In the months leading up to the birth of their first child, Bob and Betty wondered how this new stage of their lives might affect their financial position.
Betty would be taking parental leave, so the household income would drop. When she returned to work, there would be child-care costs and saving for higher education. In time, they might have a second child.
"I worry that we are not managing our savings as well as we should, and that our current lifestyle cannot be maintained once kids are in the picture," Betty writes in an e-mail. "Will we need to adjust in other areas? Will things be tight in the year I am on maternity leave with only 10 weeks of [employment insurance] top up from my employer?"
Well, the little one has arrived so they're about to find out. "We welcomed a baby girl on July 2," Betty writes. "Life is certainly different, and we are settling into this new chapter."
They are well-positioned financially. At the age of 30, both have good professional jobs, bringing in a combined $175,000 a year before tax. Bob, who makes $83,000 a year in the health-care field, has a defined-benefit pension plan. If he stays put, he can retire in 25 years – at the age of 55 – with a monthly pension of $2,886, plus a bridge benefit of $720 a month until he turns 65.
They hope to retire early. "We are still young and if we need to adjust course to meet our goals, now is the time," Betty writes. Like most folks their age, they have a house with a mortgage.
We asked Linda Stalker, a certified financial planner at Henderson Partners LLP of Oakville, Ont., to look at Bob and Betty's situation.
What the expert says
Betty and Bob's primary concern is whether they are allocating their resources properly to reach their family and retirement goals, Ms. Stalker says. Their goals are to start a family, become mortgage free, retire by the age of 55, and fund postsecondary education for their children.
"Betty and Bob's current strategy has them focusing a little bit on everything without really knowing or understanding if they are going to achieve their goals," the planner says.
"They are doing a few good things right now by paying more than the minimum on their mortgage and paying bi-weekly," she adds. They have been able to reduce the amortization to 18 years and 11 months. While their interest rate is low at 2.25 per cent, rates are starting to rise and they will likely see an increase in bi-weekly payments when they renew their mortgage.
They are both taking advantage of employer retirement-savings programs, with Betty participating in a matching program for her RRSP contributions and Bob having the good fortune of being part of a defined-benefit pension plan, Ms. Stalker says. As well, Betty is contributing to her tax-free savings account. They have surplus cash flow of about $3,400 a month – a cushion that will shrink or even disappear as their family grows.
Now that the baby has arrived, their income will decrease for a period of time, the planner says. Their expenses may increase dramatically and for an extended time, depending on the type of child care they choose and the number of children they have, she says. "And it doesn't stop there."
Betty and Bob are planning on funding their children's higher education. Their first priority should be to contribute the maximum amount to a registered education-savings plan in order to receive the full Canada Education Savings Grant. The grant provides 20 per cent of the contribution amount to a maximum of $500 a year for each child. "Education costs, coupled with costs for extra-curricular activities and additional air fares for the children when travelling, can derail the best laid plans."
An effective strategy would be for them to live on one spouse's salary while saving the other's. "By doing this, Betty and Bob will not feel the impact of a reduced income while on parental leave." Given that their current rate of savings is $1,800 a month and they have surplus cash flow, they should be able to live on one salary, Ms. Stalker says. If necessary, they could suspend contributions to savings accounts during parental leave.
Now that they have a child, the allocation of surplus funds will need to change, Ms. Stalker says. When Betty returns to work, daycare is estimated to wipe out $1,200 a month of the surplus, leaving $2,200. "It will likely be more difficult to aggressively pay the mortgage in the early years because the RESP should be a top priority."
Betty and Bob have $37,000 in savings that can be used as their emergency fund. After the RESP is taken care of, any surplus monthly cash flow should be allocated as follows: First, maximize contributions to their RRSPs to the extent that they can take advantage of employer contributions. Second, if cash flow permits, pay down their mortgage. Third, use tax-free savings accounts for any surplus funds that are not directed to RESPs, RRSPs or paying down the mortgage.
If Betty and Bob continue down the savings path they are currently on, they should be able to reach their early retirement goals, the planner says. However, they have a long time horizon and variables are likely to change, so the projections should be revisited periodically.
The people: Betty and Bob, both age 30
The problem: How to best allocate their resources in order to meet their life and early-retirement goals.
The plan: Recognize that priorities will shift over time. Emphasis will turn from mortgage repayment to education savings to take advantage of the government grant.
The payoff: A comfortable retirement.
Monthly net income: $10,820
Assets: House $475,000; her RRSP $18,923; her deferred profit-sharing plan $4,419; her TFSA $4,937; his TFSA $10,636; cash $37,000; estimated present value of his defined-benefit pension plan $47,739. Total: $598,654
Monthly distributions: Mortgage $2,167; property tax $385; home insurance $92; utilities $180; maintenance $75; transportation $425; groceries $600; clothing $100; phone, Internet, TV $348; vacations $300; gifts $50; entertainment, dining out, drinks $650; club memberships $116; health care $99; RRSPs $938; TFSAs $400; his pension-plan contribution $485. Total: $7,410 Monthly surplus: $3,410
Liabilities: Mortgage $401,000
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