National Post Article: With law-school loans and divorce paid off, couple unsure how to use freed-up funds

The National Post asked me to review the finances of a remarried Edmonton couple in their 40s with four children, navigating how to use $14,000 in freed-up monthly cash flow after paying off significant debts.

Daniella, a 45-year-old lawyer, earns $200,000 after tax annually and wants to build savings, invest, and eventually buy two properties (a cottage and a vacation home abroad). 

Her husband, John, 43, earns $300,000 and is focused on paying off their $400,000 mortgage, relying on his generous government pension for retirement.

In the article, you’ll learn:

• Why Ed estimates they need $290,000/year before tax to maintain their desired lifestyle in retirement and how they’re on track to meet this goal earlier than they think.
• Why their current mortgage payments are sufficient, and putting all extra funds toward the mortgage isn’t necessary.
• How Daniella can save $40,000/year in taxes by investing $100,000 annually within her law corporation rather than withdrawing it.
• Why three properties could be financially inefficient, and how focusing on two instead could unlock $2M in investment potential.
• How Daniella should prioritize her RRSP and TFSA contributions, including why her RRSP room is limited going forward.
• Why using a line of credit as an emergency fund can free up cash flow for immediate investment opportunities.

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

With law-school loans and divorce paid off, couple unsure how to use freed-up funds

Financial Snapshot

Income – Daniella

Employment income: $200,000 (net)

Investment income (dividends): $0

Pension (current or anticipated): CPP

Other:

Income – Husband  

Employment income: $300,000 (gross)

Investment income (dividends): $0

Pension (current or anticipated): 75% of salary (if retired in 15 yrs  or 60% if retires in 10 yrs)  

Other:

Assets

Primary residence approximate value: $800,000 MORTGAGE IS 400,000 

Rental property approximate value: nil

Other: 

Investment holdings 

Cash: $20,000 (Daniella) and $15,000 (joint) 

TFSAs: negligible (just started this)

RRSPs:$140,723 invested in stocks

GICs: nil

LIRA: nil

RESPs: $20,000 

Mutual Funds: nil

Stocks: $3,000

Rental property: nil

Other:

John does not have any investments 

Life insurance: type (i.e., term, whole) value

Daniella: $1 million term 

John:  2 yrs salary 

Monthly expenses – for household  

Mortgage or rent payments: $3,500 

Utilities: $1,250

Groceries: $1,000

Transportation costs (gas): $250

Car Loans: $1,700

Child care – nil

Insurance premiums: $405

Home repairs: $1,000 per month into house savings acct

Credit card payments: $500

Property tax: $620

Loans: nil

Dining out/entertainment: $1,000

Travel: $1,200 a month put into travel savings acct

Other?

Investments: $550

Housecleaner: $400

Life Ins: $69

TOTAL MONTHLY: $13,444

Financial Plan

Daniella & John are living comfortably spending $161,000/year ($13,444/month) after tax. To maintain this lifestyle after they retire about age 60, they will need about $140,000/year. Their mortgage should be paid off, but they will need $10-15,000/year costs for their overseas vacation property and more travel, and $5-10,000/year cost for their cottage. They likely won’t have their cottage and vacation properties paid off.

This is $175,000/year before tax, assuming they split their income effectively.

With 15 years inflation, they will need $290,000/year in future dollars for their desired lifestyle. John’s large pension and CPP together should give him about $225,000/year. John can split his pension income with Daniella to save tax, but they will likely both have their OAS clawed back. Daniella is not paying into CPP, so she will get very little.

Overall, they will need income in future dollars of about $65,000/year from investments, for which they will need $993,000 investments (essentially $1 million). Daniella’s existing investments seem to be invested in stocks, so they should get a long-term return of about 8%/year. She feels overwhelmed with investing, so this assumes she still invests well. Her existing investments plus $550/month she is investing should grow to about $1,950,000 in 15 years, so they are almost 100% ahead of their retirement goal.

This means they could retire sooner.

Their cash flow shows they have about $14,000/month left after their lifestyle expenses, or about $165,000/year. This is a lot and worthwhile to plan the best use.

Recommendations

– They plan to buy both a cottage and overseas vacation property. That will be 3 properties to maintain after they retire. This can be quite a bit of work, and their properties will be vacant much of the year. It is usually more efficient to rent vacation properties than to own them, unless they plan to live there close to half the year. Renting also means they can go anywhere they want every year and won’t have to always go to the same vacation property.

