‘Do we have to sell everything?’
a couple we’ll call Louis, 72, and Mary, 71, have a good income from their government pensions and a private consulting business they run from their home base in Ontario. Their annual income before tax of $67,290 a year has bought a comfortable life. They have a house, a cottage, two cars and a couple of small boats. But there is trouble ahead, for they currently spend more than their take-home income. The situation will get worse when Louis closes his business.
Without their business income, $26,000 a year after tax, Louis and Mary will have trouble servicing the debt, which costs them almost $28,400 a year. Their debts total nearly $295,000, about five times their annual take-home income. Louis, who still works, cannot postpone retirement much longer.
“We are spending more money than we take in,” Louis explains. “Do we have to sell everything and rent our accommodation? Can we improve our investment returns without losing money?”
Seniors who move into retirement with large debts are playing a risky game. Eventually they will run down their savings, then face insolvency. However, a debt reduction plan and an investment income enhancement strategy can turn the tables.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Louis and Mary. The strategy — sell their house, one car, trim spending and get out of GICs that don’ t even pace inflation.
expense management
They must raise cash. They can cash in about $222,000 of RRSPs. That would cost them 41% in taxes and leave just $150,000 to pay $300,000 of debt. This is a poor move.
Second, they could sell the $260,000 cottage for $247,000 after commissions. The cash would still leave $47,000 of liabilities, which is almost all of one year’s take-home income.
Third, they could sell the house for $300,000, realize $285,000 after commissions and costs, and use the cash to pay off all but $880 of their liabilities other than the car loan, which has no interest. They would have the cottage, which is well equipped with plumbing and heating, for summer and money for travel to Europe, where they would stay with family in winter. Most of all, they would have ended virtually all of the $28,380 annual loan costs they have been paying.
They can make other cuts too. They have two cars that cost $957 a month for fuel and maintenance. Insurance adds another $150 for each car.
By selling one recent model car, they would save $630 a month or $7,560 a year. The car, in mint condition, might fetch $10,000. That would pay off the $9,000 debt remaining on the two cars, though, at 0% interest, it would not save financing cost.
Louis has a whole life policy with a $15,000 cash surrender value. He pays premiums of $5,700 a year. He should put the policy on a premium holiday so the premiums come from the policy itself rather than their pockets, Mr. Moran suggests.
To save more money, they could trim combined food and restaurant spending, $1,100 a month, by perhaps $300 a month, for savings of $3,600 a year. Their phone, cable and internet bill, $536 a month, could be cut by as much as $300 by shopping for better deals. The savings: $3,600 a year. The sum of all these cuts is an astonishing $58,380 a year or $4,865 a month. The result — their monthly expenses would fall to $3,529.
investment management
That expense would be covered quite easily by their present $4,766 monthly take — home income. However, if they were to close their business, their remaining income would be $30,696 a year in government CPP and OAS pensions plus whatever investment income they could muster.
The couple’s $221,769 investments, all of which are in RRSPs, are both unbalanced and unproductive. Their non-financial assets are 70% of their total assets. In other words, just 30% of their assets generate income. The assets other than their life insurance are entirely in guaranteed investment certificates.
Half have fixed interest rates below 2% and half are market index-linked and therefore provide about 60% of any rise in the TSX or other markets indexes. The “linkers” as they are called, guarantee not to return less than purchase price even if the market falls. The various GICs are likely to produce an average of $4,400 a year in income before tax, assuming that they generate a 2% pre-tax return. Added to $30,696 government pension income, they would have pre-tax income of $35,100 a year. Tax would be negligible after personal and age exemptions, allowing them to have a monthly disposable income of $2,925. It is not enough.
If Louis and Mary cash all their certificates as they come due and invest in exchange traded funds populated with large cap companies that pay dependable and rising dividends, then with a total annual return of 4% on dividends and 4% on capital appreciation, they could have an 8% return before inflation or a 5% return after 3% inflation.
“There has to be discipline in any investment plan,” Mr. Moran says. “This is a catch-up plan and, if Louis and Mary are disciplined, they can raise returns. That will get them through their retirement, assisted by remaining life insurance cash benefits.”