Insights and Market Perspectives
Pay Now or Pay Later?
Author: Sound Choices
October 13, 2020
Education Savings:
How will you deal with rising education costs?
The content in the below article is meant for Canadian investors only.
Assuming a 3% rate of inflation, that equates to $33,1972 in 2036 (18 years later) and $138,8843 for four years of education.
How much would you pay?4
Pay now: $48,655 lump sum
- Invest a lump sum of $48,6555 today
- Growing at an average annual rate of return of 6% = $138,877 in 18 years
Pay monthly: $70,200 total
- Invest $325/month – $210 in an RESP and $115 in a TFSA
- Contributions to an RESP grow tax free until the funds are withdrawn
- RESP qualifies for a $500/year CESG
- TFSA withdrawals are tax-free
- Total invested:6
- $45,000 lifetime RESP contribution
- $7,200 lifetime CESG maximum per beneficiary
- $25,200 in additional savings
- Education savings = $139,637 in 18 years
Pay as you go: $138,884 total
- Pay at the beginning of each school year
- Year 1: $33,197
- Year 2: $34,193
- Year 3: $35,219
- Year 4: $36,275
Pay after: $186,705 total
- Post-secondary education financed through student loans that are interest-free while in school.
- After graduating, however, those loans must be repaid.
- Here’s one scenario:7
- Loan of the full amount: $138,884
- Interest rate: 6.2% (prime of 3.7% +2.5%)
- Monthly payments: $1,555.88
- Total interest paid: $47,821.60
- Total amount paid: $186,705.60
Remember: Starting early offers the benefit of power of compounding
- Investors A & B both invest $2,500 a year over 18 years in the same investment earning 6% annually (compounded monthly).
- Investor A opens a Registered Education Savings Plan (RESP) and takes advantage of the Canada Education Savings Grant (CESG) – receiving $500/year up to the lifetime limit of $7,200.
(The Government of Canada will match 20% of the RESP contribution each year to a maximum of $500 – reflecting $2,500 of the subscriber’s contributions.) - Investor B opens a Tax-Free Savings Account (TFSA).
- Both account types are tax-exempt.
Both have benefitted from compounding returns. However, Investor A accumulated almost $14,000 more than Investor B, by taking advantage of the CESG.
Source: AGF Investment Operations. This example is hypothetical and intended for illustrative purposes only. It is not meant to provide investment advice.
Contact a financial advisor who can help you determine which option (or combination of options) best suits your situation.
For more information on RESPs, including a PDF version of this article, visit AGF.com/RESP.
1 Weighted average of all major expenses for a typical undergrad student living off-campus at a Canadian university. Source: “The cost of a Canadian university education in six charts,” Macleans, April 1, 2018.
2 $19,500 with 3% inflation for 18 years = $33,197.
3 $19,500 with 3% inflation for 18 years = $33,197. $19,500 with 3% inflation for 19 years = $34,193. $19,500 with 3% inflation for 20 years = $35,219. $19,500 with 3% inflation for 21 years = $36,275.
4 Note – These calculations assume that: (a) Lump-sum investments are held for 18 years; (b) Monthly investments are made at the beginning of each month for 18 full years; (c) All investments earn an annual compounding rate of return of 6%; and (d) All distributions are reinvested. They do not include any fees or taxes payable. The rate of return is used only to illustrate the effects of the compound growth rate and is not intended to reflect future values or returns on investments.
5 A lump-sum investment of $48,655 invested now in a managed portfolio growing at an average annual compounding rate of return of 6% = grows to $138,877 in 18 years.
6 $210/month plus $500/year CESG Grant (to a maximum of $7,200) starting now earning a hypothetical annual rate of return of 6% (compounded monthly), plus an additional $115/month in a TFSA grows to $139,637 in 18 years. Note that, in this hypothetical example, the RESP lifetime contribution limit of $45,000 is reached after 17 years, 9 months so for the last 3 months, the $325 monthly contribution is invested in the TFSA.
7 Loan of $138,884 at 6.2% (prime of 3.7% +2.5%), 120 monthly payments of $1,555.88. Total interest paid $47,821.60. Total amount paid $186,705.60. Assumes first payment is six months after graduation.
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