Situation: Couple, ages 58 and 41, has a lot of debt and a low net worth for their ages
Solution: Use cash to pay off debts and cut interest, build RESP & RRSPs
A couple we’ll call Harry, 58, and Linda, 41, live in northern British Columbia with one child, Alex, age 12. They bring home $5,455 per month, each from product consulting. Linda’s company has an employee savings plan, Harry is self-employed. Their problem — in mid-life their net worth is about $150,000. They have modest equity in their house and own a timeshare they would shed if they find a buyer to take over the $12,970 loan they took out to buy it. They want to help Linda’s mom, but lack the cash flow to do it.
“My main concern is debt,” Linda explains. “I would like to have our house paid off by the time I am 55. Alex will be in university and Harry retired.”
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Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Harry and Linda. “They can fix their problems if they slash interest costs,” he explains.
Out of $5,455 take-home income each month, Harry and Linda spend $2,255 on interest on their mortgage, two lines of credit, and a $12,970 timeshare loan. The loan payments amount to 40 per cent of take-home pay.
Harry and Linda have $34,080 in cash in chequing accounts and $10,000 cash in their Tax-Free Savings Accounts. That’s $44,080. They should leave $10,000 in chequing and use the balance for debt reduction.
The most expensive loan, the $12,970 balance owed on their timeshare, which has an 11 per cent interest cost, should be first to go. That will leave $21,110.
Next, pay off the more expensive of two lines of credit which has a 6.96 per cent interest rate on the outstanding balance of $17,500. Then use the remaining $3,610 to reduce the second line of credit, with a $16,200 balance and a 4.95 per cent interest rate to $12,590.
With the timeshare loan, which cost them $575 per month and one credit line charge of $150 per month eliminated, the total, $725, can be used to pay off the second line of credit faster. That will raise line of credit payments by $725, from present $594 to $1,319. That will reduce amortization from the present 29 months to 14 months. They can then pay off their $935 monthly mortgage. They can add the $1,319 they no longer need to service other debts.
After the credit line is paid off, they can increase their mortgage payment to $2,254 per month. At that rate, they will be debt free at ages 49 and 66 rather than 64 and 81. They will have $2,254 free each month to save or spend or help Linda’s mother.
Alex has a Registered Education Savings Plan balance of $18,200. The parents add $130 per month. They should raise the contribution to $208 per month or $2,500 per year. That will qualify contributions for the full Canada Education Savings Grant bonus of the lesser of $500 or 20 per cent of contributions. In five years, when Alex is ready for post-secondary studies, the account growing at 3 per cent per year after inflation will have $31,350 at present rates or $37,500 at the recommended higher contribution rate with the same assumption. Either way, it’s enough for tuition and books for four years at a B.C. post-secondary institution if Alex lives at home.
The couple needs to build retirement savings. They have $81,000 in various retirement plans. $27,500 is in a defined contribution plan provided by Linda’s employer. It is really an RRSP with matching by her company. The sum of that plan and $23,500 in Harry’s locked-in plan, plus $30,000 in an ordinary RRSP, total $81,000, needs to be increased, for Harry has only seven years to go to age 65 and Linda 24 years. Harry will have to convert his RRSP to a Registered Retirement Income Fund by age 71 when Linda is only 54.
Linda’s RRSP contributions are limited by the Pension Adjustment which reduces her maximum 18 per cent of gross salary by the amount her company adds each year.
Assuming that Linda and Harry add $5,000 per year to their RRSPs, then in seven years when Harry is 65 and stops working, and assuming they have balanced their plans with spousal contributions, with accounts growing at 3 per cent after inflation, then the plans would have $139,100 on the eve of Harry’s retirement. Harry’s half, $69,550, annuitized for 30 years to his age 95 would generate $3,550 per year. He would have Canada Pension Plan benefits we’ll estimate at 60 per cent of the present maximum $13,610 per year or $8,166. He would also get Old Age Security of $7,075 per year. His personal income would be $18,791 per year or $1,566 per month with negligible tax. He could take CPP early at a discount of 7.2 per cent of age 65 benefits for each year prior to 65 that he starts benefits. He’d give up too much, so he should not, Moran advises. With an age 65 start to CPP, family income would be his pension income and Linda’s $53,820 after-tax salary, total $72,611. With their mortgage paid in full a year later and education savings ended, other debts long ended, they would be in good shape, Moran says.
In the 17 year interval from Harry’s retirement to her own, Linda would bring home her present $4,485 monthly salary. Family income would thus be her salary plus Harry’s income, total $6,051 per month.
When Linda is 65, her half of RRSP savings, $69,550, with continuing contributions of $4,000 per year, including the employer portion, for another 17 years with 3 per cent growth per year after inflation would become $204,600 and support payouts of $10,438 per year for 30 years after age 65.
Linda should receive 90 per cent of CPP benefits or $12,250 per year plus $7,075 annual OAS benefits 2018 dollars. Her retirement income would be $29,763 per year before 10 per cent average tax, net $26,786 per year. Combined income would be $45,578 per year or about $3,800 per month after tax. With no debts to pay or savings their present allocations of $5,455 per month would drop to about $2,650, allowing $1,150 of discretionary spending.
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Retirement stars: three retirement stars *** out of five