Situation: Heavily indebted couple faces end of disability payments in two years
Solution: Cut expenses, consolidate loans and keep working beyond 65
A couple we’ll call Harry, 63, and Suzy, 60, live in Ontario. They have two kids at home, one with three years to go to finish university, the other in Grade 10. Suzy is an office manager. Harry is very ill and on disability. Their income totals $84,220 per year before tax, but it will soon shrink. $30,000 of that sum is Harry’s corporate disability payments based on serious neurological issues. Payments end when he turns 65 in 2020. A CPP disability payment of $10,800 per year will also end when he moves into a long-term care facility. The kids get $244 each as CPP dependents and that, too, will end in the fall of 2020. The couple rents out an apartment in their basement for $900 per month.
The situation is grim just in terms of declining income, but it gets worse when you consider their balance sheet. They have a $360,000 house with a $240,000 mortgage, two cars worth $20,000 in total against car loans of $23,269, and $15,100 of credit card and credit line loans. They have $51,160 in their RRSPs and must still repay $13,000 taken out as part of Home Buyers Plan loans. Their net worth works out to $139,791.
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Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Harry and Suzy. “What looks like a late start in working life coupled with serious illness makes for a difficult situation,” he explains. “Suzy, who is effectively the head of the family, has hard and urgent decisions to make.”
Understandably, Harry and Suzy are worried. She wonders if she should sell her house. No, Moran says. The direct cost without repairs is just their mortgage at $1,136 per month. They could not rent for much less. Keep the house, he advises. Moreover, and we have to be frank about this, were Harry to pass away before he turns 71, life insurance would provide funds nearly sufficient to pay off her mortgage and add $371 per month in addition to the current payments with no taxes and all utilities covered. If Suzy can eliminate a lot of unnecessary expenses, especially debt service costs outside of the mortgage, she could live in the house in retirement with a fair amount of financial security, Moran notes.
Debt management is not a distant need. It is here and pressing. The couple’s income is stressed by the high cost of feeding two teenagers. One of their two cars has to go. They spend $1,400 per month on groceries, $200 a month for cell phones, $500 for entertainment, $494 for two car loans, $250 for car repairs and gas and $370 monthly insurance for two cars and their home. It’s a huge outlay considering the income which supports these bills. There must be cuts, Moran says. If one car is sold for perhaps $10,000, the cash could pay off one car loan. That would eliminate about $250 of monthly car loan costs, $185 of insurance costs and another and $100 in fuel and repairs. Total savings would be $535 per month.
The kids can have jobs and pay for their own phones, saving $100 a month, $400 of entertainment should be ended and $500 could be saved on food. That’s a potential $1,535 of cuts each month. There are no education savings. The kids will need jobs or scholarships for post-secondary education.
The balance sheet
Next, consolidate loans. They owe $15,100 on credit cards and on an unsecured line of credit. If they can get a secured line of credit through their bank, they could save $300 dollars in monthly interest. That would bring total monthly savings to $1,835 and spending to $3,883 per month.
In retirement, the couple will have most of its security tied to Harry’s life insurance policies. If he dies before 71, his corporate disability policy will pay $220,000, which is almost enough to pay off the mortgage. However, one policy for $100,000 expires at age 71.
Suzy has $51,160 in her RRSP. If it grows at 3 per cent over inflation for the next five years to her age 65 with no further contributions, it will become $59,310 and, if spent over the next 25 years, it would generate taxable income of $3,350 per year.
If Harry dies, CPP will pay 60 per cent of his disability and Suzy’s CPP to a maximum of $13,600 per year. The exact amount will depend on when he passes away. There are several variables, so we’ll discount the maximum and estimate that she will have $9,000 from CPP at 60. Her Old Age Security at age 65 based on years resident in Canada after age 18 would be about $6,000 per year, and RRSP payments starting, as noted, at 65 would add up to $3,350. Harry would get $7,210 per year from OAS at current rates. There would be $10,800 annual rent from the basement apartment. Total income — $36,360 per year before tax while Harry is alive.
Suzy’s income would be too high for the Guaranteed Income Supplement. The threshold is $18,096 in 2018, but she might get GST rebates. If eligible income is split, family disposable income based on pension, disability and age credits and no tax would be $3,030 per month. Suzy would have to supplement it in order to support monthly expenses that would be about $3,883 with the kids gone and many personal expenses reduced. Her early start to taking CPP at 60 means a 36 per cent cut in her benefits for the rest of her life. She would need to work a few years part time to close the $853 monthly gap.
The largest expense will be the mortgage. Suzy will be 85 when it is paid off. They could try to refinance or borrow against their home equity, but anything more than a secured line of credit to consolidate other loans would be unwise.
Still, if Suzy can cut costs and work into her early 70s, she should be able to stay in her house and live much as she does now. The sooner costs can be cut, the more secure she will be. “The initiative is hers,” Moran says.