FINANCIAL FACELIFT: Home upgrade could saddle couple with too much debt to easily meet retirement dreams

Below you will find a real life case study of a couple who are looking for financial advice on how best to arrange their financial affairs. Their names and details have been changed to protect their identity. The Globe and Mail often seeks the advice of our VP, Wealth Advisor, Matthew Ardrey, to review and analyze the situation and then provide his solutions to the participants.

Written by: DIANNE MALEY
Special to The Globe and Mail
Published August 3, 2018

Roy and Leah are in their early 40s with three young children, a mortgage to pay off and a house in Toronto that is too small for a family of five. They want to add another storey at an estimated cost of $250,000.

Roy earns a healthy income in his information technology job, while Leah is working part-time. Together, they bring in about $166,000 a year. Their goal is to keep this work arrangement for as long as possible, Roy writes in an e-mail.

“Can we afford to do the house renovation with Leah still part-time?” Roy asks. The plan is for her to supervise the house renovation starting in the spring of 2019 and go back to work full-time in 2020. They’d have to borrow to finance the renovation.

They wonder what effect the additional debt will have on their retirement plans. “When can we comfortably retire?” Roy asks. He’s planning to work to the age of 65, although he’d naturally like to retire earlier. She plans to retire at the age of 60. They both have company pensions – his a defined contribution, hers a defined benefit.

We asked Matthew Ardrey, a vice-president and financial planner at TriDelta Financial in Toronto, to look at the couple’s situation.

What the expert says

Roy and Leah are facing the conundrum that many others in their position face, Mr. Ardrey says: balancing off life today with their retirement dreams of tomorrow.

“They want to find a way where Leah can remain working part-time, complete the $250,000 renovation to add a second floor to their house and still save enough for retirement.” There is little room in their budget for the added expense of carrying new debt, the planner says. That assumes the loan is amortized over 25 years at a cost of $14,000 a year, tilting them into a cash-flow deficit.

“If they could find a way to reduce their spending by $10,000 a year, both the renovation and the part-time work can co-exist,” Mr. Ardrey says. This seems unlikely. Instead, he looked at a more feasible option in which they delay the renovation until 2023 after Leah has returned to work full-time. “Or they could do the renovation now and Leah could return to full-time work now.”

In both scenarios, Mr. Ardrey included $2,500 a year for each child for education savings, a contribution of 6 per cent of salary to a defined contribution pension plan for Roy with a matching contribution from his employer and a top-up to his group registered retirement savings plan at work of $2,940 a year. Leah retires at the age of 60, as planned, with a pension of $59,725 and a bridge benefit of $7,642 from the age of 60 to 65, indexed to inflation. The planner assumes they will begin collecting full Canada Pension Plan and Old Age Security benefits at the age of 65.

In Scenario 1, where the renovation starts in 2023, they will have taken on substantial new debt, so their focus will be on paying it back, Mr. Ardrey says. “Being debt-free is a cornerstone to financial independence.”

All surplus will be directed toward debt, except for a pause between 2030 and 2032, when they will stop making additional mortgage payments and instead focus on their children’s postsecondary education costs because the registered education savings plan funds will be running out. That assumes education costs of $20,000 a year for each child, rising at 4 per cent a year or double the rate of inflation.

Lump-sum additional mortgage payments continue in 2033 until the debt is paid off in 2038. Roy retires the following year at the age of 65 and the cash flow surplus from that one year of $37,000 is saved in his tax-free savings account.

Their retirement expenses are $84,000 a year after tax in current dollars, plus $10,000 for travel to the age of 80. If they wanted to spend all their savings, leaving only their house, they could increase their retirement spending by $9,600 a year, rising with inflation, Mr. Ardrey says.

In Scenario 2, where Leah returns to work now, the focus would again be on debt repayment. By the time their children are in university, the mortgage will be lower so they will be able to make reduced lump-sum payments while they catch up with the education expenses.

“Paying down the debt earlier has a positive effect on Leah and Roy’s cash flow,” Mr. Ardrey says. They are debt-free by 2034, ahead of target. Roy can retire three years earlier than planned at the age of 62. Between 2034 and 2036, they use their surplus cash flow of $21,000 each to contribute to their TFSAs. They meet their retirement goal. If they wanted to leave only real estate behind, they could increase their spending by $6,000 a year. Although that is less than Scenario 1, Roy does retire three years earlier.

“Unfortunately, there are no magic bullets in retirement planning,” Mr. Ardrey says. “It usually comes down to working longer, saving more, spending less or investing better.”

Client situation

The People: Roy and Leah, both 43, and their three children, ages 7, 9 and 11.

The Problem: Can they afford to add a second storey to their house with Leah continuing to work part-time for a few more years?

The Plan: Either postpone the renovation until after Leah is back full time, or do it now and have her return to work immediately.

The Payoff: They avoid overextending themselves financially and having it affect their retirement plans.

Monthly net income: $10,610.

Assets: Cash in bank $1,000; his RRSP $58,735; his employer pension plan $182,600; estimated present value of her DB pension $208,890; RESP $111,815; residence $800,000. Total: $1.4-million

Monthly outlays: Mortgage $1,410; property tax $350; home insurance $85; utilities $285; maintenance $280; transportation $625; groceries $2,055; child care $400; clothing $200; line of credit $10; gifts, charity $350; vacation, travel $345; other discretionary $1,000; dining, drinks, entertainment $660; sports, hobbies $275; subscriptions, other $40; prescriptions $25; life insurance $140; phones, TV, internet $255; RRSP $115; RESP $625; pension plan contributions $1,040; professional association, group benefits $127. Total: $10,697.

Liabilities: $317,180; line of credit $4,000. Total: $321,180.

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