PERSONAL FINANCE
Couple needs debt plan
Not far from Toronto, a couple we’ll call Herb and Torri, each 45, have a thriving life. Herb works as a senior manager for a food company and Torri has a part-time job in the provincial government. They bring home $9,314 a month from their jobs. Their problem, in a nutshell, is that they can’t afford their way of life. They live in a house with an estimated market value of $1.1 million, which is most of their wealth — their financial assets are more modest: They have $382,200 in savings, all of it in RRSPs, and a $47,100 Registered Education Savings Plan for their children ages 14 and 17.
Living well is costly. Their mortgage, line of credit payments and property taxes eat up a total of $2,652 each month — 28 per cent of their regular take-home income. Sometimes short of money, they use their line of credit, then pay it down the next year with Herb’s year-end bonus and by exercising his stock options. Neither source is guaranteed.
It’s a rat race and, understandably, they want out. “Could I retire with a $60,000 pre-tax income at 60?” Herb asks.
Family Finance asked Caroline Nalbantoglu, head of CNal Financial Planning Inc. in Montreal, to work with Herb and Torri. “Expenses are high in relation to their income,” Nalbantoglu says. “Their debt, a total of about $361,700, clings to them. Their goal is to be debt free, hopefully before their anticipated retirement age of 60.”
PRESENT FINANCES
The road map to debt reduction can start in 2017 when Herb, then 46, gets his bonus and exercises his stock options, Nalbantoglu says. He should get a combined total of $62,000 after tax. If he uses $10,000 a year for accelerated mortgage payments, then their mortgage, with 17 years to go, would be cut down to 11 years, and paid off three years before their projected retirement age at 60, Nalbantoglu estimates.
Another $10,000 from the annual bonus and stock options can be used for paying down the line of credit, which would be gone in four years or less. The remaining $42,000 can go to savings. Neither Herb nor Torri has a tax-free savings account, so each has $46,500 of TFSA room this year. With the available funds left after accelerated mortgage payments and renovations or travel, they could each put $21,000 into TFSAs. By 2019 they will have reached their cumulative limit, then $57,500 with $5,500 annual contributions, and there will be a surplus, which can go to Torri’s non-registered savings. She will always be in a lower tax bracket than Herb.
The family’s RESP, now $47,100, needs to grow. Their 17-year old can no longer benefit from the Canada Education Savings Grant of the lesser of $500 or 20 per cent of contributions, since the beneficiary’s 17th year is the end of CESG eligibility. They might as well just give the child any money if needed. The tax savings on a few thousand dollars would be modest. The 14-year-old has three years of CESG eligibility. The parents can boost monthly contributions to $208 from the present $100 a month, qualify for the CESG for three years, and provide about $30,000 for each child’s postsecondary education, paying additional costs out of pocket or by encouraging the kids to have summer jobs, Nalbantoglu says.
RETIREMENT PLANNING
At present, Herb contributes five per cent of his gross pay to a group RRSP with a 100 per cent match by his employer. Next year, he will be able to put in six per cent with a 100 per cent match. He already puts $325 a month in his RRSP, so total contributions are $650 a month. Torri puts $200 a month into her RRSP with no match. Most of the family RRSP savings will be in Herb’s name, so his future contributions should go to a spousal plan for Torri, Nalbantoglu suggests.
With this rate of saving, by the time they are 60, they will have $960,000 in Herb’s RRSP and $237,000 in Torri’s RRSP. Their TFSAs and non-registered savings will be $324,000, Nalbantoglu estimates.
By the time their mortgage is paid off at age 60, their present monthly expenses of $9,314 will have declined. They will no longer need to make mortgage or line of credit payments, will have paid off a loan from a relative, and won’t be making monthly deposits to their savings or paying for their children’s activities. Their budget will be $4,710 per month.
If they retire at 60, they can use their RRSPs or TFSAs and non-registered savings. Herb should get the maximum CPP benefit of $13,110 a year reduced by 36 per cent for retirement at 60, net $8,390 a year. If Torri gets half the maximum, she would have $4,195 a year. If they each take $25,000 from their RRSPs — which would be $275,000 from each for eleven years to age 71, when their RRSPs would be converted to RRIFs — their pretax income would be $62,585, a little above the $60,000 target. After average tax of 14 per cent, they would have $53,900 a year or $4,485 a month to spend. That would be $225 short of their budget, but cash taken from their TFSAs and non-registered savings would easily make up the difference, the planner notes.
Each will receive full Old Age Security benefits at age 65 —$13,692 total. On top of other income, they would have total pre-tax income of $76,277 a year. After splits of eligible pension income from RRSPs and no tax on TFSA payouts, they could pay 12 per cent average tax and have take home income of $5,600 a month, more than enough to cover recurring retirement expenses.
At age 71, Torri’s RRSP would be depleted. Herb’s RRSPs would have grown to $998,400, even after his withdrawals. At age 72, when RRIF withdrawals must start, he can take money out of his RRIF at the prescribed rate, 5.28 per cent in his first year. He would have $52,715 of taxable income. His total income including CPP and OAS would be $67,950, well below the present OAS clawback trigger point of $72,809. Torri would have CPP and OAS income of $11,040. Each could take money out of TFSAs with no tax consequence. Their total pre-tax income would be $79,000. With splits of eligible pension income, they would pay 10 per cent average income tax and have about $5,925 a month to spend, more than enough to cover recurring expenses.
“Their portfolio needs direction and cost reduction,” Nalbantoglu says. Swapping high-fee funds for ETFs would save a few thousand dollars a year. Investment grade corporate bonds with terms of 10 years or less would stabilize the portfolio.
Moreover, if they get off their line of credit roller coaster, this couple can have a secure retirement beginning at 60, the planner says.
“These steps can be taken gradually, but when their financial assets are restructured, their lives will be more secure.”