Posted by Tim Stobbs on February 29, 2008

Well it is time again to update my net worth. Please recall I discount my house market value by 8% to cover closing and moving costs if I ever decide to move.

**Assets**

House $350,000

RRSP $13,600

LIRA $11,300

Pension $6600

Wife’s RRSP $7700

Wife’s Investment Account $7900

My Investment Account $4500

High Interest Savings Account $5400

**Debt**

Mortgage $142,400

HELOC $2900

Therefore my net worth now stands at $261,700 for the end of Feb 2008. That is an increase of +$46,700 or 21.7% from my last update. WOW! Housing prices in Regina are really dragging up my net worth again.

Well one nice thing about the latest housing price surge is I’m now done one of my goals for 2008. I only expect my house value to increase for 4% in 2008. I’m already now past that and I still have ten months left in the year.

Besides housing my investments took a drop with the rest of the market, not too bad for loses. I’m continuing to sit on my large pile of cash for my parental leave in the spring, which I plan to top up with any tax refund I get this year. Overall our investment net worth is up to $57,000, up $3400 or 6.3% from the end of last year.

For more details see the following graphs (click to see a larger version).

Posted by Tim Stobbs on February 28, 2008

Alright, I’m still wrapping my head around the idea of Tax Free Savings Accounts (TFSA) and what they mean to us in terms of our planning. So I don’t expect to get this all right in the first go, so here’s the deal. I’ll provide my first pass on what these mean to my plans and you can poke holes in my ideas and see if you can’t come up with your own. (**Warning**: These ideas are theoretical in nature so if I messed up please let me know with a comment.)

Right now I’m focusing on an interesting idea running around my head. You see when I get paid my salary I’m taxed at once, so when I buy an RRSP the government basically provides me a refund of the tax I paid on that money (but not my CPP or EI which are deductions and not tax). So at my 35% marginal tax rate every $1 I put into an RRSP generates $0.35, which almost brings me back up to my original $1.42 my company paid me for my time at work (but I can’t get back my CPP or EI deductions).

Now by putting that $0.35 I get back for my tax refund into a TFSA I’m now growing all $1.35 of my money without any further tax, until I take out the RRSP money. Except if I only take out the minimum deduction each year from my RRSP account when I’m in early retirement (which would be $10,100 this year – I’m only using the federal number here to make things easy to understand and I’m assuming no other income in my early retirement years). In that case I would pay no tax on any of my original $1.35 I put in both accounts. Following me so far? Good.

So basically by careful planning of using both accounts I can avoid ever paying a dime of tax on that original $1.35. Effectively I’ve made some of my income tax free (but not deduction free). This as a concept is VERY interesting to me. So now I’m faced with a thought, if I can make some of my income now tax free wouldn’t that mean I should try pour every dollar I can into a RRSP and then the refund into the TFSA?

If that is right, won’t it be a better to contribute to the RRSP and TFSA than paying down your mortgage? After all the mortgage is paid in after tax dollars, so wouldn’t I be ahead to have as much as possible tax free and pay off any mortgage balance I have from my TFSA when I retire instead of paying off the mortgage early? Yet if I do that I’m paying more in interest costs. Damn this is getting complicated and I haven’t even done the math yet.

Alright, let’s break out the calculators and do some math. I’ll start by saying I currently have about $143,000 mortgage balance and I’m currently paying it bi-weekly at 5.08% and it will be paid off in 15 years. This yields a payment of $522.27 every two weeks or $13,579.02 per year. This is situation **A**.

In situation **B**, I would reduce my mortgage payments once a month over 20 years, but with the same balance and interest rate. In this situation my payment drops to $945.88 a month or $11,350.50 per year. Then let’s assume I put the difference between the payments ($13,579.02-$11350.50 = $2228.52 per year) to my RRSP and then reinvest the $779.98 tax refund I get into a TFSA.

So in situation **A** I pay a total of $60,683.76 in interest over the 15 years of the mortgage and at age 45 I’m debt free. Yet in situation **B** I will pay $77,347.26 in interest and still have a balance of $50,089.70 to pay off from my TFSA at age 45. So if you take the difference between the interest costs of **A** and **B** that would be $77,347.26-60,683.76 = $16,663.50. Now if you add in my mortgage balance on **B** to that interest cost difference you get $66,753.20. So that’s the number to beat with my additional savings from putting the extra cash in **B** into my RRSP/TFSA.

