A couple we’ll call Luis, 45, and Martha, 40, live in Alberta with their child Alex, age 8. Martha is the principal breadwinner with a base gross income of $6,615 per month plus variable bonuses and employer contributions to a company pension plan. Luis brings home $575 per month from part time work he does when he is not looking after Alex. Including bonuses and the Canada Child Benefit, which goes to Alex’s RESP, they bring home $6,233 per month. Their financial issues lie in the modest earnings of a partner who currently takes care of their child and timing future rental income from an apartment in which parents, who have modest resources, live rent free.
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They have an aging condo recently appraised at $255,000 for their residence, a $444,500 rental property and financial assets of $291,357 including $16,708 in an RESP for Alex. Their total assets are $996,857. There are liabilities of $435,605 including a $127,563 mortgage for their condo and a $308,042 mortgage for the rental house. Their net worth, $561,252, is modest for their ages but they are diligent savers, meticulous record keepers and are struggling to be good planners.
They are looking ahead to retirement. “If we want to quit work when Luis is 65 and have $65,000 per year after tax, how much would we have to save each month?” Martha asks. Their savings work out to $1,080 a month for their RRSPs plus $175 for the RESP. Their monthly RRSP savings are composed of $463 from their paycheques and $617 from Martha’s employer, and total $12,960 per year.
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Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Luis and Martha. “There is a lot that is right about this couple’s finances — no debt other than mortgages on their home and rental property, reasonable amortization on the home mortgage that will be paid in full when they are 65, and potential future profitability on the rental.”
The problems in the case are less about attaining the goal of the target retirement income, but of getting there efficiently, Moran says. For now, the couple is substituting generosity toward Martha’s parents, who live in one unit of their rental house without paying rent, for profit. The analytical problem lies in estimating when the rental will become profitable. We hesitate to predict the parents’ future. We also do not know when Luis may return to full time employment nor what he will earn. Regardless, the target retirement income is attainable, Moran concludes.
Alex has a $16,708 Registered Education Savings Plan. It is growing with annual contributions of $2,100. Assuming that Luis and Martha add $400 per year by trimming food and restaurant costs by $33 per month, to bring the annual contributions to $2,500 and that they attract the Canada Education Savings Grant of the lesser of $500 per beneficiary per year or 20 per cent of contributions, the resulting $3,000 annual contribution would boost the fund to $52,300 when, after age 17, Alex is ready for post-secondary education. That works out to $13,075 per year for four years, enough for tuition and books for most institutions in Alberta, Moran explains.
Their largest investment is the $444,500 rental house. It has two suites. One is occupied rent-free by Martha’s parents and the other has a tenant who pays $1,700 monthly rent. $755 of the $1,429 monthly mortgage payment is interest, the remainder is forced savings that is really just adding to their equity. Other rental expenses are $827 for maintenance, utilities, property tax and insurance. On this basis, the present return of the building is about zero.
The rental is not profitable, but in a few years, the parents may not occupy the suite. If we assume a higher rent is being received, say $800 for the parents’ smaller suite plus the $1,700 they already receive, total $2,500 less $827 for expenses and $755 actual interest, the net rent would be $918 per month or $11,016 per year. That rent should be available by time Luis and Martha retire. Their present equity in the rental ($450,000 market value less $308,444 mortgage debt) is $141,556.
That’s a good return plus or minus capital appreciation. In future, the interest rate they pay, 2.94 per cent, may rise, but they may also be able to raise rents. Moreover, rental condo mortgage interest is tax-deductible. Keep the rental, Moran advises.
If the couple’s $187,385 of defined contribution plan and RRSPs — they are really similar critters but with different names — grows by 6 per cent per year less 3 per cent for inflation, and if they continue to add $12,960 per year, it would become $686,678 in 20 years at her age 60 and would support payouts of $35,033 per year in 2019 dollars for 30 years to her age 90.
At present, Luis and Martha have $21,796 in their Tax-Free Savings Account. They could use that money to pay down their $127,563 home mortgage and so shorten the amortization. However, the 2.94 per cent mortgage interest rate is low and much of their monthly payments are a return of capital from paying down principal. If they put their $42,968 taxable investments into the TFSAs and if the $64,764 total grows at 3 per cent over the rate of inflation, it will become $117,000 in 20 years at Martha’s age 60. That sum, earning 3 per cent after inflation for 30 years to her age 90 would yield $5,800 per year.
When Luis and Martha are both 65, they would have retirement income of $11,016 from their rental, $35,033 from RRSPs, $5,800 from TFSAs, $20,415 combined Canada Pension Plan benefits based on employment history and Old Age Security benefits of $14,434 for total income before tax of $86,700.
With splits of eligible pension income, no tax on TFSA payouts and a 20 per cent average tax rate, they would have $70,520 annual disposable income. That’s $5,880 per month. That’s more than their target of $65,000 per year after tax, which is $5,417 per month.
3 Retirement stars *** out of 5
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