MOVE MAY PUT COUPLE ON SHAKY GROUND
In a small town in northern Ontario, a couple we’ll call Marc, 33, and Ellen, 34, are living well with two well-paid jobs, both in transportation management, a six-month-old child and a paradox: Their monthly take home income, $9,850, buys a very good life in their community, but a move to Toronto or another large urban area, which they plan, would bleed their $219,700 net worth — not counting their entitlements to their defined-benefit pension plans.
“Our goals include a transfer to southern Ontario for Ellen,” Marc says. “We anticipate having at least one more child. We want to buy a property not far from Toronto and build a dream house where our kids can grow up and have a lot of fun. Could we do this if Ellen quits her job in three years?”
Family Finance asked Graeme Egan, a financial planner and portfolio manager who heads CastleBay Wealth Management Inc., in Vancouver, to work with Marc and Ellen.
“In spite of the fact that both have solid, permanent jobs, a move to Toronto will stress their finances,” Egan says. “They have built cash savings each month. It’s a question of what matters and perhaps avoiding high home prices.”
For now, the couple’s problem is to balance their role as parents, their need to build up a Registered Education Savings Plan for their new baby, and future work to build their company pension plans and their own savings.
HOUSE PURCHASE
Moving from northern Ontario to Toronto will be a financial challenge. The couple has $66,000 equity in their $290,000 house. The average detached house price in Toronto has recently been pegged at $1.2 million, with average condo prices now at $436,000. If Marc and Ellen were to use all of their home equity, which would be eroded by selling costs of about five per cent, and if they use all of their financial assets, they could not come up with a conventional down payment on an average Toronto detached house. They might do a high-ratio mortgage on a condo, but they would not have the lawn and play space they have now. Well outside of Toronto, they could find detached homes they could afford.
Marc and Ellen are frugal. They save $3,966 a month in their TFSAs and non-registered accounts. Their RRSP savings are modest, just $600 a year, as a result of the pension adjustment and other priorities. If they defer purchase of a house for two years and contribute these savings to their TFSA and non-registered accounts, they will have $95,184, plus current balances and interest — say $97,000 in all. Add in their present home’s equity, which will have risen with 24 months of payments to perhaps $75,000 and they could have a total of about $250,000 for a substantial down payment and transaction costs on a high-sixfigure house in a town perhaps an hour’s drive from Bay Street.
EDUCATION SAVINGS
Marc and Ellen have one child. If they put $2,500 a year into an RESP and receive the $500 Canada Education Savings Grant each year for 14 years (for each child, should they have another) — the time it will take to reach the present maximum CESG of $7,200 per child — and then contribute for three more years without the CESG, then, with a three per cent growth rate after inflation, the child after 17 years would have $65,700 for post-secondary education. That should be more than enough for tuition and books at any Ontario college or university.
PENSION PLANS
Marc expects his salary to rise dramatically in future years. The longer he works for his employer, a transportation company, the higher his responsibilities and his salary. The company pension contributions reduce what he can put into his own RRSP. The mechanism, called the pension adjustment, reduces the maximum 18 per cent of previous year’s earned income an employee may contribute to an RRSP by what the employer put into the company pension plan. As Marc’s salary rises, there will be less room for annual RRSP contributions, Egan notes.
If Ellen elects to be a stay-athome mom to raise their children full time, her accrual of company benefits will stop. The couple anticipates Marc’s raise, perhaps 25 per cent, will cover loss of her income and allow her to continue to save in TFSAs and non-registered accounts. She will have the choice of leaving her pension contributions in place and taking a pension payout beginning at age 60 or 65, or taking the commuted value of her pension, which is the capital required today to pay accrued future pension benefits, and transferring the sum tax-free to a Locked-In Retirement Account. In a LIRA, the money would be hers to manage. The choice has two important variables: First, who carries the investment risk and, secondly, the math of the commuted value payout. If she retires to be a mom at home and does not return to work, the pension would pay her $9,426 a year after 65.
On the first point, risk management and return, Ellen could leave the money in the plan, certain that it is managed conservatively at very low cost by experts. On the other hand, she could make a long-term investment in major market indexbased exchange-traded funds and have an assurance that the plan’s benefits would grow in line with the TSX, the S&P 500 or other indexes
On the second point, the commuted value is specifically the value of government bonds required to maintain her entitlement. With interest rates very low, the current sum of bonds needed to pay her benefits is high. If she wants to take her money and run, this is a good time to do it, Egan says.
Retirement income prediction is speculative. Marc is likely to have a much higher salary and pension at retirement than today — but that’s 30 years in the future. His salary may replace Ellen’s income should she quit her job. If they save $10,000 a year for 32 years to Marc’s age 65, then, with a three per cent return after inflation, they would have $540,800 capital. If paid out over 30 years so that all income and capital is exhausted by Ellen’s age 95, that sum would generate $27,800 a year. Ellen’s company pension would pay her $9,426 a year beginning at her age 65 based on service to date. Add in Canada Pension Plan benefits at full value for Marc, $13,110 a year, and at half maximum value for Ellen to allow for her early retirement, $6,555, then add two Old Age Security benefits at $6,846 for each person in 2016 dollars and they would have $70,583 a year before tax. Add a conservative guesstimate pension from Marc’s employer, $50,000 a year, and the couple would have total, pre-tax retirement income of $120,583 a year. With splits of eligible pension income and no tax on TFSA income, they could pay tax at a 17 per cent average rate and have $8,340 a month to spend.
“Moving south is a gamble,” Egan says. “But time and Marc’s rising income is on their side. If Marc and Ellen manage costs, their plans should work out.”