Young with a Bright Fiscal Future

ANDREW ALLENTUCK

In Toronto, an investment banker we'll call Julius is 27. He is a rising star of the financial services industry with an annual income of $220,000 a year, including a $112,000 estimated bonus for 2009. His wife, 26, who we'll call Lisa, is a teacher with a gross income of $52,300 per year. They also have a rental property that produces net income of $14,400 per year. Total annual income: $286,700 --not bad for a couple in their mid-20s.

In financial terms, the outlook for the couple is bright, but there are stumbling blocks ahead. Julius wants to take an MBA at a major American university in a program that allows him to attend classes on weekends. That will cost $150,000, plus airfare going back and forth. It is also more than he and Lisa have in cash and non-registered investments combined. As well, Lisa plans to go on maternity leave fairly soon, a move that will cut her income in half.

The arrival of children will also change the planning goals for the couple.

At present, they are comfortable with the balance of Julius' high income and lack of job security and Lisa's position as a modestly paid civil servant with job security. If they build a way of life dependent on Julius' high income, they will also have to build up substantial savings to cover the possibility that he will go through periods of unemployment. They can't do that on their present cash flow and debt service charges. Adjustments and some long-term planning are required.

"We want to raise a family of three or four children and send them to private schools by grade seven, then pay for their university educations," Julius explains. "We would also like to move into a larger home. We want to buy another rental property as an alternative to investing in stocks. Finally, although Lisa has a good pension plan, my company does not provide anything more than an RRSP boost. I have to think about retirement planning too."

Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Julius and Lisa to develop a road map for achieving their goals.

"This is a case of two people with terrific intellectual and personal resources," Mr. Moran says. "But there is an irony too, because Julius and Lisa have arranged their affairs inefficiently from a tax perspective and from an investment point of view. What I want to do is to save them money and make attaining their goals more likely. We don't know the sequence that the couple will use to address their priorities, but the arrival of children may change them."

Education

Julius could pursue the MBA in the near future. He can cover most of the $150,000 anticipated cost out of $80,000 cash he holds, plus $46,000 of non-registered investments. As an alternative, he can tap his RRSP under the Life Long Learning Program for up to $10,000 per year, to a limit of $20,000 over a four-year period. The money would have to be repaid in equal installments over a 10-year period, beginning no later than 60 days after the fifth year following the first withdrawal, Mr. Moran explains.

Julius should also check with his employer to determine if there are programs to assist employees who want to obtain advanced business degrees. If he pays his own bills, Julius should be able to take a 15% federal tax credit for them, Mr. Moran notes. For major Canadian universities, there is no problem of qualification. For foreign universities, it is wise to check with Human Resources and Social Development Canada.

Julius could wait a year before starting his MBA. If he did that, he could use his existing savings of $80,000 in cash, plus non-registered assets of $46,000, to cut his existing mortgage and line-of-credit debt of $253,000. That would leave $127,000 outstanding. He could then use his present monthly savings of $4,222, plus the $5,417 he gets in bonus after tax (worked out on a monthly basis). That's $9,639 per month. After he has cut his debt by half, his remaining monthly debt service charges will be slashed by half as well. That's a $1,300 monthly saving. His total monthly savings rise to $10,939. If he uses that sum to discharge the remaining debt, he will be debt-free in 11.6 months. Then he can divert his substantial cash flow to paying his tuition bills.

Rental Income

Julius should make the rental income more tax-efficient. He owns a rental property and reports all rental income on his own return. That's not advantageous on a tax basis, for he is in a high -- 40.16% -- bracket while Lisa pays a tax rate of 31.15%. If Lisa does legitimate work on the property, she could obtain an income for her work. That would effectively split some of the property income of $14,400 per year.

The income split would have a further tax advantage. Julius' income is so high that he cannot use the RRSP contribution room generated by rental income. Splitting the income would allow Lisa to earn more RRSP contribution room.

Retirement Plans

If Julius wants to maximize RRSP growth, he can contribute up to $21,000 in 2009 and $22,000 in 2010 (the limit is to be indexed in 2011 and later years). Then, assuming 3% annual growth of his RRSP and existing savings of $45,550, he and Lisa would have a total of $1,368,878 by his age 60 -- 33 years from now. If the funds are preserved so as to last to his age 90, that sum would produce income of $119,615 per year, Mr. Moran estimates. Add in the couple's present rental property income of $14,400 per year and the total rises to $134,015 per year. This is actually a low estimate as it does not include non-registered savings. They will receive Canada Pension Plan payments of $10,905 per person per year on top of their investment income, but they will not get to keep much of their Old Age Security benefits. That is the price of financial success.

Family Values

"That the couple will be able to afford luxuries for their children is not in question, assuming Julius moves up the investment banking ladder into the stratosphere of seven-figure annual bonuses, " the planner notes. "But a childhood padded out with private schools, ski trips to Switzerland and the other trappings of wealth is not always advantageous. Julius and Lisa should ensure that they imbue their own sense of striving and duty in their children. Children should not feel that money is an entitlement."

SITUATION

Investment banker with six-figure income wants to get MBA, boost income

STRATEGY

Maximize tax credits for tuition costs and rental income, avoid spoiling kids

SOLUTION

Cash for MBA, kids and retirement

THE PROFILE

MONTHLY AFTER-TAX INCOME $9,835

(not including annual bonus of $5,417 per month)

ASSETS

House $500,000, Rental property $450,000, Non-registered investments $46,000, Julius RRSP $40,000, Lisa RRSP $5,500, Cash $80,000

TOTAL $1,121,550

LIABILITIES

Mortgage $234,000, Line of credit $19,000

TOTAL $253,000

MONTHLY EXPENSES

Mortgage & line of credit $2,600, Property tax $333, Food $400, Dining out $300, Entertainment $100, RRSP $550, Car fuel $200, Travel $200, Car and home insurance $150, Life insurance $80, Phone, Internet $200, Utilities $300, Miscellaneous $200, Savings $4,222

TOTAL $9,835

Used By Permission (c) 2009 Globe and Mail