Posted by Canadian Dream on December 28, 2009
Another day and another interesting question from a reader. This one comes from Andy Royer who wrote:
One question I hope you haven’t answered yet. You (and several others) keep
mentioning it’s not worth it to invest in RRSPs if you will be in the same tax
bracket or higher.
“Now in this income level you will most likely want to avoid RRSP’s as you
likely to be in the same tax bracket in retirement.” — Your March 27, 2007 blog
posting for example.
Has anyone ever done the math on this? I’m thinking the Tax Credit gives you
more money to invest now, plus the money grows tax free into retirement. So even
though you may pay more tax later are you really worse off?
My personal plan is to have 100% of my income when I retire, so this is quite
relevant to me. If you don’t have the numbers I may have to sit down and figure
this out when I get some time.
Damn I hate when I write things that come back to haunt me, but Andy brings up a good point that I shouldn’t be using a blanket statement. In that post I was referring to the fact you need to be careful about assuming a RRSP is a good thing. In some cases it isn’t, it depends on the numbers. For example, a TFSA might make more sense when you are just starting out in investing than an RRSP, since it is more flexible to be used for saving for a house down payment or retirement.
In that specific case I was referring to the fact that depending on the type of investment you make it might make more sense to hold something in a taxable account rather than an RRSP. For example, a Canadian dividend paying stock if your marginal tax rate on dividends are negative. This happens for my wife, she gets a tax credit that is greater than the tax owning so hence the negative tax rate. When that happens you are hard pressed to make up that advantage. If you don’t believe me check out my math here (I just assumed a zero tax rate on the dividends to try and make the results closer. Also anyone is free to copy the sheet and play around. Please advise me if you find a formula error). If on the other hand you were taking about interest income you likely would be correct, an RRSP would likely be better.
So really the answer should be: it depends. Check out the math for your specific case and see what makes sense to you. Hope that helps more than it confuses people.
Posted by Canadian Dream on December 21, 2009
Well after this post I suspected I would have to provide some follow up. One comment from Jordan summed it up well with:
I’d be really interested in reading an update on your household balance sheet, how you’ve managed to swing this so soon. Maybe give me some tips to get closer to the same goal.
So I’ll try to answer that question. First off my year end net worth post is coming up next week so I won’t jump into specific numbers on each account, but I’ll provide a brief overview of the items that make up what happened.
First off it’s important to recall I have a low cost lifestyle, so if you added up everything I typically need about $3100 a month to cover my costs, but that includes a larger mortgage payment than required. My normal mortgage payment would be around $750/month, but I’m currently paying about $1100/month.
Then you need to add up my non-day job income which includes:
- Distribution and dividend income from TFSA and taxable accounts which is about $2200/year
- I assumed a return off my RRSP’s and other retirement accounts of 4%, so that’s another $2200/year (based on my last Net Worth post)
- My wife’s daycare clears approximately $6000/year in profit
- My school board job pays about $23,400/year
- Total $33,800/year or $2816/month
So from here it is simple math. If I lowered the mortgage payment to the $750 my income from other sources is greater than my expenses. Or if my wife takes another kid in the daycare and clears another $350 a month in profit we also get to the same place.
Obviously there are a few holes in this crude analysis. Income taxes have not been considered on that income so that will lower the monthly amount a bit and it isn’t sustainable since it doesn’t include cash for retirement savings or expenses that are currently covered by my dental/health coverage at my day job. Yet once the mortgage is paid off in the next three years I’ll firmly be fine without the day job regardless of taxes and other expenses.
So by looking at the numbers you can see the major driver for this is my school board trustee job, which ironically I took without caring about the pay at all. So it brings for an interesting conclusion: following your passion will sometimes lead you to where you want to go sooner than you thought possible.
For many years I’ve been focusing on the expenses and savings part of the early retirement, but the other side, income, is ultimately what go me to this milestone. So this leads the path of semi-retirement which I intend to investigate in the New Year a bit more. Perhaps the issue isn’t that I want to retire early, but rather leave my day job and work on other things instead.
Posted by Canadian Dream on March 19, 2009
Well welcome back to part II of the family profile. Well last week it was determined the couple could easily have kids, but what about early retirement? Could they leave the working world at 55? Well to crack that nut we need some net worth information.
Assets
Her RRSP (including locked in) = $60,000
His RRSP (including locked in) = $60,000
Her non registered = $190,000
His non registered = $190,000
Her TFSA = $5000
His TFSA = $5000
House (no mortgage) = $400,000 (approx worth)
Debt
Her investment loans = $130,000
His investment loans = $120,000
Net Worth = $660,000
So that looks good given their ages (35 her, 37 him). Now those investment loans are suppose to be paid off in 20 years, so that would be just in time for retirement (I’m making the assumption that since his is a lower loan that he can pay it off in 18 rather than 20 years). I’m also assuming they retire when he is 55, so they have 18 years to get things together.
Now I wasn’t given a average rate of return to use, but based on what income is coming in on those loans I’m going to estimate their rate of return at 8%. Then let’s shave off 2% for inflation and 1% extra to be a buffer. So I’ll use 5% real return in these calculations.
Rather than try to determine estimate their saving rate I’m going to do this backwards assume zero extra savings for now and define the short fall if there is any.
So let’s grow these accounts forward. The RRSP’s will both grow to $147,000 in today’s dollars each. Then the investment loans I’m assuming 4% of the return goes to paying down the loans with 1% left over for growth. So those would grow to $227,500 each. The TFSA’s would grow to about $12,300 each. Which isn’t much so I’m going to just treat those accounts as extra vacation money and not worry about them. So without adding anything to the accounts they would have $749,000 at age 55.
Other income will be OAS at 65 for $12,400 a year total. CPP I’m going to assume he gets the average pension of $5777/year and she will get half that at $2888/year at age 65 (I’m assuming she is staying home with no income from post baby onwards). Therefore they will take in $21,065/year after 65.
Assuming they keep their spending the same as I proposed last week. The would need about $38,736/year in retirement income.
Now let’s draw down their accounts. I’m going to assume they shift to a bit more conservative portfolio at 55 and they are only earning 4% real return at that time. So from 55 to 65 they drawn down $3228/month. That would leave them with $641,300 at 65.
Then continuing the drawn down at a slower rate since OAS and CPP are now off setting some income requirements. So now they are taking out $1472/month. Which of course to those with handy calculators would realize is less than 4% of their remaining $641,300 at 65. So they won’t run out of money.
So in conclusion, yes they can have kids at once. Yes, she can stay home with the kids and yes they can retire at 55 if they are willing to stop using the cleaning lady and drop their travel budget down to $6000/year once the car payment is done.
Of course there are so many assumptions in these calculations I could be completely wrong, but from a high level analysis it does look possible. Also they could down size the house and free up some cash if need be and the TFSA accounts give them a little extra saving for a few bonus trips in retirement. All in all they look like they will be fine.
