Making sense of RESPs

While I'm waiting for my baby son to make his appearance (overdue by a day now ... tsk tsk ... naughty baby), I'm spending my time baking, cleaning, reading, napping and planning for our family's financial future. I'm too huge to move around much, and I figure it'll be months before I'll be well-rested enough to think clearly about these things, so I'm trying to make my plans before the new baby-craziness sets in.

Anyway, among the financial issues on my mind is baby's college fund. Will and I would like our baby to avoid starting his working life with a pile of student loan debt, so we plan to set up an RESP (Registered Educational Savings Plan) pretty much as soon as the baby's born to take advantage of the government's 20% matching plan (up to $400 each year) and the fact that the RESP is sheltered from capital gains tax until the money is withdrawn. The idea is that when your kid withdraws the money for school, his income will be so low that he'll avoid paying some or all of the withdrawal tax.

RESPs are a bit tricky though, with all the rules. This is where the PFosphere steps in and clarifies things for those of us who are wrestling with complicated explanations on the government's and banks' websites.

Frugal Canadian has a great summary of the advantages and disadvantages of RESPs, and some info on what happens when you cash out:

Advantages

• Income generated on your contributions are tax deferred. This means, you do not pay tax on the income that's earned from the contributions while the funds are in the plan(up to 20+ years of untaxed growth)
  
• Up to $7,200 of free money --The Feds give a 20% Canada Education Savings Grant matched up to $400/year. Additional incentives available for low income families and the Province of Alberta.
  
• Payments of accumulated income are usually made to the child when they have little to no income(since they are a student) and therefore minimal taxes are due.
  

Limitations

• Contributions to an RESP do not result in a tax deduction on the contributors return. This is a common misconception and is NOT the case.
  
• Contribution limit is $4000/year for the beneficiary(aka. the child) to a maximum of $42,000 lifetime. This means that if you have grandparents that want to contribute you as a parent, have to share the $4000 each year. Overcontributions are penalized.

Vancouver Dad has done some of the calculations on how to maximize your RESP:

1. Contribute the maximum $42,000 to the RESP
2. Receive the maximum $7,200 in CESGs (Ed. note: Canada Educational Savings Grant - the 20% match I mentioned earlier)
   
3. Get the money into the RESP as quickly as possible to maximize the tax-free growth in the plan

To accomplish this, do the following: Contribute $4,000 a year for the first three years of the child’s life ($12,000), then contribute $2,000 a year up to an including the year in which the child reaches age 17 ($30,000 more, for a total of $42,000).

This strategy will both enable you to maximize the contributions to the RESP, and net you the full $7,200 in free CESG money from the government (18 years X $400 = $7,200). It will also get money into the RESP as fast as possible, allowing it the maximum time to grow.

Now the tough part is that you have to balance your RESP contributions with your own retirement fund, not to mention paying down mortgage and other debts. Depending on your income and spending/savings habits, balancing these needs could be tricky. But the last thing you want is to pour all your savings into your kids' college fund, but then have to rely on them to support both you and their own families if you didn't save enough for your retirement.

To save $4,000 a year, you'd have to bank $333 per month, which is difficult to do in the first year if you take the full allowable maternity & parental leave. I don't think we'll be able to contribute that much right away, but we will start with what we can afford and increase the amount we're saving when we're both back at work full-time. If we have more kids, I don't know that we'll be able to contribute that much for each of them. In that case, we will probably set our goal to save enough for each child to complete at least the first two years of a university degree or technical program at a community college; if they want to continue with further education, it will be up to them to get scholarships and/or save for the tuition.

Finally, speaking of RESPs, there's a bit of debate on whether to participate in a savings program like the Canadian Scholarship Trust. Canadian Capitalist recommends against participating in such a program, because there are high fees attached, and if you don't contribute every year you forfeit participation (unless you pay back the 'missed' fees later). Instead, Canadian Capitalist recommends going with something like TD Canada's RESP options, which allow parents to choose mutual funds, index funds or a self-directed investment program. According to CC, TD's eFunds offer some of the lowest fund administration fees in Canada.

My stepson is already set up with a group savings RESP plan (similar to Canadian Scholarship Trust I think) which we need to reactivate by paying the missed monthly dues. Given the six-year age difference between the kids, we will probably go for separate RESPs for them rather than combining it, as the money must be paid out by the oldest recipient's 21st birthday (baby will be 15 by that point). I'm leaning towards a TD RESP account, probably tied to the Canadian Index or a balanced moderate-risk mutual fund (though this should be converted to a steadier, more boring investment when baby hits his teens in case of a market crash).

According to Canadian Capitalist, it'll take a few months to get the necessary paperwork (birth certificate & social insurance number) to set up an RESP, so we have a little more time to make a decision.

