FRUGAL PAIR TIRED OF LIVING LIKE STUDENTS
Change will allow Ontario couple to save for children’s education
Mark and Cathy, as we’ll call them, are 45 and 43, respectively. They live in a small town in Ontario, have two kids ages nine and 12 and bring home $8,670 a month, consisting of $7,000 from their jobs and net rental income of $1,670 from two properties in the north. They have two cars: one 10 years old, the other 15 years old. They worry their properties and pensions won’t support their retirements.
The rentals are in northern Ontario, where Mark works part time. They are good assets because in the north, rental housing is a seller’s market. Each house rents for an average of $35,000 a year, which produces a return after all costs of about eight per cent on the money or equity that Mark and Cathy have in them.
“We live like college students and we are tired of it,” Mark says. “But my job is not secure and that produces a lot of stress. How can we retire?”
The rental houses have an estimated total value of $905,000 and mortgages that total $388,128 for the two properties. Running a rental business in the Far North is tough. Mark spends a few weeks each month there, living with his relatives and paying some of their grocery bills. Food in the north is very costly, pushing up his cost of living dramatically.
Add the costs of providing money for the post-secondary education of their children — there is nothing now — renovating their own 130-year-old house near Lake Ontario with up to $50,000 of repairs and the problem becomes clear: cash flow to keep up with the cost of living.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Mark, who is in transportation, and Cathy, an administrator for a local government. His view is that they are coping well, and if anything they are living below their means, but are definitely in need of a financial tune-up.
RAISING RETURNS
ON RENTALS
There are two rentals. The first has a $475,000 market value and a $204,000, 2.99 per cent mortgage with just under 12 years to go on its amortization. The second has a $430,000 market value and a $184,000, 3.7 per cent variablerate mortgage with about 12 years on its amortization.
The two rentals add net income after all expenses of $20,040 a year or $1,670 a month. They are part of the rental business which is separate from personal accounts.
The problem is getting more money out of the properties. Mark and Cathy want to develop a Registered Education Savings Plan for their two children. Best bet — seek lower mortgage rates and direct the money saved to the RESP and to paying down their own mortgage.
They can renew the mortgages when their loans are due in 2017 and 2019. At present, five-year fixed rates are available for as low as 2.38 per cent. If they can get renewals at that rate, it would save them $4,180 each year. That money can go to RESPs.
Mark and Cathy can also save money on the mortgage life insurance policies their lenders have provided.
They pay $186.51 a month ($2,238 a year) for $388,000 of life insurance, which is the outstanding amount of all their mortgages.
If Mark and Cathy each buy $500,000 of coverage, the annual cost priced at the middle of the market would be $526 for Mark and $300 for Cathy with premiums fixed for 10 years. They would save $1,412 a year and have $112,000 more coverage compared to the present policies that have death benefits that decline as the mortgages are paid off.
If they go for $1 million coverage each, the cost would be $971 and $543, respectively, for $1,514 a year, still a savings of $724 a year compared to what they pay now for the rentals. Savings could be directed to RESPs.
EDUCATION FUNDING
They can ease into RESP funding with these savings and then add more when the first mortgage is due or just add $5,000 to their line of credit now, then pay those down within a year or two with the life-insurance savings, Moran suggests.
If Mark and Cathy allocate $208 per month per child to an RESP, $2,500 each a year, and attract the Canada Education Savings Grant of the lesser of 20 per cent or $500 per beneficiary for each, then with three per cent annual growth after inflation, they would have $27,500 for the younger child after eight years of growth and $16,400 for the elder child after five years of growth. The parents can average the sums to provide $22,000 for each child.
That would cover four years of tuition and books at universities near their home in southern Ontario. Summer jobs could cover any shortfall, Moran suggests.
PLANNING RETIREMENT
Both Mark and Cathy will have defined-benefit pensions from past employment. These pensions will be indexed, but not until they begin to pay. Mark’s will be $200 a month or $2,400 a year at age 65. It’s not much and by the time he is 65, Moran estimates $200 will have the purchasing power of about $110 today.
Mark could instead take the pension’s commuted value, that is the sum of money required to pay $200 a month for his life. Mark is a capable investor, so he might be able to use the payout advantageously. He might lose certain health benefits that go with the pension, however. So we’ll assume he stays in the plan. Cathy has a provincial government pension plan. Her estimated payout will be $1,548 a month or $18,576 a year. The combined annual value of the two pensions at 60 would be $20,976. They would also have RRSP income.
Their RRSPs currently total $300,322.
If they continue present contributions of $3,240 a year to their RRSPs for 20 years to Mark’s age 65, they would have a balance of $632,100.
That sum could support payouts of $31,300 in 2016 dollars for 30 years to his age 95 assuming constant growth of three per cent after inflation.
The RRSPs provide significant tax relief in Mark’s bracket and thus have an advantage over tax-free savings accounts. We’ll therefore ignore building TFSAs from the couple’s present balance of $950.
Their income from rental properties, with no changes to their present cost structure, would total $20,040 a year. Adding up pensions, RRSPs and rental income at Mark’s age 65, they would have pre-tax income of $72,316 a year.
They could add their accumulated Canada Pension Plan benefits of an estimated $19,664 and two Old Age Security benefits of $6,846 each with the eligibility reset to age 65. Their pre-tax income would thus be $105,672 before tax.
After age and pension income credits, average income tax at 16 per cent would leave them with about $7,400 a month to spend. Present expenses of $8,670 a month would drop to $6,462 a month with elimination of debt service and RRSP contributions. They would have surplus income for travel and pleasure that they now forgo, Moran says. Email andrew.allentuck for a free Family Finance analysis.