False sense of security
In Quebec, a couple we’ll call Charles, 46, and Marianne, 45, have lived a life of few financial cares and not much worry about the future. They have banked on the benefits of their employers’ pension plans and given short shrift to savings.
Now they find themselves with a big mortgage, jumbo car loans, payments for furniture and appliances — and an almost bare cupboard when it comes to educating their two children.
“We have never been good at making our savings and retirement a priority,” Marianne explains. “We have lived in the moment and dealt with savings secondarily. We have had to refinance twice in the past when we got in over our heads, and that means we have a huge mortgage — $ 195,000 — when we could have been done with it had we been smarter with our money.”
Charles’ management position with a big manufacturing company and Marianne’s administrative job in the provincial government bring them $ 7,990 each month of take- home income. Just $ 80 each month goes for RESPS and $ 200 for RRSPS.
Family Finance asked Benoit Poliquin, chief investment officer and head of Exponent Investment Management Inc. in Ottawa, to work with Charles and Marianne.
“Living for the moment is the reason that they have not reduced their mortgage and grown their savings,” he says. “Marianne’s pension will allow her to retire with 70% of her salary and Charles’ company- sponsored defined- contribution plan puts about 13% of salary into the plan each year. Those plans have built a foundation for their retirement. However, their liabilities are $ 261,462, which is more than the $ 260,043 present sum of their financial assets excluding small RESPS.”
Though their hope is to retire when Charles is 58 and Marianne is 57, Mr. Poliquin doesn’t think they should. He suggests they aim for 65.
Rebuilding equity
Each month, the couple makes $ 2,172 in payments for various debt obligations. They have $ 195,000 outstanding on their 3.8% mortgage. At $ 998 a month, it will be paid off in 30 years and four months. They owe a total of $ 61,806 for two cars with estimated current value of $ 54,000. The payments total $ 925 a month and bear interest at 6.6% for one car and about 5.0% at variable rates for the other. They also have monthly payment obligations of $ 249 for furniture and appliances which, though nominally interestfree, are still debts. The total of all these obligations is 27% of their monthly takehome income.
The couple needs to attack the debts in sequence. Cash savings of $ 22,200 should be used to discharge their highest interest debt — $ 16,000 due on the smaller of their two cars. With that obligation eliminated, the $ 334 monthly payment will be eliminated. They will then have $ 6,200 in remaining cash. The $ 334 plus $ 200 a month that can be taken temporarily from RRSP contributions, which currently earn less than the loan interest rate, total $ 534, plus $ 57 they can pick up from their miscellaneous budget can be used to accelerate their remaining car payments. They currently pay $ 925 a month on their $ 61,806 car loans. Adding $ 591 for total annual car payments of $ 18,192 a year would make it possible to pay off the nearly $ 62,000 of car loans in little more than three years, Mr. Poliquin estimates.
Then they can accelerate mortgage payments with money that had gone to other debts. That will reduce amortization to about 18 years. The couple will therefore be able to retire with all current debts paid by the time Charles is 65, Mr. Poliquin says.
With a $ 10,000 balance, RESPS for their children are underfunded. However, higher education in Quebec is heavily subsidized. If the children live at home and work part- time, they can pay for part of their own post- CGEP education, the planner suggests.
Charles and Marianne have $ 238,043 in financial assets other than RESPS and cash but including mutual funds and shares in Charles’ company. The company shares amount to 20% of total financial assets. That is a relatively large fraction, but the company is sound and the shares have been excellent performers. The balance of investments include $ 152,000 in several mutual funds from one vendor. The funds have underperformed the market and have 2.5% average management fees. They should be sold as penalties decline to 2% or less in favour of low- cost exchange- traded funds that hold companies that pay strong and rising dividends.
When Charles is 65, he and Marianne can have total retirement income based on two Old Age Security benefits that will total $ 22,640 in future dollars inflated at 3% a year, two Quebec Pension Plan payments totaling $ 32,321, $ 36,400 from Marianne’s work pension and $ 80,000 of annual withdrawals from registered retirement income funds that will have grown with Charles’ rising company contributions and 6% nominal annual returns to $ 917,600. Their total pre- tax retirement income in 2031 dollars will be $ 171,361 a year.
If they split pension income and pay tax at an average 27% rate, they will have each have $ 62,547 to spend a year, or $ 5,212 a month. Their monthly expenses net of debt- service charges and retirement savings will have risen at 3% a year to $ 9,700 in future dollars, but they will be firmly in the black.
“All this can happen only if the couple pays off their debts and retires at 65 owing nothing,” Mr. Poliquin says.