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By Andrew Allentuck
The Globe and Mail
Report on Business
Saturday, June 23, 2007
In Vancouver, a couple we'll call Caroline, 35, and Joe, 36, are struggling to cope with the high cost of living and the future expenses of raising their son, now 10 months old.
Adrian Mastracci, fee-only portfolio manager at KCM Wealth Management in Vancouver, says, "A bigger home is the largest financial challenge that Joe and Caroline face."
Joe, a business consultant, is self-employed. His gross income of $78,000 a year, together with Caroline's gross income of $69,250 a year from her management position with a charitable organization, generates a net annual family income of $95,940. That's not a lot for one of the most expensive cities in Canada and for paying off $340,282 in debts. That debt does not include $20,000 they each owe to their registered retirement savings plans for Home Buyer's Plan loans and $18,000 for a Lifelong Learning Plan loan.
Their goals are to get out of debt, build up their RRSPs, finance a registered education savings plan for their child, move out of their condo and into a 1,500-square-foot house, and travel to visit their families and to see the world. It's a tall order for now.
"We have been going along without a strategy to accomplish our goals," Caroline says. "We feel that we are small fry for our advisers and that we don't get the detailed guidance that we need," Joe adds.
What our expert says:
Facelift asked Adrian Mastracci, a portfolio manager and financial planner who heads KCM Wealth Management in Vancouver, to work with Caroline and Joe in order to determine which of their goals are attainable. "They've made a number of right financial moves," he explains. "They have been reducing their mortgage debt and they have a start on building up their RRSPs."
The core of Caroline and Joe's problem is saving, Mr. Mastracci notes. The family currently spends $80,840 a year. They also save for the RRSPs, for paying back the Lifelong Learning Plan loan, and for a small cash reserve. When Caroline, who is on maternity leave from her job, goes back to work, annual family spending will have to include child care for their infant son and payments on their Home Buyer's Plan loans.
Caroline and Joe have several choices to make. The first issue is how to manage their debts. Mr. Mastracci suggests they start with the $15,000 line of credit that charges them 7.75 per cent a year. Joe and Caroline have to earn about $140 to pay every $100 in interest, so debt reduction is a good investment, Mr. Mastracci notes. After paying off the line of credit, they can accelerate their mortgage payments. Their plan is to eliminate their mortgage in 12 to 15 years. It is a realistic goal, Mr. Mastracci says.
They will still have to carry a substantial amount of their $306,703 mortgage debt. Rather than postpone RRSP contributions until the mortgage is eliminated, they can make annual savings to their plans, as they are now doing. If buying a new and larger home in the near future is very important, they could stop all RRSP contributions, pay the tax on the Home Buyer's Plan and Lifelong Learning Plan withdrawals and then direct all savings to paying down the mortgage. They could carry forward their unused RRSP room for decades, Mr. Mastracci notes. It is a question of priorities, he explains.
If Caroline and Joe contribute $7,000 a year to their RRSPs for the next 26 years, then by the time they are 62, they will have accumulated $820,000, assuming that assets have grown at 6 per cent a year. They could begin retirement before their target age of 65, but for the sake of both their financial security and simplicity of analysis, Mr. Mastracci assumes that they will retire when Joe reaches age 65 in 2036.
In that year, the couple will have total income as follows: Joe's Canada Pension Plan $18,100, his Old Age Security $10,120 and $13,230 from U.S. Social Security from work south of the border, and $68,650 from RRSPs. A year later, when Caroline is 65, the couple's income will grow by her CPP, $18,660, her OAS $10,630, her employment pension of $26,480 and, in her year of retirement, a substantially decreased RRSP payment of $16,000. Thus, by the year that Caroline is 65, the couple will have total CPP payments of $37,320 - allowing for additional inflation, OAS payments of $21,260, Social Security of $13,430, employment pension of $26,480 and RRSP withdrawals of $16,000 for a total of $114,490. Joe and Caroline will have slightly exceeded their retirement income target of $110,000 (equal to $55,000 in 2007 dollars allowing for 2.5-per-cent annual inflation). Amounts have been rounded off to allow for fractional years.
