After living together for three years in a two-bedroom Toronto apartment, Natalia Meyer*, 32, and Wilson Eto*, 30, are expecting their first child. Natalia, a teacher, is looking forward to maternity leave. A recent round of cuts has hurt morale among her school’s staff and, after almost a decade teaching ninth graders, she’s starting to wonder whether her heart is still in it. She’s taking the full 18 months, during which she intends to seriously consider a career change.
Wilson has been working for four years as a manager at a boutique consumer-
packaged goods (CPG) company that sells men’s grooming products directly to consumers online. He understands Natalia’s career doubts.
Natalia and Wilson are attached to their apartment in different ways. Natalia considers it their first stop together before buying a place of their own. Wilson, who lived in the apartment before Natalia moved in, is comfortable as a renter and spooked by housing prices. He also likes their central neighbourhood, where they likely couldn’t afford to buy.
Wilson would be content to stay put for the time being and see what happens after Natalia’s mat leave — with both her career and the housing market. Though the couple has no plans to marry, Natalia has always seen a family and a house as inextricable, and she wants to buy before prices get any higher. After all, she has the money. In addition to her $70,000 salary and defined benefit pension, Natalia has a $600,000 inheritance from her father, who died when she was a teenager. Wilson, who earns $75,000 per year, has just over $40,000 saved in a TFSA.
Wilson and Natalia have never used an advisor. They’ve also never purchased insurance, aside from the tenant’s coverage Wilson bought from his bank. As they prepare for dramatic changes to their family and, potentially, their income, they’ve decided it’s time to develop a financial plan.
* These are hypothetical clients. Any resemblance to real persons is coincidental.
Vice-president, wealth advisor, TriDelta Financial, Toronto
Senior investment advisor, director of the private client group, HollisWealth, Toronto
Investment advisor, portfolio manager, CIBC Wood Gundy, Toronto
Answers have been edited for length and clarity.
First things first
Linda Levesque: With the financial plan, there’s a lot of information we still need to fill in. We have to get them to reveal their cash flow. They don’t look like savers. She’s been working for 10 years and has no savings, other than her inheritance [and her pension]. Wilson only has $40,000 in a TFSA.
We have to go through a personal financial analysis including any debts, their goals and objectives, and their risk tolerance. Then we come out with their investment strategy, retirement planning, estate planning and what we need to do to implement a plan.
Rory Tufford: They need to try and align their priorities. It seems like they’ve got some discrepancies of what their ultimate goals are, as far as where they want to live and if they want to buy a house. So while we can run multiple scenarios through our financial plans, they need to get on the same page as far as their future plans.
But I would recommend trying to create a budget where they can start to put some money into savings toward the kid’s education or their retirement. Maybe that’s done through automatic monthly contributions — something that’s in their plan that they can stick to, no matter what.
Matthew Ardrey: As much as people write out a budget and say, “This is everything I spend,” 99 times out of 100, when I run it through the cash flow, there’s some form of leakage. That’s usually a big eye-opener for people. If you’re out $100 a month, that’s probably not a big deal. But if you’re out $1,000 a month, that’s significant. It’s all the discretionary spending that’s not being accounted for. So budgeting is going to be the cornerstone of their plan.
They also need to realize the risks in their overall plan. A lot of young people don’t think about dying. No wills in place, especially being common-law, is definitely problematic. They have no rights to any assets, unless specified in the will.
It’s about saying, “You’ve got a child now: Who would be guardians of that child? You have these assets: Who would be the trustee if you were both gone? Could you survive on one of your incomes? If not, what sort of income replacement do you need through life insurance? Do you have disability insurance coverage through work?”
I try to delve into the nastier side of planning to make sure these things are in place in the event something terrible happens. We all know life doesn’t always go as planned.
LL: If Wilson went on disability leave, he would get short-term employment insurance (EI). We need to know his fixed costs to determine whether disability will cover them. But he needs to be able to support his family, especially while Natalia’s on mat leave and possibly through her career transition.
He needs to look at disability insurance as well as life insurance. I recommend a small, permanent plan that never goes away, with a higher term policy while the child is a minor. For example, if Wilson wanted to make sure his income was replaced without encroaching on the capital, he may need a 20-year term policy for $1 million. The permanent coverage would depend on their budget. I would recommend at least $50,000. This would cover funeral expenses and there would be some extra cash on hand. It would be very inexpensive, given their ages, as long as they’re in good health and hopefully non-smokers.
MA: Often, people go out and pick Term 10 because it’s the cheapest. But it may not be in the long run. If they’re looking at term, a Term 20 policy takes them out to age 50. That way the premiums are known. It’s a little bit more expensive than Term 10, but when you’re that young, it’s not that much more.
