Financial Post Article: This Alberta couple won’t retire for another 30 years, but they can start planning now

The Financial Post asked me to review the finances of a 30-something Alberta couple who hope to have another child in the next few years and see themselves buying some property and building a home where they will retire.

See why it’s a big benefit for you to plan for the retirement you want years ahead of time.

CLICK THE LINK BELOW TO READ THE ARTICLE BY MARY TERESA BITTI:

This Alberta couple won’t retire for another 30 years, but they can start planning now

I’m a 35-year-old tenured High School teacher in Calgary, with my wife who works for a family business.  We have a newborn son, with the hope of having another in child in a few years’ time.

My Family Finance question is; how to best ensure my wife and I have saved enough for both our retirements in the future, pay-off our mortgage(s), save money for our child(s) education, insure ourselves properly for our children in case of unforeseen deaths/medical emergencies, and to hopefully afford in retirement to buy an acreage west of where we live somewhere in Alberta and build our retirement home.

In this post, you will learn:

• Why it’s important to figure out the retirement lifestyle you want years ahead of time.
• How to decide how fast to pay off your mortgage.
• What is “Ed’s Rule of Thumb” for rental properties?
• Should you buy your retirement property years before?
• The most effective investment strategy for people not getting advice.
• How much should you save for retirement?
• Are there tax-efficient ways to save for children other than RESPs?
• Should you get life insurance on your children?

My more pertinent finance questions based on my financial situation outlined below will be in BOLD.

Currently we have a $230K mortgage on our principal residence (value $550K) and a $200K mortgage on a condo (value $300K, my wife’s previous home before we met) we rent out. The condo pays for itself, usually with a small profit ($1-3K) each year. We fully own both our vehicles worth a combined $15K. Other that we do not have any other debts outstanding.  

• Should we keep double-paying/make extra payments on our principal residence mortgage, or should we save more and invest? Should we keep the rental property or sell and diversify our investments and/or look for our future acreage property land now?  What would buying undeveloped land for an acreage now instead of later have for pros (land price increases) vs cons (investment $$ tied up, yearly property taxes, high down-payment requirement)?

I currently have a TFSA of $32K and RRSP of $52K, and my wife has a TFSA of $10 and RRSP of $32K. These funds are self-direct invested in equities, with cheap ETF index funds making the majority of my holdings and all of my wife’s holding (VCE – TSX 60 in TFSA and VOO – S&P500 in RRSP). Using Norbert’s Gambit, I change CDN to US to invest in US equity in RRSP’s and I invest CDN exclusively in CDN equity in TFSA’s. Currently we do not have non-registered investments.

• Thoughts on this investing strategy? We are long-term investors with a 20+ year time-horizon, have a high-risk tolerance, cost dollar average our way in the market 2-3 times a year and we have DRIP’s on all our investments.  Are all-equity investments the best choice at this point? Should we think about bonds?

I will max out earnings at $105K (currently $95K) as a teacher in (3) years and my wife earns between $70K-$100K, depending on commissions earned and time worked due to childcare demands, with $65K as a salary.  The family business my wife works in is stable, but we are unsure if it will be her long-term employment, due to family succession plans and type of work performed (very manually intensive).  

I have a teachers pension that takes 10% of my pay and will give me a 50% pension on my best 5-year average salary, so at this point it would be $53K/year, when I reach 58 years old (earliest I can fully retire), but it could/would go up if we receive raises and/or I went into Administration later in my career.  My wife has no pension through her work, but since we got married (2 years ago) we have been jointly contributing the equivalent of the 10% of my salary into her RRSP (approx. $9500 last year).

In addition, I currently contribute $500 a month to my TFSA and $150 a month to my RRSP (to settle the First Home Buyer withdrawal from RRSP).  My wife contributes $200 a month to her TFSA a month and an additional $150 a month to her RRSP (also to settle First Time Home Buyers plan withdrawal and on top of the $9500 a year we jointly contribute).

• Is this enough for my wife and I to save each month? Should we put more in my wife’s TFSA vs RRSP?  Should I be saving more to invest in TFSA’s based on my pension?

We plan on contributing at minimum $2500 each year to our sons (and any future child) RESP to capture the full CESG Grant.  My wife has a whole life insurance policy of $100K with a $340/year premium and I have an (2X) Annual Salary Death Benefit – approx. $200K Insurance policy at this time.  We are both in good health and have full health benefits through our work insurance plans.

• Is there any other way we can save tax efficiently to invest for our children’s future outside of CESG?  What investment vehicle options are there for RRSP, can they be self-directed?  How much life insurance should we have for our child/children, and should it be term vs. whole?

National Post Article – Retirement Planning – Calgary Teacher

Financial Plan & Questions

Calgary teacher & wife with family business age 35. Earning $180,000/year. Save 19% of their gross income (including pension contributions).

He has unreduced pension at age 58, so that is when they may want to retire. 70% of their income rule of thumb is $126,000 (in today’s dollars). They are relatively frugal, so they can maintain their current lifestyle and spend about double on travel & entertainment that they spend now on $100,000/year (in today’s dollars).

