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Who Wins The Race? A Government Tax-Free Account Or A Leveraged, Fully Taxable Account?

I don't like that the government creates a product, with a host of rules, loops and hoops, for the average Joe to get a benefit. If he chooses not to use it, he is penalized. You have to follow *their* rules, their conditions. This is the nature of tax offices worldwide, pay first and then claim back what is rightfully yours in part through credits. They can deny it, or adjust it, delay the payment, make you fill out hours of forms to get it. People become like rats having to pay others or do their own tax work. Of course you can just give up the credit and be crazy enough to pay a lot more tax because you did not follow their monarchical desire to beg and grovel before the King and they can have the pleasure of giving you your money back.

Having said all that, you'd have to be somewhat silly not to use the various registered plans of the government for investing. There are not many exceptions. One is that you are leaving the country for good and need to take your money with you - to another country's plan. But the major reason I want to consider here is if you are in a constant state of borrowing to invest.

Sometimes, investors, like owners of real estate, use other people's money. In stock investing you must be way more careful. The rate of interest is variable not fixed. Likewise, you can get a margin call, regardless of if you make monthly interest payments or not.

Most registered plans do not allow leveraged investment. So I want to compare the return on leveraged un-registered accounts with unleveraged registered accounts at various levels of leverage.

Let's start with 1.2x and an account with $100,000 net average investment in it.

If you get a 10% return over 15 years, you have $417,724. In a tax free savings account you just keep it all. In a registered retirement account it's a bit more complicated. You do pay a one time tax of say 25%, but you have more income each year that made up that original $100,000 capital base. In the savings account, you may require $130,000 of pre-tax income to invest $100,000 net (at a 30% tax rate). This is not a trivial matter because that extra $30,000 over 15 years amounts to a total of $543,042 in the registered retirement plan. If we lop-off 25%, we get $407,281. It's pretty close, obviously the longer we go and higher return, the more advantage to deducting from tax contributions (not available to a registered savings account).

Now let's look at the unregistered account (for example, in Canada).

At 1.2x leverage we have $120,000 to invest. After 15 years we have $501,000. The tax rate is about 22% of 50% or $391,000. Slightly less than the registered plan but not a lot. If you structure it right, you can deduct the margin expense from any investment income.

At 1.5x leverage it's $150,000 over 15 years or $626,587, minus taxes we get $488,737. This is *more* than the registered plans, of any variety.

The matching leveraged to non-leveraged break-even is around 1.3x. I think at 1.3x you may stay out of trouble, and you don't need to use these government plans at all.

Of course you have to carry this amount of debt for the entire period.

My conclusion is that you use leverage to invest above 1.3x, you don't need to use any registered government sponsored benevolence.