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moneysense.ca, 11/02/07
Guest Post: Retired at 34 – Almost Three Years Ago…
[I've never featured a guest on this blog before, so as an experiment, I asked (okay, pestered) Derek Foster, author of Stop Working: Here's How You Can! to contribute a post. Derek hopes that his post might spark some discussion.]
In 2004, at the age of 34, I retired. I then wrote and self-published STOP WORKING: Here’s How You Can! showing how I did it and how anyone else could. But I still encounter scepticism. Some people say you need at least $1 or $2 million dollars. Others think I’m going to run out of money because I’m looking at a half-century of retirement.
I retired with less than a $500,000 stock portfolio generating around $25,000/year. This seemed crazy! How could a family of four manage to live on that? In my book, I outline how this sum is equal to working for a much larger amount (over $60,000) once Canadian taxes and benefits are factored in.
Am I running out of money? No! My portfolio has grown over 30% – but with my strategy that’s not important. The real story is that my income has increased as dividends and distributions have.
Most “stodgy” dividend payers pay out 40% or less of their earnings in dividends and reinvest the other 60% into either share buybacks and/or growing their businesses. This reinvestment compounds over time – so I can simply spend the increasing dividends forever.
moneysense.ca, 11/02/07
Hey Derek!
Big fan of your book and strategies! Good to see you posting on CC.
FT
http://www.MillionDollarJourney.com
Hey Derek, I read your book in the spring of 2005 (I had to wait a few months on a waiting list to get it at my local library) and it changed the way I invest. I had less than 5 years of experience investing for myself (as opposed to through an advisor) and I was doing the typical ‘look for the potential big capital gains stocks and worry about income generating stocks when I get into my 50′s’ kind of investing.
One thing I am trying to figure out how to measure is how the income from a portfolio grows over time, assuming there isn’t any extra capital being added to the portfolio. In other words, how much of a ‘raise’ will your portfolio give you every year (on average). I wonder if you could talk about your experience so far with respect to the growth rate of the income from your portfolio.
Hi Derek, congrats on the retirement.
Quick question about risk & stress. Since your retirement is based upon more assumptions than that of most retirees (since you’re so young) do you feel any stress from that? ie What if inflation increases beyond what you had planned for? Are there certain things that make you nervous such as proposed dividend tax changes?
Hey Derek,
I have read your book and love it, I am trying to follow your pattern, I am 26, and Hope to retire about 2 years later than you did
I hope the government stays away from changing dividend taxes.
Pembina – Was featured in your book, and I bought it at a rather low level after the Halloween announcement of Income Trust taxes, and then they raised their dividends, and I think all that covers what the effect is going to be after taxes are charged on income trusts!
Love your book, I have bought 4 copies and gave it as Christmas gifts to friends and family
Vicks
Oxcc,
I combined a healthy dose of income trusts (between 40-50%) and dividend paying stocks. The income trust payouts is what allowed me to retire right away, while the dividend payers give me a small percentage of my income but grow more quickly over time.
I would expect the income trusts to approximately mirror inflation over the long-term whereas the dividend growers should grow a little more quickly – perhaps 8-10%/year over the long term
So over time, the dividend growers will make up a growing part of my income.
Cheers,
Derek Foster (author STOP WORKING: Here’s How You Can!)
Mike,
I don’t worry too much about inflation because companies are part of inflation. I expect (over time) that the companies should be able to pass on the extra inflation onto customers.
As an example, when Warren Buffett was a kid, he used to sell Cokes (or was it Pepsis?) for 5 cents each. Now, they cost $1 or so – so prices have risen with inflation.
Inflation is my biggest risk (not stock market crashes). That’s why I don’t own any fixed income.
Cheers,
Derek Foster (author STOP WORKING: Here’s How You Can!)
Hi Derek,
Thank you for writing your book. After reading it I experienced what S. Covey calls a paradigm shift.
I’m finding that good dividend paying stocks are not cheap. (ie high PE) However, some income trusts have come down in price. What is your take on investing in income trusts now? How do we find good income trusts that will persist in 4 years?
Thanks,
Ahmed
Vicks,
I think the whole income trust announcement will be a small negative over the long-term. The trusts will be taxed, but there will be an offsetting tax credit, so the net result is similar (with a little extra clawback of government benefits such as OAS, Child Tax Benefit, etc) which creates the small negative.
For foreign investors or those who held trusts in RRSPs, the announcement is much more negative. Since I don’t own an RRSP, that was a non-issue.
I picked up a trusts called Consumer’s Waterheater – with a yield of 9.7%.
Cheers,
Derek Foster (author STOP WORKING: Here’s How You Can!)
Ahmed,
I think a lot of garbage has hit the market over the last few years with regards to income trusts – but there’s also some good ones.
If the underlying business is sound, I think some trusts can be good investments – but the prices have come up a bit since the announcement…..so exercise some caution, IMHO.
I just sit here and collect the distributions – pretty boring strategy, but so far so good….
Cheers,
Derek Foster (author STOP WORKING: Here’s How You Can!)
Hi Derek:
Thanks for your post and thanks for taking the time to answer reader queries.
I understand from your book that you built up most of your portfolio when investors were chasing techs and dividend-growth was relatively cheaper than it now. Do you think that an investor starting today might be a) paying too much for dividend payers b) run the risk of dividends not growing much for a long time.
I raise point b) because dividends have been growing briskly over the past few years, but is it possible that dividends are going to be stagnant for a long time in the future?. Example, Royal Bank’s dividend went from 25 cents in 1982 to 39 cents in 1997 or only growing 2.8% a year.
Thanks CC for having Derek on as a guest!
Hi Derek I really enjoyed your book. I am
using your strategies, hopefully retirement
for me will be sooner than later.
Problem is all my savings are in an RRSP. I
don’t have much outside of my RRSP. Any
suggestions on retiring on an RRSP alone at the
age of 40, even though the RRSP is generating
all of my dividend income?
Hi Derek, thanks for answering my question.
Another question – although I don’t really subscribe to your method of retirement for myself, I think you are an excellent investor. Have you or would you ever considering working as an investment capacity? I realize the book is part of the answer to this question but what about something like a financial advisor/ portfolio manager / investment newsletter? Obviously working goes against the whole retirement thing but you seem to be quite interested in investments.
Great Book Derek – If not for advice, but for the story and encouragement for young, retail investors looking to build wealth with low/no fees.
