For years now, Matt and Megan have been working to pay off the mortgage on their Toronto home, which they value at $700,000. At the relatively young age of 40, they are less than two years from their goal.
"What should we do with that $2,500 a month once the mortgage expense is gone?" Megan asks in an e-mail.
Their second priority – once the mortgage is gone – is to travel a bit. They are also tucking money into a registered education savings plan for their two children, ages 8 and 4.
"My husband's job is very secure, with a pension," Megan writes. "My job is less secure, but the salary has growth potential, and a yearly bonus." She earns $83,000 before tax in a management job, he earns $76,000 as a policeman.
"We want to start planning for retirement with a plan that will leave us plenty of funds to travel," Megan writes. Should Matt be contributing to Megan's registered retirement savings plan? they wonder. What is the best strategy for investing the children's RESP funds given Matt and Megan's low risk tolerance?
We asked Stephen Osborne, a fee-only financial planner at E.E.S. Financial Services in Markham, Ont., to look at Matt and Megan's situation.
What the expert says
Megan and Matt's mortgage payment represents $2,500 a month that they have learned to live without, Mr. Osborne says. Apart from their mortgage, they have no debt, which suggests that their lifestyle fits their income.
Both have unused contribution room in their RRSPs and tax-free savings accounts, the planner notes. Their first priority after the mortgage is repaid should be to catch up with their TFSAs, where they have about $2,300 combined, compared with a contribution limit of $51,000, because the plans can easily be tapped in case of an emergency.
"The beauty of the TFSA is its flexibility," Mr. Osborne says. Taxpayers can withdraw funds from the plans tax free, then repay the money when they can without losing their contribution room. If circumstances change and they find raising their RRSP contributions makes sense, they can do so using the funds in their TFSAs.
To chip away at the unused RRSP contribution room ($49,000 for her and $28,000 for him), the planner suggests Megan direct her yearly bonus – $7,500 last year – to her RRSP. As an added benefit, this strategy will avoid her being bumped by her bonus into a higher tax bracket.
Matt's pension plan allows for additional voluntary contributions of $3,000 a year, something the planner recommends Matt take advantage of even before contributing to his TFSA. This way, he can benefit from the fund's professional management and solid investment track record.
As for the RESP, Mr. Osborne recommends they contribute $2,500 a year for each child to take full advantage of the federal government grant of $500 each, which amounts to 20 per cent of their contributions. Simply put, the government grant adds a full one percentage point a year to the RESP's annual return, he notes.
Even though Matt and Megan are uncomfortable with risk, the RESP's long time horizon should enable them to take a balanced approach, gradually building a plan that is divided evenly between equity and fixed-income securities to lift their potential return. A difference of even one percentage point is significant, the planner says.
They currently have $31,700 in the RESP. If that sum grows by 3 per cent a year, it would be $54,000 in 18 years. At 4 per cent a year the number grows to $64,200.
Should Matt be contributing to Megan's RRSP?
"At this point, absolutely not," Mr. Osborne says. Matt is in a lower tax bracket than Megan is, so she should make her own RRSP contributions.
Once they have paid off the mortgage and caught up with their TFSAs a few years from now, Matt will be in a position to resume making RRSP contributions. At that point, he might consider directing his contributions to a spousal plan for Megan instead to better balance their income in retirement, the planner says.
Mind you, this may not be necessary because current tax rules allow Matt to allocate up to 50 per cent of his annual pension income to Megan on their tax returns, Mr. Osborne says. "If the rules remain the same, they will have a perfect income split without needing to use a spousal RRSP."
Because Matt's pension plan provides a solid base for their retirement income, Mr. Osborne suggests the couple invest more in growth securities "to help them cope with any unexpected events in life."
Matt and Megan, 40, and their two children.
How to plan for the stage of their lives where their mortgage is paid off and they have some money to save and invest.
Catch up with their unused TFSA and RRSP contribution room and consider adding more of a growth component to their education and retirement savings plans.
Monthly net income
$8,600 (after taxes, group benefits and pension contribution)
Bank deposits $10,700; TFSA $2,270; her RRSP $44,000; his RRSP $39,800; RESP $31,700; residence $700,000. Total: $828,470
Mortgage payment $2,500; property tax $300; property insurance $150; utilities, maintenance $290; transportation $280; groceries $1,000; child care $600; clothing $300; gifts, charitable $200; vacation, travel $500; dining, entertainment $550; club, grooming $150; other personal discretionary $350; life insurance $25; telecom, cable, Internet $300; RRSP $200; RESP $420; TFSA $25. Total: $8,140
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