Tricia and Lars are saving in a family registered education savings plan to pay the children’s university tuition.Duane Cole/The Globe and Mail
In a year or so, Lars and Tricia will have paid off the mortgage on their Toronto-area house and are wondering where to redirect the cash flow. He is 43 years old, she is 44.
Both are senior managers in the public service, with Tricia earning $140,500 a year and Lars $156,600. Both have defined benefit pension plans.
They have two children, ages 9 and 11. Tricia and Lars are saving in a family registered education savings plan to pay the children’s university tuition.
An underlying concern for the couple is financial resilience – the ability to weather a possible job loss, financial market downturn or other events that could undermine their financial stability.
“How much do we need in the RESP if we want to support tuition for both kids?” Tricia asks in an e-mail. “When should we stop contributing?”
After the mortgage is paid off, they plan to max out their registered retirement savings plans and tax-free savings accounts. “But then what?” Tricia asks. “What should we do with that extra $3,000-plus a month?”
Their retirement spending target is $100,000 a year after tax.
We asked Barbara Knoblach, a certified financial planner at Money Coaches Canada in Edmonton, to look at Lars and Tricia’s situation.
What the Expert Says
Tricia enjoys her job and is likely to work to age 65, Ms. Knoblach says. If she does, she will be entitled to a pension of about $82,000 a year, indexed to inflation. If she leaves work at 60, she’d get a pension and bridge benefit totalling $87,000 to age 65, falling to $67,000 a year thereafter.
Lars has a DB pension from a previous employer of about $23,000 a year. If he stays in his current job to age 65, he’d get an additional pension of about $87,000 a year.
“They’ve been diligent in their personal retirement preparation, holding RRSPs valued at about $174,000 and TFSAs worth about $267,000,” the planner says. Because they have DB pension plans, their RRSP contribution room is limited.
Tricia and Lars are prepared to cover tuition for both undergraduate and graduate degrees, assuming the children go to universities in Canada, Ms. Knoblach says. They have $104,000 in a family RESP. “They are still well below the lifetime contribution limit of $50,000 per beneficiary,” she says. Her analysis assumes they have already taken advantage of the maximum Canada Education Savings Grant, which is $7,200 per child.
If they continue contributing $4,800 annually until the end of 2027, they would have about $167,000 in the RESP by 2030, when their older child turns 17. That’s based on a balanced portfolio with a rate of return of 5.4 per cent.
If both children start university at age 18 and attend for six years, the RESP will be adequately funded, Ms. Knoblach says. That’s assuming tuition costs of $12,000 a year in 2024 dollars and an annual tuition increase of 3 per cent.
“I would caution against overfunding the family RESP for several reasons,” the planner says. The children may not need this much because they earn some money of their own or get scholarships, particularly for graduate studies. “Having the children contribute to their education fosters a sense of responsibility, making them have skin in the game,” she says. “Children who invest in their education tend to perform better than those whose education is fully funded by their parents.”
If the RESP is not used up, the original contributions are returned to the subscribers, the government grant must be repaid and any investment growth is taxed in the contributor’s hands at their marginal tax rate plus an additional 20 per cent tax. If the person contributing has RRSP room available, they can transfer up to $50,000 of the investment growth to their RRSP without immediate tax consequences. But Lars and Tricia are unlikely to have unused RRSP room.
Once the mortgage is paid off and the maximum is in the registered accounts, Tricia and Lars should set up an emergency fund of at least $100,000 in a high-interest savings account, cash exchange-traded fund or cashable guaranteed investment certificate, Ms. Knoblach says. “Currently, their low cash reserves leave them vulnerable to financial shocks.”
After they build up their cash savings, it makes sense for them to begin investing in a non-registered or taxable account with a more focused strategy. As it is, they have self-directed investments, robo-adviser services and actively managed mutual funds. “This approach is not conducive to implementing a coherent investment strategy.”
They should concentrate Canadian dividend-paying stocks in the non-registered account. That’s because dividend income from Canadian sources is tax-preferred. U.S and international stocks should be held in registered accounts, with dividend-paying U.S. stocks held in RRSPs. Investments generating interest income should be held in registered accounts
Lars and Tricia’s investments are heavily weighted toward stocks and stock funds. “A portfolio with this composition can nosedive in the event of a market downturn,” Ms. Knoblach says. Instead, they should aim for good risk-adjusted returns. “This entails including blue-chip stocks and a fixed-income component for stability,” the planner says. The RRSPs should have 30 per cent fixed income
“Funds withdrawn from RRSPs or registered retirement income funds will be fully taxable at the marginal tax rate of the holder so they should be invested more conservatively so as not to run up a huge balance,” she says. The RESP should shift to more conservative holdings as the children get closer to entering university.
“TFSAs, on the other hand, can be invested aggressively for maximum long-term growth,” Ms. Knoblach says. They should be accessed late in life or left to the children.
Lars and Tricia have expressed concern about their ability to handle unforeseen events such as job loss. “Once the mortgage has been paid out, they will be able to live on substantially lower household income,” the planner says. Assuming they continue working in their current positions and contributing $7,000 annually to each of their TFSAs and $2,000 annually to each of their RRSPs from now to the time they retire, they would have an inflation-adjusted after-tax spending power of more than $200,000 a year by age 65, Ms. Knoblach says. “They are on a path to significant overfunding in retirement.” They could scale back and still likely achieve their $100,000-a-year target.
“If all goes well and Tricia and Lars stay the course, they will be in a strong position to retire long before reaching traditional retirement age,” the planner says. “At that point, work will become optional and the potential impact of adverse economic events on their financial stability will be significantly reduced.”
Client Situation
The people: Lars, 43, Tricia, 44, and their two children, 9 and 11.
The problem: How to invest the cash flow freed up when the mortgage is paid off. How much to save for the children’s education. How best to buttress their finances.
The plan: Contribute enough but not too much to the children’s RESP. Once the mortgage is paid off, set up a cash reserve of at least $100,000 for unexpected events. Then develop a focused strategy for investing long term in a non-registered or taxable account.
The payoff: Financial resilience.
Monthly after-tax income: $19,400.
Assets: Cash $27,180; her TFSA $123,900; his TFSA $143,180; her RRSP $72,705; his RRSP $100,800; registered education savings plan $104,000; residence $1,300,000. Total: $1.87-million.
Commuted value of her DB pension $342,255; commuted value of his DB pension $400,000. That’s the amount that could be pulled out of the pension plan now and transferred to a locked-in retirement account.
Monthly outlays: Mortgage $3,045; property tax $430; water, sewer, garbage $100; home insurance $85; electricity, heating $125; cleaning $300; maintenance $2,500; garden $10; transportation $300; groceries $1,165; camp $665; clothing $150; Greener Home loan $335; charity $50; vacation, travel $1,335; dining, drinks, entertainment $1,090; kids’ sports and lessons $1,085; sports, hobbies, $20; subscriptions $85; health care (covered at work); life insurance $85; phones, TV, internet $225; RRSPs $250; RESP $400; TFSAs $1,765; pension plan contributions $2,530. Total: $18,130.
Liabilities: Mortgage $41,000 at 2.49 per cent, Greener Home Loan, $39,000 interest-free.
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