Andrew Pyle
August 25, 2023
Education costs and student debt strengthen the need for RESPs
It is hard to believe that this time next week, September will be on our doorstop and with it, all the things that are associated with the first month of autumn. Leaves will change, temperatures will fall, and kids will go back to school – including those that are heading to trades school, college and university. For some of these young Canadians, there may not be any concern over how much the coming year is going to cost and how they will pay for it. They are the fortunate minority. For others, prices for tuition, books, lodging, food, and transportation have escalated to the point where stress is going to come from more than just exams.
For more than two years, Canadians have been dealing with consumer price inflation that has been well above the Bank of Canada’s target of 2% and few categories have been spared from significant upward pressure in prices.
Since the end of 2021, food prices in Canada have risen by more than 15% and there has been little indication that the trajectory is reversing anytime soon. Over the past 20 years, food prices have risen by about 81% so what has happened in less than two years represents close to a quarter of the overall rise in food costs in two decades. On an average annualized basis, food prices have risen by 3% per year. This is pretty much the annualized increase that we have seen in tuition costs.
According to Statistics Canada, undergraduate students paid about 2.6% more in tuition fees for the 2022-2023 school year, compared to the prior year. The CPI tuition sub-index was indeed up 2.3% in July from July last year. What is interesting is that the average annual pace of tuition inflation has not materially changed in the past three years. Still, the consistent increase of 3% each and every year in tuition and food costs has outpaced general consumer price inflation.
The other cost pressure being exerted on young Canadians is the dramatic rise in borrowing costs. During school these higher interest rates will make credit card bills harder to pay and we know that credit card usage is climbing as individuals look to fill the gap between income and education costs. Student loan debt, which doesn’t impact the person while in school, still represents a major challenge once studies are done and the debt needs to be repaid. According to the Maclean’s 2022 Guide to the Economy, the total notional value of student loans owed to the federal government was north of $22 billion in 2020. There was a temporary freeze on debt payments during the pandemic, but higher rates now are going to compound the problem of paying back debt on schedule.
For those heavily in debt from the time they spent in post-secondary education and training, they may wish they had devoted more time and resources to planning ahead, and this is probably felt more acutely by their parents. Students who have not yet graduated from high school may fear for their financial future and opt out of continuing their education. In a world where we are increasingly talking about job dislocation from AI and automation, the choice to not continue education because of cost fears is a tragic one.
Therefore, students, parents and caregivers need to be even more proactive from a financial planning perspective before reaching high school graduation. One of the most popular vehicles for saving towards continued education is the Registered Education Savings Plan (RESP), although there are major differences in the utilization of this plan across the provinces and income groups.
As the above chart shows, RESP assets grew strongly from the time the government started providing Canadian Education Savings Grants in 1998 to 2012. Since then, growth has slowed and assets have not even grown at a 2% average annual pace from 2012 to 2019. The mean level of assets held in RESPs in 2019 was just a little over $10,000.
Let’s stop there for a moment. The lifetime contribution limit per beneficiary is $50,000 and an RESP can remain in existence for up to 36 years. As you know, I have written about RESPs before and I have been critical of the fact that contribution limits and grants have not kept pace with inflation. From the statistics, however, the counter-argument would be that Canadians are not taking advantage of the maximum contribution limit anyway, so why bother raising it? It is a fair question, especially even after accounting for different income categories in Canada.
As the chart below shows, even at the highest income quintile, the mean level of RESP assets in 2019 was barely half of the lifetime contribution. At the bottom quintile, we are talking about mean level of assets of about $10,000. This divergence across income groups in Canada has given rise to tremendous debate over things like free tuition and debt forgiveness. I will refrain from weighing in on those direct fiscal policy questions, but I will bring it back to RESPs.
First, there is no reason why families should not be utilizing the tax-deferred advantages of an RESP to help provide funds for post-secondary education for their children or grandchildren down the road. When we sit down with families and create financial plans that incorporate an education module, we have to make assumptions. No different than plugging in spending and investment return assumptions. With annual post-secondary education costs already in the $20,000 neighbourhood for students not living at home, we are talking about $80,000 for a four-year program in today’s dollars. For a child born today, that means that the cost of education could be $33,000 per year based on the average increase over the past 20 years.
