Client situation
Twelve years ago, Luis and Bettina Reyes arrived in Canada to study mathematics. After adapting to the climate — a rather large change from their first home in Asia, the Reyes (not their real names), got advanced degrees and went to work for a major insurance company based in Toronto. Luis, who works full time, earns $145,000 a year; Bettina, working part-time while finishing her PhD, earns $10,500. After losing nearly 60 per cent of their financial assets in the 2000-2003 tech meltdown, the Reyes, each 37, are rebuilding their finances, living in an inexpensive apartment while renting out their $650,000 house. They have a toddler at home. Another child is expected this fall. “We have focused on our careers and not paid enough attention to our finances,” Luis says. “The result is that we lost a lot of money in the market and let our affairs get out of balance.”
What our expert says
Facelift asked Toronto-based financial planner Michael Cherney to speak with Luis and Bettina to determine whether they can, as they wish, build enough wealth to retire in 23 years, after they have paid for the education of their children. At that time, they hope to be able to generate $72,000 a year after tax and to be debt free.
“This couple can recover because they have invested heavily in themselves,” Mr. Cherney says. “They should also realize that steady asset growth based on a realistic strategy is more likely to be fruitful than gambling on hot stocks.”
Assuming that Luis and Bettina split their retirement income evenly, they will need to generate $45,000 each in order to have $36,000 a person after tax in current dollars, Mr. Cherney says. Assuming that they each receive Old Age Security without substantial clawbacks and begin to draw on the Canada Pension Plan at age 60 at 70 per cent of full benefit (CPP reduces benefits by 6 per cent a year for every year before age 65 that one begins to receive payments), then the couple will be able to retire not just at their target age, but a year sooner, postponing the CPP draw for a year, he predicts.
Making the plan succeed will take some careful work, the planner says. Luis’s annual income far exceeds what Bettina earns. Mr. Cherney’s plan provides for income averaging through spousal transfers of registered retirement savings plan credits. Therefore Luis should maximize his annual RRSP contributions, contributing to Bettina’s RRSP through spousal transfers until their plans are equal in value.
The plans should remain in balance thereafter, he adds. That should happen, he says, by 2007. In 2004, the contribution limit is $15,500 and will rise to $16,500 in 2005, $18,000 in 2006 and be indexed thereafter, the planner notes.
Luis and Bettina have a $210,000 mortgage that costs them $24,000 a year to service. They have been paying down principal with additional payments of $42,000 a year, so that, by 2007, the mortgage should be retired. Thereafter, they can put the $42,000 a year into non-registered investments, Mr. Cherney notes.
It is important that the non-registered investments be made with half the money coming from Bettina and half from Luis. If there is an imbalance, attribution rules would shift investment income from one spouse to the other and throw the plan off balance. By 2007, when Bettina has returned to full-time work at what Mr. Cherney assumes will be a six-figure income, they should have sufficient income to add the required $45,000 to $50,000 a year to their non-registered family investments on top of maxing out their RRSPs, he says.
Assuming that the couple can earn 6 per cent a year in their RRSPs and, after paying taxes on growth, 5 per cent a year in their non-registered accounts, and assuming as well that inflation runs at an average of 3 per cent a year, Luis and Bettina will begin their retirement in 2025 with $167,427 total income from RRSPs that each have $1,023,000 in total assets, and $1.7-million in non-registered assets.
At age 60, in 2026, their CPP payouts will begin at what Mr. Cherney projects will be $9,170 a year for Luis and $6,550 for Bettina. Their Old Age Security payments begin at age 65 in 2031, at a projected rate of $9,863 a year for each after a 20-per-cent clawback of the projected maximum benefit of $12,329. By that year, their pretax incomes will have risen with inflation adjustments and investments returns to $199,900 a year.
Luis and Bettina have good prospects of increasing their incomes substantially over their lives. Income gains, which can be assumed but not estimated, should not only finance their investments, but also enable the couple to invest at least $2,000 a year in registered education savings plans for their children and to receive the $400 annual Canada education savings grant.
Mr. Cherney suggests that the best way of achieving their targeted financial goals is for Luis and Bettina to diversify their investments by sector and style. Their principal assets are their educations.
“With their intellectual capital and sound financial decisions, Luis and Bettina should not only be able to reach, but to exceed their goals,” he says.
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