Family Struggles to Cope After Wife’s Death Slashes Income
Situation: Widower has two kids, half former income, inefficient retirement portfolio
Strategy: Ensure kids have money for university, reduce investment costs, build RRSP
Solution: Money for kids’ school, enough retirement funds to raise standard of living
The life of a Quebec government clerk we’ll call Samuel, 50, has gone from one tragedy to another. The death of his wife two years ago cut the family income in half and left him with two kids to raise and a mortgage he struggles to pay. He gets help from the Quebec Pension Plan in the form of a survivor’s benefit and an orphan’s benefit, but there are large financial challenges ahead. His children, 14 and 18, are headed for post-secondary education and his retirement, perhaps at 65, still needs to be funded.
“My wife received a cancer diagnosis shortly before we were to refinance our house,” Samuel explains. “That meant we could not get mortgage life insurance nor any other way to buy life insurance. Up until three years ago, we were a two income family with twenty years to go on the mortgage. End stage cancer meant disability benefits left us with sharply reduced income. At her death, I received a life insurance settlement equal to annual salary of $42,000. I used it to pay off some debts. But the disability benefit disappeared to be replaced with survivor benefits that are about a fifth of my wife’s monthly take home income. I came close to losing our house.”
Family Finance asked Chris Cooksey, a certified financial planner and chartered investment manager with Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Samuel. The goal — raise investment returns in retirement accounts, plan retirement income, and improve financial security for the family.
The priorities for planning start with educating his children, the first of whom will begin university this fall. He has $4,500 in a savings account that was transferred out of his RESP. It will pay for tuition at $1,800 a year. He will be in a co-op work program and that should furnish funds for his other expenses.
Samuel’s younger child has a $4,500 RESP. Samuel puts in $600 a year. In four years to his 18th birthday, those contributions will be $2,400. Add in the Canada Education Savings Grant of 20% of contributions, another 10% from Quebec and allow 3% growth after inflation and she should have $8,400 when she starts university. That will pay for up to four years of tuition at a Quebec university and, if she continues to live at home and has a part time job and summer jobs, she should be able to finish a four year curriculum with no student debt, Mr. Cooksey says.
Retirement and Cash Management
Samuel’s retirement will be based on a fully indexed defined benefit pension of $8,075 a year. He can add a Quebec Pension Plan benefit worth $12,150 a year in 2013 for total work and QPP benefits of $20,225 a year. At 67, he can receive Old Age Security, currently $6,553 a year.
On top of the work and government pensions, Samuel has RRSPs with a present value of $57,900. He can make a $10,000 contribution this year in the first 60 days. The money is in a savings account. If he can save $3,500 a year and obtain a 3% return after inflation, he can build up $190,700 in his RRSP by aged 67 when he begins to receive OAS benefits. Based on the RRIF withdrawal rate set by government regulations, his annual income would be $8,581. That would bring his total retirement income to about $35,400, 71% of his present pre-tax annual $49,800 income. In retirement, he would have about $2,655 a month to spend after 10% average tax based on personal, age and pension credits.
Samuel can do two things to raise his retirement savings. He can escape from the trap he feels he’s in.
First, increase monthly mortgage payment by 10%. The annual cost would be $759. His present savings, $1,620 a year, would support the cost increase. It would cut 2.7 years off his amortization and save $7,125 of interest, Mr. Cooksey says. The mortgage would be paid off at his age 67.
Second, cut investment costs. Samuel’s $57,900 RRSP portfolio has 11 mutual funds. They are well managed but all have high fees that average 2.5% a year. The fees eat up most of the dividends and bond interest paid by the funds. Switching to exchange traded funds focused on companies that pay dividends without fail and grow them over time would be a good strategy. Just saving 2.25% a year by switching to low fee ETFs with management expense ratios averaging 0.25% could save Samuel an astonishing $1,300 a year, twice the cost of raising mortgage payments by 10%. That is a winning bet. Over 21 years to his age 71, with compounding interest at 3% a year, those savings would compound to $36,400 and support payouts of as much as $2,500 a year from his RRIF at pre-set government rates. That would bring total retirement income to $37,900 before tax or about $2,780 a month after 12% average tax. Without mortgage payments, child care costs and retirement savings, that’s $870 cash liberated from current spending.
“Samuel has had more than his share of tragedy, but with changes in spending and investments, he can see his kids through university and have a retirement with more money than he has now,” Mr. Cooksey says. “He can escape from the trap he feels he’s in.”
(C) 2013 The Financial Post, Used by Permission