Retirement Held Hostage by Devastating Investments and Six-figure Debt
In Alberta, a woman we’ll call Rebecca, 68, stumbled into two disastrous investments several years ago. The deals, one a local real estate play, the other a mining venture in Central America, wiped out all of her savings and left her deep in debt. She still has pension income from her former work as a civil servant and she generates $37,185 annual income as a personnel management consultant. Her monthly income after tax is $5,557, yet she owes $120,000 to her bank for money she borrowed: $40,000 for house renovations and the two large, catastrophically unsuccessful investments that cost her $100,000 — $20,000 she took from her RRSP and $80,000 that she borrowed. Her retirement is now hostage to her debt.
The motive was to catch up, to fill RRSP space when she realized that her job pension, Canada Pension Plan and Old Age Security would not be enough to maintain her pre-retirement way of life. For decades she had ignored the opportunity to build RRSP savings and she never opened a Tax-Free Savings Account. So she bought into two highly speculative ventures with no research and no guidance. She was promised big returns to pad out her retirement, but she wound up with a financial disaster.
How does a career civil servant tumble into such misfortune? Rebecca had only saved $20,000 in her RRSP at the age of 65. She believed that she had no worries since she had a pension of $33,050, CPP and OAS would add a total of $15,346. The total, $48,396 before tax, was just half her working salary. It would not maintain her customary lifestyle. That set the stage for her two investments, both of which were utter failures. The first, a real estate development that should have produced a hefty return flopped but might — who knows — one day pay something. The other, a mining venture whose promoters were subsequently prosecuted for fraud, left her $80,000 in debt and cost her the $20,000 she had as the total of her RRSP.
Rebecca continues to work to produce enough income to make up for at least some of her investment losses and to pay those debts. But she cannot afford a car to replace her aging 2005 model nor many of the pleasures others take for granted. Now her modest savings, $4,000, is all that she has to bolster her pensions.
Her situation is neglect turned to tragedy, a result of failure to save regularly, failure to diversify investments, then collapse of the two investments into which she put virtually all of her savings. It is an investment problem, for it was not carefree spending that put her in financial jeopardy. And now she despairs her home is at stake.
“Once I stop work, I will not be able to continue to live in my home,” Rebecca says. “House and yard expenses and work are becoming more difficult. There is not much enjoyment in any of it.”
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Rebecca. “She lost all of her financial assets, but with a debt repayment or reduction plan, diversion of some savings to a car replacement account and avoidance of her former investment mistakes, she can have a secure retirement,” he explains.
The interest costs for financing the RRSP investments on her lines of credit are not tax deductible, Mr. Moran notes, and a net worth of $257,400 is low for a person of 68.
The Recovery Plan
Rebecca’s situation can be repaired by trading down to a less costly home and using liberated equity to pay off her debts, capturing available savings while working to buy a car to replace her nearly decade old model, and adopting rules — invest only in what you understand, get independent advice if you don’t and always diversify, the planner says.
The first issue is debt management. Rebecca’s monthly allocations including interest on her lines of credit and workrelated costs are $4,700. She saves $867 a month. If she works another five years and directs those savings to her line of credit each month, she can pay down about $52,000 of principal on the loans. She would still have $68,000 outstanding debt. She might harvest another $400 a month by cutting entertainment, travel and her miscellaneous spending, but even with a $1,267 monthly paydown, she would cut only about $76,000 out of her debt and still have $44,000 outstanding. A plan to work more years to pay down loans has another snag. Interest rates are likely to rise and make carrying the loans more expensive. That in turn would lengthen the payoff period. If she directs all savings and money from reduced spending to the loans, she would still have debt and no new car.
A better move would be to sell her $373,000 house and buy a condo for perhaps $120,000 less, which is feasible in her neighbourhood. In this case, she can work by choice rather than necessity. The cash she would get after selling costs could pay off most of the $120,000 she owes on lines of credit. If she moves to a condo, she will have to pay monthly charges, but some of those costs will just replace her present utility bills, currently $338 a month.
The Years Ahead
As long as she continues to work, Rebecca will have employment pension income of $33,050 a year, Canada Pension Plan benefits of $8,641 a year, $6,705 annual Old Age Security benefits, and $37,185 net consulting income. The total, $85,581 a year, will leave her with about $66,750 a year after average 22% income tax including a $2,100 loss to the OAS clawback of 15% of net income over $71,592. That’s about $5,560 a month after these taxes. Her expenses would be covered. Moreover, if she makes her move to a condo soon, she can use growing savings, for now too modest to pay off the lines of credit, to buy a new or newer car. Savings can be held in a TFSA for a few years until she is ready to buy the car, the planner suggests.
Rebecca’s pension-supported retirement income is secure. When the consulting business ends, as she plans, in five years, her gross income in 2014 dollars will decline to about $48,400 before tax. After 14% average tax, she would have about $3,500 to spend each month. That would support her present budget net of savings, work related expenses and perhaps $200 of miscellaneous expenses. The condo, which would be her largest asset, could be left to her single child, now 49, who has children of his own. Divorced for many years, she has no other dependents.
“Rebecca’s made the mistakes of not diversifying nor understanding the investments. She could not sell her real estate units and trading was suspended when the mining company was prosecuted. It doesn’t get much worse than that. But she has solid pension income from her former job, OAS and CPP. That income will exceed her expenses. Provided she pays off her debts, her way of life will be unimpaired.”
(C) 2014 The Financial Post, Used by Permission