CUT DEBT — AND CUT OFF THOSE ADULT CHILDREN
A couple we’ll call Charles, 59, and Wanda, 56, live in Alberta. An industrial analyst and a management consultant, respectively, they have two children in their mid-20s, a $560,000 house and four cars, two of which are used by the kids. They live well on incomes which total $220,000 before tax, but they have a problem — debt.
Their home has a $150,900 mortgage that requires an $1,800 monthly payment. There is a $146,117 outstanding line of credit on which they pay $631 a month. Debt service amounts to 17 per cent of their $13,988 monthly take home income. That’s a lot for folks headed into retirement. As well, their financial records are more miss than hit. As a result, their retirement, which they plan when Charles is 65 in six years, has a base that is not welldefined in financial terms.
“We make so much money, but we just can’t seem to get ahead,” Wanda explains. “Should we sell our house now and get out of debt? Perhaps buy a small condo apartment. Or should we pay off all our debts? I worry that we will have a terrible retirement and be poor.”
Family Finance asked Don Forbes, head of Don Forbes Associates in Carberry, Manitoba, to work with Charles and Wanda. “This case is a paradox,” he explains. “They have high earnings capacity but a lot of debt and limited savings. There is not even a Tax-Free Savings Account. They consider selling their present home and retiring to a small town in the B.C. interior. They see it as a solution to their debt problem. We can offer alternatives.”
THE BUDGET PROBLEM
The problem is not lack of money. They spend $4,440 a month supporting their two mid-20s children who are still in university. They pay these costs because they have no dedicated educational savings such as Registered Education Savings Plans or other dedicated educational savings. These costs, though temporary, are the biggest obstacle to a financially secure retirement.
Each partner has an RRSP. Charles has $177,946 in his RRSP. If it grows at $1,100 a month for six years to his age 65 with a 3 per cent annual return after inflation, it would have a balance of $300,420. If annuitized for 33 years with 3 per cent annual growth to Wanda’s age 95, it would generate $14,054 a year in 2017 dollars.
Wanda has $86,000 in her RRSP. If she adds $6,000 a year, as she does now, for the next six years, the plan will grow to $142,700 and support annuitized payouts of $6,700 a year for 33 years to her age 95.
Charles’ company’s defined contribution plan has $83,925. With $600 monthly payroll contributions that come out of gross income plus the match ($1,200 in all) and 3 per cent annual returns after infla- tion, the plan should have a balance of $196,150 at the end of his 65th year and provide $9,200 a year to Wanda’s age 95.
RETIREMENT
Each can expect full Canada Pension Plan benefits, currently $13,370 a year, and full Old Age Security benefits, currently $6,942. With no changes to their savings practices and investment strategy, by the time Wanda is 65, they will have about $70,578 in retirement income before tax. If they split eligible pension income and pay 13 per cent average income tax after age and pension income deductions, they would have about $5,100 a month to spend. That’s short of their target after-tax retirement income of $67,800 a year or $5,625 each month.
If their mortgage, mortgage life insurance at $65 a month (included in total life insurance costs) and line of credit costs are eliminated, the kids are on their own, and they are no longer contributing to their RRSPs, their monthly costs would drop to about $5,450. That would still leave them with a shortfall.
Neither Charles nor Wanda has a Tax-Free Savings Account. In five years, new TFSAs with present limits of $52,000 each would have limits of about $74,000 each. Charles has a variable bonus, not included in income, which works out to $1,200 a month after tax. If that money is directed to TFSAs, then, with growth, each TFSA could have a balance of $82,000 in the first year of retirement and produce three decades of annuitized but untaxed income of $7,680 a year or $640 a month for 33 years.
With TFSA income added, their pre- tax combined retirement income would rise to $78,258 a year. After 13 per cent tax (TFSA payouts are exempt) as well as allowing for age and eligible pension income credits, the couple would have about $5,740 to spend each month. The spending gap would be closed, though not by much.
THREE VITAL MOVES
First move — slash debt. The couple’s mortgage at present paydown rates will be gone in seven years when Charles is 66. Their line of credit can be eliminated in about seven years if they can find enough cash to pay it down at $1,800 a month. That is three times the present paydown rate but doable if the kids pay their own way. The kids could get part-time or summer jobs to help cover tuition and living costs until they graduate. Charles and Wanda have contemplated downsizing their $560,000 home and using perhaps $200,000 harvested from equity to pay down debts. If they pay off their mortgage on schedule and eliminate their line of credit, as suggested, there will be no need to sell the house.
Second move — make a budget and a commitment to record spending. Accounts at present have more questions than answers. Not keeping close tables on costs and income would mean perpetuating their present financial mess.
Third move — prune investments. Their list of investments is mostly mutual funds sold by one chartered bank and a few non-bank mutual funds. Were the couple to convert their 100 per cent mutual fund investments to exchange traded funds, they could save perhaps 2.0 per cent a year in fees. On just the present balance of $347,871 in RRSPs, that would be $6,957 a year added to retirement savings and eventually to income.