# Early Retirement Strategy Crisis of Confidence



## 0xCC (Jan 5, 2012)

I am quite interested in the discussion going on in this thread: http://canadianmoneyforum.com/showt...y-wife-contributing-to-a-RRSP-lowest-tax-rate and it has motivated me to run some numbers on registered vs. non-registered investing and retirement strategies.

Skip down to the "Crisis of Confidence Part" below to get right to the numbers. This first part is just a little background...

Some brief background. I have been saving for retirement basically since I started working full-time in mid-late 90's. I mostly switched from an advisor managed portfolio to TD Waterhouse account around 2003 or so and I have been mostly investing for dividend income since around 2005. My wife and I have fully-funded TFSAs and not fully funded RSPs as well as non-registered accounts. Roughly 60% of our portfolio is in our non-registered accounts. With the amounts that we have set aside yearly for investing we could both max out our yearly RSP contribution room and TFSA contribution room and that would only use up about half of what we save for retirement. We have mostly been avoiding RSP contributions except for what is required to get the maximum match from my employer or what is required to bring our tax owing in April down to $0. My wife has a pension so she doesn't have much RSP contribution room left over at the end of the year but I don't have any pension so I could contribute the full 18% (I don't make enough to hit the RSP max contribution limit). My wife currently has about 40% of a year's pre-tax salary available in RSP contribution room, I have about 130% available. Our plan is to retire early and I think it is unlikely that we will be working full-time past 50 (under 8 years away). Our strategy has been to try to build up dividend income from a combination of Canadian and international (mostly US) companies with a focus on dividend growth. Due to the tax advantage of Canadian dividends most of our Canadian dividend paying companies are in our non-registered accounts. 

As I said, I started running some numbers on registered vs. non-registered retirement strategies. Previously I had always been focused on the after-tax income of non-registered vs. RSP accounts, not really paying too much attention to the pre-tax vs. post tax contribution issues. As I went though some examples based on the discussion in the thread above I started to think more about thinking of RSP contributions in pre-tax dollars instead of post-tax dollars with a refund thrown in at tax filing time. Switching that thinking around has made me question whether I should be using up more of my RSP contribution room.

So using some examples to see if I can make it clear why I'm having a bit of a strategy crisis. If I want to generate $40,000 in income in retirement and I want to do that from dividend income and if I assume a 4% yield, I need $1,000,000 in capital to generate that. In the non-registered case if that were my only income in Ontario taxtips.ca says I would pay $600 in tax on that (stupid health premium). If I had the same income inside an RSP and I withdrew that I would pay $6273 in tax on that. Ok, so obviously the non-registered case leaves me with more money in my pocket, right? Yes, but that isn't really the whole story.

The whole story is both the generation of that income *and* how much had to be earned before that money could be earned by investments. It takes $1M in after-tax dollars to generate that income. In order to have the same amount of after-tax income from an RSP it would require $48795 in income from investments (and it doesn't have to be dividend income). At a 4% yield that requires $1,219,875 in capital or 21.98% more than in the non-registered case. For someone in Ontario in the 35.39%-39.41% tax brackets if the RSP contributions are made over enough years (so they stay in the higher tax bracket) making $1M in contributions to a non-registered account would be the same as making over 1.5M in RSP contributions in terms of after-tax, after investment contribution income left over.

*The Crisis of Confidence Part*

The way my numbers have worked out for this, if I use the top income for the 39.41% Ontario tax bracket of $89,401 and I say that the person maxes out their RSP contributions (18% of $89,401) they would make an RSP contribution of $16092. They would pay income tax of $15,726 and would be left with $57,853 for spending. If the same person didn't make an RSP contribution and instead made a deposit to a non-registered account they would pay $21,322 in tax and have $10496 left after taking out the same $57,853 for spending. So making the RSP contribution allowed them to have $5,596 more available for investing due to the 34.77% average tax rate that they got back. They had 53.51% more capital to invest. This blows the extra 21.98% required to overcome the tax disadvantage of having to withdraw from an RSP out of the water.

