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couple juggling debt

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The couple’s problems centre on the complexity of their plans … how much to put in each basket. ‘We’re scrimping and saving, but we may not be doing enough. How can we improve our budget? — Alberta resident Arthur, 36 In Alberta, a couple we’ll call Arthur, 36, and Jennifer, 32, are thriving in their careers. Arthur works full time for a large construction firm, Jennifer part time for a financial services consulting business. They have a three-year-old son, and are trying to save for his education and their retirement. Ottawa’s announcement this week of the ability of couples with children — in which one partner’s income is higher than the other’s — to level income and therefore tax payable subject to a cap on tax savings will not materially affect this couple’s finances. Their problem in a nutshell is that their savings are modest, Arthur is approaching middle age with only a year of pension credits at his company, and their debts amount to almost five times their annual take home income. andrew barr / national post The couple’s problems centre on the complexity of their plans. They want to supplement the pension Arthur’s employer provides, add to their RRSPs, pay down their mortgage and their car loan and build up savings for their child’s post-secondary education. The problem is to know which comes first, how much to put in each basket, and what the consequences are of each choice. Their present debt service charges add up to $2,688 a month, about 40% of their take home income, $6,830 a month. “We’re scrimping and saving, but we may not be doing enough,” Arthur says. “How can we improve our budget?” Family Finance asked Caroline Nalbantoglu, head of CNal Financial Planning Inc. in Montreal, to work with Arthur and Jennifer. “They do indeed have a lot of debt,” she says. “That may become more of a burden when interest rates rise. So paying down debt is an urgent task, more pressing than building up savings. Therefore that is the strategy for this case.” Budget management The usual strategy for debt reduction is to pay down loans with the highest interest loan being eliminated, with payments then directed to the next. But Ms. Nalbantoglu suggests that Arthur and Jennifer work toward the easiest way to increase their liquidity. That means paying off the $9,800 car loan which costs just 2%. At the present paydown rate of $592 a month, the loan will be gone in 17 months. Then they can direct that cash flow to their $31,000 basement renovation loan on which they are paying $650 a month. That loan will then be paid off in three years, a year earlier than it would have been without the increase in payments. At that point, the sum of payments that had gone to the basement and car loans, $1,242 per month, can be added to their present payments of $1,446 for their 3% mortgage and homeowner’s line of credit, making a total of $2,688. The result is that their home will paid off by the time Arthur is 47, nine years sooner than it would be with the present paydown rate. At this point, barring any new debts, they will have no liabilities. Arthur and Jennifer are putting $100 a month into their son’s RESP. That generates a 20% boost from the Canada Education Savings Grant. They could get a maximum $500 annual grant were they to push their own contributions to $208 a month. They could put in more, but they are focused on debt reduction, which is more important at the moment than a fund they can top up any time in the next decade and a half, for RESP space carries forward and, as well, allows a catch up for the CESG subject to a $1,000 annual limit or 30% of unused CESG room. However, delays in contributing will slow growth within the RESP, Ms. Nalbantoglu notes. At the current rate of contributions, the $7,700 RESP, including CESG additions, will grow at 3% after inflation to $39,500 when their son is ready for university. That will pay for tuition and books at a local postsecondary institution. They can accelerate contributions to $2,500 a year plus the CESG as debts are eliminated. If they do this after the house mortgage and line of credit are eliminated in 11 years, they could add perhaps $9,500 to the balance, bringing it to $49,000 when their son is ready for university, Ms. Nalbantoglu says. Arthur, with $51,000 of RRSP room, should use money now going to his TFSA, $350 a month, for his RRSP contributions, currently $325 a month. He should use a spousal plan, Ms. Nalbantoglu says, so that Jennifer can enlarge her RRSP and use the balance for withdrawals at her low rate when she retires. Pension-splitting is allowed for tax purposes, but the process of allocating the RRSP deduction to the higher earner is the taxpayer’s responsibility, Ms. Nalbantoglu says. That will push total annual RRSP contributions to $8,100 a year and result in $3,000 of annual refunds for Arthur. He can then put those into his TFSA. By age 60, Arthur and Jennifer will have about $500,700 in their RRSPs assuming $8,100 of annual contributions on top of the present balance of $105,700 all growing annually at 3% after inflation. That would support annual payouts of $21,300 for the 39 years from his age 60 to Jennifer’s age 95, the planner estimates. Retirement income Their TFSAs, adding $3,000 a year to their present balance of $26,000, will have grown to about $160,000 at 3% per year in 2014 dollars after inflation by Arthur’s age 60. If paid out over the 39 years from Arthur’s age 60 to Jennifer’s age 95, that capital will support $6,800 payouts each year. At 60, Arthur will have 26 years of service. Assuming his salary is still $95,000 and that the pension calculation is 2% of the average of five years’ best salary, he would get $50,350 annual pension. With no CPP benefits, their combined income at age 60 would be $78,450. If split, each partner would be in a 16% average tax bracket. They would have $5,500 a month after tax. That sum would easily cover present expenses of $6,237 a month with removal of $2,688 debt service and elimination of $775 of RRSP, TFSA and RESP savings. They can draw Canada Pension Plan benefits. If they wait to 65, Arthur would get an estimated $600 per month. At 65, his DB pension would drop by that amount so there would be no net change in his pension. Jennifer’s CPP pension based on parttime work would be perhaps half of Arthur’s, adding $3,600 a year to their income. When each is 67, OAS would add two times $6,768 or $13,536 to annual income for final and permanent retirement income of about $95,600 a year before tax. Allowing for the zero tax status of TFSA payouts and splits of eligible pension income, they would pay average tax of 17% and have about $6,600 a month to spend. There are a lot of if’s in these projections. For example, their clothing and grooming spending, $125 a month, is not likely to cover parents and a teenager when that time comes. Very important, Arthur and Jennifer’s life insurance, which now is really just twice Arthur’s $95,000 annual salary would not sustain the family were he to pass away prematurely. Arthur can purchase additional coverage of $1-million on a 20-year term non-smoker policy at $80 per month. Jennifer can also buy $1-million coverage for $50 a month. The young family needs this protection at least until debts are repaid and the child or perhaps children are no longer financially dependent on their parents. “In our projections, we have used present salaries, though their salaries are likely to rise over the years,” Ms. Nalbantoglu says. “However, even with the present salaries, it is clear that in retirement, the couple can maintain their way of life.”