It’s Thursday, AKA Nelson’s slack off day. Take it away, Eddie.
I believe this will be PF groupthink assassination post number 5.
My post this week focuses on a rather technical detail in a recent Moneysense article. I happen to read Dan Bortolotti’s article How to make it to $1 million that was published in the September/October 2014 issue.
The article postulates that it is very realistic even for a person of modest means to save a million dollars for retirement. To accomplish this feat, Bortolotti espouses several principles:
- Start Early – the earlier in life you contribute to a savings plan, the better
- Make Saving a Priority – use salary increases and employer-matching programs
- Don’t Buy Too Much Home – avoid large investments in non-productive assets like a home
- Don’t Buy Too Much Car – completely minimize investments in non-appreciating, non-productive assets like a car
- Be Frugal, Not Cheap
- Have an Investment Plan
- Let Your Plan Evolve Over Time
Bortolotti’s article espouses very basic financial principles and should be read by novices. They fit with the target market of the magazine and the level of sophistication of the average Canadian. For the more advanced, the article resides within the realm of Survive Mode.
My issue with the article pertains to a technicality in ‘Let Your Plan Evolve Over Time’. He presents three scenarios in which people at different stages in life can save a million dollars within their RRSP using different contribution rates. Bortolotti assumes that the tax refund on the contributions will be re-invested into the RRSP with a 6% rate of return. In each scenario, the contributor possesses a seven figure portfolio by age 65.
My issue with his analysis is that $1 million held within an RRSP is not akin to having $1 million to freely spend in retirement. This is because all of the funds is held within the RRSP and is subject to a tax liability upon withdrawal. While this certainly isn’t news to anybody with a basic understanding of the tax system, accounting for it using reasonable assumptions would increase the amount of contributions a person would have to make to offset the tax liability. By increasing the contributions, saving $1 million for retirement, rather than $1 million in an RRSP, just got a little more difficult.
To be fair, accounting for this tax liability can be tricky and is obviously dependent upon a person’s particular situation. Specifically, the overall tax liability is affected by the following factors (non-exhaustive):
- Marital status
- Timeline of withdrawal
- What form the RRSP takes when it is being withdrawn (Annuity, RRIF etc)
- Marginal tax rates of both partners (which is dependent upon other assets and forms of income)
- Income splitting measures
Withdrawing from an RRSP has some parallels to withdrawing from a corporation. Each can provide legal mechanisms to defer tax. A person may hold real estate, a business, or other assets within a corporate structure. However, the shareholders are limited as to how they can spend corporate funds. For example, in virtually all circumstances, the sole shareholder of a corporation cannot use the corporation’s assets to fund a year long trip around the world, as it would be deemed a personal benefit and not in the interests of the corporation. Similar to an RRSP, it would be foolhardy to assume that cash sitting in a solely owned corporation is equivalent to the same amount of cash held personally. There are significant tax implications which affects how much can be flowed to the shareholder.
I will delve into these issues in future posts and on my blog at Summaticus.