That 53% more capital vs. 22% more capital required for the same after-tax RSP withdrawn income is what is causing my crisis of confidence. I think my main mental stumbling block around this so far has been to not look at things from an after-tax perspective but just look at things from a before tax, with a refund bonus at a later date perspective.

So I know that was a little bit long-winded but are there any flaws in my reasoning here? Have I been really dumb so far by not maxing out my RSP contributions even though I could have (for at least the last 7-10 years anyway)? Should I be trying to catch up on my RSP contributions now (the example tax brackets don't exactly match my situation but they are pretty close)? I'd love to hear some constructive comments even if they are of the "you should have run these calculations 10 years ago" variety.


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## Guban (Jul 5, 2011)

You should have run the numbers 10 yrs ago!  Pretax numbers are pretty much meaningless. It is only the cash you keep after taxes that has any meaning.

I don't think that your situation is the same as the one that is going on in the other thread, since your income is definitely much higher. I haven't run the numbers like you have, but it seems to me that the general rule is that registered is better than non registered where you are in a high tax bracket. Furthermore, without a pension, your tax bracket may be lower in retirement.


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## 0xCC (Jan 5, 2012)

I agree that my situation is different than the one in the other thread but the discussion in that thread made me run some numbers. There are issues to be aware of with RSP investing like making sure your withdrawal tax rate is not higher than your contribution tax rate. 

It looks like as long as your RSP contributions are your before tax amounts vs. what you could invest post-tax the RSP is the better choice even when using a dividend income strategy.

There are a couple of things that make me feel not quite so dumb right now. The first is that I have been investing more than my RSP max each year, I just haven't been maxing my RSP so I would have had non-registered contributions anyway. The second is that minimum RIF withdrawals could have pushed me into a higher tax bracket in retirement but I haven't run the numbers on that yet. Also, it seems that even in that case a non-registered portfolio would never catch up to an RSP one in terms of total value (even given large minimum withdrawals).

Oh well, I guess it is time to start figuring out how to use up my RSP contribution room most effectively.


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## 0xCC (Jan 5, 2012)

This blog post does a good job of explaining the registered vs. non-registered issues http://www.michaeljamesonmoney.com/2014/03/debunking-rrsp-myths-with-pictures.html.

The conclusion in that post is where my blind spot was, not thinking of the RSP contribution itself + the refund as what should actually get into the RSP.


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## My Own Advisor (Sep 24, 2012)

I'm with Guban, after-tax dollars is what counts.

Put another way, do you get to spend all your gross income ?

I think there are certain "rules" that most investors should follow:

-use up RRSP and TFSA contribution room first before non-registered
-consider using RRSP for U.S.-listed equities, vs. Canadian equities
-focus on TFSA contributions in a low income bracket, vs. RRSP
-focus on RRSP contributions in a high income bracket, vs. TFSA
-try and maximize TFSA and RRSP in any income bracket
-pay down your mortgage, fast, regardless of the borrowing costs (i.e., get out of debt)
-invest in low cost indexed products for optimal portfolio growth and ease of portfolio maintenance
-ignore expert forecasts and just save your damn money 
-and more..

If most investors did this stuff (including me all the time), we'd all be fine.

@OxCC - I guess you have to run the numbers for your situation....minimum RIF withdrawals could you push you into a higher tax bracket but you won't know until the math is done on that I guess!


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## 0xCC (Jan 5, 2012)

My Own Advisor; said:


> @OxCC - I guess you have to run the numbers for your situation....minimum RIF withdrawals could you push you into a higher tax bracket but you won't know until the math is done on that I guess!


I ran some hypothetical numbers and even in the minimum RIF withdrawal case the RSP portfolio was larger in value than the non-registered portfolio. I haven't tried to figure out the optimal RSP contributions yet. Also, early retirement works well in this situation because withdrawals can be smoothed out before minimum withdrawal limits kick in.

