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Registered Education Savings Plans - Solutions to Sample Questions

Posted by David Gobeil on

This question on RESPs is about as mathematical as you can get.

On August 4, 2018, Matthew was 5 years of age. By the end of 2029, his father, Gerry, would like to accumulate $50,000 in an RESP for Matthew. At the end of each year, Gerry will contribute to the RESP and he expects that the investments within the RESP will earn 8%. Mathew will not be eligible for the Canada Learning Bonds nor the enhanced CESG rates.

 Gerry's annual contribution would be:

(A)

$2,096

(B) 

$2,196

(C)

$2,296

(D)

$2,396

 

(Choice B is correct.) Gerry would make 12 contributions, calculated as:

·       ((target date to accumulate funds - current year) + 1); or

·       ((2029 - 2018) + 1).

Age 17 is the last year that the contributions would be eligible for the CESG. Matthew is just 5 years of age, and the 12 contributions would all be eligible for the CESG.

Gerry's RESP contribution plus the CESG each year would be $2,635, calculated by:

·       entering P/YR = payments per year = 1, ×P/YR = number of years of contributions = 12 or N = number of periods = (payments per year × number of years of contributions) = (1 × 12), I/YR = nominal annual interest rate = 8%, PV = current savings = $0, FV = future value = amount to accumulate = $50,000, MODE = payments at end of year = END; and

·       solving for PMT = periodic payments = RESP contribution plus the CESG each year.

However, the plan would qualify for the CESG of 20% of contributions. The maximum RESP contribution eligible for the CESG would be $2,500.

The maximum RESP contribution eligible for the CESG plus CESG would be $3,000, calculated as:

·       (maximum RESP contribution eligible for the CESG × (1 + CESG contribution rate)); or

·       ($2,500 × 120%).

Gerry's RESP contribution plus the CESG each year of $2,635 is less than the maximum RESP contribution eligible for the CESG plus CESG of $3,000. Gerry's entire RESP contribution would be eligible for the CESG.

So, Gerry's annual contribution to the RESP would be $2,196, calculated as:

·       ((RESP contribution plus CESG) ÷ (1 + CESG rate of 20%)); or

·       ($2,635 ÷ (1 + 20%)).

 

This question requires you to select the best strategy.

Gerry and Anna have been married for four years. This week, they celebrated the birth of their first child, a daughter whom they named Erin. Gerry has $50,000 that he wants to invest for Erin's education. They do not expect that Erin will be eligible for Canada Learning Bonds or the enhanced CESG rates. What should Gerry do?

(A)

Purchase a universal life policy with enough life insurance on Gerry's life, so as to enable a contribution of $50,000; and upon Erin attaining 18 years of age, change the life insured to Erin, transfer ownership of the policy to Erin and have Erin withdraw the funds for her education.

(B)

Establish an individual RESP for Erin and contribute $50,000.

(C)

Establish an in-trust brokerage account for Erin with $50,000 and invest the funds in equities.

(D) 

Establish an in-trust brokerage account for Erin with $47,500; invest the funds in equities; establish an individual RESP for Erin and contribute $2,500; in each the 13 subsequent years, transfer $2,500 to the RESP; and in year 15, transfer $1,000 to the RESP.

 (Choice A) They could purchase a universal life policy with enough life insurance on Gerry's life, so as to enable a contribution of $50,000; and upon Erin attaining 18 years of age, change the life insured to Erin, transfer ownership of the policy to Erin and have Erin withdraw the funds for her education.

With this strategy, they could benefit from the tax deferral on any investment income and the conversion of the tax rate to that of the child. They would not benefit from the $7,200 of CESGs. The costs of UL insurance are a significant factor and the policies are not transparent, leaving the policyholder with uncertainty as to the "returns". The UL strategy is also complex and may be difficult for the potential policyholder to understand. The funds would be available for any purpose.

(Choice B) They could establish an individual RESP for Erin and contribute $50,000.

With this strategy, they could benefit from the tax deferral on any investment income and the conversion of the tax rate to that of the child. They would only receive CESGs of $500 for the first year. They would not benefit from the $7,200 of Canada Education Savings Grants. However, all of the funds would be subject to the rules restricting the use of the accumulated income to provide education assistance payments or rollovers to a registered plan.

(Choice C) They could establish an in-trust brokerage account for Erin with $50,000 and invest the funds in equities.

With this strategy, they could benefit from the tax deferral on any investment income and the conversion of the tax rate to that of the child. With this strategy, they would not benefit from the $7,200 of CESGs. The funds would be available for any purpose.

(Choice D) They could establish an in-trust brokerage account for Erin with $47,500; invest the funds in equities; establish an individual RESP for Erin and contribute $2,500; in each of the 13 subsequent years, transfer $2,500 to the RESP; and in year 15, transfer $1,000 to the RESP.

With this strategy, they could benefit from the tax deferral on any investment income and the conversion of the tax rate to that of the child. They would benefit from the $7,200 of Canada Education Savings Grants. About half of the funds would be subject to the usage restrictions.

(Choice D is correct.) With Choice D, they could obtain the tax deferrals and conversions and receive the maximum CESGs. However, about half of the funds would be subject to the usage rules. The tradeoff of CESGs of $7,200 in return for the usage restrictions on half the funds seems reasonable. None of the other choices offer better benefits and the usage restrictions would appear to be a reasonable trade-off for the CESGs.

So, they should establish an in-trust brokerage account for Erin with $47,500; invest the funds in equities; establish an individual RESP for Erin and contribute $2,500; in each of the 13 subsequent years, transfer $2,500 to the RESP; and in year 15, transfer $1,000 to the RESP.


In the above solution, please note that you need to assess each choice and then weigh the advantages and disadvantages. That is why it is only at the end of the solution that we choose the best of the alternatives. Of course, if you sell universal life for a living, you might choose Choice A and hope all of the members of the Exam committee do as well.

A candidate who wrote the Exam told us that she found the questions were more general than she expected and she did not need any technical knowledge to answer them.

We think that this question might be one of her general questions. However, we also think that you would need considerable knowledge to answer it correctly.

                                                   


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