To retire at age 58 with what they are saving, they should have about $2.1 million in retirement investments (plus his pension).

How they are doing depends on the retirement lifestyle they want:

• To retire at age 58 on $126,000 (in today’s dollars), they will need about $2.7 million. They are $650,000, or 24% behind. They would need to save about $800/month more for this retirement.
• To retire at age 58 on $100,000 (in today’s dollars), they will need about $1.6 million. They are $500,000, or 29% ahead.

He says his pension should be about 50% of his income at age 58. That is his pension PLUS CPP income. It will probably be 5-10% lower to allow for his wife to have a survival benefit if she outlives him.

Interestingly, it is relatively rare for teachers to be saving this month. Even though they teach our kids, they often think (wrongly) they don’t need to save. Most teachers I have met have surprisingly low financial knowledge, because they feel they don’t need it. It is important for teachers to learn about financial planning and investing so they can teach our kids effectively.

• Should we keep double-paying/make extra payments on our principal residence mortgage, or should we save more and invest?

Mortgage interest rates are quite a bit lower than the returns they should expect on their investments, since they are investing 100% in equity (stock market) investments. It’s a good idea to pay off their mortgage by the time they retire. They plan to retire in 23 years, so ideally they should set their mortgage based on a 23-year amortization. Since they bought their home 2 years ago, they probably have a 23-year amortization.

I recommend just making their base payment to pay off their mortgage in 23 years. Don’t double up.

Their mortgage is probably about $1,400/month and they have been paying double, or about $2,800/month. They should reduce their payment back to $1,400/month and invest the extra $1,400/month.

• Should we keep the rental property or sell and diversify our investments and/or look for our future acreage property land now?

Their return on their rental property is probably a bit higher than they should expect with their equity investments for now, but this will probably reverse in about 5 years. At that time, it’s probably best to sell it to invest.

It provides a cash flow return of $1-3,000/year, but they have $100,000 of equity in it. That’s a 2%/year return.

In addition, the property should grow in value. Long-term real estate average in Canada has been about 4%/year for real estate. Calgary has been lower the last decade. The 4%/year growth is on the full value of $300,000, or about $12,000/year. Since they have $100,000 equity, the estimated growth could be a return of about 12%/year.

Add the 2%/year cash flow return to the 12%/year property value growth, their return could be about 14%/year.

Real estate usually only has a good return when you have a large mortgage. For example, if they had no mortgage, the 4%/year growth would only be 4%/year, not 12%/year. The “leverage factor” is the main determinant of whether or not a rental property is a good investment.

“Ed’s Rule of Thumb” for rental properties is to sell them when the mortgage is half the value of the property. At that point, investments in equities (without a loan) should provide a higher return, less tax, and no work.

In about 5 years, their rental property should be worth about $350,000 and the mortgage should be down to about $175,000. That’s half the value. At that point, they should probably sell and invest in equities.

• What would buying undeveloped land for an acreage now instead of later have for pros (land price increases) vs cons (investment $$ tied up, yearly property taxes, high down-payment requirement)?

Buying their future acreage now is probably a poor investment. It would be an expense they would have to carry for 23 years. If they keep it as land, they probably can’t get a mortgage on it, so the growth (unleveraged) would probably be very low.

Probably only disadvantages. Low growth in property increases, money tied up that could be invested effectively, yearly property taxes, high down payment.

The advantages are probably only emotional – feeling they already have it. It’s better to wait until the last couple years. They may change their mind about what they want and where they want to be between now and then.

• Thoughts on this investing strategy? We are long-term investors with a 20+ year time-horizon, have a high-risk tolerance, cost dollar average our way in the market 2-3 times a year and we have DRIP’s on all our investments.  Are all-equity investments the best choice at this point? Should we think about bonds?

100% equity investing is the most effective for long-term growth. Equities are more reliable after inflation than fixed income (lower standard deviation after inflation, based on 200-year study by Prof. Jeremy Siegel).

Investing in broad indexes is the most effective way to invest for people that are not knowledgeable about investing and not able to find the top fund managers that outperform the indexes over time. Their index ETFs are a good choice, if they are not going to get professional advice.

Investing throughout the year (“dollar cost averaging”) is a good way to invest, since that probably means investing from their cash flow as it comes in. Investing monthly rather than 2-3 times per year is likely to work out slightly better, since people with a “human gut” tend to be bad at market timing.

Many financial advisors that don’t do financial plans recommend a “diversified portfolio” of stocks, bonds, & cash, but that is about reducing short-term volatility. They need an equity-life return of 8%/year (conservative for equities long-term) to have the retirement they probably want.

They are comfortable with the short-term fluctuations of equities, so they should keep their allocation at 100% equities.

He is mostly in the US with S&P500 index ETFs. Investing more broadly globally is effective diversification. They should probably invest in both MSCI World and S&P500 index ETFs.

Having a portion in Canada probably reduces their long-term returns. The Canadian stock market has lower long-term returns and is not a properly diversified portfolio. It’s mainly resources & banks, with almost nothing in most other sectors. Investing all in global or US equities should be more effective and reliable for them.

