August 9, 2007, 7:00 am

Double Dipping: Another Leverage Recipe Part 2

by: The Financial Blogger    Category: Leveraging Strategies
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I often seefinancial strategies as recipes. The main reason being you need the right ingredients, the right utensils and a good cook to make a feast. The problem is that most people have some knives and spoons here and there, get a few things at the grocery store because they have been told to and have no clue how to cook their meal at perfection. Enough with the analogy and let’s get going with some calculation!

The following assumptions will be used to show the effect of a double dip over 10 years. You
marginal tax bracket is 40%, interest rate on investment loan is 6,5% (so my
post can be accurate next year as well!), amount of the loan is 100K, expected
return on investment is 7,2%. The chart below shows the result of the double
dipping technique.


Yr


Amt Invest.


RRSP Contrib.


Tax Return


RRSP Invest


Interest Cost


Tax Cost on Invest


1

$107 200 $ –
$ 2 600 $ –
$ 6 500
$ 1 440


2

$114 918 $ 2 600
$ 3 640 $ 2 787
$ 6 500
$ 1 544


3

$123 193 $ 3 640
$ 4 056 $ 6 890
$ 6 500
$ 1 655


4

$132 062 $ 4 056
$ 4 222 $ 11 734
$ 6 500
$ 1 774


5

$141 571 $ 4 222
$ 4 289 $ 17 105
$ 6 500
$ 1 902


6

$151 764 $ 4 289
$ 4 316 $ 22 935
$ 6 500
$ 2 039

 


7

$162 691 $ 4 316
$ 4 326 $ 29 212
$ 6 500


$ 2 185


8

$174 405 $ 4 326
$ 4 330 $ 35 953


$ 6 500
$ 2 343


9

$186 962 $ 4 330
$ 4 332

$ 43 184
$ 6 500
$ 2 511


10

$200 423 $ 4 332


$ 4 333
$ 50 938
$ 6 500
$ 2 692


11

$214 854

$ 4 333
$ 4 333 $ 59 250
$ 6 500
$ 2 886


12



$230 323
$ 4 333
$ 4 333 $ 68 161
$ 6 500
$ 3 094



13

$246 906 $ 4 333
$ 4 333 $ 77 714
$ 6 500
$ 3 317


14

$264 684 $ 4 333
$ 4 333 $ 87 955
$ 6 500

$ 3 555


15

$283 741 $ 4 333
$ 4 333 $
98 933

$ 6 500
$ 3 811


16

$304 170 $ 4 333

$ 4 333

$ 110 701 $ 6 500
$ 4 086


17

$326 070
$ 4 333

$ 4 333 $ 123 317 $ 6 500
$ 4 380


18



$349 547
$ 4 333
$ 4 333 $ 136 841 $ 6 500
$ 4 695



19

$374 715 $ 4 333
$ 4 333 $ 151 339 $ 6 500
$ 5 033


20

$401 694 $ 4 333
$ 4 333 $ 166 881 $ 6 500

$ 5 396
Tot $401694 $79444

$83778 $ 166 881


$130000 $ 60339

As you can
see, I’ve had a lot of fun calculation the tax return, RRSP contribution, RRSP
growth and total cost of this strategy. It is true that too often we think about
the benefit of leveraging strategies but we tend to forget that they
include fees. In this example, total fees (including full interest cost as we
are reinvesting the tax return plus the tax on the invested amount) are equal to
$190,339 over 20 years. I used a marginal tax rate of 20% for the investment as
it combines capital gains, dividends and interest rate. In order to simplify the
calculations, I took for granted that we are paying tax on capital gains at the
end of each year even if they can be differed until the asset is sold.

After 20
years, you will end up with a net after tax profit of $278,236. That includes
your total investment plus your RRSP contribution minus all interests paid and
the tax on your investments. Keep in mind that you will also have to calculate
taxes upon withdrawals of your RRSP. So for as little as $793 a months, you can
build an half of million dollar portfolio (in today’s dollar). Inflation was not
taken in consideration as you will have 567K in your portfolio and your payment
will remain what it is as well. 567K is equal to 315K with an inflation rate of
3% a year.

I also
discover something funny while playing with my Excel spreadsheet. The benefit of
contribution to your RRSP (tax return + growth of your investment) is bigger
than the cost of interest. This means that if interest goes up, you will end up
with a bigger net after tax profit. However, the success of this strategy is
directly related to the yield earned on your investments. I think I was
conservative with my assumptions. Any comments, suggestions or questions are
welcome!

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