Children are expensive – a new bike, the latest gadgets, a backpacking vacation and their future education – it all adds up. One of the most important parts is planning ahead, and, that starts with the right professional advice. That’s why 24 per cent of households with people under the age of 45 with an advisor had RESPs, compared to just 14 per cent of households without an advisor. Now that’s smart advice. [Ipsos 2011, Department of Finance, Canada]
Democracy and political maturity must evolve in tandem through the engagement of all in the responsibilities of citizenship. Proper schooling and a strong civic culture are important, but in the end democratic citizenship is a practice, and the experience of doing it is our best teacher. – @dkorten David C. Korten; The Great Turning, From Empire to Earth Community
The mind is its own place, and in itself can make a heaven of hell, a hell of heaven. – John Milton; Paradise Lost
So earlier this week I stepped in it a bit when I posted an ad on Kijiji that dared to tell people my mission is life is to help them get out of debt. [See previous post here]. The over-all consensus I learned from most people is the debt is just a fact of life you have to use credit cards and borrow in order to get anything done. You need money to make money, etc.
I’m sorry to say it, but that couldn’t be more wrong.
What’s the big deal with carrying a little debt? You ask. Everybody has some debt, right? Maybe so, but that doesn’t make it right or a good idea. As my mom one asked, “I all your friends were going to jump off a bridge, would you?”
The point is that debt always has a cost and apart from the obvious interest charges the biggest cost to carrying debt is in lost opportunities.
I have a friend who recently came back from vacation and told me that she now has over $30,000 in debt on her line of credit. She and her family had a wonderful summer vacation and made some fantastic memories but at the end of the day they have nothing tangible to show for it.
That line of credit has an annual interest rate of 5%, or $1500 per year. Now because it’s a floating line there is no set time frame that she has to pay it off but if she decided to treat it like a conventional 5 year loan the monthly payment would be approximately $625 per month.
My friend’s son is starting high school next week. In four years he will be getting ready to go off to college and to date she has saved nothing for his education. A four year degree in Canada now costs on average $25,392 not including housing and other living expenses. In order to save that amount of money in the next four years, assuming a 6% return on investments my friend has to start putting away approximately $515 per month.
Now, in order to pay off her debt and put her son through school, my friend has to spend over $1000 per month. She simply can’t afford that and keep her lifestyle where she wants it.
Her thinking is actually to pay the minimum amount on her line of credit, which is about $250 per month so that she can focus on saving for her son’s education. In the short term that would save her about $400 per month but in the end extend her debt from 5 years to over 20 and end up costing over $60,000 to pay off $30,000.
Now consider this.
If she were to cut back her lifestyle a bit and accelerate the debt repayment to $1000 per month she would be out of debt in about 2 years and save nearly half of the interest charges. She could then turn around and put that same $1000 into her son’s education and still have it fully funded by the time he is ready. She could be out of debt and have a fully funded education fund for her son in just 4 years! That’s a full 16 years sooner than she would have been debt free using her own scenario. If she were to then invest that $1000 per month in her own savings plan for the next 16 years she could amass a staggering $680,000!
The bottom line is this. Her plan to take 20 years to pay off her line of credit will cost her nearly three quarters of a million dollars in lost opportunities! She thinks she has to do it this way in order to give her son a future but a more likely scenario is that by staying in debt she is actually showing him a president that will bankrupt his future.
The opportunity cost of staying in debt is just too great. Get out of debt before you become a character in an epic poem by John Milton!
Six Steps to Financial Freedom, Step Four
I have to confess, I personally did not follow my own advice when it comes to paying for my own education. There are a lot of reasons for that, not the least of which being that when I was young the government programs were different and my parents did not have any extra to set aside anyway. So I did what just about everyone else does, I worked my way through college and got a loan backed by the government that I repaid when I got my first job. Fortunately I went to an inexpensive school and was able to find work right away after graduation so I was able to repay my loan within the first year.
In this day and age there are a number of ways that parents can start saving for their children’s education at an early age and eliminate the need for student loans. The key in all of it is to start early and invest wisely. But I put it down as step four because you should never prioritize children’s education over debt freedom or your own retirement plan. If you can’t afford it you are better off teaching your kids the value of hard work, setting them up to work their way through college or university and yes, in this one circumstance a small student loan is not the end of the world. But I stress small loan. A student loan is not a substitute for work, even if your program is so intense that you can only work in the summer, that’s something at least and it helps set you up for the real world.
So that being said, how do we start saving for our children’s education now?
In Canada there are essentially three vehicles that people can use to save for a child’s education: Registered Education Savings Plans (RESP), Life Insurance and Non-Registered Savings.
The RESP is the most common method and in most cases the best option. People place money into a mutual fund or other type of investment plan tax differed, the government matches your investment with a small grant and when you start school you can withdraw the money at the student’s marginal tax rate, which should be close to zero. If you put the money in a decent growth mutual fund it’s reasonable to expect a return of 8-10%. Add to that the government matching grants and it’s not unreasonable for a well designed RESP to return close to 30% on the money you put in. There isn’t another (legal) investment in the world that gives you that type of return.
Consider this, if you were to start investing $100 per month in an RESP returning 10% with the government grant adding an additional $25 per month to your contribution, the investment will have grown to $70,000 by the time your child is 17. Compare that to a non-registered plan without the government grant you would need to contribute $260 per month, more than 2.5 times a much to amass the same amount of money.
Of course if your child doesn’t go to an accredited school the government takes back their grant money but you would still have the $100 per month that was invested at 10% for 16 years that you could use for anything you chose. That’s still $50,000.
So that’s two ways you can invest for education, RESPs and Non-Registered investments but what about using Life Insurance for education?
Now to be clear, I am not proposing that you purchase Life Insurance as an investment. The purpose of Life Insurance is to cover expenses associated with early death or to replace the income of a wage earner. In the case of a juvenile, if there is a history of illness in the family it’s a good idea to start an insurance program in ensure their life-long insurability before they develop something that would make them difficult to insure in later life, like diabetes or a brain tumor (like happened to my niece at the age of 17). But of none of that happens we can’t ignore the cash value in certain types of life insurance.
Take that same $100 per month. If we were to use it to fund a life insurance policy on a one year old boy we could purchase a Life Insurance policy with a starting death benefit of $110,000. In 17 years that policy would be worth $240,000 with the option to purchase up to another $150,000 of insurance with no medical exam. In terms of funding education, that policy could be used as collateral for a loan at better terms than a traditional student loan or could simply be cashed out for about a third of its official face value. As a pure investment play, Life Insurance is not your best option but if you’ve already maxed out the RESP option and there is any concern about the future insurability of your child you should consider purchasing Life Insurance as a long term strategy.
Life insurance is never any less expensive that it is today. No matter what you do it will always cost your children more to buy insurance for them self than you can purchase it for them today, assuming they are even insurable when the time comes.
For more information on these strategies for Engineering Education, or anything else discussed on this page please write to firstname.lastname@example.org