Should you save for your retirement or child’s education first?
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TORONTO – Learning you’re going to be a parent is a wonderful, joyous occasion. But, it can also cause an enormous amount of stress. Besides the fact you’re about to be responsible for another human being for the rest of your life, the constant reminder you need to start saving for their education before they have even made an appearance to the world can put a lot of pressure on someone.
With debt levels and job losses in Canada on the rise, and more Canadians living paycheque-to-paycheque (or relying on payday loan services to get by), saving for retirement — let alone for a child’s education — is not in the books for most.
Here’s some sobering statistics.
The average cost for a year’s tuition at a Canadian university in 2013 and 2014 was $5,772. That was up 3.3 per cent from the previous year and is expected to continue to rise. A child born today is expected to need over $100,000 for a 4-year college or university program when you factor in books, supplies and living expenses.
When it comes to retirement, a recent survey by TD Bank found 47 per cent of those polled weren’t contributing to an RRSP. And according to Statistics Canada, in 2012 just 23.7 per cent of Canadians who filed taxes contributed to an RRSP. Even more alarming is that many people who have been contributing to RRSPs are prematurely cashing them out because they need the money now.
This leads us to the big question — if you can put money away each month, should it go towards your child’s education or your retirement?
“Put your own financial independence on track first, and then focus on your children,” Rebekah Barsch of Northwestern Mutual wrote in Forbes last summer.
Barsch’s reasoning is that because there are options to pay for education besides saving, such as loans and grants, and because they have the “benefit of time,” it will be easier for your child to cover the cost of education on their own than it will for someone to make up the lost retirement savings.
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Accountant and best-selling author David Trahair disagrees. He believes that saving for your kids’ education trumps saving for your retirement, mainly because of the Canada Education Savings Grant (CESG). The CESG matches contributions to an RESP up to 20 per cent on a maximum of $2,500 per year (or up to a $500 per year grant to an overall maximum of $7,200 per child).
“If someone is going to give you a free grant of 20 per cent it’s difficult to turn that down,” Trahair says.
Interest earned on an RESP is also not taxed until the money is withdrawn. And if an eligible student — registered with a post-secondary institution — is the one who withdraws the money, the tax falls on them, not you. Financial advisor Andrew Rice from the Toronto firm Stewart & Kett says this is what makes an RESP attractive.
“Let’s say a student didn’t work at all. Didn’t work part-time, didn’t work in the summer and their income was under $12,000 a year, then any growth and grants under $12,000 a year would be tax-free,” he says.
But if your child decides against going to college or university that’s where RESPs can get complicated, Rice warns.
“Let’s say you only have one child and that child never goes to a post-secondary school and never will. So then you’re in a position where you have to wind [the] plan down. In that case the [grant money] gets returned to the government [and] you’re left with the question of what to do with the growth.”
Rice says the most common choice at that point is transferring some of the interest to an RRSP if you meet the conditions, or steering the growth to another child if you have more than one.
“For people who have more than one child it’s fairly flexible… if you have four kids you have four shots of getting that growth out and maybe get some of the grants out and if it doesn’t work out you repay the grants and look at the criteria for transferring to an RRSP,” he says.
When it comes to student loans, Trahair says that although they can be considered “good debt” — because they have a positive outcome — relying on them to cover all your education-related costs is not recommended.
“The unfortunate situation is somebody who runs up a lot of student loan debt, graduates and can’t find a job in their field… that’s a heavy burden to be saddled with after university,” he says.
Rice notes that student loans will also have a “consequence down the road.”
“If they want to buy a house, they’ve already used some of their borrowing capacity so they wouldn’t be able to borrow as much,” he says.
While the incentives of putting money into an RESP are nice, there’s no right or wrong choice when it comes to saving for either your child’s education or your retirement.
“Some people believe pretty strongly that they want their kids to do it themselves,” Rice says. “I wouldn’t ever tell anyone to put [money away for education] if it didn’t fit with what they wanted.”
“If you, as an individual, earn $40,000 a year you reduce your taxes from an RRSP contribution by 24 per cent. If you put money into an RESP, your grant is 20 per cent. So they’re kind of similar,” he adds.
If you opt to save for retirement instead, knowing how much you’ll need is also a tricky question.
“There’s this rule of thumb that you’ll need approximately 70 per cent of your pre-retirement earnings to maintain your standard of living after you retire. The problem is that our personal financial situation is as individual as our fingerprints,” Trahair says. “There is no one right answer, there is no one rule of thumb that suits everybody.”
Rice compares retirement to being prepared to take a long road trip.
“When you get in your car to take [that trip] it’s important the gas gauge is working. And in retirement planning I think of the gas gauge as your spending need. A lot of people will go ‘well, how much do I need?’ when the first thing you need to figure out is, how much do you plan to spend.”
Trahair says it’s more important in the long run to pay down your debt instead of saving for either.
“When trying to get ahead financially it’s all about controlling your money and making sure you spend less than you make. If you spend more than you make and you’re building up debt, you’re not really saving at all even if you do put money away because your debt is just getting higher,” he says.
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“Somebody who is a credit card revolver and can’t pay off their credit card balances and they’re paying 20 per cent interest on that balance… they really don’t have any money to contribute to an RRSP or an RESP.”
Whether you choose to save for your own retirement or kids’ education, Rice says that starting a plan one way or another is the most important step.
“If they were sitting in front of me I would say pick one and get started. If you change your mind five years down the road you can always stop that $100 a month and redirect it.”
Note: This feature is included for expository and informational purposes; it is not meant to be taken as personalized or expert financial advice.
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