Woman, 58, wants to retire now, but with debt five times her annual income, it doesn’t look possible | Financial Post

Situation: Woman in late 50s with debt five times annual income wants to retire ASAP

Solution: Debt elimination comes first, then retirement will work in her mid-60s

A woman we’ll call Alice, 58, lives in Ontario. Her two children are in their 20s and living on their own. She brings home $4,300 a month from a public service job and adds $1,000 net rental income from an apartment in her home. She faces a heap of debt — $238,000 in a mortgage with a dozen years to run and $14,700 on credit cards with interest rates as high as 19.97 per cent.

Alice would like to retire well before 65 if she can manage it, but all that debt stands in the way. Her finances were crimped by a divorce and a three-year stint in post-graduate studies that cost $100,000 in tuition plus foregone salary. She also gave $80,000 to her children to pay their university tuition bills. She is working at paying down credit card debts and a line of credit.

“I have no regrets about the costs of helping my children and my own studies, but it has meant that my $238,000 mortgage is not paid off,” she explains.

E-mail andrew.allentuck@gmail.com for a free Family Finance analysis.

Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Alice. “I don’t think she can retire much before age 65,” he says, but notes there are several ways to “make her income produce more savings and to raise her investment returns.”

Debt management

Alice has two credit cards, one with interest of 19.97 per cent on a $2,500 balance and another with a 15.9 per cent rate on a $3,200 balance. She has an unsecured line of credit with a 6.45 per cent interest rate on a $9,000 balance. Best move — set up a secured line of credit at around 4 per cent with her mortgage lender.

Alice’s mortgage is $238,000 on a house with a value of $350,000. That’s a loan-to-value ratio of 68 per cent. She could set up a secured credit line under the home equity credit facility and use the credit line to pay off her cards, reducing the cost from 17.94 per cent average to around 4 per cent. The lender could go to 80 per cent of value, meaning that she could add another 12 per cent, $42,000 on an amortizing loan for perhaps 25 years. She would pay prime plus one per cent, about 4 per cent at most these days, Moran explains.

Improving her rental apartment is the next priority. If she sets up a special tier in her line of credit, it would bear the same interest as the line of credit but could have a fixed amortization and thus not be a demand loan, which is usually the case for lines of credit.  

By restructuring her debt, Alice will be able to pay off her debt faster, and have a tax-deductible and easily confirmable credit cost for the basement apartment rental. As her mortgage is paid down, her credit line borrowing capacity will grow and that will provide emergency borrowing capacity.

At present, Alice pays $1,863 per month to pay down her mortgage with 12 years to go on her amortization schedule. If, as she hopes, she gets a promotion that allows her to increase her pay-down rate by $2,000 to $3,863 per month, the mortgage would be paid off in 6 years when she is about 64. She would save $19,982 in interest, Moran calculates, assuming that interest she now pays at 2.4 per cent does not change. The raise is speculative, so we’ll stick with present amortization.

Retirement planning

Alice has $500 in her TFSA. She could contribute it to her RRSP and get a 29.7 per cent return in her bracket. That’s the best move.

There is an alternative way to handle retirement costs — skip debt repayment for now and invest $2,000 per month more in her RRSP. What to do? Returns on investments are variable and could be negative for some time. Interest costs are likely to rise. The better move is to cut debt, Moran explains.

Alice can have more retirement income if she prunes her investment portfolio. She has 27 mutual funds and exchange traded funds for a $32,000 portfolio. Her management expense ratio is about 2.13 per cent, which works out to $682 per year. At present, Alice does not have sufficient familiarity with financial management and investments to take over her own portfolio. She would need guidance and for that she would need to pay professional fees or do a great deal of study. A plan to cut fees is a goal rather than an immediate move she can make. If she were to raise returns by even half the amount she now pays for fund management, her added returns could help pay for things not in the present budget such as a few more holidays in retirement.                                                                                      

Adding up income

Alice has an indexed defined benefit job pension that will pay her $15,540 per year at 65. She can add Canada Pension Plan benefits of $12,456 per year and Old Age Security of $7,040 per year. If Alice adds $500 from her TFSA to her $32,500 RRSP and $500 every month thereafter, then with 6 per cent annual growth less 3 per cent for inflation, net 3 per cent per year, it will become $87,950 by her age 65. If that money is spent for the next 30 years to her age 95, then with growth continuing at 3 per cent after inflation, it would generate about $4,500 per year. Add $12,000 annual net rent from her apartment in her home and her total pre-tax income would be $51,536 per year. After 10 per cent average income tax based on age and pension income credits, she would have about $3,870 per month to spend. That is a little more than $5,400 current income with $1,600 of non-mortgage debt paid off and RRSP and TFSA savings eliminated, Moran says. Her way of life could be maintained.

“This is a workable plan that relies on debt management and, of course, sticking out the job to age 65,” Moran explains. “Alice would have the freedom she craves. If she does get a major raise, then earlier retirement as early as 60 would be possible, assuming she pays off the mortgage and raises her savings rate.“

E-mail andrew.allentuck@gmail.com for a free Family Finance analysis.

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Retirement stars:  two retirement stars ** out of five

Originally posted on: http://business.financialpost.com/personal-finance/family-finance/woman-58-wants-to-retire-now-but-with-debt-five-times-her-annual-income-it-doesnt-look-possible

Published: 02 Mar, 2018 By Andrew Allentuck