Now let’s do the math on my additional savings in situation **B**. First the RRSP is getting an additional $2228.32/year or $185.71 a month. So assuming a 5% rate of return compounded monthly I will have an extra $45,701.46 in my RRSP account at age 45. Yet I also invested that tax refund of $779.98 per year in my TFSA. So let’s assume the same 5% rate of return and that results in an extra $15,993.42 in my TFSA at age 45. So in total that is an extra $67,009.34 in savings. So that just beats the cost difference between my mortgage options in the last paragraph.

So in general there are some minor possible savings there of $256.14, but not much given my assumed numbers. What would make this better would a higher return in your TFSA and RRSP accounts and a lower rate on your mortgage.

Yet one little thing to keep in mind, is in option B you would also reduce your yearly income to the government so if you are getting any child tax benefits those would increase a bit. Another issue is you would need to enough funds in your TFSA to pay off your mortgage in situation **B**, since the extra TFSA savings from the lower mortgage payments won’t be enough by themselves.

Obviously depending on your personal numbers this may or may not be useful. Doesn’t this seem very similar to the whole pay off your mortgage early or contribute to RRSP debate? *evil grin* But at least it is an interesting idea.

Posted by Tim Stobbs on February 27, 2008

I suppose I’m like most people right now. I woke up to this new world where everything has changed and no one told me. Ah, federal budgets gotta love them.

So unless you’ve been avoiding the news and have yet to read a single blog you might have come across the term of Tax Free Saving Account (TFSA). What the hell is it? Well in a nut shell it’s very similar to an RRSP, except without the tax deduction. So starting in 2009, each person over 18 can put away $5000 a year into these types of accounts (which the contribution limit does grow with inflation in increments of $500). Savings grow tax free and so are withdrawals. Here’s the kicker, when you pull money out you get back your contribution room (unlike a RRSP) and you get to carry forward contribution room even if you don’t use it in that year.

Now must people have been thinking “O great I can put my saving for my high interest savings account in there so I’ll save a tax on my 4% interest of $5000 which works out to a max of $80. Who cares?” People give your heads a shake and realize the huge potential of these accounts!

It is $5000 per person per year indexed to inflation. That means in 15 years my wife and I will have $150,000 in contribution room, which assuming I have maxed out means I could be pulling out $6000/year (assuming the 4% rule) tax free between the two of us for our early retirement and not affect any benefits I would receive from the government when I turn 65!

Wait it gets better. You can buy spousal accounts too! So now we have additional way to income split. So I can put $5000 a year for each my wife and me to theses accounts ($10,000 in total/year). Then the money grow tax free until we pull it out to use it for anything we want at any time and when we do we just get more contribution room.

Just imagine what would happen to someone turning 18 and working until 65. They can invest tax free a total of $235,000 over their working career and keep all the gains from 47 years of compound interest tax free when they pull them out! Assuming a 4% real rate of return that money would end up being $696,316 in their TFSA which would be making $27,853 per year in returns(in today’s dollars). You could take out the entire amount at 65 and not pay a dime in tax and still qualify for the GIS program (assuming they had no other income from CPP or pensions)!

So when you combine the TFSA with RRSP’s we now have a combination that can do wonders. Let’s say I put in $14,285 per year into pension and RRSP’s. That gives me a refund of $5000 (assuming a 35% tax bracket). Then I put that in a TFSA each year until I turn 45 at real rate of return of 4%. That would give me $109,123 in tax free money sitting around (in today’s dollars). I can then take the basic tax deduction for both my wife and I of $10,100 (for 2008) each out of my RRSP’s with no tax. So that’s a total of $20,200 and then I can top that up with $5000 from my TFSA to make a total of $25,200 with NO TAX AT ALL! Effectively the government has just given me a way to ensure I don’t pay a dime of tax during my early retirement! Mmm, perhaps I need to adjust my plan and see if I can’t retire a bit earlier now!

Or there is another way to think of this account. Imagine for a second you have a small sum of cash to invest and you put into some risky non-dividend paying stocks. Typically rapid buying and selling would be a good way to lose your money because fees and taxes. In a TFSA there are no tax consequences, so suddenly we have a nice new toy for day traders if you get some cheap fees (like $5/trade).

Obviously there are going to be questions like can I transfer in an existing investment? Will the banks charge fees on these accounts and how much? You get the idea. We will have to wait for some more details, but in the mean time check out the official document here (see page 76, I’m still reading it for other interesting details).

Despite the doubts over this when you put the TFSA with RRSP’s and RESP’s we now have a set of policies that actually encourages people to SAVE. If nothing else I thank the government for that.

This post is now part of the 143rd Carnival of Personal Finance.