Even Better Than RRSPs
New Cut in Capital Gains Taxes Makes Strategy Better
Copyright Talbot Stevens, 2001
While RRSPs are one of the best investment strategies, most Canadians
can produce even more retirement income by borrowing to invest outside
"Now that only 50% of capital gains are taxable, the poorly understood
approach of leveraging or borrowing to invest can be an even better
retirement savings strategy than RRSPs," says Talbot
Stevens, financial educator and author of the new bestselling booklet Dispelling
the Myths of Borrowing to Invest.
"Leveraging has always been used by the wealthy", says Stevens."Now, more middle-income Canadians are starting to realize how
tax-effective it can be to borrow to invest in equity investments outside of RRSPs"
When you borrow to invest outside of RRSPs, the interest
expense is generally tax-deductible, and produces the same tax savings as
an RRSP contribution. RRSP dollars are 100% taxable when withdrawn.
But when you borrow for equity investments, much of your returns
are in the form of capital gains which are only 50% taxable.
Stevens points out that an overlooked benefit of equity funds is
that the tax on capital gains is deferred until you, or your fund manager,
sells. This means that a
tax-efficient equity fund can provide almost the same tax deferral benefit
as RRSPs. When you combine
this with the fact that the interest expense produces the same tax
deduction as an RRSP contribution and that only half of the gains are
taxable, it is easy to see how leverage can be better.
Stevens provides an example using conservative assumptions to
illustrate. Both Randy and
Linda are 45 year-old baby boomers in the 40% tax bracket and invest
$4,000 a year, a little less than the average RRSP contribution.
They both invest for 20 years, averaging 9% equity fund returns and
will retire in the 40% tax bracket.
Linda, the leveraged investor, uses her cashflow to pay 9% interest on a
$44,444 investment loan. Both
want their retirement income to last 20 years, from age 65 to 85.
Using RRSPs, Randy, produces an annual retirement income of
$13,450 after-tax from age 65 to 85. Using leverage, Linda ends up with a 20-year after-tax income of
$14,490. In this case,
leveraging produces an extra $1,000 a year during her retirement,
after-tax. This is assuming
conservative 9% annual returns that just match the cost of borrowing,
while long-term global equity fund returns have averaged closer to 12%.
If investment returns are 12%, the leveraged
investor ends up with 37% more after-tax retirement income than produced
with RRSPs. Linda has an
after-tax income of $31,680 per year, while Randy has $23,150.
With the use of
margin accounts at record levels, Talbot Stevensí booklet is timely for investors trying to understand when it makes
sense to borrow outside of RRSPs, or to use a loan to catch-up on unused
RRSP contribution room.
Talbot Stevens is a financial educator, speaker and
author. For more information, visit www.TalbotStevens.com.