Ellen Roseman’s recent column and blog post on group scholarship plans generated a lot of comments, including the following from a group RESP seller on how the fees of group RESPs stack up against bank mutual funds:
Banks promote their family of mutual funds as the investment vehicle for just about anyone who wants to save for their child’s education with average MER’s of 2.65%. Go to a bank and ask to see for yourself, like I have. By the time junior is off to college or university, the total fees paid by the family to the bank is about 300% higher than with scholarship plans and that’s before we even calculate the erosion of compounding interest by this annual fee that is charged.
While I’ve never been a fan of high-cost mutual funds, the claim that the MER on group scholarship plans works out to 0.9% can only be justified with a lot of fuzzy math. At first glance, it doesn’t sound unreasonable: the Canadian Scholarship Trust, for instance, charges an administration fee of 0.5% and a portfolio management fee of 0.10% to 0.30% on plan assets. There are some miscellaneous fees such as depository fees and trustee fees that we’ll ignore for the purposes of this post. The total administration and portfolio fees, roughly, totals 0.90%.
The typical sales pitch is that though there is a steep enrolment fee charged initially, it is refunded partly or in full. But attention must be paid to the details — the enrolment fee refund is in nominal dollars, without any adjustment for growth and inflation. A promise to repay $200 eighteen years in the future is only worth $83 in today’s dollars at a 5% discount rate. This is a real cost that must be accounted for in calculating the MER of group scholarship plans.
I constructed a spreadsheet with the following assumptions: (1) A rate of return of 5%. (2) Annual contributions of $105. (3) An enrolment fee refund over 4 years. A self-directed RESP earning 5% would total $3,101 after 18 years. The group scholarship plan would deduct an enrolment fee of $100 from the first year’s contribution and $50 from the second and third years. At the end of 18 years, the plan should add back the present value of four future enrolment fee refund payments. The difference between the rate of return of the self-directed RESP (5%) and group scholarship plan is a fair estimation of the impact of enrolment fees:
At full refund, the group plan earned a return of 4.05%.
At a 50% refund, the group plan earned a return of 3.75%.
At no refund, the group plan earned a return of 3.4%.
So, the total impact of all the fees on a group scholarship plan is of the order of 2.15% (1.25% for the impact of the enrolment fees and 0.9% for other fees). While that compares favourably with high-MER mutual funds, it is certainly not 3 times cheaper. And parents have a much better option than having to choose between Tweedledee and Tweedledum: they can walk down the street to a TD Canada Trust branch and open a RESP account and invest in TD e-Series mutual funds for a total cost of less than 0.5%. Now, that is more than three times cheaper.
