Pinching pennies toward financial security
Between them, Don and Carmen earn $176,000 a year, but with daycare, a mortgage, two cars and tuition expenses for their part-time studies, they find they have little left each month for savings.
Carmen is a teacher, Don a consultant working from home. They are both 37.
Lately, they've been at odds about where to allot scarce resources. He favours paying down the mortgage on their Southern Ontario house as quickly as possible, while she prefers contributing as much as possible to his RRSP because he has no company pension.
While their advanced studies will likely lead to higher income in future, "we are always pinching pennies to come up with the tuition each semester," Don writes in an e-mail. He worries how they will fare when interest rates start to rise. "In preparation, I have forgone any contributions to my RRSP, instead allocating additional funds to the mortgage each month," Don says. "This is a bone of contention between the two of us."
Looking ahead, their retirement spending goal is $75,000 a year.
We asked Grant Henri, vice-president and financial planning specialist at RBC Wealth Management, to look at Carmen and Don's situation.
What the expert says
Don and Carmen are doing all the right things, Mr. Henri says. They are saving what they can, their expenses are reasonable, they have no debt other than their mortgage, they have begun saving for their children's education, they have life insurance, a line of credit for emergencies and wills and powers of attorney for property and personal care.
"They just happen to be at the stage in their lives when cash flow is under the most pressure.
"The key issue at hand is to determine the optimal use for their surplus cash flow," which Mr. Henri estimates will be between $10,000 and $15,000 a year once their eldest child starts school and child-care expenses drop. The money they have to save and invest includes the $3,600 a year they are contributing to their RRSPs and tax-free savings accounts now, as well as the tax refund (about 30 per cent) they receive on their child-care expenses. Competing demands on this surplus include lump-sum mortgage payments, contributing to a registered retirement savings plan, tucking away more in the children's registered education savings plan or contributing more to their TFSAs.
The planner suggests they first make RESP contributions of $2,500 a year for each child in order to get the 20 per cent matching federal government grant. "This is a very attractive investment for them."
With the remainder of the surplus cash flow , the planner suggests they make RRSP contributions for Don. "This should result in tax savings at a fairly high rate given Don's marginal tax rate," Mr. Henri says. He recommends they forgo TFSA contributions for now, other than possibly using their TFSAs for emergency funds.
For Don's tax refund from the RRSP contribution, the planner recommends one, or a combination of, the following: buying private long-term disability coverage if their own coverage is inadequate or has significant limitations or conditions; make additional RRSP contributions; or if their mortgage loan is causing anxiety, make a lump-sum payment. "However, with a current [mortgage] interest rate of 2.2 per cent, this would not be a priority right now if they feel comfortable with their current level of debt."
As for their retirement goals, if they are both willing to work to age 60, without taking into account any increased income they may earn, they could surpass their spending target, generating the equivalent in today's dollars of $80,000 a year after tax. Inflation is estimated to lift this amount to $136,000 by then, with about $95,000 coming from Carman's pension.
This would be in addition to saving $20,000 a year each for four years ($160,000) for their children's university education and paying off their mortgage in full. Mr. Henri's calculations assume an average annual rate of return on their investments of 5 per cent. If Carmen retires at 55 and Don at 60, they would be able to look forward to spending the equivalent in today's dollars of about $72,000 a year, just short of their original target.
Want a free financial facelift?E-mail firstname.lastname@example.org
Don and Carmen, both 37, and their children, 3 and 5.
Whether to pay down the mortgage quickly or contribute as much as possible to Don's RRSP.
Contribute to RESP for children to take advantage of government grant, then to Don's RRSP, and use tax refund from RRSP contribution to pay down mortgage, improve insurance coverage or make further RRSP contribution.
Harmony between them knowing they are taking best advantage of government breaks for RESPs and RRSPs to achieve all of their goals.
Monthly net income
Home $500,000; commuted value of her work pension $178,000; his RRSP $76,440; her RRSP $5,845; tax-free savings accounts: $1,435 (excludes RESP of $23,545). Total: $761,720
Mortgage $1,330; property tax $460; maintenance $300; utilities, insurance $310; auto lease $545; car insurance $165; fuel $400; auto maint. $170; groceries $870; child care $1,950; clothing $320; gifts $85; charitable $20; vacation $50; grooming $265; dining out $375; entertaining $120; hobbies $60; subscriptions $85; life insurance $120; disability/critical illness ins. $85; phones $220; cable, Internet $240; RRSP $200; tuition $325; TFSA $100; her DB pension plan $675; other $60. Total: $9,905
Mortgage $336,350 at 2.2 per cent variable over 35 years.