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Should couple focus on paying off their mortgage or saving for retirement?

Darryl Dyck/The Globe and Mail

It has taken time, but Jerry has built his consulting business up to the point where he is grossing $112,000 a year. That's up from $45,000 in 2014 "and much less before," Jerry writes in an e-mail. For the past decade, his wife Janice kept the family finances on an even keel thanks to her teacher's salary.

Jerry is age 47, Janice is 45. They have two children, ages 5 and 8.

They have some savings and Janice will be entitled to an indexed defined-benefit pension when she retires. Their only debt is the mortgage on their B.C. home. Now that they have some spare cash, they wonder whether they should focus on paying off the mortgage or saving for retirement. They wonder, too, whether Jerry should take out disability insurance and whether his corporation might offer some tax-planning strategies.

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Longer term, Janice wants to retire at age 58, while Jerry plans on shifting gradually from full-time to part-time work starting at age 60. Their retirement spending goal is $84,000 a year after tax.

We asked Brinsley Saleken, a financial planner and portfolio manager at Macdonald Shymko & Co. Ltd. in Vancouver, to look at Jerry and Janice's situation. Macdonald Shymko is a fee-only financial planning firm.

What the expert says

While Jerry and Janice have a solid financial base, the next 15 years will be important because their retirement plan depends on the savings that will be built over this period, Mr. Saleken says. "As always, discipline and taking advantage of their opportunities is a key to success," he says.

At this point, they should focus on building their savings, the planner says. Based on their current payment schedule, their mortgage will be paid off by the time they retire. First, they should "maximize annual RRSP savings," he adds. "Given Janice's pension, any RRSP contribution amount that she has available should go as a spousal contribution to Jerry's plan to provide balance" in their savings.

Second, they should both contribute the maximum to tax-free savings accounts. They should continue to contribute to the registered education savings plan for their children to take advantage of the government grants. Then, if they have anything left over, they could make extra payments to the mortgage. If interest rates rise, though, they may have to change course to put mortgage payments ahead of TFSA savings, the planner says.

Jerry would be well advised to sit down with a tax specialist to explore potential ways to save or defer income taxes through his corporation. For example, he may be able to retain funds within the corporate structure. "For individuals who have the option of retaining earnings in a corporation at the small-business tax rate (13 per cent in B.C.), there is a significant deferral benefit," Mr. Saleken says. "The pool of investments that can be accumulated provides flexibility at retirement for potential income-splitting and/or continued deferral given there are no required [mandatory minimum] withdrawals from a company like there are with a registered retirement income fund."

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It's worth noting the federal government is reviewing tax planning through corporate structures, "so there may be looming changes that could negate some of these benefits," Mr. Saleken says.

Jerry should look into disability insurance. All of his effort in building his business will be for nothing if he falls sick or has an accident and is unable to work, Mr. Saleken says. Now that he is earning good income, Jerry should also consider increasing the amount of life insurance he has.

"The need for insurance should be weighed against the stability of Janice's employment and what outcome the family would want should either pass away prematurely," the planner says. As well, Jerry's corporation may offer insurance opportunities such as key-man or critical illness insurance to provide working capital for the business if Jerry falls ill.

Similarly, their efforts to save for the future could go "completely to waste if the investment portfolio structure leads to mistakes and/or missed opportunities," the planner says. He asked Jerry and Janice to complete a risk tolerance questionnaire to determine what asset mix they would be comfortable with. Risk should not be solely a financial measure but rather it should be at a level that fits the clients' personality and lifestyle and allows them to sleep at night, he adds.

"They both indicated that they would begin to feel uncomfortable if their investments fell by 20 per cent or more," Mr. Saleken says. That's entirely possible in a market downturn.

Their current portfolio is all in equity investments. This may make sense if they view Janice's defined benefit pension plan as a "large fixed-income asset," the planner says. If that is the case, it is understandable that their investments are more growth-oriented, "but only if this does not lead to mistakes and undue anxiety." He suggests a co-ordinated and systematic approach, including a regularly updated investment policy statement. "The actual form of investment should factor in a well defined strategy, diversification and reasonable portfolio costs."

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As for their retirement spending target, with continued saving and income-splitting in retirement, they seem likely to achieve their goal of $84,000 a year after tax ($100,000 a year before tax), the planner says. A combination of Janice's expected pension (about $39,000 in today's dollars), Canada Pension Plan and Old Age Security benefits, and savings of $30,000 a year, and assuming a long-term return of 5 per cent a year, Jerry and Janice can expect a gross cash flow of $108,000 a year, indexed to inflation of 2 per cent a year.

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CLIENT SITUATION

The people: Jerry, 47, Janice, 45, and their two children, 5 and 8

The problem: Should they pay off the mortgage or save for retirement? Can they retire as planned with $84,000 a year to spend? Should Jerry get disability insurance?

The plan: Focus first on RRSP contributions, then TFSAs. Jerry gets disability insurance. Review their investment plan.

The payoff: A comfortable savings cushion for the future.

Monthly net income: $11,200 (variable)

Assets: Bank accounts $7,745; residence $645,000; Jerry's consulting business $50,000; his corporate account $52,000; his RRSP $64,430; her RRSP $60,440; his TFSA $9,230; her TFSA $60,360; RESP $85,010; estimated present value of her DB pension $647,695. Total: $1.7-million

Monthly disbursements: Mortgage $2,200; property tax $210; water, sewer $90; home insurance $160; heat, electricity $110; maintenance $210; garden $85; transportation $540; groceries $700; clothing $100; gifts, charitable $70; vacation, travel $1,000; other discretionary $40; dining, drinks, entertainment $400; grooming $100; club memberships $155; subscriptions $35; other personal $120; dentists, drugstore $115; health, dental insurance $95; life insurance $105; her disability insurance $145; cellphones $150; Internet $80; RRSPs $2,000; RESP $415; TFSAs $500; her pension plan contribution $1,075. Total: $11,005

Liabilities: Mortgage $347,425

Want a free financial facelift? E-mail finfacelift@gmail.com.

Some details may be changed to protect the privacy of the persons profiled.

Video: Money Monitor: Investing vs. paying down a mortgage (The Canadian Press)
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