Situation:Despite six-figure income and growing savings, couple worries their future is bleak
Solution:Set up RESP for son, develop wife’s RRSP, learn investing and tax rules
In Alberta, a couple we’ll call Mary, 37, and Ralph, 45, are raising their child, Ethan, age 2. Both researchers in communications, they bring home $8,563 per month and add $125 from the Canada Child Benefit for total monthly disposable income of $8,688 per month. They look forward to moving from their present $380,000 condo to a $500,000 house, but they hesitate for fear that their means will not support it. They are novices in finance.
In financial terms, their futures are solid. Ralph will have a generous defined benefit pension plan, Mary an RRSP-like defined contribution plan with matching grants by the employer.
They have $59,000 in Mary’s RRSP, $1,500 in her TFSA, and $23,000 cash earning nothing. They keep the $125 monthly Canada Child Benefit they receive each month in Mary’s TFSA and they have mutual funds whose fees and assets they find difficult to understand. There is no Registered Education Savings Plan, though every dollar put into an RESP up to $2,500 per year earns a 20 per cent boost from the Canada Educational Savings Grant. “We want our son to pay his own way through university,” Mary explains. The couple needs to focus on growing their wealth.
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Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Mary and Ralph. They worry they won’t have enough money to retire, he explains. Ironically, they have ample income. They take home $104,256 per year including the non-taxed Canada Child Benefit of $1,500 per year.
Their first concern is buying a larger home. In fact, they can move up right away, Moran says. If they sell the condo for $380,000 and take off five per cent selling fees, they will net $361,000. They pay $1,736 per month on their present mortgage with a 21-year amortization. If they add $139,000 to their mortgage, payments will increase by about $800 per month, depending on the terms they select. The couple can easily support the higher payments from monthly cash savings. Moreover, they can pay up to 20 per cent of their present mortgage each year without penalty, so they can be debt-free before retirement.
Though they like the idea that Ethan should pay his own tuition, they can ease his way with a Registered Education Savings Plan. Carry forward rules would allow Mary to play catch up, and essentially receive two years worth of benefits if she makes two years worth of contributions. She should take the $1,500 in annual Canada Child Benefit payments that she currently holds in her TFSA and put them into a Registered Education Savings Plan and add $3,500 from cash to make the total balance $5,000. The Canada Education Savings Grant will add $500 per year to make the sums contributed $6,000. If the parents then add $2,500 per year for another 15 years to Ethan’s age 17 and if the contributions then attract the 20 per cent CESG for that period up to the $7,200 lifetime limit per beneficiary, then assuming that the plan grows at 3 per cent per year after inflation, Ethan will have $75,300 in 2019 dollars for post-secondary education.
Almost one-sixth will have been contributed by the Government of Canada and will probably be tax-free when withdrawn, provided Ethan’s taxable income while in post-secondary studies is less than about $20,000 a year. Compared to the TFSA, where Mary is keeping the Canada Child Benefit grants at present with no tax, the RESP with a 20 per cent boost at the moment of contribution and probably with no tax when withdrawn is the winner.
Though worried about money, the couple has more than enough income for anticipated expenses for the larger house and for retirement. They list their allocations as $8,688 per month. After they pay off their student loan at $129 per month, $3,000 balance outstanding, and their car loan at $500 per month with a $4,500 balance outstanding, they will gain $629 per month discretionary income.
They can use that cash to boost their RRSP balances. Mary has $35,600 of RRSP space, Ralph $15,300 of space and no RRSP. Mary’s employment plan is a defined contribution plan, though Ralph will have an ample defined benefit job pension. They can concentrate on Mary’s space. If she contributes $500 per month matched by her employer, total $1,000 per month, the $59,000 already in the plan growing at 3 per cent after inflation will rise to $429,000 in 20 years at her age 57. That sum, still growing at three per cent per year after inflation and spent over the next 33 years to her age 90 would generate $20,660 per year in 2019 dollars.
If Ralph works to age 65, his defined benefit plan should provide $50,808 per year before tax.
Mary started her Canada Pension Plan contributions at age 31. By age 65, she will have qualified for about 73 per cent of the 2019 $13,855 CPP maximum, $10,114 per year. Ralph, who lived abroad for many years, should be entitled to about 65 per cent of the maximum, which works out to about $9,005 annually based on what will be 25 years of work following his advanced degrees. Mary can expect Old Age Security benefits of $6,856 per year based on 38 years of residence in Canada after age 18. Ralph can expect $4,700 per year from OAS based on his residence in Canada. All that, plus Mary’s RRSP and Ralph’s company pension, adds up to $102,143 when both are 65.
If eligible pension income is split and the couple pays 16 per cent average income tax, they would have $7,150 to spend each month. That is more than present spending if savings, child care and debt service are eliminated.
Ralph and Mary need to understand their finances. For tax guidance, of the best guides is Tax Planning for You and Your Family by the accounting firm KPMG. It is revised annually and is remarkably clear and concise. Investment guides are plentiful. Many online brokerages have trading tutorials worth a look.
Studying investments pays. In learning the ropes, one can invest profitably by reducing fees and/or by selecting managers after examination of their styles, costs and results.
Retirement stars: 3 *** out of five
e-mail[email protected]for a free Family Finance analysis