Nadine is a 57-year-old divorced woman who was let go from her longtime job as a customer service manager. After her severance ended, she worked part-time to supplement her pension income. She’s no longer employed but is actively applying for other positions.
In the meantime, she’s living on $47,000 a year from her defined benefit pension plan, and withdraws another $1,900 a year from her investments. But this plan is not a solid long-term solution. She needs $6,000 a year more than her budget allows. She could continue to take more money from her investments but with just $172,000 in her Registered Retirement Savings Plan, that income stream would run out sometime in her seventies. Her investments are made up of Guaranteed Investment Certificates.
Her biggest concern, however, is her home valued at $750,000. She still has a $340,000 mortgage after buying out her ex-husband’s share of the house. She’d like to remain in her home for another three years until her two kids finish university.
“My mortgage will come up in less than two years and I am worried that I will not be able to renegotiate it with my current income,” Nadine says.
The Star asked Robyn Thompson, president and financial planner of Castlemark Wealth Management in Toronto, to work with Nadine.
There’s no way around it: Nadine will be in a cash crunch for the next three years until she downsizes her home and qualifies for Canada Pension Plan at age 60, Thompson says. So part of the solution is to do what she is doing: dipping into her savings or applying for part-time work.
But she could also work on her investment strategy so her investments earn a higher return. Nadine is a conservative investor, which is why her investments are solely in GICs. Their rate of return hovers just over two-per cent.But after factoring in inflation and taxes, that rate of return could be reduced to nothing, Thompson says.
Thompson suggests Nadine consider investments that will produce returns that at least match the rate of inflation, and preferably a little more. To do this, Nadine should consider revising her risk-tolerance level, to help offset the damage that inflation can do.
Thompson also notes that Nadine’s defined benefit pension plan is not indexed to inflation. That means her income will remain consistent while her expenses continue to grow. “Then her purchasing power will shrink,” she says.
If Nadine was willing to revise her risk tolerance and reallocate a portion of her RRSP and LIRA investments into a one- to three-year bond ladder (that is, bonds with staggered maturity dates), investing only in AAA-rated bonds corporate and government bonds with the highest quality and lowest credit risk, she could lock in a coupon rate of up to five per cent. That’s double what her GICs are paying.
Bond prices do fall as interest rates rise, but the coupon rate will remain the same. Thompson notes that bonds also have a principal guarantee, and bondholders are paid first in the case of default.
Nadine’s mortgage is up for renewal in 2016, and if possible, she should aim to sell her home and discharge the mortgage before the new term to avoid penalties. If she wants to stay in her home longer, Nadine should make sure she is getting the best rate and ensure there are no surprises at renewal time. Thompson recommends speaking to her current lender now, and to a mortgage broker for comparison purposes.
Assuming Nadine gets market price for her home, she will be left with $375,000 after paying real estate fees, land transfer taxes and other moving costs.
With this money, she could purchase a smaller home or condo outright in Greater Toronto for $300,000, leaving her debt free. And here’s the treat: with no mortgage, her annual expenses will drop to $27,300. Since she receives $47,000 a year from her pension, she’ll have surplus of nearly $20,000. Thompson recommends she top up her Tax-Free Savings Account to start.
Nadine’s income will further increase when she receives CPP at age 60 and then Old Age Security at age 65. The amount of her government pension will depend on how much and for how long she has contributed to the CPP and her age when she starts her pension. Nadine can request a statement of contributions from the government that will provide an estimate of her entitled benefit, Thompson says.
The client: Nadine, 57
The problem: She’s on a reduced income and withdrawing from investments to pay all her expenses. Can she afford to stay in her family home for a few more years?
The advice: Tweak portfolio to eliminate inflation risk. Downsize the family home as soon as possible and use any proceeds to add to investments.