In Toronto, a couple we'll call Maureen, 42, and Todd, 43, have the advantages and complications that go with a $200,000 annual gross income and three children ages nine, seven and five. Maureen, employed in the financial services industry, and Todd, a public servant, are meticulous in their affairs, yet the cost of being parents shows.
They have $122,800 in financial assets and $472,800 in total assets if you count their $350,000 house. Take off debts of $188,500 and they have a net worth of $284,300, which is a good start on building a fortune.
Maureen and Todd recognize that their financially complex lives create a lot of choice: adding money to their RRSPs, paying off debts and setting money aside for a new home.
"We would like a comfortable retirement and a larger home," Todd says. "How do we finance each wish? Do we contribute to Maureen's RRSP because she earns more than me, or to mine because I earn less and will be in a lower tax bracket at retirement? And can we afford to move into a larger, more expensive home that might cost $500,000 to $600,000?"
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Maureen and Todd. "This couple focuses on their finances, but with so many choices, they need clarity. The challenge is to work through each to find the best solution."
A Bigger House
Currently, Maureen and Todd pay $1,933 a month on their $43,000 mortgage balance. Their low floating interest rate of 1.4% is unlikely to last beyond mid-2010. Rates are likely to rise substantially.
If they use $950 of their monthly savings capacity to prepay the mortgage by boosting total payments to $2,883 a month, they would be mortgage-free in just 15 months. If the couple were to sell their house for $350,000 and then borrow $200,000 to buy a $550,000 house, paying 4% or $2,883 a month, they would be mortgage-free in 6½ years,
Mr. Moran estimates. If they were to upgrade by $300,000, and still pay $2,883 per month on a 4% loan, they would be mortgage-free in 11 years. If they have to borrow $200,000 at 6%, they would need 7½ years to pay off the mortgage. With any of these deals, they can afford the more expensive home and have it paid in full before retirement.
Educating the Kids
Maureen and Todd expect their children, now in private schools, to attend university. Paying for half of their bills will be enough, the couple say. Accordingly, they have put just $300 a month--$3,600 a year --into their family's RESP.
Common wisdom is to put at least $2,500 per child per year into the RESP in order to receive the maximum Canada
Education Savings Grant (CESG) of the lesser of $500 or 20% of contributions, Mr. Moran notes. Maureen and Todd have instead chosen to encourage their children to pay half their own costs, but the penalty for this "pull yourself up by your bootstraps" plan is that the family is missing out on much of the CESG. To remedy this loss of future education funding, Maureen and Todd should boost RESP contributions to a monthly total of $208.33 per child.
If they continue to add $3,600 a year to the RESP and receive $720 in CESG grants for a total of $4,320, and they earn a 3% return on contributions, they will have $46,535 in eight years when the eldest child is 17. With continuing contributions for the younger children, that would provide each child with about $16,000. That amount won't pay all the bills at most institutions for a four-year program.
If they add an additional $325 a month to the RESPs and gain another $780 in annual CESG bonuses, they will have $89,400 for their children in eight years or about $30,000 per child. The RESP will have growth taxable at a low or zero rate when paid to the children. It's an inexpensive way to cover education costs. The loss of personal saving capacity for the parents is more than made up for by the CESG that goes to the kids' education. Mom and dad should go for it,Mr. Moran urges.
Todd and Maureen will receive full Old Age Security (OAS) payments, currently $6,204 per person before any clawback, beginning at age 65.
The maximum Canada Pension Plan (CPP) payment is currently $10,905. If Todd works to age 60, he will have accrued 85% of the maximum credits, entitling him to a $9,269 annual pension at 65. If Maureen works to 55, which is her plan, she will have earned 55% of maximum credits and receive a pension of $5,998 if taken at 65, Mr. Moran estimates.
Todd has an indexed company pension. He will receive an annual, unreduced pension, beginning at his age 60 in 2026, of $43,074 in 2009 dollars. He will also receive a bridge pension of about $8,000 a year from age 60 to age 65.
Currently, their RRSPs are rather small, but there is a tax-efficient way to add to them. Maureen should contribute to her own plan. She gets tax relief and will be in a lower tax bracket at retirement. She has $77,630 of RRSP contribution room and should transfer her annual bonus of 15% of her income -- about $17,250 -- directly to her RRSP, then add another $1,000 a month out of monthly savings.
If Maureen continues to transfer her annual bonus plus $1,000 a month for a total of $29,250 a year, their RRSP balance will grow to $188,120 by her age 47, assuming 3% annual growth. They then put in only her bonus, retaining $1,000 a month for expected higher school fees, for another eight years to her age 55 when she would like to retire. At that point, she will have $396,300 in 2009 dollars, the planner estimates.
With no further contributions, the RRSPs will grow until Todd is 60 and eligible for an unreduced employment pension. At that point, the funds will total $446,000. If this sum is spent over 30 years until her age 90, it would add $22,100 per year to their income.
Summing up all their pension and investment income, Maureen and Todd will have his employment pension of $43,074, plus the $8,000 bridge to age 65, RRSP income of $22,100, for a total of $73,174. At age 65, they will add CPP payments of $9,269 and $5,998, plus two OAS benefits of $6,204 each. The bridge will vanish, but they will have total income of $92,949. Todd's employment pension and all public pensions are indexed.
Todd and Maureen are in an enviable position, Mr. Moran notes. "Todd earns less than Maureen but will retire with an indexed pension. Maureen has no company pension, but her income can pay for a new house and allow increased funding for the children's education."
Family with three children wants to reduce debts and buy a bigger home
Pay off current mortgage quickly, then buy house, add to RESPs and RRSPs
Buy bigger house, enhance RESP for kids, add to RRSPs
MONTLY AFTER-TAX INCOME
Maureen $6,043, Todd $4,547,
House $350,000, Taxable investments $80,000, RRSPs $24,300, RESPs $5,500, Cash $13,000
Mortgage $43,000, Line of credit $145,500
Mortgage $1,933, Property tax $208, Utilities, phones, cable $442, House maintenance $220, Food $870, Restaurant $350, Clothing $165, Children's music, etc. $625, RESP $300, Car: gas, insurance, repair $808, Home and life insurance $238, Kids' tuition $1,000, Gifts, charity $513, Cleaning service $176, Miscellaneous $467, Savings $2,275