How can you tell what work you love when you're just starting out?

There are some really good discussions going on at Get Rich Slowly and The Simple Dollar regarding money, career and meaning.

Here's the question, as framed by J.D. at Get Rich Slowly:

What sort of advice would you offer to a young person just entering the work force? What’s the most important thing to look for in a job? Is money the top priority? Job satisfaction? Is it better to be in a job you love that barely pays the rent, or to be making a fortune in a job that sucks your soul out and spits it on the floor? How can you tell what you love when you’re just starting out?

Many of the commenters at The Simple Dollar advocate taking time off after high school to figure out what you really want to do. While I'm sure that's a great solution for some people, when your problem is overthinking the decision on what to do 'next' because of feeling overwhelmed by choice, putting off taking the plunge won't necessarily help you figure it all out.

The fact is that there's a lot more variety in the job market than you're aware of at 17, and when your main work experience to date has been baby-sitting, slinging burgers and maybe some volunteer work, you really have no idea if a career that sounds good is actually something you'll love to do.

As I said in the comment thread on TSD, if I could tell my younger self one thing it would be to be less afraid to act. While the choices you make early in your career do shape what comes later, the path is much more plastic than I had assumed in high school. If you have a calling, great. If you don’t, pick something you like now and get started on that, whether it’s working, volunteering, travel or some combination of things.

I'm apparently not the only one who felt despair at the number of interests I had to choose from. A TSD reader left a comment on another post here to commiserate.

I am also that kid who had so many interests that I didn't know which one to follow. (I changed majors twice in college and lived abroad learning another language for a year.) Now I have a BA and don't know what to do for a living. I have such a hard time deciding what to do, simply because I'm afraid of it not being the 'right' choice or that I'll be sacrificing something else to my future detriment. I can't tell you how many hours I've spent pondering the issue. And now, of course, the irony is that I'm treading water and getting nowhere quickly due to this indecision.

I think that it can be problematic to set yourself up with high expectations that you'll find the 'perfect' career right out of the gate. If you're an adaptable person with varied interests, and your problem is that you can't decide what to do first or which path is best, my advice is to focus on transferable skills rather than trying to force yourself to choose a specialty right away. If you like what you do, you can always change where you do it, and then you'll never be stuck in a job you hate.

I wouldn't say I've found my calling, but I do enjoy what I do, and I do feel happy and fulfilled in my life. I still hope that one day I will find work that is a calling, but for now I'm content with interesting work that helps me further other goals, teaches me new skills, establishes connections with decent people who I enjoy working with, and has good potential for future growth and new opportunities.

To stay at home, or to return to work?

One decision that has been on my mind since I first learned I was pregnant is whether to return to work after my maternity leave, or to stay at home with the kid(s).

Many of the moms I talk to run the numbers and decide that the costs of working and daycare leave them with so little take-home pay that it's not worth it to return to the workforce. I realized today though that they're probably underestimating the impact on their lifetime earnings of being a stay-at-home mom.

While it's useful to consider the extra costs of going to work and crunch the numbers to see how much 'extra' money you'll be left with at the end, I think that this method might skew the numbers in favour of staying home in most cases, but it doesn't consider one very important factor: the anticipated increase in earnings that most of us can expect over time if we continue in the workforce.

It is true that a working parent's take-home pay takes a hit from daycare costs, and that there are many other 'hidden' costs of working such as transportation, eating out more frequently, the need to maintain a professional wardrobe, and so on. But even if those costs eat up a large chunk of your take-home salary today, by choosing not to return to work, parents risk losing out on significant increases in salary over time. Just how much depends on your age and current earning power.

Take a look at VisualCalculator's Income Growth calculator (you'll need to scroll down and look for it under 'Income & Insurance Suite') to see what I mean.

Even assuming a yearly salary increase of only 3%, opting out of working for 10 years (say until two kids, three years apart, are both in school) makes a big difference. Depending on your age, type of job and potential for career advancement, the loss could be much heavier.

For me, just a year of maternity leave drops my estimated annual income at retirement by $6,000 (I'm assuming only a 3% annual increase). Were I to take 10 years off, assuming I was able to re-enter the workforce at the same salary I have today (far from certain), I'd see a drop of over $50,000, and a drop in total income earned of $2.5 million over my working life.

According to the 'cost of raising kids' calculator, it's only going to cost me about a half million to raise two kids and my stepson to age 18. While clothes, lunches, transportation and daycare do add up over that time frame, I don't think it'll total $2.5 million.

And, of course, none of this includes annual bonuses, employer benefits, employer matching of retirement savings and company stock purchases, stock options, or, most importantly, future raises. I'm only 25, and I've doubled my earning power in the last three years through switching jobs and lobbying for a raise. While I can't expect that pace to continue, I think there are pretty good odds that I'll be able to boost my annual earnings over the next 40 years by a lot more than 3%. It also doesn't factor in any potential investments/savings allocations that would be put on hold during the time when one parent stays home, or the impact of forgoing extra mortgage payments etc. during those lean years.

