A couple we'll call Susan and Murray live in Halifax. Both 30, they are civil servants, he for the federal government, she for the provincial government. They bring home $7,450 a month after all taxes and deductions. Their issue - whether to live as well as they can today and provide exceptional benefits for their two children ages three and one - or to begin planning for retirement that could be as much as three decades in the future. For now, their problem is to recover from several years of spending beyond their means. And recover they must, for they have only $500 in their chequing account.
"We don't know if we should use our available cash to buy things for our kids and day-to-day living or, as I think, save for retirement and pay down our debts," Murray says.
"I could retire as early as age 38 with a 40-per-cent pension and move to another career, if it is prudent to do so. But who is right? My view that we should pay down our debts, or Susan's, which is living for today and not worrying so much about tomorrow?"
What our expert says
Facelift asked Derek Moran, the head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Susan and Murray to solve their problem.
"They have already acquired a reasonably high lifestyle," the planner says. "They really should pay off some of their $318,750 of debts before they expand their way of life."
The issue is one of choice and risk, Mr. Moran notes. Servicing their debts eats up 39 per cent of their monthly take-home income. They have two cars, one leased, one purchased with a loan. They put just $25 a month into a registered education savings plan for their kids.
They should start reducing debt immediately, the planner suggests. The $795 a month they pay per month on their car loan and car lease can be used to pay off other debts when their car loan is paid off in 2½ years and when their car lease ends in four years. In order to continue their debt reduction program, it's wiser to keep those cars rather than buy new ones.
When the car debts are paid off, the couple will have $9,540 more cash flow a year. That is more than enough for the RESPs and to qualify for the maximum Canada Education Savings Grant of the lesser of $500 or 20 per cent of the maximum qualifying contribution of $2,500 a year. They don't need to add to retirement funds, though Murray could reduce his taxes by contributing to a registered retirement savings plan.
Retirement is distant and relatively uncomplicated for the couple. Each has a defined benefit pension coming plus Canada Pension Plan and Old Age Security. If Murray sticks with his job, he can count on $55,274 a year in 2008 dollars. He will have a bridge benefit payable to age 65 or his death of $9,429 a year. Were he to work only to age 52, he will have earned 82 per cent of Canada Pension Plan credits or $8,704. The current maximum payable is $10,615 a year.
If Susan were to work for a total of 30 years, to age 58, her work pension would be $19,998 a year in 2008 dollars with indexation. If she works to retirement at age 65, she will have earned 90 per cent of the maximum CPP benefit, or $9,554, Mr. Moran says.
Both partners will qualify for full Old Age Security, currently $6,204. At 65, therefore, they should have pretax pension income of $96,509 in 2008 dollars with no loss to the clawback if they diligently split pension income. That would be 69 per cent of their preretirement gross income.
They would not have to allocate funds to educate their children, buy work clothes, commute to work, pay employment insurance or other work expenses. They will be in lower tax brackets and therefore could have more disposable income than they have today, Mr. Moran says.
Should they choose to invest in their retirements more aggressively, then, with no further contributions to their combined $86,000 of financial investments, and assuming their assets grow at 6 per cent a year subject to a 3-per-cent deduction for inflation, they would have $242,000 in 2008 dollars at their age 65 retirement in 2043. That capital would add $14,520 in future dollars to their retirement income, Mr. Moran says. On this basis, their total gross retirement income would be $111,029 in 2008 dollars a year.
One thing the couple does not need to add is more life insurance coverage. They already have $400,000 coverage on each partner. If either were to die, the other could carry on with the death benefit and existing employment.
"The couple are in good shape, but they will be in better shape and have more choices once they eliminate their debts," Mr. Moran says. "It would give Susan the lifestyle choices she wants."
"It will be a struggle to pay off the debts," Murray says. "I expect that it is what we will do."
Halifax couple with two young children.
Debt service eats up their monthly income.
Pay down debts and finance RESPs for the kids
More disposable income for the family.
Net Monthly Income
House $255,000, car $14,000, stocks $8,000, RRSP $23,000, non-registered $55,000, RESP $400, cash $500. Total: $355,900.
Mortgage $1,436, entertainment $300, child care $900, food $750, car loan $495, investment loan $220, car lease $300, student loan $609, credit card $100, retail credit card $60, gasoline & repairs & tolls $270, utilities & phones $535, travel $300, car & home insurance $240, RESP $25, clothing $100, charity & gifts $50, miscellaneous $650, savings $110. Total: $7,450.
Mortgage $202,000, car loan $13,500, student loans $25,900, credit line $15,700, investment loan $58,000, credit card $3,000, retail credit $650. Total: $318,750.
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