Money makeover: Strange new world

IT may have only been two years ago, but the surf, sun and sand of the South Seas seem like an­cient history for Betty and Fred.

The married couple in their early 30s traded in their globe-trotting ways a little more than two years ago after spending more than four years living abroad in much kinder climates. Today, the sound of ocean waves crashing on a tropical beach has been replaced by the cries of two young children.

Because they had spent so much time abroad, Betty has not been able to collect employment insurance while she has been staying home with the children. For the last two years, they have just been making ends meet on Fred's salary of $52,000.

Betty had started up a business when they first returned home, but they decided to wind up the enterprise when they real­ized they would have to inject more capital to make it profitable. So now they're sitting on a $16,000 loan on which they're making monthly payments.

They also have a line-of-credit debt of more than $9,000 over the last two years and they have been carrying an increasing balance on their credit card, now at $2,300.

"My whole life I've paid it off as I go, and now the balance has been creeping upward," says Fred, who had considered himself a saver until he had children, but now has no savings at all.

"The problem is, we have the mortgage, the loan and living expenses and my income was not enough."

But they expect their financial situation to turn around soon. Betty has returned to work part time, earning $45,000 in annual income, and if she returned full time, her income would increase to about $70,000.

But the couple wants to pay down debt and save for retirement, emergencies and their children's education, without her hav­ing to return to work full time, Betty says.

"How much do we put away so we can re­tire at 55 and all the other goals while still having a life while we're young?"

Certified financial planner Paul Edmond says their first step is to create a detailed budget. While they have done a great job of living on the edge while raising two tod­dlers on one income, they have to nail down all possible expenses.

"How can you get where you want to go if you don't know where you are now?" asks Edmond, president of Edmond Financial Group in Winnipeg.

The couple has done preliminary budget­ing, but as Edmond points out, they have omitted important figures, including sav­ings for vacations, car repairs and mainten­ance and clothing.

For longer-term planning, they should also factor in child-care costs. Right now, they're managing to provide care them­selves, trading off when the other is at work and with the help of their parents, who provide care a couple of days weekly.

They are on a waiting list for day care -- albeit a two-year one -- and that bodes well for Betty working full time in the future.

As it stands, with her working part-time, Edmond says they have enough income to cover expenses and slowly pay down debt while gradually building up savings.

"Their family income when Betty is working part time is high enough to support their lifestyle, but their budget is tight and prone to failing," he says. "The problem is, their long-term goals might have to be shelved while they work on short-term debt reduction."

The other option is she goes to work full time three months from now, something they have been reluctantly contemplating.

This way, they can aggressively pay down all debt in 2010 and achieve their goals, including early retirement.

"Our plan illustrated Betty going back to work full time for two years and then cut­ting back to half-time after that."

In 2010, their family income could be $122,720 if they both work full time.

Because Betty can deduct the business loan from her income for next year, they can reduce their taxes payable to $15,336, resulting in a net income of about $107,000.

"They can save 35.75 per cent of the $16,000 business loss, which can be deducted from Betty's income in 2010," Edmond says. "This saves them $5,720 in taxes in 2010."

Edmond estimated their budget -- fac­toring in clothing, mortgage payments and child care -- would be about $50,000, including $5,000 for vacations.

That leaves them with $57,000 for debt re­payment and registered savings plans.

They should contribute the $5,000 max­imum each to tax-free savings accounts (TFSAs) and about $14,000 combined to RRSPs. The remaining $33,000 would re­tire their $27,000 debt and build up savings.

If a shortfall occurs, Edmond says they can take out an RRSP loan to ensure their RRSP contributions are maximized for 2010, paying off the loan the following year. "In 2011, after budgeted expenses, they will have a $51,000 surplus that can be con­tributed to RRSPs and TFSAs and used to pay down the potential RRSP loan," he says. Any of the remaining funds can be invested in other savings plans.

Starting in 2012, Betty can go back to work part time, but their surplus will be re­duced. After budget costs and RRSPs, they would have $18,000 for other savings.

Edmond also says the couple should take a look at reducing the length of their mort­gage by increasing bi-weekly payments.

"I also suggest they switch to a 20-year amortization instead of a 30-year one," he says. "It would save them $64,741.24 in interest charges over 20 years and only in­crease their payments by $99.12 biweekly."

Then comes saving for their children's education. They are collecting the child tax credit, and although this amount will change when their income changes, any amounts invested in their children's names will not attribute income to the parents.

They should start up registered educa­tion savings plans, which have two advan­tages. The amount grows tax-free until withdrawn, when it's taxed as the children's income, often meaning less tax is paid.

And second, the government offers the Canada Education Savings Grant, which matches up to 20 per cent of contributions to a maximum of $2,500. That's as much as $500 in grants a year, per child.

"If the child fails to pursue post-second­ary education by age 21, up to $50,000 of the income portion of RESP funds can be transferred to the RRSP of the contributor, provided the RESP has been in operation for 10 years or more," he says.

Although this plan is based on Fred and Betty working full time and finding means to care for their children during the day, Edmond says they can always continue on their current path with Betty working part time until they find child care.

"This might be the right compromise, but only they know what they really want."

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Fred and Betty's finances

Income:

Fred: $52,000 annual gross Betty: $45,000 annual gross on part time Betty's income with full-time option: $70,000 Total gross annual income based on full­time work: $122,000 Total net income (includes business loss, RRSP deductions and applicable credits): $107,000

Debts

Mortgage: $175,311.77 remaining on 30­year amortization (5.25 per cent interest rate for five years) Payments on principal and interest: $448.72 every two weeks Business loan (backed by home): $16,000 (5.5 per cent interest) Line of credit (unsecured): $9,147 on $10,000 limit (7.5 per cent interest) Credit card: $2,300 balance (12.5 per cent interest) Expenses (budgeted by certified financial planner Paul Edmond, based on Betty working full time): Budget for 2010: $50,000 This includes utilities, day-care costs ($6,000), mortgage payments, groceries, clothing ($2,400), vacations ($5,000), entertainment, home insurance and car maintenance.

Edmond recommends they get life and disability insurance besides the coverage provided by work benefits. Term life insur­ance coverage for $500,000 would cost them about $520 annually to cover both of them. Remaining 2010 income to pay down debt, excluding mortgage, and invest in RRSPs and TFSAs: $57,000 Towards the debt, excluding mortgage: $27,000 TFSA: $10,000 ($5,000 each) RRSP contributions: $14,000 combined Amount remaining for other expenses or savings: $6,000