Tricky footing for one-income family
Gwen, as we’ll call her, is a policy analyst for the federal government in Ottawa. At 48, she is the main breadwinner in her home with her husband who we’ll call, Ivan, 59, and child, Pat, 8. A middle-level bureaucrat, she has gross income of about $83,000 a year. After income tax and benefits deductions, she brings home $4,365 a month, pays the mortgage and buys the family’s groceries. Ivan, an artist, gets occasional commissions averaging $500 a month. His last lucrative job was nine years ago when he was doing commercial illustration, that was before they moved to Ottawa for Gwen’s work.
“When we changed cities, my husband lost the network of connections he had used to get contracts,” she says. “He had spent 30 years building a network of clients and other contacts, and what worked in Toronto did not work in Ottawa.”
She said her husband has tried other work, such as house painting and even working day shifts in a retail store before Pat started school, but the small gains in income were offset by child care costs.
“We did the math, and it made more sense for him to be a stay-at-home dad. Now the problem is that Ivan’s field has moved on and he has been left behind.”
Gwen spent a dozen years working through a BA to a master’s degree, then a PhD, then post-doctoral research. Even though she has paid off her student loans, her income is not commensurate with her training.
“Our goals are to build up the RESP, to save enough for retirement, and not live paycheque to paycheque,” Gwen says. “In the current climate of austerity, I worry about my job security.”
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with their family budget.
“There are real problems here,” Mr. Moran says. “Even at today’s very low mortgage rates, her mortgage won’t be paid off until she is 74. The mortgage is locked in for five years and rates are likely to rise. Best bet: to pay down the mortgage as fast as possible at today’s rates.” The pressure to clear the debt would be reduced if Ivan finds more work with higher income, but both age and lack of contacts in his field now work against him, the planner notes. “The reality is that it is hard to restart a career on the verge of 60 and even harder to begin a new career then.”
In retirement, the couple’s principal source of income is likely to be Gwen’s job pension. She has worked for the federal government for three years. Assuming that she is not downsized out of her job, by the time she is 65, she will have 20 years of pension contributions. Using the conventional formula of 2% of final annual salary times number of years of service, she would have a base pension of 40% of $83,000 or about $33,200 a year.
Gwen will be able to add $12,500 from Canada Pension Plan. We can estimate that Ivan will get 50% of the maximum CPP benefit — $6,250. Each will qualify for $6,612 annual Old Age Security: Ivan at 65 and Gwen at 67. At current rates, that will give them total pension income of $65,174 before tax. If they split CPP and job pensions, they could have about $4,600 a month after paying 15% average tax. All figures are in 2013 dollars. That is more than the approximately $4,400 a month they now spend. After their mortgage is paid off, their discretionary spending would have a significant increase. The problem is to cut their mortgage bill as much and as fast as possible.
Ivan and Gwen have $20,168 in cash and $13,444 in the TFSA accounts. They can use the total, $33,612, to pay down the present mortgage balance of $252,831 to $219,219. That will cut amortization by about six years to Gwen’s age 68 and save $39,364 of interest or more if interest rates rise on renewal.
They can take $9,262 from Ivan’s RRSP, which was contributed by Gwen, three years after the year of contribution. That way, there will be no tax implication for Gwen. The move will let them be mortgage free at age 67 just as her OAS begins.
The remaining issue is how to finance Pat’s postsecondary education. His RESP has a present balance of $2,122. Pat is eight and contributions up to $2,500 a year in the nine years until he is 17 will qualify for the Canada Education Savings Grant of the lesser of $500 or 20% of contributions. Currently, Pat’s RESP is getting $100 a month in contributions.
They can raise that to $208 a month, which is $2,500 a year, either of two ways. One, cancel Gwen’s $100-amonth RRSP contribution and top up the RESP with $8 on top of the present $100 monthly RESP contribution. An alternative is to take $108 from spending on Pat’s sports. The first choice works well if Gwen keeps her job and pension and does not need future savings. The second choice maintains RRSP contributions. Either way, Pat’s RESP will grow at $2,500 a year plus $500 from the CESG. When he is ready for university, the account will have $34,160 if it has grown at 3% a year after inflation. The balance will pay his tuition and books, assuming he lives at home for four years. Gwen would continue to pay the $200 a month to Pat while studying and drawing his RESP , perhaps even later if she wants to subsidize further education.
In retirement, even if they have used present cash, TFSA s and Ivan’s RRSP to pay off the mortgage, they would still have Gwen’s present RRSP balance of $55,518 plus growth. If she adds $1,200 a year and maintains contributions for 17 years to her age 65, then, assuming 3% growth after inflation, the RRSP would have a $118,660 balance. If that capital were paid out to expend the account by her age 95, it would support annual payments of $5,875.
Total retirement income from Gwen’s age 67 would thus be $71,050 or, with various credits, about $5,330 a month after 10% average income tax. There will be ample money for travel and other pleasures Gwen and Ivan have denied themselves. In the second case, if the RESP is financed essentially by cutting back on Pat’s sports, the RRSP would have a balance of $91,775. That sum, paid to her age 95, would boost retirement income by $4,550 a year to $69,724, yielding about $5,230 a month after 10% average tax. The question is who pays: Pat, by having fewer sports for a few years, or the parents, by having a lower retirement income for perhaps decades. It’s their choice.