**Choosing the right investments for retirement shapes your future financial stability.**
In Canada, a popular retirement savings option is the Registered Retirement Savings Plan (RRSP), which offers tax benefits to encourage long-term savings.
Whether or not the RRSP is useful for you is highly dependent on your current financial situation. If you’re a high-income earner, you will generally benefit more from the RRSP than someone who is a low-income earner.
This is because you can contribute money at a higher nominal tax bracket in your working years and withdraw it at a lower one. It doesn’t provide much benefit if your nominal tax bracket is the same in retirement as when you’re working.
However, it is highly likely at one point or another in your life you will contribute to an RRSP. So, we’re going to go over some popular ETFs to hold inside of one.
Make sure to check the bottom of this article as we go over some very important considerations from a tax perspective when it comes to US exposure inside of an RRSP.
Let’s get started.
What are the best ETFs to hold inside an RRSP?
Vanguard S&P 500 ETF (VOO)
Vanguard S&P 500 ETF (VOO) is one of the most established and widely recognized ETFs tracking the S&P 500 Index, providing broad exposure to large-cap US stocks. Because this is a US-domiciled fund, you won’t pay a withholding tax on the distribution if held in your RRSP (more on this at the bottom of the article.
If you own VFV, the Canadian variant of this fund, you will pay a withholding tax on the distribution.
Key Attributes:
- Diversification: VOO offers diversification across the top 500 companies in the US, including some of the most popular companies on the planet, such as Apple, Microsoft, Tesla, Alphabet, and Berkshire Hathaway.
- Liquidity: VOO is one of the most liquid S&P 500 ETFs on the planet, which allows one to buy and sell the fund without issue.
- Low Expense Ratio: VOO has a management fee of just 0.03%, meaning you’ll pay just 30 cents a year for every $1000 you have invested in the fund.
The fund has over $1T in assets under management and currently pays a distribution yield of around 1.34%.
It is important to note that you’re primarily investing in VOO here for capital appreciation and total return, not dividends.
If you want to diversify your portfolio into more US stocks, VOO provides an outstanding opportunity to do so.
iShares S&P/TSX 60 Index ETF (TSE:XIU)
Although US exposure is nice, you may still want some exposure to your home country when it comes to your TFSA. When considering the best Canadian ETF for your RRSP, you might want to look at the iShares S&P/TSX 60 Index ETF (TSE:XIU) from Blackrock.
This particular ETF offers you exposure to 60 of the largest and most liquid stocks listed on the Toronto Stock Exchange (TSX). It mirrors the performance of the S&P/TSX 60 Index, giving you a comprehensive snapshot of the Canadian equity market.
Why does the US have the S&P 500 while we only have the TSX 60? Size, primarily. Our economy is simply too small to have an index that large. For this reason, we stick with the TSX 60, which makes up 95% of the Canadian market.
An interesting fact: XIU was the first ever ETF and began trading way back in 1990. It is the most liquid ETF in Canada, with assets under management north of $13B.
XIU boasts a competitive expense ratio of 0.18%, meaning you’ll pay $1.80 a year for every $1000 you have invested. It’s not as cheap as some US-listed ETFs. However, with lower AUMs, these smaller Canadian funds need to charge a higher fee to operate.
Investing in XIU within your RRSP can be a strategic move to achieve long-term capital growth with the added benefit of the tax advantages associated with RRSPs.
You can also avoid many of the cyclical options on the TSX that are exposed to the oil and gas, financial, and material sectors by simply holding the top 60 companies. It is still cyclical, no doubt, but not as much.
iShares Core Equity ETF Portfolio (TSE:XEQT)
The iShares Core Equity ETF Portfolio (TSE:XEQT) stands out for several strategic reasons.
XEQT provides access to a globally diversified portfolio. This means your investment is spread across various regions, reducing the risk associated with concentrating on a single market.
