Pay Now or Later for Education?

As university students head back to school, many new parents are probably wondering just how they’ll manage to pay for post-secondary education by the time their little ones are ready.

Once you consider tuition, accommodations, transportation, food and other expenses, the average year of post-secondary schooling in Canada costs $19,500. Assuming a three per cent rate of inflation, that equates to $33,197 per year 18 years from now.

Continuing with the same three per cent inflation rate, a four-year program starting in 2036 would run a total bill of $138,884.

So, the big question weighing on new parents’ minds – how am I going to pay for this bill? The first answer is that you don’t have to pay this bill at all. The next generation is fully capable of applying for grants and student loans and taking responsibility for their own education expenses.

If you’re like many Canadians who don’t have enough saved for your own retirement yet, a financial planner might suggest that your own retirement savings are a larger priority after reviewing your overall fiscal situation.

But for those that can help, what’s the best option?

#1 – Pay Now: A lump sum investment of $48,655 today would grow to $138,877 in 18 years based on a six per cent average annual rate of return. Ideally, this money would be put into a TFSA account if you have the room so that the $90,222 of growth would be tax free.

#2 – Pay Monthly: If you were to invest $325 per month in a Registered Education Savings Plan (RESP) account (also assuming six per cent average return) and add on the $500 per year in basic CESG grants (up to $7,200 max) that this RESP contribution would earn, you would end up with $138,390 in the RESP account in 18 years. This would require a total investment of $70,200 of your own money in contributions.

#3 – Pay Then: If you elect to wait until the child starts school and pay the full costs at the beginning of each school year, you would need to have the excess cash on hand to foot the bill that starts at $33,197 on year one and climbs to $36,275 by year four.

#4 – Pay After: Most students can qualify for interest-free student loans while they’re in school. After graduation, you typically have 10 years to repay these loans and interest is charged during this time. Assuming an interest rate of 6.2 per cent which generates monthly payments of $1,555.88, you would end up paying a total of $186,705 which includes interest amounts of $47,821.

One option that I often suggest to clients that have saved up money inside a RESP is to have the students take out student loans for the amounts that they need (since it will be interest free while they’re in school) and then offer to repay some or all of these loans upon graduation based on criteria that you’ve set out.

One parent might simply say that if they graduate, the loans are repaid, and another might add incentive/motivation by setting out a scale of repayment based on their final grades. The RESP money would be pulled out of that account and set aside in another investment account until graduation which also allows it to continue growing for four more years.

Looking back at option #1 (pay now) and allowing the lump sum to grow until graduation (22 years) instead of for 18 years, you would only need to put away $38,539 to reach the same goal.

If and how you help fund a child’s education is up to you but there are several ways to go about doing so and some will end up costing you far more than others. Consider sitting down with a Certified Financial Planner professional to see what option works best for you.