When daycare’s over
Couple with income of $162,000 must be ready for the day kids old enough for school
The people Janaya and Richard are a professional Toronto couple in their late-thirties. They collectively earn $162,000 a year in senior health care management positions, and have two children under the age of 3. The problem Like most couples with young children, Janaya and Richard have a cash-flow crunch of big mortgage and daycare payments. Child care currently forms 31 per cent of the couple’s household budget. They have a bit of consumer debt along with a mortgage that should be paid off in 18 years. While they set up a non- registered investment portfolio with an adviser, they aren’t sure whether the product mix makes sense to their situation. The particulars Assets: House: $600,000 Non-registered investments: $67,400 Liabilities: Mortgage: $374,000 Investment loan: $25,000 Credit cards: $12,000
The plan Despite the hefty daycare costs, Janaya and Richard are actually in great shape financially, says Robyn Thompson, a fee-based planner at Castlemark Wealth Management in Toronto. That’s because the couple are still able to save $850 a month toward investing or paying other debt when many of their peers would just break even or dip into a line of credit each month to make ends meet.
They need to recognize that child-care fees are a temporary drain on their resources. When both kids start going to school, they will have family assistance for child care, freeing up $31,000 a year in their budget to use toward other things.
With that in mind, Janaya and Richard should concentrate their efforts on pre-retirement debt reduction, education savings for their children and taxefficient investing. With their available cash flow set to rise significantly over the next few years, they will need a properly prepared financial plan set up by an accredited financial planner. For now, they need to ensure they don’t ramp up spending beyond their means.
Turning to their investments, Janaya and Richard say they are medium-risk investors. While the couple’s $67,700 investment portfolio reflects their risk tolerance, it is made up of balanced segregated funds, earning a modest 3.53 per cent a year. Segregated mutual funds are insurance-based products that offer some guarantee of principal at death or at maturity of the product. However, guarantees on products come at a cost. “While a traditional balanced mutual fund might have a management expense ratio (MER) of, say 2 per cent, the segregated version of such a fund may have an MER up to three percentage points higher, depending on the guarantees offered,” Thompson says.
The couple also has a $25,000 investment loan against their portfolio. They are paying $1,200 a year in interest on the loan, which is costing them more than their investments are earning for them. Thompson recommends they sell their balanced segregated fund and pay off the loan balance.
“While they may be uncomfortable paying penalties and fees for redeeming their funds, it often makes sense to exit a low-performing investment even if there is penalty involved, because you can then look for a lower-cost alternative that starts keeping up with the market right away,” Thompson explains. “A traditional balanced portfolio with a similar asset mix has delivered an average annual compounded rate of return 7 per cent over the past 20 years — about double what their current balanced fund investment is returning.”
When the loan is paid off, the money they already use for investing and debt repayment will increase to $11,400 a year from $10,200. Thompson recommends they use the cash to clear their credit card debt and then return to a regular investing strategy.
At the top of the list is setting up Registered Education Savings Plans for their two kids. Contributing $2,500 a year per child means they will receive an additional $500 a year per child from the Canada Education Savings Grant.
By the time their second child enters school full time, the couple will have more than $41,500. They will need a properly prepared financial plan set up by an accredited financial planner who will help them set goals and look at different scenarios to determine the best use of their funds, Thompson says.
Janaya and Richard should have enough income in retirement to meet their needs from their defined benefit pension income, Canada Pension Plan and Old Age Security, but it’s always a good idea to build in a buffer should one or both of them leave their public-sector jobs down the road.
Their pension contributions will minimize their Registered Retirement Savings Plan contribution room, so Thompson recommends the couple maximize their Tax Free Savings Accounts. All investments held in TFSAs grow tax-free. If they used the $41,500 each year toward their TFSAs and their non-registered investments, their portfolio could grow to more than $1.6 million by the time they retire at age 65, assuming on a 7 per cent rate of return, Thompson says.
The couple says they both have disability and life insurance through employers and each has stand-alone critical illness and life insurance policies. But they are unclear if they are adequately insured and will require a full insurance review with an insurance adviser.
Neither of them has a will or powers of attorney for property or personal care. These estate documents are a must and it’s important for them to assign a guardian for someone to take care of their kids in the case of their passing.