MIDDLE-AGED COUPLE WANT TO ADOPT UP TO 3 CHILDREN, BUT WORRY FAMILY COSTS WOULD CRIPPLE THEIR FINANCES
Assume adoptions happen, then test their effect on savings available for retirement
In Saskatchewan, a couple we’ll call Larry, who is 45, and Penny, who is 37, have a small business that sells musical instruments. It generates an average annual profit of $400,000 a year before the two owners each take out their pay as dividends of about $100,000 a year. The downside, of course, is that with no salary income, neither Larry nor Penny add to their Canada Pension Plan benefits. Their net worth, about $2 million, is likely to grow before they retire.
Larry and Penny want to adopt as many as three children, though the ages of the kids and the number are as yet unknown. They anticipate keeping their business — the value of which is three to four times its annual earnings — and working there for another 10 years. Larry would then retire while Penny would work half time for perhaps five years, earning $50,000 a year before tax. They would like to have retirement income of $15,000 a month after tax.
“We want to have a view of what our business will be worth and what our retirement incomes will be,” Larry explains. “We worry that the adoptions will affect our other goals.”
Family Finance asked Rod Tyler, head of the Tyler Group in Regina, to work with Larry and Penny.
Present Budget
Starting with the basics, Tyler notes that present food costs, $500 a month, are likely to rise as children grow to acquire teenage appetites, but even $1,200 a month would be affordable. Add in child care expenses for 20 years, shifting from daycare to sports to supplements for university and car expenses growing over time as one vehicle at present becomes two or three and the family budget, now $8,453 a month, could expand to $10,000 to $12,000 a month. There is room for that increase in spending or saving, as the couple has been contributing $7,500 a month to help one parent pay off a line of credit that has a remaining balance of $30,000. In a few months, they will have freed up $90,000 a year.
Looking ahead
The couple will have sufficient cash flow to be parents to three children. However, the effect of the adoptions on other goals, such as retirement, needs to be analyzed. We do not know the number of children they will adopt, nor the ages at which they will be adopted. So the analysis must be based on some assumptions, Tyler says. ❚Each partner works another decade, taking a combined $200,000 a year from the business ❚Both take reduced CPP benefits at age 60 ❚Each invests $5,000 a year in tax-free savings accounts until retirement ❚Additional cash goes to TFSAs and then, when topped up, to unregistered accounts ❚Parents contribute $2,500 a year per child to Registered Education Savings Plans and receive $500 bonus per child each year from the Canada Education Savings Grant ❚The business is sold for $1.2 million in the equivalent of 2015 dollars ❚All investments — RRSPs, TFSAs and cash accounts — have a return of three per cent a year after inflation ❚Childcare expenses will be $800 per month per child, shifting to other costs related to children until each child finishes university ❚Post-secondary education costs can be financed at least in part through RESPs. ❚Their present $334,048 mortgage will be paid off in 15 years.
Larry and Penny live frugally. Their largest expense has been $2,130 a month for their 15-year, 2.2 per cent mortgage. Their other costs, such as $292 for property taxes, $375 for utilities and $300 for phone and cable, bring the total cost of their house up to $3,299 a month. Those costs are stable except for inflation and will not vary much no matter how many children they adopt.
If each of the parents continues to generate $100,000 gross income and each pays 28 per cent average tax, they will have combined take-home income of $166,000 a year, allowing discretion- ary savings — depending on the number and ages of children adopted — of $3,550 to $5,000 a month. In retirement, the couple would have $4,500 a month of core living expenses for food, transportation and travel.
Assuming that Larry and Penny get $1.2 million in 2015 dollars for their business, and that they can shelter it by dividing it in half and protecting the taxable gain over their adjusted cost base of $350,000 for each partner, then the present federal capital gains exemption would mean that they have no tax to pay on the sale. Each partner would have $250,000 taxable gain and each would be sheltered by the $800,000 lifetime capital gains exemption.
Financing retirement
At present, Larry and Penny have $290,000 in financial assets. They invest $1,917 a month in various savings plans, including their TFSAs. If their assets grow with $23,000 annual savings at three per cent a year after tax, then in 10 years, when the couple is ready to retire, they would have $661,300.
If the business is sold at that time for a sum that leaves $500,000 each for the partners after selling costs, that sum, added to the increased value of present assets, would give them $1,661,300. If annuitized to pay out all income in the 43 years to Penny’s age 90, that asset base would produce $67,250 a year.
Larry, who would have retired and realized his gains by selling the business, and Penny, who might work part time for another business earning $50,000 a year, would generate $117,250 in pre-tax income. With splits of eligible income, each would pay average tax of 20 per cent, leaving $7,800 a month to cover core living expenses. When Penny fully retires, the couple’s income would drop by $50,000, leaving pre-tax income at $90,235 before tax.
At 60, they would receive CPP benefits based on former jobs in which they received salaries. They can expect half of the present $12,780 maximum CPP benefit reduced by 7.2 per cent a year for each year before 65, for combined net of $8,179 when they start benefits. Finally when both partners are 67, they would have full Old Age Security benefits, currently $6,839 each a year. Their combined incomes would be about $89,000 a year before tax. After 15 per cent average income tax, they would have $6,300 a month to spend.
That would more than cover their $2,900 of core expenses — that is, present expenses with all debt service costs and savings removed. But their retirement income would not be the $15,000 a month after tax they would like. Even by reserving, investing and annuitizing the $7,500 a month currently going to pay a parent’s line of credit, they would be unlikely to attain their goal.
“This couple can have financial security and a family of as many as three children, but attaining a $15,000 monthly after tax income will take more savings and a two digit annual return, neither of which is feasible,” Tyler concludes.
This couple can have financial security and a family of as many as three children, but attaining a $15,000 monthly after tax income will take more savings and a two digit annual return, neither of which is feasible. — Rod Tyler, Tyler Group, Regina