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financial facelift

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A couple of years ago, life was looking good for Bob and Betty. They had a nice house, nice cars, good jobs and three children in private school.

Then Betty was downsized by her employer of 25 years, cutting the family income roughly in half. “It took me 15 months to land my current role,” Betty writes in an e-mail. The starting salary in her new job is 40 per cent less than she was making before, although she expects it to rise fairly quickly. “That has caused a strain on our cash flow.”

Bob is 54, Betty 48. Their children are in their teens. She’s a middle manager, he’s a teacher.

All the while, they’ve been paying thousands of dollars to put their children through private school, although scholarships and bursaries have helped. University is a cost the couple also want to shoulder. So far, they have about two years of postsecondary tuition saved for each child in a registered education savings plan.

They hope to retire early with a spending target of $87,200 a year after tax, plus $8,400 a year for travel. Betty would retire in 10 years, Bob in six. “With multiple demands and some cash flow challenges, and children entering postsecondary school, what should be our priority?” Betty asks. Bob has a work pension that will pay $53,290 a year at the age of 60, partly indexed.

We asked Jason Pereira, a financial planner at Woodgate & IPC Securities Corp. of Toronto, to look at Betty and Bob’s situation.

What the expert says

If they retire when Bob is 60 and Betty is 58, they will have to carry debt into retirement, Mr. Pereira says. Also, they will need to draw on their line of credit on and off over the next few years until their children have finished university, paying it down in years when they have surplus cash flow.

If all goes well, they will be able to meet their early retirement goal – provided they can earn a rate of return on their investments of 6.3 per cent, or 4.3 per cent after subtracting inflation, the planner says. He recommends a balanced portfolio with a target return of 6.4 per cent until they retire, and an income portfolio earning 5.6 per cent a year after they are no longer working.

If, by comparison, they earn 5 per cent a year on their investments, or 3 per cent after inflation, they would each have to work two more years to meet their spending goal or cut their target by $6,000 a year.

This year, the planner has them selling some stocks and cashing out Betty’s tax-free savings account to pay down their mortgage and line of credit.

Here’s where the money will come from this year. Bob earns $103,000 a year, Betty $52,500. She also got a final profit-sharing payment from her former employer of $12,000. Their combined income tax is $30,312, taking into account tax savings from pension plan and registered retirement savings plan contributions. Canada Pension Plan and employment insurance contributions of $6,904 leave them with after-tax cash flow of $130,284.

A small inheritance, the sale of non-registered investments and liquidation of Betty’s TFSA, plus a withdrawal from the children’s RESP ($82,529 in total) lifts available cash flow to $212,813 after tax.

Here’s where the money will go this year. Bob’s defined-benefit pension plan contribution is $12,396, Betty’s defined-contribution pension plan $4,200, Bob’s spousal RRSP $17,764, and RESP $10,000. This leaves them with $168,453 to cover their living expenses, mortgage, insurance and a small amount for fixing up the house. Nothing is left over.

Mr. Pereira recommends Bob and Betty maximize their RRSP and pension contributions and Bob should continue to contribute to a spousal RRSP in Betty’s name. Because Betty is younger, this strategy will enable them to put off when they will have to start taking funds from their registered savings – that is, the year the younger spouse turns 72. They should continue to contribute to the RESP until the youngest child turns 17.

The planner estimates postsecondary education costs at $30,000 a year for the two younger children for four years, and $20,000 a year for the child who is already in university.

When Bob retires in six years, they will have combined investable assets of about $1.4-million and debt of $260,960. By the time Betty retires four years later, they will have about $1.7-million in investable assets and debt of about $106,320.

The planner recommends they apply for Canada Pension Plan benefits at the age of 60 and begin drawing Old Age Security benefits at the age of 65. After they have quit working, they could take advantage of their lower income tax rate by drawing an additional $10,000 to $12,000 from their RRSPs each year to pay off the mortgage. Once they are debt free, they should establish an emergency fund to cover six months’ of expenses, and then begin to contribute the maximum each year to their TFSAs.

Client situation

The people: Bob, 54, Betty, 48, and their three children

The problem: Will they be able to pay for their children’s education right through university and still retire early without having to crimp their lifestyle?

The plan: Sell off some investments to pay down debt this year. Plan to draw on line of credit to help fund children’s education, repaying it later. Target a 6.3-per-cent rate of return on investments or be prepared to work longer or spend less.

The payoff: Financial security

Monthly net income: $10,857

Assets: Home $900,000; cash $1,000; her DC pension $1,820; her locked-in retirement account from previous employer $276,703; spousal RRSP $234,860; her TFSA $15,908; her non-registered stock $37,746; his RRSP $229,013; estimated present value of his DB pension $740,000; RESP $57,030. Total: $2.5-million

Monthly disbursements: Mortgage $2,110; property tax $614; home insurance $60; utilities $331; maintenance, garden $150; vehicle lease $525; vehicle insurance $225; fuel, oil, maintenance $450; parking/transit $100; groceries $1,400; clothing $200; line of credit $100; gifts $250; vacation, travel $700; dining, drinks, entertainment $1,100; personal care $150; club memberships $60; pets $75; sports, hobbies $600; subscriptions, other personal $125; vitamins $25; life insurance $75; cell phones $325; TV, internet $300; RESP $250; tuition $3,167. Total: $13,467 Shortfall: $2,610

Liabilities: Mortgage $277,534; line of credit $31,925. Total: $309,459

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Some details may be changed to protect the privacy of the persons profiled.