In Ottawa, a couple we'll call Charles and Louise find themselves caught in a cost squeeze. Their gross income of $177,800 a year ought to cover the costs of raising their children, ages four and two, but problems lurk below their prosperity.
Charles, 37, is self-employed as a consultant, and his business, really a one-man shop, is new. Louise, 35, works in middle management for a large but troubled company that could eliminate her job in a downsizing. The couple have plans for the kids, including private schools and university education. They also want to renovate their house, take their yearly $10,000 trip, change careers when each reaches age 60, and pay down their mortgage quickly.
“The question we need to answer is whether we are overreaching,” Charles says.
“There are uncertainties in our careers. But we need to know if what we want is feasible.”
Facelift asked David Christianson, a fee for service registered financial planner at Wellington West Total Wealth Management in Winnipeg, to work with Charles and Louise to sort out their options.
It is all feasible, but it will take some serious financial commitment, Mr. Christianson says.
“The wild card is Charles' income from consulting, which depends on a constant stream of clients and work,” the planner says. “So far, he has done very well.”
The first step in generating cash is to deal with the outstanding $148,000 balance on their mortgage, Mr. Christianson explains. Currently, the couple pay 5.14 per cent on a four-year note. Amortization is 15 years. They will still be paying the mortgage when their eldest child enters university. It would be helpful to add $500 a month to their monthly payments. That would shorten the amortization to about 10 years and save five years of interest, he adds. But they should not skip putting money into their registered retirement savings plans. Neither Charles nor Louise have a corporate pension plan.
Charles and Louise could do better if they increase the returns from their investments. Louise has $240,000 in her portfolio of various RRSPs and taxable investments. She pays 1 per cent a year to her investment counsellor, which is superficially reasonable, Mr. Christianson says. But she is not necessarily getting good value for the advice she is buying. Her $109,000 registered retirement savings plan is below its book value of $113,000.
Her non-registered portfolio has done much better, invested in three financial services stocks that pay dividends. Yet she has 45 per cent in cash and a relatively narrow selection of assets in her accounts, the planner notes. Half of her stocks are theoretically defensive health care stocks that have suffered from recent scandals involving major drug companies. A large-capitalization U.S. stock in the portfolio is in recovery from a staggering list of calamities including criminal conviction of its top officers for looting the company; not surprisingly, its market value is below its cost. More diversification would at least provide some insulation from market shocks, the planner notes.
Charles has done better with his investments, including a successful bank-run dividend fund, a couple of profitable index funds that have risk controls built in, a widely-respected and fruitful large-cap Canadian equity fund, some financial services companies, and only one health care stock that, like Louise's drug company, is below cost. He need not make adjustments to his portfolio, Mr. Christianson says.
The couple save $3,373 a month, including what they put into their RRSPs and the children's registered education savings plans or RESPs. Part of that saving is going to be the basis for their retirement, the planner adds. If they continue to put $1,875 a month into their RRSPs and invest primarily in equities that produce, by very conservative projections, a 7-per-cent annual return less 4 per cent a year for inflation, their assets and government benefits will be able to generate income of about $74,000 in 2006 purchasing power by the time Charles is 60. If the careers they take up in retirement meet their expenses for another five years, and if they do not touch their investments until they are 65, they can have total income from all sources of $90,000 a year in 2006 dollars from then on, Mr. Christianson says.
In addition to their own investment returns from taxable and registered accounts, Charles and Louise can count on Canada Pension Plan benefits. At age 60, assuming that both Charles and Louise continue to pay the maximum CPP premium each year, Charles should receive a payout of $10,135 in 2006 dollars, the current maximum, reduced by 0.5 per cent a month for each month before age 65 that payments begin. In his case, that will reduce payments to $7,095 a year.
Louise will have the same payout at her age 60, assuming that she applies for the CPP Child-Rearing Drop-Out provision. This procedure excludes benefit calculation for the low contribution months in years when their children were under seven years of age. The procedure keeps her CPP payout intact as though she had been contributing at the maximum rate in those years.
At age 65, Charles and Louise will each receive Old Age Security payments of $5,850 a year in 2006 dollars. By this time, their total annual income will be $45,000 inclusive of all private and public sources of income. The OAS clawback, which begins at $62,144 in 2006 dollars, is unlikely to affect them, Mr. Christianson says.
The children's education in private schools is going to be a challenge, Mr. Christianson says. Charles and Louise estimate that each child's tuition would be $12,000 a year. Paying a total of $24,000 a year in after-tax dollars may force a choice: Skip the annual $10,000 vacation or send them to public schools and choose the family trips as an educational tool. If they can pay off their mortgage before the children reach grade 7, which is when Charles and Louise would like them to begin private schooling, then the expense would be more affordable, the planner adds.
Paying for their children's postsecondary education will be less of a problem, providing that Charles and Louise maintain their present contribution rate of $333 a month or $167 a month per child. That is the amount needed to qualify for the maximum Canada Education Savings Grant paid as the lesser of $400 or 20 per cent of RESP contributions per child each year. Assuming that the RESP, with a current balance of $13,360, makes 7 per cent a year, the RESP will build a balance of $140,000 by the time the elder child is ready for university. That sum would support withdrawals of $14,500 a year for six years for each child if returns can be maintained, Mr. Christianson estimates.
Louise, the parent with the lower income, should apply to the Canada Revenue Agency for the $100-a-month Universal Child Care Benefit, the planner advises. The money should be invested for each child's benefit. If the money is treated like other federal child benefits and considered the child's property for tax purposes, the income will be reportable by the child, though without any likely tax consequence after the basic exemption of $8,975 applicable in 2006. If the $100 a month is considered capital owned by a parent, then interest and dividends it generates will be reportable by the parent, Mr. Christianson adds.
“The couple are in an enviable position, not just for their good incomes and savings capacity, but also for their foresight in examining their priorities,” the planner says.
“It is comforting to know that we are not being unrealistic about what we can do,” Charles says. “I understand that we may have to skip some travel,” Louise says. “But we can see our plans can work.”