Obviously there's a lot to consider, and the decision shouldn't just be an economic one. But since so many people are using income calculations to justify a choice to stay home, I think it's worth it to consider this angle as well.

Thanks to J.D. at Get Rich Slowly for pointing to the visual calculator resource page.

New beginnings

My husband and I started this year with a resolution to get control of our finances, motivated by the happy news that we are expecting a baby in May. Inspired by personal finance blogs like Get Rich Slowly and The Simple Dollar, we made up our minds to track all our expenses starting January 1, with the goal of finally creating a budget we can stick to.

Surprisingly, we actually kept our resolution. We've been religiously tracking our spending since the beginning of 2007, and each month we've revised our original Google Spreadsheets template to make it easier to keep our eyes on our money. We focused on gathering data, not on making a budget, but we found that knowing our purchases would be recorded motivated us to begin packing our lunches most days at work, clipping coupons and watching prices at the grocery store, and curbing impulse purchases. We also finally tabulated all our consumer debt (a scary process) and savings (turns out we had more than we realized!), so for the first time ever we have a very clear picture of what we earn, what we spend, what we owe and what we save.

But even that's not enough.

Having taken these baby steps towards financial responsibility, we are now branching out into other areas. While I've focused on monitoring our finances, my husband is turning into quite the grocery store guru, tracking prices of our most commonly purchased items (especially meat, coffee and certain fruits), scouring flyers, clipping coupons and shopping at multiple stores to ensure the best deals. We've learned that Superstore, for instance, seems to have the best prices for meat and staples. Their produce, however, is often sub-par. Kin's Farm Market has generally good prices and a great selection of fresh fruits and veggies, but they don't sell much else. Safeway and Save-On Foods seem to be hit-and-miss: we've gotten some very good deals, but you really have to keep a sharp eye out.

We're buying a lot more groceries now that I'm eating for two, and we're eating dinners at home and brown-bagging our lunches. We probably could cut back on our grocery spending, but we really value good, nutritious food. We've decided it's worth it to spend a little more on luxuries like asparagus, strawberries, salmon and the occasional steak. With such great food available at home, we don't feel deprived for not going out. We used to eat out several times a week, and bought our lunches almost every day.

From bills to groceries, we move to hobbies and other habits.

Both obsessive book collectors, we realized we had to purge our library (again) to make room for a crib in the nursery. Whereas in the past we've simply given away discarded books on Freecycle and brought the remainder to thrift stores, this time we're going to try to sell some of them first, to recoup at least some of the cost. Today we sold our first book for $21 on Amazon.ca - far more than we would have gotten at a garage sale and with less effort than eBay (and no listing fee!). We've got something like 60 more listed for sale, and if even a fraction of them sell it'll be worth taking the extra time (and keeping those piles of books in the corner of our condo). I do also plan to try listing some of the books on eBay to compare the experience. Whatever doesn't sell online will go to a used bookstore, and whatever doesn't sell there will be Freecycled or Sally Anned.

And finally the explanation for the photo that begins this inaugural post: as I look forward to a year at home with my baby, my 'nesting' urge is kicking in. The urge to start new projects, buy new things, and just generally feather our New Westminster nest is amazingly strong. I've been trying to channel those energies into more productive (and frugal) pursuits than shopping: I'm giving container gardening a try.

It's cheap to begin (about $20 in starting supplies), rewarding and will hopefully provide some of those fresh veggies we just can't live without. I've got several packs of seeds to plant, starting with lettuce, cherry tomatoes, zucchini, basil and chives, which are all sprouting in my seed-starter box right now. I've also got a pepper medley (sweet and spicy peppers), beans, carrots, onions, peas and dill to plant soon (maybe this weekend, if it looks like the weather will remain warm).

All in all, it's an interesting experiment. It'll be challenging in the coming months as our income drops due to the maternity leave, but we've made a really good start at reshaping our attitude towards money. We've both been far too laissez-faire about frivolous spending, and unfortunately that's left us with an ugly pile of debts to pay off. Still, by taking a realistic look at our finances, we've developed a plan to repay it, hopefully within five years despite the financial impact of a new baby.

We've already killed about a third of our debt this year by cutting back on spending and prioritizing debt repayment, while building up our emergency fund and continuing to save for retirement. It's been helpful that we've had some substantial windfalls (bonuses at work, a raise, sold some company shares) but without the internal work to change our attitude towards money, that extra cash would probably have been spent on new computers or a down payment for a new car. There's still a lot to do to fix our finances, but I feel optimistic that we're on track.