Patience is key to dream house

In Vancouver, a couple we'll call Morris, a businessman, and Jennifer, who works for the federal government, are 35 and 33, respectively. They take home $9,000 a month, and pay 28 per cent of it for mortgage costs and property taxes. They worry that they will have to sacrifice their retirement saving to buy a bigger house for their children, a three-year-old and a six-month-old baby.

"Vancouver's housing costs are eating up a large portion of our income," Jennifer says. "We would like to know what level of retirement savings we need?"

What our expert says

Facelift asked financial planner and portfolio manager Adrian Mastracci, head of KCM Wealth Management Inc. in Vancouver, to work with Morris and Jennifer. "What is most important to them is to grow their nest egg," he explains.

Can they afford to add up to $300,000 to their $600,000 mortgage to buy a new house? Yes, but only at the risk of being unable to pay if they had a financial reversal such as unemployment or a sharp rise in interest rates. It would be better to reduce their present $496,000 of debt before adding more to it with the purchase of a bigger house. That might take a few years, but the saying that patience is a virtue is applicable, Mr. Mastracci says.

Morris and Jennifer need to make advantageous investments to achieve an $80,000 pretax retirement income in 2009 dollars beginning when Morris is 65 and lasting for their lifetimes. The focus should be on risk management. The key is to reduce holdings of Morris's stock in his company, which is half the family's financial assets, and to diversify investments with cash from the sale of company shares, the planner adds.

Assuming that Morris lives to age 84 and Jennifer to 88, that they can generate a 3-per-cent average annual real return on their investments and that they will receive full Old Age Security and Canada Pension Plan benefits totalling about $34,220 a year as well as a $20,000 annual pension from Jennifer's government job, then they will need an additional $25,780 of annual income in to reach their target, though the required supplement to pensions will rise over time with inflation.

He will need investments of $1,825,000 valued at the date of his retirement in 2039, the planner estimates. At Morris's age 65, today's $80,000 income target will be $194,000 assuming 3-per-cent annual inflation. The capital required is attainable if the couple can save $16,000 a year in 2009 dollars. They already save that much through Morris's pension contributions and RRSPs.

They should double their present monthly contribution for each child's postsecondary education to $200 from the current $100. That would raise their contribution to $2,400 a year per child, a sum that approximately maximizes the Canada Education Saving Grant - a government contribution that maxes out at $500 a year.

If those funds were invested with a 3-per-cent real rate of return, their Registered Education Savings Plans would have $111,830 in 15 years when the elder child is ready for university.

The parents can split the benefits between the children. That sum would provide an approximate amount of $14,000 a year per child for four years of postsecondary education expenses, Mr. Mastracci says.

Buying a larger house is the central issue in their planning. Morris and Jennifer already have a debt equal to 2.8 times their $175,000 annual income. Morris's non-guaranteed bonuses of $30,000 a year are not included in this debt evaluation. He has prospects for promotion and Jennifer, who works part-time, could expand her hours and raise family income. Those income sources will support additional investment in RESPs and in a new house.

Assuming their good fortune continues, they could add as much as $200,000 to their debt, Mr. Mastracci says. But pushing that high is a bet on good times.

They already pay more than a quarter of their combined take-home income for mortgage payments and taxes. They can make cuts in expenses, such as the $1,000 a month they spend for entertainment. But taking on additional interest expense in advance of income increases would be of questionable prudence, the planner says.

To date, the couple has built up $220,700 of financial assets. That's about a quarter of their total assets. Most of the remainder is in their house. One cannot predict future asset prices, but it is clear that they are heavily dependent on the property market for asset growth.

Diversification might be wise. For a long-range allocation, they can put 70 per cent of their growing financial assets into Canadian, U.S. and global stocks and 30 per cent into fixed-income assets such as high-interest savings accounts. They could use cash savings to buy government bonds or conservatively managed bond funds when interest rates rise and corporate bond defaults have declined, the planner advises.

"Carrying a reasonable debt load for their income is key to making their plans succeed," he says.

Client situation

The People

Vancouver couple with young children.

The Problem

Need to buy a larger house while not sacrificing retirement.

The Plan

Tread carefully when adding to mortgage debt.

The Payoff

A balanced way to buy a larger house and fund retirement.

Net monthly income

$9,000

Assets

House $600,000, RRSP $70,700, pension $25,000, mutual funds $20,000, cash $5,000, employer stock $100,000, car $20,000. Total: $840,700.

Monthly disbursements

Mortgage $2,276, property tax $200, food $1,100, restaurant $150, entertainment $1,000, clothing $500, child care $600, RRSP $950, pension (Morris) $400, RESP $200, car fuel and repairs $400, travel $500, car and home insur. $300, charity and gifts $50, life insurance $50, interest on investment $400. Total $9,076.

Liabilities

Home mortgage $364,000, line of credit $32,000, investment loan $100,000. Total: $496,000.

Interested in a free Financial Facelift? andrewallentuck@mts.net