Leveraged TFSA vs. Leveraged Non-Registered Portfolio

The Tax Free Savings Account (TFSA) that was introduced in 2009, is a great tool for many investors and can help them avoid paying some taxes with their investment income or gains that they normally would pay with a non-registered portfolio.  However; is the TFSA always the best vehicle to use?

When investors borrow money to invest in a non-registered portfolio, in most cases the interest on those borrowed funds is tax deductible in the year it was paid. That’s not the case however for a TFSA or other registered portfolios.  When money is borrowed to invest in a TFSA, CRA does not permit you to deduct the interest payments against your income in the current year, or any other year for that matter.  With that, below is an illustration comparing the two different investment vehicles.

For illustration purposes, we have to make a few assumptions based on rates of return, interest payments, length of investment, current marginal tax rate (MTR) and MTR’s in retirement or when the funds are actually withdrawn from the portfolios, as well as income tax consequences.  Being that $20,000 is the current maximum (2012) that can be contributed to a TFSA (provided no contributions were made in previous years), I will illustrate borrowing $20,000 to invest in a TFSA vs. borrowing $20,000 to invest in a non-registered portfolio and having the funds invested in the same Corporate Class Mutual Fund or other investment where the gains are tax deferred until withdrawn.  I will also assume that the tax refund from the non-registered portfolio is reinvested so that the comparison is fair.

Assumptions:

·       30 year investment

·       6% interest only payment on loan

·       8% return on investment

·       40% Marginal Tax Rate today (investors working years)

·       30% Marginal Tax Rate in retirement

·       Capital Gains tax treatment on non-registered portfolio

TFSA

$20,000 borrowed and invested earning 8% compound annually, the total in 30 years would be $201,253.  Minus the $20,000 loan and the total TFSA value in 30 years is $181,253.

Non Registered Portfolio

$20,000 borrowed at 6% interest will create a tax deduction of $1,200 each year against the investor’s income.  At a 40% MTR, this will create a refund of $480 (1200 x 40%) per year that we would not have with the TFSA and therefore could reinvest to keep the comparison fair.  After 30 years, the portfolio will be $255,629 if it averages 8% annually. Minus the tax payable of $33,184 {[255,629 – (30 x 480 + 20,000)] /2 x 30%} and also the loan of $20,000, the total portfolio will be approximately $202,445.

Summary

Using the assumptions that we have, it clearly shows that using a non-registered portfolio vs. a TFSA is the better choice when it comes to borrowing money to invest.  It is imperative however that you speak with your financial advisor to ensure which strategy (if either, as borrowing to invest can be risky) is right for you and to use your own assumptions when determining MTR’s, interest payments, rates of return and tax consequences.

If you would like more information on this comparison or have questions, please don’t hesitate to call me at 778-478-0727 or email at scott.turner@iagto.ca

                

Individual Pension Plans

Individual Pension Plans

TFSA vs. RRSP

The question looms… which is best?  The simple answer… It depends.

Tax Free Savings Accounts (TFSA’s) were introduced in the 2008 Federal Budget and have become an important tool when planning finances.  Unfortunately, everything that is contributed to the TFSA is not tax deductibleL; with that however, everything that is withdrawn is not taxableJ.  This is a mirror image to the RRSP where contributions are tax deductible but then fully taxable when withdrawn.

Before making a contribution to either, the first thing to consider is the objectives of the contributor.

Here’s something to consider:

When income tax brackets will be the same in the contribution year as they would be in retirement, the math tells us that there will be no monetary difference between the two as you can see in the graph below.

	TFSA	RRSP
Contribution	10,000	10,000
Marginal Tax Rate @ 30%	3,000	0
Net Contribution	7,000	10,000
Total in 25 years @ 6% return	30,043	42,918
Marginal Tax Rate @ 30%	0	12,875
Net Proceeds	30,043	30,043

 

Where the TFSA may be a better solution, is when income tested government benefits are factored into the equation.  As withdrawals from a TFSA are not added on to income, like RRSP or RRIF’s, withdrawing funds from a TFSA in retirement will not negatively affect government benefits such as Old Age Security clawbacks, Guaranteed Income Supplement, HST rebates, MSP Premiums, Fair pharmacare, and others which are income tested.  These Government benefits can add up to thousands of dollars every year for retired Canadians and we would hate to miss out on them due to poor planning.

If you’d like a more in depth analysis tailored to your specific needs and goals, please contact me and I’d be glad to help.