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Money Makeover / When budgeting isn't enough

Big purchases mean new plan necessary for family of four

Hey there, time traveller!
This article was published 1/7/2011 (2238 days ago), so information in it may no longer be current.

A budget saved Flynn and Lisa once, lifting them out of the red.

But today, it seems their budgeting skills simply aren't enough, and they find themselves back in debt, sinking deeper by the month.

An adviser says only fiscal discipline and common sense can help Flynn and Lisa get their financial house in order.


An adviser says only fiscal discipline and common sense can help Flynn and Lisa get their financial house in order.

"Two to three years ago we didn't have any debt," says Flynn, a mid-40s, mid-level manager at a local manufacturer. "Five to 10 years ago we had lots of debt, so we've come a long way, but now we seem to be moving backwards."

The married couple with two children -- both in elementary school -- set aside money every two weeks for repairs, RESPs, TFSAs, vacations and to buy Canada Savings Bonds.

They also overpay their utilities and other monthly fixed expenses -- just in case.

"We pay a set amount regardless of what our bill is," says Lisa, in her late 30s and a manager at a firm with a defined benefit pension.

"Pretty much at all those places, we have a credit."

Over the last few years, they might have fallen behind at the end of the year, but a tax refund and Lisa's work bonus would always bring their finances back in balance.

That changed last summer, however, when they made three large purchases: two vehicles and a camper.

Their debt increased by $68,000 to a total of more than $328,000, including $10,400 owing on credit cards.

While the couple have a gross, combined income of $136,000 a year, and net about $7,000 a month, it isn't enough to stop the slide.

"If something unforeseen happened, and one of us lost our job, we could carry on for a little bit," says Lisa, adding they're always in overdraft. "But it wouldn't be long before we would have to start getting rid of stuff."

Certified financial planner Uri Kraut says the situation indeed looks dire for Flynn and Lisa today, but their long-term picture isn't as bad as they may think -- so long as they take immediate steps to right their current situation.

"The good news is their retirement-planning side does not need a lot of work because they have decent pensions," says the investment adviser with Assiniboine Credit Union. Without further contributions to RRSPs, they would earn about $4,900 net a month at age 65. "They could always save more, but they have no free cash flow so it is not worth it right now."

Their education goals for their children also look well-funded, he says. Based on current contributions and assets, each child will have about $24,000 in RESPs by the time they are ready to attend post-secondary education.

Now for the bad news: "They are sinking."

Kraut says Flynn and Lisa need to take a closer look at their budget, which seems to be based on costs prior to making the vehicle purchases last year.

They earn $7,160 a month after taxes and deductions, but their expenses are $7,118. That is squeaky-tight. Yet, upon closer examination, it's actually even tighter. Their monthly earnings figure includes non-monthly income streams, like Lisa's bonus. This cash isn't available for expenses on a regular basis.

"This means they are falling behind by maybe $200 a month, and this is before their savings strategies even start," he says. "Those likely cost them $500 biweekly."

That's a substantial shortfall of roughly $12,000 a year.

Kraut says no fancy financial planning tricks can help turn their situation around. Only fiscal discipline and common sense will do that.

The thrust of any new plan will involve diverting as much cash as possible to debt repayment, and the sooner they do that the better, because 85 per cent of their debt charges a floating interest rate.

"I would suggest if interest rates were to increase by one or two per cent, back to normal historical rates, they may find their current situation extremely uncomfortable," Kraut says. And if one of them becomes unemployed, higher rates would spell disaster.

One of the first steps they should take to turn the situation around is to stop overpaying on their fixed bills, especially when they owe money on the credit cards and are almost always in overdraft.

"They are receiving nominal credit for the surplus with the companies while they are getting nickel-and-dimed on overdraft charges and interest costs."

They should also reconsider aggressively paying down their mortgage. They pay $710 biweekly at a floating rate of 2.5 per cent when they have other debts -- vehicles and credit cards -- charging higher rates.

"This strategy is costing them a lot in interest penalties, far in excess of the benefits of mortgage paydown," he says.

Lisa can, however, keep contributing to Canada Savings Bonds through her work.

"I initially thought to cut that, but they use it for Christmas and I don't want to seem like Scrooge," he says

But Kraut says other savings contributions are unnecessary at this stage. The most noticeable sore point is the $150 biweekly contributions to their TFSAs, an account that Lisa mentioned might be used for a "girls' vacation" later this year.

"They need to recognize TFSAs are not core savings strategies and although it's ideal over the long term to pay yourself first, if debt is undermining you in the short term, it is not sustainable," he says.

Basically, they earn less in TFSAs than interest they're paying on debt.

That doesn't mean they should abandon the TFSA plan altogether. They just should be using it for necessary savings, like home and car repairs and a modest family vacation.

The TFSA is a good vehicle for these goals, allowing savings to grow tax-free -- although savings will be minimal in an investment that suits their needs, like a high-interest savings account.

The main take-home point, though, is Flynn and Lisa must learn to make the distinction between prudent savings goals versus unnecessary ones so all free cash will be used to reduce debt.

If they're not able to make that distinction, their budgets will always have a 'wonkiness' to their design and likely prove unhelpful, much like the one they have today.

"It simply doesn't make sense to use things like a TFSA as discretionary savings account legitimizing spontaneous or potentially imprudent spending decisions while they are sinking on debt payments."


Flynn and Lisa’s finances


Lisa: $74,400 ($3,523 monthly net); does not include annual 10 per cent bonus.

Flynn: $61,672 ($3,285 monthly net).

Total monthly net: $6,808 (without bonus); $7,160 (with bonus).


Monthly: $7,118, not including savings goals of $1,083.


Credit cards: $10,435.

Mortgage: $250,000 owing on $322,000, paying $720 biweekly at floating rate of 2.5 per cent.

Vehicle 1: $38,000 owing, paying $250 biweekly at floating rate of three per cent.

Vehicle 2: $17,400 owing, paying $130 biweekly at 6.24 per cent fixed rate.

Camper: $13,000 owing, paying $58 biweekly at 7. 5 per cent fixed.


Lisa pension: $1,440 per month at age 65.

Lisa RRSP: $45,075.

Lisa TFSA: $1,600.

Lisa Canada Savings Bonds: $862.

Lisa company stock: $3,300.

Flynn pension: $50,000.

Flynn RRSP: $22,000.

Flynn TFSA: $1,400.

Vacation/house maintenance: $1,000.

RESPs: $9,475.


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