Expert suggests a financial plan updated every five years will provide both clarity and a big picture view

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Alberta-based 30-somethings Peter* and Kristin have been married for two years and recently became first-time parents. They hope to have another child in the next few years and see themselves buying some property and building a home where they will retire.

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To get there, they are applying all the personal finance lessons Peter learned as a young boy reading the finance section of the newspaper and The Wealthy Barber: Save at least 10 per cent of your income; don’t spend more than you make; pay off your credit cards each month. Kristin shares Peter’s approach to money management and together they are focused on building their equity and wealth to create the future they want to enjoy.

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Peter is a high school teacher and currently earns $95,000 a year. Kristin works in the automotive business her parents own and operate, and earns a base salary of $65,000 plus commissions, which combined can total up to $100,000 a year. She plans to continue working in the family business for the foreseeable future, but succession plans have not been determined.

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Peter and Kristin have a $230,000 mortgage on their principal residence, which is valued at $550,000, and a $200,000 mortgage on a rental condo (Kristin’s previous home before meeting Peter), which is valued at $300,000. The condo generates a small profit of between $1,000 and $3,000 each year. They have no other debt.

The couple are currently making extra mortgage payments on the principal residence, but wonder if they should direct more money towards investing instead. They also want to know if they should sell the rental property to further diversify investments or possibly buy land now to build on later. They currently have $42,000 invested in tax-free savings accounts (TFSAs) and $84,000 in registered retirement savings plans (RRSPs).

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“These funds are self-directed, invested in equities, with low-fee (North American) ETF index funds comprising the majority of my holdings and all my wife’s holdings,” Peter said. “We don’t have any non-registered investments.”

Peter contributes $500 a month to his TFSA and Kristin contributes $200 to hers. They each contribute $150 a month to their respective RRSPs to settle the Home Buyers’ Plan withdrawals they made to purchase their home. This is in addition to the combined $9,500 they contribute to Kristin’s RRSP each year, something they have done since they married because she doesn’t have a work pension. Peter’s teacher’s pension will provide an income of 50 per cent of his best five-year average salary, or $53,000 a year based on current earnings.

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The couple would like to know if they are saving enough each month and whether they should direct more money to Kristin’s TFSA versus her RRSP. Peter and Kristin also plan to contribute at least $2,500 each year to a registered education savings plan (RESP) to capture the full Canada Education Savings Grant (CESG).

“Is there any other way we can save tax efficiently to invest for our children’s future outside of CESG? What investment vehicle options are there for RRSP, and can they be self-directed?” Peter asked.

He also wonders about their life insurance needs.

“My wife has a universal life insurance policy of $100,000 with a $340-per-year premium and I have a (2X) annual salary death benefit — approximately $200,000 at this time,” he says. “We are both in good health and have full health benefits through our work insurance plans. How much life insurance should we have for our child/children?”

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What the experts say

“They are off to a great start,” Eliott Einarson, a retirement planner at Ottawa-based Exponent Investment Management, said. “They are living within their means, have no consumer debt, their mortgages are modest and payments accelerated. They can save on top of that and they are asking all the right questions for their future.”

He suggests a financial plan updated every five years will provide both clarity and a big picture view.

“A lot can change when you’re looking 30 years into the future,” he said.

That said, assuming they both retire at age 65, Peter’s teacher’s pension, which should pay at least $50,000 annually in today’s dollars, plus maximum annual Canada Pension Plan (CPP) payments of about $15,600 each, depending on past and future contributions, and maximum annual Old Age Security (OAS) payments of $8,292 make for a good starting point.

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“They can think of these guaranteed, but taxable sources as the foundation of their future retirement income,” Einarson said.

Their RRSPs in today’s dollars with current annual contributions of $13,100 and a net-of-inflation three-per-cent return could grow to $845,825 by the time Peter turns 65.

A lot can change when you’re looking 30 years into the future

Eliott Einarson, retirement planner

“This capital continuing to grow at an average of three per cent per year net of inflation for the following 30 years to age 90 will generate $41,896 per year of taxable income for them,” Einarson said. “Adding up his potential future pension, CPP and OAS at 65 and their combined RRSPs would give them a total taxable income of about $139,000, or $69,500 each from all taxable sources. That is about 70 per cent of their current incomes. With more detailed planning, they can look at other scenarios as life unfolds, including retiring before 65.”

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As for their investment approach, investing monthly and focusing on equities makes sense given their time horizon.

“Equities are more reliable after inflation than fixed income investments,” Ed Rempel, a fee-for-service financial planner, tax accountant and blogger, said. “Their index exchange-traded funds are a good choice if they are not going to get professional advice. The Canadian stock market has lower long-term returns and is not a properly diversified portfolio. They should probably invest in both MSCI World and S&P 500 index ETFs for more effective and reliable returns.”

Einarson thinks the couple’s focus on doubling mortgage payments represents a risk-free return, but Rempel said there is no need to rush in paying off the mortgage as interest rates are lower than the returns they should expect from their 100-per-cent equity investments.

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Peter and Kristen are making extra mortgage payments on their principal residence.
Peter and Kristin are making extra mortgage payments on their principal residence. Photo by Getty Images/iStockphoto

“It’s a good idea to pay off their mortgage by the time they retire. Until then, I suggest reducing their mortgage payment to the basic payment, which gives them about $1,400 per month more to invest,” Rempel said. “They will probably be in a lower tax bracket after they retire and he will be able to split his pension income with his wife on their tax returns, which makes maximizing RRSPs before TFSAs more effective.”

The planners also differ on when the couple should purchase their retirement property. Einarson said it’s doable now, particularly if they sell the income property, and “land is likely not going to get cheaper.” But Rempel said buying now ties up money that could be invested more effectively.

“It’s better to wait until the last couple of years before retirement,” he said. “They may change their mind about what they want and where they want to be between now and then.”

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As for the rental property, Rempel recommends selling it in about five years when it should be worth roughly $350,000 and the mortgage is down to about $175,000 or half the value.

“At that point, investments in equities — without a loan — should provide a higher return, less tax and no work,” he said.

Both experts agree the RESP should provide the money necessary for postsecondary education.

“Saving $2,500 per child over 18 years with an average three-per-cent net-of-inflation return and the CESG grant will see values well over $100,000 per child,” Einarson said.

Another option: investing in informal trusts.

“If they invest as they are for growth, capital gains are taxable to the kids, which means tax free since they each get $14,000 per year in a basic personal tax credit,” Rempel said.

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Einarson recommends the couple get term life insurance that is renewable and convertible with the option to change to permanent life insurance.

“It has to be enough to replace income needs, including saving for retirement for a survivor, usually calculated as part of a lump sum that can be invested,” he said.

Rempel suggests they get a joint 20-year term, $1-million life insurance policy.

“The premium will likely be only $100 to $150 per month and protects both of them well,” he said.

As for life insurance for the kids, Rempel said it’s not necessary.

“There is no logic in getting life insurance now when the children won’t need it until they have people dependent on them in 20 or 30 years,” he said. “At that point they can buy 10 times that insurance coverage for the same premium. Ignore the sales pitches.”

* Names have been changed to protect privacy.


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