# I suck at math...help?



## Lilyukyuk (Nov 30, 2011)

Hi friends...

Hope the subject line caught your eye -  I'm wondering if there are any math gurus out there wouldn't mind helping me calculate something or tell me if I'm missing something huge in my thinking here.

I'm looking at best (tax efficient) ways to spend $10k. My options are as follows:

1. RRSPS - I make around $75k a year gross - I'm mid 30s and single. I have very minimal RRSPS thus far (less than 5k). Should I take all $10k and put it into RRSP (funds) right off? I have lots of contribution room.

2. Pay down loans - I have 2 govt student loans: $10k at 3% and $11k at %5 - should I take the 10K and just pay down the 5% one?

I'm trying to figure out if maybe there is an advantage of putting all 10k into RRSPS, wait for a tax refund and then pay down the loans...


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## jamesbe (May 8, 2010)

pay the $11k loan.


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## the-royal-mail (Dec 11, 2009)

Pay down the loans and then start saving an emergency fund.


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## CanadianCapitalist (Mar 31, 2009)

I'd pay down the loan.


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## MoneyGal (Apr 24, 2009)

From a tax efficiency standpoint, the RRSP contribution is the winner, hands-down. (This doesn't mean that's what you should do, but it does answer your question.)

We don't have enough information to fully answer your question, but here's what I did:

- Assume both loans are being repaid at the rate of $100/month

- At those rates, and with those amounts of debt, and using that repayment schedule, you will pay about $822 in interest over the course of one year

- (average monthly interest on a 5% loan with a $11K balance is $44.57; average monthly interest on a 3% loan with a 10% balance is $23.96)

- that $822 in interest paid will give rise to a tax credit of $123.35 - it will reduce your total tax payable by this amount

Compare to the RRSP. Assuming you are in Ontario, an RRSP contribution of $10K on a $75K salary will reduce your taxes payable by $3,254.69. 

The most efficient course of action is to make an RRSP contribution of $10,000 and then use the $3250 refund + $123 tax credit to make a lump sum payment on the $11K loan. 

Your out-of-pocket costs are the same ($10K), you get the RRSP tax refund and you preserve the $123 tax credit on the loan payments. 

Rinse and repeat until both student loans are gone - it will take 2-3 years, depending on how large your monthly payments are on the loans. 

This is the most tax-efficient path (reduces your total tax payable by the most).


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## jamesbe (May 8, 2010)

Moneygal, are you assuming $10k a year or just a one time payment? Because yes that works great the first year but if that cannot be duplicated the next year interest will grow over more than 3 years on the remainder will it not?


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## Lilyukyuk (Nov 30, 2011)

MoneyGal said:


> From a tax efficiency standpoint, the RRSP contribution is the winner, hands-down. (This doesn't mean that's what you should do, but it does answer your question.)
> 
> We don't have enough information to fully answer your question, but here's what I did:
> 
> ...



MG - thanks - that's what I thought too but I couldn't quite figure out the calculation part of it since I couldn't figure out the tax credit portion - I'm in Alberta.


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## MoneyGal (Apr 24, 2009)

jamesbe said:


> Moneygal, are you assuming $10k a year or just a one time payment? Because yes that works great the first year but if that cannot be duplicated the next year interest will grow over more than 3 years on the remainder will it not?


I only looked at one single year. However, that model is still optimal (just from a tax-efficiency standpoint) as long as the assumptions I made are held constant. 

The total interest paid (ignoring time value of money) on the $11K loan at $100/month payments and 5% interest is $3745 (and it takes something like 12 years to repay). 

The route I outlined puts $3373 in her pocket when she gets her tax refund next year.


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## jamesbe (May 8, 2010)

Without doing the math I had assumed interest would be much more than $3700 on that loan over 12 years. Thanks for clarifying.

I guess I've watched too much till debt do us part where their $10k loans turn into $30k after 20 years all the time it seems.


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## Lilyukyuk (Nov 30, 2011)

MG and James - a bit off topic for this forum - any thoughts on the "best" investment vehicle to dump the 10K RRSP investment? I have safe GICS already and aggressive funds....maybe balanced or growth funds?


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## Potato (Apr 3, 2009)

I'd recommend avoiding all those various fund labels and look into a low-fee passive strategy.

