In Calgary, a couple we'll call Mark, 30, and Helen, 28, are building their careers, He is in health services, she is in financial services. Together, they have a gross annual income of $177,120. That ought to be enough for this currently childless couple to live well. They plan to marry and contemplate retirement at age 55.
But there are problems. The biggest is debt service charges of $6,155 a month, most of which goes to pay off student loans. That's 57 per cent of their monthly after-tax income.
What our expert says:
Facelift asked Derek Moran, head of Smarter Financial Planning Ltd., in Kelowna, B.C., to work with Mark and Helen to make their money work harder for them.
"There are glaring opportunities in this case," he explains. "What they have to do is get rid of their debts with cash they already have."
First move - use $150,962 of non-registered assets to pay off student loans that total $113,260. These loans cost the couple interest rates of between 7.25 and 8.25 per cent a year. Once the student loans are paid off, they can set aside $20,000 for their wedding. That leaves $17,702 to pay down their mortgage.
By paying off their student loans, the couple will reduce the chance that interest rate rises will increase their carrying costs. Moreover, they will be getting rid of the relatively ineffective deductions for student loan interest. Because student loan interest is a non-refundable tax credit rather than a fully deductible expense like RRSP contributions, the deductions generated by student loan interest are less valuable than one might expect. Indeed, after tax adjustments, the net cost of their student loan interest is still 5.44 per cent a year, which is more than the interest they have to pay for their condo mortgage, 5.03 per cent.
Once the student loans are paid off, the couple will have freed up $4,650 a month of expenses they have spent servicing their student loans. They can then use this money to pay down their mortgage. If they put the full $4,650 toward mortgage reduction, they will be mortgage free in less than four years, Mr. Moran says.
Alternatively, they can add $3,700 per month now to the mortgage payments and $950 a month to Mark's registered retirement savings plan. If they did that, they would be mortgage free in less than five years. This plan takes longer to liberate the mortgage, but it is more tax-efficient.
These plans will run down the couple's cash. They can use a line of credit secured by their condo as an emergency fund.
Mark has no registered retirement savings plan. If he saves $950 a month, he can accumulate $415,636 in 2008 dollars by age 55, his retirement target age, assuming 6-per-cent average annual growth and 3-per-cent annual inflation. The tax refunds generated by RRSP contributions would be about $3,648 a year. That money can be used to pay for an annual vacation, Mr. Moran notes.
Helen has $70,374 in her RRSP. She adds $1,032 a month to her group plan. At this rate, assuming 6-per-cent average annual returns and 3-per-cent annual inflation, her plan will have $598,859 in 2008 dollars by the time she is 53 and Mark is 55. Together, their plans will have total projected assets of $1,014,500 by the time Mark is 55. Their savings, if withdrawn at an even rate, will provide $45,766 in 2008 dollars from the time Helen is 53 until she is 90. If they retire when Mark is 55 and Helen is 53, neither will have worked long enough to qualify for maximum Canada Pension Plan benefits of $10,615 in 2008.
For this analysis, assuming that each draws 80 per cent of the maximum benefit at age 65, Mark and Helen would get $8,492 each. They could begin benefits at age 60 by accepting a reduction of 0.5 per cent a month of the age 65 benefit for each month prior to age 65 at which they begin benefits, but neither should do this, Mr. Moran advises. CPP will be their largest indexed pension. Therefore, each partner should preserve the largest indexable amount possible.
Mark and Helen will each qualify for full Old Age Security of $6,070 a year. If they elect to postpone taking their CPP benefits until Mark is 65 and Helen is also 65, then their total retirement income would be $45,766 from Mark's age 55 to his age 65, then as much as $74,890 once all of their CPP and Old Age Security payments have begun. All these sums are in 2008 dollars.
"The plan, in the simplest sense, is for the couple to give up liquidity and pay down their debts," Mr. Moran says. "This is financially efficient and simple to do. In fact, by holding as much as they have done in cash and unregistered assets, they have had to make unnecessary and quite large interest and income tax payments. "
"This makes sense to me," Mark says. "Having cash was novel after being a student. Now I see that I should give up liquidity and get rid of my debts."
Calgary professional couple ages 30 and 28.
High debt and large interest charges make it buy home, plan retirement.
Pay off debts, accept lower liquidity, and build assets.
Appreciably higher discretionary income and a pleasant retirement.
NET MONTHLY INCOME
RRSPs $70,374, non-registered $150,962, condo $290,000, car $10,000. Total: $521,336.
Mortgage $1,265, condo fees $196, property taxes $108, utilities $80, food & restaurants $500, clothing $50, student loans $4,650, RRSP $1,032, company share purchase $750, professional dues $351, entertainment $227, disability & life insurance $85, Car gas & insurance & maintenance $340, car loan $240, Alberta health care $66, travel $250, miscellaneous $400, savings $204. Total $10,794.
Student loans $113,260, car loan $14,300, mortgage $195,000. Total: $322,560.
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