Category Archives: Investing

Juggling the Mortgage, RRSP’s and TFSA’s

Alright, I’m still wrapping my head around the idea of Tax Free Savings Accounts (TFSA) and what they mean to us in terms of our planning. So I don’t expect to get this all right in the first go, so here’s the deal. I’ll provide my first pass on what these mean to my plans and you can poke holes in my ideas and see if you can’t come up with your own. (Warning: These ideas are theoretical in nature so if I messed up please let me know with a comment.)

Right now I’m focusing on an interesting idea running around my head. You see when I get paid my salary I’m taxed at once, so when I buy an RRSP the government basically provides me a refund of the tax I paid on that money (but not my CPP or EI which are deductions and not tax). So at my 35% marginal tax rate every $1 I put into an RRSP generates $0.35, which almost brings me back up to my original $1.42 my company paid me for my time at work (but I can’t get back my CPP or EI deductions).

Now by putting that $0.35 I get back for my tax refund into a TFSA I’m now growing all $1.35 of my money without any further tax, until I take out the RRSP money. Except if I only take out the minimum deduction each year from my RRSP account when I’m in early retirement (which would be $10,100 this year – I’m only using the federal number here to make things easy to understand and I’m assuming no other income in my early retirement years). In that case I would pay no tax on any of my original $1.35 I put in both accounts. Following me so far? Good.

So basically by careful planning of using both accounts I can avoid ever paying a dime of tax on that original $1.35. Effectively I’ve made some of my income tax free (but not deduction free). This as a concept is VERY interesting to me. So now I’m faced with a thought, if I can make some of my income now tax free wouldn’t that mean I should try pour every dollar I can into a RRSP and then the refund into the TFSA?

If that is right, won’t it be a better to contribute to the RRSP and TFSA than paying down your mortgage? After all the mortgage is paid in after tax dollars, so wouldn’t I be ahead to have as much as possible tax free and pay off any mortgage balance I have from my TFSA when I retire instead of paying off the mortgage early? Yet if I do that I’m paying more in interest costs. Damn this is getting complicated and I haven’t even done the math yet.

Alright, let’s break out the calculators and do some math. I’ll start by saying I currently have about $143,000 mortgage balance and I’m currently paying it bi-weekly at 5.08% and it will be paid off in 15 years. This yields a payment of $522.27 every two weeks or $13,579.02 per year. This is situation A.

In situation B, I would reduce my mortgage payments once a month over 20 years, but with the same balance and interest rate. In this situation my payment drops to $945.88 a month or $11,350.50 per year. Then let’s assume I put the difference between the payments ($13,579.02-$11350.50 = $2228.52 per year) to my RRSP and then reinvest the $779.98 tax refund I get into a TFSA.

So in situation A I pay a total of $60,683.76 in interest over the 15 years of the mortgage and at age 45 I’m debt free. Yet in situation B I will pay $77,347.26 in interest and still have a balance of $50,089.70 to pay off from my TFSA at age 45. So if you take the difference between the interest costs of A and B that would be $77,347.26-60,683.76 = $16,663.50. Now if you add in my mortgage balance on B to that interest cost difference you get $66,753.20. So that’s the number to beat with my additional savings from putting the extra cash in B into my RRSP/TFSA.

Now let’s do the math on my additional savings in situation B. First the RRSP is getting an additional $2228.32/year or $185.71 a month. So assuming a 5% rate of return compounded monthly I will have an extra $45,701.46 in my RRSP account at age 45. Yet I also invested that tax refund of $779.98 per year in my TFSA. So let’s assume the same 5% rate of return and that results in an extra $15,993.42 in my TFSA at age 45. So in total that is an extra $67,009.34 in savings. So that just beats the cost difference between my mortgage options in the last paragraph.

So in general there are some minor possible savings there of $256.14, but not much given my assumed numbers. What would make this better would a higher return in your TFSA and RRSP accounts and a lower rate on your mortgage.

