Reverse Tax Engine
Did you ever question how 'shortfall/deficit' and 'average tax rate' ever got into the lexicon? They arose because financial planning software developers just couldn't do the math. It is not that the tax calculation is complex.... after all, some individuals still complete their tax return by hand!! I have a copy of my parent's 1943 tax return.... it had 12 distinct tax brackets. The computer/calculator wasn't around in 1943, and yet in 2006, most financial advisors still use average tax rate programs. Go figure!
Here, mathematically explained, is what RRIFmetic's "Reverse Tax Engine" is all about.
BTW....Other vendors refer to Artificial Intelligence or 'optimization', the RTE is exactly the same process, only more accurate and much faster.
First of all, let's look at income tax explained as a known mathematical concept (expressing net income as a function) .......
net income = TAXF (age, year, province, salary profile, interest income, dividend income, RSP/RIF withdrawls, RSP contributions, loan pmts, insurance prems, charitable donations, CPP status, OAS status ) + nonreg capital out - nonreg capital in
Notice, that instead of referring to pre or post retirement, we refer to a 'salary profile' Also, don't forget the effect of time.... compound interest, inflation and the indexing of the tax brackets!
The above function called TAXF( ) is complex but it is not rocket science. It is a known piece of math. You will appreciate this when you do your T1 each year.... the progressive tax structure, OAS clawback, surtaxes, etc. Spreadsheets can do this although they can be messy, the math will be very approximated, and they will be SLOW!.
Here is the problem this formula poses for financial planning. ....
Whereas most of the arguments in the formula can be quantified (age, salary, loans, CPP status... etc) there are four items which are not immediately quantifiable. They are- RSP withdrawals, RSP contributions, nonreg capital out and nonreg capital in. (i.e. the movement of investment capital) There are unknown variables on the right-hand side of the equation!!
How do you determine what these amounts are to be? Most S/W requires that the planner make subjective decisions about what these cash flows should be in order to derive an 'acceptable' net income. The degree of acceptability is referred to by the program as a 'shortfall', 'deficit' or 'surplus'.... comparing the net income that the above formula delivers to the subject's desired net income (or lifestyle).
It is necessary to manually massage the flow of capital in, out and between the registered and nonreg capital pools, and this causes the planner headaches. Some programs attempt to have the cash flows automatically optimized, however they are very slow and the results are badly approximated.
This accounts for the bloated and time-consuming nature of this type of planning S/W (NPX, CCH, PlanPlus....). No interactive 'what-ifing'... these are 'come back next week' programs.
RRIFmetic takes the above TAXF( ) formula and rewrites it in terms of investment cash flows:
reg/nonreg cash in/out = REVTAXF ( net income or 'needs' profile, salary profile, future lump sum capital gain, age, year, prov, CPP status, OAS status, charitable donations, loans, insurance )
Notice that the newly derived function REVTAXF( ) has arguments which are immediately quantifiable by the planner and/or client. The known variables are on the right and unknowns on the left. After all, the client wants to tell the program what his net income (i.e. lifestyle) needs are, NOT the other way round! This new calculation creates -on the left hand side- the cash flows (monies going in, out and between the Reg and nonReg capital pools) automatically! No tweaking, no subjective decision making, no 'shortfall/deficit'. An immediate 3 second solution.
This 'goal-based' math is truly unique. The tax routine (to the same degree of detail as a T1 program) is a separate machine language dll, it is passed approximately 5000 to 20000 times in a single run. This is a unique financial planning paradigm. Don't try this at home with your favourite spreadsheet, kids!
Read How the RRIF became the programmer's worst nightmare (or how RRIFmetic got its name)
The Reverse Tax Engine produces a goal-based solution in a fraction of the time that "artificial intelligence" and "optimizing" S/W require. RRIFmetic is far easier to use and fully interactive.
No more hours of data massaging... The 'what if scenario' is back!