Private schooling a tall order

Frugal couple may have to put retirement plans on hold
Bob and Ryan Challis are frequent contributors to The Winnipeg Free Press Money Makeovers column. In this article, Ryan offers his advice to a couple wondering if they can afford private school for their child. See December 18, 2010 article.

Jim and Melissa are living life in the fast lane financially — only it’s not what you think. They’re not living on the edge, jet-setting and running up a massive tab that even their gross, combined annual salaries of more than $160,000 can’t cover.

No, their fast lane is an accelerated payment plan on their mortgage. In a little more than four years, their $375,000 home will be all theirs, leaving them entirely debt-free, but with a few tough choices to make afterwards.

For one, there’s a decision to make about their two young children’s education.

“We have two more years before the kids enter school, but I want to know if we can afford to send our kids to private school,” says Melissa, a health-care sector manager.

“I want to know whether we can afford private school or should we be saving for university.”

Jim, 44, and Melissa, 36, have $6,800 in an RESP, to which she contributes $100 a month.

The couple also has a solid foundation of retirement savings, about $170,000 in RRSPs and non-registered investment, including mutual funds and stocks. They also have $5,000 in a Tax-Free Savings Account (TFSA) for emergencies.

Ideally, they would like to retire at 55. But Jim says it’s likely he will have to work longer, seeing as their children will still be in school when he reaches that milestone.

The couple says they think they’re headed in the right direction, yet they would like an expert’s opinion, just to be sure.

“We work really hard to make a lot of money, so we want to be smart about how we plan for the future,” she says.

Jim and Melissa are doing everything right: working hard, saving and staying out of debt.

Yet they may have to scale back their plans regardless, says certified financial planner Ryan Challis.

“I’d say they’re being pretty ambitious with a relatively short timeline,” he says.

Their biggest cost in the near term is private school. Tuition at St. John’s-Ravenscourt School, for instance, varies from about $12,000 to $16,000 a year.

“Although a wonderful school, they can expect a 12-year education for two children at SJR to total over $400,000 and that will definitely affect their own retirement plans,” says the planner with Nakamum Financial Solutions in Winnipeg.

As an alternative, they could send their children to public school until high school and choose St. Paul’s, with tuition about half the cost of SJR, says Challis, an SJR alumnus.

Regardless of their choice, they should be able to pay for their children’s undergraduate university education, providing their RESP investments earn five per cent a year and they continue contributing $200 a month.

“With government grants for the next 15 years, they should be well on target for their desired university funding goals,” he says, adding that should give them more than enough to cover $62,000 in tuition costs.

Considering they’re good savers, Challis says Melissa and Jim might be able to reach all of their goals by optimizing what they’re already doing financially.

For one, they should take a closer look at their investments — at least with regard to mutual funds.

“In analysis of the mutual fund holdings within the portfolio, there are many different funds in there that are not performing very well,” he says.
They also own many similar funds, only held at different institutions: a good indication of a need to get a little investment advice.

“By doing their investing a little bit here, a little bit there and a little bit over there, they’ll find quite a bit of overlap when they add all the holdings up together,” he says. “It’s possible they have a high degree of concentration in a handful of stocks.”

But investment choices aside, they can also save more efficiently. While they’re debt-averse, Challis says they should consider using their money in the TFSA to pay down their mortgage.

They are paying four per cent interest on the mortgage and earning as little as 0.5 per cent in savings in the TFSA.

“It’s more efficient to apply (the TFSA) money against the mortgage,” he says, adding they can set up a home line of credit for emergencies.
Instead of using the TFSA vehicle for short-term savings, they should consider using it to invest in equities for the long term to provide them with a tax-free source of income in retirement.

Challis says the TFSA will be especially valuable for Melissa who, with a good pension, likely doesn’t have a lot of RRSP contribution room.

“Typically, you’re going to want to max out the RRSP first, then the TFSA and then if there’s any more room, the next most tax-efficient vehicle would be a corporate-class mutual fund,” he says.

Corporate-class funds are mutual funds held under the umbrella of a corporate structure. This provides them with a few tax advantages over normal mutual funds, which are structured as trusts.

“With corporate-class funds, you can switch funds within the corporation structure without triggering a taxable distribution,” he says. An investor can move from an underperforming fund to another fund without tax consequences.

Furthermore, interest earnings within a corporate-class structure are taxed as capital gains when the fund is redeemed.

“So technically, you could be holding balanced funds, which have interest-bearing investments, and that interest, which is normally taxed at the highest rate, is only taxed as a capital gain when the money is withdrawn from the fund.”

But even with savings optimized to the maximum, they also need to consider the risks to their goals.

Challis says they’re under-insured, even though they have life insurance through work and a term policy worth about $400,000.

“Melissa’s unearned income over the next 21 years is over $2 million and Jim’s is almost the same.” To mitigate the potential income loss if one of them dies, they each need about $750,000 to $1 million in life insurance coverage, he says.

Of course, insurance is just one more cost and consideration added to an already long list. And Jim and Melissa may find they have to scale back their overall plan or drop some parts of it entirely to achieve others, Challis says.

“And that may be working longer for retirement because (private school) will take up a big chunk of their cash flow.”

By Joel Schlesinger, Winnipeg Free Press

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