Keep in mind that this is a one-year cost. Let’s assume that for every child born, the parent(s) are magically able to put $50,000 into that child’s RESP. Let’s also make a conservative assumption that the average rate of return on that RESP until the child reaches 18 is the same as the average annual inflation in education costs. This would mean that that the lump sum contribution would grow to provide 2.5 years of post-secondary education. Not bad, and there is some merit to the argument that the RESP is a supplement and that the student should contribute to these costs. The problem is that the mean RESP asset level is not anywhere close to $50,000.
This doesn’t mean the strategy shouldn’t be used. Afterall, anything that can be contributed to the higher cost of learning means less stress and, potentially, less debt. The question is how can we get RESP contributions higher? With families facing higher debt costs and prices at the grocery store, this might sound like a ridiculous question, but it comes down to incentivization. This year, the federal government rolled out its First Home Savings Account (FHSA) in an attempt to help Canadians keep up with the massive rise in home prices. It was the perfect combination of an RRSP (where one can realize the tax benefit from contributions) and a TFSA (where withdrawals are not taxed). Home affordability and supply is a major, major problem for Canada, but so is education and treating the growing problem of student debt. If an RESP can play a role in addressing this, then why not treat it like the FHSA?
First, the FHSA is held by the prospective first-time home buyer. The annual maximum contribution of $8000 provides a tax break for the buyer, not the person providing the funds towards it (which will often be a parent, grandparent or other caregiver). On the RESP, why not make the contributions tax deductible for the owner, even though the beneficiary is someone else? Furthermore, why not allow the payments that come from the RESP tax free? Currently, when an RESP pays out, the funds are taxed in the hands of the beneficiary. Since that young person is probably in a much lower tax bracket, the tax paid will be much less than what would have been paid on the investments if the owner of the account held it in a non-registered account instead of the RESP. The math is sound, but it doesn’t mean it is optimal.
With fiscal discipline around the world somewhat lacking, this may not be seen as the time to initiate another tax initiative that comes with a dollar tag. Yet, if we think of human capital the same way we think of the housing stock and want to stimulate it, then spending some dollars today in terms of providing tax relief to accelerate RESP balances is worth it. But, we also shouldn’t wait for changes to happen to decide on using RESPs to help fund what will be an expensive education future for young Canucks. And, on a final note, for those with RESPs make sure you are closely watching the asset allocation strategy in those accounts, especially as the beneficiaries get close to starting their post-secondary journey. The closer they are, the more defensive the RESP should be since one really bad year for markets can strip away much needed capital.
On behalf of the Pyle Group, have a wonderful weekend.
Andrew Pyle
CIBC Private Wealth consists of services provided by CIBC and certain of its subsidiaries, including CIBC Wood Gundy, a division of CIBC World Markets Inc. “CIBC Private Wealth” is a registered trademark of CIBC, used under license. “Wood Gundy” is a registered trademark of CIBC World Markets Inc. This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed and is subject to change. CIBC and CIBC World Markets Inc., their affiliates, directors, officers and employees may buy, sell, or hold a position in securities of a company mentioned herein, its affiliates or subsidiaries, and may also perform financial advisory services, investment banking or other services for, or have lending or other credit relationships with the same. CIBC World Markets Inc. and its representatives will receive sales commissions and/or a spread between bid and ask prices if you purchase, sell or hold the securities referred to above. © CIBC World Markets Inc. 2023.CIBC Wood Gundy, a division of CIBC World Markets Inc. Insurance services are available through CIBC Wood Gundy Financial Services Inc. In Quebec, insurance services are available through CIBC Wood Gundy Financial Services (Quebec) Inc.
Clients are advised to seek advice regarding their particular circumstances from their personal tax and legal advisors.
Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. The views of Andrew Pyle do not necessarily reflect those of CIBC World Markets Inc.