Dale Jackson

Personal Finance Columnist, Payback Time

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No matter how much care you put into choosing the right investments for your retirement, three silent portfolio killers could be draining your savings over time.

Taxes, debt and fees all draw from the amount that can be invested and compounded over the long term, and together can add up to hundreds of thousands of lost dollars in retirement.

These are necessary evils for most Canadian retirement investors, but keeping their costs low is a risk-free way to boost returns. 

KEEPING MORE TAX DOLLARS IN YOUR PORTFOLIO

Tax experts say an effective tax strategy implemented over an investor’s lifetime can add as much as 25 per cent to the value of a portfolio. 

In most cases, that strategy begins with investing through a registered retirement savings plan (RRSP). Contributions are permitted to grow tax-free over time until the funds are withdrawn.

The tax savings from RRSP contributions are biggest for investors with the highest income, because the amount they save equals their highest marginal tax rates. In other words, if your top marginal income tax rate is 40 per cent, then 40 per cent of your contribution will be deducted from that year’s tax bill.

Assuming refunds are re-invested, the biggest RRSP savings come to those who contribute during their high-earning years and withdraw in their low-earning years, ideally in retirement.

To keep those withdrawals at a low marginal rate in retirement, it’s important to ensure your RRSP doesn’t grow too much. Eventually, you will be forced withdraw your savings at a higher marginal rate and could even risk Old Age Security clawbacks.  

That’s where a tax-free savings account comes in. Unlike an RRSP, contributions to a TFSA cannot be deducted from income. However, investments in a TFSA and the gains they generate over time are not taxed when they are withdrawn.

Using them together allows investors to withdraw funds from their RRSPs at a low marginal tax rate and top up required funds tax-free from their TFSAs.

Other tax tools available to most Canadians outside RRSPs and TFSAs include dividend tax credits for eligible stocks and a 50 per cent capital gains exemption when equities are sold.

THE POWER OF COMPOUNDING DEBT IN REVERSE

Imagine all the interest and interest on that interest (and so on) you pay in a lifetime on student debt, consumer loans and mortgages.

Lowering or eliminating that debt can turn the tide and divert your money from the bank to your portfolio.

The recent spike in interest rates has made it more lucrative to pay down debt. Eliminating debt at 10 per cent, for example, is comparable to earning 10 per cent on a risk-free investment (which doesn’t exist.)

Even consolidating high-interest debt into a low-interest loan backed by a secured home equity line of credit (HELOC) will free up more money for further tax savings in an RRSP and TFSA.

INVESTMENT FEES HOBBLE RETURNS

If you want good investments with good advice, you have to pay for it one way or another. But when fees get too high they can actually be a hindrance to growth.

As an example, most Canadians invest for retirement through mutual funds, which can impose annual fees above 2.5 per cent on the total amount invested. Fees on segregated funds, which are insured mutual funds, are even higher.

To achieve an annual return of 5 per cent on a mutual fund with a 2.5 per cent fee, the fund manager must post a return of 7.5 per cent. If the fund loses money in any given year, you must still pay the fee, adding further losses.

There are many lower-fee alternatives including exchange-traded funds (ETFs), flat fees for advice or investing directly.

In many cases, an advisor will cut you a better deal as your savings grow. The investment fee structure in Canada is complicated, so understanding exactly what you are paying, compared with how much you have, is a good first step to lower fees.