You can build that up with TD's e-series funds
Reasons to avoid active management.
Reasons to index.
MER drag on returns in pictures

Oh and look, a short book on that very subject: [/self promote]


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## iherald (Apr 18, 2009)

I'm with moneygal, put the money in your RRSP and use the refund to pay off loan #2.


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## Guigz (Oct 28, 2010)

Why not use the refund to buy more RRSP if the benefit is so much better than paying off the loan? 

The OP could get a RRSP loan(y$) that would equal the return that she would get + her tax return on y$.


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## MoneyGal (Apr 24, 2009)

It's just the idea of striking a balance between two objectives. She also has cashflow to consider - the two loans require servicing every month. 

Also, I made no assumptions about how her RRSP is invested - it could be in a HISA or even cash for the purposes of the example I worked through (as in the investment return is irrelevant to the model, as she said she wanted tax efficiency - not most efficient return). 

By introducing investment risk, you add another dimension which doesn't necessarily help work through the problem as she's framed it. 

I don't mean any kind of disagreement with you. I approached the problem in a particular way, which responded to her framing of it.


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## Guigz (Oct 28, 2010)

Sorry if I was not clear. By return I meant tax return. 

What I am saying is that instead of putting the 3356$ tax return on the loan, she should contribute more in the RRSP in the beguinning (take a RRSP loan if needed) in such a way so that her tax return now equals 3356+ her rrsp loan. There is no risk involved.


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## MoneyGal (Apr 24, 2009)

Try working out the math and you will see the problem with your suggestion.


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## Guigz (Oct 28, 2010)

Yes, I am aware this is a recursive problem.

My point is that if the benefit is so great, why not use leverage to increase it?

Assuming a marginal tax rate of 32.54%, a loan of about $4,823 should do it and leave her with 40 cents in "extra" tax refund.


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## MoneyGal (Apr 24, 2009)

Interesting discussion. I don't typically think of RRSP loans as leverage, although I suppose they meet the strictest definition of leverage. 

I didn't think of suggesting an RRSP loan because she says she has $10K to work with, and I started with that amount and limited my considerations to that amount. 

The RRSP loan as you have outlined may be a good option in her case...but it doesn't really help her pay down the student loans faster. It does help build her net worth, though.


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## heyjude (May 16, 2009)

Potato said:


> I'd recommend avoiding all those various fund labels and look into a low-fee passive strategy.
> 
> You can build that up with TD's e-series funds
> Reasons to avoid active management.
> ...


Agree with all the above, but I checked out your blog and book, and, well, it's a PROSTATE, not a PROSTRATE. To rescue your credibility, you must do an "R" ectomy!


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## Nitrodog (Jan 1, 2012)

Lilyukyuk said:


> MG and James - a bit off topic for this forum - any thoughts on the "best" investment vehicle to dump the 10K RRSP investment? I have safe GICS already and aggressive funds....maybe balanced or growth funds?


Pay off the loan and then contribute $5,000 into your TFSA every year. A good idea would be to buy Canadian bank stocks for your TFSA where you will enjoy dividend increases annually. If you still have $$$ to invest then you can look at putting some into your RRSP.


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## Lilyukyuk (Nov 30, 2011)

Nitrodog said:


> Pay off the loan and then contribute $5,000 into your TFSA every year. A good idea would be to buy Canadian bank stocks for your TFSA where you will enjoy dividend increases annually. If you still have $$$ to invest then you can look at putting some into your RRSP.



Nitro - Im confused...why wouldnt I use the RRSP first, get a return, then pay off the loans?


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## somecanuck (Dec 23, 2011)

I have a similar situation where I contribute to a defined benefit pension and also make RRSP contributions. Would anyone happen to have a link to a calculator that shows me the optimal contribution amount for taxes?


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## MoneyGal (Apr 24, 2009)

Try this one: 

http://www.walterharder.ca/RRSPCalculator.asp


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## somecanuck (Dec 23, 2011)

That's nice, but I'm not certain how to figure my pension contributions into it. I understand that they reduce the amount, but not by how much. Whenever I try, it goes like this. 

67000 * 0.18 = 12060 to contribute 
11036 pension * 9 - 500 = 0 left

That means I don't receive any tax benefit, unless I have unused room from prior to the years I've contributed? 

Thank you.


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## Nitrodog (Jan 1, 2012)

Lilyukyuk said:


> Nitro - Im confused...why wouldnt I use the RRSP first, get a return, then pay off the loans?


