Luke and Lorraine are in their late 30s with a toddler and a second child on the way. She is a professional, he works for the government. Together, they bring in more than $340,000 a year, including bonuses.
They spent most of their careers overseas, returning to their native Toronto a while back and starting out anew. They have a house with a mortgage and now find themselves with competing demands on their pocketbooks.
"Our primary financial goal is to ensure that our children receive the education and skills needed to be self-sufficient," Lorraine writes in an e-mail. Their youngster has special needs. As well, they may expand their family to a third child at some point.
"Our secondary financial goal is to ensure a comfortable retirement," Lorraine adds. They hope to retire at the age of 65 with $120,000 a year after taxes. If they stay with their current employers, both will have defined-benefit pension plans.
Short term, they need to finance another parental leave soon and buy a new car. Longer term, they want to pay off their mortgage and build a safety net. They wonder whether buying a condo to rent out would be a sensible investment.
We asked Stephanie Douglas, a Certified Financial Planner (CFP), partner and portfolio manager at Avenue Investment Management in Toronto, to look at Lorraine and Luke's situation.
What the expert says
Luke and Lorraine want to ensure they can afford specialized therapy for their daughter until she is 18, as well as a private-school education where her special needs can be accommodated, Ms. Douglas says. They will also have child-care costs for the new baby. They estimate the costs for specialized therapy, private school and daycare will add up to $70,200 a year from 2018 to 2022, and $51,000 a year from 2023 to 2032.
If Lorraine takes the full parental leave, her income will drop from more than $190,000 a year to about $40,000. When factoring in all income and costs, the planner expects they will have a shortfall of roughly $30,000 for the year. Lorraine could decide instead to return to work four months early while Luke takes paternal leave: He is entitled to four months of parental leave at full pay, so they would both receive salaries for that period (Lorraine is entitled to six weeks' full pay).
"This would be the best option purely from a cash-flow perspective because their combined income would cover their expenses," the planner says.
Alternatively, they could take the funds to cover the shortfall from their TFSAs or use a line of credit that could be paid off when they both return to work. They could also cut their expenses.
After the second baby is born, the planner suggests the couple open a family RESP to ensure the plan can be used by either child.
"If they contribute $2,500 per child to get the maximum [Canada Education Savings] grant of $500 until each child is age 17, at an assumed return of 5-per-cent net, they would have about $78,000 for their first child and $77,000 for their second, for a total of $155,000 to use towards their education," Ms. Douglas says.
If they open an RDSP (registered disability savings plan) for their daughter and contribute $1,000 annually to receive the maximum $1,000 federal government grant, and they do this for the next 14 years until the child is 18, assuming a 5-per-cent rate of return, she would have a total of $39,000 at her disposal.
Luke considers his job uncertain, as it is not unionized and there has been some downsizing. While he thinks he could find another job, he could potentially be jobless for a few months, the planner says. A good emergency fund would be three to six months of living expenses, which in their case would be $45,000 to $90,000. Depending on their risk tolerance, they may want to keep a lower amount in cash and have a line of credit readily available in case of emergencies, she says.
They would also like to buy a vehicle in the next couple of years. They could pay for it in cash by withdrawing from their TFSAs, or by using whatever savings they accumulate over this timeline. "However, this could impede their ability to build up an emergency fund or save for retirement," Ms. Douglas says, so they may instead want to consider leasing or financing the vehicle.
As for their retirement goal, they will have to be disciplined savers to achieve it without having to sell their house, the planner says. If Luke stays with his current employer, he will get a pension of roughly $60,000 a year at 65. Lorraine will be enrolled in her company's defined-benefit pension in April. Her estimated pension at 65 would be about $65,000 a year. They will also get Canada Pension Plan and Old Age Security benefits, reduced for the amount of time they worked outside of Canada.
The planner's calculations show the couple would need financial assets of about $2.2-million by the time they are 65 to achieve their spending goal, adjusted for inflation. That assumes a 5-per-cent rate of return while they are working and 3 per cent after they have retired.
"Taking into consideration their current retirement savings, this would require an additional annual savings amount of $24,000 until age 65 to achieve their goal," Ms. Douglas says. They currently have a monthly surplus of $1,739 that could be put toward this goal. Or they could increase their savings in their later years once their mortgage has been paid off and child-care costs have decreased.
Lorraine and Luke wonder if it would make sense to borrow against their home and tap their TFSAs to buy a rental condo for $500,000. Ms. Douglas cautions against having too much exposure to Toronto real estate. Their house is by far their biggest asset and makes up more than 80 per cent of their net worth. "If the housing market were to crash, this could have a huge impact on their net worth." Also, increasing their debt load could be detrimental if interest rates continue to rise.
Their investments could use some tweaking, the planner says. They have 20 per cent cash, 15 per cent fixed income, 10 per cent Canadian equity and 55 per cent foreign equity (mainly through defined-contribution pension plans from their previous employers). The heavy cash weighting might be appropriate if they plan to use their TFSAs to fund their parental leave. Once they have both returned to work, they should review their asset allocation to ensure it is appropriate for their risk tolerance and their goals.
Because they plan to retire in Canada, the planner suggests they focus on increasing their exposure to Canadian securities to better diversify their holdings. "I suggest they aim to keep a minimum of 25 per cent of their portfolio in Canadian equities."
The people: Lorraine and Luke, both 39, their daughter, age 4, and their second baby on the way.
The problem: Lorraine and Luke would like to allocate their funds in the best way to achieve their dream retirement while ensuring their children receive the education and skills needed to be self-sufficient.
The plan: Take advantage of registered accounts as much as possible in saving for their goals and focus on having a clear plan.
The payoff: Financial security
Monthly net income: $17,000
Assets: House $1,870,000; RRSPs $37,500; defined-contribution pension plans $279,465; TFSAs $48,500; non-registered account $4,250; cash $6,500; estimated value of Luke's defined-benefit pension plan $31,000; RESP $13,250. Total: $2.3-million
Monthly distributions: Mortgage $3,753; property tax $700; utilities $280; property insurance $165; maintenance $370; transportation $510; groceries $1,000; childcare $3,200; clothing $200, dry cleaning $100; gifts $100; charitable $100; vacation, travel $300; professional fees $83; dining out, drinks, entertainment $770; personal care $120; subscriptions $25; sports $200; medical $2,670; health, life, disability insurance $185; phones, TV and internet $220, RESPs $210. Total: $15,261. Surplus: $1,739 (goes to TFSAs and other savings).
Liabilities: Mortgage $655,000
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