Winnipeg Free Press - PRINT EDITION

Build nest egg or raise a chick

Young couple balance retirement, newborn's investment needs

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Over the past few months, Seth's and Katherine's world has been one of dirty diapers and irregular sleeping habits after welcoming their first child into the world.

As if caring for a newborn is not stressful enough, the couple also have financial worries on their plate.

For one, they have to manage the household budget on a reduced income. Katherine, a teacher, is on maternity leave until next year. Right now, her employment insurance payment is less than half her regular, full-time income of more than $83,000 gross a year.

Seth is also earning less than he's accustomed to, having switched jobs about two years ago to enrol in an apprenticeship program. He earns about $36,800 a year before taxes.

With $1,200 monthly mortgage payments, money is tight, so they have been budgeting meticulously.

Once Katherine returns to work, they'll have much more slack in their cash flow, but they also expect to pay almost $900 a month for daycare.

They also have long-term concerns, such as saving for university. Over the last few months, they've been inundated with solicitors for life insurance, group RESPs and other products.

"What we're looking at right now has to do with financial advice for our new child -- how to invest wisely for her," said Katherine, in her mid-30s.

"Our RRSPs are not doing well right now, so we're not sure about what to do with RESPs."

Even though their incomes are reduced for the time being, Katherine and Seth have been able to set aside $1,000 a month for savings, partly because Seth, in his late 30s, has no pension plan.

He is contributing $300 twice a month to his RRSPs.

Combined, they have set aside more than $73,000 in their RRSPs.

Katherine stopped contributing to her work pension plan while on leave, and when she goes back to work, she wants to top up her pension by $6,200 to make up for the missed contributions.

The couple also have saved about $8,600 in a TFSA and a non-registered money-market fund as reserve.

Once Katherine returns to work, they estimate they will be able to save at least $2,000 a month for retirement and education.

Still, they're concerned they may save too much for one goal at the expense of the other, Seth said.

"How do we do both adequately?"

Scotiabank financial adviser Darcy Grosney said Seth and Katherine should keep things simple. Contributing money every month to an RESP is their best and easiest option.

"There are no annual limits to how much they can contribute to their RESP, but there are yearly limits to the Canada Education Savings Grant (CESG) they can receive from the federal government," she said.

The CESG is a 20 per cent top-up to a maximum of $2,500 in RESP annual contributions. Seth and Katherine contribute $2,500. The government will throw in $500 in grant money.

The grants and contributions grow tax-free until money is withdrawn for school, when it's taxed at a low rate in the hands of the student.

In fact, Seth and Katherine stand to get a little more grant money this year.

"While Katherine is on EI, however, they qualify for an extra 10 per cent on the first $500 due to their annual income falling below the $83,000-net threshold," Grosney said. "That's an extra $50."

But RESP contributions will be a challenge this year. Until Katherine returns to work, they have a monthly deficit of about $150. They do, however, have some leeway in their budget because they're saving $1,000 a month. Seth's RRSP contributions make up most of those savings, and he shouldn't stop contributing, because he has no pension.

That still leaves $400, which is more than enough to make the maximum RESP contribution of about $208.34 a month while ensuring they're not in the red every month. They also have money in their TFSA and money-market fund in case of unexpected costs.

As for where to invest RESP money, simplicity is their best bet.

"All they need to start is a balanced mutual fund, aiming for about a four per cent annual return," Grosney said.

If they contribute the maximum for the next 18 years, they will have saved more than $77,000 for their child's education. This should be more than enough to cover four years of tuition, even if it increases six per cent a year.

Once Katherine returns to work, they should have plenty of cash flow to achieve all their goals, Grosney said. At that point, Katherine can top up her pension over the course of a year, or they could cash in their TFSA and non-registered money at the end of the year and make a lump-sum payment. Then they can replenish their savings over time.

Another positive for them is that Seth will see increases in his salary over the next few years as he works toward journeyman status.

Overall, Grosney said a well-funded RESP and comfortable retirement are attainable.

"Assuming a 5.5 per cent rate of return, Seth would hold $492,600 in his RRSP by the time he is 63," Grosney said. "If he converts that RSP into a RIF at age 63, he would earn approximately $33,600 annually until age 90."

That's about $25,000 a year in today's dollars.

Katherine will have saved about $214,900 based on the same return and her limited contribution room because of her work pension.

This would provide her with $14,900 a year until age 90. Combined with her pension, she'd earn about $61,000 combined a year, or $45,700 in today's dollars.

They'd also receive CPP and OAS -- at age 67 -- making for an even rosier outlook. But Katherine's income may be high enough that some of her OAS could be clawed back.

"In 2012, the clawback kicks in when annual net income exceeds $69,562."

To reduce her income to avoid a clawback, they should be able to split her pension, something they should do anyway.

"Katherine can give up to 50 per cent of her pension income to Seth for tax-splitting purposes," Grosney said, adding this would substantially reduce their taxes.

"It is also advisable they increase their tax-free savings accounts, because that investment income is non-taxable."

If they redirect half their savings from their RRSPs to TFSAs, they'd have a tax-free nest of more than $350,000. This would give them more flexibility in keeping their taxes in retirement as low as possible, she said.

In the meantime, however, they do have other considerations, such as life insurance.

"They should look at it as income replacement," she said. They also need an up-to-date will and power of attorney.

In general, however, their financial future is bright. They have good savings habits, and their income should be sufficient to achieve saving for their child's education while building a decent retirement piggy bank, Grosney said.

"They just need to follow these strategies and keep honing them as they go along to keep more money in their pocket after taxes."

giganticsmile@gmail.com

Republished from the Winnipeg Free Press print edition June 23, 2012 B12

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