Caught Between Kids and Retirement

ANDREW ALLENTUCK

In Toronto, a couple we'll call Peter and Chris, ages 41 and 38 respectively, have civil service jobs -- she with the Ontario government, he with the federal government. They bring home $9,375 each month, but they have nearly two decades to go before their children, ages nine, five and four, are through with their post-secondary education. Meantime, they need to balance the money they put into life insurance, their retirement savings and reduction of mortgage and other debts.

"I would like to ensure that there will be enough money for my children in their RESPs when they are ready to begin their undergraduate studies," Peter says. "We also have to decide whether to save or pay down our debts."

Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Peter and Chris. "Their situation does need some reorganizing, but if they do as I suggest, they will be fine in financial terms."

Peter's annual pre-tax income is $105,000, while Chris' annual pre-tax income is $70,000. Both are in high tax brackets. They get $200 per month in federal child-care credits, a sum that will drop to $100 in March when one child turns six. They also receive the Universal Child Care Allocation in the amount of $128 once every three months. Their current family income, a total of nearly $178,000 without counting any money from taxable investments, gets no relief from the interest they pay on their debts.

Debt Management

First step: Cash out all nonregistered mutual funds, a total of $21,000. The cash will be used to pay down $2,000 in credit card debt with rates as high as 19.75%. In future, they should use a line of credit to make payments in full. A bank line of credit costs far less than carrying credit card balances.

Second step: Pay off the $8,500 car loan that bears interest at 7.9% per year.

Third step: Pay off the $9,800 line of credit.

Fourth step: With the savings from loan payments they no longer make -- $695 per month in interest charges alone -- they can increase RESP contributions from$125 per month per child to $208.33, an extra $250 in total for the three children. This brings the annual RESP contribution to $2,500 per child, the sum required to get the maximum Canada Education Savings Grant (CESG) of $500 per year.

Fifth step: Debt reorganization and the tax refunds for child-care expenses will add money to the family account, which can be used to speed up paying down the mortgage. The $695 freed up by the elimination of personal debt, minus the extra $250 to RESPs, leaves a $445 balance. Child-care costs are deductible against Chris' income and will produce $343 per month of tax refunds. Applied to the mortgage, the $445 + $343 would reduce their amortization from 19 years to 12 and save them $70,500 in interest payments, Mr. Moran says.

Life Insurance

Life insurance is a good thing when children or others are dependent, but there are limits to coverage needed. Mr. Moran says $500,000 coverage for each parent should be enough.

Peter has a permanent life policy for $250,000. His employer provides another $210,000 and an annuity that would be paid every year in the amount of $10,000 per year for the spouse and $2,000 each year for each child.

Chris has permanent life coverage for $175,000 and a $25,000 bonus for accidental death. If she dies before Peter, he will get three times her salary plus a lump sum of $10,000. They also have mortgage life insurance.

In total, Peter has $772,000 of life insurance. Chris has $612,000 of coverage.

That's sufficient coverage, but the type of insurance is not suitable, Mr. Moran says. Permanent insurance does not keep up with inflation. Conventional mortgage life coverage usually protects only the lender. Dump the mortgage life insurance that was sold by the lender and replace it with conventional term insurance to cover the outstanding debt, Mr. Moran suggests. The lender will require proof of insurance, a document the new insurer can provide.

By shifting from their whole life and mortgage life policies to $500,000 of 10-year term insurance, premiums (some of which are deducted at source from payroll) will drop from $2,916 per year to $700 per year. That will provide savings of $2,216 per year. If the new policies are paid annually in advance, costs will be reduced by a further 5%, Mr. Moran notes.

Education Savings

The family's RESP accounts currently have a total balance of $11,900. Including the Canada Education Savings Grant, $5,400 per year is being added to the accounts. If contributions rise by $250 per month, plus an extra $50 from the CESG, the total annual contribution grows to $9,000. By the time the eldest child is 18, RESP balances will be $109,700 (assuming a 3% real annual return), the planner says.

Contributions can continue for the other two children until the year each child turns 17. That would allow as much as $29,330 of contributions, including the CESG. That means that each child would have $46,350 in 2009 dollars for post-secondary education, enough for tuition at a local institution, Mr. Moran estimates.

Retirement Savings

Peter and Chris are both civil servants with excellent defined-benefit pension plans. Chris will qualify for a full pension on the factor 90 rule (age plus years of service) at age 56. One year later, Peter, who will be 60, can take an un-reduced pension. Indeed, that's his plan.

Their pensions will pay about 60% of their salaries with a small reduction for survivor benefits. Each will qualify for 85% of Canada Pension Plan benefits, for a total of $18,538 per year. Both will qualify for full Old Age Security benefits, currently $6,204 per year, Mr. Moran says. They should have a modest income of perhaps $600 per year from their present RRSP balance of $8,450, assuming 3% annual real growth, depending on when they are converted to RRIFs. Most of their pension base is indexed.

Their combined pre-tax retirement income will be about $136,500 per year with incomes almost perfectly split They will suffer slightly from the OAS clawback that begins at $65,335 per year per person (takes 15% of each additional dollar).

Further RRSP contributions are an option, but not a compelling one. Projected high tax rates in retirement and the need to cut debt mean more emphasis on debt repayment than RRSPs, Mr. Moran says.

SITUATION

Family with three young kids finds choices limited by debt

STRATEGY

Pay down debts in to liberate cash, rationalize life insurance

SOLUTION

More opportunities for children and retirement

THE PROFILE

MONTHLY AFTER-TAX INCOME $9,375

ASSETS

House $372,000, Mutual funds $21,000, TFSAs $5,000, RRSPs $8,450, RESPs $11,900, Cars (2) $14,000

TOTAL $432,350

LIABILITIES

Mortgage $312,000, Lines of credit (4.25%) $18,100, Car loan (7.9%) $8,500, Credit cards (19.75%) $2,000

TOTAL $340,600

MONTHLY EXPENSES

Mortgage $2,442, Utilities $470, Food & restaurant $900, Entertainment $100, Clothing $150, Child care $1,100, RESP $375, TFSA $834, Car, home insurance $305, Car fuel $350, Cars repairs $200, Life insurance $152, Lines of credit $400, Car loan $295, Kids activities $450, Miscellaneous $500, Savings $352

TOTAL $9,375

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