In Toronto, a couple we'll call Dave and Theresa are building a life for themselves and their two-year-old child. Dave, 36, is a pilot. Theresa, 32, is a project manager. Their combined gross annual income, $172,000 a year, would pay for a comfortable suburban life in most parts of Canada. But in Toronto, an expensive city, it's a middle income for an average way of life.
"We moved to the big city for job opportunities," Dave explains. "We have paid off our student loans with capital gains from property investments and we managed to find a good home in an excellent neighbourhood. But we are unsure of where we should put any extra money. Should we pay down our mortgage, invest in the stock market, or increase our RRSP/RESP contributions?"
What our expert says:
Facelift asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Dave and Theresa in order to sort out their choices.
"This couple has an overwhelming amount of common sense and they use it. They have paid off $50,000 of student loans and they have made smart real estate choices. They bought one of the least expensive houses in one of the most affluent areas of Toronto. Moreover, they are asking the right questions."
Dave and Theresa have a $447,000 mortgage on which they pay $2,950 a month. For each rise of one percentage point when the mortgage comes up for renewal in 2016, they would have to pay an additional $150 a month. At renewal, they will still owe $343,200.
Another $920 can be put into the mortgage each month. With that sum and the tax refund of at least $4,000 a year from RRSP contributions put into mortgage reduction, the amortization period of the mortgage can be shortened by 10 years from its present expiry in 2033. The couple will also save $184,210 in interest assuming that their present 5.95-per-cent rate continues. Once the mortgage is paid off, they will have freed up $2,950 plus $920 a month - that's $3,870 - or $46,440 a year.
Currently, Dave puts $100 a month into his registered retirement savings plan. Theresa puts in nothing. They could use higher RRSP contributions to bring their marginal tax rates down and put them in a lower tax bracket, Mr. Moran notes.
If Dave puts $1,000 a month into his RRSP and, assuming that savings grow at 6 per cent a year less 3 per cent for inflation, then he and Theresa will have $398,860 at Dave's age 55, $521,470 at his age 60 and $668,230 at his age 65. All figures are in 2008 dollars.
Dave and Theresa are not well versed in capital markets. They are well advised to study the field and either take charge of investing their money or hire an adviser to look after it, the planner says.
Retirement is distant, but it appears that Dave and Theresa will each qualify for full Canada Pension Plan benefits, currently $10,615 a year, and full Old Age Security payments of $6,028 a year in 2008 dollars. The RRSP, if spent between Dave's age 55 and Theresa's age 90, would produce an annual income of $17,488 a year, also in 2008 dollars. If withdrawals are deferred to Dave's age 60, the RRSP would support annual payments of $24,677, and if deferred to his age 65, it would support payments of $34,825 a year, the planner notes.
Dave is already enrolled in his company's defined contribution pension plan.
He contributes 3 per cent of his salary and the employer matches each dollar over 1.5 per cent of salary. So when he puts in 3 per cent, he gets a total of 3.75 per cent of salary or a 25-per-cent immediate return, Mr. Moran says.
If 3.75 per cent of Dave's salary is invested, he will have $84,587 at age 55, $115,383 at age 60 and $151,084 at age 65. These figures are based on today's share prices and assume a 6-per-cent annual return and 3-per-cent annual inflation.
Dave and Theresa are paying $140 a month for mortgage life insurance. The insurance covers only the amount owing on the mortgage, but the premium does not drop as the debt declines. Dave and Theresa can pay their premiums annually and save as much as 8 per cent or drop the coverage entirely and buy what may be less expensive term life from an independent insurance agent. If Dave and Theresa choose to replace the mortgage life policy with an individual policy, they will have steady premiums, as they would with mortgage life, but the residual death benefit will rise as the mortgage balance declines, Mr. Moran explains.
"This couple are debt averse and very sensible," Mr. Moran says. "Even though we don't know where they will be in a financial sense when it is time to retire, I feel confident in saying that they are ahead of most of their peers and on the right track."
Dave, 36, and Theresa, 32, live in Toronto with their two-year-old child.
How to allocate monthly savings between RRSP and mortgage costs.
Use monthly savings to boost mortgage payments and RRSP contributions.
More rapid growth of wealth and lower income taxes.
Net Monthly Income
House $615,000, RRSP $31,300, taxable investments $22,000, RESP $10,000, pension $1,500, car $8,000, cash $6,000. Total: $693,800.
Mortgage $2,950, property taxes $360, mortgage life insurance $140, child care $1,600, food $600, restaurant $400, utilities & phone $520, car & home insurance $260, clothing $100, RRSP contributions $100, car fuel & repairs $200, transit pass $100, charity & gifts $200, miscellaneous $400, savings $1,520. Total: $9,450.
Copyright 2008 Globe and Mail, Used by Permission