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financial facelift

-Glenn Lowson/The Globe and Mail

Despite his high income, Adam is feeling the squeeze. His wife, Lilith, has been home with the children for the past eight years. She plans to return to teaching once their youngest is in kindergarten.

Adam and Lilith are both age 38. They have three children, ages one, six and nine.

Adam makes about $180,000 a year including bonus and dividends on his company stock. They have a home in Southern Ontario valued at $630,000 with a $537,000 mortgage. Their aim is to "loosen the purse strings a bit," Adam writes in an e-mail.

"We live on a pretty tight budget and are careful with our money," he writes. "Things will change drastically when Lilith goes back to work, but teaching jobs are scarce in Ontario so there is uncertainty about how steady [the work will be] and when her income will start," he adds.

With so much debt, they worry, too, about rising interest rates. They plan to step up their mortgage payments once Lilith returns to work. As well, some of the extra income would go to diversifying their investments.

Their long-term goal is to retire at age 55 with $85,000 a year after tax.

We asked Kurt Rosentreter, an accountant and senior investment adviser at Manulife Securities Inc. in Toronto, to look at Adam and Lilith's situation.

What the expert says

At 38, Adam and Lilith already have more than $840,000 in savings, so if that grows by 5 per cent a year for 17 years, they will be close to their retirement goal by the time they are 55, Mr. Rosentreter says. They can begin collecting Canada Pension Plan benefits at age 60, Old Age Security at 67 and U.S. Social Security at age 62 (Adam worked for a while in the United States).

The big unknown is what Lilith's pension might be when she retires.

Their $85,000 spending goal is about $100,000 before tax, Mr. Rosentreter estimates. By the time they are 55, this will have risen to $140,000 a year in 2014 dollars with 2 per cent inflation.

Mr. Rosentreter estimates Adam and Lilith will need about $2.5-million in savings to meet their goal. At a 5 per cent growth rate, their existing savings would grow to $1.7-million in 17 years. Income from that, plus their various government benefits, should put them in the range of their retirement cash flow goal, Mr. Rosentreter says. Lilith would need a work pension of at least $10,000 a year starting at age 60.

But that's a long way off. Lilith and Adam would do well to revisit their financial plan as things change, Mr. Rosentreter says. Right now, they face more immediate financial planning issues. Because Adam is investing heavily in his company's stock, their investments are not properly diversified. It's a classic case of too many eggs in one basket.

They're also short on the basics. Adam – with four dependants – has only $720,000 in life insurance, while Lilith has none. Their wills, prepared while they were living in the United States, are not valid in Canada, the adviser says.

"With three children and a dependent spouse, a mortgage of $537,000 and net worth of about $170,000 if you leave out the house – the family would need somewhere to live – Adam is significantly underinsured," Mr. Rosentreter says. He recommends a minimum $2-million of 20-year term insurance.

If Adam and Lilith retire at age 55, at least two of their children likely will still be in university. While they are contributing to a registered education savings plan, they may find their savings fall short.

"He may find that all three children are in university at the exact time he wants to retire and he has to come up with a substantial sum of money at that time," Mr. Rosentreter says. So far, they have $37,700 in the children's RESP. They're contributing just $30 a month.

The cost of post-secondary education at a university out of town can be $100,000 for a four-year program for each child, or $300,000. With inflation of an estimated 2 per cent a year, $300,000 will grow to about $403,760 in 18 years. "The optimal would be $2,500 a year for each of the three children, or about $625 a month," he says. By not contributing $2,500 a year for each child, they are not taking full advantage of the Canadian Education Savings Grant. Under this program, the federal government contributes up to $500 a year for each child, with a lifetime maximum of $7,200 a child.

"This 20 per cent free grant may well be a bigger return than Adam's company stock is generating," the adviser says.

Then there's the debt. A two percentage point increase in interest rates could raise their mortgage payments by 25 per cent, the adviser says, making it more difficult to pay the mortgage off before they retire.

Adam might want to consider selling half of his stock, paying off his investment loan, topping up the RESPs for the children, opening tax-free savings accounts to serve as an emergency fund and using the balance to pay down the mortgage, Mr. Rosentreter says.


Client situation

The people: Adam and Lilith, 38, and their three children.

The problem: Can they spend a little more, save for their children's education and retire comfortably at age 55 with $85,000 a year after tax?

The plan: First things first. Draw up Canadian wills, take out more life insurance and up the savings for the children's education. When Lilith returns to work and it is clearer what the family income will be, revisit their financial plan. In the meantime, consider selling some of Adam's stock and paying down debt.

The payoff: More flexibility than they would otherwise have both now and when they quit working – and a much more solid financial foundation.

Monthly net income (variable): $10,130.

Assets: Bank $8,000; company stock $505,000; Adam's 401K (U.S. retirement plan) $325,000; Lilith's RRSP $15,200; RESP $37,700; residence $630,000. Total: $1,520,900

Monthly disbursements: Mortgage $2,605; property tax $490; insurance $195; utilities $260; maintenance $120; vehicles $505; groceries $830; child care $40; clothing $180; loan payment $1,635; gifts, charitable $100; vacation, travel $300; dining, drinks, entertainment $560; sports, hobbies $100; other personal $20; life insurance $60; disability insurance $90; dentists, drugstore $20; telecom, TV, Internet $150; RRSPs $505; RESP $30; group benefits $40. Total: $8,835

Liabilities: Mortgage $537,000 at 2.79 per cent; investment loan $132,000 at prime plus 0.5 per cent. Total: $669,000

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