Ben Nelms/The Globe and Mail
After working out of the country for a year, Edgar and Abby are ready to set down roots. He's self-employed, bringing in anywhere from $120,000 to $200,000 a year. She works in communications, earning roughly $90,000 a year.
He is 41, she is 34. They have a toddler and hope to have another child or two before long. As a result, they want to move up from their condo to a family-sized home in the Toronto area.
"How much can we afford to spend on a new home?" Edgar asks in an e-mail. "And is it possible to hang on to our existing home as a rental property?"
Neither has a company pension, so their long-term goals include "building a good financial foundation for our retirement," Edgar adds. "Should we be prioritizing retirement savings or paying down our mortgage?"
They wonder, too, how much money they will need when they retire and what effect their age gap will have on their plans.
"My wife will be in her working prime when I'm retirement age," Edgar says.
We asked Jason Pereira, a financial planner and investment adviser at Bennett March/IPC Investment Corp. in Toronto, to look at Edgar and Abby's situation.
What the expert says
"Edgar and Abby have three immediate goals that unfortunately conflict and would take too much cash flow – have another child, upsize their home and keep their current property, all within the next two years," Mr. Pereira says. Even with their high income, they can't achieve them all at once, he says.
"The loss of income for a year due to maternity leave, and the high cost of having two children in daycare, are big issues," Mr. Pereira says.
In order to buy a larger home, Abby and Edgar would have to borrow as much as possible against the equity in their condo, the planner says. If they did, and then rented the condo out, it would likely lose money for the first few years after mortgage and condo fees, he says.
"Given that you want a bigger home, sell the condo." They do not want a starter home that they would have to move up from later, he notes.
"This can be a wise decision as it saves the costs associated with moving," he says. They plan to look for a house in the $950,000 plus range, which they could afford if they sell their condo and liquidate assets outside their RRSPs and RESP, Mr. Pereira says. "This size home, and its corresponding mortgage, will leave them without much wiggle room," he adds.
The planner offers a glimpse of their financial picture once the new house is bought and Abby is on parental leave. Their net income will drop to $167,400 (Edgar $144,200; Abby's employment insurance $20,800; childcare benefit $2,400). He then subtracts Edgar's RRSP contribution ($25,200) and income taxes ($46,960) for net cash flow of $95,240. He further subtracts registered education savings plan contributions for the children of $5,000, and lifestyle expenses of $87,067 for net cash flow before debt repayments of $3,173.
"Therefore, in the year the house is purchased, they will have to dip into their savings to pay the estimated $28,600 mortgage payment on their $491,720 mortgage," the planner says. That assumes the condo is sold and the net proceeds, plus some of their savings, are used for a down payment.
The situation improves a bit when Abby goes back to work, although childcare expenses of $25,462 take a big chunk of their income. Their net cash flow before debt payments will rise to $35,366, leaving free cash flow of $6,766 a year after the mortgage payment ($28,600). "All free cash flow should be used to pay down the mortgage faster," Mr. Pereira says.
Indeed, Edgar and Abby asked what their priority should be, paying down the mortgage or saving for retirement.
"Both," Mr. Pereira says. Given Edgar's high income, contributing as much as possible to a registered retirement savings plan should be a priority, he says, providing tax relief of more than $10,000 a year. Once the children are in school and Abby is back at work full time, they should contribute $10,000 a year to her RRSP, with any additional funds going to pay down the mortgage. This way, they should be debt-free with enough money for them both to retire by the time Edgar turns 65, the planner says.
"Assuming a 7.5-per-cent rate of return from now until they retire, they will have about $3.7-million saved at retirement," Mr. Pereira says. This money, plus their Canada Pension Plan and Old Age Security benefits, should be enough for them to maintain their lifestyle until Edgar is 96, after which they will still have their house to fall back on.
**
Client situation:
The problem: Can they afford to buy a larger home while still hanging on to their condo as a rental?
The plan: Sell the condo, buy the larger home, then focus on both paying down the mortgage and saving for retirement.
The payoff: Financial security, both now and in future.
Monthly net income: $10,000 to $14,000.
Assets: Cash $30,000; non-registered investments $98,000; his TFSA $40,000; her TFSA $39,000; his RRSP $220,000; her RRSP $70,000; RESP for child $8,000; residence $483,000. Total: $988,000
Monthly disbursements: Mortgage $756; condo fees $405; property tax $130; other housing $152; transportation $800; grocery store $1,200; child care $1,500; clothing $500; line of credit $73; gifts, charitable $350; vacation, travel $1,100; other discretionary $150; dining, drinks, entertainment $970; grooming $235; sports, hobbies $170; other personal $100; life insurance $108, critical illness insurance $65; telecom, TV, Internet $160; RRSPs $1,460; RESP $250; TFSAs $915. Total: $11,549
Liabilities: Home mortgage $156,000 at 2.69 per cent; investment loan $25,000; loan from parents $20,000; his income tax owing $18,000. Total: $219,000
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