Divorced Dad’s Heart Condition Makes Planning Urgent
Andrew Allentuck
Situation:
Divorced dad is approaching retirement with substantial debt and heart problems
Solution:
Work with ex-wife to sell house, pay off debt, smaller house, liberate income
Carlos, as we’ll call him, is a 55-year-old civil servant with a unit of the Ontario government. Divorced, he lives with his 9-year-old son, sharing custody with his ex-wife. He worries about his financial security. His take-home income is $5,180 a month. That buys a good life in his northern town, but his future is uncertain, for Carlos has been diagnosed with a heart condition.
Apart from his defined benefit pension, which would pay approximately 60% to 70% of his present $102,000 annual pre-tax salary — depending on when he retires, he has relatively modest savings for mid-50s person – about $357,000 (not including an RESP) mostly in taxable accounts, an $183,000 mortgage and a $223,500 of equity in his $630,000 house. His ex-wife has the other half of the house. He’d like to buy out his ex, but he does not know if he can afford to do it.
“Should I sell the house and move into a less expensive townhouse for about $450,000 or get my ex to sell me her half of the house and then rent it out?” he asks.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Carlos. He notes that a major question – keep the house and buy out the ex-partner or sell, buy a townhouse and maintain financial assets – turns on his health and the fact that Carlos is just a year from being able to take early retirement at $63,409 a year. “The key to this case is Carlos’ heart. That can affect his life expectancy and his resilience to stress. The implication is that what counts is not maximizing his pension, but his life.”
Cash Management
Waiting to age 60 to retire would boost the pension to $72,604 and probably more with salary increases. But the pension is a life annuity and, with a heart condition in the picture, the word “life” takes on special importance. However, Carlos recalls that his father, who had a similar condition, lived to 85. Thus he thinks he’ll hold out to 60 to start retirement.
Debt management is the immediate issue. He should start by comparing costs, Mr. Moran suggests. Even at a rate of 4.0%, monthly payments of $1,850 would be needed to pay off the mortgage in 10 years by age 65. The present $183,000 mortgage is amortized over 28 years. If rates rise, as is likely, the cost of paying off the mortgage in 10 years would increase dramatically.
Carlos pays $760 a month on the mortgage, He cannot afford to boost payments to $1,800 month. He does not have the spare cash in his $5,180 take-home income.
Best move — sell and find another dwelling priced at $450,000. If Carlos can get $600,000 for the house after primping, selling and moving costs, he would be able to net $417,000 after paying off the mortgage. He would keep $208,500, which is his half. He could use some of his taxable investments, $286,462 in money market funds earning about zilch, and have $494,962, which would be more than enough for a $450,000 townhouse he has in mind. $45,000 would be left over for moving costs or just an addition to his small amount of cash. The debt burden would be gone and Carlos would save the $760 he pays each month on the mortgage. As a single person with little investment sophistication, this makes sense, for debt reduction is safe and secure while investing money is intrinsically risky, Mr. Moran notes. Moreover, with less stress to pay off debt, Carlos’ life will be more enjoyable. That’s an important consideration given his medical condition.
Carlos and his ex-wife each put $104 a month into the child’s RESP, which Carlos manages. If the account, which has a current balance of $25,000, grows at 3% a year after inflation at $2,500 a year and attracts the maximum Canada Education Savings Grant of $500 a year, then in eight years when the child is 17, he will have about $59,150, more than enough tuition and books for four years at a local university. Carlos and/or his ex can make up the difference out of his savings if the institution is distant from home or the child can get a summer job and contribute to educational costs.
Retirement Planning
When Carlos retires, he will be able to draw on a gold plated government pension. At age 56, just a year from today, he would have a $63,409 annual pre-tax benefit. If he works to age 60, as he anticipates, he would have a $72,604 benefit.
Carlos’ Canada Pension Plan benefit at 65 would be 90% of the maximum $12,460 in 2014, $11,214. At 60, it would be $7,176 a year. Using age 60, his total starting retirement income would be $79,780 a year.
Carlos can add to his $46,888 RRSP, but his contribution room is limited by the pension adjustment which takes into account money going into his civil service pension. Anyway, the money he could contribute might be better spent on a new house or just enjoying life. His retirement income will be sufficient.
If the present $46,888 RRSP balance grows at 3% a year after inflation for five years to his age 60, then with no further contributions, it would have a value of $54,400. If that money is paid out to Carlos’ age 90, it would add $2,750 to annual income, pushing the annual total to $82,480 before tax. His present TFSA balance, $23,719, growing with annual contributions of $5,500 at 3% a year after inflation would reach $57,573 when he is 65. Paid out to exhaust capital in 30 years, the TFSA account would generate $2,850 a year. Add OAS at age 65 of $6,620 a year to make retirement income $92,000 a year. After the 15% clawback on net income over $71,592, not including TFSA payouts, and regular income tax, Carlos would have about $6,000 a month to spend.
“Long tenure in the civil service is the key in this case,” Mr. Moran says. “What Carlos will not have from his defined benefit plan is control over the capital behind it. The government guarantee of payment is the good part of the pension, but in the end, it is not his money. Building up capital in a paid-for house with no interest rate exposure and saving a good deal of his retirement income will be the way to build a legacy for his son.”
Financial Snapshot
After-tax monthly income $5,180 Retirement stars: 3 out of 5
Assets
House (1/2 market price) $ 315,000
RRSP 46,888
RESP 25,000
TFSAs 23,719
Non-reg investments 286,462
Cash 7,000
Car 5,000
TOTAL $ 709,069
Liabilities
Mortgage 3% $ 183,000
Net Worth $ 526,069
Monthly expenses
Property tax $ 350
Mortgage 760
Food & restaurant 700
Phone, cable, internet 266
Utilities 263
Car fuel & repairs 550
Home and car insur. 198
House maintenance 300
Clothing & grooming 100
Entertainment 100
Travel 350
Child care 186
RRSP 110
RESP 208
TFSA 458
Charity and gifts 100
TOTAL $ 5,180
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