I read your book 2 years ago after seeing you on Breakfast TV and it encouraged me to research my own investing strategy.
Thanks again.
CC,
You raise a great point – the solid dividend payers have gotten a lot more expensive over the last few years.
I think Royal has a more diverse income stream than in the 1980s, but even if it did hit a stagnant patch, other stocks such as Manulife, J&J, etc should pick up the slack.
Cheers,
Derek Foster (author STOP WORKING: Here’s How You Can!)
KS,
If you have enough in it, you can just use your RRSP to provide you with income forever – as long as there is enough in there.
Cheers,
Derek Foster (author STOP WORKING: Here’s How You Can!)
Mike,
Perhaps – I’ve been busy lately with family related duties, but I might want to write another book first. I find it difficult to know what I’m doing next week, let alone in a few years, so who knows
Cheers,
Derek Foster (author “STOP WORKING: Here’s How You Can!)
Jon,
Best of luck! Glad you enjoyed the book.
Cheers,
Derek Foster (author STOP WORKING: Here’s How You Can!)
He doesn’t waste a lot of words about it, but there’s a page or so in Derek’s book that is potentially more important than the rest of the book (investing in quality dividend paying stocks and living within your means is obviously a great strategy but it ain’t rocket science) and I am talking about where he says no thank you to RRSPs.
It’s dispensed with rather quickly and I don’t have the book here with me, but in about a page he gets into the critical argument that one is better off paying down a mortgage as quickly as possible and borrowing against the resulting equity to purchase investments with tax deductible interest.
If you combine Derek’s investment strategy regarding quality dividend stocks and related tax-friendly investments plus the strategy of paying off your mortgage (no RRSP payments to make thank you) and borrowing for a non-registered investment portfolio you can retire young and probably live a little less frugally than Derek. You might be older than 34 though!
I like the book but if there was a newer edition one day a chapter that more strongly pummels the RRSP for the stooge of the banking industry that it truly is would be great!
Interesting points notstupidanymore – the paying down the mortgage and then borrowing to invest is a good concept.
One thing to keep in mind about rrsps is that it is a tax deferral tool which is a lot more useful for some people than others. If I’m not mistaken, Derek never made much money in any one year which would make rrsp contributions counterproductive for him. Someone else who makes 100k per year has a lot more incentive to make contributions. As Rob has said in previous posts – the key to rrsp investing is maximizing the tax deferred and minimizing the tax paid on withdrawal. For lower income people this might mean not using the rsp at all. For a high earner who wants to retire early – they should probably be maxing it out. Everyone else is somewhere in between.
Paying down the mortgage and borrowing to invest outside of an RRSP is more than a good concept…it’s the path to a brighter financial future and a painfully simple way to achieve it imo.
I have to disagree completely with your tax deferral argument. This is the longstanding tired old line about RRSPs but it just doesn’t stand up to scrutiny when compared to the alternative.
You are deferring tax, but when it comes time to withdraw you are not going to pay 0% tax…you are going to be taxed on 100% of your withdrawals at your tax rate of the day, which will most certainly be a lower tax bracket, but not a 0 tax bracket. Talk to people who are in their late 60s and you’ll find out many of them are totally stressed about how to manage their RRSP withdrawals because all that money is now 100% taxable.
You can also defer tax by using a Derek Foster style of investment strategy, which is buying and holding quality. If you pay down your mortgage using the money you would have been using to max your RRSP and then borrow against that equity to invest in quality that you will hold, the interest is fully deductible, you get a bit of income that is taxed better than any other form of income (dividends) and you are deferring tax by simply not selling the investment itself until such time as you need or want that equity to go to cash.
And the income you are getting from the dividends (after the favourable tax treatment) is 100% yours, free and clear.
Sorry to be so blunt but I used to be quite stupid about these things and needed to be hit in the head with a big hammer to escape my brainwashed state of denial about RRSPs. I was raised to believe and spent a lot of my life believing that maxing my RRSP was the greatest thing in the world. Despite being confronted with clear evidence to the contrary it took quite a few bashings from a couple of wiser people before I could take the rather simple step of turning my bad debt into good debt and doing away with RRSPs forever.
Like so many people I became capable of endless smooth talk and wise sounding comments about RRSPs – I think I could have been a new character in the Wealthy Barber II – but it was all built on the mythology created by banks and other financial institutions because a big fat long lasting mortgage and maxing out of RRSPs is exactly what is best for the them – not for you.
Well just for the record I don’t max my rrsp, partially because I’m more concerned with paying down the mortgage.
I’m going to read Derek’s book in a couple of weeks so it should be an interesting read.
I’ll have to think more about the merits of investing outside the rrsp even if you’re in a high tax bracket.
Start saving money by buying the book from Chapters rather than the stopworking.ca website.
I wouldn’t bother reading it, although it is a nice easy read.
I can summarize the whole book for you (without having it here) and maybe others can throw in too….
1) employment income is the worst kind of income because you get killed by all kinds of horrible taxes so put your employment income to work as effectively as you can in generating other types of income (i.e. dividends)
2) a penny saved is worth two pennies earned so think carefully about how you spend
3) solid Canadian companies that pay good dividends are a boring but magnificent investment thanks to their returns and the preferential tax treament of dividend income
4) RRSPs are not the answer for just about anyone, although for specialized purposes such as income splitting they are worthwhile
Unless you find any of those first three assumptions challenging you should probably skip Derek’s book and read the book that covers the Smith Manouevre…it is written in a rather bizarre fashion but by the end you should end up a believer in the pay off the mortgage non-RRSP investing with borrowing from your home equity plan…
I forgot to say…
Crazy as it may sound to you, you should crunch the numbers on what would happen if you pulled your entire RRSP (yes, taking the huge tax hit right off the top at your current marginal tax rate) and applied it in full to your mortgage and then immediately borrowed back that money and invested it outside of an RRSP…I bet you will find that you will be much much much better off in the long run.
notstupid: I’ll have to disagree completely with you. I’ve mentioned that I think mortgage pay downs and RRSP contributions are equally good. But I definitely disagree that RRSPs are bad compared to savings in taxable accounts.
Of course, RRSP withdrawals will be taxed because no taxes were paid when money was contributed! Why is that a bad thing? Also, don’t forget that you get to defer taxes on capital gains, dividends and interest, which is significant for middle and upper income ranges.
