Question about re-investing returns...

I've not researched the RRSP details. This suggests it's not like our

401k account with a fixed list of funds. If it were, my observation of 401k high fee vs post tax ETF, low fee would hold. If OP chooses to spend the fees regardless, then your spreadsheets are valid, and the difference between pre and post tax is in favor of pre.

OP should read, and read some more, then consider what his choices are. The index route (even just SPY, and maybe a mix of smaller cap, and/or DVY) is likely his better choice.

JOE

Not likely. The only way that a non-sheltered investment could beat a tax-sheltered investment (IRA/401K/RRSP) is if the expense ratio savings was greater than the tax savings. Given a 30% tax rate and a 7% annual return, you're looking at tax savings of about 2-3%. Differences in expense ratios are more like 1%.

Ok. I ran a spreadsheet which I am happy to forward or post.

Assumptions; Taxable Account $10,000 deposit Total return of 10%/yr, 8.5% is long term, 1.5% is dividends taxed each year at 15%. The growth is taxed at 15% at withdrawal. End of year 20 - $64,576 gross, net is $57457 (The LT gain was $47457 and is taxed 15% or $7119).

401K Investment is $13,889 (the gross up of $10,000/.72) Growth of 10% - .87% extra expense = 9.13%/yr.

20 years later $79863, tax is $22,362, net of $57,396

Over 20 years, it takes .87% in incremental expenses to negate the pre-tax benefit.

For this exercise I used 28% tax rate, and didn't attempt to 'stack the deck' by using a lower rate in early years and the 28% for the withdrawal. Remember, the expense is every year, compounded. The 2-3% 'savings' you cite are mostly recouped at the end withdrawal. (BTW - If I drop the return to 7%/yr, the numbers move to my favor, and an expense difference of .69% is the break even, holding the tax rates and time the same)

JOE

mea culpa, you are right.

I was fixated on the fact that assuming the same initial tax rate and withdrawal tax rate, tax-sheltered accounts will always beat a non-sheltered account. But I was overlooking the fact that long term cap gains are 15%, which essentially lowers the non-sheltered account's withdrawal tax rate to 15%. In which case a 1% expense ratio difference will make the non-sheltered account the better choice.

Learn something new everyday!

Send a copy of your spreadsheet to snipped-for-privacy@hotmail.com for me please with cherries on top. I would really appreciate. Maybe I can build upon it somehow.

I'm contributing equal amounts of money to both sheltered and non sheltered investments and I'd like to play with some numbers and see what sort of returns "might" be in the future. It'll let me know if I'm being too conservative or too aggressive and hopeful.....

Looking through the various Canadian retirement options, here's what the rough analogs seem like:

CRA = IRS CPP = Social Security QPP = Social Security for Quebec'rs RPP = 401K RSPP = IRA QIC = Annuity

My spreadsheet also agrees with you. If 100% capital gains in taxable, the threshold is about ~0.85% in extra expenses. If it's a balanced portfolio of dividend payers+REITS+bonds+etc, the threshold is more about ~1.35%. Of course, if you do both taxable and tax-deferred, you should split out LTCG stuff in taxable and dividends/REITS/bonds in tax-deferred for maximum bang.

joetaxpayer wrote:

I created a simple version with Google Spreadsheets so that everyone can view it. In order to play with the parameters, you need to do File

The key parameter related to the case that JOE was talking about is the total return. For the taxable account, the annual return is reduced by

0.22% (1.5% dividends taxed at 15% rate). For the tax-deferred account, the total return is reduced by 1% assuming greater expense ratio.

I thought of another factor too. Those assumptions also mean that you cannot sell the investments in the taxable account. Otherwise, you will have to pay the cap gains that year. Even with a buy and hold philosophy, you will probably be doing some rebalancing every few years, which will reduce the effective annual return. In the tax-deferred account, rebalancing has no tax impact.

your "tax deferred" looks right. I get the $56045 as well. the "taxable" seems off. The first year, 10K gives off $150 in dividends, which nets $128 after tax. You need to keep a tally of reinvested dividends, so in my sheet, reinvested dividends adds up to $7119, which isn't taxed again, as it's added to basis. Taxable gain is $47457 and the net final number for me is $57457. My spreadsheet requires a calculation line each year to tally the dividend, so it won't likely fit on one page the way Google or iRows sets up. I need to spend time to see if it makes sense to load it there. AHE - your email address bounced on me as 'not valid'.

JOE

And if you have Vanguard funds in your tax-deferred account? Why are we assuming greater expense ratio in the tax-deferred accounts?

Elizabeth Richardson

Because to answer the question "should I fund my pre-tax account as much as I can or invest post-tax (but not Roth)?" I proposed that it would be good to know the expenses within the pre-tax account. Then I ran a spreadsheet or two, and found that holding tax rates even, (going in and comming out) that the pre-tax account was favorable unless its expense was about .85% higher. It wasn't an assumption, it was a calculated breakeven point (for a 20 year time horizen). JOE

Capital gains, at least in Canada are taxable at much lower rates than other forms of income. That said Capital gains Losses mean a tax refund of sort so there is incentive to dispose of underperforming or declining positions. I also believe that capital gains and losses can be carried forward for a few more years. I know the losses are anyways, but I'll have to double check the gains as well. You can have a stellar year in your taxable investments and offset that with your dismal year from say 2 years prior to balance the tax penalty.

In many cases don't most mutual funds or other fund managing firms pay your taxes in those funds on your behalf? I've selective funds that pay dividends as well has having solid large cap companies and dividends are taxable for me at 8.5% but the fund company pays those on my behalf based on how many fund shares I own, then disperses the dividends either to my account or reinvests the dividends...

Also in Canada many companies converted to a form of trust unit so that profits are dispersed to unit holders (Is that what a REIT is?). The government here saw they were going to lose about 500 million in corporate taxes a year so they elected to stop the practise of tax free profit dispersal by 2010 or 2011 (causing a 20 billion dollar wipe-out of security assets in a day for a nation of 30 million people).

snipped-for-privacy@hotmail.com Watch the spelling :)