Latest / How Canadian Markets Work / Episode 99: Registered Plans (The Symmetric Choice)

Transcript

Episode 99: Registered Plans (The Symmetric Choice) · How Canadian Markets Work

• 0:00
  Last time, we walked you through the brutal math
• 0:02
  of Canadian investment taxation. Right, how interest
• 0:05
  just gets completely hammered. Exactly. And why
• 0:09
  where you hold an asset matters just as much
• 0:12
  as what you actually buy. Yeah, asset location.
• 0:14
  Right, asset location. So today, we are handing
• 0:17
  you the ultimate cheat code to those rules. Oh,
• 0:20
  I like that, the cheat code. Yeah. If we think
• 0:24
  of the previous deep dive, the tax rules being
• 0:26
  this harsh, unrelenting financial weather system,
• 0:30
  today is all about the shelters. The customized
• 0:32
  shelters. We are diving into registered plans
• 0:35
  of the RRSP, TFSA, FHSA, RESP, and the RRIS.
• 0:39
  That is quite the alphabet soup. It really is.
• 0:42
  But the mission for this deep dive is to strip
• 0:45
  away the endless confusing debate about which
• 0:47
  account to use. Because there's so much bad advice
• 0:49
  out there. So much. And we're going to replace
• 0:51
  that guesswork with pure symmetric arithmetic
• 0:54
  based on detailed breakdowns of Canadian market
• 0:57
  mechanics from our sources. Which is really the
• 1:00
  only way to do it. Because otherwise, you're
• 1:02
  just guessing. You're going off what, I don't
• 1:04
  know, a bank teller told you or what your parents
• 1:07
  did in the 90s. Right, exactly. But these accounts
• 1:09
  aren't mysteries. They operate on completely
• 1:13
  predictable math. So let's transition into the
• 1:16
  biggest debate, the one every Canadian investor
• 1:18
  faces, choosing between the two heavyweights.
• 1:21
  The RRSP and the TFSA. Right. People argue over
• 1:24
  this like it's a sports rivalry. But. It's like
• 1:28
  debating whether a raincoat is better than a
• 1:30
  winter parka. Yeah, it completely depends on
• 1:32
  the weather you're standing in at that moment.
• 1:34
  Exactly. So let's look at the core mechanics
• 1:36
  of the older shelter first, the RRSP, because
• 1:39
  people get this wrong all the time. Oh, constantly.
• 1:42
  The single most dangerous misunderstanding is
• 1:44
  that the RRSP is a tax -free account. It is absolutely
• 1:49
  not. No, it's not. It is a tax to fail. Right,
• 1:51
  you get a deduction on the money going in. which
• 1:54
  feels great in April when you file your taxes,
• 1:56
  but you haven't eliminated the tax. You've just
• 1:59
  kicked the can down the road. Exactly. Every
• 2:02
  single dollar is fully taxable when you pull
• 2:04
  it out. So it's tax later, not tax never. Tax
• 2:07
  later. I like that. And there's a massive danger
• 2:10
  here if you withdraw early. Oh yeah, this is
• 2:13
  huge. If you put money in an RRSP and then say
• 2:16
  you lose your job or I don't know, your roof
• 2:18
  caves in, and you need cash fast, if you pull
• 2:21
  that money out, you lose that contribution room
• 2:24
  permanently. It is just gone. You never get it
• 2:28
  back. Never. Which makes the RRSP a terrible
• 2:30
  place for an emergency fund. Right. It's financial
• 2:33
  self -sabotage. But if we contrast that with
• 2:36
  the TFSA, the tax -free savings account, the
• 2:39
  mechanics are flipped. Completely inverted. Yeah,
• 2:42
  because there is no deduction going in. You fund
• 2:44
  it with after -tax dollars, but it is tax -free
• 2:46
  forever. on the growth and the withdrawal. And,
• 2:50
  crucial for your emergency fund scenario, when
• 2:52
  you withdraw from a TFSA, you actually get the
• 2:54
  contribution room back. But, and this is a massive,
• 2:57
  but you don't get it back right away. No, you
• 2:59
  do not. We have to talk about the November Trap
• 3:01
  because this catches thousands of people. It
• 3:04
  really does. So let's say you've maxed out your
• 3:07
  TFSA. Completely full and in March you pull out
• 3:11
  10 grand to buy a used car right then in November
• 3:13
  you get a bonus at work And you think hey I'll
• 3:15
  just put that 10 grand right back in to rebuild
• 3:17
  my savings and boom you've over contributed Exactly
• 3:20
  because the room you freed up in March it does
• 3:22
  not restore until January 1st of the following
• 3:25
  year It's so sneaky. So what happens when you
• 3:28
  put it back in November? The CRA flags it, and
• 3:32
  they start charging you a 1 % penalty per month
• 3:35
  on that over -contribution. A month. A month.