Fortunately for me, PHN has performed the analysis making reasonable assumptions. The report is available here.
Link
BTW, melting down the RRSP to pay down the mortgage is definitely crazy. Please crunch the numbers and show us how it is better.
I agree with Canadian Capitalist regarding RRSP. For the majority of the population, RRSP is superior than non-registered. I wish the contribution room is higher than 19%.
That are many flaws in notstupidanymore’s logics. Some of which are already debunked in the link provided by CC. There one assumption that you can also defer taxes in non-registered accounts by not selling. Problem is if you follow Derek’s strategy, you’ll buy some income trusts and some US dividend payers. Many high quality income trusts like Yellow Pages, Parkland and North West Company distribute > 80% income that are fully taxable. Dividends from good quality US stocks like JNJ are also taxed as regular income. Some stocks can also be bought out by other companing, forcing you to cough up capital gain taxes.
Is the following a valid statement?
“If you plan to earn as much or more money in retirement than you do now then there is no value
in having an RRSP.”
BTW, a buy and hold strategy consisting of Canadian blue-chip stocks would provide no benefit of being held inside an RRSP.
Assume the following two identical portfolios:
Portfolio A
- held within RRSP
- generating $5000 annually in CDN dividends
Portfolio B
- held outside of RRSP
- generating $5000 annually in CDN dividends
If I were to withdraw the $5000 annually from both portfolios I would end up paying more in taxes from Portfolio A.
As investors why should we plan to earn less after retirement? I’m saving hard and investing
even harder so that when retirement comes my investments are generating enough income to equal what I make now if not more.
The only benefit I could see of having an RRSP is if your employer has a mathcing benefit plan. For example for every $1.00 contributed, some companies will contribute $0.50 towards your RRSP. Thats an automatic 50% return. So perhaps the employer contributions can be used to pay the tax when it comes time to withdraw money from your RRSP.
They’re not identical portfolios, because you’re mixing up pre-tax and after-tax capitals.
Assuming dividend yield is 5%. To generate $5000/year, portfolio A’s capital is $100,000 inside RRSP which is pre-tax. Outside RRSP in portfolio B, it’s only worth $60,000 assuming marginal tax rate of 40%.
5% yield on the $60,000 is only $3000.
What’s going on here is typical…people who have dedicated their entire lives to the belief in the RRSP don’t want to believe that they could be doing much better by having no RRSP at all. Or withdrawing it.
That PHN report does not consider an appropriate “Smith” strategy in the calculations. Behaving like you are investing with an RRSP and then attributing that same behaviour to a non-registered strategy is obviously going to yield results that favour the RRSP.
Some of the comments here are indicative of just what I was saying…people are desperate to cling to their beliefs.
It is not a “bad thing” that tax will be paid on withdrawal of the RRSP, but many people (ask around) really haven’t figured in that it is 100% taxable when they take it out. So yes, you get some tax advantages but you do pay at the end of that long road, and you also lose out on the opportunity for tax deductible interest by investing outside of your RRSP – that is tax deductible interst for the lifetime of that loan, and it really isn’t so hard to figure out how to invest so as to bring returns that come in the form of Canadian dividends which are 100% yours once the very kind tax treatment is done with them.
This is HUGE and people don’t seem to get it for some reason – or they don’t want to.
They also don’t want to face up to how much their mortgage is actually going to cost them over the life of that mortgage, and the gobs of money they will save by powering it down rapidly by converting their bad debt mortgage into a good debt non-registered investment account.
What is sad is many people who work in the financial services sector aren’t screwing people with the RRSP myth on purpose, they really are just as stupid as the person across the desk.
I’ll never forget the day my wife and I dealt with TD Waterhouse and TD Bank when we started down this path. They looked so sad. I went to the bother of explaining to them why they should not be sad because our mortgage would be paid off much more quickly saving us gobs of money (I gave them the figure) and we’ll have a more efficient return on our investment portfolio strategy to boot thanks to tax deductible interest. Laid it all out for them and everything, just so they would not look so sad.
The wheels would go around and around in their heads, and then they would say something like “but…you’ll lose this or that advantage!”
And then I’d explain how it might be an advantage verus burying it in a hole in the back yard, but compared to our non-RRSP strategy it wasn’t an advantage at all. I told them I appreciate their concern and aksed them to please explain how we were wrong.
They could not do it. They could only sit there and look confused. And a bit sad.
Some specific responses…
It is not an “assumption” that you can defer capital gains by not selling. Obviously, as in the ridiculous example chosen, if you buy the wrong income-yielding investments you’ll be taxed on them. Fortunately most people who get this far aren’t so stupid as to do that
Cashing out the RRSP and paying off mortgage…
You’ll have to crunch your own numbers on your own situation (I should already be getting paid a huge fee for all this, even if people can’t find their way to see the light) but if you have a significant mortgage, definitely look into it. Calculate the hit on your RRSP withdrawal.
Now, take what is left and put it 100% towards your mortgage. Now borrow back 100% of that money and invest it outside of an RRSP. Assume a rather crappy return, say 8%.
Now look at how much you saved by paying down your mortgage so much early and add that to the return on your non-RRSP account.
Guess what…that “big hit” you took withdrawing your RRSP money is going to be looking not so big.
If this is all too scary I will go away and let everyone go back to their happy place
notstupidanymore: Instead of just talking about your investment plan, as was suggested in a previous comment why don’t you put together some numbers and share them with us? I’m always open to new investment ideas and would love the opportunity to discuss, analyze, and try to apply to my situation. Insulting everyone by suggesting that we are not intelligent enough to understand the advantages of your financial idea ignores the fact that you haven’t proven your idea with a specific example (including some numbers) and it also ignores the fact that a lot of people on these forums (especially myself) are very skeptical people. I’m skeptical of investing in rrsps, investing outside rrsps, any financial marketing, the Smith maneuvre, the Derek Foster strategy, passive investing, active investing, for that matter any kind of investing strategy at all. I don’t believe anything until I run the numbers, completely understand all the facets of the idea and understand how it can relate to my personal financial situation.
Another thing I’m skeptical about? I don’t believe that any one strategy has to be followed 100%. You can find people who swear by owning only individual stocks or only mutual funds or only ETFs but is it so hard to imagine an investor that owns 2 of those vehicles? Or even all three? I have no intentions of giving up my rrsp because I know it’s a good strategy for MY situation but I’m also intrigued by the Derek Foster plan of buying quality dividend stocks outside my rrsp. Maybe I can do both? And I also want to investigate further the concept about borrowing to invest and deducting the interest to buy investments (div stocks maybe?) outside my rrsp. Will I do it? I’ll have to let you know after I determine if I think it’s an appropriate strategy for my personal situation.
