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Blooming incomes, blossoming risks

John is self-employed and just starting out in a new business that will bring in the equivalent of $400,000 a year over the next year and a half. But it's a one-time contract. His previous work brought in $125,000 a year.

John has no life or health insurance and no pension and is not even sure how to go about drawing money from his new corporation.

"How do we manage that income?" his wife, Judith, asks in an e-mail.

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Judith is on maternity leave, and while she could go back to her $70,000-a-year job in August, she and John would like to have a second child soon. She is 33, he is 39. Rather than returning to work full time, she wants to build her own consulting business.

"We'd like to understand how we can afford to do that," she adds.

They recently bought a new home in a suburb in Nova Scotia. Now they would like to build up an emergency fund as well as a diversified investment portfolio. Longer term, they want to pay off their mortgage, save for their children's private schooling and begin saving for their retirement.

We asked Warren Baldwin, regional vice-president of T.E. Wealth in Toronto, to look at Judith and John's situation.

What the expert says

Judith and John are in fairly good shape for their age and stage in life, Mr. Baldwin says.

"However, they are really entering the high-risk zone for their finances," he cautions. On the plus side, they have some definite ideas about how to deal with their expanding family and education costs over the next 20 years or so. "On the other hand, they have been spending virtually every dollar that they make."

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In so doing, John and Judith are not adding enough to their long-term financial security "and they are definitely not taking care of some severe potential risks that exist today." Their savings add up to $21,000 but they owe $216,000 on their home mortgage and another $11,000 to their registered retirement savings plans for money withdrawn under the federal home buyers' plan.

Because John's contract is a one-time event, their income could drop again once it is over. If and when that happens, either Judith will have to go back to work or John will have to drum up another lucrative contract to make up for the loss of Judith's income.

"If she is off for another couple of years and she then only earns some part-time self-employment income, they run the risk of being hard pressed to afford current expenses let alone the need to accumulate savings and assets for retirement," Mr. Baldwin notes.

In his analysis, Mr. Baldwin assumed that Judith returns to work full time and that together they each will be able to contribute $12,000 a year to their RRSPs and completely retire their mortgage debt over the next two years thanks to John's big contract. They will also pay off their car loans and repay the home buyers' loan.

The cost of nearly $24,000 a year for their nanny will persist over the next 20 years in one form or another, Mr. Baldwin says: first, as the nanny's salary, then as the cost of private school, then as money to help the children with university expenses.

Judith and John hope to retire when he is 55. The planner's first analysis assumed John retires at 55 but Judith works for another six years until she is 55. Their lifestyle expenses in retirement would be $60,000 a year in 2011 dollars, but by the time John is 55, with 2 per cent inflation, that amount would translate into $82,000 a year.

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"Unfortunately, at his age 55 their total assets given the RRSP contributions and a 5-per-cent return on investment only total $690,000," Mr. Baldwin notes. Even with Judith working until she is 55, by which time her income will have risen to nearly $100,000 a year, their assets when Judith retires would only be $790,000. They would run out of savings when John turns 72.

"The bottom line is that additional after-tax savings of $22,000 a year would be required for them to retire with $60,000 in after-tax income at age 55," he says. Alternatively, they could spend less in retirement, limiting themselves to the $48,500 a year their savings would provide.

Mr. Baldwin did a second analysis in which John works to age 60 and Judith to age 54, so they would both retire the same year. They would run out of assets at John's age 77.

"However, if they can save $13,500 a year after tax in addition to their RRSP contributions for the next 27 years, they could afford their $60,000-a-year retirement at his age 60," the planner concludes. If they could cut their expenses to $50,000 a year in retirement, their RRSP savings would be enough to live on until they are both age 90. The planner also suggests they take out life and disability insurance as soon as possible.


The people

John, 39, and Judith, 33.

The problem

Now that John has won a big contract, can they arrange things so Judith can stay home, have another baby and work for John's company without too much risk and while still achieving all their financial goals, including paying off their debts, putting their children through private school and retiring at 55?

The plan

Take a less risky approach in which Judith keeps her job, they pay down their debts, save prodigiously and retire at age 60 with $60,000 a year after tax.

The payoff

Financial security both now and in future.

Monthly net income



House $370,000; savings, including RRSP $20,700. Total: $390,700.

Monthly disbursements

Mortgage, property tax $1,300; utilities $375; insurance, security $140; maintenance $300; car loans $1,065; other car expenses $380; groceries $1,600; clothing $200; vacations $400; dining out $800; pets $100; personal $400; telecom, cable, Internet $415; RRSP $1,000; child care $1,900. Total: $10,375.


Mortgage $216,000; credit cards $7,770; car loans $25,275. Total: $249,045.

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