In a small Ontario town, a couple we'll call Loretta and Hugh have made a good life on a combined family income that they expect to be $122,000 for 2006.
Hugh, 30, works a night shift at an industrial plant. Loretta, 27, who has extensive mathematical training, has only been able to find what amounts to subsistence accounting work in her small town.
Though relatively young, they want to organize their finances in order to start a family and then retire when Hugh reaches the age of 52 in 2028.
"We don't have any dependents, but they aren't far off in the distance," Loretta explains. "We'd like to have a solid financial footing before we take that step."
What our expert says
Facelift asked Mathieu Paradis, a certified financial planner with the Independent Planning Group in Ottawa, to speak with Loretta and Hugh and help them devise a plan for managing their expenses and building up assets for the family they plan to have.
"The couple feel overwhelmed and aren't sure what decisions they should make," Mr. Paradis says. "They question whether they should pay down their mortgage quickly or invest for their retirement. With their high savings rate, they can actually do both."
Modest spending is the base for the couple's future wealth, the planner notes.
Hugh and Loretta have take-home income of $7,312 a month. Every month, they spend $3,508 after paying their $920 monthly mortgage and save $2,884.
With that rate of saving, the couple can afford to pay down their $165,000 mortgage by accelerating payments. They can increase their current payments of $460 every two weeks by $92 to $522 and make lump sum payments of up to 20 per cent of the amount outstanding on the annual anniversary of the mortgage, Mr. Paradis says. Doing both things will cut the remaining time it will take to pay off the mortgage from 20 years currently to just seven years. The two moves will save the couple $56,762 in interest charges, the planner explains.
For retirement, Hugh is in a defined benefit pension plan. He has $50,500 of unused registered retirement savings plan contribution space while Loretta has $20,000 of available RRSP space. They have a spousal plan through which Hugh, who is in a high tax bracket, gets the larger immediate tax benefit. Loretta will eventually be taxed on withdrawals at what is likely to be a lower rate.
By 2014, the mortgage will be paid off if the couple have used accelerated payments and prepayments to full advantage. Loretta will then be able to invest her entire net income of $1,500 a month in taxable investments. If she selects equities, she will be able to postpone recognition of capital gains until her planned retirement in 2028 or later when she has no other income. That will minimize the tax consequences of the investments.
The couple should put $1,000 a month into their RRSPs, Mr. Paradis suggests. As novice investors with no bear market experience, they can use a balanced fund made up of a common blend of 60-per-cent stocks and 40-per-cent bonds until they gain more market experience.
In four years, the $1,000-a-month RRSP contributions recommended will have just about exhausted Hugh's unused RRSP space. He will have only $600 a year of contribution room each year after his large pension adjustment. By that time, the couple are likely to have one or two children and it will be important to save for their postsecondary education, the planner says.
Hugh's income is expected to rise by $25,000 in 2009. That will raise his take-home income by $16,750. His annual net income will rise to $87,750, the planner says. That sum will enable the couple to contribute $2,000 a year to their planned child's registered education savings plan.
They will qualify for the annual Canada Education Savings Grant of $400 a child per year for each of the two children they plan to have, beginning with the first in 2008. Hugh and Loretta aim to have $5,000 per child available after each graduates from high school. If they use a family plan that pools the interests of both children into one plan and contribute $2,000 a year for the first child and raise the total contributed to $4,000 a year when child No. 2 arrives in 2010, and continue until 2016, they will have achieved their $5,000 a child per year educational supplement, assuming that funds have grown at 5 per cent a year.
The parents can continue contributions when the children reach their teen years. If they add another eight years of contributions and CESG grants until the first child reaches 18, and if the money continues to grow at 5 per cent a year, then they will be able to give each child $8,900 a year for four years. If the second child's RESP grows a further two years, the both children would have $9,200 a year, the planner says.
Hugh wants to retire at age 52 when he hits 30 years of service with his employer. His pension will be 60 per cent of his best three consecutive years of earnings. Overtime and bonuses do not count as pensionable earnings. That pushes his effective pension rate down to 45 per cent of total earnings with overtime and bonuses, Mr. Paradis notes. Nevertheless, from age 52 onward, he will receive an indexed pension of $87,944 a year in 2006 dollars. It is integrated with the Canada Pension Plan. Regardless of when CPP payments begin, at age 65 the defined benefit pension will drop by an equal amount.
Hugh should take early CPP at age 60 at a penalty of 30 per cent of the maximum (a cut of 0.5-per-cent per month prior to age 65 that payments begin).
Early encashment will reduce negative cash flow and preserve assets, Mr. Paradis explains. If Loretta gets half the maximum payments, the couple's total CPP at reduced payment rates will work out to 70 per cent of maximum for Hugh and 35 per cent for Loretta.
CPP will split their income so that each receives 52.5 per cent of the maximum $844 a month in 2006 dollars. That will reduce the effect of the Old Age Security clawback that currently begins at $62,144 of individual net income a year, the planner notes. At age 60, then, Hugh will have pension income of $105,000 in 2036 dollars and CPP of $13,830 in future dollars for a total of $118,830, Mr. Paradis adds.
Hugh expects to do some part-time work in retirement that will add $20,000 a year to his income until age 65 when he and Loretta begin to receive full Old Age Security of $484 a person, in 2006 dollars, in 2041.
At Hugh's age 69, the couple can convert their RRSPs to registered retirement income funds. At age 69, Hugh's RRSP will be just $13,410. Loretta's spousal RRSP will have grown to $460,924, assuming that each plan has produced average annual returns of 5 per cent a year.
At Hugh's age 70, the couple's total income will be $189,860, composed of pension income of $106,300, total CPP for the couple of $25,344, combined OAS of $27,700, family non-registered income of $29,980 and Hugh's RRIF income of $536. When Loretta reaches age 70, she will add $34,984 of RRIF income, bringing total family annual income in 2050 to $224,844 in that year's dollars. The clawback, adjusted for inflation, should not affect the OAS they retain, Mr. Paradis says.
"This couple face short-term financial challenges," Mr. Paradis says. "But the future should be very prosperous if they maintain their present course of saving at their high rate."
"This report makes me realize that we have been on the right track," Loretta says.
"With our debts in hand, the future looks bright. We're relieved."
Interested in a free Financial Facelift? Then drop a line to the writer at 444 Front St. W., Toronto M5V 2S9 or
Hugh, 30, and Loretta, 27, live in Ontario and are planning a family.
Monthly net income: $7,312.
Assets: House, $230,000; RRSPs, $7,000; two cars, $10,000; boat, $10,000.
Monthly expenses: Mortgage, $920; property taxes, $300; house insurance, $125; maintenance, $100; utilities, $425; auto insurance and gasoline, $430; food, $520; clothing, $50; personal items, $400; restaurants, $200; charity, $20; travel, $150; miscellaneous, $788; savings, $2,884.
Liabilities: Mortgage, $165,057; line of credit, $5,069.