When You're Spending More Than You're Earning

ANDREW ALLENTUCK

In Toronto, a couple we'll call Walter and Brenda, both 44, feel they are in a bind.
Walter, a scientist, and Brenda, who works in media, have substantial intellectual accomplishments, but not the income to show for their many years of study. Their total income last year was $121,000. In Toronto, one of Canada's most expensive cities, it's not a lot for paying off a mortgage and raising two kids, ages 13 and 11.

“We feel it is hard to get ahead, as is symbolized by our line of credit,” Brenda explains. “We pay off $100 with each paycheque, then some big expense comes along and sets us back again. How do we stop living from one paycheque to another?”

What our expert says

Facelift asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Walter and Brenda.

“They are spending more per month than they earn,” he says. “This situation is about debt management.”
The couple's largest source of expense is a $213,000 mortgage, which comes up for renewal in a few months. They pay $1,465 a month, based on a 5.2-per-cent interest rate, but they should be able to renew at a lower rate, Mr. Moran says.

Using a recent 4.4-per-cent rate for a five-year closed mortgage, they could keep their payments at $1,465 a month and reduce their amortization from 19 years to 16.5 years or keep the amortization constant and have payments reduced by about $100 a month. They could add the $100 to their $415 car payments and eliminate that debt two months sooner, the planner notes.

Alternatively, they could choose to go to a floating-rate mortgage at a little under 4 per cent at recent rates. That would drop their mortgage payment by $160 a month or, if they do not change the amount paid per month, it would cut amortization to 16 years. Five-year floating rates tend to come with exit penalties, though some plans allow borrowers to lock in rates. Rather than try to predict interest rate changes and risk being dragged up to rates higher than today's historic lows, it could be best to lock in today's deals, Mr. Moran concludes.

Walter and Brenda need a new car to replace a rusty 1993 compact they bought for a dollar that has turned out to be costly to maintain. Replacement is on order. In 11 months, the loan on their newer car will be paid off, so they can spend perhaps $10,000 on a good used model.
Assuming repair costs on the replacement car will be minimal, recent repair bills that on an annualized basis have recently soared to $700 a month could be added to the new car payment. That would pay off the new ride in as little as a year. They will have two reliable cars fully paid. In little more than 2 1/2 years, they can pay off their line of credit.

Walter and Brenda put $525 a month into registered retirement savings plans that total $113,000. If at age 49, they increase them by $1,000 a month, then assuming a 3-per-cent real rate of return on investments, they will have $432,260 in 2009 dollars at age 60.
With the same assumptions, this capital would support retirement income of $22,050 a year ending at their age 90. Saving and retiring five years later would allow them to build up $598,270 of total capital. That sum would generate income of $34,360, the planner estimates

They have $5,500 in their registered education savings plans and contribute $140 a month. RRSP refunds from their increased contributions will average 35 per cent or $4,200 a year. If the couple can use this money to raise RESP contributions to $350 a month, they will be able to get a 20-per-cent boost from the Canada Education Savings Grant – $840 a year. That will mean that by time the 13-year-old is ready for university, they will have $17,648 in their family plan. By the time the 11-year-old is ready for university, there will be $28,954 in the plan, less any withdrawals for the elder child. Assuming the parents equalize what the kids get, they could provide $14,000 a child.

Retirement at age 60 is not a viable option for the couple. Old Age Security (OAS), which currently pays $6,204 per year, does not begin until age 65. They could take Canada Pension Plan (CPP) benefits at age 60, but only with a penalty of 30 per cent of what they would get at age 65.
At age 65, using 2009 payment rates, they will qualify for full OAS benefits for a total for the couple of $12,408 and estimated CPP payments of $10,153 for Walter and $8,702 for Brenda.

Adding $34,360 from their RRSPs, they would start their retirements with total income of $65,623 or $5,469 a month before tax. They will have paid off their mortgage. Their kids will have left home. They will no longer be paying CPP premiums, commuting costs and other employment expenses that total about $3,000 a month. Their disposable incomes will have increased and they will be able to maintain their way of life.

“The variable in this story is the rate of savings that Walter and Brenda can maintain,” Mr. Moran says. “But given their awareness of the issues and their skills, they can be comfortable in retirement.”

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