Below you will find a real life case study of a couple who are looking for financial advice on how best to arrange their financial affairs. Their names and details have been changed to protect their identity. 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.
Written by: DIANNE MALEY
Special to The Globe and Mail
Published June 22, 2018
After working in the United States for a spell, Joyce and Bill are back in Canada and wondering how to allocate their income to meet competing goals. He is 41, she is 42. They have two children, ages 4 and 6.
Bill makes about $260,000 a year, including bonus, working for an international company. Joyce earns about $45,000 a year working part time in the health-care field. Their goal is to retire at 58 with $90,000 a year after tax.
In the meantime, they want to buy a cottage, take a month-long vacation with the children, pay off the mortgage on their B.C. house and ensure they save enough money for their children’s education.
They have more than $100,000 sitting in the bank and are wondering what to do with it: top up their registered retirement savings plans (RRSPs) and tax-free savings accounts (TFSAs), buy a vacation property, or pay down some of the $800,000-plus mortgage.
“We would like to retire in 17 years,” Bill writes in an e-mail. “How can we make this a reality?”
We asked Matthew Ardrey, a vice-president and financial planner at TriDelta Financial Partners in Toronto, to look at Joyce and Bill’s situation.
What the expert says
The first and most obvious challenge for Bill and Joyce is budgeting, Mr. Ardrey says. They do not seem to know where their money is going. “They need to get a solid understanding of their spending and ability to save. This is a cornerstone of their financial plan.”
Short term, Joyce and Bill plan to buy a cottage for $300,000 in about three years and take a big vacation this year costing $20,000. They are trying to decide how to use the $100,000 or so they have in the bank.
Bill has about $82,000 of unused RRSP room and Joyce $33,000 of TFSA room, the planner notes. “Based on their tax rates, these are the areas in which to focus their investments,” Mr. Ardrey says. In 2018, he assumes $33,000 goes to Joyce’s TFSA, $40,000 to Bill’s RRSP, and $20,000 to vacation expenses.
From the RRSP contribution Bill will get a $20,000 tax refund, which will go to savings. “In addition, the monthly surplus of $1,800 continues to accumulate for their short-term goals.” In 2019, Bill contributes another $40,000 to his RRSP, generating another $20,000 refund.
In 2021, they buy a cottage for $300,000 with a down payment of $75,000 and mortgage of $225,000. They expect to rent it out for a good portion of the year. He assumes a net rental income after expenses of $1,000 a month. “The property being a rental would also have the benefit of making the mortgage partly tax deductible.”
After 2021, Bill and Joyce start to focus on their longer-term goals, which include paying off their mortgage. The $1,800 of monthly savings is now assumed to go to additional payments on their mortgage. “With this strategy, they should pay off their mortgage by 2032, which is just before they plan to retire.”
Once the mortgage is paid off, the planner has them taking the $1,800 a month surplus, plus the $3,790 a month that had been going to the mortgage, and putting it toward longer-term savings.
Bill and Joyce want to provide for their children’s postsecondary education. Mr. Ardrey assumes an annual cost of $20,000 for each child. Education costs are forecast to rise by 4 per cent a year, double the inflation rate. They contribute $2,500 a year for each child to a registered education savings plan until the children turn 18. Even so, they will fall short. “By allocating about half of their postmortgage surplus to these costs, they will be able to foot the bill.”
The plan assumes that Bill continues to take full advantage of his RRSP contribution room, that he and his employer continue making contributions to his deferred profit sharing plan at work, and that both Bill and Joyce contribute the maximum to their TFSAs for the rest of their lives.
The final part of the plan is their investments, which historically have returned 4.83 per cent a year before fees. Mr. Ardrey assumes this drops to 4.28 per cent a year after they have retired and shifted to more conservative investments.
“Based on these assumptions, Bill and Joyce cannot meet their goal,” he says. “They exhaust their investment assets by age 82.” If they sold their cottage at that point, the extra capital would tide them over another five years to age 87. At this point they could sell their house and downsize.
Instead, he recommends they diversify their investment portfolio to include some alternative investments such as funds that hold private debt, global real estate, and accounts receivable factoring to boost their returns and offset stock market cycles. Their existing portfolio holds mainly stock funds and real estate investment trusts (REITs).
“A market correction at the wrong time could really have a significant impact on their ability to retire.” He recommends a portfolio of 70 per cent stocks, 20 per cent alternative investments and 10-per-cent fixed income, with the equity portion falling and the fixed-income rising as they near retirement.
“This portfolio should produce a 6.5-per-cent rate of return before investment costs of 1.5 per cent, providing a net return of 5 per cent,” Mr. Ardrey says – enough to allow Bill and Joyce to achieve their retirement goals.
Client situation
The People: Bill and Joyce, in their early 40s, and their two children.
The Problem: How to catch up with savings and investments now that they are back in Canada.
The Plan: Direct cash and surplus to Bill’s RRSP and Joyce’s TFSA for the tax benefits. After the mortgage has been paid off, redirect the surplus first to the children’s RESP. Review investment portfolio.
The Payoff: A better chance of achieving all their financial goals.
Monthly net income: $16,870.
Assets: Joint account $104,000; cash $2,500; stocks $13,500; U.S. retirement savings $174,261; his TFSA $36,140; her TFSA $7,100; his RRSP $172,970; her RRSP $35,350; commuted value of her DB pension $40,000; RESP $13,300; residence $1,360,000. Total: $1.96-million.
Monthly outlays: Mortgage $3,790; property tax $435; water $130; home insurance $75; heat, hydro $250; maintenance, garden $275; transportation $410; groceries $1,200; child care $785; clothing $425; gifts, charity $135; vacation, travel $835; dining, drinks, entertainment $510; subscriptions $35; other personal $600; TV, internet $145; spending that is unaccounted for $1,870. Total lifestyle spending: $11,905.
Plus: RRSP $400; RESP $415; TFSAs $915; his and his employer’s group pension plan contributions $1,435. Total Savings: $3,165. Total monthly outlays: $15,070. Surplus: $1,800.
Liabilities: Mortgage $808,475 at 2.8 per cent.
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Some details may be changed to protect the privacy of the persons profiled.
