November 1998

After-Tax Income
is All That Matters

© Talbot Stevens

This is the first of what will be several Strategy Sheets outlining over two years of personal research. The result is an approach that fundamentally changes the way we choose the best investment strategy.

For the majority of Canadians, their most significant, long-term financial planning goal is retirement. More specifically, their objective is to produce the maximum after-tax income from retirement until death.

If your investment goal is to produce the maximum income over a 20-year retirement period, then it only makes sense to evaluate investment approaches in terms of their ability to produce After-Tax Income (ATI) over a 20-year period.

Unfortunately, almost all analysis of investment approaches, including my own until recently, compares before-tax future values. Professional advisors know that comparing before-tax values of strategies that are taxed differently can lead to the wrong conclusions.

To illustrate the importance of focusing on after-tax income, consider the following. Would you rather have $100,000 of RRSPs or $80,000 of unregistered equity funds? Is $1.50 invested in RRSPs growing at 10% better than $1.00 of global equities growing at 12% per year?

Goal-Based Evaluation. Choosing the investment strategy that produces the most after-tax income is the only thing that matters for income-based goals like retirement and saving for a 4-year education.

After-Tax Income analysis of fundamental investment strategies has, to the best of my knowledge, never been done.

In attempting to assess the after-tax merits of RRSPs versus unregistered investments, it is not fair to RRSPs to assume the worst case where they are withdrawn in one year, unless you are evaluating after-tax estate values. On the other hand, simply comparing the after-tax income that can be produced without touching the principal isn't right either. With any unregistered investment, we always get our own money back tax- and clawback-free. This tax-free return of our original principal, technically called our Adjusted Cost Base, is a significant factor that is often overlooked.

The proper way to evaluate strategies is in terms of their ability to achieve the desired goal. All financial goals equate to either producing a lump sum amount or an income to last a number of years.

Accurate analysis of the math, tax, and human nature parameters is not simple, but is essential to identifying the strategy that produces the most after-tax income. Between four and seven key parameters are critical to specify an individual's unique situation. As explained in earlier Strategy Sheets, the human nature factor identifying which RRSP Refund Strategy is used is perhaps the most important parameter.

Next month, we will focus on understanding how unregistered equities can be better than RRSPs.

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