Financial Checkup: Young couple face tough choices

Sarah is a chartered accountant, making $80,000 a year. Bob also earns $80,000 annually as a computer specialist at an oil company. Both spouses’ employers offer group RRSPs, with the firms matching employees’ contributions – but neither spouse has enrolled in these programs yet.

Bob’s spending comes from buying the latest computer technology, gadgets and equipment; buying expensive clothing; and going out with his friends to sporting events and expensive meals. He also leases a BMW for $500 a month, although he could use public transit to get to work. Sarah has a 2008 Toyota that is fully paid for.

The couple rents an apartment for $2,500 a month and have no assets. Both their incomes have gone into paying off Bob’s credit cards. Even so, Bob still has $25,000 in credit card debt.

The couple’s goals include:

1. Getting out of debt.

2. Building up an emergency fund of $25,000.

3. Buying a house suitable for two children, which the couple suspect will cost about $500,000.

4. Starting a family.

5. Starting retirement savings by age 40.

Sarah, who pays all the bills, thinks that $80,000 a year will cover their necessary annual expenditures, Bob’s car lease and $15,000 for a vacation, periodic eating out and entertainment and other “occasional” treats.

Bob is onside, in theory, but wants to know how to get his spending under control.

the recommendations: Both Brain and Stoneman say the problem is finding a way for Bob to reduce his spending in a way that leaves him feeling that he still has control over what he earns and that he is an equal partner in determining the financial plan.

It would not be good for Bob to give his paycheque to Sarah and have to get permission from her for anything he spends.

“Money has many nuances beyond currency, including power and control,” Brain says. “Having one spouse controlling the purse strings can lead to resentment.”

Stoneman agrees, noting, “Sarah shouldn’t be a mother to Bob.”

Nor should Bob be asked to go cold turkey on his spending. He should have some discretionary money and the prospect of “rewards” if he sticks to the plan.

That said, Bob needs to understand that if he doesn’t take drastic action to curb his spending, neither his own goals nor those of the couple will be achievable.

Stoneman’s projections are based on the couple’s spending being kept to $80,000 a year in today’s dollars and putting 3% of each salary (currently, $2,400 x 2) into the group RRSP plans at work. If this is done, the couple could:

1. Pay off Bob’s credit card debt and put $11,000 into an emergency fund in 2015.

2. Put another $14,000 into the emergency fund and $22,000 into another account for a house down payment in 2016.

3. Put $36,000 into the down payment account in each of 2017 and 2018.

4. Put $6,000 into the down payment account and $15,000 each into self-directed RRSPs in 2018.

This would mean that at age 32, Bob and Sarah would not only be debt-free but have a $25,000 emergency fund, $100,000 for a down payment and $42,600 each in retirement savings.

Furthermore, if the couple continue to put 3% of their salaries into group RRSPs and $36,000 in today’s dollars into individual RRSP contributions every year thereafter, they would each have about $1.2 million in today’s dollars in retirement savings at age 65. (This scenario assumes an average salary increase of 4% a year for each spouse, an annual return on investments of 6% after fees and annual inflation of 3%.)

Other scenarios may be more beneficial, Stoneman notes, depending on the couple’s future incomes. Options include putting more money toward the mortgage and/or contributing to a tax-free savings account and registered education savings plan when Bob and Sarah start a family. Although RRSP contributions provide a very good tax break, taxes have to be paid when money is withdrawn – and sometimes the applicable tax rate is higher than it was when the contributions were made.

Brain says Stoneman’s plan is good, but he suggests two amendments. First, he suggests that Bob explore paying off the credit card debt with a line of credit (LOC), as the annual interest on LOCs is around 4% vs 20% for credit cards.

But, Brain warns, unless Bob changes his spending behaviour, this isn’t a permanent solution. Indeed, lowering the interest he pays on his debt could “give him more rope to hang himself.”

Second, Brain suggests putting the first $50,000 of the down payment money into RRSPs because Sarah and Bob could withdraw $25,000 each from their RRSPs if they buy their house under the Homebuyers’ Plan (HBP). Under the HBP, the couple would have 15 years to repay what they withdraw from their RRSPs, starting in the second year after the withdrawal. If at least 1/15th of the withdrawn total is not repaid in any year, that amount will be included in their income for that year.

Given that RRSP contributions are tax-deductible, Brain says, “the tax savings that come with this approach will dwarf any modest returns they get from investments made for short-term savings.”

These projections will, of course, work only if Sarah – and, in particular, Bob – stick to the plan. Here are some ideas about how to make the plan as robust and as bulletproof as possible:

– Budgeting. “Unless you enjoy discipline and attention to detail,” says Brain, “most people find sticking to a budget difficult.” He prefers a “pay yourself strategy,” in which the couple automatically directs a portion of their income to the goals that are important to them, and do what they want with the rest. “That way, you are still working toward your objectives but without the rigid framework of a budget.”

– Accountability. It’s important that there be an outside person to whom Bob and Sarah must account for any failures to stick to the plan. If it’s left to only the couple, then Bob will be accountable to Sarah if he overspends and accumulates more debt, which will put strain on the marriage.

Stoneman says if she had a couple like this as clients, she would insist on reviewing the plan with them at least semi-annually – preferably, quarterly – and preferably in person.

– Credit cards. Everyone needs a credit card for emergencies, but it doesn’t have to have a high credit limit. Bob should get rid of all his credit cards except one; lower the limit on that one to $2,000; and commit to paying off any balance each month. If he finds that he’s still accumulating credit card debt, he should switch to a prepaid credit card.

– Car lease. This is a luxury that Bob doesn’t need. He can use public transit and share Sarah’s car. But it could help if Bob is given a choice between keeping the car or getting rid of it and being able to spend that money on whatever he wants. This, in effect, rewards him for making a good choice while keeping the plan intact.

– Goal-setting. In a situation like this, in which so much money needs to be saved, says Stoneman, it’s best to break the goals into manageable pieces that are achievable in relatively short time periods. Achieving each goal produces a sense of satisfaction and can be rewarded. For example, a winter vacation could be dependent on achieving certain goals within the designated time period.

Thus, Stoneman’s plan is broken into three successive initial stages: pay off the debt, which takes less than one year; build an emergency fund, which takes less than two years; and save enough for a down payment, which takes less than five years.

– Paying bills. Bob and Sarah should share the responsibility for paying the bills equally. With their current arrangement, Bob probably never sees the bills and doesn’t know what things cost. If he’s equally responsible, he can discuss decisions about what the couple need and where they can cut back. This is treating Bob as an equal adult rather than as a child who’s being told what to do.

– RRSPs. Joining group RRSPs at work is a simple, non-intrusive and very efficient way to start saving. The contributions, adjusted for tax-deductibility, are taken out before a paycheque is issued, so nothing is required of Bob or Sarah. And with their employers matching the contributions, they will accumulate twice as much as they put in.

– Treats. Both spouses should have a certain portion of their paycheque available to spend as they choose. If Sarah wants to buy an expensive pair of shoes or purse, she shouldn’t have to rationalize that to Bob. When Bob goes out with his friends, he shouldn’t have to tell Sarah where they went and how much he spent. But these “discretionary” amounts have to be specified and agreed to by both.

Both advisors note that the couple’s current budget allows them $15,000 for a vacation and other treats. Brain considers this to be a “champagne lifestyle” and Stoneman calls it “pretty extravagant.”

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