If you want to put me on salary I can examine everyone’s financial situation and prove to them that they would be better off paying down their mortgage as quickly as possible and borrowing the equity for a non-registered investment account, but I don’t see why people would not do it for themselves…I’ve been through this before and no one will have the same situation with me so all it does is promote further sketpicism “yeah but I have three kids, my mortgage is bigger…” etc and so on.
Skeptical is fine. If my tone seems insulting it is because there is a difference between being skeptical and being in denial, and I am seeing some denial here. People who are in denial (as I was myself at one time on this issue) need a big cold splash of reality and if they feel insulted, maybe they will figure out that the only reason they have to be angry is that they are angry at themselves. And then maybe they decide that instead of being angry, they should take action!
That’s how it worked for me
There are certain undeniable truths here. The core of Derek’s thinking is undeniably true – if you don’t waste your money on stupid things and if you generate income in the most tax effective manner you will end up with more money. You can haggle about his particular investment suggestions but that’s really moot – the point of his book is to bash it into our skulls that dividend income is awesome! It’s undeniable that dividend income is better than the equivalent in employment income or capital gains income because it is taxed more favourably.
The core of what I am trying to convey here is also undeniably true. A mortgage is a BAD DEBT because it has no tax advantages (in the US things are different).
Borrowing to invest results in a GOOD DEBT because the interest is tax deductible.
Therefore, if you change $200000 worth of mortage debt into $200000 worth of investment debt, you are undeniably better off…not only is the interest now deductible (HUGE!!!) but you can of course make money with the loan from the return on the investments (also HUGE!!!).
Right? Right.
Let’s start there and see how it goes. If skeptics etc can’t get past this point, then I am truly wasting my time.
In response to the previous comments I was looking up what the taxes on dividends were using the following calculator (I live in AB).
http://www.taxtips.ca/abtaxcalc.htm
It seems that the tax rate on dividends that qualify for the enhanced tax credit is crazy low. Am I missing something? It looks like dividends from all canadian based corporations qualify. So I assume that would include the likes of BMO and RBC? I had always just assumed that dividends were taxed like capital gains. I never really looked into it.
If this is accurate then paying this tax rate on dividends and getting a deduction from an investment loan at my marginal rate looks pretty appealing. I’m pretty sure I’m missing some important details so all you smart guys can enlighten/mock my ignorance.
I think you are correct Bryce – As far as I know dividends have always been taxed differently than income and capital gains and there have been significant changes over the years (for the better). I think the current taxation model for divs has only been in place for a few years.
Thanks for the link – I was planning to investigate the tax differences myself.
YES!
Dividends are a WONDERFUL form of income, and YES, dividends from Canadian companies like the chartered banks qualify. There are also some terrific Canadian dividend ETF products. I think these can be ideal for a non-registered strategy. Good stocks that will bring at least a modest return while at the same time giving you a very friendly form of income!
Sooo, is this right?
Say I got a $20,000 loan @ 6% then it would cost $1200 to carry the loan for a year. If I used it to buy BMO at today’s price (~$71) then I’ll have ~280 shares. If I assume they pay out the same dividend ~2.25 per share I’ll get $630. So then I used the tax calculator and entered the dividends and I entered the loan amount as though it was a RRSP deduction (I assume that will work out the same) and the result is I pay $338 less taxes in that year (assuming I have a salary of $60K). So if you add up the dividend and the refund and less the carrying cost you get
$630+338-1200=-232
so
232/20000 = 1.2%
so it costs 1.2% to borrow $20,000 worth of BMO shares? That doesn’t sound right. So if the shares go up 2% you are in the money? I realize the amount of times ‘assume’ appears in my comment is quite a bit.
The nice thing about dividend income is that once you set it up, if you’ve bought the great companies that are in the habit of regularly increasing dividends, you get a raise on a regular basis without ever lifting a finger! Once your dividend stream equals the income you need to live on, you can retire and never work for money again – which is how I retired at 34. The key is buying the correct stocks following the proper criteria: dominant, recession-proof, etc.
The only negative is with the gross-up, there’s a clawback of certain benefits (OAS, GST credit, etc.)
notstupidanymore,
I used leverage a few years ago when everyone was buying Nortel and shunning boring things that paid unreal distributions. I could borrow at less than 8% and buy something with a partial tax-deferred income (income trusts with return of capital provision, etc) that yielded around 12%. So I made less income but also saved income tax!
Cheers,
Derek Foster (author STOP WORKING: Here’s How You Can!)
Bryce,
It gets better. Don’t worry about the shares going up. Instead, just wait for BMO to hike their dividend a couple of times and you’ll start being positive cashflow regardless of what direction the shares go.
Cheers,
Derek Foster (author STOP WORKING: Here’s How You Can!)
Looks fine to me Bryce although I’m no dividend tax expert.
Back to the RRSP discussion. notstupidanymore, a diversified portfolio shouldn’t have 100% Canadian dividend paying stocks. You should have some US dividend paying stocks and income trusts. You should put your Canadian stocks outside RRSP and US stocks and income trusts inside RRSP. My own RRSP has only US dividend stocks and income trusts.
Examples with numbers. Assumptions -
* Marginal tax rate = 40%
* Yield = 6%
* Loan interests = 6%
Portfolio A: Outside RRSP
- Borrow $6,000.
- Pre-tax income = $360
- Loan Interest (deductible) = $360
- Net income = $0
Portfolio B: Inside RRSP
- Borrow $10,000 to fund $10,000 of pre-tax RRSP. Get $4,000 tax refund and use it to reduce loan to $6,000.
- Pre-tax Income = $600
- After-tax Income = $360
- Loan Interest (not deductible) = $360
- Net Income = $0
(Please double check my numbers.) The only difference, notstupidanymore, is that during accumulation, you defer your taxes so you can compound much faster and get you to early retirement sooner.
Silverm, it doesn’t appear that your example shows exactly what you’re getting at. The net dividend income outside the rrsp will be greater than the deductible loan interest since the dividend is taxed at a lower rate the the rate that is deducted for the interest. So there should be a small profit for the outside rrsp example if I’m correct.
