In a small city in Ontario, a couple we’ll call Bill and Theresa are raising their one-year-old daughter, Sarah, and paying off their mortgage. Bill, 37, who does market research work for various companies on contract, has a medical condition that makes it hard for him to work continuously. Theresa, 34, a medical technologist, works two days a week, spending the rest of her time caring for Sarah. Bill and Theresa are in a quandary. Should they pay off their mortgage as swiftly as possible or decelerate payments on their mortgage and buy a cottage? They also want to save for Sarah’s university education, her wedding and perhaps establish a trust fund for her. That’s a lot on their combined gross incomes of $120,000 a year. “We try to plan for our future, but the unknown is the state of my health,” Bill says. “A digestive disorder could become more serious and force me to retire early. That would crush any plans we might make. So we save a great deal, perhaps more than others in our income bracket would. It’s really a form of insurance for the future.”

What our expert says

Facelift asked Toronto-based certified financial planner Michael Cherney to work with the couple in order to sort out their options and to establish a strategy for achieving their goals.

Working in their favour, he notes, is the family’s modest level of consumption. They spend just $4,385 a month before registered retirement savings plans and accelerated mortgage payments out of a combined take-home income of $6,885.

“The couple’s immediate question is whether they should pay off their house mortgage quickly or pay it down more slowly and buy a cottage,” Mr. Cherney says. “A cottage would make it tougher to retire at age 60, as Bill would like. But a cottage can be a good investment and may appreciate faster than the stocks and bonds that usually go into RRSPs. Given that Bill and Theresa want to have the freedom to retire early, the cottage — along with its implied reduction of choices to do things other than go to the cottage in the summer — is not the best choice.”

The foundation of Bill and Theresa’s retirement will be their RRSPs, Mr. Cherney notes. If the couple can contribute $16,000 a year to their plans, then, assuming conservatively that assets grow at after-inflation rates of 3 per cent a year in the RRSPs and 2 per cent in the taxable accounts, and that Bill and Theresa each live to age 90, then the couple can achieve an annual income of $40,000 in 2004 dollars, which will be $78,943 in 2027 dollars, when Bill begins retirement, Mr. Cherney says. They will have combined RRSPs with a value of $1,164,000 that generate $72,194 a year. Bill and Theresa will each receive Canada Pension Plan retirement benefits at 70 per cent of the age 65 value, accepting a reduction of 6 per cent a year for each year they cash in before age 65. Bill’s CPP benefits will therefore begin in 2027 at $6,750 a year, compared with the maximum CPP benefits payable of an estimated $19,282 a year, the planner estimates. Theresa’s CPP benefits will begin in 2030 when she reaches age 60 at an estimated level of $7,376 a year, compared with a maximum potential payout of $21,070, Mr. Cherney estimates. Each will receive full Old Age Security benefits at age 65 — Bill in 2032 at a projected rate of $12,698 a year, Theresa in 2035 at $13,875 a year. By 2035, when all pension elements are in place, the couple will have total retirement income of just over $100,000 a year. That’s $40,000 a year pretax income in 2004 dollars.

Educating Sarah to completion of a four-year university degree will be costly, but manageable, Mr. Cherney says.

Sarah’s four-year university degree will cost about $100,000 if she begins her studies when she is 18. If she chooses to live away from home the cost could be as much as $150,000.

Bill and Theresa can save for that cost by making use of a registered education savings plan (RESP) that allows contributions up to $4,000 a year with a Canada education savings grant (CESG) of 20 per cent of contributions up to $2,000 year or $400 per child.

Budgeting for an out-of-town education will cost $5,000 a year or $4,600 after the CESG grant; $600 in excess of the $4,000 annual RESP limit would have to be invested via an in-trust account for Sarah. For an in-town education, the cost would be $2,800 a year in RESP contributions or $2,400 a year after the CESG grant.

Given the low level of spending the family now has, they can readily budget for either level of savings in addition to their RRSP savings, Mr. Cherney says.

“The dilemma the couple began with, whether to buy a cottage, is really a question of financial freedom,” Mr. Cherney says. “Bill and Theresa want to be free of debt and to have more, not less, choice in their lives.

“If they forgo the cottage and invest wisely for their retirements and for Sarah’s education, they should have a secure future. The cottage would leave them more encumbered and less secure, especially in view of Bill’s health. Bill may not be able to work continuously due to illness, so they need freedom and security more than they need a second house.”

“We have to build our retirement savings on our own because I think that, when I reach age 60, the Canada Pension Plan won’t exist any more,” Bill says. “CPP on top of our other retirement income sources would leave us very comfortable, but I feel we have to save aggressively if we are to have a secure retirement.”