Now That I've retired and understand the RRIF rules it makes the TFSA look better and better. I have a lot of non registered assets that I can live on (dividend income). Once you open a RRIF and this can be done any time after 55 but before your 71st birthday, you are required to withdraw a % of your RRIF annually and the % increases annually. so assuming you have $400,000 in your RRIF at 71 years old you must withdraw 7.38% ($29,520) whether you need it or not. This is taxed at your marginal rate.

The money in your TFSA compounds annually and the dividend income as well as the principle is tax free. So if you put $5,000 into your TFSA each your for 30 years and buy blue chip dividend stocks that historically raise their dividends, using an annual return of 8% (stock $ increase+dividends) at the end of the 30 years you will have saved $616,729 all of which is tax free.

But it's even better than that. over 30 years your dividends will increase as well. Using an amount of 5% increase in dividens per year, at the end your stocks will be paying you 21.6% annually. On the $616,729 that's $133,213 in tax free dividend income per year.

I'll take the tax free income anytime.


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## steve41 (Apr 18, 2009)

As I have demonstrated many times.... for the normal working stiff, saving for retirement, drawing down those savings after retirement, and a 'screw the kids' philosophy (i.e. not overly estate-obsessed).... the RRSP (which provides a nearterm refund, but is fully taxed on withdrawal) and the TFSA (which provides no nearterm tax refund, but is not taxed on withdrawal) are virtually identical in overall after tax performance.


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## GregoryWong (Aug 11, 2011)

steve41 said:


> As I have demonstrated many times.... for the normal working stiff, saving for retirement, drawing down those savings after retirement, and a 'screw the kids' philosophy (i.e. not overly estate-obsessed).... the RRSP (which provides a nearterm refund, but is fully taxed on withdrawal) and the TFSA (which provides no nearterm tax refund, but is not taxed on withdrawal) are virtually identical in overall after tax performance.


Hey Steve, do you have a link to one of your examples? I'm interested in taking a look at this.


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## steve41 (Apr 18, 2009)

This is a 35 year old earning $65K and planning to retire at 60. In one case, he directs all his savings to his TFSA and in the other, he directs it to his RRSP.

I took the $5K TFSA limit off in order to make the comparison simpler.

A $38K net income forcing runs the capital out at age 88 in each case.

TFSA strategy
RRSP strategy

Market rate 5%, inflation 2%, in BC, normal CPP/OAS/GIS.


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## steve41 (Apr 18, 2009)

I feel it necessary to make the comment that this took me 5-10 minutes max, including the commentary/cosmetics. This was not a major exercise.... it was a no-brainer.


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## GregoryWong (Aug 11, 2011)

steve41 said:


> TFSA strategy
> RRSP strategy


Thanks for the links!

Does the RRSP example include non-registered funds being factored into the equation, with the first 4 years when the person turns 60, being funded by non-registered returns?

If I "dumb it down" a little without the nice graphs, if you went strictly head to head for a comparison using 2 people:

- each 35 yrs old
- each putting $5000/yr in for 25 years
- annual return of 5%
- Person A strictly uses RRSP
- Person B strictly uses TFSA

I would think Person B comes out on top because they are not paying tax when they take their money out. I know there are a lot of other factors, but in a general sense isn't that how it would work?


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## steve41 (Apr 18, 2009)

The comparison is based on after tax income.... the amount you get to spend on stuff....lifestyle. All the rest (taxes, investment cash flows, etc) are incidental. In each example/plan, the individual's lifestyle was an equivalent $38K per year (in today's $). This is the essence of the 'needs-based' financial plan.


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## MrMatt (Dec 21, 2011)

GregoryWong said:


> Thanks for the links!
> 
> Does the RRSP example include non-registered funds being factored into the equation, with the first 4 years when the person turns 60, being funded by non-registered returns?
> 
> ...


Not really because Person B is investing before tax money.

Optimal strategy is to contribute to use the RRSP contributions to equalize your marginal tax rate (including program clawbacks etc) is the same during contribution years and in retirement.
If you can get your current marginal tax rate lower than your expected marginal tax rate at retirement, then put that money in the TFSA.
If you know for sure your current marginal tax rate is higher now, a RRSP is the superior retirement savings vehicle.

Either option is better than unregistered investing. If they're close it's only the difference in tax rates.

I don't know what the future holds, but I don't see tax rates going down, or clawbacks going down. For those under 50, it's a gamble what the tax policies will be when we're retired.


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