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When financial planning involves ‘so many ifs'

Globe and Mail Update

In Ottawa, a couple we'll call Vern, 34, and Isabel, 30, are raising two kids, ages one year and three months. Isabel stays at home, while Vern has a management job that pays $4,200 a month after tax, not including his bonus.

Vern's bonus is in the form of an annual dividend from shares in his employee-owned company that, this year, will total $51,615. After tax, that income boost will amount to $37,700. They live in a house with an estimated market value of $250,000, have two cars worth a total of $15,000, and have financial assets of $198,000.

Vern and Isabel have nearly two decades of child rearing ahead of them. The kids will need the usual gear from diapers to registered education savings plans. The couple plan to retire when Vern reaches 60. There are many financial unknowns in the years ahead: Rates of return on capital, what he will earn, what tax rates will be.

“How do I plan around something with so many ifs?” he says.


Facelift asked Caroline Nalbantoglu, a financial planner with PWL Advisors Inc. in Montreal, to work with Vern and Isabel.

“He is already doing a lot of things right,” she notes. “He has accelerated the payment of his mortgage and should be free of the debt in four years. He can then add the money he is using for the mortgage payments to investments, yet a lot depends on whether he stays with the same employer and whether the bonuses he receives will continue to be paid. Without the bonuses and the dividend payments from $75,000 he has invested in company shares, his monthly cash flow is just sufficient to meet his monthly expenses.”

Financing the education of their children should be relatively easy for the couple. They already have $3,000 in their family RESP. Their second child will double the annual limit for the Canada Education Savings Grant, which is the lesser of 20 per cent of contributions or $500 a child.

If they contribute $5,000 a year to a family plan and receive the full $1,000 CESG each year, the plan should have $182,500 by the time the first child reaches 18, assuming assets have grown at 6 per cent a year less 3 per cent for inflation. This sum will allow each child to have $22,813 a year in 2008 dollars for four years of undergraduate study, Ms. Nalbantoglu says.

Vern and Isabel can split investment income by shuffling assets. By age 42, Vern's non-registered investments, including money saved from bonuses, should have grown to $185,000, Ms. Nalbantoglu estimates. He could use that money to buy half the principal residence, which may then be worth $370,000, from Isabel, who did work in the past and did contribute to the purchase of the house. Any growth in the money she receives for her share of the house will be taxed in her hands.

Vern has not maximized his contributions to his registered retirement savings plan. He has $16,807 in contribution space. At a marginal rate of 43.4 per cent, the RRSP contribution will save him about $7,300. He will have his full $16,807 working for him and, as well, the $7,300 he has saved from tax, the planner notes.

Vern is currently a member of a defined contribution pension plan. He contributes 5 per cent of his base salary and his employer matches it. This leaves him with a good deal of contribution space. He can use this contribution room to build a spousal RRSP for Isabel.

He can also use the new Tax-Free Savings Account that goes into operation Jan. 1. He can put $5,000 a year into his own account and the same into Isabel's account. Together, Vern and Isabel can shelter $10,000 a year. By the time Vern retires at age 60, he and Isabel should each have $275,000, the planner estimates.

Looking ahead to retirement at Vern's age 60 and assuming, very conservatively, that his company shares do not generate sufficient dividends that will lead to large budget surpluses, that Vern contributes the maximum to his RRSP and that his mortgage has been paid off by retirement, then by age 60 he should have $379,000 in his RRSP, $965,000 in Isabel's RRSP, $680,000 in his company pension plan and $550,000 in their combined TFSAs. This capital will total $2,574,000.

Assuming a pretax nominal return of 5 per cent a year, Vern and Isabel will have investment income of $128,700 when Vern is 60. He will be eligible for Canada Pension Plan benefits of $12,400 in future dollars. Total family income will be at least $141,100 in 2034 dollars, the planner estimates.

Any pension benefits and investment returns that Isabel has earned and any returns from large bonuses that Vern has accrued will add to this income. They are likely to suffer a reduction of the current $6,204 annual Old Age Security payments, which begin to be clawed back at about $65,000 a year of individual taxable income and which are entirely lost at an individual taxable income of about $105,000 a year. Assuming 3-per-cent annual inflation, the threshold and the cutoff for OAS should have approximately doubled by 2034.

“Vern and Isabel can do very well, but the income level provided by his bonuses is critical. If he leaves his employer, he will have to replace that income,” Ms. Nalbantoglu notes.

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