Parenthood Means Giving up Luxurious Lifestyle
Created on Friday, 14 October 2011 08:00
In Vancouver, a couple we’ll call Martin, 35, and Liza, 33, are thriving in their careers. During the week, they live in Liza’s rented apartment. Weekends they spend at Martin’s $500,000 condo in Whistler, skiing in winter and hiking in summer. They are living the good life and are considering having a child, with Liza taking a year off from her job.
Martin and Liza have been living for the present. With combined before-tax incomes of $244,000 a year — or $14,630 a month after tax — they spend nearly all of it. Travel: $1,100 a month. Clothes and grooming: $800 a month. Sports: $1,200 a month.
They have $140,000 in financial assets plus $350,000 equity in the Whistler condo. Their employer has a defined-benefit pension plan that will pay them more than $100,000 a year when they retire, the exact amount depending on how much time Liza takes off from her work to have and raise children.
They would like to buy a townhouse in Vancouver at a cost of perhaps $700,000. But Liza might not want to stay in her job for her full career. That would mean the family would have to get by on Martin’s $8,830 monthly after-tax income. That could mean giving up some luxuries or adding to the risk that their well-heeled lives could come crashing down if one or both faced the loss of a job or other crisis.
Family Finance asked Derek Moran, RFP, head of Smarter Financial Planning Ltd. in Kelowa, B.C., to work with Martin and Liza to stress test their plans and to answer the question whether they can afford the townhouse and the condo along with two kids.
“Life is about to get a lot more expensive for the couple,” Mr. Moran says. “If they do have children, some of the extras they now enjoy will have to be on hold for a few years. The question that they will have to answer is whether trading freedom for family life will be worth it. Their problem is philosophical as much as it is financial.”
Martin and Liza already spend 82% of their income. Adding the mortgage cost of a $700,000 condo would stress their budget. Assuming they put 10% down and finance $630,000 at 5.2% on a five-year, closed-term mortgage with a 25-year amortization, monthly payments would be about $3,750. They could afford that if they ended their city apartment rental at $1,100 a month, cut $800 a month for clothing and grooming, eliminated $1,100 a month for travel and the $735 they spend in restaurants – for a total of $3,725. Whether they would want to give up all that is another issue. Property taxes would add to their costs. Taxes average 8/10ths of 1% in B.C. On the $700,000 property, that would add $5,600 a year, or $467 a month. They could nick the $1,200 a month they spend on fitness and sports to cover that bill. The choice is theirs.
If Liza has her first child and takes maternity leave, her income will decline from $69,600 a year before tax to $42,420 before tax. Tax on her cash flow while on leave would be $6,855, so her net income in the period could be $35,565, Mr. Moran estimates. That would cut total household income to 58% of the present $244,000 before tax. At this point, payments for the Vancouver townhouse will have to be financed via borrowing or consumption of capital.
Financial recovery could require the couple to rent out their Whistler property when they are not using it. If the property were to generate $24,000 a year, it could offset part of mortgage interest, taxes and condo fees of $43,800 a year. Appreciation could cover some or all of this cost, but it is a bet on an already pricey market, the planner says. Some of the mortgage carrying cost is accruing equity, but on a cash basis, the cost would remain a strain on their budget, Mr. Moran notes.
If the couple wants more children, some larger luxuries will have to go. If Liza has a second child and takes another year off, the parents will be left trying to raise two children and pay two mortgages that, with taxes and fees, could total $7,867 a month. That’s more than half their current take-home income or more than two-thirds of their income when Liza is on maternity leave. They must decide either to sell the Whistler condo or skip buying a Vancouver townhouse altogether.
One problem the couple won’t have is pension income. Their employer provides each with a defined-benefit pension with probable but not guaranteed indexation. Martin can expect a $60,000 annual pension with a $17,868 annual bridge to age 65. Liza can expect a $47,244 pension if she works full-time to age 57 plus a bridge to age 65 of $7,872 a year. Taking time off for maternity leave could cut down her pension.
Martin should earn full Canada Pension Plan benefits of $11,520 at current rates. Liza should get 80% of total benefits or $9,216, for a total of $20,736 at current rates. Each will get full Old Age Security benefits at age 65 of $6,456 a year. Total public pension benefits — $33,648. Added to Martin’s $60,000 pension and Liza’s $47,244 pension, both at age 65, they would have $140,892 a year before tax in 2011 dollars. RRSP income would add to the total. However, if future tax law still permits it, they will be able to split pensions. That would allow them to avoid much of the OAS clawback that now begins at $67,668 a person a year.
This analysis shows the minimum feasibility of having one child, buying a second home and retiring. In fact, the costs of raising children are not factored in. Academic studies put the cost of having children at between $160,000 and $250,000 a child from birth to age 18, not including parents’ foregone income. Post-secondary costs would add to the expenses.
“They cannot afford to buy the second home, raise two kids and maintain their present way of life on just Martin’s after-tax income nor loss of his employment for any reason,” Mr. Moran says. “It’s too risky to live with that level of debt and its required spending.”
(C) 2012 The Financial Post, Used by Permission