1. What will be the annual after-tax withdrawal from the RRSP? Remember that the entire withdrawal each year will be subject to income tax at the contributor’s marginal tax rate. Assume that the contributor retired just before withdrawals start, and that her marginal tax rate (at her reduced income level) is 25%.
2. Unlike contributions to an RRSP, contributions to an RESP (or to a TFSA in Question 3) are not deductible from taxable income. Consequently, of the pre-tax $1500 available for investing, 0.33333 × $1500 = $500 must be used to pay income tax. That leaves only $1000 each year to contribute to an RESP or a TFSA, or to invest outside of a tax-favoured plan. Recall that the federal government will provide a CESG grant of 20% of the annual $1000 RESP contribution. Therefore, the combined annual contribution to the RESP is $1200.
What will be the annual after-tax withdrawal from the RESP? Remember that only the portion of a withdrawal representing investment growth and CESG grants is taxable, and then only at the student’s marginal tax rate. After tax credits, this rate is effectively 0% for income below $15,000.
3. As with the RESP, only $1000 of the pre-tax $1500 is left after tax to invest. What will be the annual withdrawal from the TFSA? Remember that withdrawals from a TFSA are not taxable.
4. As with the RESP and TFSA, only $1000 of the pre-tax $1500 is available after tax to invest. What annual after-tax withdrawal will the unsheltered portfolio sustain? Remember that each year’s investment returns will be taxed at the investor’s marginal tax rate. For the first 20 years, this rate is 33 1/3%. Therefore, the after-tax rate of return during these 20 years will be 7.5% × (1 - 0.3333) = 5.0% compounded annually. During the final eight years, the retired investor’s marginal tax rate is only 25%.
5. Rank the four scenarios in the order of their annual payout. Express each payout as a percentage of the lowest annual payout.
6. Identify the main one or two factors that give:
a. The top-ranked plan or outcome its advantage over the second-ranked plan or outcome;
b. The second-ranked plan its advantage over the third-ranked plan;
c. The third-ranked plan its advantage over the fourth-ranked plan.
The Points of Interest in Sections 8.5 and 10.5 have described the main features of three plans (RRSPs, RESPs, and TFSAs) that Canadians can use to enhance their ability to save for retirement or for the post-secondary education of their children. As we have seen in those Points of Interest, the enhancement is achieved through favourable income tax treatment of the contributions to these plans or the earnings of investments held within the plans (or both).