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Financial Facelift: Couple with high incomes needs tighter budgeting to meet their goals

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Below you will find a real life case study of a couple who are looking for financial advice on when they can retire and how best to arrange their financial affairs. The names and details of their personal lives have been changed to protect their identities. The Globe and Mail often seeks the advice of our VP, Wealth Advisor, Matthew Ardrey, to review and analyze the situation and then provide his solutions to the participants.

gam-masthead
Written by: DIANNE MALEY
Special to The Globe and Mail
Published Friday, Sep.02, 2016

Rose and Ron are feeling squeezed financially despite their high income. Ron, who will be 37 this year, makes $120,000 a year in marketing, while Rose, who will be 40, earns $175,000 working in the health-care field. But they want to renovate their basement and send their children to summer camp. Then there’s the $2,890 a month in child-care expenses and the $2,600 a month in mortgage payments.

They have two children, ages 5 and 2. Their expenses – which they track loosely – seem to eat up nearly every dollar they make.

“How do we put aside enough money for both our kids’ education and our RRSPs while still meeting our monthly obligations?” Ron writes in an e-mail.

“Currently, we do not save any money each month for emergency funds,” Ron writes. “I’m worried that if we have a major home issue, we won’t be able to cover the costs,” he says. “How do we curb our spending? It feels like there’s a never-ending stream of expenses.”

Earlier this year, Rose set up a professional corporation. “With the corporation, how would it be best to shelter income and withdraw it when needed?” Rose asks.

We asked Matthew Ardrey, a vice-president and wealth adviser at TriDelta Financial in Toronto, to look at Rose and Ron’s situation. Mr. Ardrey holds the certified financial planner (CFP) designation.

What the expert says

Fotolia_76895572_XSaThe couple’s three short-term goals are mostly in hand, Mr. Ardrey says. They have borrowed against their house to pay for the basement renovation. With a rate of 2.2 per cent a year and payments of $1,200 biweekly, their $170,000 mortgage will be paid off in five years.

As for retirement savings, Ron and his employer contribute to Ron’s defined contribution pension plan, so he has no extra RRSP room. Rose’s corporation offers a more tax-efficient way of saving for retirement than an RRSP, but more about that later.

They are saving about $2,000 a year to their children’s registered education savings plan (RESP), mainly through gifts. If they top this up to the annual maximum of $5,000 for their two children, they will have enough to pay for a four-year degree for each child, assuming an annual education cost of $20,000 a year for each child, adjusted for inflation, Mr. Ardrey says. “As there is no surplus in their budget, these savings will need to come from a reduction of other expenses.”

As well, they would like to raise their travel budget to $1,000 a month and send each child to summer camp starting when they reach Grade 1. The eldest starts two years from now. The cost initially is $2,500 for Grades 1 and 2, and escalating from there as the children get older.

“By the time they have both children in camp, they will have paid off their mortgage and the funds will be readily available without any further budget constraints,” Mr. Ardrey says.

A major concern for the couple today is budgeting. They have a lifestyle with more than $3,000 a month in discretionary spending alone, plus $1,000 a month in travel costs, the planner says. To achieve all of their short-term goals, they will need to make some adjustments to the expense side of their budget or find a way to increase their income. “The crucial years will be the next five until the debt is paid off,” Mr. Ardrey says. “As they are tight against their budget, they will need all of Rose’s income from the corporation to make ends meet.”

Rose can take dividends instead of salary from her corporation, which will save some tax. Her children (in trust), husband and mother are also shareholders. She might also be able to pay dividends to her mother (depending on her mother’s income), which could further reduce her tax bill.

After five years, when the mortgage debt is paid off, Rose will be able to reduce her draw from the corporation by $50,000 a year and they will still be able to meet their budget, Mr. Ardrey says. This will allow these funds to be taxed at the lower tax rate of a CCPC (Canadian-controlled private corporation) and accumulated for retirement inside the corporation.

When Rose retires, these savings will create a future dividend income stream of $65,000 per year, assuming equal payments from her corporation starting when she retires at 65 and lasting until she is 90. At that time, Rose should look at the income of her adult children to determine if there is any tax advantage to paying them the dividends instead of her, the planner says. “She would pay their reduced tax bill and then take home the larger after-tax income amount.”

When they retire, the planner assumes Rose and Ron will begin collecting maximum Canada Pension Benefits at 65. Their Old Age Security benefits will be clawed back because of their high income. He assumes the rate of return on their investments is 5 per cent a year and the inflation rate that affects their expenses is 2 per cent. He further assumes that they both live until the age of 90.

