Costly divorce means businessman needs to rein in his housing

MONTHLY CHILD/SPOUSAL SUPPORT PAYMENTS $4,250

In Ontario, an executive we’ll call Herb works in the packaging industry. At 53 he is drowning in post-marital obligations and large mortgage payments. His $10,617 monthly after-tax income is dissipated by expenses that are beyond his control. Herb has two children in their early teens from his marriage. Child and spousal support obligations add up to $4,250 per month. His mortgage adds another $3,680 each month. Other expenses push total monthly spending to $11,736. Herb finances the difference by drawing down his savings.

“I am borrowing from my financial assets so that I can retain in my home for another four years,” Herb explains.

The asset drawdown works out to $13,428 per year. That is in post-tax dollars and it erodes Herb’s ability to save. He has no Tax-Free Savings Account and almost all his savings are in job-related defined contribution savings plans and his own RRSP.

Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Herb. Drilling into Herb’s finances, the cost of marital dissolution becomes clear. He boosted his mortgage by $500,000 to a present level of $779,000 to obtain money for his divorce settlement. His net worth is $1,233,642 after those adjustments. But the mortgage won’t be paid off until Herb is 81.

He’d like to quit his hightech job at 60, but doing that will take some adjustments.

“My home is my largest asset and represents my largest debt,” Herb explains. “The basement suite provides rental income. What should I do with the house and the mortgage?”

Herb has $50,000 in cash. $35,000 of that balance could be used to pay down the mortgage. That would cut the amortization by a year. The $15,000 balance should be retained for unexpected expenses, Moran suggests. His 2012 economy car will need to be replaced soon.

Herb’s present floating mortgage rate is 3.6 per cent. That could be negotiated down to perhaps 3.0 per cent, which is a 17 per cent reduction. Herb wants to stay in his house until his kids start university — that would be another five or six years. The cost of the house is partially subsidized by the $1,200 per month he charges as rent on a basement suite.

The balance of Herb’s savings is about $800,000. He has stock options worth $42,953 he could exercise. There would be tax to pay, but additional cash as well to put toward the mortgage, Moran notes. When the kids do leave home, Herb will only have to pay his core living expenses. Excluding debt service, child and spousal support and RRSP savings, his expenses are just $3,168 per month.

Herb has no spouse with whom to split any income or to do a documented loan to take advantage of what might be a lower tax bracket. However, spousal support is tax-deductible. In retirement, Herb can expect full Old Age Security, currently $7,290 per year, and CPP of about $13,800, close to the current maximum.

RETIREMENT

FINANCE

Herb’s $222,000 in RRSP accounts and a combined balance of defined contribution savings of $486,000 and other savings of $42,860 add up to $750,860. If Herb and his employer continue to add $26,500 per year to his RRSP and defined contribution savings plan for seven years to age 60 and if the account grows at six per cent per year less three per cent for inflation, it will have a value of $1,126,500 in 2019 dollars at age 60.

If that sum is spent to his age 90, it would provide income of $57,475 indexed and taxable when paid out of registered plans.

If Herb were to continue working and contributing to his age 65, his RRSP and defined contribution accounts would grow to $1,446,600 and support payouts of $83,100 for the following 25 years to age 90.

Adding up components of Herb’s income, if he works to 60 then retires with CPP and OAS starting at age 65, his income would be $57,475 per year for five years to his age 65. At that time, he would be able to add $7,290 OAS and $13,855 CPP for total pre-tax income of $78,620. After 20 per cent average tax, he would have $5,240 per month to spend.

If Herb works to age 65, he would have $83,100 RRSP income, $13,855 CPP benefits and $7,290 OAS for total, pre-tax income of $104,245. After 24 per cent average tax, he would have $6,600 per month to spend.

Herb’s present mortgage payments, $3,680 per month, would consume 70 per cent of his retirement income were he to leave work at 60 and 56 per cent of his disposable income if he quits work at 65.

DEBT MANAGEMENT

The cost of mortgage service is a very heavy burden for quitting at 60 and still a big obligation even if Herb sticks out his job to 65. The obvious move, Moran says, is to downsize the house and pay off the mortgage.

Using only today’s numbers, Herb’s house, with a $1,200,000 asking price and the $779,000 mortgage, has $421,000 of equity. If paydown reduces the mortgage to $550,000 when Herb downsizes in, say six years when his kids have started university, he would have about $650,000 in equity. He would be able to pay off the mortgage and buy a condo or small house in a town well away from Toronto. He would end his current mortgage payments of $3,680 per month but also give up his $1,200 basement rental income.

The move to a smaller house or condo nevertheless would allow Herb to retire with substantial discretionary income for aiding his children or travel or other pleasures in retirement.

Herb’s child-support and spousal-support payments will end at about the time that his two children are ready for post-secondary education. That will compensate for the low present RESP balance of $3,782. If the combined $4,250 monthly child and spousal support payments then are used for the kids’ educational expenses, a total of $51,000 per year, their costs would be amply covered. Indeed, the sums not spent on tuition and books could be used for debt reduction, Moran notes. “When debt service and post-marital costs end, Herb can have a secure retirement.”