Alternatives to RRSP investments
The Advocate, Wednesday January 5, 1994
I'm sure most would agree that an RRSP is a good idea. The tax deduction motivates most people to start an RRSP. The higher the marginal tax bracket, the more the motivation - right?
But, is there a better way? How would you like to have the advantages of an RRSP without the disadvantages. Instead of deferring taxes how would you like to eliminate them and still have a tax shelter working for you in addition to making two to five per cent more?
A) $3,600 invested each year in a RRSP for 20 years at 10 per cent = $206,190. To receive a monthly income at this point you have two options: 1) an annuity (fixed monthly income) or 2) a RRIF. Both are taxed as regular income.
If your tax bracket is lower you will pay less tax than you do today. $206,190 would buy a life annuity (guaranteed 10 years) at age 65 of $1,720.02* (fixed monthly income). *Based on November 1993 competitive interest rates.
B) Borrow $36,000 of Other People's Money (OPM) at 10 per cent = $3,600 interest per year. Invest the $36,000 in a Canadian Corporation (Mutual Fund). The interest is now tax deductible. In 20 years at 12 per cent you would have $347,266.55 or $141,076.55 more than A. At 15 per cent it would be $589,195.35 or $383,005.35 more than A.
Less CNIL it would be tax free up to your $100,000 capital gains exemption. If it was jointly owned you could enjoy $200,00 tax free. For example, you could receive $2,893.89 per month based on a 10 per cent withdrawal program from the $347,266.55 or $3,472.67 monthly based on 12 per cent.
Both significantly more than A. Much of this income comes to you tax free. The monthly amount can also be indexed to inflation to keep up with the cost of living so that you will never get stuck with a fixed income.
Which would you rather be, A or B?
Although RRSP's have helped many Canadians save for their retirement the other side of the coin needs to be examined.
RRSP's are rife with legislated constraints. Here are some of them:
1) 80 per cent plus Canadian contents.
2) Income fully taxable.
3) No collateral value.
4) The income alternatives are carefully prescribed.
With B, a leverage program, you have none of the above restraints.
1) Investments can be globally oriented. This allows them to have a better return because of more and better opportunities.
2) a SWP (Systematic Withdrawal Program) attracts very little tax.
3) excellent collateral value.
4) This is not a government program so the methods of receiving income are not decreed. You have complete control and flexibility.
Should I borrow?If you can invest so that your rate of return is more than your after tax cost, then it makes sense to borrow.
When asked how he made his fortune, the great financier Barnard Baruch replied "OPM- Other People's Money."
We should be careful to define between borrowing for luxuries and consumer goods and borrowing to invest.
NEVER borrow for luxuries. Borrow only to invest.
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