Facelift for April 9, 2011.Geoff Robins for The Globe and MailGeoff Robins for The Globe and Mail/The Globe and Mail
When illness struck, Greg and Melissa were unprepared financially, which made a frightening situation worse. You can sense the fear in Greg's e-mail.
"My wife was recently diagnosed with breast cancer," he writes. "She will be off work for the next eight months as she undergoes chemo and radiation. Nothing is more important than her getting better for either me or our children."
Greg is 46, Melissa 50. They have been married for 25 years and have two children, aged 16 and 19. He works in administration, she in sales.
Melissa will collect employment insurance for four months until her long-term disability insurance kicks in, which means a sudden drop in the family's income. Once her LTD insurance begins, it will pay about 91 per cent of her after-tax earnings.
"We unfortunately have not socked away money for a rainy day," Greg writes. But they have been making substantial extra payments to their mortgage on their home in Kitchener, Ont. Greg wonders whether they should stop these payments when the mortgage comes up for renewal in three months, what else they can cut and whether they should draw on their line of credit to cover the income shortfall.
Looking ahead to when Melissa has recovered, they wonder how they can arrange their financial affairs better so that they can build some savings and pay off their debts more quickly.
We asked Lynne Triffon, registered financial planner and vice-president of T.E. Wealth in Vancouver, to look at Melissa and Greg's situation.
What the expert says
The first four months, when Melissa is collecting employment insurance, will be the worst financially, Ms. Triffon notes. The shortfall will be $1,078 a month.
Once Melissa's LTD insurance kicks in, she will net $2,620 a month, compared with her current take-home pay of $2,866 - a shortfall of only $246 a month. Her disability benefits are tax-free because she pays her own premiums. So the total shortfall over the eight months she is expected to be off work will be $5,296.
Greg and Melissa should stop making the extra mortgage payments of $700 a month immediately, the planner says. This will save them $2,100 from April to June, the remaining term of the mortgage. They also have a line of credit - used to buy a car, renovate and take a vacation - against which they are paying $200 a month. Making extra mortgage payments while borrowing for personal expenditures doesn't make sense, Ms. Triffon says.
"While accelerating payment of your mortgage is an excellent financial planning strategy, it has to be balanced with meeting your living expenses, including vacations and saving for retirement."
She recommends they roll the line of credit into their mortgage when it comes up for renewal. The combined total will be about $235,000. With a rate of 4.04 per cent for five years and a 25-year amortization, the monthly payment would be $1,240, leaving surplus funds for education savings or RRSP contributions.
Next step would be to review living expenses to see whether anything can be cut. Any savings could be stashed away in a high-interest savings account and used as an emergency fund - "ideally the equivalent of three to six months of living expenses," the planner says.
Greg belongs to a defined benefit pension plan and has recently purchased past service, Ms. Triffon notes. (Greg's pension plan allows him to "buy back" time in the past when he was eligible for the pension plan but was not enrolled.) The plan will pay him $5,700 a month when he retires at age 65, indexed to three-quarters of the consumer price index. When he retires, he can split this pension income with Melissa, who is in a lower tax bracket, resulting in significant tax savings, Ms. Triffon says.
Melissa has a group RRSP (defined contribution) through work. Both Melissa and Greg have substantial unused RRSP contribution room. Because Greg is in a higher tax bracket, he should be making RRSP contributions to a spousal plan for Melissa before she makes further contributions to her own RRSP.
"The exception to this advice would be if Melissa's company matches any portion of her contributions to the group RRSP," Ms. Triffon says. "Wherever there is free company money on the table, that should take precedence."
Greg and Melissa should ensure they have wills and powers of attorney in place that reflect their current wishes and circumstances, the planner says.
"While Melissa's recent breast cancer diagnosis will make her health top of mind, Greg could be hit by a bus tomorrow." They also need to review their insurance. While Melissa's $350,000 of term life insurance appears to be sufficient, Greg's $500,000 does not because he is the higher income earner, bringing in 71 per cent of the family income.
If anything were to happen to Greg, Ms. Triffon assumes that Melissa could live comfortably on $60,000 a year until 2019, when both children become financially independent, and then reduce her living expenses to $40,000 a year. To provide this income, Greg would need an additional $740,000 in life insurance, the planner calculates. This assumes that Melissa would keep working full-time until age 65 and does not include any downsizing of the family home.
Special to The Globe and Mail
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The People
Greg, 46, Melissa, 50, and their two children, 16 and 19.
The Problem
How to cope with a sudden drop in family income because of Melissa's illness.
The Plan
Stop making extra mortgage payments, cut discretionary spending and build up an emergency fund. Roll the line of credit in with the mortgage when it comes up for renewal this spring.
The Payoff
The comfort of knowing the family finances are manageable short term and on more solid footing long term as well.
CLIENT SITUATION
Monthly net income
$10,855 (when Melissa is working).
Assets
Bank account $1,000; RESP $28,500; spousal RRSP for Melissa $3,600; Greg's pension plan $176,500; home $380,000. Total: $589,600.
Monthly disbursements
RESP $200; employer pension plan $850; groceries, drinks, takeout $1,350; lunch $70; clothing, dry cleaning, haircuts $330; drugstore, dental $25; tech tools and toys $215; pet care $130; gifts $55; mortgage payments $2,000; property taxes $400; house insurance $85; heating, hydro, water $360; phone, cable, Internet $385; repair and maintenance $200; furniture, appliances $100; vacations $400, courses, hobbies $55; books $20; club membership $55; children's activities $200; auto expenses, including gas $500; loan payments $200; life insurance $90; bus $10; group life, disability insurance $225. Total: $8,510.
Liabilities
Line of credit $55,600; mortgage $179,000. Total: $234,600.