RESPs (Registered Education Savings Plans) are a tool used by many Canadians as a vehicle to save money for their children’s post-secondary education. The government gives great incentives in the form of grants and tax deferrals, which makes it a very attractive option for education savings. However, just as most other financial tools, there is more than 1 option, and you better make sure you do your homework on which one you’re choosing, before you sign on the dotted line!

 

There are generally 2 different types of RESPs – Self-Directed Plans and Scholarship Plans. In a Self-Directed RESP, the contributor has the flexibility to determine how much to invest and how often. They also have the control to determine how and where the funds are to be invested, and if managed properly, the investment can enjoy substantial gains. You can start and stop contributions and also increase/decrease contributions as you so choose – there is no penalty for doing this – and the full amount of your contribution goes into the plan. The vast majority of the population that uses RESPs, has this type of structure.

 

Then there’s Scholarship Plans. Also known as “pooled” plans, this is where all the investors are pooling or ‘grouping’ their money together into this plan. The pool is based on the year of birth of your child – for example, if your child is born in 2012, the money will be pooled together in a plan with all others who were born in 2012. Now, the design of these plans differs significantly from the regular self-directed plans, and there are several key things to watch out for.

 

Fees

 

Investors in Scholarship Plans have to watch out for multiple fees that are built into these plans. Scholarship plans have very heavy loaded front end fees as well as ongoing account/management fees for the investment within these plans. The ongoing management fees for the investment are standard for any fund investment that you get involved with, so that’s not something that’s a big surprise. The massive front end fee, however, is a different story. The front end fee means that the first 2-3 years of your contributions will go towards paying the “Sales Charge”. What is the sales charge? This is you paying your salesperson’s commission for them selling you this product.

 

In the Prospectus of Global RESP Corporation, one of the more well-known companies for Scholarship Plans, it reads “100% of your first Contributions go toward the sales charge until 100% of the sales charge is paid off. Altogether, it will take you up to 26 months to pay off the sales charge.” 26 Months! That is over 2 years of your hard earned money going into your salesperson’s pocket. That is over 2 years of your hard earned money NOT growing. In the Heritage Education Funds Prospectus, another very well-known Scholarship Plan provider, it states that it will take up to 33 months for the sales charge to be paid in full. If anybody knew this fact up front, would they ever agree to get into this plan? Seems doubtful.

 

Lack of Control

 

Another downfall of Scholarship Plans is the complete lack of control that you have over your plan. The RESP Company takes full control in choosing which investments they want to put the pooled money into. Generally, they’re very low risk and provide a low return for plan members – mostly invested into things like Bonds, GICs, Money Market etc… We know everybody has a different risk tolerance and investment objective over time, which is why having a ‘pre-packaged’ product that is the same for everybody doesn’t seem very diligent. For the 2 largest Scholarship Plan providers, the 5 year average rate of return ranges in about the 4-4.5% range. Now, this might not be a ‘horrible’ return, but if an investor decided they wanted to be more conservative and cautious in their investment approach, they could just get that same type of low-risk investment themselves, with possible higher returns, through a Mutual Fund or ETF – and, without paying that heavy sales charge.

 

Lack of Flexibility (contributions)

 

With Self-Directed Plans, you get to decide when you contribute, how much you contribute, and can change those variables at any time without penalty. With Scholarship Plans, once you start, you better not stop or change your contribution; otherwise there may be hefty penalties for doing so. Firstly, if you stop within the first 2-3 years of starting the plan, you would have essentially lost all (or the vast majority) of your contribution, as that money that you have paid into the plan, had gone to pay your salesperson’s commission. However, even after the sales charge has been paid in full, there is a chance that you can lose all or most of the money you contributed into the plan.

 

Generally, pooled plans are structured in a way that, if someone leaves or stops paying into the plan (and resulting in a ‘default’ or cancellation), all of the money (above the sales charge) would stay in the pool and be divided up amongst those plan members who stayed in the plan until maturity. So essentially, your loss is someone else’s gain. There are Scholarship Plans that will allow you to get back into the plan and start participating in the pool again if you do so within certain number of years. However, they would generally require you to make up all the previous missed payments first. Not only that, most plans will also require you to make up the amount equal to the return that was generated from that pool for the time you had been ‘inactive’. Depending on the amount of contribution that was being made prior the payments being stopped and the rate of return that plan had, that could be thousands of dollars that would have to be made up, before you get back into the plan.

 

Some plans offer some type of ‘paid up’ feature, which essentially takes a portion of the amount you contributed since the beginning of the plan, and removes that from the pool and lets it grow over time. This is somewhat of a ‘dim light’ in an otherwise dark room, but the fact remains, a good chunk of your payments are not even part of the calculation (as they were used to pay the sales charge/commission). On top of that, you wouldn’t be eligible for the ‘attritions’ or ‘additional payments’ that the pool provides to the rest of the plan members (which is just the money left behind by those plan members who had cancelled or defaulted their plans) – which, defeats the whole purpose of getting into that Scholarship plan in the first place!

