Messy Divorce Leave Lawyer on Shaky Ground
In Ontario, a 68-year-old lawyer we’ll call Charles has a substantial six-figure income. But after a bitter divorce that cost him a bundle in legal fees and property and left him with four children to raise on his own, he had to start over.
Today, Charles pulls down a $148,000 salary that goes with being counsel in a large corporation. When he finally quits, he will have a pension which, with Canada Pension Plan benefits, will be just over half of his present income. Moreover, he will not have much of a financial cushion on which to rest. After he services debts that are 1.2 times his net worth, he will have a meager income on which to live.
Charles’ current net worth, about $260,000, is less than the $320,000 value of his house. He has debts of about $319,000, including a $246,564 mortgage on the house, which he bought in 2010 after renting for many years and not capturing capital gains in the booming Ontario real estate market. Now he has $105,436 equity in his house and $83,580 of financial assets. And those assets are a story in themselves.
Currently, 70% are in low-return GICs. Aware that he was neophyte in stock investing and dubious about the prospects of managed mutual funds, he stayed in things that would not go down in a sinking stock market.
“I did not get good investment advice, realized that, and moved my money to GICs,” he explains. He preferred to take losses through inflation rather than through sinking share prices. It was short-run prudence over long-run fear, he admits.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. of Kelowna, B.C., to work with Charles.
Charles’ present income, $148,200 a year plus $11,000 of CPP, leaves him with $98,000 a year to spend.
That’s $8,166 a month. In retirement, he will rely on a pension that, including CPP, will be $78,000 a year plus a one-time severance payment of $70,000 subject to tax at a rate that could be as high as 58%.
In retirement, Charles will be able to keep most of his Old Age Security benefits and so have $82,243 a year, or $6,853 a month. before income tax.
Income tax at an average 26% will leave him with disposable income of $5,070 a month, 62% of his current take-home income. Debt-service charges of $15,516 a year, or $1,293 a month, will leave him with $3,777 a month.
That would cover monthly expenses but leave little room for unexpected costs. He will be on tight budget at best on a discretionary income that is just 47% of what he brings home now.
There are several things Charles can do to raise his retirement income and to reduce expenses, Mr. Moran says.
Strategically, he should plan to reduce taxes, starting with the official retirement date. The OAS clawback, which starts when gross income is $69,562 at 2012 rates, takes all Old Age Security income back when gross income reaches $112,772.
If Charles were to take his severance in the same year that he does not work and has only his pension, CPP and OAS, he would lose more than half of the severance to the combination of regular income tax and the OAS clawback. If he takes his severance in the later part of a pre-retirement year after he has passed the end point of the clawback, his severance will have a lower tax rate. The result is contrary to what one would intuitively expect, Mr. Moran notes.
Rebuilding the balance sheet
Even before he retires, Charles can increase his disposable income. First, harvest taxable investments of $30,105 and $7,000 cash and use the money to pay down the credit line from $72,060 to $34,954. Interest on the line of credit is 3.75%, more than what his cash is earning.
Second, put $20,000 of the $70,000 severance cheque into an RRSP. The remainder will be taxable, leaving about $28,000 as disposable income. That can go to reduction of the line of credit to $6,954. The balance can be repaid with monthly savings in less than two months. Elimination of the line of credit will save $210 a month in interest payments. Remaining savings can accelerate mortgage paydown until Charles retires, reducing amortization from the present 27 years to 21.
Fourth, use funds in the tax-free savings account, $15,234, for contribution to the cost of a small car to replace a beater that has no value. The current return on GICs in the account, 1.55%, is unattractive. Spend the cash, Mr. Moran suggests.
Fifth, restructure RRSP investments to eliminate GICs and boost returns. After inflation at an estimated 3.0% per year, the $31,241 portfolio could generate $937 a year. Money liberated from GICs should be invested in exchange-traded funds with low management fees in a blend of equity and short-term bond portfolios. If present RRSP assets plus $20,000 from his severance are put into RRSPs and grow at 3% a year, the RRSP portfolio would have a value of approximately $69,000 in 10 years.
“Charles has the intellectual tools and the motivation to raise his retirement income,” the planner adds. “The problem will continue to be the balance of his large mortgage, but he can either carry that and service it in retirement or, if he wishes, sell his $175,000 cottage and use the proceeds to cut the debt.”
(C) 2012 The Financial Post, used by Permission