Monday, 11 February 2008

Book Review: RRSPs by Preet Banerjee

This book is written by Preet Banerjee, a financial advisor by day and a dedicated blogger at WhereDoesAllMyMoneyGo by night. The subject - Registered Retirement Savings Plans - is near and dear to all Canadians' hearts, especially at this time of year, when all the banks and mutual fund companies are exhorting everyone to invest for their retirement before the end of February, the deadline for contributions to apply to the 2007 tax year.

The book is thus a timely contribution and a very useful one at that. It is divided into three sections. The first section explains the basic rules about RRSPs and how they fit into the Canadian tax system. The second section is the guts of the content with a series of 41 chapters on a wide variety of topics involving RRSPs in one way or another, ranging from simple tips, rules subtleties to complicated investment strategies. Due to the nature of this content, it is not necessary to read the book from one end to the other. The strategies are stand-alone. The third section is a brief appendix with other sources of information, notably including blogs that Preet has found useful. It is flattering to find my own blog listed among those he finds to be useful - how could I disagree! His description of me as a "very detail oriented writer" is accurate and for me, at least, a compliment - I've found that paying close attention to details is necessary to avoid unpleasant 'gotchas'. This book is not an exhaustive, definitive guide and reference source. Its aim is to provide inventive ways of effectively using RRSPs.

Preet's writing style is informal and free-flowing, very readable and natural. He does a good job explaining terms and technical details, a real bonus for those just getting into RRSPs.

Preet's day job as an advisor shows through in the realism of the examples he chooses and the comments he makes. Key choices that most people must make are analyzed - e.g. pay down the mortgage or contribute to the RRSP, since most people don't earn enough to do both simultaneously. And he does the analysis with numbers, which is far more believable. He also comments on the psychological challenges that often prevent people from gaining the benefit of a strategy, such as the temptation to spend the tax refund from an RRSP contribution instead of investing it somehow or the panic that causes a sell-off at precisely the wrong time when using leverage.

The introduction of Monte Carlo simulation of investment returns in the analysis of various scenarios such as RRSP vs mortgage and RRSP vs non-registered account is a major improvement over traditional modeling, which usually assumes some constant rate of increase. Monte Carlo is vastly more realistic. It gives a much better sense of the risk involved in investing when returns swing amongst a range of positive and negative results from year to year. The fact that an 8% average growth rate with different patterns of positive and negative years can result in vastly different total wealth / retirement incomes will probably be a revelation to many. The book is well worth it for that analysis alone.

There could be a simplified presentation of the long analytical chapters 26, "RRSP vs Mortgage" and 28, "RRSP vs non-Registered Account". So far as I can tell, some factors and information are irrelevant to the conclusions, like the inflation rate, the value of the house and its rate of value gain and how long the investor lives. Though this extra data was likely added to present a believable scenario, it makes no difference to the choice of which is better to do. Another quibble is the conversion of the net savings/wealth to retirement income. We are never told specifically how that happens, though I assume again, if it is done consistently, it makes no difference. The possible confusion is that all the charts show wealth on the Y-axis not income. Some of the charts appear to show unsuccessful outcomes with higher net wealth than successful ones, a puzzle for sure. Could this just be a problem with graphics?

One part of the RRSP vs mortgage analysis that I question concerns the assumed contribution of the $2009 monthly mortgage payment to the RRSP in various scenarios after the mortgage is paid off. At $60k salary, the contribution limit is 18% times $60k or $10,800 yet the analysis posits contributions of 12x$2,009 or $24,108 per year plus an amount of $3,000 already being contributed that grows with salary. Since the investor's salary and contributions are assumed to grow at 4%, in 25 years here is what I calculate: salary $153,798, new RRSP limit $27,684, existing $3k contribution up to $7,690 plus $24,108 equals $31,798, or $4,114 too much. This especially affects scenarios B and D where the investor is assumed to pay off the mortgage early then contribute the mortgage payment amount to the RRSP. I wonder how the conclusion would differ taking that lower RRSP contribution room into account? Would scenario D still beat C?

At the end of the many pages on RRSP vs mortgage, the summary table on page 125 is the key. The basic answer is that when the rate of return of the RRSP exceeds the mortgage rate, the RRSP is better and vice versa. Moshe Milevsky had already shown and explained that in his book Money Logic so it's good that they arrive at the same conclusion. Beyond that, the relative certainty of the mortgage rate against the uncertain, variable investment return is a major consideration that Preet examines at length.

It is surprising to see that the book does not present a case or scenario in chapter 28 on the RRSP vs non-Registered account comparison that shows one of the core supposed benefits of the RRSP - namely, that when one gets deductions at a higher tax rate when working and a lower tax rate on withdrawal when retired, one is much better off saving in an RRSP. The scenario of Anna in the book appears to show that she ends up in the same tax bracket, though that is not explicitly stated. However, it is significant that the non-Registered account strategy only beats the RRSP when the on-going investment taxes of the non-Reg account are paid with other funds. Such an approach does not compare apples with apples, as Preet himself says on page 148.