 

We all know that ‘life happens’, and being ‘stuck’ into a payment that essentially is ‘forced’, is not something that is favourable for anybody, let alone a family that might not be as financially stable as others. There is great Value in having the flexibility to choose the regularity of your contributions, and how much you contribute, as well as where you want to contribute. Scholarship Plans simply do not offer the flexibility that someone would want or need.

 

Lack of Transparency

 

These plans seems to have a serious lack of transparency in exactly how they’re set up, the structure, as well as the total fees that a plan member will have to pay. Also, there sometimes seems to be a level of uncertainty as to which post-secondary institutions would qualify to receive the benefit under these plans. There have been cases where students would switch a program within the same University, which resulted in the child not qualifying for payments, or, a child not qualifying for payments because of a strike at the University.

 

The reality is, there are many people who are not aware of how their contributions are being used and what % of their contribution is paying the salesperson’s commission. There are also many salespeople who are promoting ‘guarantees’ that these plans offer, when they don’t offer any. It can be very difficult to fully understand these products as the Prospectus can be anywhere from 50 to 80 pages, and can often confuse many investors.

 

Having full transparency is something that all investors should be given, without having to ask for it. It makes the entire education and investment process much easier and less complicated, and ensures that the investors are getting full Value out of their hard earned money.

 

‘Dropout Rate’ – plans not reaching maturity

 

As mentioned above, the design of these plans tries to ensure that all of the money that goes into this pool stays in this pool. This means, if someone stops paying into the plan or transfers the RESP to another institution, they can lose most or all of the funds that they had contributed up to that point. What then happens is the money in that pool gets split among the remaining clients when it is time for their kids to enter post-secondary schooling. The entire basis of this type of plan is that they know up to 40% of clients will not live out the full life-time of the plan, thus, being able to split more money among less people.

 

That 40% number is not an imaginary number, as that is the approximate percentage of plans that do not reach maturity. Heritage Education Funds has averaged 39.3% of plans not reaching maturity from 2009 to 2013 (indicated in their Prospectus). Global RESP is the only one that doesn’t state this number in their prospectus, but between Heritage and the other 2, they are generally in the same ball park.

 

Regulator Crackdown

 

Over the last decade or so, the amount of complaints that have come up for these Scholarship Plans has skyrocketed. This has caused the regulators to start paying more attention to them and start investigating the Plan Providers. One investigation even found the CEO of one of the companies to be involved in improper business practices, resulting in him being removed by the OSC.

 

Scholarship plans have come under a lot scrutiny (rightly so) over the last several years and there’s even some whispers as to whether these plans will be shut down altogether or not. Regulators have been coming down hard on the Scholarship Plan providers and likely will continue to do so, as the number of complaints continues to increase. Regulators are also finding the business practices of some of the sales representatives to be unethical and misleading, as some sales representatives have been promising and promoting guarantees, where there are none.

 

All these points combined leads us to ask ourselves why these plans are even allowed to be sold. We already know why sales representatives sell these plans – the big payout – but the question as to whether these sales representatives REALLY know what they’re selling or not is one that definitely deserves an answer. The licencing component of RESP Scholarship Plans seems to be very poorly designed, essentially making it so that almost anybody can be licenced to sell these plans within a couple of weeks.

 

 

The high fees, lack of control, lack of flexibility, lack of transparency and regulator crackdown, are all reasons people should think twice about getting into these plans. Often we talk about every product/service having pros and cons, but there doesn’t seem to be any ‘pro’ for getting involved with these products – unless you’re the salesperson making the hefty commission. If you’re not sure whether you’re in a Scholarship Plan or not, you can know by the company your RESP is with. There are 4 Scholarship Plan providers – Heritage Education Funds, Global RESP Corporation, Knowledge First Financial and Universitas Management – so if your plan is with one of these 4 companies, you know you’re in a Scholarship Plan.

 

Post-secondary education costs have been rising annually, and will continue to rise for the years to come, and it is increasingly becoming more important to have a proper savings plan for kids to be able to afford the type of post-secondary education they deserve and want. This is why it is crucial for all investors to make sure that they have a strategy for themselves that ensures their money is working for them in the best possible way, so they can have the funds necessary to pay for the education, when it comes time. RESPs are a great tool to use to save for children’s post-secondary education, if used properly, but be aware; not all RESPs are designed alike. This is where the advice of an Elite Financial Advisor can help you to determine the best course of action for you.

 

An informed investor is always going to come out ahead of someone that is not informed, and it is becoming increasingly more important for clients to have as much knowledge as possible about their options, so as to empower them to make the best decisions for themselves. In today’s investment landscape, where there are so many different options, clients along with their Financial Advisors need to evaluate all the details of each option, before making a decision.