Dangerous debt leaves couple to rely on daughter in retirement
In British Columbia, a woman we’ll call Cindy, 35, is a health-care professional just finishing a training program and soon to be moving up in her field. She helps her aging parents financially. Her father, Sam, 68, is a florist. Her mother, Gloria, 69, works in a medical office managing records. Total family monthly pre-tax income is $3,333 for dad, $3,416 for mom and $5,026 for Cindy. That adds up to $11,775 per month before tax and $9,619 after tax and Cindy’s benefits. Her parents’ financial situation is tragic — they cannot afford to live without Cindy’s help now, nor do they have the means to live independently in their eventual retirement.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C. to work with Cindy and her parents.
“Sam and Gloria have been sold high-fee financial products that have transferred a great deal of their income to mutual fund companies, insurance companies and, of course, to people selling those products,” Moran explains. Sadly, there’s no cure so late in life. Cindy will have to continue to help her parents in their retirement, possibly impairing or delaying her own retirement.”
DEBT
Standing in their way is the parents’ $300,000 mortgage plus their $27,000 line of credit, $125,000 investment loan and, on top of that, a $50,000 loan from a relative. Added up, the parents owe $502,000. They are currently paying $3,468 per month to service and pay down those debts, a figure that consists of $1,468 on the mortgage, amortized over 25 years, and $1,000 each on the line of credit and loan to a relative. That works out to half their take-home income.
There are assets — a house with a $750,000 assessment in the inflated B.C. market, and financial assets that add up to $270,867. Subtracting their debts leaves them with a net worth of $533,867. But the real problem is not the numbers, but how they got there.
FINANCIAL PRODUCTS
Cindy’s parents are not sophisticated investors. They have purchased a variety of complex insurance policies. The policies are Universal Life, a concept that wraps insurance around investment products. They have two UL policies, each with a face value of $100,000 at an annual cost of $3,226 per year for Gloria and $3,586 per year for Sam. It would have been more prudent to have purchased term insurance for a great deal less and used the difference for debt service or investment, but the parents are no longer insurable. Therefore, Moran advises, these policies should not be cancelled; the couple should also keep their long-term care policies at $89 per month.
In addition, mom and dad purchased insurance-related mutual funds called segregated funds at an annual cost of 4.95 per cent on a $125,000 floating rate investment loan. The borrowing cost is tax deductible but they are demand loans and could be called at any time.
Sam and Gloria have little financial mobility because of their debts and insurance bills. But they can make the their lives easier, Moran says.
BOOSTING RETIREMENT INCOME
Their best bet is to cut debt service costs for all loans except their mortgage. They could do this by applying for a separate mortgage loan from their present lender (keeping it separate would make cost tracking and tax deductions easier) and use it to pay down the investment loan. That would cut costs by a couple of per cent and define the amortization. They could also blend and increase their home mortgage, which has a 2.44 per cent interest rate, to include the line of credit and the family loan, each of which now costs them $1,000 per month, $2,000 total. Within the mortgage at lower rates, they could reduce the monthly carrying costs to $450 per month, saving $1,550 monthly. They could assign their life insurance as security.
An alternative is to sell the Vancouver house, taking advantage of the city’s high prices. The $750,000 house after five per cent sales costs would yield $712,500. They could then pay off the $300,000 home mortgage and have $412,500 left over for a modest dwelling outside of Vancouver. Given that the parents still work in Vancouver, this partial solution can be shelved for now.
More income can be liberated if the parents stop making RRSP contributions of $525 per month as soon as they retire and convert to a Registered Retirement Income Fund by 71. It’s obvious, but the saving would be $6,300 per year.
Looking ahead to retirement, Cindy will have a defined benefit pension with an option to purchase extended medical at low cost.
But her parents have no company pensions. All they have is CPP, OAS and $124,400 of RRSPS. If their RRSPS grow at three per cent per year after inflation, they would support an income of $6,950 per year for 25 years.
Sam and Gloria each receive $7,000 per year from the Canada Pension Plan. Sam gets $6,492 per year from OAS, Gloria $6,852 per year based on years resident in Canada between 18 and 65. RRSP income will boost cash flow before tax to $34,294. If split and with applicable pension and age credits it would be tax-free. They would have $2,860 monthly to spend.
That sum would not pay current monthly expenses of $9,619. However, with recommended cuts of net $1,550 for line of credit and family loan payments; elimination of $1,300 of $1,483 for vehicle costs when Sam no longer goes to work or delivers flowers; business supplies of $500 per month; $525 monthly RRSP contributions; and a $300 cut in their monthly grocery and restaurant bill, they could slash outlays to $5,444 per month. Unfortunately, their projected monthly income would not cover that bill. Cindy would still have to contribute $2,684 each month to help her parents. At 65, she would have a pension equivalent to 60 per cent of her best five years of income plus CPP and OAS and what she can save after many years of helping her parents. “Cindy must delay her own retirement or have less when she does retire,” Moran concludes.