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Financial Facelifts

Strange New World

By Joel Schlesinger

Originally published December 5, 2009 in The Winnipeg Free Press

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 Today, the sound of ocean waves crashing on a tropical beach has been replaced by the cries of two young children.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."

The information provided is based on current laws, regulations and other rules applicable to Canadian residents. It is accurate to the best of the writer's knowledge as of December 5, 2009. Rules and their interpretation may change, affecting the accuracy of the information. The information provided is general in nature, and should not be relied upon as a substitute for advice in any specific situation. For specific situations, advice should be obtained from the appropriate legal, accounting, tax or other professional advisors.