FINANCIAL FACELIFT

Live well now or
retire well later

Spending more than they earn eats into couple's future plans

BY ANDREW ALLENTUCK

Vancouverites Frank Sims and Jack Hudson (not their real names) are partners. Frank is an airline employee while Jack manages a catering company.

At their respective ages of 34 and 38, their incomes total $111,000 a year plus benefits.

Their combined incomes have given Frank and Jack, who have maintained a household for five years, a very comfortable life. They wine and dine like millionaires though they are not - and travel frequently.

As a result, they spend more than they earn. Today, though still relatively young, they have a choice: To live well now or to live well in the future. On their current incomes and with their present level of spending, they cannot have it both ways.

"We love our lifestyle, which focuses on living the good life and taking it easy," Frank says. "Jack has a cellar of over 200 bottles of fine wines and we spend over $1,500 a month going out to dine. We make two or three trips a year to ... Montreal and Toronto."

Dining, travel and other discretionary expenses consume 47 per cent of the household budget an analysis reveals.

Frank and Jack know they have to begin estate planning, map out their retirement, buy life insurance and invest at least some of the wealth they have received through gifts and inheritance. Rather than investing in stocks, bonds and mutual funds, they are considering opening a wine store.

What our expert says

Facelift asked financial planner Daniel Stronach, of Stronach Financial Group in Toronto, to work with Frank and Jack on their plans. Mr. Stronach notes that the men's disposable income is $98,412, while they spend $99,600 a year. As a result, they have $30,000 in personal debts, including $22,000 on the mortgage of the condo in which they live.

Frank and Jack have an immediate investment decision to make.

Frank's father recently died and left him with a two-thirds interest in, a fully furnished condo in Montreal with an estimated market value of $80,000. Frank can buy out his sister's remaining one-third interest in the condo for a third of the tax valuation of the property, which is $55,000.

That would enable him to get the full income of the property for an outlay of only $18,333.

As a rental property, the condo is not a very good investment. Against expected rental income of $1,100 a month, Frank will be able to deduct debt service charges of $225 on a $30,000 loan and other expenses that Mr. Stronach estimates at $690 a month. The net return will then be $185 a month.

If the condo is worth $80,000, that is a rather modest 2.78-per-cent annual return. Unless sentiment or future capital gains are important, the Montreal apartment is not an attractive proposition, Mr. Stronach says.

To plan for the future, Jack and Frank should maximize their contributions to their registered retirement savings plans. Frank already contributes $2,100 a year to an RRSP, which is only a fraction of his allowable limit after taking the pension adjustment from his airline job into account.

Jack contributes between $4,800 and $5,400 a year, compared to maximum deductible contribution limit of $9,000 a year, Mr. Stronach notes. To ensure that they can live as well in retirement at age 60 as they do today, Frank and Jack need to save much more money.

If Frank stays employed and Jack increases his RRSP contributions, then with a 5-per-cent nominal return on assets and 2-per-cent average annual inflation, in 2030 Frank would have $76,000 gross income in 2030 dollars, including his company pension, the planner says. Jack would have $21,760 in 2030 dollars.

After tax, they would have total income of $76,700 in 2030 dollars. That represents a $23,300 deficit in terms of their $100,000 retirement income target in 2003 after-tax dollars and a $47,000 deficit from their target in 2030 dollars.

To reach their $100,000 target in 2030 post-tax dollars, Frank and Jack have to decide whether they will eat well now or in future. They must either save another $7,000 a year and invest that in their RRSPs or get more work that pays at least $7,000 after tax that allows them to increase investments.

The men’s increased savings could easily come from the $9,000 a year they spend on wine or the $18,000 a year they spend in restaurants, Mr. Stronach notes.

Before adjusting their spending to allow for this level of savings, the men can do a few things to increase their cash flow.

First, Mr. Stronach says, they should pay off Jack's car loan and Frank's line of credit.

If Jack wants to open a wine store, he should make plans to borrow $50,000, the sum he estimates he needs for store fixtures and some stock.

One way to get funds at a low rate would be to refinance the Montreal condo and thereby obtain money at today's low mortgage rates. If interest costs rise, they could bring the store's net income down to zero.

Financing should be arranged as soon as possible while Jack is earning full-time income from his food service employer. Once he opens the wine store, he will be able to work only part-time in catering and his credit profile could deteriorate, Mr. Stronach warns.

"If Frank and Jack take the steps essential to preserving their way of life by compromising a little of it today, then they should be able to retire with $100,000 of after-tax income in 2003 dollars," Mr. Stronach concludes. "If they don’t, their future ... is not going to be bright."

Frank doesn't agree.

"We are starting to realize the repercussions of this, but retirement is far away. . . . I think it is reasonable to work until we die."

Interested in being considered for a free Financial Facelift? Drop a line to the writer at 444 Front St. W, Toronto, M5V 2S9, or at the address below with details of your situation.

ajames@total.net