Caroline and Joe should make use of a registered education savings plan for their infant son. The March 19 federal budget proposed that the maximum Canada Education Savings Grant rise from $400 to $500. If the parents contribute $2,500 a year for the next 17 years and receive the $500 CESG each year, then the fund should have a value of $101,250 when the child is ready for post-secondary education, assuming an 8-per-cent rate of return, Mr. Mastracci says. If the fund continues to generate an 8-per-cent return, the fund will support $30,500 a year in educational expenses for four years, Mr. Mastracci says. That rate is consistent with investing the RESP entirely in stocks. Liquidity and short-term volatility are not important considerations given that the money will be in the account for one and a half decades, Mr. Mastracci says.
A bigger home is the largest financial challenge that Joe and Caroline face.
However, there are limits on what they can afford. So far, they have done well in the Vancouver real estate market. Their condo, for which they paid $350,000 in 2005, currently has an estimated market value of $550,000, they say. Yet even if $200,000 of current home equity is transferred to an $800,000 home, the sum would challenge their present incomes.
Even with a 5-per-cent mortgage and a 25-year amortization, they would have to pay $3,500 a month. It's too much for their budget, the planner explains. A $600,000 house with a $200,000 down payment and monthly mortgage payment on similar terms would be $2,345, not that much more than the $2,154 they now pay on their mortgage, including condo maintenance fees. The problem is not to buy the house. Rather, it is how to buy it and satisfy all their other obligations, the planner notes.
Caroline has life insurance from her employer. Joe, however, has no life coverage. To provide for his son's needs in the event of his death, he should buy at least $250,000 of term life. At his age, as a non-smoker, he should be able to obtain 10-year level term coverage for $205 a year, Mr. Mastracci says.
At Joe's relatively young age, disability is a greater risk than death. Given that Joe is the main financial support of the family, he should get a disability policy with a benefit of $3,900 a month payable to age 65 after a three-month waiting period. That policy would cost $160 a month, Mr. Mastracci says. A sound disability policy has to be a priority for this family.
Currently, Joe and Caroline have about $3,000 in cash. They should build up a contingency fund with perhaps three to four months of living expenses, the planner advises. In their case, that would be $24,000. In the alternative, they could rely on additional lines of credit. They could even use their RRSP balances for cash, after paying income tax on withdrawals. It's a costly way to obtain cash, Mr. Mastracci warns.
"Joe and Caroline cannot have everything they want as soon as they want it," Mr. Mastracci says. "They should stay in their present home and make it work. That is the only way they can have the means to build up their RRSPs, build an RESP for their son and pay off their debts. They understand their finances, but they have to pay closer attention to where their money goes."
"We are much more interested in making our current housing situation work than we are in sacrificing our other goals," Joe explains. "One of the best things about this exercise is that it has forced us to think long term about what we want to do. Breaking down our goals has made them more understandable," Caroline says.
Client situation
Joe, 36, and Caroline, 35, live in Vancouver with their son, age ten months.
Net monthly income: $7,995.
Assets: Condo $550,000, RRSPs $91,370, car $20,000, cash $3,000.
Total: $664,370.
Monthly expenses: Mortgage & condo fees $2,154, property taxes $340, utilities $234, food & wine $875, entertainment $368, clothing $250, child care $200 (will be $1,200 starting in Aug.), RRSP contribution $600, car insurance & fuel $440, car loan $321, home insurance $30, travel $500, charity & gift $225, miscellaneous $800, savings $658.
Total: $7,995.
Liabilities: Mortgage $306,703, line of credit $15,000, auto loan $18,579, Home Buyer's Plan loan $40,000, Lifelong Learning Plan loan $18,000.
Total: $398,282.
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