However I think this example doesn’t show the advantages of an rrsp particularly for a higher income person. Ironically notstupidanymore got me thinking of the advantages/disadvantages of rrsps today and I am actually more in favour of them now than I was this morning.
I’m thinking a proper example of rrsp investing should always show the end result of the withdrawing from the rrsp and compare that to the investment that was made outside the rrsp.
I used to always think that if you made an rrsp contribution at a certain marginal rate and then later on, withdrew that money at the same marginal rate, then you are roughly breaking even. Today it occurred to me that you are still coming out ahead. If we take silverm’s example, the non-rrsp investment was taxed at the marginal rate of 40% right off the bat so only $6000 was invested, meanwhile the rrsp investment stayed at it’s original $10000 amount. During the duration of the investment the non-rrsp investment will accrue dividend tax and be reduced accordingly. At the end of the investment period the non-rrsp investment will be reduced (hopefully) by capital gains. The key thing with the rrsp investment is not that the dividends aren’t taxed until withdrawal or that the withdrawal is considered income and not capital gains but rather the fact that 1. you have the option of not withdrawing it all at once which can help reduce the income tax and more importantly 2. when you withdraw the money from the rrsp – it’s not taxed at the 40% rate that the non-rrsp was taxed at in the beginning – even if you are in a 40% marginal tax rate at withdrawal. The reason is because of the progressive tax system so when the withdrawal is made, the average amount of tax taken on that years income will be? 30%? 20%? 10%? depending on the situation, which is why the rrsp result will generally be better. The only way the outside rrsp example would win out is if the original tax bracket is very low or if the dividends increase at a very high rate.
After all this writing I hope I have this right!
>>>>”The net dividend income outside the rrsp will be greater than the deductible loan interest since the dividend is taxed at a lower rate the the rate that is deducted for the interest.”
No. They’re taxed at the identical rate. As I’ve mentioned before, when you’ve a diversified portfolio, you put the most tax inefficient investments inside RRSP. They can be US dividend paying stocks, income trusts that pay a lot of interest income, and fixed income. Forget about dividend tax credits, because they don’t come into the picture.
* If you spend the income each year, then they’re equal in performance if you factor in loans. Without loans, RRSP is ahead.
* If you’re accumulating for retirement, RRSP is much more superior than non-RRSP due to tax deferral. That’s true even if marginal tax rates are the same.
notstupidanymore wrote:
>>>>”you are deferring tax by simply not selling the investment itself until such time as you need or want that equity to go to cash.”
Sounds good in theory, but unrealistic. If it wasn’t for the income trust tax ruling, BCE, Telus and many other strong Canadian dividend payers would’ve converted to trusts and you would’ve had to pay capital gain taxes. How about mergers? Can you guarantee that the companies which you own today won’t get bought out between today and your retirement? Finally, don’t you have to rebalance once in a while? What if the fundamentals of some of your holdings are deteriorating?
===
I used leverage a few years ago when everyone was buying Nortel and shunning boring things that paid unreal distributions. I could borrow at less than 8% and buy something with a partial tax-deferred income (income trusts with return of capital provision, etc) that yielded around 12%. So I made less income but also saved income tax!
Cheers,
Derek Foster (author STOP WORKING: Here’s How You Can!)
===
Very nice sir!
I should add that what I have been describing is not actually leveraging, as I had to explain to my “financial advisor” at my bank when I pulled out all my dough. Leverage involves increasing your debt, whereas I am only proposing exchanging mortgage debt for investment debt.
I think you should write another book but you are probably too busy working on your list
My wife and I are very close to devoting ourselves to our own lists full time
> silverm Says:
> February 15th, 2007 at 7:01 pm
> Back to the RRSP discussion.
> notstupidanymore, a diversified portfolio
> shouldn’t have 100% Canadian dividend paying > stocks.
Sigh. I never said that it should. I was responding to one of the various disingenuous responses that pointed out that if you were an idiot you could chose to put your money into investments that were not optimal for a non-registered account.
> You should have some US dividend paying
> stocks and income trusts. You should put your > Canadian stocks outside RRSP and US stocks
> and income trusts inside RRSP. My own RRSP
> has only US dividend stocks and income trusts.
There are many ways to gain exposure to the US and other markets while still getting favourable treatment in a non-registered account.
> Examples with numbers. Assumptions -
> * Marginal tax rate = 40%
> * Yield = 6%
> * Loan interests = 6%
>
> Portfolio A: Outside RRSP
> – Borrow $6,000.
> – Pre-tax income = $360
> – Loan Interest (deductible) = $360
> – Net income = $0
>
> Portfolio B: Inside RRSP
> – Borrow $10,000 to fund $10,000 of pre-tax
> RRSP. Get $4,000 tax refund and use it to
> reduce loan to $6,000.
> – Pre-tax Income = $600
> – After-tax Income = $360
> – Loan Interest (not deductible) = $360
> – Net Income = $0
>
> (Please double check my numbers.) The only
> difference, notstupidanymore, is that during > accumulation, you defer your taxes so you can > compound much faster and get you to early
> retirement sooner.
Why are you comparing $6000 to $10000?
And why are you ignoring the fact that all along I have been talking about directing that $6000 (or $10000 whichever you like) to paying down the mortgage and then borrowing from that resulting equity to invest outside of an RRSP. To understand the value of this strategy you need to do a few more calculations, not the least of which is figuring out how much you have saved on your mortgage by paying it down by $10000!
And then to make it even better, invest in Derek-style equities and take the dividend income and put that towards the mortgage too…and then borrow that back and increase your portfolio again! And now your investment portfolio keeps getting bigger and your mortgage keeps getting smaller! You save gobs on your mortgage and end up with a big portfolio that delivers income for you and gives you a tax refund on the interest for the life of the loan (which you should never pay off by the way).
Although it is relatively simple, it is not so simple as the comparison you were making
silverm Says:
February 16th, 2007 at 12:56 am
notstupidanymore wrote:
>>>>”you are deferring tax by simply not selling the investment itself until such time as you need or want that equity to go to cash.”
Sounds good in theory, but unrealistic. If it wasn’t for the income trust tax ruling, BCE, Telus and many other strong Canadian dividend payers would’ve converted to trusts and you would’ve had to pay capital gain taxes. How about mergers? Can you guarantee that the companies which you own today won’t get bought out between today and your retirement? Finally, don’t you have to rebalance once in a while? What if the fundamentals of some of your holdings are deteriorating?
