In Ottawa, a couple we’ll call Jerry and Sue are in the process of building a good life for their family. They have two teenage children and one about to enter the teens. With an annual combined income of $147,000, and net worth of $664,900, they should be feeling secure about the future. Nevertheless, Jerry, 46, a high tech manager who has no corporate pension plan, and Sue, 43, who is employed by the federal government, worry that they will not have enough savings for the retirement they have planned and for their children’s university expenses. “Would it not be smart to earn money outside of an RRSP, perhaps in real estate investments, so that I can use the funds to spend on a car, fix up the house or lend to family members?” Jerry asks. “But before I do that, I have to know if I have enough in my RRSPs to stop contributing.”

What our expert says

Facelift asked Michael Cherney, a certified financial planner in Toronto, to work with Jerry and Sue to determine if, indeed, they do have enough saved in their registered retirement savings plans and if the plan to invest outside their registered plans is feasible.

“You say that you have been staying up nights worrying about your investments,” Mr. Cherney says. “I would like to put your mind at ease. You are doing nicely in retirement savings and debt reduction, though there is more that you can do for education savings.”

The couple’s issues centre around how to allocate savings, Mr. Cherney notes.

Currently, the family has $300,000 in RRSPs and $24,400 in registered education savings plans and accounts for the children. Jerry and Sue already have a real estate investment of $300,000 in the estimated market value of their house. “Real estate investment is a supplement to financial assets in RRSPs, not a substitute for them,” the planner insists.

The tax advantage of continuing to invest in RRSPs is compelling, Mr. Cherney explains. A few decades of potential tax deferral make a strong case for continuing to use registered savings. Real estate investments, while offering substantial opportunities for growth and deferred gains, lack the immediate tax savings offered by RRSPs, he says.

Real estate investing is riskier than putting money into RRSPs, the planner explains. On a strictly financial basis, the decision of whether to buy an RRSP or a rental property comes down to comparing the return from a portfolio of tax-deferred investments to the return of an investment property bought on a mortgage.

Property management is a matter of details, but in gross terms, the problem is simple. Assume that a property produces gross rents of 10 per cent of the property’s price. Assume further that it is financed with no down payment, just for the sake of simplicity and to avoid estimating what the down payment could have made if invested elsewhere. If the mortgage is 6 per cent and maintenance is 3 per cent, then the net return of 1 per cent is meagre. Depreciation allows cash flow to exceed earnings, but buildings do need repair and eventual replacement. So the greatest part of the return will have to come from a capital gain. That is a speculation on the real estate market, Mr. Cherney says. Moreover, financing a rental property by remortgaging their house would run contrary to the couple’s desire to be debt-free.

Assuming that Jerry and Sue each live to age 95, an assumption that ensures that they don’t run out of money too soon, and that Sue can get by on 80 per cent of the couple’s income after Jerry dies, their retirement should be comfortable.

If the couple suffer no financial reversals, then, by Jerry’s age 65, they can begin retirement on a projected income of $135,900, which is equivalent to about 60 per cent of current family gross income adjusted for inflation that is assumed to run at 3 per cent a year.

In the first year of retirement in 2025, family income will consist of $41,590 of registered retirement income funds converted from Jerry’s RRSP, $25,790 from Sue’s RRIFs, $30,900 of Sue’s defined benefits pension, $10,200 of Old Age Security income for Jerry, $17,780 of Canada Pension Plan income for Jerry and $10,930 of CPP income for Sue. The total, $137,190, should be immune from the clawback, which, if the current start point of $62,144 grows at 3 per cent a year from inflation, will only be triggered in 2025 for individual incomes over $108,970 — more than either Jerry or Sue will be receiving.

Avoiding the clawback will be a problem Jerry and Sue will have to manage very carefully, Mr. Cherney says. Jerry has put all of his spousal contributions into Sue’s plan. For the future, it will be enough for Jerry to put 60 per cent of his contributions into Sue’s plan. But Sue, who has contributed to her own plan in the past, should stop immediately, Mr. Cherney says. He reasons that Sue’s tax bracket, about 31 per cent for combined federal and provincial income tax, is less than Jerry’s, 43 per cent at his income level. “The family will have more money if Jerry does all the RRSP contributions,” the planner says. “After all, at this bracket, the tax savings are much higher than Sue’s.”

Assuming the couple maintain their contributions, then, when Jerry’s retirement begins in 2025, they should have a total of $1.46-million in their portfolios, assuming they have been able to sustain a 5-per-cent annual average rate of return. That rate is conservative. Recently, stock market returns have been higher, but it is not clear they are sustainable, Mr. Cherney says.

Jerry and Sue should give attention to their three children’s RESPs, Mr. Cherney says. The couple have put $600 per child a year into a family plan that allows flexible payments to each child for post-secondary education. Right now, the total in all the plans is $26,400. A university education plan will pay $1,750 per child a year. The first child, age 16, could begin university within two years, the second, age 14, has four years to go. The third, age 10, is eight years from beginning university. The RESPs have to be increased. Mr. Cherney suggests Jerry and Sue can save the $10,500-a-year the family spends on children’s sports, postpone the purchase of new cars, or use the family’s net savings of $480 a month to increase the RESPs.

The children have failed to benefit from the maximum Canada education savings grant of as much as $400 a year for annual RESP contributions of $2,000 per child, Mr. Cherney says. Jerry and Sue can, however, accelerate their RESP contributions by putting up to $4,000 per child a year into RESPs. A provision of the RESP rules allows a Canada education savings grant (CESG) of as much as $800 per child a year for catch-up contributions, the planner notes. If they do this for eight years, then their youngest child would have about $46,000 for university, assuming Jerry and Sue use the $4,000 annual limit and obtain a 5-per-cent return on their contribution and on the $800 CESG that will flow in each year under the special provisions, he adds. The middle child, age 14, could have most of his expenses paid out of current spending for sports, Mr. Cherney adds. “This couple have done a good job of creating a financial base for their retirement,” Mr. Cherney says. “But they have done it partly at the cost of their children’s educations. They have enough money to give their eldest child a good start in university and they have the time to save for their younger children’s educations.”

“I thought I would have enough for my children to go to university, but I agree that we should divert money from sports to education. The money that is going into the mortgage, which we’ll have paid off by 2009, plus the money we spend on sports would put $24,000 per year into their education and that, together with the educational savings we have, should do the job,” Jerry says.