Prudent pair want to loosen up a bit

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Like most young couples with a child and a mortgage, Leah and Ezra are feeling constrained by their tight budget.

They have shown themselves to be prudent money managers, paying off Leah's student loan, making regular payments on the loan from Ezra's parents for a down payment on their southern Ontario home, and tucking away as much as they can each month into their various savings plans.

Leah, who is 26, has just returned from maternity leave to her teaching job. Ezra, 27, works as a financial analyst but is planning to join his father in the family business next year.

"We haven't taken a real vacation or bought anything for our house or ourselves," Ezra says in an e-mail. Most of their furniture was handed down.

If they could free up a little cash, they'd finish renovating their basement. They'd like to have a second child soon. And they'd love to have $3,000 or so to take a vacation.

Their question: "How can we free up our cash flow to spend a little now to live life, while also paying down debt and saving for retirement?"

We asked Ngoc Day, financial planner at Macdonald, Shymko & Co. in Vancouver, to look at their situation.

What Our Expert Says

It's a fine balance, Ms. Day says. "There's not much fat to trim."

Leah and Ezra have made sound financial decisions and have begun their married life on a solid financial footing, Ms. Day says.

"They should be proud that they have achieved what many people find difficult: living within their means."

At the heart of their dilemma is the old familiar tradeoff between funding short-term lifestyle expenses and saving for the future.

The key, the planner says, is discipline - and making any savings the couple can find as tax-effective as possible by contributing them first to a registered retirement savings plan (RRSP) and spending the refund.

While Leah has a defined-benefit pension plan, Ezra has a defined-contribution one. His employer has been contributing 3 per cent of Ezra's monthly income to a group RRSP. Ezra has been contributing the same amount, although there is no requirement for him to do so. He also plans to put his $6,000 bonus into this group RRSP.

Putting his bonus into his RRSP may further constrict the couple's cash flow, Ms. Day notes.

The couple lease two vehicles, but they intend to drop one next summer when Ezra will be able to catch a ride to work with his father. This will free up about $300 a month.

In their haste to pay down their mortgage, Ezra and Leah have chosen a 17-year amortization rather than the usual 25 years, Ms. Day says. While this will save them a bundle on interest over the life of the mortgage, it means their monthly payments are about $200 higher than they would be with the longer amortization.

"If the mortgage was amortized over 25 years, Ezra and Leah may have the extra wiggle room in their monthly budget that they so desire."

Ms. Day suggests that Leah and Ezra negotiate with their bank to increase the amortization, freeing up $200 a month. They could then direct that money to Ezra's RRSP.

Given Ezra's current RRSP contributions of $500 a month (which includes his company's monthly contributions of about $300 and his own of $200), the extra $200 from the lower mortgage payment and $300 from dropping one car, Ezra could meet his goal of contributing $11,000 to his RRSP each year without investing his bonus, Ms. Day says. His tax savings would be about $3,600 a year - enough to enable them to finish their basement renovation or take a long-awaited vacation.

But not both.

As well, Ezra might want to consider making all his contributions to his own self-directed RRSP account, where he may have more investment choices than with the company plan, she adds.

She suggests he invest in exchange-traded funds rather than mutual funds because of the lower management expenses.

"Given Ezra's age, any cost reduction compounded over the long horizon of investing until retirement could add significantly to his return over time."

As well, the couple could use a line of credit for their emergency fund and put the $3,000 they have in their savings account toward Ezra's RRSP for still-greater tax savings.

As for insurance, both Leah and Ezra have life and disability insurance coverage through their employers' group benefit plans. They also have mortgage insurance.

When Ezra quits his current job to join his father, the couple will have to review their insurance coverage to see what his father's firm offers, Ms. Day says.

They also may want to consider replacing their mortgage insurance coverage with a term life policy. The big disadvantage with mortgage insurance is that while the maximum death benefit is based on the declining mortgage balance, the premium does not decline over time, she says.

Short term, Leah and Ezra have to strike a balance between living for today and paying down debts and saving for the future, Ms. Day says.

If a second child arrives next year, the family's expenses would likely rise and their saving capacity fall. "This is not unusual given the couple's season in life."

Over time, though, their income can be expected to rise as they advance in their respective careers, so their budget constraints will ease, the planner adds.

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Special to The Globe and Mail