Lauren is an impressive saver and investor. Only 22, she has $39,005 of mostly stock in her tax-free savings account, $37,134 of investments in her non-registered accounts and $10,000 in the bank. Her goals are to buy a place of her own in pricey Toronto ($500,000), buy a car ($30,000) and tuck away 15 per cent of her earnings each year for her long-term goal of retiring at 55.
Oh yes, she wants to save as well to help her future children with their higher education and go back to school to get her Master’s degree. All this on $60,000 a year, plus another $4,000 from a part-time job. Lauren is fortunate have a defined benefit pension plan indexed to inflation.
She wonders how much she should be contributing to her registered retirement savings plan. She has also been making additional voluntary contributions to her work pension plan and asks if she should continue. She wonders, too, what she should do with the $10,000 “just sitting in a very low interest savings account,” Lauren writes in an e-mail. “Should I invest it?” she asks.
“I want to buy a property very soon, but with interest rates going up, is it a good time for me to buy?”
We asked Morgan Ulmer, an associate financial planner at Viviplan, a fee-for-service financial planning firm, to look at Lauren’s situation.
What the expert says
First, Ms. Ulmer looks at Lauren’s retirement savings. She is contributing $5,630 a year to her work pension plan, an amount that is matched by her employer. As well, she is making additional contributions of $3,000 a year, for a total of $14,260 a year.
Lauren’s income from all work sources is about $64,000 a year, so 22 per cent of her gross income is going toward her retirement savings. That tops her stated goal of saving 15 per cent of her income. “With so many other competing goals for her money, Lauren does not need to worry about contributing more to RRSPs,” the planner says.
There’s another argument for not putting any more money into RRSPs, Ms. Ulmer says. Lauren began contributing to her pension plan at 20. Assuming she stays with her employer until retirement, her retirement income (pension, government benefits and investment income) could be high enough to trigger the claw-back of her Old Age Security benefits.
On the other hand, she has more than $20,000 in unused RRSP room and has maxed out her TFSA, “which makes contributing to her RRSP a valid option,” the planner says. Lauren might want to consider contributing to her RRSP now but waiting to deduct the contribution until her income is in the highest tax bracket in order to maximize the tax savings. If she retires early, as planned, she could use planning techniques such as a combination of early RRSP drawdown strategies plus postponing CPP and OAS benefits to the age of 70 to even out her income over time and thus pay less income tax over all.
There is one other major consideration that favours not contributing to an RRSP at this time, Ms. Ulmer says. (She also recommends Lauren redirect the voluntary contributions she is making to her pension plan to her non-registered investment account.)
Many of Lauren’s goals have a short time horizon. Some of them – such as going back to school – may also affect her income earning ability. As such, Lauren’s next priority for her money should be to save for these goals in order to minimize her use of debt.
While Lauren has savings in her TFSA and non-registered account totalling more than $76,000, they are invested heavily in equities. “While these funds could technically be used toward her goals, her time horizon and her asset allocation aren’t a match,” Ms. Ulmer says. “It would be less than ideal for Lauren to withdraw from these investments at a time when they are down (as they are now), thus crystallizing losses.”
Investing is best suited for goals more than 10 years away, but at the very least five, the planner says. “Because of Lauren’s upcoming goals, she should focus on saving aggressively in a high-interest savings account.” She already has about $10,000. Her budget shows surplus cash flow of about $1,500 a month. Over three years, her projected savings total would be $64,000 ($10,000 plus $54,000, not including any interest).
The more Lauren can save for a down payment, the lower both her mortgage payments and Canada Mortgage and Housing Corp. insurance will be, the planner notes. Mortgage insurance is typically required by lenders when home buyers make a down payment of less than 20 per cent.
If she can save up a down payment of $100,000 or 20 per cent, Lauren would not have to pay mortgage insurance. “A lower [or no] CMHC premium not only means saving the cost of the premium itself, but also all of the interest charged on that premium throughout the mortgage.”
Lauren’s investments may rebound in time for her to cash them in and use the money toward a down payment. Alternatively, “pushing her home ownership goal out a few years would allow Lauren to save more toward a down payment, and with her diligence maybe even the full $100,000,” Ms. Ulmer says.
The person: Lauren, 22
The problem: How to achieve her many goals, including buying a house and planning for an early retirement.
The plan: Shift her focus to her short-term goals and save for them in order to reduce the reliance on borrowing. Try to save up a 20-per-cent down payment on a home.
The payoff: A clearer and more orderly progression toward short and the longer-term goals.
Monthly net income: $4,630 (includes investment income of $250).
Assets: Bank accounts $10,000; TFSA $39,005; non-registered $37,134; RRSP $250; estimated present value of defined benefit pension plan $18,000. Total: $104,389
Monthly outlays: Rent $1,075; hydro $48; transit $150; groceries $250; clothing $20; gifts $100; dining, drinks, entertainment $220; sports, hobbies, subscriptions $110; travel $290; cellphone $75; internet $50; pension plan $470. Total: $2,858. Surplus of about $1770 goes to voluntary pension contribution ($250); TFSA and non-registered assets ($1,520).
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