THE GOVERNMENT MAKES MY ANNUAL RSP AND TFSA CONTRIBUTIONS. WHO'S MAKING YOURS?
I believe in leverage, period. Whether we're talking about leveraging our human resources or leveraging capital, leverage plays a huge role in our lives and if we learn how to use it properly we can most certainly accelerate our progress in more ways than one.
First, let's talk about leveraging our human resources. I like to call this a Board of Directors or Using Other People's Brains approach. It helps us understand that we need to seek out the best resources in any given field of expertise where we may be seeking advice or guidance. Today, we have hundreds of self-help books, seminars, web casts and bloggers and we seem to believe that almost anyone who authors a book, seminar, course or otherwise stands out as an expert in any particular field, and is actually a real expert in their field. Being an expert does not necessarily mean standing out in a crowd and being loud and aggressive, however, many individuals follow these "show" guru's just because of the hype and the apparent success they portray. Their belief is that if it's good enough for this crowd, then it must be good enough for me. There are many mentors that work one on one without the typical fanfare, crowded rooms and webinars and their results, in the area of their expertise, is second to none and makes a huge difference to those who seek compelling evidence and need to be convinced that this mentor can make a dramatic difference in the results they want their clients to realize. Remember, at all times, to do your due diligence properly as there are many charlatans making claims that their "program" is guaranteed to bring you the results you are seeking. Some of these so called mentors even have public "records" which inform others of their "errors" which most attendees will never find out until it's too late.
Financial leverage or Using Other People's Money is an important step to wealth creation and to understand it fully we must work with a professional who can point out that using borrowed money to invest in any asset class can be a two edged sword. We must come to understand both sides of this equation before we decide that we want or don't want to participate in this strategy. I believe that anyone who takes the time to truly understand this principle will be well rewarded over time. This is especially important to know when equity markets all over the world are crashing and wiping out billions in wealth due to a lack of discipline and following the emotional instead of the rational examples set by the great unwashed; those who think they are "investor's" but act like "speculators". Taking the time to observe how "losses" are created and understanding that someone's loss is another person's potential gain. Remember, the founding principle of investing is to buy low and sell high and not to buy high and sell low.
Those of us who have bought real estate for the right reasons, for family and investment for the long term will understand that home ownership is usually entered into with a long term intention. Many professionals state that "you do not wait to buy real estate, you buy real estate and wait" which implies that you hold your asset through all market conditions. Real estate will also fluctuate in value over time although not as sharply as financial assets. The average homeowner understands that it may take 25 or 30 years to pay off a mortgage and usually, the interest charged to that mortgage will see homeowners pay for their homes twice over. No wonder real estate grows in value.
For those of you who read the title of my post and thought that my explanation about how the government pays for my RSP contribution would be the focus of my writing this article, I apologize. However, a discussion regarding the strategy must also come with some basic fundamentals of understanding before you decide that you want to make the strategy yours as well. So, I will repeat for your benefit that you need an extraordinary financial advisor that is willing to walk you through and explain every step you need to know to successfully implement this strategy including full disclosure of the proposal and all documents that support the advisor/client in suggesting a suitable leveraged strategy.
OK, now that we have established the foundation, let's get into the details.
In Canada, when you borrow for investment purposes, the interest you pay on your loan is deductible from taxable income. If that investment pays out any income it will offset the interest deduction. Your advisor, or I, will be able to explain this in more detail.
For illustrations sake, I'd like to establish that the borrower has a reasonably high net worth, good credit rating, good income, no more than a 40% TDSR which includes the new loan interest and, in this case, the ability and need to deposit the maximum RSP contribution of approximately ($25,000.00 annually) for tax savings and TFSA's as well for the purpose of building the financial reserve necessary to maintain his/her/their retirement lifestyle.
The client borrows $1,000,000.00 to invest. Whether the loan comes from a mortgage, PLC/HELOC or other collateral, matters not, there are many different ways to accomplish the result we are seeking. Please reach out to me for additional loan info as I have a few specialized lending options that are not available through conventional lenders. There are NO margin calls. The rate for the loan (P+1.00%) in this illustration is at 5% making the annual cost $50,000.00 yearly or $4,166.67 per month. The $50,000.00 is tax deductible. The tax saving at 50% is $25,000.00. Therefore I have achieved the first part of the desired result; I use the refund to make the RSP purchase. To keep things simple, I am suggesting the client funds the investment loan for a year before getting the refund that he/she will deposit into the RSP in year two of the plan. The RSP refund will then fund the TFSA in year 3.
Here's where this becomes even more fun. The $25,000.00 RSP deposit is also a deduction from taxable income and again, for illustration purposes, the tax saving on the RSP contribution is $12,500.00 or 50%. This refund can be used to purchase or add to an existing TFSA for spouses or partners as the maximum TFSA contribution is $6,000.00 each for 2020. You could direct some of this refund ($5,000.00 for 2 children plus the applicable 20% government (CESG) contribution) into an RESP if saving for your children's education would be a priority before investing the net of $7,000.00 divided by two in a TFSA. There's still $500.00 in cash so treat yourself to a movie night with all the fixins.
In summary, we borrowed one million at 5 percent and deducted $50,000.00 from taxable income saving $25,000.00 in tax.
We then invested the refund of $25,000.00 into the client's RSP. He/she received a $12,500.00 refund.
We then used that refund of $12,500.00 and purchased TFSA's for client and spouse.
We could invest $5,000.00 into RESP's for 2 children and then $3,500.00 into 2 TFSA's.
We have created an additional $37,500.00 of capital that was also invested. It's like getting a raise from your employer. And if you are the employer, we have other "unconventional" strategies available for you.
If the million grows at 8% it will be worth $2,159,000.00 in ten years you will have over one million outside your RSP after you paid off the $1,000,000.00 debt. We would create a "pay down the loan plan" over ten years so that we will not pay taxes all at one time.
In addition, we will have $37,500.00 to invest in RSP's and TFSA's for ten years and if we received 8% annually on these funds they would grow to $586,688.00.
We have increased your assets by over $1,586,000.00 in a decade for the total out of pocket cost of $250,000.00. The total time for this plan is 20 years which also results in additional asset growth on the declining loan balance and further RSP/TFSA contributions and growth.
I am suggesting that the loan be paid out over 9 years to minimize taxes so a withdrawal of $150,000.00 annually will pay off the loan and applicable taxes. If the income from redemption is strictly a capital gain, $75K is received tax free and the taxable portion will be $75,000.00 resulting in taxes at 50% of $37,500.00. Therefore $112,500.00 will be used to reduce the loan balance annually.
The end result will be a portfolio valued at $3,791,892.00 before any consideration for taxes.
DISCLAIMER; We used an 8% compounded return which is less than the 9.4% return for a 60/40 balanced fund according to Andex charts from 1950 to 12/31/18. The above is only an example of a wealth creation strategy based on certain assumptions and should not be considered a guarantee as past performance is no guarantee of future results. The above example is fictitious, however it demonstrates how a disciplined investor with the necessary financial position and means can accommodate a strategy of this kind based on the assumptions I have presented and is not guaranteed. Do not attempt to recreate this strategy on your own and make sure you have a financial advisor and an accountant who will walk through every step so that you understand every aspect of a strategy as described. This is not to be taken as financial advice as it is only an example. You should not construe any of the information in this article as legal, tax, investment, financial, or other advice whatsoever. The complete set of financial numbers which prove the calculations that were used for this example are available for review by request.
Copyright 2020 Richard M. Kiernicki. All rights reserved.
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