GUEST EXPERT. Labour-sponsored investment funds (LSIFs) have been a part of Quebec’s retirement savings world for a long time. The two funds offered to Quebecers are the FTQ Solidarity Fund, created in 1983, and the CSN Fondaction, created in 1996. Is it profitable to invest in one of these funds?

Returns and tax credits

To analyze the potential profitability of an investment in one of these labour-sponsored investment funds, one will obviously have to consider the tax credits they will give entitlement to. Assumptions will also need to be made about future returns. Finally, we can also consider the effect of using an RRSP for this investment. Of course, one can also invest in these funds outside of an RRSP, but for the purposes of this analysis, we will focus on contributions to the RRSP.

Except for an additional 5% credit granted by Quebec to contributions made to Fondaction (CSN) until the end of May 2021, the tax treatment of the two funds is similar: both allow you to claim a 15% credit, both federal and provincial, up to a maximum of $5,000 in annual contributions. These credits are in addition to the tax deduction from the RRSP.

The average annual returns for the past ten years of these funds (without considering tax credits) are as follows (as of November 30, 2020):

• Fondaction: 4.1%

• Solidarity Fund: 7.0%

Over a longer period, the past 25 years (as of May 31, 2020), the returns of the funds are estimated as follows:

• Fondaction: slightly less than 1.5%

• Solidarity Fund: slightly less than 4.0%

• Balanced investments (funds made up of 50% Canadian equities, 40% Canadian bonds, 5% American equities, 5% international equities, before fees as of December 31, 2020): slightly above 7.0%

Although the dates do not match perfectly due to the publication dates for the results of these funds, for future comparison purposes, it can be assumed that labour-sponsored funds will generate a lower return than a comparable investment in terms of volatility. We will therefore use an assumption of an annual return spread of 2.0%. Moreover, the Solidarity Fund itself presents, on its website for projection purposes, a modest estimate of a future return of 3.0% to 3.5%.

Analyse

There is no better way to understand than an example. Imagine someone who makes a single RRSP contribution, either to a labour-sponsored investment fund or to a traditional investment. Let’s go with an equivalent savings effort, that is to say the total amount paid after taking into account all tax credits. The following assumptions will be used:

• Savings effort (net cost of the contribution): $600.00

• Marginal tax rate during working years: 40%

• Marginal tax rate at retirement: 30%

• Traditional investment return: 5.00%

• Labour-sponsored investment fund return: 3.00%

• Duration of investment: 5 years

• We assume that all necessary RRSP contribution room is available.

• We did not consider the temporary additional credit from Fondaction.

The first line of the table shows the standard metric, which is a traditional investment. With a marginal tax rate of 40% at the time of the contribution, an RRSP contribution of $1,000 requires a savings effort of $600 (taking into account the tax refund). This contribution, invested at an annual return of 5.00%, will translate to an RRSP balance of $1,276.28 after 5 years. If at that point the person is retired, with a marginal tax rate of 30%, and withdraws the entire amount, after taxes they will end up with $893.40. Note that we have arbitrarily set the rates at 40% and 30% to illustrate a gap because in general, we have less income (and therefore we pay less taxes) after retirement. This net withdrawal works out to a compound return of 8.29% on the savings effort of $600. This return is composed of a return on investment of 5.00%, to which is added a return of 3.13% resulting from the difference in marginal tax rate between the time of the contribution and the time of withdrawal. In other words, this 3.13% represents a gain coming strictly from the difference in marginal tax rates spread over 5 years. These two compound returns produce the total annual return of 8.29% ((1 + 5.00%) * (1 + 3.13%) = 1.0829%).

The second line of this table shows the investment in a labour-sponsored investment fund (LSIF). With a marginal tax rate of 40% at the time of contribution, an RRSP contribution of $2,000 in an LSIF requires the same savings effort as in a traditional investment, $600 (contribution of $2,000 – deduction of $800 – credits of $600 = $600). This contribution, invested at an annual return of 3.00%, will translate into an RRSP balance of $2,318.55 after 5 years. If at that point the person is retired, with a marginal tax rate of 30%, and withdraws the full amount, after tax they will end up with $1,622.98. This net withdrawal works out to an annual compound return of 22.02% on the savings effort of $600. This return is composed of an annual return on investment of 3.00%, to which is added an annual return of 14.87% from the credit, and an annual return of 3.13% from the difference in marginal tax rates between the time of the contribution and the time of withdrawal. These compound returns produce the total annual return of 22.02% ((1 + 3.00%) * (1 + 14.87%) * (1 + 3.13%) = 1.2202%).

In Conclusion

In light of these numbers, labour-sponsored investment funds are certainly a relevant option, at least over a relatively short investment horizon. Over longer horizons, it might be pertinent to use these funds, but the difference will be less spectacular! This is because their lower return means that, over time, the benefit of tax credits will diminish. Finally, it should be noted that these funds no longer allow contributions by lump sum until May 31, 2021. A financial planner can help you establish an investment policy corresponding to your investor profile.

Martin Dupras, A.S.A., Pl. Fin., M. Fisc., ASC

Fellow of IQPF