It should be easy for a Toronto financial services middle manager we'll call Tom to move with his wife -- we'll call her Sally -- from their current struggle to pay the mortgage to a cushy retirement. Tom, 36, and Sally, 32, are raising their children, ages three and eight months, on a combined gross income of $109,000 a year. They save diligently and have no lavish expenses.
There are problems, however. Sally's contribution to family income is $24,000 a year from part-time work. She can return to full-time work, but that would be of only marginal benefit, for her child care costs would rise by the additional money she would make. The family's financial future therefore rests on Tom's career.
"I haven't wanted to spend my income paying down a mortgage," Tom says. "After all, on a mortgage with 17 years to run, like we have, almost all the money you pay is interest. I hate being in debt."
What our expert says
Facelift asked Christie Henderson, a chartered accountant and certified financial planner with Henderson Partners LLP in Oakville, Ont., to work with the couple to clarify their choices and financial future.
"Tom is in a rush to pay down his mortgage," Ms. Henderson says. "Yet in comparison to many other middle managers, he does not have too much debt and certainly not more than he can manage."
Tom and Sally save $1,350 a month for their accelerated mortgage pay-down, registered retirement savings plans and for their children's registered education savings plan. They have $1-million each in 10-year term insurance. But there is more that they can do to build up savings for their hoped-for move up to a more lush life and for retirement in 29 years when he will be 65, the planner says.
The couple's largest liability is their $170,000 mortgage, financed at 5.45 per cent for 10 years. If Tom and Sally increase their payments by $25 every two weeks, they can decrease their outstanding principal to $30,000 at the end of the term of the mortgage, the planner notes.
The key to building up savings is Tom's RRSP contribution room of $50,000. That sum is the amount that he has not contributed but could have over the years. Tom and Sally should make serious efforts to increase their RRSP contributions, for every dollar contributed will save them 43 cents in tax, Ms. Henderson notes. It is unlikely that they will be able to use up their contribution room this year.
Going forward, they can put the $800 a month they currently contribute to cash savings into the RRSP in addition to the $300 they already contribute for a total of $1,100 a month. They can also add in the $250 a month they save for accelerated pay-down of their mortgage. That sum of $1,350 a month will boost their contributions to $16,200 a year, the planner says.
Therefore, in three years, they will have added $48,600 to a spousal RRSP for Sally. Tom, who will have a six-figure defined benefit pension payment when his retirement begins, should put all of his future RRSP contributions into Sally's RRSP via spousal contributions. That tactic will produce the lowest combination of tax and clawback at retirement, Ms. Henderson says.
Alternatively, Tom and Sally can take out an RRSP loan for a period of 10 to 15 years. This would allow them to top up their RRSPs very quickly. On the downside, Ms. Henderson notes, interest paid on these loans is not tax-deductible and the principal and interest owed can put a strain on current cash flow.
For the children, Tom and Dana should increase their RESP contributions to $2,000 a year per child in order to receive the full $400 Canada Education Savings Grant that is available, Ms. Henderson says. Currently, they contribute $1,200 a child. Tom and Sally should boost contributions to $6,000 this year in order to receive the maximum amount of the CESG.
For 2005, if they fill up their RESP contribution room, the plans will receive a CESG payment of $1,200. That's $800 this year for the three-year-old, for two years, and $400 for the eight-month-old, the planner says, noting that CESG carries forward on the basis of RESP contributions already made.
For the future, the couple should increase their RESP contributions to $333 a month from their current level of $200 a month, the planner says. By 2020, when the older child is ready for postsecondary education, the RESP, which should be a family plan, will have a balance of $160,620. Assuming a 6-per-cent annual return within the plan, each child can take out $24,927 a year for four years, the planner projects.
Tom and Sally need to have cash for emergencies, but they have other priorities too. Currently, they have $6,000 in cash and are adding $800 a month to the fund.
They really should have three to six months of expenses in their fund, a total of $14,750 to $29,500, but they can get a better return from their present savings by adding to their RRSP contributions. Instead of cash contributions, the couple can arrange a line of credit and pay interest only when the credit line is used, Ms. Henderson notes. Three years from now, when Sally's RRSP room has been filled, the couple can resume cash savings, the planner notes.
Tom and Sally should be able to have a comfortable retirement when Tom reaches 65, provided he maximizes his RRSP contributions. The current limit of $16,500 will be reduced by $4,500 for his pension adjustment, reflecting his company's pension plan. That will leave him with an annual limit of $12,000, Ms. Henderson says.
At the beginning of retirement in 2034, Tom can expect $17,133 in Canada Pension Plan payments for the year, assuming they rise at a rate of 3 per cent a year with inflation, the planner says. He will receive $3,438 net annual payments from Old Age Security after the clawback that at present begins at $60,800.
His defined benefit company pension plan will pay him $104,000 a year before tax. His RRSP, expanded as Ms. Henderson suggests and invested at 6 per cent, will generate $55,900 a year. Adding it up, he will have gross annual income of $180,471 and, after paying an estimated $72,900 a year in taxes, he will have net annual income of $107,571, the planner estimates.
Sally will begin to receive OAS payments of an estimated $15,015 when she reaches 65 in 2038, the planner estimates. Adding in her $40,129 RRSP annual income paid through a registered retirement income fund, plus annual CPP payments of $25,710, she will have a total $80,854 less taxes of $35,090 for net annual income of $45,764. Thus in 2038, when she is 65 and Tom is 69, the total family income will be an estimated $153,335 in 2038 dollars, Ms. Henderson says.
"Tom is more sensitive to his current debt than he is to the future income that he can realize from a program of maximizing his RRSP for the retirement he wants. He has no cash crunch today, but he will have one in future unless he switches his priority from current debt reduction to current RRSP investment," Ms. Henderson says. "If he does not adjust his savings, then, by the time he gets his mortgage paid at age 45 through accelerated payments, he will not have enough time left to save what he will need for the retirement he wants."
Client situation
Tom, 36, and Sally, 32, live in Toronto with their two children, ages three years and eight months.
Net monthly incomes: Tom, $5,072; Sally, $1,400.
Total: $6,472.
Assets: House, $300,000; Tom's RRSP, $58,300; Sally's RRSP, $10,000; cash, $6,000; RESP, $2,400.
Monthly expenses: Mortgage, $1,280; taxes, $200; food, $500; diapers and toys, $200; life insurance, $90; car lease, $405; alarm system, $27; home & car insurance, $400; transit, $150; daycare, $100; phones & utilities, $400; RRSPs, $300; RESP, $200; mortgage pay-down, $250; clothing, $250; gasoline, $200; gifts, $85; charity, $100; cash account, $800; miscellaneous, $400; other savings, $135.
Total: $6,472.
Liabilities: Mortgage, $170,000; credit cards, $200.
© The Globe and Mail
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