In Toronto, a couple we'll call Roger, 39, and Ellen, 42, are developing careers with industrial companies and raising their three children ages 6, 8 and 10. Roger and Ellen each earn $75,000 before taxes. Bonuses add another $12,000, pushing their annual family income to $162,000.
Even with their substantial incomes, fixed costs that include a $4,250 monthly mortgage payment and $1,400 a month for private school fees have left them strapped for cash. The crunch is so serious that they sometimes have to put their company-paid daily lunch allowances of a combined total of $17 into their grocery budget.
Ellen hopes to quit work in five years, Roger in 26. Right now, those plans are questionable. They have only $45,000 in registered retirement savings plans, just $8,000 in registered education savings plans for the kids and, as yet, no clear path to retirement. Accelerated payment of the mortgage will save future interest charges, but today they are house poor.
"Our goal is to pay off the mortgage within the next five years so that Ellen can afford to retire," Roger explains. "We feel we have to pay off the mortgage very soon. If Ellen stopped working, which is her plan in five years, then we could not afford to carry the mortgage and other expenses. We have defined benefit plans with large companies. Now the question is whether our plan will work."
What our expert says
Facelift asked Dan Stronach, a financial planner in Toronto, to work with Roger and Ellen in order to clarify their goals and to develop a strategy for meeting them. His take on the family situation is that they have to understand their pensions.
"Roger and Ellen tend to see the large print on their pension plans, but, really, they have to look at the fine print," Mr. Stronach says. "Roger has changed jobs so often that he has compromised his benefits while Ellen has been a part-time worker and has not generated substantial pension benefits."
Superficially, at least, life is good for the couple. They have two cars, each paid in full by their respective employers. Roger and Ellen have only a personal use benefit to report for their personal taxes.
But Roger's expectation that he will have a substantial company pension is misplaced, Mr. Stronach says. Ellen's plan to retire in five years depends on her employer's willingness to provide early pension benefits. They each need to put in more years with their employers, he insists.
Roger has not remained with any employer very long. His average tenure has been four years, though pension contributions from his last employer have been transferred to his present employer. But he is not sure how long his present job will last. Industrial rivalry and even regulatory issues could, he fears, end his job with his company.
If Roger does stay with his present employer -- with which he has just one year's service -- for the next 26 years, then at retirement at age 65 he can expect a pension of $46,908 in future dollars when he retires in 2031, Mr. Stronach estimates. The projection is based on his current salary growing at 2 per cent a year. That works out to $3,909 a month. But if Roger continues to change employers, the pension could be reduced by the year of entitlement he loses each time he moves to another job.
Ellen has worked on a mostly part-time basis. She is employed full time now. If she works full time for the next five years, then, adjusted for the loss of 4 per cent of maximum benefits for each year is she retired before reaching age 62, her pension will be reduced by at least 63 per cent of maximum benefits to $1,130 a month in future dollars, he explains. The benefits can be taken as a pension or rolled into a locked-in retirement account with limited withdrawal rights.
In order to provide a bridge to Ellen's company pension benefits, she should top up her RRSP contributions. She has $9,624 of space available, Mr. Stronach adds.
Once Ellen's RRSP is fully funded, Roger can shelter additional income in his company's deferred compensation plan, the planner says. The plan permits an employee to contribute the greater of 18 per cent of earned income to a maximum of $18,000 or the pension adjustment for each year.
Roger can receive full Canada Pension Plan benefits in 27 years at an estimated rate of $16,676 a year in future dollars, assuming that benefits rise at 2 per cent a year, the planner explains. Roger will also be eligible for Old Age Security at a rate of $789 a month in future dollars, subject to partial clawback.
Ellen can receive CPP in 18 years at an estimated rate of 25 per cent of the maximum payout for a total of $207 a month in future dollars. She will be eligible for OAS payments beginning in 2028 when she is 65. In her first whole benefit year, she would receive $744 a month in future dollars, assuming inflation runs at an annual rate of 2 per cent a year, Mr. Stronach estimates.
Ellen's retirement in just five years will reduce family income drastically.
Roger has been using a variety of strategies to increase his RRSP, chiefly relying on recommendations from a much publicized investment guru. Assuming a 5-per-cent return after fees on investments and a 2-per-cent average annual rate of inflation, then in 2032, the first full year of Roger's retirement, they will have total family net income of $101,814 in future dollars. Their expenses will be $85,209, Mr. Stronach estimates.At retirement, their non-registered investments will have grown to $408,333 and their registered investments to $242,060, the planner says. Those investments will produce $30,800 each year, which is already included in their total incomes, the planner notes.
Roger and Ellen need to increase their life insurance coverage, Mr. Stronach advises. He needs $500,000 of coverage to pay for education of their three children and to pay off their mortgage. Ellen should have a similar amount, the planner advises.
In the large picture, the plan that Roger and Ellen have developed hinges on their ability to sustain their large mortgage prepayments, Mr. Stronach says. That really adds risk to their strategy, because they are left with no financial flexibility.
"They have painted themselves into a corner. If any part of their plan fails, they could have to get second jobs just to survive their cash crunch. It would be better for them to be making discretionary mortgage prepayments and to develop an emergency fund. That would increase the family's security and well being."
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Client situation
Roger, 39 and Ellen, 42, live in Toronto with their three children.
Monthly net incomes: Roger, $4,830; Linda, $4,330.
Total: $9,160.
Assets: House, $400,000; RRSPs, $45,000; RESPs, $8,000.
Monthly expenses: Food, $1,040; mortgage, $4,250; school fees, $1,400; utilities, $700; charity, $90; gym fees, $60; loan payment, $300; home and life insurance, $95; clothing, $150; vacations, $170; RRSP, $417; miscellaneous, $300; savings, $188.
Total: $9,160.
Liabilities: Mortgage, $250,000 at 3.5 per cent; loan of $25,000 from family member with no interest charge.