## Does it Make Sense to Borrow to Fund an RESP?

### The Scenario

When your child was born, you and your spouse vowed to assist with his post-secondary education costs. In the year he was born, you contributed $1,250 to his Registered Education Savings Plan) RESP, which attracted a Canadian Education Savings Grant (CESG) of $250 (equal to 20% of the contributed amount). You expected that you would be able to contribute more as time went on and your incomes improved. As it turned out, you never did increase your contributions. It always seemed that there were more immediate concerns that needed to be dealt with. On top of that, as much as you wanted to contribute to your son’s post-secondary education costs, you knew you had to save for your retirement years so that you wouldn’t become a financial burden on your son when you were old; a circumstance you felt was much worse than your son needing to take on a larger student loan.

So here you are in your mid-40s with a 15-year-old child and an RESP that you estimate will be worth $35,600 by the end of this year. That’s better than a lot of parents do for their children, but you think it’s going to be a financial challenge for your son to make it through four years of university without taking on a huge student loan. You realize that you have left a lot of CESG money on the table because you couldn’t maximize your contributions. Is there anything you can do to add a bit more?

### How About Borrowing to Boost the RESP?

The thought occurred to you that maybe you could borrow to increase your contributions to your son’s RESP. After all, don’t a lot of Canadians borrow to contribute to their RRSPs each year?

### How an RESP and an RRSP are Not Like Each Other

When you borrow to fund an RRSP, the big advantage is that each dollar contributed reduces your taxable income by the same amount. Let’s assume your income puts you in a combined federal and provincial marginal tax rate of 29.65%. If you borrow $10,000 to contribute to your RRSP, the effect is that you get a tax refund of $2,965. Of course, to pay off the $10,000 as quickly as possible, you will need to put that tax refund entirely on the loan. In addition, there will be monthly payments to take care of the balance. Based on a rate of 7.2%, you will pay an additional $7,308 over 9 months to pay off the loan. This is still costly, but if you have, for example, 25 years or so until you expect to start withdrawing from your retirement savings, the value of that $10,000 can compound tax-free every year while it remains inside the account.

The RESP does not offer the incentive of tax refunds for contributions. The timeline is typically not as long, either. While you can theoretically have an RESP open for 35 years, the more common situation is of parents contributing for 18 years (from the year of birth until age 17), and then spending it all down in four or fewer years. There is one incentive, though, that makes the RESP quite attractive. That is the Canada Education Savings Grant (CESG) as well as an Additional CESG and the Canada Learning Bond (CLB). These latter two are available based on family income. For this analysis, I will assume that neither the Additional CESG nor the CLB apply.

### How an RESP and an RRSP are Like Each Other

When investing in a non-registered account, you usually can deduct the interest on amounts borrowed to facilitate the investment. That is not permitted in either the RESP or the RRSP.

### The CESG is the Incentive for Borrowing

If you don’t have the money to make a full contribution to an RESP in any given year, there is a kind of carryover of contribution room that is available. In the scenario described above, the parents are unable to contribute the full amount of annual contribution room available, which is $2,500. Instead, they contribute $1,250. Instead of CESGs each year of $500 ($2,500 x 20%), they receive grants of $250, half the grant for half the contribution.

By contributing $1,250 per year from the year of birth to age 15, they have contributed a total of $20,000, which has attracted $4,000 in grant money. Given that the parents can contribute up to $50,000 to an RESP for a single beneficiary and that a beneficiary can receive a maximum of $7,200 in CESG, there is still room available to contribute.

The problem, however, is not the *availability* of contribution room and grant money; it is that the *ability* to contribute the maximum is not within the parents’ means. What can borrowing do to increase the grants that their son will receive?

### What if You Do Not Borrow?

Below is the history of the RESP as of the end of 2023. The assumptions are:

- The child was born on January 1, 2008.
- Contributions of $1,250 are made at the beginning of each year. These are matched by grants of $250, for a total of $1,500 received at the beginning of each year.
- The assets are invested in a globally diversified portfolio of equities in the first two years, followed by a gradually increasing percentage invested in bonds in subsequent years. This is done to reduce risk as the age to start withdrawing from the RESP approaches.
- Estimated Returns are based on the Projection Assumption Guidelines provided by FP Canada as applied to the allocations in a typical asset allocation ETF.
- The balance at the beginning of the year for 2008 represents the initial $1,250 contribution plus $250 CESG. The Estimated Return in dollars applies to the percentage figure in the Estimated Return column to the Balance at the Beginning of the Year. The Balance at the End of the Year is simply the addition of the beginning balance plus the Estimated Return.
- From 2009 forward, the figure in the Balance at Beginning of Year, consists of the Balance at End of Year plus the Total Contribution and Grant that went into the RESP at the beginning of the year.
- By the end of 2023, the Balance at End of Year is estimated to be $35,599.22.

