via The Star | September 29, 2013
Alfredo and Theresa are risk-takers recovering from a business failure.
They owed $100,000 when the business failed a few years ago and had to move in with relatives. A well-paying job has since allowed them to take on mortgages to buy a home and a rental property, but they owe nearly 4.5 times their projected $112,068 annual employment income and spend more than they earn.
“Virtually everything is (going to) a monthly payment — for the utilities and other debts — with no room for savings or vacation funds,” frets Alfredo, 47. “Month in, month out, we spend more than we take in.”
Things improved after their business failed and Alfredo found a job with a union wage and pension plan. Having maintained a good credit rating, they were soon able to buy a small home of their own, then a larger home they estimate is worth about $549,000. As home prices rose, they borrowed more to pay half the cost of a rental property in partnership with a relative. They worked to fix it up before renting it out to students this fall, and now hope to buy one or two more properties.
These major decisions were made without independent financial advice. By the time Makeover called on Warren Baldwin and Matthew Ardrey of T.E. Wealth for advice, the couple had little financial wiggle room.
The two Certified Financial Planners have urged Alfredo and Theresa, 44, to track their spending more closely and to start scaling back expenses in order to repay debt, and save for retirement. But they have yet to respond to the suggestion, and appear headed for difficulty. The only way we could balance expenses with income was to cut amounts allocated for a vacation and movies, cut charity gift amounts in half and reduce spending on telephones and hairdressing and meals.
“Until they get their own financial house in order, it would be our recommendation that they do not purchase any additional real estate,” say Baldwin and Ardrey. “They need to focus on paying off their existing debt before exposing themselves to more leverage.”
“Also, by focusing solely on the real estate market, they are placing all of their eggs in one basket. If this market falters or they are unable to get the requisite amount of quality tenants, it will further compound their budgeting situation.”
Alfredo and Theresa hoped to retire at ages 65 and 62 respectively – just 18 years from now. They would like to have the equivalent of $70,000 after taxes to spend each year. To do so, they would need to save much more money to fill gaps in pension income. At this point, the chances of that seem remote.
Alfredo’s pension plan would only pay the equivalent of $37,698 a year, unless he is able to get job promotions to raise his income. He would also receive close to the maximum age-65 pension from the Canada Pension, worth $12,150 in today’s dollars.
Theresa’s $21,693 annual income will earn her less than half the maximum CPP at 65, and even less if she starts to collect the pension at age 62. Neither spouse would collect Old Age Security, worth nearly $6,600 a year, until age 67. They expect about $5,700 in rental income (in current dollars) from the student rental property, after expenses.
All of the pension and rental income would add up to the equivalent of about $72,000 a year – before taxes – but not until five years after they hope to retire. So they would have an income gap before Theresa reaches age 67, and afterward, because Alfredo’s employer pension is not indexed to the rising cost of living.
“To live within their means they would have to reduce their lifestyle spending to $53,064 per year in current year dollars,” about 24 per cent less than their current lifestyle expenses, not including debt repayment and saving, Baldwin and Ardrey estimate.
“To meet their goals of the future, they need to get an understanding of where they are spending their money today,” the planners advise. “When reviewing their expenses, there were several items that did not match or did not seem to be realistic.
“The only way to build for the future is to spend less than you earn.
“They have $37,000 in cash but owe $494,000. Though some of these (savings) funds may be earmarked for renovations on the rental property, there should be enough to pay off the credit card balances of $3,500 at a minimum. The interest rates on credit cards are extremely punitive and they should not carry this type of debt.”
The planners estimate Alfredo would need to save $5,000 a year, and Theresa $3,960 a year, inside of registered retirement savings plans. In addition, they would need to save $5,500 each inside tax-free savings accounts to meet their retirement goals.
“They would not only meet their retirement goal of spending $70,000 but slightly exceed it. They would be able to have maximum annual lifestyle expenses of $71,485 in current year dollars.” The couple had planned to speculate on real estate gains and downsize to an apartment in retirement instead.
The planners urge the couple to consider whether they want to help their children save for post-secondary education. If so, they should start registered educations savings plans to qualify for a 20 per cent government grant.
“Alfredo and Theresa have now come to the crossroads in their life,” warn Baldwin and Ardrey. “They can no longer be blind to how their current lifestyle is impacting their future. They have enough time to make the corrections in their life today that will secure their financial picture for tomorrow.”
Alfredo, 47, Theresa, 44, with two children, ages 13 and 9.
The two-income earners need to rebuild their life after a business failure. He found a well-paying job with a pension, and they have invested in a rental property. But repaying mortgage debt will not be enough to prepare for the retirement they imagine just 18 years from now.
Start tracking spending. Cut back drastically to make room for more savings: $8,960 a year in their two registered retirement savings plans, plus $11,000 in tax-free savings accounts. Use a lending strategy to save on taxes.
Share of rental property $92,000
Bank deposits $16,000
Cars (Not disclosed)
Credit card debt $3,500.
Projected rental income $5,700
Income tax $19,054
CPP & EI $4,458
Union dues $1,038
Home mortgage $19,800
Other debt $1,860
Home operation/taxes $14,165
Other household expenses $6,639
Groceries and restaurants $10,800
Lifestyle expenses $4,520
Gifts and charity $3,200
Dental care $3,300
Life insurance $2,800
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