—-
Sigh. You are on a desperate search for the preservation of denial.
Is it really worth all the disadvantages of an RRSP just so you won’t be “burdened” with the capital gains that would result from one of these events? Oh no, BCE is converting to an income trust and the market is responding by driving up the price and now I also have to deal with a bigger income that will have some tax taken out of it. Mercy! Horrors!
When you are rebalancing sometimes you don’t always take a gain, right? Sometimes you take a loss. Personally I don’t find myself selling off stocks that making me money so I can “rebalance.”
If you follow Derek’s lead, you won’t find yourself messing around with this sort of situation very often. My buy and sell days are long over. I am much happier with a passive but very effective strategy, and I don’t have to worry about “what to do” with my RRSP. Once the government is done taking their little piece of my dividends, that cash is mine…all mine. I’m not there yet but it truly won’t be long until the dividend income is enough to live on quite comfortably, and that’s without even touching the more than 10% that I am up on the investments themselves. I don’t know that I will ever need to sell them. It’s the one thing I will have to organize which is to pass them on to others when I leave this world.
It’s painfully boring and incredibly effective. No waiting until “retirement age” to “pull out my money.” And no searching around for the next hot tip. Give me some Royal Bank stock any day. I never dreamed it would go up more than 100% but that’s what has happened, I just got in for the nice dividend and nice track record on said dividend. And I’ve always done just like Derek says…when it takes a dip I just buy more, I know it is going to recover and go up again, and there’s no panic – the dividend will keep coming.
Derek retired in his 30s and he never had a big salary in any of his jobs. And it had NOTHING to do with an RRSP.
Personally I am not as frugal so I feel I need a bigger portfolio and the strategy I have used with my mortgage and borrowing for investing purposes has proven the answer, and more.
It’s a great combination of strategies…paying off your mortgage as quickly as possible, borrowing to invest in a non-registered account, and using a Derek style strategy to purchase boring quality revenue-generating equities that become your primary source of income. I am really close to where I won’t need anything from my portfolio beyond continuing to pay out similar dividends. The actual gains in the stocks is likely to be there for someone else but is there if I need it.
>>>>”There are many ways to gain exposure to the US and other markets while still getting favourable treatment in a non-registered account.”
Yeah but you’re making restrictions on yourself because now you have to work the system. When it’s inside RRSP, you’re free to focus on the most fundamentally sound investments instead of the most tax-efficient investments. You can’t all of a sudden change topic. You’re trying to following Derek’s strategy, aren’t you? He said up thread that he invests in US dividend stocks and Canadian income trusts.
>>>”Why are you comparing $6000 to $10000?”
You’re kidding right? Why do you have such a strong negative opinion against RRSP when you don’t know the difference between after-tax $6,000 and before-tax $10,000? If you earned $10,000 gross, you can either invest the entire amount inside RRSP, or you can pay $4,000 in taxes and invest the remaining $6,000 outside RRSP.
>>>>>”And why are you ignoring the fact that all along I have been talking about directing that $6000 (or $10000 whichever you like) to paying down the mortgage and then borrowing from that resulting equity to invest outside of an RRSP.”
How could I have incorporated that? I started with $0, remember? The $6,000 was borrowed money to invest. My equity is already in the house, so there’s nothing more to transfer.
>>>>”And then to make it even better, invest in Derek-style equities and take the dividend income and put that towards the mortgage too”
What does this have anything to do with the RRSP vs non-RRSP debate? Actually, you can do that even better with RRSP. Instead of having just $6,000 after-tax to earn $360 pre-tax or only $216 after-tax to pay down your mortgage, you can invest $10,000 pre-tax inside RRSP to earn $600 pre-tax or $360 after-tax to pay down your mortgage.
Please stop selling Derek’s strategy. Nothing against Derek, but he didn’t invent the dividend paying strategy. Many people have been practicing this strategy before he was born. The RRSP debate has NOTHING to do with this strategy. You still can buy dividend paying stocks and income trusts when you invest inside RRSP.
Just for the record, my RRSP is maxed out. I have US dividend paying stocks and income trusts inside my RRSP, while Canadian dividend paying stocks (e.g. BNS, BMO, IGM, TRP, X, GWO, SLF, CNR, ENB, SAP, BCE, etc) outside RRSP. I have also used the Smith Maneuver for my previous house, so I’m familiar with how it works. By the way, the Smith guy didn’t invent the maneuver.
>>>>”Is it really worth all the disadvantages of an RRSP …”
Emm, what disadvantage?
SilverM you are wasting your breath
How did you find the Smith Maneuver? Did you feel happy with the results?
>>>>”How did you find the Smith Maneuver? Did you feel happy with the results?”
It’s not life changing, but for me it’s better than nothing. Mortgage interests are about 0.9% lower than prime. If you put the money into your mortgage and pull out a secured line of credits, you’ll be paying prime rate.
Suppose prime is 6% and you’re thinking of depositing your $5000 dividends into your mortgage. That $5000 will save you prime-0.9% which is $255. But if you borrow the $5000 from secured line of credits, you’ll be paying $5000 X 6% which is $300. After receiving the tax refund, you’re reallying paying $180.
The difference is $75 per year. If you’re a low income earner, then the SM might work against you.
I paid $150 to setup my secured LOC and I’d have had to pay more to increase the limit. There might be better deals today if you shop around.
Yesterday, Encana was another one that raised their dividend – it’s quadrupled in around three years – but it still doesn’t seem too high even if the price of oil/nat gas comes off quite a bit – like it did for them in the 4th quarter. They’re also buying back lots of their own shares, so hopefully there’s a stock market correction soon so they can buy more shares back at cheaper prices!
Cheers,
Derek
Apparently I’m being censored since I can’t post anymore under my old name (notstupidanymore) so I guess “stay in our happy place” is the way of this group. Too bad for those who actually want to enjoy life a little more.
My life is perfect the way it is!
Hi Derek, I subscribe to the diviend investing strategy, however I believe you may be setting the expectation just a tiny bit too high.
Low Income + Dividend Paying Stocks do not equal retirement at age 34.
In my opinion, it’s important to disclose your Altria bet that that you made 11 years ago. If I remember the detail correctly, you used $60k of your money and borrowed another $60k to buy $120k worth of Altria stock, and it doubled in a few months? Obviously, due to compounding, the money went a long way.
