Should this family worry about debt as they hope to add another child?

Martha and Jason of Burlington, Ontario, feel fortunate for many reasons. Both have established themselves in good paying careers, with 35-year old Martha working as a Marketing Director and Jon, 37, as an Operations Supervisor. They have paid off their student loans and been able to keep their first home as a rental property. A little over year ago, the couple added a baby boy to their family.

Financially, though, it has been a struggle. Despite having a gross family income of over $200,000, they worry about the debt they have acquired in the last several months.

Many costs hit them at once. They moved to a larger house, which accommodates their growing family better and is more central to work, but they incurred moving and set up costs along the way. They put a new roof on the rental property and converted it into two income-producing units. They did all this while on a reduced income from their maternity and paternity leaves.

As Martha laments, “we blew through our savings, TFSAs and have balances on our lines of credit, which is a priority to pay off. We want to ensure we’re good for the longterm.” Their balances on their lines of credit total $34,000.

The couple wants to hit a longterm goal of retiring at age 60 with $65,000 after tax and maintain their standard of living along the way. They do not have any pension programs, but group RRSP matching through their employers.

Is this doable? Narciso Bomben, a financial planner at IG Wealth Management in Hamilton, Ontario, weighs in.

What is the couple doing well?

Narciso firstly acknowledges how organized this couple is, “Half the battle in achieving financial well-being and independence is being organized, and this couple definitely is.”

Martha and Jason have goals identified, are saving for retirement by paying themselves first, and setting money aside monthly for their son’s education.

They have a will, Narciso says, which over half of Canadians either do not have or the will is not up-to-date.

The couple is also paying off their lines of credit more aggressively than just the interest costs. They say that any additional money coming into their household – such as tax refunds and bonuses – are being used towards paying down their credit lines.

Will the couple achieve their goal? Why or why not?

Martha and Jason save $1261 per month to their retirement savings and both have group RRSP matching programs at work, adding a further $1038 monthly.

If the couple continues at their same savings rate, they are on pace to achieve their retirement goal, even with the current levels of debt, Narciso says. “What they will need to be conscious of as it relates to maintaining the current standard of living along the way are future increased expenses such as having a second child.”

Martha and Jason are on track to fund a little over $10,000 per year for four years for their son starting post-secondary education at 18 years of age. This would meet their goal of having a good base for post-secondary, but not worrying about covering all expenses at this time. When the second child arrives, they could replicate the strategy and use a family plan for flexibility.    

As for eliminating their debt as soon as possible, Narciso recognizes this is a personal choice, but to not rush into it without assessing options. Trade-offs need to be made against other competing interests.  Are there other options that might add net worth at a higher rate of return than debt interest? Or opportunities to manage risk? Otherwise, debt repayment is a great objective, especially over additional lifestyle expenses.

What new steps can be taken to help achieve the goals?

Martha and Jason are in line to achieve their goals, but there are still opportunities to improve their situation. Narciso suggests the following considerations:

• More detailed cash flow planning will be required to manage the next maternity/paternity leave.

• Is this couple okay with being landlords for the rest of their lives? Martha and Jason view their rental property as part of their retirement strategy. Yet owning a rental property often requires time and effort, which may interfere when raising a young family or enjoying their lifestyle in retirement.  Rental income is also fully taxable, whereas a non-registered account is taxed more friendly and a TFSA is not taxed.

• Explore a Spousal RRSP for Jason.  His current balance is much lower than Martha’s and an equalization savings strategy over the years will help with tax planning in the future.  At current income levels, the RRSP is a great retirement savings vehicle, but future evaluation of RRSP vs TFSA for retirement savings should also take place.  TFSA income is not taxed and therefore does not count against government programs such as OAS.

• Take another look at risk management. Like most people, Martha and Jason’s lifestyle is dependent on their ability to each earn an income. Now that saving strategies are in place, it is worthwhile to look at life insurance and other risk reduction strategies.

Is there anything else that would help this couple?

Martha and Jason currently have $500,000 each in term life insurance, with 19 years to go. Considering final expenses of $20,000 each and replacing 85% of living expenses and saving strategies, they are both underinsured. The current coverage is only enough if they were to pass at the same time, Narciso notes.

Jason has disability insurance coverage, whereas Martha does not. If something were to happen to Jason, the family would be fine financially. If something were to happen to Martha, the family would need to dramatically reduce expenses, sell assets or take on debt.

There is no Critical Illness coverage. In the event of a critical illness – whether it results in a disability or not – a payout can be used to fund a leave, pay for additional medical expenses or anything else the family needs. One strategy is to fund a year of after-tax income for the individual that suffers the critical illness.

“All insurance and critical illness strategies are a balance between logic and comfort level and should be reviewed with an licensed insurance professional,” Narciso concludes.