Woman raising teens faces hurdles on road to retirement
In Ontario, a woman we’ ll call Doris, 52, is raising her two teenage children on an after- tax income of $ 5,200 a month. She works in high tech promoting the products of a small company. She owns a $ 550,000 house far from the roller- coaster Toronto property market, but her plan to retire in ten years presents a challenge. Raising her kids on her own with scant financial assistance from her ex has left her with a mortgage and line of credit that add up to $74,800.
“I could downsize to a condo to liberate some equity in my home, but that would only be when the kids are gone,” she explains. “I’d also like to help my children so they don’t graduate with massive debt. One is headed to university, the other to trade school. Having enough money for my retirement at 62, say $ 50,000 a year after tax, is my goal.”
Family Finance asked Caroline Nalbantoglu, head of CNal Financial Planning Inc. in Montreal, to work with Doris to improve the odds she can have the retirement she wants. Doris would like to quit at 62, but the outlook is that she will have to work to 65, Nalbantoglu says.
“Debt is the problem in this case,” Nalbantoglu explains. It is substantial and could climb with education costs and a plan to convert her basement into an apartment that would rent for $1,000 a month.
DEBT MANAGEMENT
Her $ 23,000 mortgage, on which she pays $ 767 a month, will be paid up in 2.5 years, but she will still have a $ 51,800 line of credit on which she currently pays $ 400 a month. If Doris then adds the $ 767 she paid on the mortgage to her line of credit, it can be paid off in about three years after the mortgage is eliminated. That would be within her age 62 timeline for retirement, but she needs another $ 21,000 for education costs so the kids can graduate without debt of their own. Her current cash flow would not support that level of saving, so she would have to add to her line of credit debt. The basement construction would cost perhaps $50,000. That, too, would have to be financed on a line of credit at an estimated rate of paydown of $900 per month for five years. If the job is done quickly, the rent flow would cover the finance cost.
What’s needed now is a cash allocation plan, Nalbantoglu suggests. She is contributing $100 a month to her family RESP. The youngest is 17 and can no longer receive the Canada Education Saving Grant. Rather than contributing to the RESP, she can direct funds to her Tax-Free Savings Account. She is already putting $ 200 a month into the TFSA. If she can boost contributions to $ 458 per month, perhaps by trimming $ 750 monthly restaurant, travel and entertainment, she will accumulate enough money for a year of tuition. The rest of the cost will have to be added to her line of credit. Or the kids could help out with summer jobs.
Doris’ TFSA space is the present limit, $ 52,000 less $ 2,400 present balance, net $ 49,600. If she can contribute her annual $ 5,500 limit from age 56, when her children will have finished their degrees or certificate programs, she would have about $60,700 in the TFSA at 65 assuming three per cent growth after inflation. However, if she directs her savings after debt repayment to her TFSA to fill up all her space until age 65, she could double her contributions. We’ll assume the lower amount just to be conservative.
Making the required $458 monthly TFSA contributions will be possible when present debts are paid off. She can make some economies, such as scaling back on the money she spends on restaurants and entertainment each month.
Doris’s RRSP, to which she adds $500 a month with a $ 200 addition by her employer, will have a value of $ 415,000 at her age 65 assuming contributions continue for 13 years and generate three per cent after inflation. That sum, still invested at three per cent after inflation, would generate $21,200 per year for the next 30 years. Her rental apartment after interest costs would generate $1,000 a month less operating costs, say $700 per month or $ 8,400 per year net before tax. Her Canada Pension Plan benefits, assuming that she works to 65, would be $ 13,370 per year and Old Age Security would add $ 7,004 per year at current rates. The total, $49,974 before 14 per cent average income tax, would leave her with $ 3,580 per month to cover expenses of perhaps $ 3,200 after she stops all debt service and savings. That is below her $ 50,000 after- tax target, but it is adequate after her kids are gone and her expenses drop.
THE RISKS OF PLANNING
The risks to this forecast are substantial. Construction of the rental apartment would delay the time when she is debt-free. Rather than start CPP early at a cost of 7.2 per cent per year of start before 65 and impair her largest indexed pension, she should draw down her RRSP. If she takes no more than $10,000 a year until age 72 when RRIFing has to start, the RRSP would not be seriously depleted. That will also provide a measure of income averaging, the planner explains. Other risks — interest rates are likely to rise, thus adding to the total cost of financing the basement apartment construction. There might be difficulty renting the apartment. Her children might need support after graduation.
The alternative to staying in her house and building a basement apartment is sale. If she were to realize $ 550,000 less selling costs of five per cent, net $522,500 at age 65 and then buy a condo for, say, $300,000, the $ 222,500 invested at three per cent after inflation would generate $ 6,675 indefinitely or $11,500 per year if paid out for 30 years. Earlier sale with a longer payout would affect these numbers, but they are in the ballpark with some timing adjustments.
To make all this work, Doris should stay on the job to 65. After paying off the line of credit, she should have four to five years with no new debts. That is the critical time for her to build up savings, Nalbantoglu explains.