Rising Income Will Rescue Couple Whose Finances Have Been Crippled by Illness

Andrew Allentuck 
Situation: Incomes and savings of couple in health care have been slashed by wife’s illness
Solution: Use income when doctor goes into practice and asset management to restore savings
An Ontario couple we’ll call Harriet, 45, and Paul, 40, have seen their lives transformed by illness. Harriet, a physiotherapist who practiced for 10 years, developed a serious case of rheumatoid arthritis which ended what had been a promising career with annual income around $70,000 before tax. She is on disability and gets $3,000 a month. She and Paul drained $90,000 of savings over several years prior to 2014 for procedures in the U.S. which Ontario’s medical insurance system didn’t cover. Treatment in Ontario required a two-year wait. She could not take the suffering that long.
Paul, who formerly owned and managed a medical supply company, is a physician nearing completion of his residency in obstetrics. His present $5,000 monthly gross income, $3,600 net, is likely to soar to $25,000 a month before expenses when he begins full time practice in 2018. He will then be 44 and will have a fraction of the career time of doctors who started in their early thirties to make up the $200,000 he spent on medical school tuition and related costs and to earn back what he and Harriet have spent on her care.
We bled a fortune on my care and we are worried that we will never be able to afford an enjoyable lifestyle in retirement
Now in mid-life, the couple wants to enjoy the things their peers with two decades of work and saving behind them have already achieved. They have a house and cottage, but they would also like to have a vacation home in Florida, to build up savings, to pay off the mortgage on their house and to settle down to the security many middle-aged couples take for granted. They have no children nor plan any.
“We bled a fortune on my care and we are worried that we will never be able to afford an enjoyable lifestyle in retirement,” Harriet laments. “For now, we take it for granted that my return to practice will be impossible.”
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Harriet and Paul. “There is an anxiety issue here, which is understandable. They fear being poor, which is a reflection of their own less than affluent childhoods. Harriet worries her illness may worsen or at least cost much more. They want to have what other middle aged couples have, and they have only half an adult working life to get it. But with some financial planning for their future savings, they can have the security they seek.”
Paul is putting $6,000 a year into his RRSP. Best bet – stop contributions. In a few years, he will be in the top tax bracket and will get far more tax savings for every RRSP addition. The RRSP space is carried forward and the extra tax benefit will easily make up for potential losses of growth for a few years, Mr. Moran says.
The couple has a $112,060 mortgage on their house. Harriet has $117,851 in taxable securities. They can cash these assets, pay tax due on accrued but unrealized gains, and use the funds to pay off their mortgage. The saving will be $1,592 a month, dropping reported allocations other than savings to $3,869 a month. The additional cash flow available can then be used to fill Paul’s approximately $20,000 available TFSA room.
Harriet’s disability payments are not subject to tax. She has a small investment income. She can make withdrawals from her $216,000 of RRSPs with low or no tax depending on amounts taken. After all, a dollar in the pocket is worth more than a dollar in an RRSP. Once Paul is in private practice, they can rebuild their savings, Mr. Moran notes.
If their present $286,137 of savings and investments after payment of their house mortgage grow with total RRSP and TFSA savings of $11,400 a year, then they will have $371,000 of savings when Paul is 44. If those assets grow at 3% after inflation and if Paul can save a total of $10,000 a month in registered and non-registered accounts when he is in private practice at age 44, their savings will have growth to $3,087,000 when Paul is 60. That capital would support payouts of all capital and income of $153,000 a year for the next 30 years with an early start to average tax over a longer time. At 65, estimated Canada Pension Plan benefits of $8,100 each, which is 65% of the maximum $12,460 in 2014, would raise the couple’s total pre-tax income to $169,200 at age 65. After splitting qualified pension income and paying average 20% income tax on income other than TFSA payouts that are not taxable, they would have $11,300 a month to spend.
Old Age Security, $6,765 a year beginning when each is 67, would be drastically reduced by the clawback which currently begins at $71,592 a year even if the couple splits qualified pension income. If Paul and Harriet wind up paying 15% of the amount over the trigger point, which would be influenced by how much non-registered dividend income is inflated by the dividend tax gross-up used in calculating the dividend tax credit, their permanent disposable income would remain about $11,000 a month in 2014 dollars.
The largest risk to the couple’s retirement will be a disability that might strike Paul. He should purchase adequate disability coverage if he is in private practice or ensure he has coverage provided by a hospital or clinic that employs him. Paul also needs to buy a sufficient life insurance to benefit Harriet both now, before his income rises, and later, when their lifestyle changes. Harriet may not be insurable given her condition, however.
Harriet and Paul are among the minority of their friends who do not have a home south of the border. Harriet thinks that the foreclosure bargains will vanish, so she is eager to buy. The problem is that they haven’t much time to use any Florida home, so if they spend, say, $500,000 on a property and pay perhaps $20,000 a year for mortgage and utilities, insurance, taxes and security costs, for a maximum of two months of annual use, then, dividing expenses by months of actual use, they would be shelling out about $10,000 a month for the time they use the home. Renting would be cheaper.
They will also have U.S. tax exposure if they own a home and generate rental income for the months they do not use it. There will also be legal and accounting costs to comply with American tax law. At the least, they should wait until Paul is retired or until they have the cash to buy. In any event, there are far easier ways to accumulate wealth than owning property through the boom and bust cycles of Florida real estate. Finally, with a house and cottage in Ontario and a property in Florida, they would have little time for travel outside of North America. In the end, the house would be an anchor they do not need before Paul’s retirement, Mr. Moran says.
(C) 2014 The Financial Post, Used by Permission