Their Situation
Frank and Susan were theoretically in a good position when I met them. Both had corporate jobs that were secure, and Frank had a defined pension plan and benefits to go along with them. Their kids were grown and out of the home, though still requiring financial aid here and there. They had a home, investments and RRSPs as assets, but remaining debt on the mortgage and a car loan.
Overall, they owed about $127,000 on their mortgage and $21,000 on their car.
They had $46,000 in savings earning some interest and over $200,000 in registered funds and the home was worth $540,000.
Frank and Susan had, however, lived a bit beyond their means and were not as ideally poised for retirement as they could have been considering their combined income. So, with a lot of anxiety developing, they sought help in making the most of their position.
First Steps to Recovery
The saving grace for Frank and Susan was their combined defined pension plans. While they did not have a sufficient amount of equity or savings on their own, the additional income of Frank’s pension put them in a situation where they could position themselves for a comfortable retirement.
To put things in context, the corporate pension combined with their government pensions meant that they could expect around $5,840 a month net after retirement based on their current salaries, the corporate pension and their government pensions.
So, their retirement income was going to be appreciable, and there would be room to move. This means that getting their situation in order for retirement would start with debt management, given the debt they were still carrying was their primary source of anxiety. So the question was, how to get rid of it?
As mentioned, they had 2 long term debts, the mortgage and the car to the tune of $148,000.00. They were also sitting on cash savings of $46,000.00. The first strategy we employed was to use and take advantage of their high marginal tax rate to pay down debt.
Considering they had unused RRSP room, they contributed their savings into an RRSP and used the tax refund to eliminate the car loan all together, and then started focusing on the mortgage.
They now had an improved cashflow to help rebuild savings and apply to the rest to the mortgage, which left them with a mortgage debt of $127,000.00 going forward into retirement.
Refining the approach
We discussed two different aggressive approaches they could take towards the mortgage, because freeing themselves from debt as soon as possible would directly impact their standard of living in retirement.
To put it in context, their pre-debt management monthly expense for their preferred lifestyle was around $7,593 a month all-in. After the elimination of the debt, their monthly expenses would fall to $5,693.
So, how to take care of that mortgage quickly with little time left to go?
They had a traditional mortgage, which creates a complication where early repayments were limited to a maximum of 10% and even carried punitive penalty clauses. This is typical as some lending institutions, not wanting their interest income to evaporate, have high penalties that can compromise and limit planning. To get around this, we needed to think outside of the box.
The first option we discussed was to immediately use the monthly car savings by increasing the mortgage payments (2.89% interest) and opt for bi-weekly interval. This helped us increase our payments and tackle the debt faster. This approach would reduce their 10 year amortization to 6.
An alternative strategy we discussed was to invest the freed-up cashflow into additional RRSP’s and use the tax savings to pay down their mortgage- in 6 years they would have built an RRSP portfolio worth over $88,000 and a mortgage with a balance of $49,000. The RRSP’s could then be used to pay down the remaining mortgage over a few years and improve their future cashflow.
They now budget $6,000 yearly vacations, and have multiple sources of income to choose maintain their lifestyle.
Retirement is good.