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By ANDREW ALLENTUCK
Special to The Globe and Mail
Report on Business
Saturday, April 12, 2008
In Southern Ontario, a couple we'll call Neville and Claudia are in trouble.
Neville, 56, has a factory job. Claudia, 57, has several part-time jobs. Their total income from employment, $72,000 a year, is less than half their debts of $165,000. They have an RRSP balance of $590 and undeveloped land that generates a negative cash flow.
Adrian Mastracci, “fee-only” portfolio manager at
KCM Wealth Management in Vancouver, says, "This couple has had a reasonable income, but they have not managed their finances well."
"Our problem is that we have almost no savings, virtually no RRSPs and still have large debts to deal with," Neville explains. "We're getting close to retirement in four years and we need to know how to deal with these debts. We don't expect a miracle, but we need to be able to live in comfort without selling our house. We've just finished paying off the mortgage, so it would be nice to enjoy it for a few years."
WHAT OUR EXPERT SAYS
Facelift asked Vancouver-based financial planner and portfolio manager Adrian Mastracci, head of KCM Wealth Management in Vancouver, to work with Neville and Claudia.
"This couple has had a reasonable income, but they have not managed their finances well," he says. "They live from paycheque to paycheque. Moreover, they appear only recently to have taken even a modest interest in the immense debt that they have carried for as long as they can remember."
The couple do not have enough money to retire. About 39 per cent of their $4,316 monthly after-tax income goes to pay $1,677 of monthly services charges on their $110,000 line of credit, loans on their two cars and credit cards that have reached charge limits. The couple have two business interests: A small farm they rent out for sums that do not even cover real estate taxes and an entertainment company that generates no cash.
Neville can retire at age 60 with a pension of $2,000 a month. The company pension declines to $1,250 a month at his age 65. It is not indexed. He has worked in Canada for about 27 years. He can expect to receive $481 a month, the average Canada Pension Plan benefit, if he retires at age 60.
He can confirm the benefits for which he has qualified by requesting a statement of contribution from CPP. Retirement at age 60 will reduce CPP benefits payable at age 65 by 0.5 per cent a month for each month prior to age 65 at which retirement begins. Claudia can take the same early retirement benefit, the planner notes. This option will give the couple total income at age 60 of $2,968 a month, just 69 per cent of their current expenses including debt service charges.
If Neville and Claudia work to age 65, they will receive an estimated $629 a month each in CPP payments plus Neville's $1,250-a-month pension from his employer plus Old Age Security. Claudia, who has lived in Canada all her life, will receive $502 a month in OAS payments while Neville will receive a reduced OAS benefit of $340 a month. Their total monthly income at age 65 will therefore be $3,350 in 2008 dollars. This strategy leaves a monthly deficit of $966 based on current spending. They need to cut that much to end the deficit. This approach also leaves them with $165,000 of liabilities.
More needs to be done to raise retirement income and to pay down debt. They can cut expenses at Neville's retirement by having only one vehicle. That will take about $400 of loan charges out of their expenses plus about $250 a month for insurance, repairs and gas. They will no longer have to make RRSP contributions - that's another $50 saved each month. Finally, they can track and probably save most of the $247 in unaccounted "miscellaneous" costs. Total saved: $947 - close enough, Mr. Mastracci says.
The couple can take on debt reduction more aggressively. The first option is to downsize the farm. Neville and Claudia estimate its value at $400,000. Selling half of it would bring in $200,000. If they cannot sell a piece of it, they must sell the whole thing.
Cash from sale of half the farm would allow discharge of all debts and provide a balance of about $35,000 they could use to add to their registered retirement savings plans. Their unused RRSP space is $62,200 for Neville and $28,200 for Claudia. If the $35,000 generates a 6-per-cent nominal return, it will add $175 a month to their pretax retirement income. Sale of the whole farm would liberate more capital.
Alternatively, Neville and Claudia could remortgage their house, taking a $165,000 loan at a cost of perhaps 6 per cent a year. This would swap high-cost loans for lower-cost debt, but would not eliminate it.
Neville has to work to age 65 if the family's present way of life is to be maintained. "Neville and Claudia have to take charge of their finances before their debts destroy the equity they have built up in their house. They must sell some or all of their property and then scrimp to accumulate cash. It's harsh medicine, but it has to be taken."
Client Situation
THE COUPLE
Mid-fifties couple in Southern Ontario.
THE PROBLEM
Deeply in debt, the couple cannot afford retirement.
THE PLAN
Sell a major asset, pay off debts, put leftover cash into RRSPs.
THE PAYOFF
A modest retirement that permits the couple to continue their way of life.
NET MONTHLY INCOME
$4,316
ASSETS
House and farm $400,000, 2 cars $30,000, cash $1,000, RRSP $590. Total: $431,590.
MONTHLY EXPENSES
Property tax $200, food $500, entertainment $30, house & car insurance $350, gasoline $240, dining out $120, clothing $40, charity & gifts $40, utilities & phones $572, travel $250, car loans $770, line of credit $607, credit cards $300, RRSP $50, miscellaneous $247.
Total: $4,316.
LIABILITIES
Line of credit $110,000, credit cards $28,000, car loans (2) $27,000. Total: $165,000.
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