• 3:38
  And they don't always notify you right away,
• 3:40
  so it just quietly accumulates in the background.
• 3:42
  That is brutal. Okay, so RRSP is tax later with
• 3:47
  rigid room. TFSA is tax never with flexible but
• 3:51
  delayed room. Right. But here is the real aha
• 3:54
  moment from the sources. Yeah. How do you actually
• 3:56
  mathematically choose between them? Yeah, so
• 3:58
  we can strip away all the jargon here. The entire
• 4:00
  debate reduces to exactly one variable. Just
• 4:04
  one. Just one. It is your marginal tax rate today
• 4:07
  versus your marginal tax rate at the exact moment
• 4:11
  of withdrawal. That is the whole ballgame. OK,
• 4:13
  wait. I have to push back on this a bit. Sure.
• 4:16
  What if your tax rate is exactly the same in
• 4:19
  both periods? Like, surely one account still
• 4:22
  has a slight edge. You'd think so, right? Yeah,
• 4:24
  because the TFSA compounding happens on a post
• 4:27
  -tax amount. Or maybe the RRSP wins because you
• 4:30
  get that upfront refund to reinvest. Nope. It
• 4:32
  is an absolute undeniable mathematical tie, down
• 4:36
  to the exact dollar. Wait, really? Truly. And
• 4:40
  the proof is rooted in grade school math. the
• 4:43
  commutative property of multiplication. Oh, wow.
• 4:45
  Throwing it back to middle school. Yeah. So,
• 4:47
  you know, A times B times C is the exact same
• 4:49
  as C times B times A. Right. The order doesn't
• 4:51
  change the outcome. Exactly. So think of your
• 4:53
  principal investment as A. Your growth over time
• 4:56
  is B, and the portion you keep after taxes is
• 4:59
  C. OK, I'm following. Whether you take the tax
• 5:01
  cut at the very beginning, which is the TFSA,
• 5:03
  or you take it at the very end, the RRSP, the
• 5:07
  final number in your pocket is identical, assuming
• 5:09
  the tax rate didn't change. I mean, we need to
• 5:12
  run the numbers on this. Let's use the exact
• 5:14
  example from the sources. So we have $10 ,000
• 5:16
  of pre -tax income. We're going to invest it
• 5:18
  for 20 years at a 6 % growth rate. OK, so scenario
• 5:22
  A. Your tax rate today is high, say 40%. Rough.
• 5:26
  Yeah. But you expect it to drop to 30 % in retirement.
• 5:30
  OK, pretty common scenario. Right. In the RRSP,
• 5:33
  the full $10 ,000 goes in because of the deduction.
• 5:36
  It grows at 6 % for 20 years. It turns into about
• 5:39
  $32 ,000. But then you have to pay taxes on withdrawal.
