Fred and Marsha make good money, but with a major renovation to their Toronto home last year, a variable income and two young children, Fred wonders whether they can achieve their ambitious goals.
Both are turning 40 this year, so the need to save for retirement is adding to demands on their considerable income. He makes about $150,000 a year in salary, plus a substantial bonus if all goes well. She runs her own business, from which she draws a salary of about $60,000 a year.
The work on their home added $370,000 to their mortgage, an amount that fell short of the final cost, forcing them to borrow on their line of credit.
"The renovation was the best thing we ever did and our home could probably sell for $1.4-million," Fred writes in an e-mail. "But the great part is it is a place our two kids will enjoy until they move out. It is a great family home in a great family neighbourhood."
Fred's salary goes to pay the fixed expenses – housing and car costs – while Marsha pays the rest with income from her company.
"It is tight and if anything ever happened to Marsha's business, we would have to make some significant adjustments," Fred writes. "I worry about things like this …my wife does not!"
Short term, Fred wonders whether they should use their non-registered savings to pay down the $40,000 credit line. Longer term, he wonders whether they can retire at about age 60, when the youngest child will be 21.
We asked John Home, a consultant at Weigh House Investor Services in Toronto, to look at Fred and Marsha's situation. Weigh House is a fee-only financial planning firm that does not sell investment products.
What the expert says
Fred and Marsha have a significant income and a significant "burn rate" to match, Mr. Home says. Their irregular income causes them to worry unnecessarily because they do not have a financial plan that captures the big picture. The couple's strategy is to cover their monthly expenses out of their monthly cash flow and invest with the net proceeds of Fred's annual bonus payments. "This is a reasonable strategy," the planner says.
Because they have irregular income and Marsha is self-employed, one of their first steps should be to establish an emergency fund of about $50,000 to cover fluctuations in monthly expenses – with replenishment coming from future monthly cash flow, Mr. Home says. This emergency fund will help them through any unforeseen interruptions in income.
Because Marsha runs her own incorporated company and takes an annual salary, she should consult with her accountant to discuss the optimal mix of salary and dividends, the planner says. Dividend income is taxed more favourably than employment income, so this may represent an opportunity for her to reduce her tax payable.
Fred wonders whether he should use his bonus to pay down the mortgage and line of credit, or invest first in his registered retirement savings plan. Mr. Home's plan shows that, in their case, the best strategy is to pay down the mortgage and line of credit first. Fred's goal of being mortgage-free in 14 years can be achieved with a $13,000 lump-sum payment annually, the planner calculates. The annual vacation budget of $8,000 can also be sourced from these funds.
Next, Fred should make the maximum annual RRSP contribution, using up his unused contribution room of $40,000 in the initial years and allotting most of the money to a spousal plan for Marsha. Fred will get a big tax deduction for the contribution and Marsha will withdraw the funds at a much lower rate.
Their next priority should be to maximize their annual tax-free savings account (TFSA) contributions and use up their $15,000 of unused contribution room over the next three years with contributions of $10,000 a year.
Fred has been unhappy with the performance of their portfolio, which consists of high-fee mutual funds that have been underperforming. First, they need an investment policy statement to serve as a guideline in structuring, rebalancing and monitoring their portfolio.
Second, they should lower the equity component in their portfolio from 75 per cent, "which represents more risk than they need to achieve their goals," Mr. Home says. "Their financial plan calls for a 5.25-per-cent return and 50-per-cent equity content – much lower downside risk in the event of a major market decline."
Given the size of their portfolio – $331,000 – Mr. Home recommends low-fee, broadly based exchange-traded funds that can easily be rebalanced each year. Finally, they need performance updates to show whether they are earning the 5.25 per cent they need to match their goals.
Fred and Marsha, both 40, and their children, ages 1 and 8.
Devising a framework for saving, investing and paying down debt that is tax-effective and provides a cushion for bumps in the road.
Establish an emergency fund, pay down the mortgage, then put surplus bonus money into a spousal RRSP for Marsha. Contribute the maximum to TFSAs. Simplify investments and lower their cost.
The ability to retire debt-free at age 60, when the children have grown, without having to take much of a drop in their standard of living.
Monthly net income
$13,642 (excludes Fred's bonus, which was $105,000 last year).
Employee share ownership plan $31,316; Fred's RRSP $149,295; spousal RRSP for Marsha $30,427; Marsha's RRSP $30,522; Fred's LIRA $24,596, Fred's defined-contribution pension plan $31,755, RESP $33,093; house $1.4-million. Total: $1,731,004
Mortgage $4,335; heat/hydro $325; property tax/insurance $750; telecom cable, Internet $150; arts, entertainment $640; groceries $1,200; child care $1,500; transportation $1,880; health/life insurance $387; charity $40; personal grooming, clothes, $500; hobbies $85; educational needs $425; pension contribution $250; savings $800. Total: $13,267. Monthly surplus $375
Mortgage $860,000; line of credit $40,000. Total: $900,000
Special to The Globe and Mail
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