I think that one thing to add to your list of rules for investors is to contribute to your RSP and use the refund to add to your RSP contribution the following year. That will mean you reach your investment contribution goals faster and there will be more left over for non-investment activities.


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## My Own Advisor (Sep 24, 2012)

0xCC said:


> I think that one thing to add to your list of rules for investors is to contribute to your RSP and use the refund to add to your RSP contribution the following year. That will mean you reach your investment contribution goals faster and there will be more left over for non-investment activities.


Excellent point.


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## RBull (Jan 20, 2013)

Good post OxCC. 

Your findings support what I had looked at years ago. As an earlier retiree I will be smoothing our RSP withdrawals as well. 

Better even than waiting for the refund to invest is apply with CRA annually to have tax at source reduced for the remainder of the year, with proof of contributions already made or auto bank contributions to be made monthly. I think its form T1213. Then you can stop overpaying the government and waiting for your refund. You can now invest the payroll tax savings amount and get your money working for you sooner.

MOA, pretty good summary above on saving and investing.


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## steve41 (Apr 18, 2009)

We are forgetting something. Maxing your RSP makes sense net income-wise if you live to a comfortable age. However, if you die prematurely, your heirs will be shortchanged. There is an actuarial component to the problem.


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## gibor365 (Apr 1, 2011)

> If most investors did this stuff (including me all the time), we'd all be fine.


You are very right  This is more or less what we did.... when we finished paying mortgage and daycare for our kids, we fast maxed up our RRSPs and TFSAs and maxing up every year.... however, we don't have non-registered equity account, as this is our Cash portion and we try to keep 40-45% of all assests in Cash (HISA and GICs)...
To your list I'd add another point: if spouses are in different tax brackets, setup first Spousal RSP -> huge saving


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## cougar (Oct 15, 2014)

I am retired and if I were to do it all over again I might have carried forward my unused RRSP room to my last career years when I was in a higher tax bracket. Don't think I understood this concept at the time. I contributed the max each year. Granted I would have lost some compounding on interest but may have saved on income tax. In my case, particularly, I retired with a large, unexpected severance pay and no unused RRSP room and paid about 50,000 in taxes all in one year. I wished I did have some unused RRSP room because I could have had money directly put in there and deferred higher tax bracket taxes until lower income retirement years. Of course I am grateful for the severance but would have liked to have kept more of it. So there could be an advantage in your current situation if you suddenly found yourself in the same situation as me.


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## My Own Advisor (Sep 24, 2012)

Interesting point about severance cougar. Never really though about that but true.

I guess I figure I'll invest what I have control over now, i.e., try and maximize TFSA first, then RRSP. If I just happen to max out my RRSP account, and should something happen to my job - well, so be it.

I do have control over my RRSP contributions as much as possible now, I don't have control over what my employer might or might not do with me.


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## cougar (Oct 15, 2014)

Certainly you are right that you can't predict your future. The strategy we used was very similar to yours and I feel we have enough put aside to supplement my monthly pension. But it did smart a bit to give such a big chunk of cash all at once in income taxes!!


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## My Own Advisor (Sep 24, 2012)

No doubt cougar!


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## 0xCC (Jan 5, 2012)

The severance issue is a good point and one that is unfortunately relevant in the industry I work in. In fact I have had a severance situation in the past but it wasn't a large severance so it didn't have a big tax consequence.

I think my strategy from this point forward will be to put as much into an RSP as I can such that I get myself to the top of the tax bracket I hope to be in when I am retired. I think that will slowly reduce my RSP contribution limit but I don't think it will ever bring it down to under 20% or so of my salary. If I do ever find myself in a severance situation again then I should be able to shelter a good chunk of the payout. If I don't find myself in a severance position I will likely end up with unused RSP contribution room when I retire.


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## Davis (Nov 11, 2014)

The best time to plant a tree (or make an RRSP contribution) is ten years ago. The second best time is today.


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