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By Andrew Allentuck
Special to the Globe And Mail,
Report on Business
Saturday, February 23, 2008
In a small town in Nova Scotia, a couple we'll call Liz and Dan have built a secure life based on two incomes that total $100,000 a year.
Adrian Mastracci, “fee-only” portfolio manager at
KCM Wealth Management in Vancouver, says, "To make this family's hopes turn into reality, Dan has to make his business work."
Liz, 44, is a civil servant. Dan, 46, owns a business that he runs out of his home. Their problems rest with the fate of the business. If it does well, the problems will be easily fixed. If the business fails, the family's financial problems will be compounded.
The couple have net worth of $433,400. They have financed some expenses by running up their bank line of credit. They worry that as their children - ages 15, 13 and 8 - grow older, family expenses will rise. For now, their immediate concern is their $73,600 mortgage, which comes up for renewal in a year. In the meantime, they want to replace a 13-year-old car and pay for routine house repairs. They have suspended contributions to both the children's registered education savings plans and their own registered retirement savings plans to build a cash reserve.
WHAT OUR EXPERT SAYS
Facelift asked Vancouver-based financial planner and portfolio manager Adrian Mastracci to work with Dan and Liz. His assessment is that with planning, their needs will be within their means.
"The couple makes good money, yet they feel poor," the planner says. "Dan is developing his business and his concern for cash flow is understandable. The business has been growing and, assuming that it continues to do so, debt repayment, educational expenses and retirement will all fall into place."
Liz makes $76,000 a year while Dan draws $24,000 each year from his business. Their after-tax monthly income is $5,600. However, they spend $5,880 a month, making up the difference by extending their $68,000 line of credit. Adding $2,400 to their debt each year is nothing to fret about, Mr. Mastracci says.
Their future is tied up in Dan's business. If it thrives, it will generate sufficient cash to take care of debts, the kids' university bills and provide for their retirement in 19 years when Dan is 65. At that time, they think they would like to have an annual income of $75,000 in pretax 2008 dollars. To generate that income until Dan dies at an assumed age of 84 and Liz at an assumed age of 88 will take $1.1-million of financial assets growing at 6 per cent a year. Inflation is assumed to run at 2.5 per cent a year, the planner explains.
Liz will have a pension of $19,000 a year when she retires at age 65. In nine years, after the couple's debts have been paid off, the couple's present $158,000 RRSP balance will have grown to $267,000, assuming 6-per-cent average annual growth but no further contributions. Their RRSP room will have grown by $15,000 a year to $260,000, Mr. Mastracci estimates. It will continue to grow by $15,000 a year, he adds. They will be able to save $40,000 to $50,000 a year, assuming that Dan's business is doing well.
Starting in 2017, the couple can begin to fill their RRSP room at a rate of $40,000 a year, assuming that Dan's business is thriving. That rate of contribution would give them $1-million by Dan's age 65. If they put in $47,000 a year, they will meet their $1.1-million savings goal for supplementing public pensions, the planner adds. This fund will satisfy their $75,000 pretax retirement income goal adjusted for inflation running at 2.5 per cent a year. This target will have grown to $120,000 by the time Dan is 65. At that time, he will have Old Age Security payments, currently $6,028 a year and 80 per cent of maximum CPP benefits at age 65, which currently are $10,615 or $8,492.
Liz will work for another two years, maintaining family income. In 2029, when Liz retires, she will add $19,000 from her pension, OAS of $6,028 and CPP of $10,615. The couple's total income in 2029 will add up to $50,163 from Liz's CPP and OAS and her $19,000 annual pension. To meet their $75,000 pretax income target in 2008 dollars, they will have to draw $24,837 from their RRSPs. If Dan's business has been good, the money will be there, Mr. Mastracci says.
To obtain the most CPP benefits, Dan, who takes his pay in the form of dividends from his company, should switch compensation methods to receive a salary that will qualify for CPP benefits, Mr. Mastracci suggests. While he is rearranging his pay, he should also look into obtaining disability coverage. In the future, if the business thrives, Dan might be able to sell it and make use of the $750,000 exemption for capital gains realized on the sale of a Canadian Controlled Private Corporation.
For now, there is not much more that Dan and Liz can do to add to their minimal cash savings or to contribute to their RRSPs and RESPs, Mr. Mastracci says. Assuming that Dan's business grows, he should be able to use additional funds to pay down his mortgage and line of credit, both of which carry interest rates of about 6 per cent. Once their debts are paid, Dan and Liz can begin to add to their registered savings, using up their abundant room in their registered plans.
There are a few other tactics that may boost family income. As Dan's business grows, it may be possible to hire the two older children to provide services. The amounts paid must be reasonable, but the result should be more money for the family after tax. The children will be in lower tax brackets, Mr. Mastracci notes.
"To make this family's hopes turn into reality, Dan has to make his business work," Mr. Mastracci says.
Client situation
THE COUPLE
Dan and Liz live in New Brunswick with their three school-age children.
THE PROBLEM
Negative cash flow, no savings for retirement or children's education.
THE PLAN
Adjust investments to maximize income and future CPP benefits, reduce taxes.
THE PAYOFF
A comfortable retirement and funds for children's education.
NET MONTHLY INCOME
$5,600
ASSETS
House $330,000, business $50,000, RRSPs $158,000, RESP $5,000, kids' GICs $30,000, cash $2,000. Total: $575,000.
MONTHLY EXPENSES
Mortgage $1,134, utilities $310, water $116, cable & phone $135, home repairs $200, food $700, dental $300, child care $500, sports $250, clothing $75, car fuel $300, car & home insurance $210, line of credit $500, restaurant $150, miscellaneous $920. Total: $5,800.
LIABILITIES
Mortgage $73,600, line of credit $68,000. Total: $141,600.
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