Disability insurance is probably more important than life insurance because the odds of becoming disabled are much higher than dying.
Should they house hunt?
RT: It really is a lifestyle question. If they want to stay in their current neighbourhood, it might mean continuing to rent. If they want to buy a property, they might have to look in a different neighbourhood outside of the city. Given where housing prices are in Toronto, it might start to get out of their range or make things really tight.
MA: The average price of a two-bedroom home in Toronto is around $942,000. So if they’re buying the average house, and putting $600,000 down, they only have a $342,000 mortgage. It’s really not that expensive, though moving and land transfer tax are additional expenses.
But houses are a lot more expensive in their current neighbourhood — likely $1 million plus. Also, they’re probably not going to put all $600,000 down. Plus there’s double land transfer tax in Toronto. They’d get a rebate on some of that as first-time homebuyers.
Since they’re living in an apartment, they have to factor in the cost of different furnishings. There are also expenses for the baby and an emergency fund while Natalia’s on maternity leave.
RT: If they make a down payment of $200,000, or 20%, they’ll still have some leftover money, which could ease things if Natalia doesn’t go back to work right away.
MA: There’s also a whole conversation about taking the inheritance and buying a matrimonial home with someone who’s common-law. In Ontario, the property rights are very different for common-law versus married. In common-law there is no matrimonial home. So, if separated, the one whose name is on the title or the lease can kick the other one out. Property should be owned/rented jointly or as tenants in common to avoid this. There are a lot of little mines around this idea of buying a house.
LL: They don’t need to rush and buy a house. There are too many variables. Natalia is considering a career change. That means Wilson is responsible for bringing in income. If they can’t live renting right now on two incomes while saving, they’re not going to be able to afford the house in Toronto.
If it’s really a priority to have the house, they’ve got to make some lifestyle changes. While Natalia’s still working, they should try living on one income and fully put the other aside to increase the down payment or have an emergency fund.
Investing the inheritance
LL: Natalia should max out her TFSA. Since she’s never contributed, she has room for $69,500. If she’s been keeping the inheritance in a bank account or GIC, then she’s been paying taxes she didn’t need to. Also, if she had invested in one of the more conservative balanced funds when she turned 18, she could have more than doubled her money.
RT: When you look at the full amount of the inheritance, they need to break it down and decide what it could be used for. If they’re buying the house, how much should they set aside for the down payment? For the short-term outlook, you probably want to be in something more liquid and safe. How much could be earmarked for the future, whether in an RRSP or TFSA? Then you want to keep a longer-term investment horizon where you’re looking for more growth. But that all needs to be explained to them if they don’t have any experience investing — as well as the risks.
LL: Since Natalia has no investment experience, she should have her money invested in a balanced fund that is 50/50 or 60/40 equities to fixed income to start.
MA: Longer term, if Natalia’s going to be out of work, possibly changing careers, look at income-generating investments. You can get Canadian dividend income without paying taxes. The mechanics of the dividend income gross-up and tax credit are as follows: an eligible dividend (from a publicly traded corporation) is grossed up by 138%. So $1,000 in dividends becomes $1,380 on your tax return. You then receive a credit of 6/11 of the grossed-up part (in this case, 6/11 × $380 = $207.28). This credit is applied against your taxes owing. The bottom line is, in Ontario, you can earn almost $50,000 in Canadian dividends and pay no taxes due to the dividend tax credit.
MA: Natalia’s first option is to leave it where it is. She could also transfer it out to a locked-in retirement account (LIRA), much like an RRSP. Or, depending on what career she goes into, she may be able to transfer that pension. Let’s say she goes back to school and ends up working at a university or hospital. Providing the new employer allows for the transfer in, she could use it to buy back years of service in the new plan.
RT: She needs to understand what the benefits and risks are of either leaving the money in the pension or taking it out at the commuted value. By leaving it in the pension, she gets the certainty of the known amounts, when she’s going to get them and how long they’re going to last. However, she takes the risk of the pension provider’s ability to honour the payments.
With the commuted value, she gets more control over her investments. She can control the taxation because she can defer a little longer if she doesn’t need the funds. If something were to happen to her and Wilson is designated as a beneficiary, then the full value of the assets roll over to the common-law partner. The biggest risk with the commuted value: she won’t have the certainty of the known payments and timing.
MA: With Natalia uncertain about her career, I would say, “Leave it in there. You’re likely still going to get contributions while you’re on mat leave, so just leave it. We’ll discuss once you’ve made the decision on what you’re doing with your career.”
Right now, the key thing for them is getting their budget in place, getting them thinking on the same page, and covering off financial risks in insurance and estate planning.