Couple’s $330K debt puts retirement plans at mercy of interest rates
Acouple we’ll call Mort, 42, and Susan, 38, live in Quebec. They have three children ages 9, 8 and 4, a house with a $450,000 price tag, and debts of $329,100. Their income is $5,752 per month based on Susan’s job as a school administrator and Mort’s catering business. Their combined monthly income is $4,773 plus $979 federal and provincial child benefits, but they spend $6,600 per month. They carry the deficit on their home equity line of credit.
Family Finance asked Caroline Nalbantoglu, head of CNal Financial Planning Inc. in Montreal, to work with the couple. “They are living above their means,” she explains. “Mort’s business barely breaks even. They have heavy debts because they use their line of credit to support the business and to maintain their way of life.”
They pay $1,100 per month on the $274,900 line of credit with a 3.7 per cent interest rate. The loan will not be repaid until Mort is in his 80s or longer if, as is likely, interest rates rise. They also have a $54,192 mortgage outstanding with a 2.69 per cent interest rate. It is due to be paid off in full in seven years when Mort is 49. It costs them $680 per month.
If Mort can sell his business, even at a loss, he might get a job with a $50,000 annual salary. This is a “might” but it is critical to the following plan. He figures he can get $120,000 for the business. Sold at a loss, there would be no capital gains tax.
Mort and Susan receive $718 per month from the Canada Child Benefit plus $261 from Quebec’s Child Assistance plan. If Mort gets a job with the $50,000 salary, benefits would be cut to $500 and $166 per month, respectively, Nalbantoglu estimates.
BUILDING ASSETS
Even with that reduction, they could set up a family Registered Educational Savings Plan and aim to contribute $2,500 per child per year. The federal government would add 20 per cent to a limit of $500 and the provincial government half of that with a $250 annual maximum. Some of the money can come from Susan’s $200 monthly RRSP contributions. RRSP funding can be suspended until the RESPs are at least partially filled. The kids will start post-secondary education before Mort and Susan retire. After the mortgage is paid off in seven years, they can direct the $680 a month they have been paying on it to their RRSPs.
REPAYING DEBT
With the RESP set up, they might find cuts in the budget to increase debt repayment. If they can add another $1,000 to monthly paydown, the line of credit would be paid off in 14 years rather than 40, as it is now set up, Nalbantoglu says. They can reduce clothing and grooming from $400 per month to $200, food and restaurant, $1,350 per month, by $350 per month, $250 per month travel by $100 per month, and entertainment and fitness from $425 per month to $225. Those cuts add up to $850. They would boost monthly line of credit payments to $1,950 and make the $275,000 debt, still bearing interest and likely at rising rates, vanish in about 15 years.
Assuming Mort gets $120,000 for his business, he can direct $75,000 to the line of credit, bringing the sum owed to $200,000 and taking another four to five years off the amortization, also depending on where interest rates go. The $45,000 balance, can wait — or be extended — until Mort gets another job, then paid down.
Susan will be 49 in 11 years and their home equity loan will be history, so the $1,950 per month or $23,400 per year they have used to pay it off can go to savings.
RETIREMENT PLANS
Mort and Susan see his mid-60s as their threshold for retirement. He will be 64 in 22 years, Susan 60. 2040 can be their retirement year, the planner suggests. Susan is in a 40 per cent marginal tax bracket. She should take the RRSP deduction for a spousal contribution to Mort’s RRSP, Nalbantoglu suggests.
At 60, Susan, who has a defined benefit plan, will have the required 35 years of service. That will put her over the magic number 80 for payment of her full pension which allows retirement with no penalty. She will be entitled to an estimated $61,000 per year. Family expenses with the kids gone will decline to $3,500 per month.
Mort and Susan can each apply for Quebec Pension Plan benefits at 60 and get benefits for an additional five years compared to retiring at 65, albeit with a 36 per cent reduction of the age 65 amount. Susan will be close to the maximum benefit, currently $13,600 per year, so her reduced benefit will be $8,700 per year. Mort, with years of making little income and contributing little to CPP from his business, may receive half the maximum, $6,800, with a 36 per cent discount for early retirement, net $4,350 per year.
They have $84,000 in their RRSPs. If they resume RRSP savings when their youngest child, age 4, is ready for post-secondary education in 13 years, they would have about a decade to build their RRSPs. Allowing for $3,000 average annual contributions at 3 per cent growth after inflation, the couple’s RRSPs would grow to $147,300 after 10 years. That sum, assuming a modest future growth rate of two per cent, annuitized so that all income and capital would be expended in the 30 years from Mort’s age 64 to Susan’s age 90, would generate $6,770 per year.
At Mort’s age 64, when Susan is 60 and able to take her work pension without any reduction, they would have her $61,000 annual work pension, her QPP benefit of $8,700 per year, Mort’s 4,350 QPP benefit, and annuitized RRSP benefits of $6,770 per year for total pre-tax income of $80,820 per year. They can each add Old Age Security of $7,075 per year at 65. That would make total pre-tax income $94,970. After splits of eligible pension income and tax at an average rate of 20 per cent, they would have $6,330 to spend monthly, which would provide ample discretionary spending without debt payments.