A woman we'll call Jenny ought to have her financial house in good order. A long-term employee of an Ontario municipality, she lives near Toronto and earns a gross income of $43,334 a year. Now 48, she estimates that she will receive a $21,000 annual pension when she retires. Jenny wants financial security, but a trip into the stock market proved disastrous for her retirement plans.
In 2001, she added $50,000 to her $45,000 mortgage in order to buy stocks within mutual funds that she hoped would produce capital gains sufficient to pay off her mortgage and the new loan. She wound up with a $17,000 loss. Today, she doubts it was wise to make bets on the stock market. She wants to recover financially -- pay down her enlarged mortgage, cut her investment risk, and put the losses behind her.
"My financial adviser told me that she could pretty much guarantee that I could make money in the market in a short time, enough to pay off my mortgage in three years," Jenny says. "Worse, the investments were in mutual funds with backload fees for getting out within a few years of purchase. I took risks that I should not have taken."
What our expert says
Facelift asked Caroline Nalbantoglu, a vice-president and consultant with fee-only financial planning firm T.E. Financial Consultants Ltd. in Montreal, to work with Jenny on her problems of debt and risk management.
"Jenny is right in that she should never have borrowed on her house in order to invest," Ms. Nalbantoglu says. "She does not have the ability to carry that much risk."
Jenny's goal should be to reduce her risks, the planner says. She can do that by paying off her debts and building up her registered retirement savings plan in low-risk investments. She can prepay 20 per cent of her mortgage loan of $95,000 with no penalty. To do that, she can sell $19,000 of $33,000 she has in non-registered investments, the planner says.
Next year, she can make a payment with the balance of the non-registered portfolio, $14,000. In subsequent years, she can continue to make her usual $656 monthly payments on her mortgage, Ms. Nalbantoglu explains.
Jenny will be able to retire before age 65, Ms. Nalbantoglu says. Under a rule used by the Ontario Municipal Employees Retirement Board (OMERS), when the sum of years of service plus employee age equals 90, the employee can retire with a full pension. Thirteen years from now, Jenny will be 61 and she will have had 30 years of service. She will have satisfied the "90 rule."
At that time, she will receive her $21,000 OMERS pension. She will also get a $7,900 bridge benefit to age 65, plus 76 per cent of the potential Canada Pension Plan maximum benefit of $9,770 in 2004 dollars. Taking CPP four years before age 65 will cost her a penalty of 0.5 of a percentage point a month for each month prior to age 65 that she cashes in her CPP. At age 65, she continues to receive CPP benefits reduced by 24 per cent and the full OMERS pension, but she will no longer receive the OMERS bridge benefit.
At age 65, Old Age Security will begin, paying her $5,660 in 2004 dollars. At each stage, she will have more income than she is now earning. Her present spending level can be preserved or even increased in retirement, Ms. Nalbantoglu explains.
In addition to her provincial and government pensions, Jenny has $68,000 in her RRSPs invested in a mix of mutual funds that hold U.S. and Canadian value stocks. She will need that money to supplement her pension, the planner says. Jenny has $15,600 in RRSP contribution room.
She can contribute up to $7,000 a year within her 31-per-cent tax bracket to maintain her highest level of tax deductibility. If she makes that contribution each year until she catches up to her contribution limit, she will obtain an annual tax reduction of $2,170 that she can save, invest, or accumulate to finance a car to replace her 1992 Toyota, the planner says.
Ms. Nalbantoglu proposes that in the first year of her new financial plan, Jenny should cash in most of her $8,456 of Canada Savings Bonds. They pay less than the 5.35-per-cent interest charged by her mortgage.
Jenny should stop buying Canada Savings Bonds, the planner adds. Their interest is paltry and fully taxable outside of RRSPs. The $5,200 a year taken from her paycheque for CSBs should go to mortgage reduction or to her RRSPs, the planner says.
If she uses the money she has invested in CSBs to prepay her mortgage on top of her regular monthly payments, she would be debt-free in 66 months, Ms. Nalbantoglu says. If she chooses to divert the $5,200 to add to her RRSP, she will have paid off the mortgage in 87 months. If she builds her RRSP with $5,200 a year invested conservatively to produce a 4-per-cent nominal return from a low-fee bond fund or from an exchange-traded fund of five-year Canada Bonds called the iG5, she can obtain a return of approximately 4 per cent a year. She will be able to add value to her present $68,000 of registered funds invested in stocks that should generate a 6-per-cent return each year.
By doing this, she should have RRSPs with a balance of $227,500 by age 61. That sum can produce an income of $9,100 at a 4-per-cent annual withdrawal rate or grow until age 69 when she must decide to convert the RRSP to an annuity, take a lump sum withdrawal or convert to a registered retirement income fund.
Which should it be? Paying down the mortgage is the lowest-risk strategy. But contributing funds that have been used to buy CSBs to the RRSP will produce an annual $1,612 tax refund each year in her tax bracket and will provide some inflation protection through internal growth.
"I think Jenny should take the course of investment in her RRSP," Ms. Nalbantoglu says. "She is already paying down her mortgage rapidly, even without diverting the CSB money, $5,200 a year, to even faster pay-downs. It is more important for her to build her RRSP. Delaying adding money to her RRSP will reduce her retirement assets and income.
"This case shows the risks of leverage," Ms. Nalbantoglu says.
"Jenny more than doubled her debt to get funds to play the market. It didn't work and she was left with an inflated debt and a capital loss on non-registered assets. The good news is that if she follows this plan, she can pay off her mortgage and maintain her present lifestyle in retirement."
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Jenny, 48, above, with her dog Jack, is a civil servant in an Ontario community.
Income: Total net, $30,317 annual; $2,526 a month.
Assets: House, $165,000; RRSPs, $67,787; non-registered, $34,700; Canada Savings Bonds $8,456; chequing and savings accounts, $3,500; car, $4,000. Total: $283,443.
Monthly expenses: Food, $300; mortgage, $656; real estate taxes, $253; phone & Internet, $63; heat, hydro, water, $142; car insurance, $60; car maintenance, gas, $80; house insurance, $22; RRSP, $100; clothing and grooming, $400; miscellaneous & charity, $450. Total: $2,526.
Liabilities: Mortgage, $93,000.