There are several spots where the author says that a number of other factors could affect the conclusion (e.g. page 155 regarding the RRSP meltdown strategy) but he neglects to explain even the nature of the effects. That's frustrating for the reader.

I notice that some of the book's content seems also to be on the author's WhereDoesAllMyMoneyGo blogsite so interested readers can get a sense of the book for themselves there.

All in all, the book could be better but it still quite useful; it only takes one good idea to be worth the money.

My rating: 3.5 out of 5.

The book can be purchased at the RRSP Book website,


Preet said...

Hi Jean, thanks for your detailed review. I should address your concerns about the RRSP contributions you mention: he is quite able to make the contributions since he can carry forward unused RRSP room indefinitely. By the time he starts contribution to his RRSP, he has built up $280,000 in unused room. In fact, when he finishes contributing to his RRSP, he still has over $200,000 in unused RRSP room in Scenario B.

I would be happy to send over the reports and graphs to back that up. Or you can just do the math yourself:

$60K(indexed to increase by 4%) x 18% x (65-30 years) will give you his lifetime contribution room he will generate for this test case.

Even if we didn't increase his salary and assumed a $60K salary until the time he contributed to his RRSP's in scenario's B and D, he would have generated $172,800 in RRSP room to be used from that point on.

I'll reply in detail to your other points, but wanted to clear that up first since one of us is wrong, and for once I think it might be you! :) However if I am indeed forgetting the basics of RRSP contribution room accrual, I'll have some serious work to do!!



Preet said...

Hello again, I wanted to address that one section of your review first, but now will address the others.

Your quibble about the conversion of net wealth to retirement income: You are right, I will explain it in more detail for the 2008/2009 version, but in a nutshell, the software package pulls income out of the various pools of money (registered/non-registered) as necessary to minimize taxes. If there are RRIF withdrawal minimums, it will adhere to that as necessary. It does not dip into real estate equity (unless you ask it to, which I didn't). I can include the withdrawal charts in next year's addition, but I wonder if it will add that much more to the discussion for 90% of the readers. Perhaps I will include the charts in an Appendix... yes, that seems a good compromise.

The unsuccessful trials in the monte carlo graphs: A good observation - perhaps this information will help explain? --> The condition of an unsuccessful trial is the requirement to dip into a line of credit for $10,000 (not including home equity). The reason for unsuccessful trials at higher net wealths is due to the variation in returns. For example in one instance (okay two), it is possible to have a certain level of wealth and have a near term annualized rate of return of 10% or -10%. In the latter case, it is possible to have a higher net wealth (due to increase in real estate equity but less of a decrease in other assets). If I opened up the software to encroach on any assets, it would be a different story.

The next criticism of Chapter 28 with respect to exploring the difference in tax rates between now and retirement: You are right, I should've explained this in more detail as my analysis does take into account the difference in tax rates during accumulation versus decumulation - but this particular example does not show it, nor do I explain it in depthly. The software package increases the tax rates with inflation and the company that provides the software also includes updates to tax rules as necessary (to be expected for a ~$800/year software lease PER USER!)

I suppose a way to address that concern: I could have a different end goal of a set amount of income (at a decidedly lower tax bracket) in retirement and then compare this across scenarios.

I envision next year's book increasing to 50 strategies quite easily!

Thank you for your analysis and I will indeed include more commentary in next year's edition to explain the software/assumptions/graphs in more detail.

I guess a nice segway would be to recommend that readers consult with their own qualified advisor (as always) to address their own concerns with the material (or desire to explore other questions that might help them out with their planning.)

Thanks Jean! My observation that you are a very detail oriented writer was clearly accurate. :)


Four Pillars said...

Great review as always Jean!


CanadianInvestor said...

Preet, thanks for your comments and clarifications. Forgot to mention that the Preet Principle thankfully is not related to its anagram the Peter Principle! I know it's hard (due to space/length) in a book which is not a scientific paper to outline all the assumptions but some of them are key to understanding. Most people just want a simple answer but for those who want to understand the why's, or for those situations where it is not possible to give a simple answer, an understanding of the direction and importance of the different factors, whether it is investment return, borrowing rate, volatility, tax rates etc really helps. If you are intending to publish an update, maybe I should send you the other two pages of my notes on the book.

btw, what was the Monte Carlo software you used?

Preet said...

Hi Jean - yes I would love to have your other notes as I plan on making the book better every year (and to keep it up to date).

I've been using EISI's Naviplan Extended. You can go to their website and download a free 30 day trial, but be warned: it take a LONG time to really be able to harness its power, and one small mistake (one unchecked box for example) can throw your entire plan into complete catastrophe.

I believe:

There are, no joke, around 1000 reports you could create. I'll send you copies of a sample plan (exported to word format) if you like to see some of the things it can do...?

The website has some good tutorials, but they need many more. I believe they have a video tutorial on the monte carlo projection tools, but the pdf training manuals (and their 1-800 support lines) are great as well.


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