Again, I’m not saying dividend stocks are bad, but I’m just setting the right expectation.
SilverM – as always you are the voice of reason in these types of discussions.
However I don’t think Derek is hiding anything about his past – I’ve included a link to a G&M article where it mentions his Altria purchase. You can find it on google if the link isn’t correct.
In my opinion Derek is a fantastic value investor who has taken advantage of that gift to retire early. Is it realistic for anyone else to be able to follow his footsteps to a “T”? Probably not given that his investment record probably makes him the Canadian equivalent of Lynch, Buffett etc.
However, some of the things I’ve learned (or relearned) from him are (and I know he didn’t invent any of these): there is value in “value investing”, Canadian dividends are a good source of income if bought cheaply enough, and that ‘frugal’ living can go a long way to speed up retirement plans.
I think the book has some great information and ideas for a lot of investors (and would be investors) and if he renamed to “How I retired at 34 and you can retire at 48 if you follow the same path” wouldn’t sell as many copies and then not as many people would get the message.
http://www.theglobeandmail.com/servlet/story/RTGAM.20050212.wxstmain12/BNStory/SpecialEvents2/
One more kick at the happy place can…must because I care.
http://ca.pfinance.yahoo.com/ca_finance_planning/20/rrsp-or-mortgage/
See the link above for a typical plain jane recommendation of mortgage vs RRSP.
Now add in what I have been discussing – borrowing from the home equity and building a non-registered portfolio with tax deductible interest AND a Derek-style strategy with dividend income and quite simply you will totally KICK ASS compared to any RRSP-focused strategy.
OK, I’m done now. Good luck to all.
NotStupidAnymore, I can do a quick Google and find plenty of articles for and against RRSP and mortgage, but what I want is for you to write down in your own words and numbers why you think your strategy is better.
Frankly, Duncan Hood doesn’t support your strategy at all, so I don’t know why you view that article as proof that non-RRSP is better vs RRSP. The article is about RRSP vs mortgage, and how a mortgage has a better risk-adjusted return than a stock portfolio held inside RRSP. Duncan Hood is basically telling you to stay away from the stock market until the mortgage is paid. This is totally different from your strategy. Your strategy isn’t to pay off your mortgage, but to turn your mortgage into a tax-deductible loan via the Smith Maneuver. i.e. giving the mortgage a different name rather than eliminating it. You also invest in the stock market right away instead of waiting until the mortgage is paid.
There were a couple of errors anyway. A 5-year fixed mortgage is 5.1%, not 6.0%. The long-term return of stock market is around 10%, not 8%. If you’re following Derek’s stragegy, there wouldn’t be a 2% MER, right? If making extra mortgage payments is a “KICK ASS” strategy as you claimed, why must he cheat on his numbers?
Here’re my numbers. (Seems like I’m the only one giving real numbers in this exchange.)
Mortgage Scenario:
* Has $10,000 pre-tax
* Pay $4,000 tax, and only has $6,000 left.
* Use it to pay down mortgage to save only $306 of after-tax mortgage interests. ($6000 x 5.1%)
RRSP Scenario:
* Has $10,000 pre-tax
* Invest $10,000 in dividend paying stocks.
* Earn 10% or $1,000 of profits, or $600 after-tax. This is almost 2 times better than the mortgage scenario.
For RRSP, we can also break down the capital appreciation and income. If the weighted yield between your income from dividend stocks and income trusts is 5%, then $10,000 earns you $500 pre-tax or $300 after-tax. This is a little bit less than the $306 compared to paying down the mortgage, however there are 2 BUT’s.
(1) The $300 after-tax has the element of growth. After all, you’re buying stocks that have long histories of raising dividends. It’ll take only a year to surpass $306 after-tax, and after that is a LIFETIME of outperformance.
(2) We’re only talking about yield. I haven’t counted the stock appreciation component.
>>>>”OK, I’m done now.”
Whatever man. If you want to build a convincing case, show me YOUR numbers.
Mike, I think I’ll just leave it as that. Investors shouldn’t expect to retire by 34 with dividend stock investing alone.
Sigh. The point was that making a straight up comparison between paying down a mortgage vs an RRSP doesn’t produce a clear winner (as you say, many articles for and against) so you can blow the roof off that debate by adopting the strategy that I am suggesting – which pays your mortgage off *even faster* while at the same time gives you an income-producing investment portfolio. Sigh. I said it was my last kick at the can so I’ll stick by it. I wish I could say I’ll bump into you during my retirement activities in two years, but I don’t think too many of you here will be joining me. Closed minds = limited returns
>>>>”comparison between paying down a mortgage vs an RRSP doesn’t produce a clear winner”
Who cares? That’s not what we were debating about. You said non-registered is better than RRSP, so I disagree with you and I have hard numbers. You don’t. How can you be the one open minded when your argument has no leg to stand on?
Why are you constantly looking to start a debate on dividend investing and the Smith Maneuver when I don’t have anything against them anyway? If you feel the need for some victories, why don’t you just say so?
>>>>”I said it was my last kick at the can so I’ll stick by it.”
You should for your own good.
I’ll pull a NotSoStupidAnymore by sharing a link with you:
http://www.efficientmarket.ca/article/RRSP_vs_NON_REGISTERED
The reason why I’m doing this is because I’m not the best writer in the world, and this author is probably doing a better job in explaining the different scenarios. He covered 3 cases:
Case 1: RRSP versus Buy and Hold Growth Stock
Case 2: RRSP versus High Yield Canadian Dividend Stock
Case 3: RRSP versus extra mortgage payment
I’d like to highlight a few statements:
- The arguments for non-registered investments generally involve a lot of handwaving and grand claims so let’s break it down and look at the numbers. (Sounds familiar?)
- For many people the tax on withdrawls from an RRSP will be lower in retirement than the tax saved at contribution time.
- Almost everyone who argues that the non-RRSP is better ignores the fact that the non-RRSP payment was made with after tax dollars. (Again, sounds familiar?)
Sigh. Hopeless. You haven’t paid any attention at all and keep recycling the same old financial industry crap that compares apples to organges – comparing the best use of an RRSP to the worst use of altneratives.
Now get real!
The non-RRSP is established with borrowed funds. The borrowed funds come from paying down your mortgage – more quickly than if you were instead putting the money into RRSPs. The money is borrowed from your home equity thus turning the bad debt mortgage into a good debt investment loan.
