What parents need to know about student debt

Parenthood is full of excitement, anxiety, joy, and thoughts about what the future holds. The vast majority of parents begin to start thinking about their child’s success shortly after leaving the maternity ward. Much of those thoughts lead to attending university and with that comes a cost. 

Each year of university in Canada can cost in the range of $18,000 to $25,000 including tuition, lodging, food, and books. Over four years, most Canadian universities report the total cost reaching upwards of $80,000, if not more. Many Canadian students are leaving university with a first-year’s salary worth of debt. Studies have shown Canadian university students leave post-graduation with $27,000 in student debt responsibilities. A load of debt like that can be crippling to long-term success.

However, the costs are real and feeling glum will do no good! Creating a plan early can prevent the future stress of dealing with the high cost of a university education. It is not uncommon for parents to have thoughts of the future for their child but take no reasonable action toward improving the situation. Planning ahead and creating manageable goals for the costs of post-secondary education will go a long way toward offsetting the massive expense university can be.

Each stage in a child’s life presents different opportunities to contribute towards the ultimate goal of paying for university. Here is a breakdown of each milestone and ways to maximize saving for university during each stage to avoid accruing student debt.

Age Zero – Four

Infancy and toddlerhood are some of the most expensive times for parents. Daycare, diapers, housing, and all the things a baby requires put a massive strain on any budget. This can lead to a dearth of cash flow that makes saving for anything almost unrealistic. Spend this time settling on a budget that allows you to pay off common debts like credit cards to free up discretionary funds later.

Regardless of what you are putting towards other debts, this is the time to open a Registered Education Savings Plan (RESP). These plans are ideal, as any member of the family can deposit into the savings account. Rather than excessive toys and clothing as gifts, family and friends can contribute to the future education of your child. With that said, further discussion about what an RESP is and does is likely beneficial.

The Canadian government created the RESP in 1972 and updated it in 1998 to add a federal grant designed to encourage saving for the post-secondary education of Canadian children. The money grows tax-free and is supplemented with rather beneficial grant funds.

Creating an RESP account is not difficult. The social insurance number for the child is required at the time of account opening. Ideally, setting up the account will occur as soon after childbirth as possible. The mere presence of the account is a reminder that saving for the future university education of your child is a paramount task.

Upon researching RESPs, you will notice three options including individual, family, and group plans. The group option can likely be eliminated straight away. These involve high fees, a predetermined contribution plan, and a loss of investment if the plan is cancelled for one reason or another. 

Individual plans are fine for families who only plan on having one child and family plans are advantageous for those who even might have multiple children. Family plans allow multiple beneficiaries on one RESP. 

Some parents inquire about creating a trust rather than an RESP. While this may be a viable option for those with more than $500,000 to invest in the future of their child, trusts are not likely to be beneficial to those looking to simply save for university. 

Savings Goals

Setting goals at this early stage can be challenging for new parents but the rule of thumb is to be ambitious as possible. If a higher monthly payment is set early on you are more likely to keep it up than to try and remember to increase your payment later in the life of your child.

The grant primarily responsible for benefitting RESPs is known as the Canadian Education Savings Grant (CESG). This grant provides up to a 20 percent return on investment into an RESP, which is an astronomical number in the financial savings world. Getting the most out of this grant requires a $2,500 a year commitment (or just over $200 a month). 

There are no annual limits on RESP accounts, however, there is a per child maximum of $50,000. If you cannot meet your $2,500 goal each year, you can work to catch up in subsequent years. In theory, parents have until their child’s eight birthday to take full advantage of CESG funds, but it would require a $5,000 per year commitment. Thus, committing to paying the $200 per month right away is likely more reasonable than deciding to pay over $400 per month after your child turns eight.

Saving is hard enough for families with a meaningful budget, but the Canadian government realizes not every child lives in a household with a moderate income. The Canada Learning Bond (CLB) was established as a grant program to provide low-income children funds to get a jumpstart on university costs. Even without a single contribution from the family, this bond can provide children from low-income homes $2,000 in grant funds toward university expenses. Families that qualify and open an RESP will receive $500 up front, $25 annually until the child reaches 15, and have the administrative cost of opening the RESP covered.

Investment Decisions

RESP accounts do require some decision making to determine how the money should be invested in the relatively short 18-year timeframe before university typically begins. This decision has no bearing on the 20 percent guaranteed return from the CESG. Thus, parents should be aware that aggressive investment is likely not required.

A simple GIC from a bank is a good investment strategy, as these term deposits are relatively risk-free. The returns may be considered on the low end but combined with the return on the CESG, any funds in addition to your contributions could prove to be enough.