While the S&P 500 and TSX 60 expose you to 500 and 60 stocks, respectively, XEQT has over 10,000 holdings that give investors single-click exposure to the entire global markets. You still get that US and Canada exposure, but you also get much more.
XEQT has a low expense ratio of 0.2%. You may think that is high, considering the other ETFs on this list. But keep in mind that this fund is much wider reaching and has an added level of convenience.
The ETF has a quarterly distribution, but it’s not much. It yields around 1.93% and aims to provide investors with a higher total return than dividends.
The fund is rebalanced automatically, aligning with target asset allocations. This saves you time and the effort of manual rebalancing if you are an individual stock picker.
Overall, all-in-one ETFs are catching on in a big way, and XEQT is no different. They’re certainly a solid option for those looking for a one-click solution to tracking the markets.
Of note is that there is a wide variety of all-in-one funds available in Canada, such as XBAL, VEQT, VBAL, VGRO, and XGRO.
What is the main difference between them all? Equity to fixed income allocation, primarily. Some will be 80/20, some 60/40, and like XEQT, some 100% equity. It is important to understand your overall risk tolerance and financial goals when choosing one of these ETFs.
Schwab U.S. Dividend Equity ETF (SCHD)
When considering an Exchange-Traded Fund (ETF) for your Registered Retirement Savings Plan (RRSP), the Schwab U.S. Dividend Equity ETF (SCHD) stands out for several reasons.
First, it is a low fee. It has a total expense ratio of only 0.06%. This is lower than you’ll see with most Canadian-listed ETFs and is primarily due to the fact that US ETF fund providers have access to a much wider pool of capital, which allows them to operate efficiently on lower fees.
This ETF offers potential for tax efficiency because it is a US-domiciled ETF. Unlike a Canadian ETF that holds US stocks, you’ll avoid the withholding tax in an RRSP with SCHD.
SCHD’s primary objective is to mirror the performance of the Dow Jones U.S. Dividend 100™ Index, which is renowned for its focus on high-quality dividend-paying stocks.
The ETF’s methodology selects companies based on strong financial ratios, not just yield. With SCHD, you’re not just investing in any dividend-paying stocks but in those that are considered to have a more reliable payout and have been growing earnings consistently.
This strategic focus on sustainable dividends could be especially beneficial in providing income during your retirement years.
Including SCHD in your RRSP aims to provide a steady income stream through dividends while also emphasizing the long-term growth potential of US companies. This can serve as a strategic component of a diversified portfolio.
BMO Aggregate Bond Index ETF (TSE:ZAG)
When considering diversification for your Registered Retirement Savings Plan (RRSP), incorporating a mix of asset classes can be wise. This, of course, depends on your risk tolerance and is going to be different from investor to investor. However, I thought I’d include a bond ETF on this list regardless.
The BMO Aggregate Bond Index ETF (TSE:ZAG) offers a solid choice for fixed-income exposure within your portfolio.
It aims to provide a return that replicates the performance of the FTSE Canada Universe Bond Index and includes a variety of investment-grade fixed-income securities, such as Federal, Provincial, and Corporate bonds with terms greater than one year.
This gives you a balanced blend that is particularly valuable in times of economic uncertainty or stock market fluctuations.
The fund has an expense ratio of 0.09%, meaning you’ll pay 90 cents annually for every $1000 you have invested. Considering of how much of a pain it would be to collect and buy all of these bonds individually, this is a relatively low cost to pay.
It yields 3.55%, much more than any other fund on this list. However, it likely has the lowest room for capital appreciation. It is more so seen as a hedge against market volatility.
Fixed-income investments generally have lower risk levels than equities. This means ZAG could serve as a counterbalance against the market’s ups and downs.
In an environment of falling rates, it could also be seen as a capital appreciation play, as bonds tend to be inversely related to policy rate movements.
Why ETFs in your RRSP?
Exchange-traded funds (ETFs) have become a favoured option within RRSPs due to their cost efficiency and diversity.
With an ETF, you can invest in a basket of assets, such as stocks or bonds, which can help spread out risk while providing the potential for steady growth.
