Laura and Liam are in their 30s with two children, aged 3 and 6. Like most people their age, they have a home with a sizable mortgage that they want to pay off as quickly as possible. But they also want to save and invest for retirement.
"What is the ideal balance between aggressively paying down our mortgage and investing?" Liam asks in an e-mail. They are paying $2,900 a month on their mortgage.
Their financial position is strong. He earns $143,000 a year working for the government. She is a stay-at-home mom who plans to return to teaching in three years or so. In the meantime, she makes $10,000 a year doing part-time work.
Near-term demands on their money include a big family vacation ($10,000), a larger vehicle ($20,000) and some renovations to their Calgary home ($10,000).
They hope to retire in their mid to late 50s with an after-tax retirement income of $96,000 a year. Liam will be entitled to a pension of about $7,000 a month when he retires at age 57.
"Should our TFSA [tax-free savings account] room be utilized for short-term goals (vacation, vehicle) or should it be used for long-term investing only?" Liam asks. Should Laura withdraw money from her RRSP while her income is low?
We asked Marc Henein, an investment adviser and financial planner at ScotiaMcLeod in Mississauga, to look at Laura and Liam's situation.
What the expert says
At the rate they are going, Liam and Laura will have their mortgage paid off in about 12 years, when Liam is 50 and Laura is 47, Mr. Henein says. This is well before their target retirement date.
Laura and Liam should treat their tax-free savings account as a long-term investment vehicle rather than using it for vacations or vehicle purchases, he says. Instead, they could use the $22,000 or so they have in their bank account for short-term needs. As for the TFSA, "the growth they will realize with their regular contributions ($500 a month) will be significant" – and tax-free, Mr. Henein notes. He assumes the TFSA is invested for the long-term and generates an average annual return of 5 per cent a year.
They are contributing $2,500 for each child to a registered education savings plan (RESP), thereby taking full advantage of the federal government's grant of $500 a year for each child. "This strategy will likely cover the majority of the university expenses," the adviser says. The RESP is already worth about $40,000.
Meeting their retirement spending goal should not be a problem, especially with Laura going back to work in three years, Mr. Henein says. She will be earning about $65,000 a year before tax. They should split her income between the mortgage and retirement savings, the adviser says. If she retires at age 55, as planned, that will give her another 17 years in the work force.
In the meantime, she could withdraw $10,000 a year from her RRSP (keeping her income below $20,000 a year) and allocate the money to either of their TFSAs, Mr. Henein says.
Next, the adviser looks at the couple's retirement cash flow. Currently, they are spending $5,000 a month net of their mortgage payments, he notes. By the time they retire at Liam's age 57, this number will have risen to about $7,300 a month with inflation at about 2 per cent a year.
Liam's pension will pay about $84,000 a year before tax. Their Canada Pension Plan and Old Age Security benefits will bring another $31,000 a year, for a total of $115,000. They would need another $35,000 pre-tax to meet their $96,000 a year after-tax spending goal, Mr. Henein says. This assumes a 30-per-cent tax rate.
As it is, they have $94,000 in RRSPs. In 19 years, at a 5-per-cent annual growth rate, this number will have risen to $237,533, assuming no further contributions.
After they retire, Liam and Laura will draw 5 per cent a year from their RRSP savings, or $11,800 a year. They would still be short $23,000 a year ($35,000 needed to meet their spending goal minus $11,800 from their RRSPs). To bridge the gap, they will need to save another $460,000 or so.
Once the mortgage is paid off, they can redirect their mortgage payment ($34,800 a year) to retirement savings, taking full advantage of their tax-free savings plans, Mr. Henein says. The combination of Laura's income and cash flow freed up by paying off the mortgage will "put them in a strong position to meet their retirement goals."
The people: Liam, 38, Laura, 35, and their two children
The problem: How to strike the right balance between paying off mortgage and saving for retirement.
The plan: Pay off the mortgage first, then shift cash flow to retirement savings, taking full advantage of tax-free savings accounts.
The payoff: Worry-free retirement
Monthly net income: $8,240
Assets: Cash in bank $22,600; her TFSA $16,500; RRSPs $94,000; commuted value of his defined-benefit pension plan $340,757; value of her pension plan from previous employer $7,795; RESP $39,400; residence $550,000. Total: $1.07-million.
Monthly disbursements: Mortgage $2,900; property tax $265; water, sewer $150; insurance $154; electricity, heating $250; maintenance $140; transportation $384; grocery store $500; child care $600; clothing $100; gifts $50; charitable $900; vacation, travel $200; other discretionary $430; dining out $100; dentists $100; life insurance $50; telephone, Internet $50; RESP $417; TFSAs $500. Total: $8,240.
Liabilities: Mortgage $376,500 at 3.04 per cent
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