Maggie is age 50 and on her own again with two teenaged children. She is eligible to retire from her $105,000-a-year teaching job in five years.
“Having bought out my ex, I have a mortgage again,” Maggie writes in an e-mail. “It is unclear to me if I should continue working past my retirement date as my mortgage is quite high,” she writes. “Or should I retire and supply teach for a couple of days a week?”
Maggie recently inherited some mutual funds from her parents. “Should I cash these in to pay down my mortgage or keep the investments?” She and her former spouse will share postsecondary education costs for the children. Even so, she wonders if she should continue working as long as the children are in school.
Her goals are to retire without having to worry about mortgage payments, to travel and to help her children with education and living expenses while they are in university. She also wants to help each of them with a down payment on a first home after they’ve graduated.
We asked Tom Feigs, a certified financial planner with Money Coaches Canada, to look at Maggie’s situation.
What the expert says
Maggie is recently divorced and has custody of her two children, ages 15 and 19. There are no child support payments from the former spouse. “This split of financial resources has significantly changed Maggie’s financial outlook,” Mr. Feigs says. “Maggie wants to rework her finances to support her kids through postsecondary education and retire in five to 10 years.” She will be entitled to an unreduced pension of $61,500 per year starting at age 55, $72,300 at age 60 and $74,000 at age 65.
Maggie’s living expenses for a family of three are well below her earnings, but the high mortgage payments are eating into cash flow month after month, the planner says. “Maggie has to dip into savings to keep up with the payments,” he notes, “and the mortgage will persist for 20 to 25 years – well beyond her desired retirement target of five to 10 years.”
Her finances are stable and her spending is reasonable, but the size of the mortgage is a significant challenge, Mr. Feigs says. It could get worse if interest rates increase.
“We need to look at all of Maggie’s assets and home equity to work out the best way to manage the mortgage debt.”
After making a recent mortgage prepayment, Maggie still has $334,000 worth of mutual funds. “There will be little concern around tax implications because tax would have been settled previously during the execution of the will,” the planner says. Even so, Maggie can ask the mutual fund sales rep to estimate the tax amount, if any, to be sure, he says. “I recommend cashing out the mutual funds and directing the full balance to the mortgage.”
The mortgage contract has a penalty clause of three months’ interest on the amount that is prepaid, the planner notes. Only 15 per cent of the original balance is allowed to be paid without penalty. “This penalty would be $4,000 and there will be fees of about $1,500 to refinance to lower payments with a longer amortization period,” he says. “Nobody wants to pay penalties, but it is cheaper than continuing interest payments at 6.15 per cent and servicing a mortgage during retirement.”
Cashing out the mutual funds will pay off 57 per cent of the mortgage, so there is more to be done to get to debt free, Mr. Feigs says. After running the numbers on Maggie’s salary, spending and mortgage payments, he concludes that Maggie will need to continue working full time to age 60. She’ll also have to downsize, selling her house and buying another place that is 20 per cent cheaper and has 20 per cent lower operating expenses. She could do this when the children are finished university and she has retired.
“I assumed a tepid 1-per-cent home equity growth,” the planner says. The proceeds from the home sale should be enough to pay off the balance of the mortgage, he adds. “For Maggie, being debt free will equal financial independence.”
The analysis assumes mortgage rates will remain at 6 per cent and the rate of return on investments will average 5 per cent a year after fees. He assumes an inflation rate of 2.3 per cent and that Maggie lives to age 95. The forecast also assumes that Maggie has steady income of $105,000 a year to age 60.
The planner recommends Maggie start her teacher’s pension of $72,300 at age 60. This includes a bridge benefit of 13 per cent to age 65. He also recommends she start her Canada Pension Plan and Old Age Security benefits at age 65. “This serves to create higher lifetime income for basic spending.”
Maggie has little financial room to help each of her children with a down payment on their first home unless she downsizes her home even more, Mr. Feigs says.
The Person: Maggie, age 50.
The Problem: A large mortgage after a divorce settlement has put her retirement path in doubt.
The Plan: Use the inherited mutual funds to pay down the mortgage, downsize the home by 20 per cent upon retiring and after the children are finished postsecondary education. This 20 per cent downsizing is expected to be enough to pay down the balance of the mortgage.
The Payoff: A debt-free retirement with the peace of mind that her lifetime pension income brings.
Monthly net income: $6,785.
Assets: Bank accounts $0; RRSP $51,000; TFSA $27,000; $334,000 mutual funds; residence $1,200,000. Total: $1,612,000.
Estimated present value of her defined benefit pension: $685,000. (This is what a person with no pension would have to save to generate the same cash flow.)
Monthly outlays: Mortgage payment $3,965; property insurance $130; vehicle insurance $200; donations $50; heating $175; city services $70; electricity $205; home repairs $210; vehicle repairs $65; cable/internet $75; property tax $580; land line $20; cellphone $115; subscriptions $75; bank fees $15; transit $20; groceries $710; vitamins $50; pet food $40; veterinarian $35; beauty $90; gasoline $70; entertainment, dining, lunches $90; alcohol $30; clothing, shoes $125; gifts $40; sports $435; vacation/travel $100; other $135; RESP contributions $315; pension plan contributions $785. Total: $9,020.
Liabilities: $590,000 mortgage at 6.15 per cent.
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Some details may be changed to protect the privacy of the persons profiled.