They plan to spend $85,000 a year in retirement, very close to their spending today once savings, debt repayment, child care and travel expenses are removed, Mr. Ardrey notes. They would like to spend an additional $20,000 a year on travel, inflation adjusted, in today’s dollars, from when Ron retires till he is 80.

Based on these assumptions, they will not only meet their retirement goal, but have a substantial financial cushion. They currently have retirement investment assets of about $1.4-million, and with contributions and growth over the next 25 years those assets will grow to more than $6.5-million, the planner says. They will be able to spend $178,000 a year in current year dollars on an inflation adjusted basis over and above their travel budget. In addition, at the age of 90 they will still own their house.

There are some risks to consider, Mr. Ardrey says. The first is job loss. Though Rose, as a medical professional, wouldn’t likely lose her position, it is conceivable that Ron may lose his job. If that happens it may have a significant effect on their financial plan. Next is insurance risk. Rose has a healthy amount of coverage at more than $2-million, but Ron’s is much smaller at $652,000.

He also suggests some changes to their investment portfolio, which is 28 per cent in cash and 45 per cent invested in Canada. A better approach would be to shift their cash into fixed-income investments and diversify their equity holdings geographically.

Finally, the planner explores how to get funds out of Rose’s corporation tax efficiently. Because the corporation has multiple classes of shares, Rose and Ron can allocate dividends to themselves or their children. Providing dividends to adult children is one way to pay for education or other expenses tax efficiently, Mr. Ardrey says.We recommended Levitra to patients who have erectile dysfunction. Once the child is an adult, the attribution rules no longer apply. Thus, dividends can be paid to the adult child directly when they are in a low tax bracket.

Insurance can also be a useful tool, Mr. Ardrey says. Rose could insure her mother on a policy paid for and owned by the corporation. The policy benefit would be paid to the corporation tax-free. Any amount in excess of the adjusted cost basis would be credited to the capital dividend account (CDA) in the corporation and the funds in the CDA could then be paid out tax-free to the shareholders. If Rose’s mother is in good health, this policy would likely pay out close to Rose’s retirement. “This would provide her with a lump-sum, tax-free payment at or near retirement,” Mr. Ardrey says. “This is one of the most tax-efficient ways to get money out of the corporation.”

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The people: Rose, 40, Ron, 37, and their two children.

The problem: How to deal with short-term financial pressures and still save. Longer-term, how to take best advantage of Rose’s corporation to shelter tax.

The plan: Look for ways to cut spending now. Use corporation’s share structure to make dividend payments to adult children to help cover higher education costs. Consider using an insurance policy to generate tax-free income for Rose. Review insurance and investments.

The payoff: All their goals achieved with plenty of money to spare.

Monthly net income: $15,250

Assets: GICs $72,000; equities $899,000; his TFSA $61,000; her TFSA $30,890; his RRSP $166,000; her RRSP $188,000; market value of his pension plan $40,300; RESP $37,400; residence $882,000. Total: $2.4-million

Monthly outlays: Mortgage $2,600; property tax $580; water, sewer, garbage $70; property insurance $108; electricity $150; heating $145; security $35; maintenance $250; garden $400; transportation $560; groceries $1,250; child care $2,890; clothing $150; gifts $20; vacation, travel $750; dining, drinks, entertainment $880; miscellaneous shopping $250; grooming $250; sports, hobbies $125; subscriptions $15; uncategorized personal spending (children’s activities, house cleaning; gifts, vet bills) $1,500; dentist, drugs $70; vitamins $35; health, dental insurance $100; life insurance $475; disability insurance $250; cellphone $65; Internet $65; TFSAs $900; his pension plan contributions $350. Total: $15,288

Liabilities: Mortgage $170,000

Matthew Ardrey
Presented By:
Matthew Ardrey
VP, Wealth Advisor
matt@tridelta.ca
(416) 733-3292 x230

Financial Facelift: Couple in good shape to retire early, but spending plans need review

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Below you will find a real life case study of a couple who are looking for financial advice on when they can retire and how best to arrange their financial affairs. The names and details of their personal lives have been changed to protect their identities. The Globe and Mail often seeks the advice of our VP, Wealth Advisor, Matthew Ardrey, to review and analyze the situation and then provide his solutions to the participants.

gam-masthead
Written by: DIANNE MALEY
Special to The Globe and Mail
Published Friday, Jul. 15, 2016

Like so many people with defined-benefit pension plans, Norman and Lena can hardly wait to retire. He is 51, she is 50. They have two grown children.

Fotolia_100642283Norman works in manufacturing, earning about $93,700 a year. Lena works for the provincial government, earning $88,900 a year. Although their pensions will not be indexed to inflation, they give the couple choices that people without such plans likely don’t have.

The couple’s goals are to pay off the mortgage on their Greater Toronto Area home, retire and travel. They have a mortgage of $142,340 on a house valued at $750,000.

