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Saturday, October 16, 2004Frugal pair are advised to concentrate on
near-term plans, rather than on a distant financial target, to ensure
A Toronto pair we'll call Jack and Lucy face a problem many young couples encounter -- how to balance their present needs with what they'll require in the future. Jack, 25, has a software engineering job. He grosses $80,000 a year. Lucy, 23, a health care professional, makes $70,000 before taxes. After taxes, Jack and Lucy have $86,000 a year to spend.
They are acutely conscious of a need to build a life that includes their wedding in a few years, a house for a family they want to have, and for retirement. And they worry that in spite of their relative affluence after years of living modestly as students, they won't have enough money for the life they anticipate.
Jack and Lucy save zealously. Jack has already paid off $20,000 in student loans. Lucy had the good fortune to have her tuition costs paid by her parents.
As students, they operated on tight budgets. That sense of economy has carried over to their current lives. They spend $3,200 a month, leaving a residue of $3,961 as savings.
This high rate of savings, 55 per cent of after-tax income, should last until 2009 when Lucy cuts her work to part time to raise the family they are planning.
"We have so much to plan for," Lucy says.
Adds Jack: "I have been concerned that with our rising incomes, we have to save an increasing amount over time so that in retirement we'll be able to continue the lives we led before retirement."
What our expert says
Facelift asked Michael Nuschke, a financial planner in the Halifax office of Assante Capital Management Ltd., to work with Jack and Lucy in order to plot a course that will help them make sensible plans.
Jack and Lucy have two sets of goals: A short-term plan to gather $20,000, which they are budgeting for a wedding in two years, and longer-term goals of saving $50,000 to cover a down payment and closing costs when they buy a house in three to four years. Beyond that, they want to build an undetermined amount of money for retirement.
"It seems a fairly sure thing that either Jack or Lucy or both will have company pensions that, if the present trend continues, would pay 50 to 70 per cent of the last few years' income," Mr. Nuschke says. "That alone would take care of retirement at their modest expectations of what their living standard will be. At the moment, they seem to have culture shock going from the poverty mentality of students to the income level that their careers produce."
The plan works best if all of Lucy's take-home income of $46,000 is saved, Mr. Nuschke says. Lucy is in a lower tax bracket and will be able to retain more income from non-registered investments that are sold in order to pay for the wedding or the house down payment and closing, Mr. Nuschke says. The funds should be accumulated in a money market fund. Investing in an equity fund presents too much risk in the short term, the planner says, noting that any term of less than eight to 10 years is fairly short.
Setting a goal for retirement income is difficult, for Jack has 40 years to go before he reaches 65, Mr. Nuschke says. Jack and Lucy have set a target of $1-million as a retirement fund, but it makes more sense to set an income goal and then save toward making the goal a reality, given suitable assumptions about rates of return on investments and inflation rates, he says.
Allowing for an average annual inflation rate of 3 per cent for the next 42 years until she reaches 65, and growth of underlying investments at a nominal rate of 6 per cent a year, Lucy's accumulated pension credits, assuming she begins to work part time for a decade beginning in 2009, will produce a pension of $30,000 a year in 2004 dollars, Mr. Nuschke says.
If combined with Jack and Lucy's expected Old Age Security and Canada Pension Plan income, the couple will already have a substantial, if difficult-to-estimate, pension with no further registered retirement savings plan or other retirement savings, Mr. Nuschke notes.
Even so, it makes sense to maximize RRSP contributions to achieve long-term tax deferral. Jack should make contributions each year, because his employer matches 50 per cent of his group RRSP contributions up to $3,000 in contributions. Jack also has an employee stock purchase plan that lets him buy company shares with a 15-per-cent discount from market price up to 10 per cent of his gross income. Jack should take full advantage of the Group RRSP matching, Mr. Nuschke advises.
Jack and Lucy are at risk of planning for more than can be foreseen, Mr. Nuschke warns.
Inflation rates, interest rates, stock market returns and real estate price trends cannot be predicted accurately in the 40 years until Jack retires, he says.
"What is more important than picking the right investments is for Jack and Lucy to set sustainable targets for savings and spending," he explains.
And it is good to have your own, private disability coverage. It can be expensive, but at this stage Jack and Lucy can afford it, the planner advises.
The young couple are reluctant to stop hoarding.
"We don't feel that our quality of life is impaired by living modestly. These are the years when we can save a lot more than we spend. It will be harder when we have children," Jack says. "Our view is that it is a lot easier to let expenditures drift upward than to push them downward in future when we have kids."
"Jack, like other engineers, is trying to plan too much," Mr. Nuschke says.
"The risk in overplanning is that a plan will break down from what are personal issues. The world doesn't always go according to plan."
Interested in a free Financial Facelift? If so, drop a line to the writer at 444 Front St. W., Toronto, ON, M5V 2S9, or firstname.lastname@example.org
Jack, 25, and Lucy, 23, live in Toronto and plan to marry and start a family.
Income: Jack: gross $80,000 a year; Lucy, $70,000 a year.
Total: $150,000 gross a year; $7,166 net a month.
Assets: RRSPs, $5,000; non-registered investments, $5,000; cash, $7,000.
Monthly expenses: Rent, $910; food, $300; furniture, $200; utilities, $160; transport, $175; clothing, $120; RRSP (Jack) $750; entertainment, $150; miscellaneous and charity, $440. Total: $3,205.
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