A Cross-Country Move Left a Few Loose Ends, But Overall This Young Family Looks Set For a Good Life
In Prince Edward Island, a couple we’ll call Victor and Barbara, both 34, are raising their two children ages three and one. They moved from Ontario just a year ago, leaving solid jobs with big companies and big company pension plans to enjoy living by the ocean.
The move meant lower income — their pay cuts add up to $25,000 a year, but they gained a house “dividend,” paying $400,000 for their seaside house after selling their Ontario home for $580,000, a rental property in Ontario for $270,000, and clearing debts. Currently, they take home $10,290 a month, which buys a good life in their town.
Looking back at the move, Victor and Barbara recognize that they left issues unresolved. Both have solid careers, Victor as a management consultant with another large company, Barbara as a chemist. Barbara’s pension from her Ontario job remains in place with a commuted value (the sum needed to pay the eventual pension) of $240,000 parked in a Locked-In Retirement Account (LIRA). Along with various other financial assets, they have $538,000 in savings, plus $24,000 in a Registered Education Savings Plan for their children.
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The move left loose ends. They consider taking the commuted value of their pensions, which in a period of low interest government bond interest rates that support payouts, will be very high. Unlocking LIRAs is a problem, but it can be done. They would give up lifetime pensions. They consider buying a cottage to rent out for a couple of months a year, thus letting tenants contribute to their growth of equity. If that works out well, they might buy another vacation cottage, they say.
“We have a lot of issues, especially the question of cashing in our pensions,” Victor says. “There is also the matter of saving up for our children’s post-secondary educations. What should we do?”
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Victor and Barbara. “They are diligent savers and they ask the right questions,” Moran says.
Real estate is only 43 per cent of their net worth, which is very low for Canadian families in their thirties. But buying it for rental raises issues: Rental income is fully taxable; there is potential vacancy and tenant damage; and the asset is illiquid. The property has not been purchased, so its profitability can’t be determined. For now, they can use spare cash to pay down their $35,000 line of credit.
Education savings plans & child security
The parents have contributed to RESPs for each child’s years, for a total
Without the CESG, an RESP only has a tax benefit if the kids are in lower income brackets than the parents. The kids might not go on to university or a college, so the parents could just as well stop after 11 years for the elder, at age 14, and use the same approach for the youngest. Assuming three per cent growth after inflation from now to that time, then continuing to generate growth at the same rate, the elder child will have $63,400 for university and the younger about the same if the strategy is maintained, Moran says. Each child would have $15,500 a year for university. The parents can add more as needed or the kids can get summer jobs.
Victor has $130,000 of whole life coverage in place, and Barbara has $40,000. They have insurance equal to a few years’ salary with their jobs, but all of it together is insufficient. They should replace whole life policies with term coverage for $750,000 each. Whole life has tax deferral benefits, but its value grows very slowly. They can switch to term and buy stocks that pay dependable and rising distributions with the premium money they save, Moran suggests.
Defined-benefit pensions often have attached health care benefits or the option to purchase benefits at very low cost. Moreover, tax on some part of the investment flow would reduce what they have to spend, even if they can shelter some of the commuted value or income flow in TFSAs or by other means. However, we’ll value the pensions as though taken in cash in order to project pension income.
We’ll assume that the taxable portion of a pension payout, which might be $110,000 in their case, would be taxed at 30 per cent immediately, leaving $77,000. Now invest the $77,000 plus $130,000 locked in for 26 years to age 60. We’ll assume a generous return of six per cent, less three per cent for inflation. The adjusted sum would rise to $446,400 by 2041.
If that sum were spent evenly for 30 years to their age 90 with the same internal growth rate in their investments, it could generate $22,750 a year with payouts at the end of each year, all in 2016 dollars. Some of the payout would be a return of capital, which is not taxable.
Our $22,750 figure is indexed in full, though their DB pensions will have only 75 per cent indexation. Each spouse will qualify for full Canada Pension Plan benefits, currently $13,110 in 2016 dollars. They will each qualify for full Old Age Security at age 65. The maximum payout is presently $6,846 a year.
If Victor and Barbara continue to add $12,000 a year to their $63,000 of existing RRSPs and can grow the assets at three per cent over the rate of inflation, they will have $612,400, in 2016 dollars at age 60. If spent evenly over the next 30 years to their age 90, it would generate $31,250 a year.
Their TFSAs add up to $52,000. If they each continue to add $5,500 a year under the revised TFSA limit for 26 years and obtain a three per cent annual return, they would accumulate $549,000 in 2016 dollars. If that sum is spent over the next 30 years with all capital exhausted at the end of the period, it would provide $27,200 a year of tax-free income.
Adding up the various income flows, they would have $22,750 a year from their commuted pension dollars privately invested, $26,220 in combined CPP, $13,692 in combined OAS at 65, $31,250 from RRSPs and $27,200 from TFSAs. That adds up to $121,112 a year. If eligible income were split, each would have about $60,560 before tax.
TFSA cash flow would not be taxed, thus eliminating risk of exposure to the OAS clawback, which currently begins at about $73,000 of individual income. As well, return of capital in some other investments would be tax-free. Using a 20 per cent average tax rate, the couple would have $8,075 a month to spend, a good deal in P.E.I. and more than enough for $10,290 present monthly spending with child care, RRSP and RESP savings removed.
of four contribution years. That’s 4 x $2,500 plus four Canada Education Savings Grant annual top ups of $500. Add this year’s contributions and the sum of contributions and top ups is $18,000. Investment growth pushes the total in the fund to $24,000. They should continue to contribute until they reach the maximum CESG, which is $7,200 per child. That equates to 14.4 years of contributions per child.