Should we be continuing to make such high mortgage payments to get that paid off, or should we be investing more money in our RRSPs?” Lena asks. Norman wants to retire in September 2017, while Lena would retire a few years later.

We asked Matthew Ardrey, vice-president and adviser at TriDelta Financial in Toronto, to look at Lena’s and Norman’s situation. Mr. Ardrey holds the certified financial planner (CFP) designation.

What the expert says

Though Lena must wait another nine years before being able to receive a full pension, Norman can retire as early as next fall with a full pension, Mr. Ardrey says.

One large question looms over this couple, the planner says: Can Norman retire even though they will still have mortgage debt? Likely, Mr. Ardrey concludes, but the priority is to pay off the mortgage. “If they maintain their current payment schedule,” he says, “they should be debt-free by 2020, which is only a few years after Norman retires.”

Norman and Lena use their RRSPs to save for retirement. She saves $2,600 a year and he saves $3,400 a year. They use their tax-free savings accounts for short-term goals, such as vacations.

When Norman retires at age 52, he will have a pension of $56,472 a year. That includes a bridge benefit of $16,080 until age 65, at which point his pension will be reduced to $40,390. When Lena retires at age 59, she will have a pension of $51,226 a year. That includes a bridge benefit of $11,830 until age 65, at which point her pension will fall to $39,439.

In addition, both do some work on the side, bringing in at least $2,100 each a year. In preparing his plan, Mr. Ardrey assumes they continue with these roles until their respective age 65. Because they are retiring early, Mr. Ardrey assumes they will get 75 per cent of the maximum Canada Pension Plan benefits; they will get full Old Age Security benefits. “Both of these pensions will be taken at age 65.”

He further assumes that the rate of return on their investments averages 5 per cent annually, that the inflation rate affecting their expenses is 2 per cent and that they live until age 90.

When they retire, they plan to spend $55,000 a year – close to their spending today once savings and debt repayment are removed, Mr. Ardrey says. In addition, they would like to travel, spending $10,000 a year from when Norman retires until his age 80.

Based on these assumptions, Norman and Lena should be able not only to meet their retirement goal, but have a substantial financial cushion,” the planner says. Once their debt is paid off, they can increase their spending by $27,500, to $82,500 a year, over and above travel spending.

Having this financial flexibility is important for the couple because they plan to retire so early, leaving a lot more time for life to present a problem that requires a financial outlay,” Mr. Ardrey says. As well, their budget is less than precise. Spending in some categories is high; in others, such as car expenses, clothing, gifts and vacations, it’s non-existent. He recommends they prepare a more detailed budget before the final retirement decision is made for Norman to ensure the target retirement expenses match what is actually being spent.

Finally, Lena and Norman should review their investment strategy. They have five RRSP accounts, one spousal RRSP and one locked-in retirement account (LIRA). “Though the spousal and LIRA accounts cannot be consolidated, the RRSPs can,” the planner says. Consolidating them would make them easier to manage.

Their retirement assets are invested in balanced funds and individual stocks. “An investment strategy that focuses on asset mix and disciplined investing would serve them better,” he says.

Their current asset mix is 23 per cent cash and fixed income, and 77 per cent equities. Mr. Ardrey suggests they shift their holdings at a rate of 5 per cent a year until they have 60 per cent equities and 40 per cent fixed income. “This,” he says, “will help with any volatility in the markets as they approach and enter the early part of their retirement.”

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The people: Norman, 51, and Lena, 50.

The problem: Can they retire early while paying off a mortgage without affecting their retirement spending goal?

The plan: Keep up the big mortgage payments so the debt will be repaid a few years after Norman retires next fall.

The payoff: A sizable financial cushion to buffer any expenses that might arise.

Monthly net income: $8,950

Assets: His RRSPs $176,820; his TFSA $4,800; her RRSPs $26,520; her spousal RRSP $14,275; her locked-in retirement account $7,576; commuted value of his pension plan $379,750; commuted value of her pension plan $311,690; residence $750,000. Total: $1.67-million

Monthly outlays: Mortgage $3,280; property tax $360; water, sewer $60; electricity $270; heating $125; car lease $420; grocery store $1,200; line of credit $50; dining, drinks, entertainment $850; grooming $125; club membership $125; pets $500; cellphones $185; TV, Internet $200; RRSPs $500; tax-free savings account $800. Total: $9,050. Shortfall $100

Liabilities: Mortgage $142,340; line of credit $5,500. Total: $147,840

Matthew Ardrey
Presented By:
Matthew Ardrey
VP, Wealth Advisor
matt@tridelta.ca
(416) 733-3292 x230
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