If this family carried on at the same pace, the final two years before their son goes to school would look like this:

Let’s now assume that the entirety of the money from 2026 through 2029 is held in a cash or cash-equivalent product returning 2.30%. At this stage, the risk of loss due to fluctuation is unacceptable. The money is withdrawn in approximately equal proportions over four years. The slight increase each year is due to the 2.30% interest earned on the balance.

I suspect that a lot of young Canadians heading off to university would be grateful for this amount of money being set aside by their parents for their education. However, university is getting more expensive every year, so efforts to improve the amounts available are understandable.

### What If You Borrow?

First, how much should you borrow? If the goal is to maximize the grant, then the maximum one can contribute per year per beneficiary child is $5,000. This assumes that both contribution room and grant room remain. Earlier, we acknowledged that contributions through 2023 have been $20,000 and the CESG received was worth $4,000. In this scenario, therefore, significant room remains. The last two years look like this:

Assuming the family continued to contribute $1,250 per year of their own money to the RESP, they needed to borrow $3,750 per year to contribute $5,000 each year. This allowed them to maximize the CESG of $1,000, for a total of $6,000 per year in contributions and grants. This boosted the balance at the end of 2025 to $50,882.71, an increase of $9,494.60.

### Where Did They Borrow the Money?

In this scenario, I assume that the couple borrows from their unsecured line of credit. I assume a rate of 10%, based on publicly available information showing rates between 8.20% and 14.20%. In 2024, they borrow $3,750 and pay the interest owing each month. That works out to $375. In 2025, they borrow an additional $3,750 for a total of $7,500, which adds another $750 to the interest paid, for a total of $1,125.

### Paying Off the Line of Credit

The couple decided that they could absorb the interest payments and they would allow the $1,250 of their own money that they contributed in each of 2024 and 2025 to remain part of the RESP assets. However, they also decided that at the first withdrawal, they would take back the $7,500 that they had borrowed and pay off the line of credit. The result is that the withdrawals look like this:

The green row shows the withdrawal from the RESP of $7,500. Since this is part of the contributed principal in the RESP, it can go back to the RRSP subscribers, the parents, tax-free, allowing them to pay off the line of credit. This leaves the balance available for the student. In this situation, the total amount able to be withdrawn from the RESP over four years is $44,902.50. This works out to an improvement in the money available from the RESP of $2,064.47 ($44,902.50 – $42,838.03). However, if we consider that the parents spent an additional $1,125 in interest payments in those final two years, we might consider the net improvement to be $939.47.

### Consider This Alternative

Although the net improvement above is modest, it is meaningful. Instead of borrowing, however, what might happen if the parents simply decided to contribute an additional $375 in 2024 and $750 in 2025? This is the interest that they paid while their line of credit was outstanding. This would increase the contribution in 2024 from $1,250 to $1,625 and the grant from $250 to $325. In 2025, they would boost their contribution from $1,250 to $2,000 and their grant from $250 to $400. In this alternative scenario, the final two years of contributions and grants look like this:

The new withdrawal amounts are indicated in the table below:

The result is that there is an increase over the base scenario of $1,465.34. If we again consider the extra out-of-pocket costs to the parents and reduce the increase by $1,125, a net advantage remains, although a more modest $340.34.

## Should You Borrow to Fund Your RESP?

Based on these scenarios and outcomes, the answer appears to be yes. However, the current interest rates on any money borrowed for this purpose make it a challenge. Banks tend to offer special RRSP loans at favourable rates. To my knowledge, those special rates are not available for RESP contributions. It may make sense to borrow to fund an RESP, but depending on the rate you can obtain for the money you borrow, this option may be uneconomical.

*This is the 212th blog post for Russ Writes*, *first published on 2023-08-28*

If you would like to discuss this or other posts, connect on Facebook, Twitter aka X, LinkedIn, or Instagram.

Click here to contact me for an appointment.

Click here for a 2-week free trial of the Money Architect Financial Planning platform.

Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.

Photo: Waseda University, Tokyo, Japan