In Alberta, a couple we?ll call Wilt, 36, and his wife, Susan, 44, are thriving with a total take-home income of $ 8,000 a month. Both self-employed as consultants ? he in management, she in health care ? they have come to a point in their lives in which they have a good deal of unencumbered cash flow. Their net worth, about $ 229,000, is modest, but they are planning far ahead. Their goals ? educate their five-year-old daughter and plan a retirement.
Family Finance asked Lenore Davis, a registered financial planner with Dixon, Davis & Co. in Victoria, to work with Wilt and Susan. ?They are scattered in terms of where they deploy their money,? Ms. Davis says. ?They do indeed need a plan to get them to their retirement goal while looking after their daughter?s educational needs.?
Financial management
For now, Susan and Wilt need to reduce their debts and to rationalize their investments. To do that, they have to resist the urge to increase their personal spending parallel to their increased income. Their method has been to run all their income through their personal corporation and pay themselves as needed. Their $ 8,000 monthly draw leaves $ 983 a month unspent. They can use it for their child?s RESP ? $ 2,500 a year, which will attract $ 500 a year from the Canada Educational Savings Grant ? and putting $ 8,000 into lump-sum mortgage reduction on each anniversary due date.
After taking their draws from their corporation and allowing for deductions, there should be $ 60,000 in their company each year to be invested. The money can be left inside the company or flowed out to Wilt and Susan so that they can invest it personally.
Corporate income tax rates ? federal and provincial ? on active Alberta small-business income are low at 14%, compared to personal income tax rates in their bracket of 32% on salaries. But investment income from money left in a corporation is taxed at 45%. So the best thing for now is to distribute the income to the couple as dividends, Ms. Davis advises. In time, they should consider adding to salary to boost Canada Pension Plan benefits, she adds. Dividends are not salary or wage income and do not generate CPP credits.
Any payouts of surplus cash can be used for RESPs, mortgage paydowns, TFSA contributions or filling RRSP space. Wilt has $ 67,000 of unused RRSP space, Susan $ 86,000 of space.
Retirement planning
In 29 years, when they are ready to retire, if they have built up CPP benefits at the maximum rate, currently $ 11,840 a year, they can add their entitlement to full Old Age Security benefits, currently $ 6,480 a year, to build a base of public pensions of $ 36,640 a year in 2012 dollars. Their present spending net of school tuition, saving and debt repayment, about $ 4,000 a month, or $ 48,000 a year after tax, would be approximately $ 74,000 before 35% average tax.
To achieve that level of income, they would have to add $ 37,360 of annual investment income. At 65, when Wilt and Susan begin their retirement, they would need capital of $ 622,700. That would produce the required annual supplement to public pensions, assuming all their income and capital would be used up by the time Wilt is 90. To get to that level of capital, they will have to save $ 11,220 a year for the next 29 years and achieve a 3.0% real rate of return.
The couple already saves more than $ 14,000 a year in RRSPs and taxable savings, so reaching the target should be no problem. Yet Wilt and Susan have shown a knack for investing in risky undertakings with sad outcomes. For example, they have $ 100,000 in a real-estate venture that has gone into receivership. The couple needs to switch investment methods from the concept of adventure to a steady system for diversifying assets and estimating dependable returns from stocks, bonds and perhaps real-estate mutual funds or exchange-traded funds that have strong and rising payouts. Their allocation to bonds should grow to perhaps 25% of total investments within the next few years and rise to 65% by retirement age, Ms. Davis suggests.
Investing in security
The final issue in Wilt and Susan?s future is their view of the purpose of investments. When they had little money, they invested for the thrill of it. Now that they have substantial incomes and substantial assets, they must act like good managers for themselves and for their child.
To avoid the risk of buying the wrong stock or bond, commodity or parcel of real estate, the couple can use low-fee exchange-traded funds with diversified assets. Over a period of 29 years, ETF fees that would average about 0.50% a year will tend to outperform actively managed mutual funds with fees five times higher. The 2.0% annual saving will translate into a 58% value retention over 29 years. Competent managers of higher-fee mutual funds could boost returns and justify their fees, but the odds of finding mangers who can beat the market for nearly three decades are poor.
Wilt and Susan could increase their financial security by purchasing disability insurance. Disability coverage prices vary widely. For payments of $ 5,000 a person a month that begin 90 days after a reported injury or illness, Wilt would pay $ 125 a month to age 65 and Susan would pay $ 243 a month to age 65. The premiums could be paid by their company as a taxable benefit to the employees.
?This couple is in a great place to make their financial situation secure,? Ms. Davis says. ?By taking concrete money-management measures, they can stop worrying about past losses and focus on a comfortable future lifestyle and a solid retirement plan. A relatively small amount of planning and a move to a sound investment style with reasonable costs should get them to a comfortable retirement.?
? Need help getting out of a financial fix? E-mail andrewallentuck@mts.net for a free Family Finance analysis.
From:Financial Post | Business ? Personal Finance
Source: http://financeexplained.info/2012/01/28/scattered-investing-scattered-results/
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