Saturday, July 18, 2009
No place like (affordable) home
Special to The Globe and Mail
In Vancouver, a couple we'll call George, 47, and Suzanne, 44, ought to be enjoying the benefits of their careers. They have a combined pretax income of $144,000 a year from George's job in software development and Suzanne's in corporate management, but the costs of raising their two children, ages 4 and 2, and the high price of houses have left them in a mid-price condo.
"We would like to move up to a house, but don't want to overload ourselves with debt," Suzanne explains.
What our expert says
Facelift asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with the couple. "They can get a lower interest rate on a mortgage on a new house than what they currently pay and have a comfortable retirement," he says.
George and Suzanne have $190,000 in their RRSPs, $100,000 in taxable stocks, $130,000 in cash, $15,000 in RESPs and life insurance with a cash value of $7,500. Their only liability is the $158,000 due on the mortgage on their $360,000 condo. They pay their credit card bills in full each month.
Their mortgage interest rate, 5.2 per cent, is high by today's standards. They can make prepayments equal to as much as 15 per cent of the original balance of $175,000 each calendar year. The mortgage is up for renewal in August, 2011. They can make a penalty-free payment of $26,250 this year, Mr. Moran notes.
Cash is earning less than the interest they would save by prepaying the mortgage. Moreover, interest they might earn is taxable. Best course - make one prepayment this year, perhaps another next year if they prefer to wait six months, and pay the remaining balance in a lump sum. The penalty will be a few months' worth of interest. With present rates as low as 2.85 per cent, prepayment in full is worth considering, the planner says.
George and Suzanne are skilled at balancing tax rates and RRSP contributions. George earns $60,000 a year, which is less than Suzanne's $84,000 annual pay. So George, the lower-earning partner, claims child care expenses to a limit of $7,000 a year per child under 7. After deducting $14,000 of the $24,000 annual child care bill and payroll taxes, his net taxable income will decline to the top of the lowest tax bracket. An RRSP contribution would create a refund equal to 22.7 per cent of income or less and is, therefore, not tax efficient, Mr. Moran notes.
Suzanne is in a higher tax bracket. Part of her income is taxed at 29.7 per cent and part at 32.5 per cent. Those rates make RRSP contributions more tax efficient. She currently puts $1,333 a month into her RRSP. She has $65,000 of room and should contribute that amount, drawing funds from her non-registered stock portfolio or contributing the stock for an in-kind contribution. She should deduct the contribution over three years, Mr. Moran suggests. Her refund will be about $6,000 a year in addition to her current refund. The swap from non-registered to the RRSP portfolio will also defer taxes on asset growth, he adds.
The New House
If the couple buy a detached house for $650,000, they would add $290,000 to the value of their present $360,000 condo. They could also use funds left over in the taxable stock portfolio after the mortgage is paid off. If they put $2,114, which is what they currently pay for their condo plus some of their monthly savings, each month into a new mortgage, as they have budgeted, they could have the house paid in 14 years at a 4 per cent interest rate or 16 years at 5 per cent, the planner says.
If Suzanne continues to put $1,333 a month or $15,996 a year into her RRSP and adds $65,000 to use up her space, her $190,000 RRSP balance will grow to $819,900 by the time George is 65, assuming a 3 per cent real rate of return on assets.
This capital would support an annual payout of $42,422 for the 28 years from George's age 65 to Suzanne's age 90, Mr. Moran estimates. Each should qualify for 90 per cent of maximum Canada Pension Plan credits, or $9,815 a year. Each will receive Old Age Security benefits, currently $6,204 per year. Adding it up, the couple will have $74,460 of pretax retirement income at age 65. That is less than their present pretax income, but by eliminating such expenses as child care, RRSP and RESP contributions, and mortgage costs, they are likely to have more discretionary income than they now have, Mr. Moran explains.
The only major deficit in the couple's financial planning is life insurance, the planner notes. Each partner needs $500,000 in the event of the death of the other, Mr. Moran advises. Suzanne has $120,000 from her employer, so she needs to buy only $380,000 more term coverage at a cost of $528 a year. George needs half a million as well, for which the cost would be about $780 a year. Premiums can be set for 10 years, Mr. Moran suggests.
"They can buy a small house in Vancouver or a bigger one far away at the price of a long daily commute," Mr. Moran says. "The financial problem is, therefore, to balance the chances of market price changes with the stress and cost of a great deal of driving."
The People: Vancouver couple in mid-40s with two young
The Problem: To buy a house and fund retirement
The Plan: Pay off high-interest mortgage, boost RRSP savings
The Payoff: Sufficient funds to buy house and maintain lifestyle in retirement
Net monthly income: $9,850
Assets: Condo $360,000; RRSP $190,000; RESP $15,000; Cash $130,000; Taxable stocks $100,000; Life insurance cash
value $ 7,500; Total $802,500
Monthly disbursements: Mortgage pmt. $1,268; Property taxes $170; Strata fees $200; Food, diapers $1,500; Restaurant $200; Car & home ins. $288; Car fuel & repairs $400; Charity & gifts $200; Child care $2,000; Clothing $150; Utilities, internet $200; Medical, dental $300; RESP $400; RRSP $1,333; Travel $250; Misc. $145; Savings $846; Total $9,850
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