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By ANDREW ALLENTUCK
Special to The Globe and Mail
Report on Business
Saturday, December 13, 2008
In Toronto, a couple we'll call Henry, 32, and Julia, 31, have a house they bought last fall, a plan to start a family, and a concern that debts totalling $669,000 will be difficult to manage if Julia takes maternity leave for several months. That would cause their after-tax monthly income of $9,100 a month to drop to $6,300, although federal maternity and parental benefits could boost that by about $1,740 a month.
Adrian Mastracci, “fee-only” portfolio manager at
KCM Wealth Management in Vancouver, says, “It is important that they maintain a debt repayment schedule and still have the flexibility to enjoy life.”
"We need a Financial Facelift to develop a financial strategy for the period my wife is off work," Henry says.
WHAT OUR EXPERT SAYS
Facelift asked Adrian Mastracci, a fee-only portfolio manager who heads KCM Wealth Management Inc. in Vancouver, to work with the couple.
"It is important that they maintain a debt repayment schedule and still have the flexibility to enjoy life," he says.
Henry, who earns $120,000 a year including an optional bonus of $20,000 a year, should see his base salary as an IT manager rise to $150,000 within five years, he says. Julia earns $48,000 a year as a manager in the private sector. The problem of debt service is therefore a matter of bridging the time that she is off work.
The couple's debt service charges will rise to 51 per cent of take-home income from their current 35 per cent when Julia is off work, although that does not take federal benefits into account. The debt burden is only temporary, but it would be hard to carry, even for a few months, because the two have only $6,000 cash to tide them over her maternity leave.
They should build a fund to cover four months of living expenses. They can do that within the shelter of a Tax-Free Savings Account (TFSA) that will be available after Jan. 1. Money going into the account will be tax-paid, but growth and payouts will be free of tax. Each partner can shelter $5,000 a year, and unused TFSA space can be carried over.
Debt management comes next. Henry has an income property that does little more than break even. It has an estimated value of $250,000 and a $200,000 mortgage at an interest rate of 5.24 per cent. Interest is tax-deductible, but if he were to sell the property and apply the $50,000 equity to other debts, including his $365,000 house mortgage and an $80,000 debt incurred for his MBA, he would liberate a good deal of income.
Henry makes $700 a month in contributions to his registered retirement savings plan. He should make those deposits through his employer to get matching contributions. The rest of any unused RRSP space can be left until the mortgage is paid off, Mr. Mastracci says.
The home mortgage can be repaid with cash left over from RRSP contributions, Mr. Mastracci says. All cash going to reduce the 5.1-per-cent home mortgage will generate a return equivalent to as much as 9.4 per cent in Henry's top tax bracket, the planner says.
The arrival of a baby will increase expenses by perhaps $500 to $800 a month, plus the cost of funding a registered education savings plan. The Canada Education Savings Grant will add the lesser of $500 or 20 per cent of contributions to a maximum of $2,500 a year.
The pair would like to retire at age 60 with a pretax income of $80,000 in 2008 dollars.
Assuming Henry lives to age 82 and Julia to age 87, that inflation runs at 3 per cent a year, that investments generate a pretax return of 6 per cent a year, and that each partner gets full Old Age Security (currently $6,204 a year) and maximum Canada Pension Plan (CPP) payments (currently $10,615 a year), they will need $2,750,000 of financial assets to meet their target, Mr. Mastracci estimates. Henry and Julia would have to save $35,000 a year or $2,917 a month to meet that target. Such savings are beyond their means now, but they can accelerate savings as debts are reduced and incomes rise, Mr. Mastracci says.
If they choose to retire when each is 60, they will have to go five years without Old Age Security and may wish to start receiving their CPP at a reduction of 0.5 per cent a month for each month prior to age 65 that they begin benefits. That would cut their first-year CPP benefits to $7,431 a year in 2008 dollars. A year later, Julia's CPP would begin at the same rate, making for total public pension income of $14,862 in 2008 dollars.
In 2042, when Henry is 66 and Julia is 65, their income in 2008 dollars will consist of two CPP payments of $10,615 a year, two OAS payments of $6,204 a year, and at least $46,362 in investment returns, the planner estimates. That will meet their $80,000 pretax retirement requirement.
It won't be an easy trip to generate the investment income they will need. They must reduce debts, Henry has to get raises to boost his income to $150,000 a year, and Julia must return to work within a year of having her baby and earn $50,000 or more a year. Those are the requirements for saving $35,000 a year for retirement, funding a RESP at $2,500 a year, and paying the other costs of raising a child.
"Starting a family is an expensive affair," Mr. Mastracci says. "But this couple has the earning power to handle debts and fund retirement."
Client situation
THE COUPLE
Torontonians in early 30s planning a family.
THE PROBLEM
Heavy debts that will be harder to support when maternity benefits replace income.
THE PLAN
Sell a rental property and harvest equity to pay down debts and build up a fund for expenses.
THE PAYOFF
Substantial debt relief now and in future.
NET MONTHLY INCOME
$9,100.
ASSETS
House $400,000, rental property $250,000, registered investments $78,800, non-registered investments $9,000, personal property $4,000, cash $6,000. Total: $747,800.
MONTHLY DISBURSEMENTS
House mortgage $1,787, rental mortgage $988, property taxes $478, food & restaurants $800, entertainment $250, clothing $150, RRSP $1,100, gas & subway $250, car repairs $50, travel $150, car & home insurance $287, life insurance $40, family loan $600, MBA loan $830, misc. $460, gifts and charity $80, savings $800. Total: $9,100.
LIABILITIES
Mortgage house $365,000, rental property $200,000, Visa card $3,000, MBA loan $80,000, family loan $15,000, line of credit $6,000. Total: $669,000.
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