Levered Investing As An Alternative To An RRSP or TFSA

Preparing for life after work. RRSPs, RRIFs, TFSAs, annuities and meeting future financial and psychological needs.
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Park
Silver Ring
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Levered Investing As An Alternative To An RRSP or TFSA

Post by Park » 13 May 2017 17:06

http://www.theglobeandmail.com/globe-in ... cle543383/

The above comes from a 2012 article in the G&M by Tim Cestnick.

Assume you have $5000 aftertax to invest annually, a 20 year time horizon, a 7% rate of return and a marginal tax rate of 46%.

The first scenario assumes that you put $5000 each year into an RRSP and invest the yearly tax savings in a TFSA. After liquidating the portfolio in 20 years, you have $204.977.

In the second scenario, you invest the $5000 yearly into an TFSA. In 20 years, you have $204,977.

In the third scenario, you invest the $5000 yearly into an open account. If on assumes that all returns are cap gains and taxed only at the end of 20 years, you would have $180,832. If the return is yearly interest income with the corresponding taxation, you'd have $145,537.

In the fourth scenario, you use the $5000 to pay 7% interest on an interest only loan. You'd be able to borrow $71,400. Assume the only tax you pay on the $71,400 will be cap gains tax at the end of 20 years. Assume that you invest the tax savings from the tax deduction in a TFSA. After paying off the loan in 20 years and liquidating the portfolio, you'd have $276,295.

A reasonable criticism is that assuming the only tax you'd pay would be cap gains tax after 20 years is not realistic. However, the assumption that interest and growth will be the same might be pessimistic. Also, if you invest outside Canada in a TFSA or RRSP, growth may not be tax free.

There are advantages of an RRSP. You can split RRSP income with your spouse. Your tax rate in 20 years might be lower than your present tax rate (for example, decreased income in 20 years as retired). So a tax savings might be possible, that wouldn't with levered investing. With an RRSP, you're not taking on the risk of leverage. If tax laws were to change, I'd hazard a guess that the interest rate deduction would more likely be hurt than RRSPs.

There are advantages of a TFSA. Your tax rate in 20 years might be higher than your present tax rate, which would be to your advantage with a TFSA, but not with levered investing. You're not taking on the risk of leverage. If tax laws were to change, I'd hazard a guess once again that the interest rate deduction would more likely be hurt than RRSPs.

There are advantages to levered investing. The contribution limits of an RRSP/TFSA may be less of an issue with levered investing. There are no forced withdrawals unlike RRSPs, which can cause problems with OAS. You have greater freedom in what you can invest in.

What I find interesting is that levered investing can be a reasonable alternative to an RRSP or TFSA. That makes sense, because all three are forms of tax advantaged investing.

Park
Silver Ring
Silver Ring
Posts: 781
Joined: 13 Aug 2010 20:51

Re: Levered Investing As An Alternative To An RRSP or TFSA

Post by Park » 13 May 2017 18:23

http://www.globeinvestor.com/servlet/Ar ... 29/RRCESTY

Tim Cestnick wrote a similar article in the preTFSA era. The link is above.

Assume you have $7500 of aftertax income to invest annually, a 20 year time horizon after which you liquidate the portfolio, an 8% rate of return and a marginal tax rate of 46%.

In an RRSP, you'd have $322,773 after 20 years.

In an open account, you'd have $298,776 after 20 years. This assumes that the only tax you'd pay is cap gains tax after 20 years.

In the third scenario, assume you use the $7500 to pay 7% interest on an interest only loan. You would borrow $107,000. Assume you invest your tax savings from the interest rate deduction each year. After liquidating the portfolio and paying off the loan, you'd have $439,063. Although he doesn't state it, I think there is the assumption that the only tax you'd pay is cap gains tax after 20 years.

Once again, the assumption that the only tax you'd pay is cap gains tax after 20 years is highly debatable. OTOH, a 1% difference between portfolio growth and interest rate might be pessimistic. And once again, if you invest in an RRSP outside Canada, it may not be tax free.

One advantage of an RRSP or TFSA is that you don't have to be concerned about how tax efficient your investing is. That may give you considerably more freedom, when it comes to investing.

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