Reinvesting their distributions automatically like they are doing (“DRIPs”) is effective to stay invested.

• Is this enough for my wife and I to save each month? Should we put more in my wife’s TFSA vs RRSP?  Should I be saving more to invest in TFSA’s based on my pension?

They are not maximizing their registered accounts and would need to invest about $800/month more to be on track for retiring on 70% of their work income. They should reduce their mortgage to the basic payment, which gives them about $1,400/month more to invest.

Since his wife’s family business may not be her long-term career and is physically demanding. It is advisable to try to be ahead of their retirement goal, to give them a margin of safety.

They are not maximizing their registered accounts:

RRSP teacher: Contributing $150/month for Home Buyer’s Plan, but probably gets about $3,000/year of new RRSP room. He may have past RRSP room, as well.

RRSP wife: With an income of $85,000/year, she gets $15,300/year of new RRSP room. She is contributing $9,500/year plus her Home Buyer’s Plan repayment.  She should have $6,000/year ($500/month) more RRSP room. She may have past RRSP room, as well.

TFSA teacher: He is contributing $500/month and has $32,000 in his TFSA. That means he has contributed for 4 or 5 years. Total TFSA room since they were created in 2009 to 2023 is $88,000. He probably has about $60,000 of TFSA room plus is contributing $500/year less than the maximum of $6,500.

The $500/month he is contributing was the annual maximum until 2022 of $6,000. He did not increase it to $541/month, which is the new maximum of $65,00/year.

TFSA wife: She has $10 in her TFSA (probably a misprint of $10K) and is contributing only $200/month. She has about $88,000 of TFSA contribution room (or $78,000 if it is $10K now).

Their incomes are higher today than when they retire, so they should prioritise RRSP over TFSA.

I suggest reducing their mortgage payment by $1,400/month and investing it. First, maximize their RRSPs and contribute the rest to their TFSAs. They have lots of TFSA room.

His pension is fully taxable and TFSA gives them some tax-free investments to access in retirement. However, whether to contribute to RRSP or TFSA is mainly dependent on their marginal tax bracket today vs. after they retire.

They will probably be in a lower tax bracket after they retire. He will be able to split his pension income with his wife on their tax returns.

Therefore, maximizing their RRSPs before TFSAs is most effective for them.

• Is there any other way we can save tax efficiently to invest for our children’s future outside of CESG? 

RESPs generally save about enough to cover a 4-year undergrad degree with both tuition & living costs, if they invest in equities. Unless they want to give their kids more, it is probably not necessary to save more for their kids.

If the want to, investing in informal trusts is essentially tax-free growth for their kids, but no RESP grant) Invest in their names “in trust for (ITF)” their kids. If they invest as they are for growth, capital gains are taxable to the kids, which means tax-free since they each get $14,000/year in a basic personal tax credit. Any dividends or interest are taxable to the parents, so they should keep any ITF investments focused on growth.

• What investment vehicle options are there for RRSP, can they be self-directed? 

He probably means RESP, since he has index ETFs in self-directed accounts for their RRSPs now.

Their index ETFs are a good choice for RESPs. Yes, they can be self-directed. RESPs can be invested the same as RRSPs or TFSAs.

I suggest global and US index funds or ETFs for them.

• How much life insurance should we have for our child/children, and should it be term vs. whole?

Life insurance is to provide for people financially dependent on you. Children cost much more than they earn 😊, so they do not need any life insurance for the kids.

Life insurance on their kids is for the parents as beneficiaries not for the kids. Life insurance salespeople try to sell life insurance on kids as looking after the kids, but it’s not.

There is no logic in getting life insurance now when they won’t need it until they have people dependent on them in 20 or 30 years.

Whole life insurance for kids is a disaster. When they are married in their 20s or 30s, they will probably need life insurance of $2-3 million. Whole life insurance is so expensive that people can only afford tiny amounts like $50,000 or $100,000. Those are a rounding error and not relevant long-term.

Buying whole life insurance is awkward when the children grow up. I’ve seen this many times. Parents pay for whole life insurance for 25 years for kids and then suggest the kids take it over. However, in their 20s, they can buy 10 times that insurance coverage for the same premium. The kids almost never want the policy and usually cash it in immediately or keep it out of guilt.

Avoid whole life insurance to avoid this awkward future of trying to give them a low return, high premium tiny policy they won’t want.

In short, they do not need any life insurance on the kids. Ignore the life insurance sales pitches.

The parents should get life insurance. To maintain their current lifestyle and their retirement goal, taking into account his work life insurance, he needs about $800,000 and his wife needs about $1 million. There is a price break at $1 million.

I suggest they get a joint 20-year term $1 million life insurance policy. The premium will likely be only $100-150/month and protects both of them well.

They should probably cancel her whole life insurance once they get a proper term policy. $100,000 is not nearly enough and whole life insurance policies are a low return investment. They are expensive because you pay for insurance for life, even though hardly anyone needs life insurance after they retire.

Ed