• 5:43
  Exactly. You pull it out, pay your new lower
• 5:46
  30 % tax. You are left with $22 ,450. OK. $22
• 5:52
  ,450. What about the TFSA? Well, with the TFSA,
• 5:55
  you pay that high 40 % tax upfront. Right. Before
• 5:58
  it even goes in. So out of 10 grand, you lose
• 6:00
  4 grand to the government. Only 6 ,000 goes in.
• 6:03
  It grows tax -free for 20 years. You pull it
• 6:06
  out, and you have $19 ,243. Oh, wow. So the RRSP
• 6:12
  wins big there. $22 ,000 versus $19 ,000. Because
• 6:15
  you deferred the tax to a lower bracket, you
• 6:19
  played the system. OK, so scenario B. Let's flip
• 6:22
  it. Say you're young, maybe a student or in a
• 6:24
  bank. Right, with a low income. Yeah, your tax
• 6:26
  rate is 30 % today. But you expect to be super
• 6:31
  successful. So in retirement, your rate will
• 6:33
  be 40%. Okay, well, in the RMSP, the 10 grand
• 6:36
  goes in gross to 32 ,000, but when you pull it
• 6:40
  out, you get hit with that 40 % retirement tax.
• 6:42
  Which leaves you with? $19 ,243. Wait, that's
• 6:47
  the TFSA number from the first scenario. Exactly.
• 6:49
  Because now let's look at the TFSA in this scenario.
• 6:52
  You pay the 30 % upfront, so $7 ,000 goes in.
• 6:54
  Right. It grows tax -free. And you walk away
• 6:57
  with $22 ,450. The exact numbers just flipped.
• 7:01
  The TFSA wins, yeah. Because you locked in the
• 7:04
  cheap tax rate when you were young. That is wild.
• 7:07
  OK, but scenario C, the tie. Prove it to me.
• 7:11
  35 % tax rate today, 35 % at retirement. OK.
• 7:15
  RRSP, 10 grand goes in, grows, pay 35 % on the
• 7:19
  back end. You get $20 ,846. And the TFSA. TFSA.
• 7:26
  Pay 35 % upfront. Invest the remaining $6 ,500.
• 7:29
  It grows tax -free. You walk away with $20 ,846.
• 7:34
  Identical. Literally to the dollar. Cure symmetry.
• 7:37
  That is so relevant, especially for younger listeners.
• 7:41
  If you're early in your career, do not rush to
• 7:44
  burn your RRSP room. Exactly. Don't do it just
• 7:46
  because someone said RSPs are good. Right. Use
• 7:49
  the TFSA first. Save the RRSP deduction for when
• 7:52
  you actually have a high income and need the
• 7:54
  tax break. It empowers you to just look at your
• 7:56
  bracket and let the math decide. But, you know,
• 7:58
  it's also kind of annoying. Why is that? Because
• 8:00
  the government is basically saying you could
• 8:02
  have a tax break today or a tax break tomorrow.
• 8:05
  Choose one. Right. Have they ever just given
• 8:07
  us both like a glitch in the matrix? Well, historically,
• 8:11
  no. But as of 2023, the answer is actually yes.
• 8:14
  The FHSA, the first home savings account. Yes.
• 8:18
  The newest shelter on the block. If you're reading
• 8:20
  a finance book from even like. 2022, this won't
• 8:25
  even be in there. No, it wouldn't be. This account
• 8:27
  was born entirely out of the Canadian housing
• 8:29
  crisis. Because things just got so wildly unaffordable
• 8:32
  for young people. Exactly. The government needed
• 8:35
  a policy tool to help bridge that gap. So they
• 8:37
  built a super shelter. A super shelter. Yeah.
• 8:41
  It honestly sounds too generous when you look
• 8:43
  at it. How does it actually work? It literally
• 8:45
  combines the best features of both the RRSP and
• 8:48
  the TFSA. Break that down. When you contribute.
• 8:51
  You get a tax deduction for that year, exactly
• 8:54
  like an RRSP. Amazing. The money grows tax sheltered.
