Staring Down Retirement, Spendthrift Deep in Debt

staring-down-debt

Andrew Allentuck

In Vancouver, a woman we'll call Suzette, 58, has put 37 years into her job and wants to retire in a few months, then return to work part-time. She will have to work to supplement her pension, for her financial cupboard is almost bare. Her assets are $2,500 in an RRSP. Period. She lives on credit. She rents a home from her ex-husband for $900 a month, which is 18% of her $4,983 monthly take-home income.

Her plan, which she would put into place when she turns 59 in March, would boost her monthly pension income with $3,500 part-time income and, after deductions and taxes, give her about $7,000 of after tax income each month.

Tied Up with Debt

She would like to buy a condo one day and to have extensive dental work done that would have a $40,000 price tag. A good friend might advance the funds for the dentistry, most of which is not covered by her employment dental plan, but only on condition that she make prompt repayment. That's not necessarily easy, for she has $15,000 due on a Visa card with a 19% interest rate, $1,000 due on store plastic that bears a 20% interest rate, as well as an $18,000 car loan with a 1.6% interest rate. Each month she spends $700 on miscellaneous things she can't quite pin down.

"I have been a poor money manager in the past and have spent above my income and acquired a lot of consumer debt," Suzette says. "I have learned that the more I make, the more I spend. I am embarrassed to see how poorly I have prepared for my pending retirement."

Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Suzette. His view is optimistic. "She is a nice lady. If she can face her demons and work through them, there is little or no risk in her retirement even though she has almost no savings. The sum of her indexed pension income, Old Age Security and Canada Pension Plan benefits and pay for part-time work will be ample for a mortgage on a modest condo, taxes and fees. Her only challenge could be higher mortgage interest rates and her urge to splurge."

The Five-Year Plan

Year 1 (2011) Retire in March and start drawing a pension of $4,387 a month. Return to work and double dip, adding $3,500 a month and boost income to $7,000 after tax. Shift loans to a low-interest credit card and pay them off at $2,000 a month from enhanced income. Her $16,000 of loans other than her car loan should be paid off by the end of the year. The low-interest car loan with three years remaining can be paid on schedule.

Year 2 (2012) Deal with the dental work. Her employment dental plan will not cover the amount of work to be done. The $40,000 estimated bill could be cut drastically if Suzette goes to Mexico or Germany. If the work can be done for half the Canadian bill in another country, she could get a nice vacation out of the arrangement. If Suzette chooses to have the dental work done in Canada, her remaining debt would rise to $58,000. She could pay that off in about four years at $1,250 a month that could cover principal and interest at 6% a year. She can find $1,250, for she already pays $911 for her credit cards and car payments. The balance could be found in her $700 a month of unaccounted-for spending, Mr. Moran says. If she raises her payments to $2,000 a month, which will be possible with part-time work, she would be free of debt in two years and five months. "She will have to look hard to find a low-interest unsecured loan, but she should be able to do it," Mr. Moran says. Once she is debt-free, she can direct $2,000 a month to her RRSP and build a $25,000 down payment for a condo in 13 months. She can use that sum for the Home Buyer's Plan to make a down payment that would have to be repaid over 15 years or be taken into income at a rate of $1,667 a year, which is the more likely choice.

Year 3 (2013) Suzette will turn 60 early in the year. She can start Canada Pension Plan benefits, but the penalty, which is being phased in over several years, will have risen from 0.5% a month of the age 65 monthly benefit to 0.6% a month of the benefit or to 36% of the age 65 CPP benefit. She should not start benefits unless she is in a cash crunch, the planner warns.

Year 4 (2014) With debts paid and teeth fixed, Suzette can start searching for a condo. She may need to use a high-ratio mortgage, but a home purchase is now in sight. She has a down payment in hand. The $960 a month she pays in rent will cover most of a five-year, $175,000 closed mortgage at about 4.2% interest with a 20-year amortization that costs $1,075 a month for principal and interest payments She can find money for taxes and condo fees in the $513 a month liberated from terminated car payments.

Year 5 (2015) Suzette's $960 pension bridge to age 65 will end in early 2016, but CPP in a similar amount will replace it. She will be able to add Old Age Security of $524 a month. That will push her total income up to $8,411 a month, or $100,932 a year before tax and potential $4,000 clawback, all in 2011 dollars. If she stops working, the OAS clawback would disappear but her income loss would need to be compensated by severe spending cuts.

The Long Term

Having lived on her own for many years, Suzette has been accountable to no one for her spending. She feels that saving is useless and that living for today is the best she can do. That mindset has led her to spend for reasons that are as emotional as they are functional.

Being broke is fixable, but the mindset is much more durable — her intellect and discipline will be key tools. Now and in future, Suzette has to differentiate between needs, which are rent, food, car payments, utilities and a few creature comforts, and wants, like visits to clothing boutiques or lavish travel.

"She loves to shop, but that must stop, for it's addictive. A substitute for shopping might be physical activities or amateur theatre. Whatever works," Mr. Moran says.

"Suzette is very intelligent, but she has not acted intelligently in her own finances," Mr. Moran says. "She can have a six-figure income when she is 65 if she continues to work part-time. That's more money than she has ever had. She has a long rope. She can easily hang herself by spending potential savings or use the rope to pull herself out of debt. Paying off bills and getting money for the condo is not going to be hard if Suzette reins in her love of shopping and becomes a disciplined saver."

(C) 2011 The Financial Post, Used by Permission