Money Makeover: From owing to growing

Enlarge Image

Paying off his tax debt is a top priority for Kirk in order to avoid stiff government penalties for his outstanding balances. (PHIL HOSSACK / WINNIPEG FREE PRESS) Photo Store

Kirk has a nightmarish vision of a mid-life crisis that he'd rather not see play out in reality.

"I don't want to be 45 and have a bunch of loans outstanding," says the 30-year-old IT manager.

Yet every time he scrapes and claws his way out of a debt hole, he seems to jump right back into the pit.

"It usually takes me about six to eight months to pay off the cards, and then they go back up again," he says.

Kirk works full-time with a salary of about $40,000 a year, and he also has a part-time job earning another $7,000.

He owes about $16,000 on two credit cards and a consolidation loan, but he also has a Canada Revenue Agency bill of $7,060.

The money owing to the CRA is originally from taxes owing from an RRSP loan to buy a home he didn't end up purchasing. Instead of returning the money to the RRSP, his banker suggested he pay down debt, which he did. At first, he owed about $4,600 in taxes, but the amount has grown over time with interest, penalties and additional taxes owing from his part-time work in the years following.

"My goal last year was to save up enough in RRSPs so I wouldn't owe the government any taxes," he says, adding he contributed about $4,800.

"I want to be able to hit the point of putting in $8,000 in my RRSP a year so my amount owing to the government is zero."

But getting out of debt entirely -- not saving for retirement -- is his highest priority, he adds.

"I live modestly. I don't go out and buy the newest, flashiest things, but I still like to go out with friends and take the occasional vacation," he says, adding his holidays often add to his credit card debt.

His one major expense is his vehicle, but as a self-professed car nut, it's an expense he's not willing to adjust.

Every other expense, however, is on the chopping block. All he needs is a little guidance.

"Once I know what I have to do, I have no problem doing it," he says.

Debt counsellor Christi Posner says Kirk needs a three-step process to help get him ahead financially for the long term. First, he has to create a budget, then he has to save strategically, and third, he needs a debt-reduction plan.

Although Kirk has a rough budget at the moment, it needs a lot of work, she says.

"The first thing I noticed when looking at Kirk's budget was that he does a great job of knowing what he earns, but he probably isn't as sure where his money is going each month," says Posner, with the Credit Counselling Society in Winnipeg. "I would encourage him to track his expenses for a month or two, with an eye to reduce his living expenses by five to 10 per cent."

Just based on his rough estimates of expenses, which are often lower than in reality, Kirk spends $245 more a month than he earns. This is likely the reason he often finds as soon as he gets out of debt, he quickly slides back into the red.

His budget must not only include regular monthly and discretionary costs. He also needs to account for expenses that occur occasionally during the year, such as vacations, birthdays and car repairs, which often send finances off the rails.

By budgeting meticulously -- monitoring expenses week after week, month after month -- he will start to have an awareness of how his money is being spent. And more importantly, he can start making better choices about how to spend his money.

One way he could find immediate savings of 10 per cent a year is temporarily halting RRSP contributions until he's out of debt.

"He is actually getting further behind making those contributions while paying high interest rates on his debts," Posner says. Furthermore, he has a work RRSP plan, so he's not entirely forgoing saving for the future.

Kirk should also ask his part-time employer to withhold more taxes at source so he's not faced with a bigger tax bill every spring because he has not paid enough income tax on his supplementary income.

Starting a small, regular-savings strategy is another measure that can help him avoid being sent off course by the unexpected.

"He can start an emergency savings account by automatically transferring $50 each month into a tax-free savings account (TFSA)," she says.

A good rule of thumb for a savings goal is three months' worth of expenses, she adds.

With a budget and a modest savings strategy, Kirk moves on to dealing with the debt monkey on his back. One common, simple strategy is to make the minimum payment on every debt and put any available additional funds toward the debt with the highest interest.

"Once his first debt is paid off, he can take all of that money he was paying on that first debt and focus it on the next most expensive debt," Posner says.

But it's important he actually uses additional funds to pay down debt, or else it will take him 20 years to pay off all his debts making only minimum payments -- and he will find himself living out that mid-life crisis nightmare.

As an alternative, he can ask his financial institution for another debt consolidation with a lower interest rate so he can make a regular payment over a fixed time period. This will offer Kirk a little more assurance that he's making progress toward becoming debt-free. The catch is he may need a co-signer, she says.

In any case, the money he owes to the CRA should be the highest priority because not only does he have to pay the government interest on what he owes, the government charges a stiff late penalty, too.

Posner says the first step, however, is for Kirk to balance his budget. Once he eliminates his monthly deficit, he can focus on eliminating debt. Otherwise, he's going to be stuck in a cycle of indebtedness that is hard to escape.

"How quickly he wants to become debt-free will depend on how hard he wants to work at it," she says.

If, after a few months, he still finds it hard to manage his debt, he can always get help, exploring debt-reduction strategies such as a consumer proposal.

"Kirk always has the option to visit a non-profit credit counsellor for free-of-charge advice to explore all of the other debt-repayment options," Posner says.

giganticsmile@gmail.com

KIRK'S FINANCES

INCOME:

Full-time work: $40,410 ($2,350 net a month)

Part-time work: $7,000 ($500 net a month)

MONTHLY EXPENSES: $3,115

DEBTS:

Credit card 1: $5,000 at 19.99 per cent

Credit card 2: $600 at 19.99 per cent

Vehicle loan: $300/biweekly; $40,000 owing

Personal loan: $10,700 at 10.9 per cent

CRA back-taxes owing: $7,060

ASSETS:

Personal RRSP: $6,700

Work RRSP: $12,000

Republished from the Winnipeg Free Press print edition March 9, 2013 B11