Proper investing of RESP funds is more about risk tolerance than anything. Again, the CESG guarantees a 20 percent return and that is often enough for those taking full advantage.

For those who can financially tolerate potential volatility, equities represent a good opportunity to grow RESP funds more substantially. Putting 70 to 75 percent of the RESP funds into equities represents a higher risk but is a fairly common way to invest.

However, if you are not a hands-on investor or are confused by the process, simply contributing the maximum over the lifetime of an RESP will lead to a high-quality university savings fund.

If you do enjoy investing or feel confident in doing so, contributing 25 percent into the following funds will diversify your risk while producing similar results to having 100 percent of the RESP funds in equities: Canadian bond mutual fund, Canadian equity index, United States equity index, and international equity index. Alternatively, you could invest in a balanced mutual fund portfolio but keep in mind management costs will arise with this type of investment.

Finally, certain investments are designed to balance over their lifetime as your child approaches the date of entrance into university. These are known as target-date mutual funds and are a “set it and forget it” investment option. Fees can appear relatively high but this is a simple approach to maximizing RESP funds.

Age Five – Seven

This time frame represents a time to consider the ultimate goal of RESP savings. Are you planning to cover the entirety of university for your child? Is paying for housing and a meal plan enough? Making these determinations now will help shape your goal and fine-tune your savings plan.

Some experts suggest that having a child pay a portion of university costs is a solid way to educate them on the realities of life and financial planning. Whether you decide to pay for the whole cost of university or only a portion, this age range is a good time to start having conversations around the importance of money management and savings. 

Age Eight – Fourteen

Eight years marks the optimal year to begin contributing to the RESP if you have not been diligent about doing so. It is still possible to “catch up” on the CESG funds, as they continue to be available until the December of the child’s 17th year. 

You can contribute any amount to the RESP each year. The are no limits on deposits outside of the $50,000 lifetime maximum. Even if you cannot contribute a lot of money, beginning to contribute in this timeframe is essential to taking full advantage of the CESG grants. In any case, you must begin contributing before the child turns 16 or the opportunity for grant funds will disappear.

Limit Equity Exposure

Now is the time to reevaluate the investments you have made with the RESP funds. Equities represent a high risk and any serious losses during these years could be devastating to the overall value of the RESP. As your child gets older consider dialing back the percentage of RESP funds in equities.

By the time your child turns 14, you should be at most 50 percent in equities with the intent of moving to all cash by age 17. This will increase the safety of the funds as your child nears entering university. Limiting risk during this time frame will provide confidence that the RESP will be able to provide for any university costs when the time comes.

Age Fourteen – Eighteen

This is a prime age to really begin discussing the details of how finances work. Many children are beginning to seek out part-time employment to pay for things they like to do. Unfortunately, it is rare for a child to reign in their spending and the habit of living pay check to pay check is quickly formed.

Discussing responsible spending habits now could be life-changing for your child. If your child is unaware of an RESP or what it is, inform them during this age range. Even if you do not want your child to be burdened with university costs, you can still educate them on how saving works and encourage the habit. 

A good way to encourage a solid attitude toward saving is by setting an account up for extra university expenses like nights out or fun on the weekends. Work out a budget of what four years of these types of expenditures would look like and create a plan to work toward that number.

As your child enters the ninth grade, you should begin inquiring about potential scholarships that could help pay for university. This will allow you to plan financially and provide encouragement for your child to strive for excellence in the classroom.

During your child’s final school year, you should begin making plans for the appropriate withdrawal of funds from the RESP. Discuss this with your financial adviser or a tax expert to ensure you are not paying extra taxes or fees unnecessarily. 

For Those Who Have Not Contributed to an RESP

Not everyone can save in advance for university costs or fully fund an RESP for the entire four years of university. There are options available for families that just do not have the extra funds in their budgets. It will certainly be more challenging, but it is still possible to deal with the cost of a university education.

If you have been saving funds to a Tax-Free Savings Account, these may be used to supplement any gaps between your RESP and actual university costs. Some prefer to use a TFSA as their main source of university savings, given its tax advantages. It is also easier to deal with in the instance that your child decides not to attend university. 

Many families find that paying off a mortgage coincides with the time their child heads off to university. Rather than spending the newly free funds that went toward the mortgage, consider using those to pay for university costs in cash.

Whether you have saved since your child was born or are just starting as they turn 14, it is possible to make a dent in the cost of university with a solid savings strategy. Every little bit helps and the end result of your child leaving university debt-free will be worth any sacrifices made along the way.