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financial facelift

Justin Tang/The Globe and Mail

Not long into their first real jobs, Adam and Liz want to do everything at once: Buy a house, get married, travel, pay off his student loan, have children and save for retirement.

Where to start? He is 28, she is 24. Together they bring in $139,000 a year before tax.

Both have work pensions, his a defined-benefit government plan, hers a private-sector defined-contribution plan. But we're getting ahead of ourselves.

Weighed against their goals and aspirations, their savings look modest – $49,500 between them. The house they want to buy in the next two or three years will cost in the range of $500,000. The wedding will cost another $15,000.

Fortunately, they have kept a tight rein on their spending so they have a surplus each month. Should they use it to pay off their student loan, save for the down payment on their first home or save for retirement? they ask in an e-mail.

They also wonder how to invest their savings in the meantime – in a tax-free savings account, registered retirement savings plan, guaranteed investment certificate or bank savings account.

"Should we put all of our savings toward the house or put some to retirement?" Adam asks.

We asked Ross McShane, director of financial planning at McLarty & Co. Wealth Management Corp. in Ottawa, to look at the couple's situation.

What the expert says

Adam and Liz are on solid footing, Mr. McShane says. They have good incomes and have been diligent in controlling expenses in favour of paying down their student loans and accumulating some savings.

They have a surplus of about $25,000 a year, which will accumulate to $75,000 over the next three years. That, plus their existing savings, would give them close to $125,000, enough to cover a $100,000 down payment and a $15,000 wedding.

Because Liz and Adam will need the money before long, the planner suggests they leave existing TFSA monies in a daily-interest savings account.

In the meantime, they should take some of that cash they have in the bank to pay down the student loan. "The loan is costing 5.2 per cent, and even though they receive a tax credit, the after-tax cost well exceeds the return they could achieve (at least on a guaranteed basis) if the funds were invested," Mr. McShane says.

With a lump-sum payment of $15,000 to $20,000 and regular monthly payments of $700, the loan would be paid off in less than three years.

Liz and Adam could put less than $100,000 or 20 per cent down on their house, but they would have to pay mortgage insurance. With 5 per cent down, for example, they would pay 3.6 per cent of the purchase price for insurance, an amount that would be added to the principal, the planner notes. "Keep in mind there will be closing costs and maybe some additional costs for blinds and appliances and so on," Mr. McShane says. "Given that many expect housing prices to retrench somewhat, I am inclined to play it conservatively by waiting until they have 20 per cent saved up," he adds.

The planner does not suggest the couple add to their RRSPs at this stage unless Adam's income (now $76,000 a year) surpasses $82,000, in which case a contribution would be prudent in order to put him back below that $82,000 mark (bottom of the 35-per-cent marginal tax bracket), he says. Otherwise, they'd be better off carrying forward their RRSP contribution room to when their incomes are significantly higher and they enjoy a larger tax savings per dollar contributed.

"Existing RRSP funds can be withdrawn tax-free under the federal Home Buyers Plan for a down payment if required."

As for retirement saving, "one step at a time here," Mr. McShane says. "They should focus on short term goals first, and besides, they are already contributing to pension plans …"

They might consider buying a less expensive house. "They will have mortgage payments, repairs and maintenance, property taxes and utilities, so a house can eat up a chunk of their cash flow." A $500,000 home with a $400,000 mortgage amortized over 25 years at 3 per cent a year would cost $1,895 a month, or $22,740 a year. Taxes, maintenance and utilities could add another $800 to $1,000 a month "and before you know it, your cost to carry the house is over $32,000 a year," the planner says.

As it is, they are paying $17,220 a year in rent, so while they would be building equity if they bought, their cash outflow would rise by $15,000 and cut into their surplus.

"Perhaps a less expensive home to start should be considered to give them some extra breathing room – especially important should they start to raise a family," Mr. McShane says. A $400,000 house with a 20-per-cent down payment of $80,000 would lower the mortgage to $320,000, "which translates into a monthly payment of $1,517 and likely has lower property taxes." To be safe, the couple should also budget for rising interest rates in future, he adds.

Once they buy the house, they will have to decide whether to pay down their mortgage first or contribute some of their surplus to the RRSPs and TFSAs, the planner says.

"If and when they decide to have children, they will come at a cost (day care, activities, education). All of this needs to be factored into the big picture and their long-term plan."


Client situation

The people: Adam, 28, and Liz, 24.

The problem: How to set priorities for the use of their earnings given their competing goals.

The plan: Pay off the student loan, save up a 20 per cent down payment for a house and don't be too concerned about saving for retirement yet.

The payoff: A clear financial road map for the next few years, to be revisited in future.

Monthly net income: $8,868

Assets: His TFSA $10,400; her TFSA $6,500; his cash in bank $6,400; her cash $16,200; RRSPs $10,000; her DC pension plan $288 (she just started contributing to it). Commuted value of his DB pension plan $35,743. Total: $85,531

Monthly disbursements: Rent $1,435; home insurance $40; food $770; clothing $150; group benefits $76; health care $82; professional $62; TV, cellphones, Internet $210; miscellaneous personal $186; entertainment, dining out $760; hobbies, activities $350; gifts, donations $50; travel $556; miscellaneous discretionary $190; transportation $600; loan $700; pension contributions $548. Total $6,765 Surplus available for savings $2,103

Liabilities: His student loan $43,000

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