• 8:57
  And then when you withdraw it to buy a qualifying
• 9:00
  first home, the withdrawal is completely tax
• 9:03
  free, exactly like a TFSA. So you basically have
• 9:06
  your cake and eat it too. The government never
• 9:08
  taxes that money. Not on the way out. They just
• 9:10
  step away entirely. That is unbelievable. Which
• 9:13
  is why the limits are strict. You can only put
• 9:15
  in 8 ,000 a year up to a lifetime max of 40 ,000.
• 9:18
  Right. But here's the catch I always wonder about
• 9:20
  with this one. What's that? What if life happens?
• 9:24
  You fund the FHSA, but then you just you decide
• 9:26
  you don't want a house or you move to another
• 9:28
  country or whatever. Right. Do they claw back
• 9:30
  all those refunds? Exactly. Is there a massive
• 9:32
  penalty? No. This is the brilliant loophole.
• 9:35
  If you don't buy a house within 15 years, you
• 9:38
  can simply roll the entire balance directly into
• 9:41
  your RRSP. Wait, but doesn't that eat up your
• 9:44
  RRSP room? No. It doesn't even consume your existing
• 9:48
  RRSP contribution room. Are you kidding? That's
• 9:51
  an insane loophole. It really is. It's like getting
• 9:54
  VIP tickets to a concert, and if the concert
• 9:56
  is canceled, they just give you VIP tickets to
• 9:59
  the next show, no questions asked. Perfect analogy.
• 10:02
  So mathematically, if you qualify as a first
• 10:04
  -time homebuyer, the FHSA should be your absolute
• 10:07
  top priority. over the TFSA, over the RRSP. Period.
• 10:12
  Okay, but let's pivot. Because tax optimization
• 10:14
  is great. But eventually, we need to talk about
• 10:18
  actual immediate guaranteed returns. Free money.
• 10:21
  Yes. Because... People spend hours optimizing
• 10:25
  a 0 .2 % fee on an ETF. Right. And they completely
• 10:30
  ignore the literal piles of cash the government
• 10:33
  or their employer wants to hand them. So let's
• 10:35
  look at the RESP, the Registered Education Savings
• 10:38
  Plan. OK. Mechanics are different here again.
• 10:40
  You do not get a tax deduction on the way in.
• 10:42
  OK. And the growth is sheltered. So it sounds
• 10:44
  a bit like a TFSA. Right. But the magic is the
• 10:47
  government matching grants. The Canada Education
• 10:50
  Savings Grant. The CESG. Right. For every dollar
• 10:54
  you put in, the government guarantees a 20 %
• 10:56
  match. 20 %? Up to $500 a year. I mean, a 20
• 11:00
  % guaranteed return on day one? You can't beat
• 11:03
  that in the stock market. You really can't. But
• 11:06
  what's the exit strategy? Like, when the kid
• 11:08
  actually goes to university, how does the tax
• 11:10
  work on the way out? It comes out in two buckets.
• 11:13
  The original money you put in comes out tax -free.
• 11:16
  Because you already paid tax on it. Exactly.
• 11:18
  But the growth and all those government grants,
• 11:21
  those are taxed in the hands of the student.
• 11:24
  And this is where the trick is, right? Why is
• 11:26
  taxing the students such an advantage? Because
• 11:29
  of the basic personal amount. Right. Every Canadian
• 11:33
  gets to earn a certain amount tax -free every
• 11:35
  year. Right now, it's around 15 grand. And most
• 11:38
  full -time students aren't making 15 grand a
• 11:40
  year working part -time. Exactly. So their effective
• 11:43
  tax rate on that RESP money is literally zero.
