In a small Ontario town, a couple we'll call Loretta and Hugh have made a good life on a combined family income that they expect to be $122,000 for 2006. Hugh, 30, works a night shift at an industrial plant. Loretta, 27, who has extensive mathematical training, has only been able to find what amounts to subsistence accounting work in her small town. Though relatively young, they want to organize their finances in order to start a family and then retire when Hugh reaches the age of 52 in 2028.
"We don't have any dependents, but they aren't far off in the distance," Loretta explains. "We'd like to have a solid financial footing before we take that step."
What our expert says
Facelift asked Mathieu Paradis, a certified financial planner with the Independent Planning Group in Ottawa, to speak with Loretta and Hugh and help them devise a plan for managing their expenses and building up assets for the family they plan to have.
"The couple feel overwhelmed and aren't sure what decisions they should make," Mr. Paradis says. "They question whether they should pay down their mortgage quickly or invest for their retirement. With their high savings rate, they can actually do both."
Modest spending is the base for the couple's future wealth, the planner notes.
Hugh and Loretta have take-home income of $7,312 a month. Every month, they spend $3,508 after paying their $920 monthly mortgage and save $2,884.
With that rate of saving, the couple can afford to pay down their $165,000 mortgage by accelerating payments. They can increase their current payments of $460 every two weeks by $92 to $522 and make lump sum payments of up to 20 per cent of the amount outstanding on the annual anniversary of the mortgage, Mr. Paradis says. Doing both things will cut the remaining time it will take to pay off the mortgage from 20 years currently to just seven years. The two moves will save the couple $56,762 in interest charges, the planner explains.
For retirement, Hugh is in a defined benefit pension plan. He has $50,500 of unused registered retirement savings plan contribution space while Loretta has $20,000 of available RRSP space. They have a spousal plan through which Hugh, who is in a high tax bracket, gets the larger immediate tax benefit. Loretta will eventually be taxed on withdrawals at what is likely to be a lower rate.
By 2014, the mortgage will be paid off if the couple have used accelerated payments and prepayments to full advantage. Loretta will then be able to invest her entire net income of $1,500 a month in taxable investments. If she selects equities, she will be able to postpone recognition of capital gains until her planned retirement in 2028 or later when she has no other income. That will minimize the tax consequences of the investments.
The couple should put $1,000 a month into their RRSPs, Mr. Paradis suggests. As novice investors with no bear market experience, they can use a balanced fund made up of a common blend of 60-per-cent stocks and 40-per-cent bonds until they gain more market experience.
In four years, the $1,000-a-month RRSP contributions recommended will have just about exhausted Hugh's unused RRSP space. He will have only $600 a year of contribution room each year after his large pension adjustment. By that time, the couple are likely to have one or two children and it will be important to save for their postsecondary education, the planner says.
Hugh's income is expected to rise by $25,000 in 2009. That will raise his take-home income by $16,750. His annual net income will rise to $87,750, the planner says. That sum will enable the couple to contribute $2,000 a year to their planned child's registered education savings plan.
They will qualify for the annual Canada Education Savings Grant of $400 a child per year for each of the two children they plan to have, beginning with the first in 2008. Hugh and Loretta aim to have $5,000 per child available after each graduates from high school. If they use a family plan that pools the interests of both children into one plan and contribute $2,000 a year for the first child and raise the total contributed to $4,000 a year when child No. 2 arrives in 2010, and continue until 2016, they will have achieved their $5,000 a child per year educational supplement, assuming that funds have grown at 5 per cent a year.