Yet one little thing to keep in mind, is in option B you would also reduce your yearly income to the government so if you are getting any child tax benefits those would increase a bit. Another issue is you would need to enough funds in your TFSA to pay off your mortgage in situation B, since the extra TFSA savings from the lower mortgage payments won’t be enough by themselves.

Obviously depending on your personal numbers this may or may not be useful. Doesn’t this seem very similar to the whole pay off your mortgage early or contribute to RRSP debate? *evil grin* But at least it is an interesting idea.

Why Isn’t There Universal Personal Financial Education?

It’s occurred to me that despite the idea coming up several times by various people over the years, there never has been a serious attempt to get personal finance as part of the basic high school curriculum in every school in North America. Why is that? Then it hit me. Perhaps the better question is who has an interest it in not happening?

After that question rolled into my head I started to give the matter some serious thought. Then it occurred to me what would happen if everyone knew about personal finance and most of them followed it. There is a huge number of companies that would out billions of dollars in easy money.

No more just signing their mortgage renewal forms from the bank, people would actually negotiate their rate. Then they would insist on free banking and high interest chequing accounts. Before you know it the poor bank wouldn’t be able to keep having record profits year after year. Then think about all those poor mutual fund salesmen, we won’t buy a fund with a MER over 1%. Then the insurance companies couldn’t sell us too much insurance for things we don’t need. Most of us would be living in our means so the big screen TV manufactures and the SUV producers would lose millions in sales. Then worst of all the poor credit card companies would have almost no interest charges and the pay day loan industry would vanish.

To put it bluntly there are a whole lot of people who are making a living off of everyone’s stupidity: including me and you. You don’t believe me? Then please show me which mutual funds that you own that don’t actually have a single bank, insurance or financial service stock as part of their mix. Even if you manage to pass that one, you are telling me you don’t own any energy stocks which benefit from North America’s addiction to oil? So let’s face it. We the smart people that understand just a little bit of personal finance are making a killing off the stupidity of everyone else.

Are you feeling guilty yet? Because I’m not. The reality is there is more than enough tools out there to get educated if you have even the slightest interest. The only reason people are dumb is they have chosen to be that way. If you don’t believe try a few Google searches like “save money” which gives you 2.91 million websites while “personal finance” gives you 13.6 million websites. The fact you’re even reading this post proves you managed to do it, so why can’t your neighbor? Because they chose not to. Whether the choice is conscious or not would be an interesting psychological debate, but in the end we need stupid people to make money off of so you and I are the reason there is no universal financial education.

This post is now part of the 126th edition of the carnival of personal finance.

Dumb Luck Is Also Required

Larry MacDonald recently had a post on his blog about Derek Foster which was questioning weather the math of Derek’s strategy would let other people follow in his foot steps.  The short answer I believe is no.

Each early retirement story I’ve read of very young retirements (ie: under 50) all seem to have a common thread.  Each person will tell you how it is possible for you to do the same as them.  Yet the reality of it all is a bit of dumb luck is also required.

Granted most of the very early retirees do have plans to make some money with real estate or stocks and they do have a strategy.  Yet in every plan there is that wild card of luck.  Where the results of your plan far exceed what you expected to happen.  For example, when I bought my first house I knew it had a good potential for fixing it up and reselling.  Yet the renovations were more expensive than I would have guessed.   About $10,000 more expensive due to a leaking roof.  So I was hoping to just break even and not lose my shirt.  The reality was the local real estate market was hot and I made about $55,000 in profit in two years.  You could try to call it good planning or anything else, but in reality it is just dumb luck.

So you see each early retirement path is unique.  I don’t expect anyone to take the exact same path as me, because they will have different values and different opportunities.  Yet learning from each of these very early retirees teaches you something different such as controlling your spending, dividends are good, or avoid tax is important.  Yet each one echoes a similar lesson: luck favours the bold.  If you want a retirement under 50 you are going to have to take a few risks.