Situation: Single woman recently bought a home but large debts threaten her retirement security
Solution: Slash expenses, use funds freed to pay down debts, then build retirement savings
In Quebec, a single mom we'll call Charlotte, 53, has seen her daughter, 22, through university. Charlotte's life in financial terms is based on her middle management job with a large financial business which provides $3,974 monthly take home income. Unfortunately, it's not enough to pay her bills which add up to $4,609 a month. The difference winds up on her line of credit and credit cards. Her total debts, including her mortgage, amount to six times her annual take-home income.
Charlotte worries that she has taken on more debt than she can handle. It is a legitimate concern. She has leveraged her future on a great deal of debt that will grow unless she takes strong measures to pay it down.
“Are my credit card and line of credit balances and my mortgage too high” she asks. “With the debt I have taken on, when will I be ready to retire”
Charlotte's wish for many years was to have a home of her own. Recently, she fulfilled her wish by buying a $300,000 condo with a $222,208 mortgage. She used the Home Buyers Plan to apply $25,000 in her RRSP for part of the down payment. She must repay the HBP debt to her RRSP over 15 years, beginning at the end of the next year.
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Family Finance asked Caroline Nalbantoglu, head of CNal Financial Planning in Montreal, to work with Charlotte to examine her debts and preparations for retirement in future.
Budget for fast debt elimination
“Her challenge will be to convert what is now a monthly deficit to a surplus in order to pay down debts,” Nalbantoglu says. “She has to look at her allocations to see where to cut. If interest rates were to rise a few per cent, her debt service costs for her mortgage, credit card and line of credit would make her present budget unsupportable.”
At present, Charlotte's monthly budget, with the mortgage included, adds up to $635 more than her take-home income. If she cuts her monthly restaurant, clothing and entertainment budget to $60 for each and reduces the gifts budget to $0 or just buys gifts when she can afford them, she will save $688 a month and bring total monthly allocations down to $3,921, which would be within her income and leave $53 a month for unexpected costs.
Annual premiums for the Quebec Pension Plan and Employment Insurance are paid in the first six months of the year, so she can save those premiums for emergency spending. In 2018, she will have to begin paying her Home Buyers Plan back at $139 a month, or $1,667 a year. The money she saves this year can help to pay the HBP next year, Nalbantoglu says.
Charlotte has to tackle her large debt repayments. At her current repayment rate, it will take 2.5 years to eliminate the $12,131 credit card balance and 11 years to eliminate her $26,230 line of credit balance — and that is assuming that she does not add to either debt. The credit card has the highest interest rate, 10.9 per cent, so it should be the first to be paid off. She lacks the cash flow to do it, however.
The solution – rather than direct $300 to her RRSP and cash savings, as she does now, she can use the money for her credit card balance. Her company pension plan is generous, so she can skip these savings for a few years. If she redirects the $300, increasing monthly payments to $700, the credit card it will be paid in 18 months.
Once the credit card is paid off, the funds liberated — $700 a month, including the suspended RRSP contributions — can be added to the $200 regular payments for the line of credit, with its interest rate of 4.7 per cent. Payments of $900 a month will eliminate the $26,230 line of credit debt. It will then be discharged in less than three years. So, within five years, the credit card and line of credit debts will be history.
Financing the new home
Charlotte will now have $600 a month liberated from former non-mortgage debt service, some of which can be used for retirement savings or just for some breathing room. If she were to take advantage of the extra cash, about $140 a month, liberated after QPP and EI premiums stop mid-year, and put it aside she would have $1,680 a year to help with repayment of her HBP loan.
At 58, Charlotte will have $81,393 in her retirement accounts. If she then contributes $600 a month — $500 from money liberated from debt service repayment and her previous $100 monthly contribution — to her RRSP and attains growth of three per cent after inflation, then at her age 65 she would have about $147,500 in her retirement accounts. If that sum were paid out over the next 30 years so that all capital is gone by her age 95, it would generate $7,300 a year.
Charlotte would not retire entirely debt-free, because at 65, she would still have a mortgage balance to pay plus $5,000 owed on her HBP loan. However, at 65, she would be entitled to a company defined-benefit pension of $49,680 a year, QPP benefits of $13,110 a year and Old Age Security of $6,846 a year in 2016 dollars. That adds up to $76,936 a year. After 25 per cent average tax and age and pension income credits, Charlotte would have $4,800 a month for expenses. That is more than her present take-home income. With savings and debt service other than the mortgage removed, she would have $900 more discretionary income each month than she has at present.
Most of her retirement income would be indexed. Her government pensions from the QPP and from OAS are indexed to inflation. The home would provide a high level of security and if, in late old age, she were to need assisted care, the condo could be sold or rented to provide money for the bills.
In spite of what could be called a late start in buying a home, Charlotte will be able to have the security of ownership. It is usually not a good thing to carry a large debt into retirement, but with a high proportion of income guaranteed by a DB pension and government benefits and aggressive paydown of non-mortgage debt, Charlotte can manage her finances before and after retirement to produce a comfortable level of security, the planner notes.
“Charlotte has achieved her dream of owning a home,” Nalbantoglu says. “She will have to do some belt tightening for the next five years and live within her means. If she stays out of further debt, she can have a financially secure retirement. If she does not slash her non-mortgage debt, her retirement could be difficult.”