Posted by Optimize on January 24, 2020
Couple ready to play the long game as they plan for retirement
Author: Warren MacKenzie, Head of Financial Planning at Optimize Wealth
Special to The Globe and Mail
With four children and busy working lives, Aden and Alison are wondering how to set their financial priorities. Should they pay down the mortgage first or save for their children’s education and their own eventual retirement?
Aden is 46-years-old and earns $180,000 a year plus bonus in a senior management job. Alison is 44 and earns $56,000 a year plus bonus. Their children range in age from 7 to 17. Alison and Aden have a home valued at $875,000 in the Greater Toronto Area with a mortgage of about $208,000, which they plan to pay off in 10 years or so.
Their goal is to semi-retire at the age of 60 and retire fully at 65 with $90,000 a year after-tax. In the meantime, they want to spend time with their children, taking a camping and road trip once a year at a cost of $5,000. When it comes time for the children to go to university, Alison and Aden want to contribute $6,000 a year to each child’s expenses.
“What investments should we maximize – paying off the mortgage, contributing to tax-free savings accounts, RRSPs, a spousal RRSP – to meet our retirement and financial goals?” Aden asks in an e-mail. He wonders whether he should stop contributing to his personal RRSP and shift to a spousal RRSP for Alison so they can split their pension income.
We asked Warren MacKenzie, head of financial planning at Optimize Wealth Management in Toronto, to look at Aden and Alison’s situation.
What the expert says
“Aden and Alison are level-headed and sensible Gen-Xers, and they’re doing a good job of managing their finances and their family,” Mr. MacKenzie says. They worry about whether they’ll have enough money to educate their children and achieve their other goals, he adds.
Given their solid income, they should have no problem, the planner says. But the family is exposed to a big potential risk. “They are totally dependent on Aden’s high income.” If something untoward were to happen to him, “Alison and the four children would be in dire straits,” Mr. MacKenzie says.
Aden has disability insurance coverage at work that would cover 66 per cent of his salary if he was unable to work. He should consider spending about $1,500 a year to purchase a $200,000 critical illness policy that would provide the cash necessary to pay off the mortgage if he were to fall ill, the planner says. “But with $1.1-million in life insurance, he is underinsured in the event of a premature death, thereby exposing his family to an unnecessary risk,” he says. “Aden should have at least $2.5-million of term life insurance, or a combination of term and whole life.”
Next, the planner looks at the children’s registered education savings plan, which is now worth $19,000. Until the youngest child finishes university, Aden should continue to contribute $6,000 a year to the family RESP. By the time the youngest child graduates, Aden’s contributions to the plan will have been about $120,000. “The Canada Education Savings Grant, plus the estimated earnings on the balance in the RESP, will amount to about $40,000 over the next 16 years,” he says. This adds up to $160,000, which would be enough to support each child in the amount of $10,000 a year for four years.
“They will have the cash flow to do this and this has removed a big concern.”
Although they are in good shape financially, there are some things they can do to improve their financial situation, the planner says.
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“Income tax will be their biggest expense for the rest of their lives,” he says. “One of the best ways to increase their financial security will be to minimize income tax. And one of the best ways to minimize income tax is by income-splitting to the extent possible.”
Aden should be making the maximum contribution to a spousal RRSP for Alison, Mr. MacKenzie says. “At Aden’s tax rate, this will give him a tax deduction of almost 50 per cent of the RRSP contribution.” Alison will withdraw the money when she is no longer working and in a much lower tax bracket.
“This strategy will benefit them in two ways: They’ll get the tax-free compounding of investment income for many years, and when the funds are eventually withdrawn, the tax rate will be lower than it was when they got the deduction for the contribution.” Aden should continue making contributions to the spousal RRSP until Alison’s RRSP is as large as his, which is more than $452,000, he adds.
With regard to their investment portfolio, they are almost entirely in broadly based exchange-traded funds and indexed funds. About 80 per cent of their investments are allocated to equity investments. To diversify their holdings, they might want to allocate some of their savings to actively managed funds and alternative investments such as private equity, private debt, infrastructure and real estate funds, Mr. MacKenzie says.
“The inclusion of the alternative asset class has the effect of increasing the average rate of return while reducing volatility,” he adds. “Individuals with relatively small portfolios can access this type of investment,” the planner says, and many funds are “quite liquid,” which means they can be easily traded.
Aden and Alison are directing their surplus cash flow to paying down their car loans and funding the family RESP, Mr. MacKenzie says. “When their debt has been paid down, they should use their surplus cash flow to catch up on their TSFA accounts,” he says. Aden has only $615 in his TFSA and Alison has nothing.
Long term, assuming an inflation rate of 2 per cent, and lower spending after the children leave home, at the age of 65, Aden and Alison’s $90,000 spending goal will have risen to about $160,000 a year, the planner says.
His calculations show that by this time they will each get about $35,000 a year from Canada Pension Plan and Old Age Security benefits (with inflation), for a total of $70,000. They will each turn part of their RRSPs into registered retirement income funds (RRIFs) and withdraw $30,000, for a total of $60,000. They will require an additional $30,000 of cash flow.
“This will come from the income earned on their non-RRSP portfolio, by then $1-million,” Mr. MacKenzie says. Part of this growth will come from downsizing their home when the children have moved out and investing the net proceeds. By the age of 90, their net worth will still be more than $1-million.
The people: Aden, 46, Alison, 44, and their four children
The problem: How to set priorities to help them achieve their financial goals.
The plan: Continue saving to RESP, Aden contributes to spousal RRSP for Alison. Once debt is repaid, they shift focus to TFSAs.
The payoff: Financial security
Monthly net income: $13,290
Assets: Cash $27,000; his TFSA $615; his RRSP $452,050; her RRSP $61,575; her locked-in retirement account $10,240; RESP $19,000; residence $875,000. Total $1.45-million
Monthly outlays: Mortgage $1,610; property tax $415; home insurance $105; utilities $330; household maintenance $500; car insurance $265; fuel, oil $615; vehicle maintenance $150; parking, transit $330; groceries $1,200; child care $450; clothing $475; car loans $885; gifts, charity $400; vacation, travel $400; other discretionary $150; dining out, drinks, entertainment $980; personal care $325; club memberships, sports, hobbies $360; pets $55; subscriptions $205; other personal $400; doctors, dentists $250; prescriptions, supplements $80; health, dental insurance $15; life insurance $255; disability insurance $85; cellphones $280; RRSP $815; TFSA $200; RESP $500; her pension plan contributions $90. Total: $13,175
Liabilities: Mortgage $208,300; car loans $23,000. Total: $231,300
Warren MacKenzie is Head of Financial Planning at Optimize Wealth Management