– Daniella’s dividends from her professional corporation are $200,000/year after the corporation tax, but she still would pay about $57,000/year in personal tax. She can get a tax deferral of 25% by leaving money inside her corporation to invest, instead of withdrawing it. She only pays 11% tax inside her corporation, but then pays an additional 25% on the dividend if she withdraws the cash.

– This is an effective tax planning strategy. She has been taking all her income out of her corporation as dividends, so she has not been getting this 25% deferral.

– Daniella can pay $40,000/year less tax by withdrawing only $100,000 after corporation tax from her corporation, instead of $200,000. This is an optimal income level that keeps all her income in low tax brackets of 22% or less. This is her most tax-effective option. She gets no RRSP room and this is more tax-efficient than TFSA, since she would have to pay tax on money from her corporation to contribute to her TFSA. This means she can invest $100,000/year inside her corporation, and only have their cash flow reduced by $60,000.

– They plan to retire in 15 years. Their existing mortgage payment should pay off their mortgage in 13 years, so it is necessary to make extra mortgage payments. They save mortgage interest by paying it off faster, but could make quite a bit more over time by investing their extra cash, especially if they invest effectively and tax-efficiently in stocks.

– They are not saving for education costs for their 4 kids. They have not specified whether they want to pay for all, part or none of this. However, they can get a 20% grant on RESP contributions of $5,000/year/child. They get the grant on $2,500/year/child, but can catch up one past year every year. They have many years of available grant. Contributing $20,000/year into a family RESP would be an effective savings to support their children with their education.

– If they want to buy both a cottage and overseas vacation property within 15 years, they will need to continue to save a lot. If each property costs $500,000, they would need $1 million to buy both. They can save $1 million in 15 years with $40,000/year, assuming more conservative balanced investments earning 5%/year.

– Daniella does not get RRSP contribution room, because she pays herself only dividends. John only gets a small amount every year because of his large pension. He is in a very high tax bracket, so it is definitely worthwhile for John to maximize his RRSP. It is likely only $2-3,000/year, although he probably has a decent amount of room he can contribute. He would get a 47% tax refunds on his RRSP contributions, and likely only pay 30% tax on withdrawing from his RRSP after he retires. It is also worthwhile for both to maximize their TFSAs for tax-free growth.

– Putting it all together, they have $165,000/year extra cash. If Daniella invests $100,000/year inside her corporation, she saves $40,000 tax, so they should still have about $105,000/year. They can contribute $20,000/year to a family RESP for their kids and save $40,000/year or more to buy their cottage and overseas vacation property. This leaves them $40,000/year, which should more than maximize John’s small RRSP room and both of their TFSA rooms.

Their questions

Q.

“I think I want to increase my Registered Retirement Savings Plan and Tax-Free Savings Account contributions, but John wants to put all our “extra” money on our mortgage. What do the experts think?”

A.

Daniella should reduce her annual dividend, ideally to $100,000 after the tax in her corporation. RRSP and TFSA are still more beneficial than paying off a low-interest mortgage, but leaving money inside her corporation to invest is most effective. She would save about 35% tax on RRSP contributions, but she will likely pay 31% tax on withdrawing from her RRSP after retiring (since John will split his pension income with her), so the benefit is not high. She would have to pay tax on a dividend to withdraw money and contribute to her TFSA, so that is less effective than investing inside her corporation, as well.

To be optimal, she should reduce her dividend to $100,000/year and contribute annually to her TFSA from this. She could take a one-time additional dividend from her corporation to maximize her RRSP room with a net tax savings of about 8%. This would be her last RRSP contribution, since she does not get new room.

Q

“Should I use my line of credit and my savings to maximize my TFSAs and RRSPs?”

A.

Daniella could contribute her $20,000 savings account and $3,000 in stocks to her RRSP first, and then TFSA. Using her credit line may not be much benefit, since her interest rate would be higher, and likely not much less than her investments would earn over time. Her savings account is her emergency fund, but she could use her line of credit as her emergency fund. That should work well, given both of their high incomes.

Q.

In the short term, Daniella is focused on building up cash reserves to cover up to six months of expenses and beyond that she wants to build their savings, buy a cottage and start looking at investing in a vacation property outside Canada. 

They both have high incomes, so if they have a cash emergency or even if one loses their income, either of them makes enough to pay all their lifestyle expenses. They could keep a credit line for emergencies and then focus on saving & investing to buy their cottage and vacation property. It may be more effective for them to rent a vacation property every year, than to own one that is vacant much of the year.

Having 3 paid-off properties is a lot of dead equity that could be worth $2 million altogether. 

Having 2 properties instead would give them significant additional investments, which would be a more effective use of their money. This strategy should give them more income for a more comfortable retirement.

Ed