 in federal grants, meaning the government is matching 20% of what you put in. When your child turns 18, assuming a nice, modest 5% return compounded annually, the balance will be just shy of $14,000. This is a pretty good return on the investment, considering that all you had to do was put in $8,500 in over 17 years. Now suppose you contribute $1,000 every year. With the same 20% matching and 5% annual returns, you would have a little over $27,000 when the child turns 18. You will have contributed $17,000 over 17 years and received $10,000 in free money from the grants and interest earned.
A Canadian university degree consists of 40 courses, at roughly $700 in tuition per course. While there is always some variation in tuition based on the type of degree and the university, a typical degree in Canada will cost about $28,000. Essentially, $1,000 per year in contributions for each child, from the time they are one year old until they turn 18, will cover their tuition.
Down payment blues
With no RESP contributions, the $28,000 would most likely be repaid in student loans. While the loans are interest free for the duration of study, interest charges will begin six months after graduation. A typical fixed interest rate for a Canada student loan is 3.2%. The $28,000 could be paid off in 10 years if payments of $300 per month are made six months after graduation. With tuition and interest paid altogether, the degree will have cost just shy of $36,000.
And so, you can either set up a RESP and pay $17,000 of your own money to fund your child’s degree, or you can contribute nothing and have them pay $36,000 for the same degree. The RESP is basically cutting the cost of the degree in half. People with degrees tend to have higher incomes and live longer, healthier lives. If nothing else, try to give them these gifts.