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May 29, 2023

Insights From ETFs ETFs for the Registered Education Savings Plan (RESP)

by Barkha Rani

Registered Education Savings Plans (RESPs) are designed to help Canadian parents save for their childrenís post-secondary education. An RESP is a tax-sheltered savings account that a parent, guardian, grandparent or other relative/friend (called a subscriber) over the age of 18 can open for a child under the age of 18 (called the beneficiary). An RESP can be used to cover any education-related expenses once enrolment in a qualifying post-secondary program can be confirmed. Eligible expenses can include tuition, books and transportation. The federal government provides a 20% Canadian Education Savings Grant (CESG) grant on the first $2,500 contributed annually, up to a lifetime maximum of $7,200 per child. Low- and middle-income families can also qualify for up to $2,000 from the Canadian Learning Bond (CLB).

Advantages of an RESP

RESPs offer an excellent way for parents to save for their childrenís post-secondary education as they offer several advantages. First, RESP contributions are tax-deductible, up to a certain limit, meaning parents can save money on their taxes. Second, government grants for different income levels help boost total savings in the RESP. Additionally, investment earnings and gains in an RESP can grow tax-free until withdrawn, which can result in significant savings over time. Lastly, the money can be withdrawn tax-free to pay for qualified expenses including tuition, books and living expenses.

How Does an RESP Work?

Eligible funds contributed to an RESP by the subscriber compound tax-free until the funds are withdrawn for educational purposes. When the funds are withdrawn for the studentís education, the student claims them as income. Students are usually in a lower tax bracket than the subscriber, and therefore taxes on the earnings and grants will be lower.  Unused RESP funds can be rolled over to a Registered Retirement Savings Plans (RRSP) or transferred to another beneficiary.

To optimize an RESP, it is important to start early and contribute consistently. When choosing investments for an RESP, it is important to consider the childís time horizon and risk tolerance with the capital. For example, for younger children who are many years away from starting post-secondary education, a portfolio tilted to growth-oriented assets may be more suitable. As a child gets closer to the age of starting post-secondary education, it may be prudent to move some or all the RESP assets into conservative assets such as bonds, GICs or even cash.

Exchange-Traded Funds (ETFs) offer an attractive option for investing in an RESP given the ease, low fees, and more flexibility. ETFs also help reduce the workload with maintaining a portfolio of securities as they are often rebalanced in tandem with the underlying index.

Here are a few ETFs that you can consider for an RESP:

iShares Core MSCI All Country World ex Canada Index ETF (XAW)

Offering global exposure, the iShares Core MSCI All Country World ex Canada Index ETF (XAW) tracks the performance of the MSCI All Country World ex Canada Index, which includes companies from both developed and emerging markets. Nearly 61% of fund assets are invested in U.S. companies. Sector-wise, Information Technology, Financials and Healthcare are the top sector exposures. XAW charges a Management Expense Ratio (MER) of 0.22%, offers a distribution yield of 1.65%, and manages just over 9,000 underlying securities.

iShares Canadian Select Dividend Index ETF (XDV)

The iShares Canadian Select Dividend Index ETF (XDV) tracks the performance of the Dow Jones Canada Select Dividend Index and offers exposure to invest in Canadian equities. The benchmark includes companies that have a history of paying high dividends. By holding XDV, investors can achieve exposure to Canadian equities and earn dividend income. The fund charges an MER of 0.55%, offers a distribution yield of 4.2% and manages 30 underlying securities. Not surprisingly, Financials represent nearly 50% of the fundís total assets, while Utilities and Communications represent 12% and 11.7%, respectively.

iShares S&P/TSX 60 Index (XIU)

The iShares S&P/TSX 60 Index (XIU) is an excellent option for investors who want broad exposure to the Canadian stock market. The ETF tracks the performance of the S&P/TSX 60 Index, which consists of 60 of the largest and most liquid Canadian stocks. The fund charges a low fee of 0.18% and offers an attractive distribution yield. The top sector exposures are Financials at nearly a third, Energy at 17%, and Industrials at 13%.

Vanguard FTSE Canada All Cap ETF (VCN)

The Vanguard FTSE Canada All Cap ETF (VCN) tracks the FTSE Canada All Cap Index, which includes small, mid, and large-cap Canadian stocks. Small and mid-cap exposures are beneficial for investors with young children as they have a longer timeframe before the money is withdrawn. Nearly 20% of VCNís assets are invested in mid- and small-cap companies. Charging a fee of 0.06%, VCN is one of the most affordable ETFs in the market.

iShares Core S&P500 Index ETF (CAD-Hedged) (XSP)

Investors looking to diversity the RESP portfolio with exposure to the U.S. stock market should consider the iShares Core S&P500 Index ETF (CAD-Hedged) (XSP). This ETF tracks the performance of the S&P500 Index, which includes the 500 of the largest U.S. stocks. XSP is included in this list (instead of SPDR S&P 500 ETF Trust (SPY) ) for vanilla-like investors who want to eliminate currency risk since XSP is CAD-hedged. XSP has an expense ratio of 0.10%.

iShares Canadian Universe Bond Index ETF (XBB)

Investors who want to add fixed income exposure for diversification benefits can consider iShares Canadian Universe Bond Index ETF (XBB). This ETF tracks the performance of the Barclays Capital Canada Aggregate Bond Index, which includes a broad range of Canadian investment-grade fixed income securities. The fund makes a monthly cash distribution and is well-diversified across maturities. Nearly 38% of XBBís assets are invested in federal bonds, with another 35% in provincial bonds, with the remaining invested in corporate bonds. Nealy 73% of total exposure is rated AA or above. XBB charges an annual fee of 0.10% and currently has a distribution yield of 2.90%.

When considering ETFs for an RESP, it is important to note factors such as expense ratios, diversification, and the overall investment mandate for the fund. Investors should also consider the different types of ETFs available, such as those that track an index, provide exposure to a specific sector or region, tracks a different asset class, or those that are actively managed.

Additionally, investors should also consider a childís age and the expected education expenses. RESPs for younger children have a longer investment horizon, allowing for more risk in the portfolio, whereas, an RESP for a child nearing the start of their post-secondary education, may require a more conservative portfolio.

Lastly, parents should also be aware of the fees associated with RESP accounts. In addition to the fees associated with ETFs, RESP accounts may also charge account administration, contribution, or withdrawal fees. It may be beneficial to shop around and choose an RESP that has low fees and does not erode investment returns.

Overall, RESPs are a smart way for Canadian parents to save for their childrenís post-secondary education while taking advantage of government grants and tax benefits. By using ETFs, parents can optimize their RESP portfolios and help ensure that their children have the financial means to pursue post-secondary education. 

By Barkha Rani, CFA
Analyst for 5iResearch.ca
Disclosure: Authors, directors, partners and/or officers of 5i Research have a financial or other interest in XIT and ZRE.