Dushan Milic
Amanda is a 47-year-old single mom with a 15-year-old daughter, living on one income with no child support in Vancouver. When she's not working full-time as a graphic designer, she runs a small silk-screening business to make extra money. Living in one of Canada's most expensive cities, she describes herself as "thrifty" or, to put it another way, "cheap."
She takes home $1,500 biweekly, and the mortgage on her two-bedroom condo is paid off thanks to proceeds from the sale of her late father's house. She pays $260 in monthly maintenance fees.
She has money in RRSPs and RESPs, and two years left to pay off her car.
"I find it nearly impossible to save on my income," Amanda says. "The basic cost of living scares me. Bills and food prices just keep going up and up. I need to save more.
"I sit listening to BNN while I'm working," she adds. "I'm always trying to learn something about investing."
Her goal is to be debt-free by 50, and she would love to work part-time at her "real" job while running her business part-time. Without a pension and a second income, though, she worries about having enough to live on. She jokes that her backup plan is to live in her car on the coast of California.
We presented Amanda's case to Anne Hammond, a financial adviser with Rogers Group Financial in Vancouver, and Bettina Schnarr, a certified financial planner with South Surrey's DWM Securities Inc. Both suggested Amanda obtain a proper financial plan that incorporates the future needs of her daughter.
The basics:
- $68,800 in short term and money market funds
- $54,000 in Canadian fixed-income mutual funds
- $10,000 in Canadian equity mutual funds
- $4,000 in a TFSA
- $66,000 in self-directed RRSPs
- $4,000 in a 4-year RRSP (year 3)
- $3,000 undirected RRSP savings
- $7,000 in daughter’s RESP by 2014
Anne Hammond's tips:
- Amanda should spend time with a financial adviser to develop an investment policy statement, a written outline of the parameters for her investments. Between her RRSP, tax free savings account and non-registered accounts, she has about 15 per cent of her holdings in equities, with the remaining 85 per cent in cash or guaranteed investment certificates (GICs) and bond funds. This is an unusually conservative portfolio for someone her age, and it may not accurately reflect her risk tolerance. In addition, having such a high percentage invested in fixed income and cash means she can expect to earn low real rates of return (the return after it is adjusted for inflation), which means she will probably need to save significantly more to reach her goals. That tradeoff may or may not be acceptable to her, and an investment policy statement will help her make an educated choice.
- She should track her spending closely for several months, categorizing her expenses as “necessary to live,” “important” or “nice to have.” Armed with better knowledge of how she is spending her money, she will be in the driver’s seat when making decisions. She has already set up a small monthly RRSP contribution – an excellent savings tool – and having more control over her spending may help her to increase this amount.
- Even if she is not able to direct much of her current income toward savings, Amanda can get more mileage out of her investments by using some of her non-registered funds to maximize contributions to her RRSP and TFSA. Contributing to her RRSP will reduce the amount of income tax she pays, leaving more cash in her pocket, which she can direct to savings. Funds in her RRSP will grow in a tax-deferred environment until she withdraws them. Any earnings on investments in her TFSA will not be taxed at all, unlike earnings on her non-registered investments.
Bettina Schnarr's tips:
- Amanda should have the maximum of $15,000 in a TFSA. This can be used as an emergency fund or as a big-expense fund (such as annual vacation costs or car and house insurance). However, it doesn’t make sense to me to shelter 1 per cent to 2 per cent of interest income in it. Instead, you want your TFSA holdings to have the potential for higher gains, such as dividend paying stocks, dividend mutual funds or income mutual funds. Since Amanda already has a line of credit that she can access, this works well. She could wait for funds to recover – if they were down, as in our current environment – before withdrawing them.
- Amanda should maximize her RRSP contributions, even if she doesn’t claim them all in the same year, by shifting some of her open investments into the funds. Where else can you get an immediate return of 20 per cent or more on your money just by shifting where it sits? The tax refund can then be used to pay down the line of credit. Also, since Amanda is running on a tight budget, I don’t think that she is putting much more, if anything else, into her retirement savings.
- Based on Amanda’s selection of investments, and because she is dependent on herself for retirement, I suggest that she create her own “pension.” Personally, I’m not a fan of annuities, but in certain circumstances they make sense. For Amanda, I think there is a better alternative: a guaranteed lifetime withdrawal benefit (GLWB) plan. Basically, this investment alternative is mutual funds with an insurance wrapper around it. For example, if Amanda invested $200,000 now in a GLWB plan (assuming the GLWB rate is 5 per cent), at age 65 she could have an annual income of $19,000. That, coupled with $17,900 in Canada Pension Plan and Old Age Security benefits, would give her an annual income of $36,000. In addition, I would like to believe that in 18 years, the underlying fund will have made some gains too, and these products typically have a three-year reset. The good thing is that unlike an annuity, Amanda could still withdraw her investment. I don’t recommend that Amanda put all of her investments in here (both RRSPs and non-registered accounts are eligible) but instead see it as a core holding – her pension, so to speak. Also, when this product is held in an open investment, it offers tax advantages on the payout.
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