Monday, December 23, 2013

Which Takes a Bigger Bite from Your TFSA: Income Taxes or Mutual Fund Fees?

Getting into the Grinchy side of the Christmas spirit, I thought I’d take a look at how both income taxes and mutual fund fees affect TFSA savings. The effects of these costs will vary considerably from one person to another, so we’ll just look at one particular case.

From stage left, our saver Sally enters. She saves $5000 in her TFSA every year (rising with inflation) starting from age 25 until she retires at age 65. We’ll assume that she makes a return of 4% above inflation each year (before fees). From age 65 to 85, she draws $15,000 per year to live on (in today’s dollars).

For Sally’s tax bite, we’ll look at how much income she had to earn to make the $5000 TFSA contribution. Let’s assume that Sally lives in Ontario and earns between $87,907 and $136,270 so that her marginal tax rate is 43.41%. This means she has to earn $8835 to get $5000 after income taxes. This makes the tax bite on her TFSA contribution $3835 per year.

For the bite of mutual fund fees, let’s assume that Sally is invested in funds with a 2.5% MER. This MER cost will start small in the first year, but will build as her savings build. Here’s how the mutual fund MER bite compares to Sally’s tax bite each year:

By the time Sally is 50, her savings take a bigger hit from mutual fund fees than income taxes. Over the full 60 years, the income tax total (in today’s dollars) is $153,419. But the total mutual fund fees (again in today’s dollars) are a whopping $199,163!

It seems hard to believe that a seemingly tiny 2.5% MER could amount to more than a 43.41% income tax rate. The important difference is that the income taxes apply each year only to the TFSA contribution; each dollar only gets taxed once. With the mutual fund MER, each dollar is hit every year for as long as it stays invested in the mutual funds.

The moral of this story is that when it comes to investing, costs matter.


  1. Yet another very convincing consideration. Thank you.
    Did you consider publishing your posts as an e-book?

    1. @AnatoliN: I've thought about writing a book. I have no immediate plans. I'll think about it more seriously after I'm done with my day job.

  2. Another great post on how MERs are killing our investment returns.

    Michael, I like how you've put the MER costs in a context so that the 'Average Joe' can understand the incredible damage they are doing to our portfolios.

    In your last post, you told people how many years MERs will take away from their retirement. If that doesn't make people wake up, then this post showing that we pay more in MER costs versus taxes, should convince the remaining people.

    Great post!

  3. "But fess don't matter, the only thing that matters is the net rate of return!" .... said some commission collecting person somewhere.

    Nice article Michael

  4. A book from you on the subject, that I can present to my kids, will save them from making the mistakes I made by investing in mutual fund. They haven't started investing yet, but I don't think they'd take my word... but a book from you showing the vagaries of high fees would help steer them away from these toxic products!

  5. @Neil: I was told once that "fees are the last thing you should worry about." Either last or first.

    @Be'en: Thanks for the vote of confidence. We'll see if I ever get motivated enough to write a book.