Debt before retirement

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Teachers Martin and Lara should pay off their mortgage faster so they are in better financial shape to retire. An adviser suggests they pay an extra $835 a month on their mortgage. (PHIL HOSSACK / WINNIPEG FREE PRESS) Photo Store

Lara's, Martin's finances:

INCOME:

Martin: $73,125 ($4,064 net a month)

Lara: $68,834 ($3,957 net a month)

Total: $8,021

MONTHLY EXPENSES: $7,177

DEBTS:

Mortgage: $182,132 owing at 2.15 per cent variable interest until 2016; 11 years amortization

Line of credit: $6,089 at 6 per cent interest

ASSETS:

Home: $325,000

Non-registered investments: $14,365

Lara RRSP: $67,193

Martin RRSP: $58,308

RESP: $22,423

Lara pension: $2,175 a month at age 60

Martin pension: $2,872 at age 55

NET WORTH: $299,068

Martin and Lara are two teachers with retirement in sight.

The problem is their mortgage -- about $182,000 -- is standing in their way.

"Right now, our retirement is tied directly to our mortgage," says Lara, 53.

When it's retired, they retire.

The couple has two sons, one in high school and the other just starting university. They are paying $1,500 a month on their mortgage, which puts them on pace to pay off their recently renovated home in 11 years.

But Martin, 50, says they'd like to be able to pay it off four years sooner so they can retire when Lara turns 60.

Although the couple takes home more than $8,000 a month, they say they are struggling to ensure they don't go over budget every month.

"I totalled it up to what I think we should be spending, and then I thought, 'Hold on a second here, we're bringing in $8,000 a month, and after the set expenses plus food, we've got $3,500 missing a month,' " Martin says. "So I went into our bank accounts and I looked at all our expenses month-to-month and categorized them."

It turns out their costs were more than they had thought. Their monthly spending is more like $7,177.

Martin says additional money is often going toward their $6,600 line of credit, a result of overspending with credit cards and unexpected costs.

The couple also has some money invested in RRSPs and non-registered investments, totalling about $139,000. For their kids' education, they've saved about $22,000 in a RESP, and they expect to help their children out during the next decade with the cost of college.

As a result, Martin and Lara expect they will rely on their work pensions as their major source of income in retirement.

"From the numbers, we would probably have somewhere between $5,100 and $5,200 coming from our pensions every month before taxes," he says. "We're going to depend a lot on that and reducing the debt as (per) our retirement plan, but some people have tried to tell me to invest -- 'You're paying 2.15 per cent and maybe you can invest and earn three per cent... blah, blah, blah, blah' -- but I like to sleep at night and that means no debt in retirement."

If only they could find the money in their budget to eliminate their debt faster, he adds.

Certified financial planner MaryAnn Kokan-Nyhof says Lara and Martin have the right idea. Debt repayment must be their priority.

"I've just seen it turn out so badly for people on many levels when they retire owing a lot of money," says the adviser with Desjardins Financial Security Investments.

"They often end up spending their whole retirement trying to pay it off, and that's not what it's supposed to be about."

Their situation isn't unique, either. Many couples with good incomes spend a little too much at the expense of their future.

"Because they have lots of free cash flow every month, they just do what they want," she says. "They don't worry about it until retirement is coming up and then they have to buckle down."

More often than not, the assumption is they can rely on their pensions in retirement. This often lulls people into a false sense of security.

The truth is they might not be a well off as they think.

Although Lara's and Martin's work pensions will be the foundation of their retirement income, they don't have a lot of additional savings.

Given they're likely going to help out their children with school and possibly other expenses such as weddings, Martin and Lara could find themselves dipping into their savings far sooner than expected, making the likelihood their money will last long into retirement in a tangible way pretty slim.

Moreover, Lara and Martin may not earn as much as they assume from their pensions.

Kokan-Nyhof says they should ask their pension administrator for an accurate estimate -- not the figure they see on their pension statements.

"Often those numbers from their annual pension statement never factor in that they have a spouse, so Martin and Lara might be surprised to find out their actual pension payments are lower than expected."

A requested estimate factors in different scenarios, such as a death benefit whereby if one spouse dies, the other receives a partial payment of the deceased's pension until his or her death. This additional layer of assurance reduces the monthly pension benefit for each spouse upon retiring.

In fact, Kokan-Nyhof says the couple is well-advised to spend a little more time learning about their pension plan, and they certainly should have the opportunity to do so in the coming years.

"TRAF (Teachers' Retirement Allowances Fund) runs retirement seminars fairly regularly, so they should attend one at least five years before retirement," she says. "I've had some clients who go to two or three, because it takes that long to get the information and let it sink in as to what it means for them."

Proper preparation will help them understand how a variety of financial decisions and economic conditions, including inflation, can affect their pension incomes.

"From what I know, if they are teachers with TRAF, they are not guaranteed any cost-of-living adjustment increase with their pension," she says. "It's decided every year by the board, and last year the increase was only 0.97 per cent when the consumer price index -- the measure of inflation -- was 2.3 per cent, so they could see their purchasing power slowly eroded year after year."

Still, their pension incomes, combined with the Canada Pension Plan and old age security, should be enough for them to live comfortably, provided they don't have a mortgage, she says.

Fortunately, Lara and Martin should be able to pay off their mortgage in seven years. To do so, they'll need to pay an extra $835 a month.

Considering they have about $844 of monthly cash flow that's not accounted for in their budget, they should be able to find the money, Kokan-Nyhof says.

Still, Martin and Lara will have unexpected costs -- emergency car and home repairs, for example -- that can put them off course, and it's also likely their debt interest costs will increase in the near future, meaning they'll have to put even more money against their mortgage to remain on schedule.

All this points to some tough spending decisions ahead.

"They have to be constantly conscious of spending, monitoring their expenses monthly," she says. "This means figuring out which expenses are necessary and which ones are discretionary that can be reduced or cut entirely."

Furthermore, debt repayment must be at the top of their expense list. That $835 additional payment should automatically be withdrawn every month so they can't change their minds about whether or not they have the money every month to do it. If it's automatic, they will be forced to adjust their spending.

And because they have substantial incomes, they have the flexibility to adjust.

"If that's their most important goal, it has to be at the top of the list."

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Republished from the Winnipeg Free Press print edition March 2, 2013 B13