The interest on the borrowed money is fully tax deductible. The non-RRSP investments are utilized to generate tax-friendly income (less than $10 per $100). This becomes your money – after tax – generated by borrowed money with tax deductible interest that came from the equity in your home that you paid off more quickly because you were not getting sucked into an RRSP which is best for your bank but not best for you.
To get that wonderful sort of after tax income you can do it yourself with a Derek style strategy or you can use professionals who will operate your investments as a type of “open pension” where the income from those investments is returned to you for as little as $5 on a $100. But even without going that professional route, paying of your mortgage more quickly and borrowing with that equity to purchase non-RRSP and derive generous after-tax income is and will always be far superior to any RRSP strategy.
But the banks don’t want you to do that, and people are too stupid to break free of what they have been conditioned to believe. It’s really very freaking sad.
I agree about the apples and oranges comparison. The RRSP v. Mortage v. Non-rrsp debate is a debate about what to do with money that you HAVE. AAAAAgggghhhh (notstupidanymore) you are talking about a method to go into debt further with the oportunity (a pretty good one it sounds like) of getting rid of ALL your debt earlier. It is still taking on more debt even though you are using it to eventually reduce other debt. It is not magic but it really sounds like a good strategy that I am thinking of exploring. If you are really adverse to risk then maybe this is not the right thing for you. It isn’t a one size fits all and be glad for it. If everyone wanted to do it then those good dividend stocks would be even harder to find.
Sorry my spelling was terrible. I’ll proof my posts better in the future.
Excellent. I see we’re making progress. Let’s start at the point where you’ve just moved all your equity into your home, and you’re ready to borrow from your home line of credit.
Please show a very *clear* numeric example of how you can get ahead with non-RRSP vs RRSP. Don’t forget to outline your assumptions at the beginning.
e.g. Tax = 40%. Investments = Income trusts & US Dividend paying stocks. Canadian dividend paying stocks can stay outside RRSP. No problem.
Hey Guys,
Just logged on and noticed my newest addition – Consumer’s Waterheater – hiked their payout 4.9%, so far so good….. Just picked this up after the Oct 31. trust announcement.
I’m in Florida right now and decided to see what’s up. We’re staying at a neat loft-type condo with two bathrooms and loads of amenities for the kids for….get this…..$150 for the week. If you have a bit of time to check the net, there are some good deals to be had if you’re flexible on your arrival and departure times.
Hope winter ends by March 1, when we get back, but I won’t hold my breath!
Cheers,
Derek Foster (author STOP WORKING: Here’s How You Can!)
Ok Derek, where did the money come from, lets put this in its right perspective, you say that you started to save in 1992, at a rate of $200 per month, that’s $2400.00 per year and you retired in 2004, that gives us a total of 12 years @ $2400.00 per year = $28,800.00.
Your chapter 20 on Example Portfolio reveals this.
To have an income of $18,845.00 per year one would have to own all the company’s that you mentioned in that chapter. To own that amount of share’s and the cost of them share’s comes to $325,500.00, at a rate of $2400.00 per year it would take 136 years to get there.
Even just to own one company, lets say Riocan the total cost is $40,000.00 at a rate of $2400.00 per year it would take 17 year to get there.
You might have retired at the age of 34, but not with $2400.00 per year investments.
Am I missing something or is this another one of them books that is all smoke and mirrors.
John
Bryce // Feb 20, 2007 at 2:43 pm I agree about the apples and oranges comparison. The RRSP v. Mortage v. Non-rrsp debate is a debate about what to do with money that you HAVE. AAAAAgggghhhh (notstupidanymore) you are talking about a method to go into debt further with the oportunity (a pretty good one it sounds like) of getting rid of ALL your debt earlier. It is still taking on more debt even though you are using it to eventually reduce other debt. It is not magic but it really sounds like a good strategy that I am thinking of exploring. If you are really adverse to risk then maybe this is not the right thing for you. It isn’t a one size fits all and be glad for it. If everyone wanted to do it then those good dividend stocks would be even harder to find.
===
LOL, I feel ARGGGHS pain, like me I don’t think he/she fully understands how he arrived at his own success. He only know that it works, or that’s at least his/her main motivation for trying to discuss it.
Bryece, you don’t increase your debt load with SM, that simply is not true.
If you do SM starting with a $750k mortgage on a $1mill home, at the end of it all you will have a $1mill home and $750k worth of investments purchased with borrowed money.
At no time will you have more than the $750k debt you started with!
I’ve read Derek’s book by the way and liked it very much and actually plan to incorporate some of his strategies once my mortgage is totally gone.
CC, this is a great website, I can’t believe all these great topics and discussions!
Kevin
After briefly seeing Mr. Foster on a TV program about a week ago (July 2009) doing an interview, I immediately took an interest and started looking up info. about him and what he was saying. I started reading some of the numerous info. available from him, and in these articles, Globe & Mail, etc.
Mr. Foster has highlighted that it is not worth it to work hard in this country because we are taxed to death. Only low income people (even the RICH ones) benefit from all the tax benefits. I can’t believe that someone who has liquid assets of over $400k is allowed to collect Child Tax Benefit.
Some of us have to work hard to get to just a comfortable level in their life even with illnesses. Yet, never collect anything for free from the Government…no EI, nor nothing else.
The more you work in Canada, the less rewards you get from the Government…basically, I don’t have any liquid assets, but a big mortgage because I have to live close to my job, but I am subsidizing Mr. Foster’s lifestyle.
While I found all the arguments about RRSP vs. paying off your Mortgage very interesting (have me thinking), I do think it is unfair that Mr. Foster is allowed to collect CTB.
What’s Fair, instead of whining why not offer a better solution? Maybe reducing the CCTB but giving it to everyone would be better?
The CCTB is based on income. Mr. Foster, probably gets less than others because his income includes dividends. Lets say for instance two families making 50K per year, one works and the other makes 50K in dividends by investing in companies that pays for the other ones job. The one working gets 237 a month (2844, common law, ontario, one spouse 40K income). Mr. Foster if he made only dividends would get 166 a month (1992 a year).
Of course their taxes are different too . . . one gets a discount for investing in companies that makes jobs for others, and one pays what most people pay . . . and whines about how unfair life is while he wastes money on a big screen TV.
Whoops, I did the calculation on 40k a year and claimed they both took home 50 at the start . . . but the math still applies.