via The Globe and Mail | June 26, 2015
Penny and Paul are in their mid-40s with two children, ages 12 and 15, and good jobs in the medical field. He teaches at a university, while she works at a clinic. Together, they bring in about $238,400 a year.
Even so, a long-planned renovation of their rural Ontario home, followed by some unplanned and expensive house repairs, have pushed their financial plan off track, Paul writes in an e-mail. As a result, money is tight.
“We have been planning, investing and paying debt for years,” he adds. “We’re looking for a reassessment to help us reset priorities among mortgage and line of credit repayments, and retirement and [registered education savings plan] investments.”
Their top short-term goal: “Ease tightness of cash flow.” They wonder whether they could afford another $100,000 in renovations in a few years without jeopardizing their retirement plans.
Penny asks the planner to look at a couple of other possibilities: First, how their goals would be affected if she were to lose her job or stop working in five years; and second, if she were to buy a business and take a temporary drop in income while she builds her client base.
We asked Matthew Ardrey, vice-president, Toronto, at T.E. Wealth, to look at Penny and Paul’s situation.
What the expert says
Mr. Ardrey looked at four situations and how each would affect the couple’s retirement plans. The first assumed no renovations or job changes, the second another $100,000 renovation, the third Penny loses her job or quits working entirely in five years, and the fourth, she buys a practice that gives her $40,000 a year for the first seven years, rising to $100,000 a year thereafter.
When they retire, Paul at age 65 and Penny at 62, they want to maintain their lifestyle and do a little more travelling. In preparing his analysis, Mr. Ardrey has them spending $84,000 a year plus another $10,000 a year for travel until Paul is age 80. By the time he retires in 2035, these figures will have inflated to $124,800 and $14,900, respectively.
He assumes an average return on assets of 5 per cent a year, inflation of 2 per cent a year and that they live to age 90.
Paul has a defined benefit pension plan that will pay him $88,470 a year when he retires. The consumer price index would have to rise by more than 2 per cent a year for the plan’s indexing to kick in. Mr. Ardrey assumes it does not.
“In three out of four scenarios, they can achieve their retirement goals,” Mr. Ardrey says. The one that would leave them short is where Penny leaves the work force in five years. They would still be able to pay off their debt but they would not be able to save for the future unless they cut their lifestyle spending, the planner says.
When they retire, they would be able to spend $67,200 a year rather than the higher amount they are hoping for. (The couple would still have the additional travel budget of $10,000.) That assumes they spend all of their investment assets and leave only their home to their heirs.
The first scenario is a breeze. In the second one, where they spend another $100,000 for renovations, they would not be debt-free until mid-2023. The mortgage would be paid off before then, but not their credit lines. Penny would still contribute $12,000 a year to her registered retirement savings plan, but contributions to their tax-free savings account would be delayed until 2024, at which time they would tuck away $13,050 a year each.
“They can reach their retirement goal, albeit with much less cushion,” Mr. Ardrey says.
In the fourth scenario, where Penny buys a business and takes a big drop in income for the first few years, they would be able to pay interest only on their line of credit until 2019. At that point, additional cash would be freed up because they would have paid off other debts and finished contributing to the children’s RESP. By 2024, the combination of increased income and no debt would allow them to save $17,150 each to their TFSAs. Penny would continue to save $12,000 a year to her RRSP.
“If they decided to spend all of their investment assets and only leave their real estate to their heirs, they would be able to spend $89,200 a year in current dollars,” Mr. Ardrey says.
“The key to their success is continued employment at or near their same income level,” the planner says. “This allows them to pay off their debts in the next few years and then redirect some of that cash flow to saving for the future.”
The people: Penny, 44, Paul, 45, and their two children, 12 and 15.
The problem: Figuring out what’s possible and what’s not for their financial future.
The plan: Continue to pay off debt. Once it is repaid, shift emphasis to savings. Penny gives up the idea of dropping out of the work force in five years.
The payoff: Peace of mind.
Monthly net income: $13,960.
Assets: Bank $1,500; his TFSA $36,060; her TFSA $5,330; his RRSP $169,570; her RRSP $98,600 (including spousal); current value of his DB pension $396,510; RESP $83,890; residence $466,000. Total: $1.26-million.
Monthly disbursements: Mortgage $1,350; property tax $275; insurance $155; utilities $390; maintenance and repairs $1,075; garden $100; transportation $740; grocery store $1,800; clothing $110; LOC $1,900; car loans $695; gifts, charity $180; vacation, travel $335; other discretionary $385; dining, drinks, entertainment $385; grooming $65; club memberships $55; pets $50; subscriptions $35; other personal $225; doctors, dentists $200; prescriptions $40; life insurance $330; disability insurance $120; telecom, TV, Internet $300; her RRSP $1,000; RESP $500; pension plan contributions $1,040. Total: $13,835.
Liabilities: Mortgage $128,000 at 2.99 per cent; line of credit $110,000 at prime plus 0.5 per cent; car loans $17,575. Total: $255,575.