Bob and Brenda make good money, but with three children all under the age of 16, they haven’t been able to save as much as they would like. Their consulting company had income after tax of $157,000 last year.
“Can I retire at 60?” Bob asks in an e-mail. “Or is 85 more realistic?” In the past, he and Brenda both drew a salary, he as technical consultant and she as office manager. Now they are both taking their remuneration in the form of dividends. Their corporation also owns an income property.
While their affairs seem complicated, their concerns are shared by many Canadians: How to help their children pay for postsecondary education, pay off the mortgage on their house and save for retirement. Their retirement spending goal is $7,000 a month after tax. They wonder what they could be doing better.
We asked Matthew Ardrey, a vice-president and financial planner at TriDelta Financial in Toronto, to look at Bob and Brenda’s situation. Mr. Ardrey holds the certified financial planner (CFP) designation.
What the expert says
“Bob and Brenda have a large mortgage and lifestyle expenses today that are in direct competition with their ability to save more for tomorrow,” Mr. Ardrey says. They need to find a better balance.
First, he looks at education costs. So far, Brenda and Bob have saved about $45,000 in a registered education savings plan (RESP). Each month, they add $270. The eldest child will start university in 2018, the second in 2022 and the youngest in 2024. Bob and Brenda figure they can cover half the cost provided the children live at home while they are studying.
Tuition, books and transportation will cost $10,000 a year for each child, Mr. Ardrey estimates. Brenda and Bob should have enough saved to cover half of that, adjusted for inflation. “The remainder will come from their children working or taking on student debt,” Mr. Ardrey says.
Next, he looks at the couple’s income and expenses. Removing the savings component of $2,845 a month from their total spending of $13,375 leaves their basic cost of living at $10,530 a month. This includes mortgage payments of $1,655. This is more than the $8,335 a month they are drawing in dividend income, “yet they aren’t recording any shortfall,” the planner observes.
They are spending more than they draw because they are running personal expenses through their corporation, he says. “Many business owners do.” The problem is that, unless the spending is carefully tracked, it can lead to “budget confusion, which I feel has happened here,” Mr. Ardrey says.
Their company had net income after tax of $157,000 in 2016. They each draw $50,000 a year in dividends and the company saves $12,000 a year to an investment account. That leaves $45,000 that’s not being accounted for, the planner notes. “Though some of this difference may be accounted for by an increase in the company’s cash holdings, there is still some significant leakage occurring somewhere in their budget,” the planner says. They need to get a better understanding of where all the cash is going.
Next, Mr. Ardrey looks at their retirement spending goal of $7,000 a month after tax at age 60. Based on their current holdings, they can expect an average annual return on their investments of 4.5 per cent. After subtracting fees and management expenses (2.5 percentage points) and an inflation rate of 2 per cent a year, they are earning virtually nothing in real terms.
Because they are taking dividends now rather than income, they are not paying into the Canada Pension Plan, so he assumes they will get 10 per cent of the maximum CPP benefits and full Old Age Security, both at age 65. They would both get $171 a month in CPP, and $894 each in OAS for a total of about $2,130 a month at age 65.
Bob is tucking $11,400 a year into his registered retirement savings plan (RRSP) and Brenda, $7,500. Bob will exhaust his current contribution room around June, 2019, and Brenda around June, 2020. After that, they should direct their savings to tax-free savings accounts (TFSAs) to catch up with their unused contribution room there. In addition, the $12,000 a year that they save through the company’s investment account can be drawn down as dividends after they have retired.
“Based on these assumptions, Bob and Brenda will fall well short of their retirement goal,” Mr. Ardrey says. “Instead of being able to spend $7,000 a month, they would only be able to spend $3,000 a month.”
To improve their prospects, the planner suggests they “correct some of their portfolio shortcomings,” which should increase their return to 5.5 per cent a year (while they are still working) and lower their investment costs to 1.5 per cent. If they do this, they still would need to save another $3,850 a month to a non-registered investment account to achieve their spending goal, Mr. Ardrey says.
“This level of savings may be very difficult to achieve.”
Another alternative has them making the needed portfolio changes but instead of trying to save so much more, they work five years longer, to age 65, sell their house when they retire, and invest the net proceeds. If their house value grows in line with inflation, it would be worth about $818,000 when they retire. After paying off the mortgage and covering selling expenses, they could add $645,000 to their portfolio. They could then meet their goal. They would then rent rather than buy a home.
Finally, their investments. They have 15 per cent of their portfolio in cash, which isn’t even keeping pace with inflation. They have a few odd stocks that don’t seem to fit into any over-arching strategy. The remainder is invested in mutual funds and segregated funds that have high management expense ratios. They need to review their holdings to see if the performance justifies the fees.
“If not, they may want to consult with a fee-only financial planner to help them in creating an index portfolio of low-cost exchange traded funds (ETFs). This would be a part of an overall comprehensive financial plan, which I also recommend they undertake,” the planner says.
The people: Bob and Brenda, both age 42, and their three children
The problem: Finding the right balance between current spending and future saving
The plan: Track spending, draw up a budget and find ways to cut costs if possible. Consider working longer and perhaps downsizing and renting when they retire.
The payoff: Financial security
Monthly net income: $8,335
Assets: Cash $13,665; stocks $34,540 (held by corporation); loan to relative $205,398; his TFSA $15,448; her TFSA $3,435; his RRSP $117,484; her RRSP $50,968; RESP $45,000; residence $528,000; rental property $573,815 (corporation). Total: $1.6-million
Monthly outlays: Mortgage $1,655; property tax $265; water, sewer, garbage $115; home insurance $90; electricity, heating $155; maintenance, garden $250; transportation $975; grocery store $1,150; clothing $515; gifts $550; vacation, travel $530; dining, drinks $945; personal care $260; entertainment, pets, sports & hobbies, subscriptions $1,200; doctors, dentists, prescriptions, health and dental insurance $1,050; life, disability insurance $350; telecom, cellphones, Internet, TV $475; RRSP $1,575; RESP $270; corporate mutual fund purchases $1,000. Total: $13,375 Shortfall unaccounted for: $5,040
Liabilities: Residence mortgage $421,033; rental mortgage $396,478 (corporation). Total: $817,511
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