• 11:47
  It's a brilliant wealth transfer. But what if
• 11:50
  the kid doesn't go to school? What if they join
• 11:52
  a band? Yeah, the classic worry. Well, you get
• 11:54
  your original money back. You do have to return
• 11:56
  the government grants, which is fair. Yeah, that
• 11:58
  makes sense. But the investment growth can usually
• 12:01
  be transferred into your own RESP if you have
• 12:04
  room. That's good to know. And if you have a
• 12:06
  family RESP instead of an individual one, it's
• 12:08
  even better. You can direct the funds to a younger
• 12:11
  sibling who is going to school. So it's not just
• 12:14
  locked away forever. Exactly. Exactly. Which
• 12:16
  brings up the workplace equivalent of this free
• 12:18
  money, the employer match. Oh, this is critical.
• 12:22
  If someone is doing the mathematical gymnastics
• 12:24
  of RRSP versus TFSA, should they pause that to
• 12:29
  grab an employer match? Emphatically, yes. If
• 12:32
  your boss offers a match, say, 100 % up to 5
• 12:35
  % of your salary, that is an immediate 100 %
• 12:38
  return. Grab the free money first. Always. It
• 12:40
  beats any tax arbitrage. It beats everything.
• 12:43
  It's crazy how many people leave that on the
• 12:46
  table. And by the way, real quick, if tracking
• 12:48
  all this room sounds exhausting, our sources
• 12:51
  are very clear. Do not guess. Yeah, never rely
• 12:53
  on your own spreadsheets for this. Right, just
• 12:55
  log into your CRA account online. It takes two
• 12:58
  minutes. That's the only way to safely avoid
• 13:00
  those silent penalties we talked about. Absolutely.
• 13:02
  Rely on the official portal. OK, so we've talked
• 13:05
  a lot about getting money in and getting government
• 13:07
  matches. But to truly master this weather system,
• 13:12
  we have to understand the end game. What happens
• 13:15
  when the government forces you to take the money
• 13:17
  out? This gets the least attention, but it is
• 13:19
  the most dangerous phase. The R .I .F.? Yes.
• 13:23
  So, that R .S .P. tax deferral, it has a hard
• 13:28
  expiration date. By the end of the year you turn
• 13:30
  71, your R .S .P. must be converted. You can
• 13:34
  just leave it growing? Legally, no. It typically
• 13:38
  becomes a R .R .I .F., a Registered Retirement
• 13:41
  Income Fund. Okay, and this is where it gets
• 13:43
  aggressive. Very. Once it's a RRIF, the government
• 13:46
  mandates minimum annual withdrawals, a set percentage
• 13:49
  you must take out every year, and it goes up
• 13:51
  as you age. And every dollar of that is fully
• 13:54
  taxable. Fully taxable. Whether you need the
• 13:56
  money for groceries or not. That feels like a
• 13:59
  trap. I mean, think about the sequence of returns
• 14:01
  risk here. What if the stock market crashes right
• 14:04
  after you convert? It's a huge structural flaw.
• 14:07
  It's like being forced to sell your house the
• 14:09
  day the housing market crashes, just because
• 14:11
  it's your birthday. It's exactly like that. You
• 14:13
  lock in those losses permanently because the
• 14:15
  government forced the sale. But the sources point
• 14:17
  out an even bigger headache with the RIF, the
• 14:20
  effective tax rate. Yes, the hidden taxes. Right,
• 14:23
  because didn't we just solve the tax rate math
• 14:25
  with scenario C earlier? We did, but we were
• 14:28
  using headline tax brackets. Retirement introduces
• 14:31
  income -tested government benefits. Specifically,
• 14:34
  old age security or OAS. Right. So if your income
• 14:38
  goes above a certain threshold, around $90 ,000
• 14:41
  right now, the government starts clawing back
• 14:43
  your OAS. How does a callback work? Did they
• 14:46
  just cut you off? No, it's gradual. For every
• 14:48
  dollar you're over the threshold, they take back
• 14:50
  15 cents of your OAS. Oh, I see where this is
• 14:53
  going. Yeah. Because your mandatory RRIF withdrawals
• 14:56
  count as fully taxable income, a large RRIF can
• 14:59
  easily push you over that 90 grand threshold.
