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By Andrew Allentuck
Special to The Globe and Mail
Saturday, October 6, 2007
In Toronto, a couple we'll call Matt and Bobbi are trying to organize their lives. At their respective ages of 30 and 32, they pose an interesting question: How can one live reasonably well in an expensive city like Toronto on a family income that will likely never be very large?
Adrian Mastracci, fee-only portfolio manager at
KCM Wealth Management in Vancouver, says, "This financial plan will maintain their standard of living in retirement, for they will have paid off their mortgage and have contributed to their pensions."
Matt is a pastor at a Toronto church. Bobbi is a psychologist. Their gross annual income is $90,300, which is a good deal in many places in Canada but not a lot in Toronto - where dinner for two at a good restaurant can run to $200.
"I am a recently ordained minister," Matt explains, noting that his wife practises her profession with only modest compensation. "While we recognize that our chosen professions will not make us rich, we don't think we have an excuse for living hand to mouth."
What our expert says
Facelift asked financial planner and portfolio manager Adrian Mastracci, who heads KCM Wealth Management in Vancouver, to work with Matt and Bobbi and devise a plan that answers their question.
"How to weather the perfect storm of children, need for a house, a possible need for a car without the expectation of a large income over the long run is the couple's top financial concern," the planner explains. "It is a tall order - hopefully a manageable one - but they have a considerable saving capacity."
Matt and Bobbi live modestly. Out of their present annual net income of $72,200, they pay $1,400 a month for a mortgage on their condo. With few frills, they save $1,245 each month. The costs of fulfilling their hopes for children, travel and retirement all depend on close attention to their priorities, Mr. Mastracci explains.
There is no need to rush to buy a house, the planner suggests. The couple's condo will accommodate one or two children for the first two or three years; there is no need to buy a larger home until then. With more equity in the condo they would sell, the couple could buy a house with a substantial down payment, transferring income currently allocated to the condo mortgage to the house mortgage.
Each child will require an increase in family spending. A new baby could cost $500 to $800 a month, the planner suggests, and estimates the cost could be $175,000 by age 18. And the cost could be much higher, the planner says, depending on the parents' lifestyle choices.
Matt and Bobbi have $71,000 equity in their $260,000 condo. They would like to buy a house and keep the condo, renting it out for income. That's not a good idea, Mr. Mastracci says.
Owning another home would add too much debt. Were there an economic downturn, the condo might be hard to rent. The couple should avoid excessive financial risk, which means not adding another mortgage to their debts in the near future, he says.
Matt and Bobbi's largest single financial goal is purchasing a house. Matt's church sold its parsonage many years ago. But the couple has a choice to make. Should they use savings to pay down their condo mortgage or to build up a registered retirement savings plan? RRSP deposits will reduce Matt's taxes at a rate of $310 for each $1,000 contribution. On the other hand, paying down the 5.3-per-cent mortgage will generate a return of 7.6 per cent on a tax adjusted basis.
Mr. Mastracci suggests a balanced approach: Out of annual savings of nearly $15,000 a year, put $7,000 into RRSPs for Bobbi and invest the balance of $7,000 each year in an accelerated mortgage pay down and $1,000 a year toward paying back Bobbi's $14,000 Home Buyer's Plan loan. Annual RRSP contributions will generate tax savings that can be used for additional mortgage pay downs, the planner notes.
When Matt and Bobbi retire, they would like to have $50,000 annually in 2007 pretax dollars, Mr. Mastracci notes. Assuming that Matt lives to 82 and Bobbi to 87, that inflation runs at an average annual rate of 2.5 per cent for the next half century, that Old Age Security and the Canada Pension Plan are indexed at 2 per cent a year and that investments earn 6 per cent a year, the couple will need $525,000 of assets in addition to sums that will be generated by Matt's church pension and his $13,500 U.S. Individual Retirement Account from a job he had in the United States. If they continue to save $7,000 a year in their RRSPs until Matt is 65, the couple would be able to meet their savings goal, the planner notes.
There are other details. Matt and Bobbi can reduce their annual taxes in advance of refunds after filing their returns by reducing source deductions, the planner notes. The procedure is to ask the Canada Revenue Agency to permit the employer to reduce source withholdings for deductions not normally provided for on the TD1 form. This is like receiving their tax rebates in advance, he notes.
Matt and Bobbi need to buy life insurance for the family they plan to start one day. Matt would need $400,000 of coverage and Bobbi $200,000. The total cost at their ages would be less than $500 a year. These premiums are for single annual payment 10-year level term policies, the planner notes. Each policy should designate the spouse as beneficiary.
Over time, Matt and Bobbi will build their capital. They are relatively young and can therefore afford to tilt their portfolios toward a rather aggressive weighting of 70-per-cent stocks and 30-per-cent fixed income assets. They can buy conventional mutual funds with fees that average 2.5 to 3 per cent a year or they can buy index funds or exchange traded funds with annual fees typically less than 0.5 per cent a year. Over time, studying the investment market and learning to make some of their own decisions could have large financial benefits for the couple, Mr. Mastracci suggests.
"In their current planning, the couple have placed too much emphasis on investing and not enough on debt reduction," the planner says. "This financial plan will maintain their standard of living in retirement, for they will have paid off their mortgage and have contributed to their pensions. Their children will be finished with school. This is not a plan for people who seek wealth, but a plan for those who seek a balance between consumption and service to others."
Client situation
THE COUPLE
Matt, 30, and Bobbi, 32, live in Toronto where he is a church minister and she is a psychologist. They plan to have a family.
THE PROBLEM
Stretching an average family income in a very expensive city.
THE PLAN
Pay off the mortgage quickly out of annual savings and build up RRSPs.
THE PAYOFF
A well-structured financial life with security for children to come, a house and RRSPs generating sufficient income to cover retirement.
NET MONTHLY INCOME
$6,013
ASSETS
Condo, $260,000; RRSP, $4,656; U.S. IRA, $13,562; church pension, $6,000; GICs & cash, $14,500.
MONTHLY EXPENSES
Mortgage, $1,400; property taxes, $136; condo fees, $257; utilities, $50; phone and Internet, $95; food and wine, $400; dining out, $200; clothing, $250; RRSP, $325; non-registered investments, $500; transit, $100; travel, $200; charity and gifts, $350; miscellaneous, $505; savings, $1,245. Total: $6,013.
LIABILITIES
Mortgage, $189,000.
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