The landscape of ETFs in Canada is vast, with options ranging across various sectors and asset classes. The investment vehicle has simply exploded in popularity over the years.
When considering ETFs for your RRSP, the management expense ratio (MER) is important, as it can impact your returns over time.
Canadian ETFs typically offer lower MERs compared to mutual funds, making them the preferred choice among DIY investors.
Because there are so many ETFs these days, you must consider funds that align with your investment goals, whether you’re looking for global equity exposure, Canadian stocks, or even U.S.-specific holdings.
Understanding the RRSP and its benefits
Registered Retirement Savings Plans (RRSPs) are an essential part of retirement planning in Canada.
This government-sanctioned program allows you to save for your retirement in a tax-efficient way, mitigating your taxable income during your highest-earning years.
Benefits of RRSP:
- Tax Deferral: Your contributions are tax-deductible, meaning they reduce your taxable income for the year in which they are made. This deferral can create significant tax savings. If it isn’t optimal from a tax perspective, you can always carry contribute room and even contributions forward to future tax years.
- Tax-Sheltered Growth: Investments in your RRSP grow tax-free until withdrawal, allowing your portfolio to benefit from compound growth without the drag of taxation.
- Diverse Investment Options: You can include a variety of investment vehicles, such as ETFs, bonds, stocks, and GICs, within your RRSP.
- Flexibility for Withdrawal: While RRSPs are intended for long-term savings, you can access your funds through programs like the Home Buyers’ Plan (HBP) or the Lifelong Learning Plan (LLP), albeit under certain conditions.
Remember, the objective of an RRSP is to build a substantial nest egg for your retirement. Utilizing an RRSP helps to ensure that you have a reliable source of income when you do hang up the proverbial skates.
Why hold US stocks and ETFs in an RRSP
Investing in US stocks and ETFs within your Registered Retirement Savings Plan (RRSP) can be a tax-efficient strategy for long-term growth.
One of the primary advantages is the favourable treatment of dividends. Normally, US dividends are subject to a withholding tax for non-residents.
However, under the Canada-US tax treaty, holding these investments in your RRSP exempts you from this tax. By holding your US stocks and ETFs within an RRSP, you avoid the 15% foreign withholding tax that would apply to dividends outside of this retirement account.
When you invest in US-listed ETFs (more on this in a bit) through your RRSP, you’re investing in a diversified portfolio that may include hundreds or thousands of stocks.
You should consider a mix of investments, and US stocks and ETFs might be a strategic component of your diversified, long-term retirement portfolio.
A withholding tax catch you may not know about with an RRSP
Many Canadian investors hear that if they hold US stocks or ETFs inside an RRSP, they can avoid a 15% withholding tax on the dividends. For the most part, this is true. However, you may be purchasing funds with the intention of avoiding the withholding tax, but in reality, you’re paying it anyway.
That is because if you own a Canadian-domiciled ETF that contains US-domiciled stocks or ETFs, you will still pay a withholding tax inside an RRSP. In addition, unlike a non-registered account, where you would be able to recover the tax via the foreign tax credit, with registered accounts like an RRSP or Tax-Free Savings Account, you lose the tax and cannot recover it.
The most obvious example I am bringing up is whether to hold the Vanguard S&P 500 Index ETF in Canadian or US dollars. Those holding VFV, the Canadian version, will pay a withholding tax on the distribution even if held in an RRSP. On the other hand, those who hold VOO, the US version, will not.
Considering VFV simply holds VOO, many investors are likely confused by this. But when you think about it, it makes sense. VFV is a Canadian-domiciled fund which holds a US-domiciled ETF, VOO. This makes it eligible for withholding taxes even in an RRSP.
For this reason, putting all other considerations aside and only focusing on the withholding tax situation, you are better off holding US-domiciled ETFS inside your RRSP than a Canadian version.
I’ll attach an image below that should help clear the air on this situation a bit more.