• 15:02
  So you're paying your regular, say, 30 % income
• 15:04
  tax on the withdrawal. Plus the 15 % OAS clawback
• 15:08
  penalty. So your effective marginal tax rate
• 15:10
  spikes to 45 % or 50%. Exactly, which completely
• 15:14
  blows up the RRIF. versus TFSA math we did in
• 15:17
  section one. It turns scenario A into scenario
• 15:20
  B. You defer tax at 30 % only to pay 50 % in
• 15:24
  retirement. Precisely. And meanwhile, TFSA withdrawals
• 15:27
  don't count as taxable income, so they never
• 15:29
  trigger OAS clawbacks. That is huge. No wonder
• 15:32
  financial planners say taking the money out is
• 15:34
  way harder than putting it in. But decumulation
• 15:36
  phase is a minefield. Wow. Okay, let's step back
• 15:40
  and summarize the actual mechanics we've unpacked
• 15:42
  today. Sounds good. First, we proved that RRSP
• 15:45
  versus TFSA is just about your marginal tax rate
• 15:49
  now versus later. If the rates are identical,
• 15:52
  it's a tie down to the penny. Right. Second,
• 15:54
  the FHSA is an absolute gift for first -time
• 15:57
  homebuyers. A double tax advantage with a massive
• 16:01
  RRSP rollover loophole. Third, opportunity cost.
• 16:05
  Grab the guaranteed 20 % RRSP match and the employer
• 16:08
  match before you even worry about tax optimization.
• 16:11
  Free money first, always. And finally, The end
• 16:15
  game. The forced reality of RRF withdrawals,
• 16:18
  sequence risk, and how OAS clawbacks can completely
• 16:21
  upend your lifetime strategy. It's dense, but
• 16:23
  if you look at it as pure arithmetic, you can
• 16:25
  navigate it. You just need to know the mechanics
• 16:27
  of the shelter you're standing in. Absolutely.
• 16:29
  And speaking of the mechanics working exactly
• 16:31
  as designed, I want to leave you with a final,
• 16:33
  provocative thought based on this deep dive.
• 16:36
  Oh, I'm ready for this. We just talked about
• 16:37
  those mandatory RRF withdrawals. Think about
• 16:42
  this. What happens if you are simply too successful
• 16:45
  at investing inside your RRSP? I mean, that sounds
• 16:49
  like a great problem to have. On paper, sure.
• 16:52
  But say you pick incredible investments, it compounds
• 16:54
  for 40 years, and your RRSP balance is massive.
• 16:58
  Okay. When it converts to a RRIF... those mandatory
• 17:02
  minimum percentages are applied to that massive
• 17:04
  balance. Right. Your forced withdrawals could
• 17:06
  become so enormous that they push you into the
• 17:08
  highest possible marginal tax bracket in your
• 17:10
  80s. Oh, wow. While simultaneously guaranteeing
• 17:13
  that every single cent of your government benefits
• 17:15
  is clawed back. So you're just bleeding taxes.
• 17:18
  Exactly. Okay. It leaves you wondering, could
• 17:20
  the ultimate perfectly executed tax deferral
• 17:23
  strategy accidentally turn into the ultimate
• 17:25
  tax trap? It's the great paradox of the RRSP.
• 17:29
  Extreme success inside the shelter is exactly
• 17:31
  what forces you out into the harshest elements
• 17:34
  of the tax code. Just something to mull over
• 17:36
  the next time you're reviewing your portfolio.
• 17:39
  Thank you for joining us on this deep dive into
• 17:41
  Canadian registered plans. We've taken you out
• 17:43
  of the harsh financial weather, walked you through
• 17:45
  the shelters, and hopefully you now have the
• 17:47
  cheat code to make the math work for you. Take
• 17:50
  care, and we'll see you next time.