Hey there, time traveller! This article was published 16/5/2015 (1010 days ago), so information in it may no longer be current.
Rachel has a new job, a new home and is embarking on a new journey with her partner.
Yet the house could use an update — a lot of updating, in fact — so she and her boyfriend are mulling over a substantial renovation.
"We're planning to spend between $70,000 and $100,000," says Rachel, in her late 30s, earning $85,000 a year in the private sector.
"I just started my job, so I have yet to get my first paycheque."
At the moment, the couple owe $205,000 on a home worth about $400,000. They split the $612 biweekly payments along with the other household bills.
And they expect to pay an additional $300 in mortgage payments every two weeks if they go ahead with the renovations.
"I want that mortgage to be paid off at 60 come hell or high water, and I'd like to be retiring at about the same time."
So far, Rachel has been saving aggressively in her RRSP and TFSA because she has no work pension. All told, she is saving more than $1,200 a month and has more than $150,000 in combined savings, including $25,000 in a non-registered savings account from the sale of her previous home.
"I do have money left over at the end of every month — but not a ton of it," she says, adding her TFSA monies are invested in low-yielding GICs and savings accounts.
"My biggest concern is how this renovation is going to affect my ability to save and what I will have over every paycheque?"
Certified financial planner Karen Diamond with Diamond Retirement Planning in Winnipeg says Rachel is best-served staying the course with regard to her savings strategy.
"She needs to be saving aggressively now to accumulate an adequate amount of capital to produce the income she will need in order to retire at 60."
Once retired, she would need to draw about $50,000 in savings a year, which combined with CPP (reduced for early receipt) should be enough to cover her basic needs and lifestyle costs — at least, based on her current spending.
"Using a conservative overall rate of return of about four per cent on her RRSP investments," and less for her TFSA given it's invested in low-yielding GICs and savings, "she would need to accumulate roughly $800,000 in invested assets by age 60."
Taking a different approach with her TFSA would help provide more tax-free cash flow once retired — good for larger spending needs such as a new car, home repairs and travel.
"At the very least, she should look at a conservative income fund for her TFSA to provide some measure of growth in excess of inflation, and yes, she should take advantage of TFSA contribution room, now $10,000 per year, to put her savings — the $25,000 — to work," Diamond says.
Moreover, Rachel should continue contributing as much as she can to her RRSPs, because not only will she need the money once retired, it also makes sense from a tax-planning perspective.
"At Rachel's level of income, RRSP contributions are valuable because she is saving tax at the rate of 39.4 per cent on each dollar contributed," Diamond says. "With good planning, she will pay a lower tax rate on those dollars when they come out as retirement income at, for example, 27.75 per cent or less."
While Rachel likely can retire at 60 based on her current savings rate, the ambitious renovation plan might throw a monkey wrench in its execution.
In Diamond's opinion, Rachel and her partner need to consider the following before going ahead with the renovation: Will the money they spend translate into a corresponding increase in the value of the home? What would happen if they sell prior to paying off the mortgage? Will the renovations stay within budget, taking into account most home-improvement projects cost more than anticipated?
And perhaps most importantly, how adamant is Rachel about retiring at 60?
Diamond says they must proceed with caution, because the additional debt costs will likely have more of an effect on their cash flow than they estimate. For one, Rachel has yet to get her first pay stub, so she's not entirely sure how her take-home pay will measure up to future costs.
Second, they need to carefully review their budget because it isn't comprehensive, and it needs to be if they're planning on adding $100,000 in debt. For example, it doesn't include property taxes. Furthermore, most of their expenses appear to be ballpark estimates.
"Unless they have tracked every penny they spend for several months or even a year, it's likely they have underestimated — as most people tend to do — what they really spend," Diamond says.
This is especially important because Rachel indicates she doesn't have much left at the end of the month.
Another consideration is Rachel should examine ways to increase cash flow, including having her take-home pay adjusted to reflect contributions to her RRSP rather than waiting until tax time to receive a refund.
"Having less tax withheld from her paycheque every month would help her better meet cash flow needs."
Rachel will likely need as much additional cash as possible, particularly because she should set aside money for insurance to protect her financial plan.
If it's not provided by her employer, she should consider buying critical illness and disability coverage.
"This is very important, as an illness or injury could seriously derail her savings plan and probably even affect her ability to meet her basic monthly expense obligations," Diamond says. "If she doesn't have this built into her monthly expenses, she needs to consider these premiums as a basic expense."
Long story short, Rachel has much to consider before taking the plunge on the home renovations. Diamond says Rachel's goals are achievable, but they will require a lot of detailed planning. For this reason, she is probably well served enlisting the help of a financial planner, who will help weigh her options because it's likely tough decisions lay ahead.
"Compromise is warranted," Diamond says. "Targeting a reasonable rate of return on her assets, taking a little longer to pay off the mortgage and, yes, putting off retirement are all strategies she can combine with an aggressive savings strategy to maximize the end result."