DEBT IS THE ENEMY OF COUPLE’S FORTUNE
Not far from Toronto, a couple we’ll call Ezra, 45, and Penelope, 46, have made their home with two teenage children and a house full of pets. A management consultant and a budget officer for mid-sized companies, they bring home $10,416 a month. The kids are just a few years from starting university. They want to pay off their mortgage within a few years and wonder if they can manage to retire at 60.
“We don’t feel that we live above our means, but we don’t do without either,” Ezra says. “Can we maintain our travel and other pleasures and still meet our other goals?”
Family Finance asked Guil Perreault, a fee-based financial planner with G. Perreault Financial Inc. in Winnipeg, to work with Ezra and Penelope. “If there are no unforeseen problems, such as loss of employment and income, their goals should be achievable,” he says. “However, we need to make adjustments in how they invest and spend their money.”
Ezra and Penelope pay $1,227 each month and have $67,891 remaining on their mortgage with a 3.09 per cent interest rate.
There is also a line of credit with a $34,715 balance and a 3.07 per cent interest rate. They pay $1,240 on that debt each month.
With this rate of payment, the mortgage will be gone in less than five years. The line of credit will be paid in about 2.5 years.
EDUCATING THE KIDS
The family’s RESP has a balance of $78,797. Their older child, 18, can’t receive any more Canada Education Savings Grants, but the younger child, 14, can benefit from another three years of contributions. If Ezra and Penelope contribute $2,500 a year for three years and get the maximum CESG of $500 for each year (they have not yet hit the $7,200 cap for each child), the balance will rise to $87,797 in total contributions, including estimated growth of $9,000. Each child can have about $45,000 for university tuition plus a bit of asset growth. That will pay for just about any curriculum at an Ontario university.
If the kids live at home, the RESP will be sufficient. If they need more money, then they can divert a large part of the RESP to their older child and make up the rest later out of pocket with as much as $2,467 of monthly cash liberated from the terminated debt payments.
Alternatively, the kids could contribute to their educational expenses with part-time or summer jobs, Perreault notes.
RETIREMENT PLANNING
The couple’s retirement savings are made up of $359,608 of RRSPs and company definedcontribution pension plans. Ezra’s employer will match up to five per cent of his gross pay, while Penelope gets a match up of to four per cent of her gross pay. Ezra also has a defined-benefit pension from prior employment that will pay him $2,038 a month or $24,456 a year when he is 60.
They contribute to their RRSPs through work — Ezra’s plan adds $5,100 a year and Penelope’s $2,824 a year — and also make irregular contributions with Ezra’s annual bonus, which varies from $12,000 to $24,000 a year with little or no predictability. We’ll allow $5,000 as a conservative estimate of his additional annual RRSP contribution. Thus, total contributions to their various company and personal RRSPs are $12,924.
If the plans continue to be funded at this rate and grow at three per cent a year after inflation, then in 15 years when Ezra is 60, their RRSPs will have a total value of about $808,000.
If annuitized to pay all capital and income by the time Ezra is 95, the plans would generate $36,500 a year.
Ezra and Penelope have virtually no tax-free savings account assets. When their mortgage and line of credit balances are paid, which will be by the time Ezra is 50, they can use some of the $29,607 per year they use for paying off their debt to add to their present $1,000 total TFSA balances. Debts gone, if they then each make initial $15,000 catchup contributions to their plans and then contribute $5,500 each for 10 years to Ezra’s retirement, the plans would grow to $171,000 at his age 60. Annuitized to pay out all capital and income by Ezra’s age 95, the TFSAs would yield $7,700 a year.
At retirement at 60, the couple would have Ezra’s DB pension of $24,456, annuitized RRSP and TFSA payments of $36,500 and $7,700, respectively, for total annual pre-tax income of $70,506.
If they split income and pay tax at a 14 per cent average rate, they would have $4,900 to spend each month in 2016 dollars.
If present allocations of $10,416 a month are reduced by elimination of monthly debt service charges, children’s activities and car loan payments, $200 of gasoline for sales trips, $400 of food and other supplies and $200 of restaurants and entertainment, they would need just $6,241 a month.
Finding a less expensive gym than their present one, which costs them $185 a month, taking $100 out of the clothing and grooming budget and ending home repairs at $1,050 a month would close the gap to within a few dollars.
When Penelope and Ezra are 65, they can draw full Canada Pension Plan benefits, currently $13,110 a year, and full Old Age Security benefits of $6,846 each a year for total and permanent retirement income of $110,418 before tax. If eligible pension income is split and age and pension credits applied, they would pay tax at a 15 per cent average rate and no tax on TFSA payouts and thus have $7,820 a month to spend in 2016 dollars.
INVESTMENT MANAGEMENT
Retirement at 60 will, with a few budget cuts, leave them at a break-even budget, with no savings until they reach 65. Then they will have a good deal of income in excess of reduced spending. Their budget will be stressed if they do extensive home renovations, as they would like, after their mortgage is paid off. They did other renovations recently and put the bill on their line of credit.
Debt is the enemy of their fortune and, by electing to spend money they do not have, they jeopardize their retirement savings, Perreault says.
Ezra and Penelope want to travel a good deal in retirement. They already allocate $9,240 a year for travel. They could spend much more when they retire. For now, they should not exceed their present allocation to travel until they are retired, Perreault advises.
At present, the couple has excellent dividend stocks and several low cost exchange-traded funds in their RRSPs. Ezra is in a higher tax bracket than Penelope, so he should maximize his RRSP contributions each year. If they spend Ezra’s bonus and any excess cash on TFSA contributions, they will increase their fortune and make the most of tax planning, Perrault says.