Larry and Lucy are set to welcome a baby, their first, this spring. Lucy is a teacher and Larry works in advertising. Together they earn about $273,000 a year. “We’ve always been very good savers, but now our finances are set to be upended,” Larry writes in an e-mail. “Alongside the new baby, we have to move out of our one bedroom condo into a new two bedroom place, a move that will increase our rent by almost 70 per cent,” he adds. “We live in Toronto and so prices are quite high, yet we are holding out hope to buy our first house in the next few years.”
Because they are good savers, Lucy and Larry are amassing “a decent down payment,” Larry writes, but they’ve always prioritized retirement. So they wonder: “Are we over-saving for retirement?” In their early 30s, they already have $369,000 in retirement accounts and are tucking away an additional $30,000 to $40,000 a year in work pensions and registered retirement savings plans. (Larry’s employer matches his defined benefit contributions.)
“How should we best make room for the increase in living expenses while still delivering on retirement savings, short-term cash reserves, a newly formed desire to set up a registered retirement education fund, and a pending down payment on a home in three to five years – especially when considering we will be largely suspending my wife’s earnings during her coming maternity leave?” Larry asks.
We asked Stephanie Douglas, a financial planner and portfolio manager at Harris Douglas Asset Management in Toronto, to look at Larry and Lucy’s situation.
WHAT THE EXPERT SAYS
At the ages of 34 and 35, Larry and Lucy have a net worth of $729,500, $369,000 of which is in RRSPs and Larry’s defined contribution pension plan, Ms. Douglas says.
Lucy will be going on parental leave soon. “Based on Larry’s income, including his annual bonus, and the income Lucy will receive from government benefits, they have enough to cover their current living expenses,” the planner says. They would still have a surplus of about $45,000 this year. “This surplus, however, will likely be reduced due to additional expenses, which are likely to grow over time as their baby grows; for example, child-care costs, additional costs as they might have a second child, and extracurricular activities.” They will have to track and make any adjustments to their budget going forward, Ms. Douglas says.
“I suggest that they prioritize saving in Larry’s defined contribution plan, where he receives an employer match, followed by their RRSPs, their tax-free savings account and the child’s RESP. They can contribute $2,500 a year to an RESP account up to a lifetime maximum of $50,000. They would receive the maximum Canada Education Savings Grant of $500 a year up to a lifetime maximum of $7,200.
One area they could put on hold for the time being is their car fund, in which they have about $10,000. “They will have ample time to save for this when Lucy returns to work,” Ms. Douglas says. “I would also suggest that they forgo making RRSP contributions for Lucy this year,” she adds. If Lucy does decide to make a contribution, she should claim it on a future tax return when she is back to work so she will get a larger tax deduction.
Lucy and Larry have an emergency fund of $25,000, slightly less than three months of their current living expenses minus any savings, Ms. Douglas says. ”I suggest they continue to track their spending and adjust this fund to their increased expenses so that it stays equivalent to three to six months,” the planner says. This will be particularly important after they have bought a home because they will need funds on hand to cover emergency repairs.
Larry and Lucy expect to pay up to $1.4-million for a house in the Toronto market. “For a down payment of at least 20 per cent, plus additional closing costs estimated to be 5 per cent, they will need a total of $350,000. They have $65,000 in a down payment account and $171,000 in their TFSAs to use toward this goal, for a total of $236,000. Assuming an interest rate on their savings of 0.75 per cent, they would have to save about $35,680 annually for the next three years, or $20,500 annually for five years, to reach $350,000,” the planner says.
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Alternatively, they could also use the funds in Larry’s stock account of $80,000 and/or consider taking advantage of the federal Home Buyers’ Plan, withdrawing $35,000 each from their RRSPs so they could buy sooner.
“I suggest they move any funds they anticipate using toward their down payment to cash as they get closer to their home purchase so they are not forced to withdraw from these accounts in a down [stock] market and sell at a loss.” This is particularly important if they draw on their TFSAs, which are invested 90 per cent in stocks and 10 per cent fixed income and gold, she says. “If they decide to also use Larry’s stock account, they should be mindful of capital gains, so they do not have any surprises when they file their tax returns.”
Larry and Lucy would like to retire in 21 years with an annual spending requirement of $120,000 net, adjusted for inflation. This would be $182,000 net in 2042 when adjusted for inflation of 2 per cent a year. “Based on a life expectancy of age 95, they are not over-saving,” Ms. Douglas says. “They are doing a great job of working toward this goal.”
If they can max out Larry’s defined contribution plan, their RRSPs and their TFSAs each year, they should be able to accomplish their goal – provided they can achieve a rate of return of at least 5.5 per cent after fees on their investable assets, the planner says.
In terms of tax efficiencies, the planner suggests they open a spousal RRSP for Lucy so they are better able to income split in retirement. Much of their retirement savings are in Larry’s RRSP and defined contribution pension plan. “The goal should be to have roughly equal-sized RRSP accounts in retirement,” Ms. Douglas says.
Finally, the planner suggests the couple have their wills drafted as soon as possible. “This will allow them to choose an executor who will manage the affairs of their estate and to elect a guardian for their child in case something happens to them.”
The people: Larry, 34, and Lucy, 35
The problem: How can they adjust to their new, higher rent and baby expenses while still saving for a house and retirement.
The plan: Continue to save toward their goals and do regular financial planning to ensure they stay on track.
The payoff: Reassurance that they are on the right path to achieve their various goals.
Monthly net income: $15,755
Assets: Bank accounts $4,500; savings accounts $105,000 (down payment, emergency, mat leave and car purchase funds); his stocks $80,000; TFSAs $171,000; RRSPs $202,000; his defined contribution pension plan $167,000. Total: $729,500.
Monthly distributions: Rent $3,700 for new apartment; home insurance $50; heat, hydro $200; transportation $530; groceries $800; clothing $300; gifting $250; vacation $1,050; dining, drinks, entertainment $1,100; personal care $100; club memberships $130; golf $400; sports, hobbies $150; subscriptions $50; telephone, internet, TV $145; RRSP contributions $675; TFSA contributions $2,200 (catching up); his pension plan contributions $1,125; stock purchases $1,825; future car-purchase saving $350; other $175. Total: $15,305. Surplus $450.
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