Now, in terms of the % calcluations I did – they are ballpark estimates – to illlustrate the principle; here is a hypothetical example with numbers:

Investment Capital: $100K
Pre-Tax Return: $10K or 10%
Post-tax return or “effective” or “tax-adjusted” return (assumes 45% marginal tax rate): $5500 or 5.5%

So, to get the 5.5% after-tax return on 100K invested, you would need to earn $10K, assuming a 45% marginal tax rate.

Tim

I’m not sure that you can just take a percentage and multiple or divide by 1 minus the marginal tax rate to get a post- or pre-tax return respectively. See this long discussion here: “The Home Buyer’s Plan.

Our situation might be a bit easier to analyze as we are going to be contributing the maximum to our RRSP over the next year. So for the $9k we should compare between putting it towards the principal of the loan or putting it in a non-RRSP investment. Yeah the situation would look a bit different if we put it the RRSP now and then we make the choice of what to do with our monthly contributions (that no longer need to go so much towards the RRSPs because of the $9k helper). But it would simplify the calculations if we assume our RRSP will be maxed and the RRSP tax refund has to be invested in a non-RRSP account or the LOC.

For the $9k in non-RRSP case… Here you can multiply the rate of return by some factor since it’s the capital gains and dividends being taxed. Can’t remember the formula for dividend and capital gains right now and they seem to have changed a lot since I last had to declare capital gains and dividends! With these post-tax dollars I’m going to get taxed again on the capital gains and the dividends. With the loan I won’t get taxed but the return is lower (at much lower risk).

I would probably go for paying down the LOC rather than putting the $9k in a non-RRSP investment. If it was a non-RRSP investment it would probably be low-risk because we would probably use it towards a down payment or something in a few years. Capital preservation would be important. Not sure if I can get much better than 6% (at almost no risk).

I hope this post makes sense. I wrote it quickly.

Now, adding the $9K to your RRSP gives you a tax-free return (assuming you are putting it in to a well-diversified pool of funds, equities, fixed income, you may get) of maybe 9%. However,you also get a tax refund on the $9K – if you are in highest tax bracket in Ontario, 45% -that really boosts the attractiveness here. Of course, putting the $9K in your RRSP is more risky than the zero risk paydown of debt. But, given that you are already paying into your RRSP – and assuming that you will not reach your contribution limit – putting the money in your RRSP may be the way to go.

The relative attractiveness of the RRSP option diminishes as the LOC interest rate increases…and increases as the expected return of your RRSP increases.

I would prefer to have that money now rather than later. Therefore, every year, what I do is complete a CCRA form called “T1213 Request to Reduce Tax Deductions at Source”. I simply provide evidence to CCRA to prove that I am making periodic RRSP contributions, and they provide authorization to my employer to reduce the amount of taxes that are subtracted from each paycheque. As a result, over the course of the year, I receive my “tax refund” every 2 weeks, rather than having to wait until March or April of every year. What’s more, I can immediately take the savings from my paycheque and invest it into an RRSP, therefore increasing the time during which the investment compounds, etc.

Just a tip.