Retirement: ‘Can I keep my home and the convertible?’
Giselle, as we’ll call her, has had a good life in Quebec. Age 59, she owns a lovely home and a glamorous BMW convertible, actually a car she keeps for summer when she parks her other car, an aging economy ride. But things have not gone well of late for her. Laid off from her high-tech job in November 2013, she lost her salary of $108,000 a year. Recently, she found another job in data management with a $48,000 annual paycheque. Her take-home income is $3,120 a month, but present expenses exceed that by almost $800 a month.
Giselle also has to deal with debt service charges — $520 for the mortgage with an $84,700 balance and a decade and a half yet to pay off, $700 for a $34,000 car loan, $350 for a $6,600 home equity line of credit and $200 on a retailer’s home repair loan. Total debt repayment charges are $1,770 a month for debts which total $132,100.
“My career was demanding,” she says. “Having been forced to take a major cut in pay, I am now wondering if early retirement is feasible. Would I be able to afford to keep my home and the convertible?”
Family Finance asked Benoit Poliquin, a chartered financial analyst and financial planner who is lead portfolio manager for Exponent Investment Management Inc. in Ottawa, to work with Giselle.
“Living on a new salary that is 44% of a former salary requires strategy and some sacrifice,” Mr. Poliquin says. “If expenses can be slashed and if she works another six years to age 65, she can have a secure retirement. That’s the condition for surviving what could be a desperate situation.”
Expense management
The first move has to be to deal with two large expenses — her home mortgage and her car. One of them has to go. If the home were sold, Giselle would have only the car loan and some lines of credit to pay. She could rent, not have to worry about ownership costs, and liberate her equity in the home, $325,300. If that sum were invested at 4% after inflation in a dividend-generating exchange traded fund, she would have annual investment income of $13,012 before tax and perhaps $10,410 after 20% tax. Her largest debt would be gone. If her rent were $1,500 a month or $18,000 a year, she would have to add $7,590 out of pocket to the after-tax income from investing the proceeds of the sale of her home, but she would also be losing a capital asset which should appreciate over time and which, as a principal residence, will have no tax on future gains. That’s a lot to give up in preference for retaining a car which depreciates and has no tax advantages.
Sell the convertible. It has an estimated $40,000 price as a used car and she might get something close to that. It would enable her to pay off the $34,000 outstanding loan on it. She will save $700 a month for payments and not have to make a final balloon payment of $15,000 in August 2016. She will still have an economy car she uses in the winter on which she owes nothing. On the plus side, she will shed a major obligation and its unusual future final payment that will be 40% of her take-home income. On the minus side, she will lose a car she loves. Sometimes prudence has to outweigh love, Mr. Poliquin says.
Keeping the house and selling the car will make it easier to make the $520 monthly mortgage payments. Her 2.25% present rate on the mortgage will pay off the mortgage in full in just under 17 years. Her line of credit will be paid off in 18 months. Her zero interest store loan will be paid off in less than three years. With the car loan ended, her expenses and her take-home income will just about balance.
A bit of trimming to save $100 a month would balance income and outgo. She could use up her TFSA , cash and tax- able investments to pay down the mortgage, but that would leave her dependent on lines of credit for any extra spending. Stay the course with the present mortgage, Mr. Poliquin suggests.
Retirement planning
Giselle’s retirement has to be reconsidered in view of her reduced income and saving capacity. Her former employer gave her a lump sum layoff package in January 2014. She put $115,000 of it into her RRSP and $21,000 into her tax-free savings account. Her financial assets add up to $444,285 in her RRSPs, $19,000 in non-registered stocks, $22,200 in her TFSA and $36,500 cash. The total, $521,985, is substantial. But it will be her retirement capital, for her ability to save out of her present takehome income will be quite limited.
If she waits to age 65 to retire, Giselle can receive Old Age Security of $6,619 a year at 2014 rates, annual Quebec Pension Plan benefits of $12,460 at present rates, and income from her financial assets. Her $521,985 financial assets could be invested half in dividend paying, low-cost exchange traded equity funds and half in investment-grade corporate bond exchange traded funds with average terms under 10 years. That package would generate a combined, partly sheltered return of 4% after inflation to produce $20,879 a year before tax. If Giselle works for another six years to age 65, her financial assets will grow to $660,500. At the same after-inflation rate of return, that capital would produce $26,420 a year. Added to government pensions, she would have pretax income of $45,500. After 20% average income tax, she would have $36,400 a year, or $3,033 a month, to spend to support expenses that currently add up to $3,910, or $3,210 without the car.
Giselle can increase her retirement income by using an annuity model that will pay out all capital from her financial assets by age 90. In the 25 years from her age 65, she would be able to take $40,655 a year out of her financial assets, including income, and add government pensions for total, pre-tax income of $59,134. After 22% average tax, she would have $46,124 a year, or $3,843 a month. That would cover expenses that will decline as her debts are paid off. At age 76, her house, by then fully paid, could be sold for what is likely to be a substantially enhanced value to create capital for assisted living if that is required.