Violet and Les have come a long way since their first Financial Facelift in 2012. Back then, they were enjoying their double income, no children status, earning $166,000 a year between them and spending most of it.
Today, with a house in pricey Vancouver and children, they’re more than $1-million in debt with competing demands on their pocketbook. “Since we last participated, we’ve had two children, moved twice, I started a company and COVID-19 hit,” Violet writes in an e-mail.
Les is now age 44, Violet is 39. Their children are 3 and 5. Les, who earns about $100,000 a year in education, has a defined benefit pension plan. Violet, who owns her own communications company, earned about $106,000 last year, but her income is variable. They get another $21,450 a year in net rental income from a separate rental on their property.
“I feel stressed about money,” Violet writes. “I wonder if we’re doing the right things and if we’re secure.” They’d like to retire when she is 65 and he is 63 with a spending goal of $110,000 a year after tax, indexed to inflation. Between now and then, they want to build a rental suite in their basement, buy a second car, build a deck, pay for their children’s education and buy a bigger house.
We asked Wesley Fong, a financial planner at T.E. Wealth in Vancouver, to look at Violet and Les’s situation.
What the expert says
Mr. Fong starts by looking at where the couple’s income will come from when they leave the work force. If he retires as planned at age 63, Les will get $44,400 a year from his current defined benefit pension plan and $10,550 a year from a previous employer. The amounts will fall to $43,860 and $7,620 from age 65 onward. Violet will get a defined benefit pension of $4,970 a year at age 65. All three pensions are indexed to inflation.
In 2047, when Violet is age 65, she will get Canada Pension Plan benefits of $31,780 a year. When Les is 65, he will get CPP of $22,895 a year. They will get Old Age Security benefits of $12,355 for Violet and $11,192 for Les at age 65.
By the time they retire, their investments will total about $1,189,875, the planner estimates. The total assumes Violet saves $7,000 a year to her RRSP as well as any surplus cash flow over and above their expenses. By the time Violet retires in 2047, their spending goal of $110,000 a year will have risen to $184,075 based on a 2 per cent inflation rate.
Assuming a 5 per cent return on investments – “a reasonable rate of return for a balanced portfolio” – they would have sufficient assets to spend $110,000 a year in retirement to their age 98, he says. By 2080, “it would leave them with about $1,637,000 of investment assets (equivalent to $508,990 today), plus their principal residence,” the planner says.
If they chose to deplete their investments, they could only afford to spend an additional $4,300 a year. “This indicates they don’t have a huge buffer and must continue to live within their budget,” the planner says. “Their employment income must remain steady, they need to continue renting their existing suite, and if they proceed with the basement renovation, they must rent the basement as well.”
Using a 3.25 per cent rate of return, “which is fairly conservative,” their investments would be depleted at Violet’s age 98, except for the principal residence. “This indicates that they should not be too conservative with their investments or they won’t reach their goals,” Mr. Fong says.
With the renovation, the second car and the new deck, “their cash flow is very tight and even negative over the next three years until daycare costs go down when their youngest child starts school,” Mr. Fong says.
Violet is saving $500 a month in her corporation and repaying $1,000 a year to the federal Home Buyers’ Plan in her RRSP. “I recommend that she consider paying out the surplus savings from her corporation as salary and contributing the funds to her RRSP instead,” the planner says. “For most balanced investors, RRSP investing will likely generate more dollars in your pocket compared to investing in a corporation after all taxes are considered,” he says. “This is especially true over a longer period of time – 30 plus years – which would be the case given Violet’s age.”
Violet has $75,000 in her corporation. If she has the RRSP room, she could take that money out this year and contribute the entire amount to her RRSP, Mr. Fong says. “She will get a deduction for the contribution, offsetting the increased dividend income from the corporation,” he says.
As to financing the basement renovation, choosing a mortgage over a line of credit would result in lower borrowing costs, Mr. Fong says. A $250,000 mortgage with the same term as their existing mortgage (26 years and nine months at 2.99 per cent) would have monthly payments of $1,130, so rental income of $1,200 would offset the mortgage payments. “As long as the rental income continues to exceed the mortgage costs, there won’t be much impact on their cash flow,” Mr. Fong says. “By Violet’s retirement, the renovation would be paid off,” he notes. The basement renovation would likely increase the resale value of their home if they decide to sell in the future.
“They should discuss with their accountant whether the basement renovation would cause the basement to no longer qualify for the principal residence exemption,” the planner says. If it does not, for example, because they made structural changes to the property, the basement (that proportion of the square footage) would be subject to capital gains tax when they sell the home, he says.
Finally, the planner looks at the couple’s education savings plan. They are contributing $2,500 a year for each child to a registered education savings plan in order to get the maximum Canada Education Savings Grant. Based on maximizing the lifetime CESG per child of $7,200 (based on RESP contributions of $36,000 per child), and with a 5 per cent rate of return, they will have accumulated about $150,000 by the time the elder child starts university, he says. The average cost of university for students living at home is $11,330 a year, or $22,730 a year for students living in residence. “If the children continue to live at home while they are in university, there should be sufficient assets in the RESPs to fund their undergraduate degrees,” Mr. Fong says. If they both live in residence, there would be a shortfall of about $56,000 when the younger child finishes university.
The people: Les, 44, Violet, 39, and their two children, 3 and 5.
The problem: Should they renovate their basement to rent it out? Can they pay for their children’s education? Are they on track for a secure retirement?
The plan: Finances will be tight for the next few years so they need to stick to a budget. Violet should consider taking a salary from her corporation and making contributions to her RRSP. Depending on the future income, they may have to rethink buying a larger home.
The payoff: Understanding what they need to do to gain some peace of mind.
Monthly net income: $15,570
Assets: Bank account $2,440; her non-registered $8,900; his non-registered $6,000; her RRSP $127,290; her TFSA $13,740; her corporate investments $75,000; children’s RESP $28,240; house $1.68-million; half-ownership of rental property $146,250; estimated present value of her DB pension from previous job $2,700; est. PV of his DB pension from previous job $67,290; est. PV of his current DB pension $97,005. Total: $2.25-million
Monthly outlays: Mortgage $4,350; property tax $600; home insurance $205; utilities $350; maintenance, garden $350; miscellaneous housing $100; car payment $375; other transportation $635; groceries $1,200; child care $1,730; clothing $725; gifts, charity $400; vacation, travel $400; other discretionary $200; dining, drinks, entertainment $1,070; personal care $125; sports, hobbies $90; subscriptions $25; life insurance $75; disability insurance $295; phones, TV, internet $295; RRSP $85; RESP $335; his pension plan contributions $800. Total: $14,815
Liabilities: Mortgage $966,050; share of rental mortgage $75,515. Total: $1.04-million
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