Divorce, child with disability weigh on B.C. woman’s retirement planning
A woman we’ll call Laura, 54, lives in B.C. Divorced, she has two grown children, one with a severe disability. A civil servant, she takes home $5,548 per month. She lives with the severely disabled child who we’ll call Pat, 31. Pat’s in-home care is provided and paid by public agencies; those expenses are outside of Laura’s personal budget.
Pat will move into a government funded residence in 2018 with all costs paid by the B.C. health system. Then Laura can focus on her own future: retirement at age 60 and choices of what to do with her present home — keeping it, renting out space she no longer uses, or downsizing to a townhouse with a price tag about half that of her present $1,050,000 house. Money is tight because Laura had to borrow to buy out her house in a divorce, and was unable to make the most of her RRSP and TFSA space.
Family Finance put the problems of when to retire and where to live to Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C.
“She will be an empty nester with a simpler life when Pat is in government care,” Moran notes. Her home has appreciated to seven figures from the $310,000 she paid for it two decades ago. After deducting $420,000 of home mortgage debt and $30,000 she owes on her car, she has net worth of about $668,600.
Laura’s total pre-tax annual retirement income will vary from as little as $36,324 at 60 if she keeps her present large house or as much as $55,104 per year before tax if she moves to a smaller $500,000 home, once her mortgage debt is eliminated.
Big house or smaller home is the vital issue in planning for she currently has two mortgages on her home which total $420,000. Mortgage one, acquired to buy out her former husband, is $186,000 at 2.99 per cent for 25 years with the term ending in 2018. The second mortgage, used to establish a discretionary trust for Pat, is for $234,000. The second mortgage is essentially a line of credit with payments temporarily deferred.
THE CHOICES
Laura can choose one of four courses: Keep the present house and live in it; sell the house and buy something smaller; sell the house,
invest and rent; or finally, keep the house, rent it out for income and rent her own home elsewhere.
Choice 1 — Stay put. The full cost of Laura’s $420,000 of mortgages is $2,052 per month, even though she pays less due to the deferral of interest on the second debt. Her present payments do not cover the full cost, but the growing difference will have to be covered and the entire $420,000 repaid when she sells her house. Even though the house price is $1,050,000, the mortgage debt along with the growing sum of deferred interest may grow as fast or even faster than the house price. “I personally would not take that risk,” Moran says. Laura may never pay off the mortgages if rates rise, so the house will have to be sold. It is a question not of whether, but when.
Choice 2 — Downsize. Laura could sell her house for $1.05 million, pay off the $420,000 debt and have $600,000 after selling and moving costs. She could buy a townhome or condo closer to her work for perhaps $500,000. She would be debtfree save for the car loan. The money she now plows into mortgages would be liberated. She would have $100,000 cash for investment, travel or other uses. We’ll assume a three per cent rate of return after inflation for the cash, $3,000 per year. This is the best of all four choices, Moran explains.
There are two other scenarios: Sell the house and rent. If a home or apartment with $2,000 monthly rent were suitable, Laura would have to earn about $2,800 per month on the $600,000 or about 5.6 per cent before inflation adjustment to cover it. Rent is paid out of after-tax income but she could be squeezed by falling income and rising rent costs.
Finally, she could keep the house, rent it out and use the income to rent a smaller home. She would still have her mortgages. If interest rates rise, mortgage renewals could ruin her plans.
Of the four, the second choice is the least risky and gets rid of debt and her hefty mortgage payments. We’ll assume she takes choice two — downsize and invest $100,000.
RETIREMENT PLANS
As a salaried employee, Laura has few ways to reduce taxes. Her RRSP is the best for her for now. If she takes choice two, she can use some of the $100,000 estimated cash left over from buying a smaller home for the RRSP and the balance to start a Tax-Free Savings Account.
With cash from the house sale, she can put $20,000 into a TFSA and $43,900 into her RRSP to use up some of her $66,000 space. Assuming she adds $5,500 per year to her TFSA and $5,064 per year to her RRSP before retirement at 60, then with three per cent annual growth after inflation her investments would total about $137,500. Annuitized for 30 years, that sum would generate total income of about $7,015 per year or $585 per month. The RRSP-TFSA ratio can change each year to optimize tax advantage as long as the total contribution is not changed, Moran adds.
If Laura retires at 60, she would get $1,975 per month from work pension plus a $552 bridge to 65. Her CPP at 60 would be $682 per month. Investment income would add $585 per month for total monthly income of $3,794 or $45,528 per year before tax or $3,300 per month after 13 per cent average tax. At 65, she would lose her bridge, but gain $587 Old Age Security raising her pension income to $3,829 per month for total annual income of $45,948 per year before tax and $3,293 per month after 14 per cent average tax. Her present expenses, $5,548 per month, would drop to $3,120 with elimination of all mortgage debt, a $100