In Toronto, a single mom we’ll call Carol, 42, is raising her two children, ages 10 and 13. She nets $3,500 per month after tax from her home-based business to which she adds $1,300 child support for total monthly after-tax income of $4,800. She is able to finance some expenses through the business, but there is not a lot of money left over at the end of the month.
Carol pays $1,200 a month on her mortgage and $220 for property taxes. The mortgage, with a 3.74% rate of interest for four more years, will be paid off in 8.5 years when she is 50.
Carol is making ends meet, but she seeks a degree of freedom that she does not have now. Surplus income that she can save after her kids leave home will go to RRSPs, she suggests. Her biggest concern is that she may not be saving enough for her retirement.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Carol to plan her financial future. “The situation is less dismal than she suspects,” he explains. “Carol has common sense and great discipline. She manages her savings well.”
Carol’s disposable income should rise over time. Her car payment will be eliminated in four years. The child support she receives is customarily payable until each child’s age 19, but could continue through their university years. It is possible that some child support could end in six years when her eldest child is 19 and all could terminate when the younger child begins post-secondary education.
The Pension Plan
If Carol works to age 65, she would be eligible for what might be 80% of maximum Canada Pension Plan benefits, currently $11,210 a year. That would provide $8,968 a year. She will also be eligible for full Old Age Security benefits of $6,222 a year. Both amounts are indexed and taxable. To her current RRSP balance of $80,900, she adds $200 a month plus a $4,000 lump sum from her husband, from whom she is separated. If these numbers continue, with 3% average annual real growth, she will have a balance of $357,300 at her age 65, Mr. Moran estimates.
This RRSP balance will enable Carol to draw $21,093 from age 65 to age 90. If potential savings from eliminating her debts are ignored, then from age 65 to age 90, her total income would be $36,283 per year in retirement.
That will be a respectable but hardly a lavish retirement. A more expansive retirement, perhaps with a few trips each year, will take a lot more money. Currently, she has 14 mutual funds in her RRSP. They have high management fees, but good track records for the most part. However, she has scant bond exposure to stabilize the stock funds. Moreover, the funds are held in erratic amounts — $15,000 in one Canadian stock fund, $17,000 in another Canadian stock fund, $12,000 in yet another and $8,900 in a balanced fund with Canadian stocks. The picture is one of overlap and fee inefficiency. Carol is paying multiple managers to do the same thing.
Reducing Investment Costs
The portfolio should be rebalanced to introduce some government and corporate bonds laddered with terms of two to perhaps seven years. She should be able to get an average of 3% to 5% annual interest from her bond blend with the chance to reinvest principal as the bonds mature. A 40% allocation to bonds would provide stability, cash flow and steady compounding, Mr. Moran notes.
Carol can buy a couple of senior chartered bank bonds, a bond from a regulated public utility and a couple of federal or perhaps provincial bonds and get sufficient diversification, Mr. Moran says. She could get more diversification were she to use a bond mutual fund or a bond exchange-traded fund, but neither alternative reverts to cash as a real bond does at maturity, allowing for spending or reinvestment. Moreover, bonds are far more secure than stocks, for bond interest is a contractual obligation of a company rather than a dividend that is issued at the discretion of a company’s board of directors.
Alternatively, Carol could simplify her portfolio by chucking some of her high-fee stock funds and buying one or two balanced funds with MERs of not much more than 1% and without sales charges. Each of these solutions is simpler and should provide more stable long-run returns. There are many good funds with low MERs and no sales fees. Carol’s investment advisor should be able to direct her to them.
Life and Disability Insurance
Carol needs to revisit her life insurance. At present, she has coverage of $25,000, which is insufficient in the event that she were to die. Her separated husband might take care of the children, but “might” is not good enough. She should increase coverage to $250,000, Mr. Moran suggests. Her present rate of savings, $100 per month, should cover premiums. Were she to quit smoking, savings on cigarettes would easily cover premiums.
Carol has a critical illness policy that costs her $95 a month. Often, people buy critical illness coverage as an inexpensive form of disability insurance. But there is a major difference. Critical illness policies often pay a lump sum for claims. Disability policies pay income replacement to age 65, often with cost-of-living adjustments. She should shop for disability policies with an initial waiting period of perhaps 90 days. That policy would be competitive in price with the policy she now has, Mr. Moran says. In any event, if she were quite ill and unable to work, she would need the cash flow of a disability policy rather than the payoff on a gamble that she would have the kind of disability named in her policy, he adds.
As well, she should have a will drafted that ensures that her estate does not flow to her separated husband — unless she prefers her present arrangement. The new will should also clarify her intentions for bequests to her children, Mr. Moran says.
Carol thus has a good deal of homework to do in order to protect her children and her retirement. She should discuss a restructuring of her investments with her financial advisor. Her goal should be to put shock absorbers under her income and assets with bonds and ultimately with meaningful life insurance.
“Carol’s careful allocation of her extra money will allow her to have a modestly comfortable retirement,” Mr. Moran says. “She will be able to increase her savings after her mortgage and car loan are paid off. Then, after her children leave the nest, her savings rate can increase further. Chances are, in coming years, she can boost savings and achieve a more comfortable retirement. She has the time and the capability to do it.”
Financial Post, Used By Permission