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Couple begin a new chapter in financial lives

Otto and Polly will have their line of credit paid in full this fall, freeing up $800 a month in cash.

With competing claims on their income – mortgage payments, long-term savings, possibly buying a larger condo – they wonder how best to use the money. She is 41, with a good job (more than $100,000 a year) and a defined benefit pension plan. He is 39 with a less secure job ($48,000 a year) and no company pension.

When they married three years ago, they moved into her condominium and rented his out. They have been using the net rental income from Otto's condo to repay the line of credit, taken out to buy equipment for a part-time business venture he started up when he was out of work for a spell.

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"We don't have a major financial issue, but our circumstances are changing in the fall when we will have a major debt paid off," Polly writes in an e-mail. They have an emergency fund, their car is paid off and Polly's parents contribute each year to her tax-free savings account, as an early inheritance.

Polly still has a mortgage of about $57,000 on her Toronto condo with an interest rate of 5.4 per cent, against which she and Otto are paying $1,800 a month.

"What do we do with the extra $800?" Polly asks. "The mortgage? His TFSA? His RRSP?" Longer term, they hope to retire at age 65 with an annual budget of $80,000 after tax.

We asked Linda Stalker, a financial planner at Henderson Partners, to look at Polly and Otto's situation.

What the expert says

Polly is fortunate to have a defined benefit pension plan, Ms. Stalker says. Polly also contributes the maximum to her RRSP each year. In addition, she and Otto have been saving $400 a month, which has in part funded a TFSA for Otto. All of these put the couple in a good position.

Because Polly's mortgage loan is costing 5.4 per cent, the couple should use the $800 freed up by the loan repayment to pay down the mortgage as quickly as possible. "The interest rate is high relative to what they could be earning if they invested, it is a non-deductible interest charge and they are young enough to pay off their mortgage and then invest enough to meet their retirement needs," Ms. Stalker says.

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As well, they should take the $400 they are saving each month (partly for Otto's TFSA) and apply it to the mortgage, too, the planner says, making the maximum lump-sum payment each year and doubling up on the monthly payments. That will put them in a good position to move to a larger, more expensive condo in the future. "At that time they could sell the rental property (as well as their principal residence) to fund the purchase and be mortgage free, or take out a mortgage with a disciplined strategy to pay it down over a short period of time, as they have done with their current mortgage," Ms. Stalker says.

Polly's pension will pay $50,065 a year when she retires at 65. By that time Canada Pension Plan benefits will have risen to an estimated $12,075 with inflation, and Old Age Security of $6,290 will kick in when Polly is age 67. Otto will be entitled to full CPP at 65 if he continues to earn his current salary, and OAS at age 67. Thus their income from her company pension and government benefits will be $74,215 at 65 and $85,366 at 67. At an average tax rate of about 18 per cent, that will give them an after-tax income of about $70,000. The balance of their target income will be made up from RRSP and TFSA savings.

The planner's projections assume an average annual inflation rate of 3 per cent and an average return on investment of 4 per cent a year.

CLIENT SITUATION

The people

Polly, 41, and Otto, 39

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The problem

Where best to direct the extra $800 a month they will have once they have paid off their line of credit this fall.

The plan

Use the money to pay down the mortgage on their home as quickly as possible because it bears an interest rate of 5.4 per cent. This will put them in a good position to buy a new, larger home in the not-too-distant future, especially if they sell the rental condo to help finance the purchase.

The payoff

Financial security now and in future.

Monthly net income

$10,667

Assets

Home $380,000; rental property $320,000; RRSPs $108,100; TFSA $32,400; non-registered investments $5,100; bank accounts $7,500; emergency fund $15,000; present value of defined benefit pension plan $78,042. Total: $946,142

Monthly disbursements

Mortgage $1,800; property taxes, condo fees, property insurance and repairs $1,666; transportation, gas, car insurance, maintenance, parking $459; groceries $600; clothing $100; charitable $700; phone, Internet, cable $254; vacations $300; entertainment, dining out, drinks $450; club memberships $500; medical expenses $100; disability insurance $188; personal care $250; subscriptions $50; Rental property expenses $575; RRSP contributions $600; contribution to DB pension plan $850; other savings $400; line of credit $800. Total: $10,642

Liabilities

Mortgage on principal residence $57,170; line of credit $3,200. Total: $60,370

Special to The Globe and Mail

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