Up in Smoke: A Marriage, a Job and a Business
Situation: Fire devastated family business and home of divorced woman
Strategy: Get insurance settlement and a job, invest for retirement
Solution: Retirement income two-thirds more than pre-fire salary
Trouble, it is said, comes in threes. The case of a woman we’ll call Judy, 50, appears to prove the rule. Recently divorced, she found her home destroyed by fire and her source of income terminated.
Judy owned, lived in and ran a ski lodge in Alberta until it was burned to the ground in an electrical fire in late 2010.
A seasonal operation with 15 rooms, it barely broke even after paying Judy a $48,000 annual pre-tax salary. She had insurance, of course, but it was a low-cost package that did not cover loss of business or provide for full replacement cost of the lodge.
So instead of paying out potentially millions it would take to rebuild at today’s prices, she will be left with an insurance settlement of $400,000 and the lot where the lodge used to be, which is worth about $75,000.
Investing everything scares the heck out of me. I need a plan but don’t know where to start. I am still frightened by what happened and I have planning paralysis
There is no money to rebuild the lodge. Judy has moved to a rental apartment in Vancouver and is looking for a new job. There won’t be any payment for loss of business, which was a break-even operation to begin with.
So far she has received $200,000, which she is using to supplement the $1,212 she gets every month from employment insurance. In the expensive Vancouver housing market, her settlement may not even be enough to buy her a new home.
With twin sons in university and her own retirement to consider, she is nervous.
“What do I do now?” Judy asks. “I could buy another home, but that is impossible in Vancouver. Investing everything scares the heck out of me. I need a plan but don’t know where to start. I am still frightened by what happened and I have planning paralysis.”
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Judy. In his view, she can solve her problems if she can get a new job, perhaps in hotel management, and make sensible investments. It will take a series of steps, he says.
Mr. Moran suggests a couple of first steps: Put $10,000 of her $175,670 cash — what’s left after paying some of her transitional living costs and replacing clothing and other goods — into her tax-free savings account.
Second, pay off a $5,000 line of credit with a 7.5% interest rate.
Third, sell a $40,000 building lot to her ex-husband via a vendor-take-back mortgage. If he misses a payment, she gets the lot back. The deal is not without risk, for if the market price of the lot were to drop and he missed payments, she would be left with an asset of reduced value.
A sale is pending of the $75,000 lot where the lodge once stood.
Judy can make several economies. She allocates $450 a month to her sons’ educations on top of income from their $38,000 trust accounts. Yet each son can make $225 a month with part-time work. Her $650-a-month spending for clothing covers replacement of her wardrobe, which was lost in the fire. It will be reduced over time.
Judy can apply the skills she used in many years of ski lodge management to running a conventional hotel or another lodge. She expects to replicate the $48,000 annual salary when, soon, she expects to have full-time work.
She can eliminate $200 a month for the cost of her line of credit, $450 for university costs, $253 for property taxes on the lots, $650 for clothing expenses, and $350 a month for keeping her horse (due to be sold).
Remaining expenses, including a normalized budget of $200 a month for clothing and grooming, would add up to $3,535 a month. If her retirement income after tax can produce that amount, her retirement would be adequately financed and, with a bit of financial engineering, some capital would be preserved for her sons to inherit.
If she invests in high-quality corporate bonds or dividend-paying stocks that generate a conservative return of 2% after inflation and income taxes, her assets of $527,670 (including her insurance settlement) would grow to $739,000 in 17 years when, at 67, her Old Age Security begins. In retirement, that capital could generate 3% or $22,170 after average 10% income tax. All figures are in 2012 dollars.
If Judy is prepared to exhaust her capital in 25 years to age 90, her financial assets could generate $47,000 a year to age 90, Mr. Moran estimates. Judy is on track to earn full Canada Pension Plan benefits at 65 of $11,840 a year. She will also receive $6,540 in Old Age Security at age 67. Her gross income at age 67, assuming capital exhaustion by age 90, would total $65,380. or $4,900 a month, after 10% income tax.
If Judy gets a job and is able to save $10,000 a year out of salary and investment income until she is 67 and her OAS begins, she could grow $204,000 additional capital by 65. In retirement, that money could generate $6,120 a year at 3% before tax. If this capital is not exhausted, it could be a legacy for her children. In this case, Judy’s total pre-tax annual income would rise to nearly $71,500 a year, or $5,363 a month, after 10% tax.
In spite of the fire and its destruction of her way of life, her after-tax retirement income in 2012 dollars would be 1.7 times more than her annual salary before the blaze. She could easily cover expenses less the cost of stabling and feeding her horse, which is due to be sold, debt service and university expenses for her sons.
There are a lot of ifs in these projections, Mr. Moran admits. Judy should be able to get a job in hotel management. The final insurance settlement of $200,000 is probable, but at the moment, the money is just a contingent asset.
She could also choose to use some of the insurance money for a down payment on another house where she finds permanent work. In that case, her $1,400 monthly rent payments could be spent on mortgage payments. Utilities and upkeep would add to that, but it’s her future choice.
Nevertheless, Judy is, as Mr. Moran says, by nature a saver. “If she can invest wisely and work to cover living expenses and to provide a margin for saving, she should be able to have a comfortable retirement,” he says.
(C) 2012 The Financial Post, Used by Permission