Regular RESP contributions have the additional benefit of dollar-cost averaging: investing equal amounts of money at regular intervals (say, once a month) instead of larger lump sums less often (say, once a year). This decreases market risk and smooths returns over time. Let’s run some numbers using a simplified example. If you were to contribute $2,500 annually, you would reach the $7,200 CESG limit in the RESP’s 15th year. The $50,000 contribution limit could be reached by making a bigger contribution—$7,500—in year 18. Assuming a 6% average rate of return, the final RESP account balance would be $101,514: $50,000 from contributions, $7,200 from the CESG and $44,314 from investment income.
Liut’s take on this approach: “This is a great option for many people who don’t have extra money to contribute upfront but want to maximize the CESG. For those who have extra non-registered funds, however, I am often asked if a lump-sum contribution is the best approach.”
Next, we’ll explore using a lump sum to front-load an RESP.
Option 2: Front-load the maximum RESP contribution
Few families will have the ability to contribute the maximum $50,000 in year one, and this approach also carries the risk of markets slumping soon after investments are purchased. However, it’s worth considering this option to see the potential benefits of getting investments tax-sheltered early.
Contributing the maximum $50,000 in year one would only result in $500 of CESG. On the other hand, all that money can grow tax-free for the full 18 years. For illustration purposes, assuming a 6% average rate of return as in our first example, front-loading with $50,000 would result in a final balance of $144,144: $50,000 from contributions, $500 from CESG and $93,644 from investment income.
So, we have our answer, right? Not so fast.
Disadvantages of front-loading an RESP with a large lump sum
Even though front-loading appears to be a better strategy than option 1 because of the higher overall return, here’s why it’s not: It ignores the fact that if the $50,000 had not been used to fund the RESP, it could have been invested elsewhere. Those investment returns, particularly if they are received within a tax-sheltered account like a TFSA or RRSP, would negate the benefit of front-loading. To be beneficial, any lump-sum contribution must come from funds available after RRSPs and TFSAs have been maxed out.
“The benefit of lump-sum RESP contributions is really to move funds into a tax-sheltered account as early as possible,” says Liut. “So, it only works if the other registered accounts are already being maximized.”