How a young couple can kill $142,000 in debt and start investing
After a work injury strikes, are they on track?
After a work injury strikes, are they on track?
Julie and David live in Calgary with their two daughters, aged 10 and 7. David, 40, is a cable technician earning $150,000 annually while Julie, 37, works part-time at a retail store near their home and earns $6,000 annually. In 2014, their lives changed when David fell on the job and injured his left side, leaving him disabled for two years.
Through physiotherapy, massage therapy and other alternative medical care he has been able to make an almost complete recovery. “It’s been a long road but David is now back at work and is able to function at about 90 per cent of his previous abilities, which is wonderful,” says Julie.
In the months that David was off work, the couple quickly started drowning in debt. They now have about $142,000 in debt that includes $46,000 in high-interest credit card debt, an $11,000 car loan, a $5,000 student loan, a $12,000 bank loan, a $52,000 line of credit, $1,250 in bank overdrafts and $14,000 from family and friends.
As renters, they have no mortgage but they’ve still managed to load up on debt. “The debt really got out of control for those two years that David was off work,” says Julie. “We started drowning in bills, taking out our savings for additional therapies for him, extra costs for everyday home essentials, and caring for family who flew in from Toronto to care for our kids during several surgeries. We just weren’t able to manage how fast the money was going out.”
The couple is considering paying off all the debt, except the interest-free loan from family and friends, which they’d like to pay in July 2019, when they will receive about $14,000 as a gift from Julie’s parents.
The couple knows they have been given a great opportunity to start over. In February, David accepted a voluntary leave package of $220,000 from his employer. He plans to work for a few more months, and then he will receive half of the money, with the other half paid on Jan. 1, 2019. “We’ll be able to save a bit on taxes that way,” says David, who loves his job but is ready for a move.
The couple is planning to leave Calgary and settle in Oshawa, Ont., where both of their extended families live. “The move is a good decision for us,” says Julie. “We plan to live with a sibling for a year and pay about $1,000 a month all in. The kids can go to school and I can return to work full time as an administrator, likely earning about $60,000 a year. David can take a few months off to watch the kids and then in early 2019 get a job doing customer tech support where he will likely earn $60,000 annually as well. I think we can make it work.”
When David leaves the technician job he’s had for 10 years, he will also have access to other money he has saved with his employer. He will get $4,200 in company shares as well as $21,000 in an employee RRSP and $93,000 in a defined contribution pension plan (DCPP) with his employer. “We’ll likely leave the $93,000 and $21,000 where they are,” says David. “They’re in a mix of mutual funds with an insurance company and I think our inclination is to leave that money aside for our retirement. But the $4,200 in shares we could definitely cash in and put to use elsewhere.”
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Julie says David’s $220,000 severance package will allow them to pay off some debt and start a saving and investing program. And with no child care costs because of help from family to pick up the kids after school, that will be a big saving. “Raising kids on one salary has been challenging, and with David’s accident, we’ve fallen behind the eight ball with our financial goals,” says Julie. “But with this money from his employer, we want to do it right.”
The couple’s top three questions include:
Once the couple moves out of their sibling’s home July 1, 2019 (Julie’s sister wants to sell her home then), the couple plans to rent a two-bedroom condo from friends in Oshawa for about $2,000 a month, all inclusive. “We like the neighbourhood and know it will be waiting for us,” says David. “The kids can go to school with their cousins because it’s in the same area, and we think they’ll enjoy that. We don’t plan on buying a house. We’re going to be renters for the foreseeable future.”
Julie is already looking for a full-time job in Toronto and expects to find one paying $60,000 annually by July, while David will likely work part-time at his sibling’s gas station, earning $2,000 a month until he finds a full-time job earning $60,000 annually, likely by January 2019. “David knows a lot of people and he already has a few leads, but I think he’d like to spend a bit of time with the girls before going back to full-time work in early 2019,” says Julie. “It will be a good break for him and allow me to transition to my new job. I think it will work.”
Julie knows this is a once-in-a-lifetime opportunity. “We can’t afford to mess up this chance. Any help you could give us to get our affairs in order and move forward with saving and investing would be deeply appreciated.”
Voluntary leave package
(net after 30% taxation) $154,000
Defined contribution pension plan 93,000
David’s RRSP 21,000
David’s employer shares 4,200
TOTAL ASSETS $272,200
Credit card debt (27%) $46,000
Line of credit debt (11%) 52,000
Loan from family (0%) 14,000
Bank loan (12.9%) 12,000
Car loan (4.3%) 11,000
Student loan 5,000
Bank overdrafts 1,250
TOTAL LIABILITIES $141,250
(Assets minus liabilities) $130,950
David and Julie’s expenses are somewhere in the $80,000 to $100,000 annually, including rent, child care and debt repayment costs. “This means they could likely live off $70,000 to $80,000 gross after moving back to Ontario, negating the child care costs and getting the debt paid off,” says Jason Heath, a certified financial planner with Objective Financial Partners in Toronto. Heath says the couple needs to know how to become debt free and start investing.
Heath’s advice: David may have a $220,000 voluntary leave package, but this will be subject to tax. There is a reference to $154,000 being left over after 30% taxation, but the 30% rate is just the required withholding tax that will be applied to the payment. If he earns $75,000 of income at his $150,000 annualized rate working a half year in 2018, the 50% of the $220,000 package he will receive in late 2018 will actually be taxed at about 43% when he files his 2018 tax return. That means he will likely pay an incremental 13% tax in excess of the 30% withholding tax rate.
The same situation will likely apply in 2019. If he expects to earn a $60,000 salary, the other half of his $220,000 package paid in January 2019 will be taxed at about 41%. That’s an extra 11% more than the 30% withholding tax.
I think this is an important consideration for anyone doing their own tax calculations, especially when it comes to extraordinary income like this. David and Julie may have about $26,000 less from the package after tax.
They could offset some of the tax payable by contributing to David’s RRSP, given he has $182,000 of RRSP room. But then they have fewer funds available to pay off the debt that has been crippling them the past couple years. Given the family’s balance sheet, I would be more inclined to pay down debt than worry about tax savings and retirement savings.
If David is able to sell his $4,200 in employer shares without restriction, I would do so now. Maybe he’s earning a dividend of a couple per cent on the shares. Maybe he’s hoping to see a little bit of capital appreciation over the coming year. But I highly doubt his return will be better than the 27% interest he could avoid on his credit card debt by selling the shares and paying some of that high-interest debt down.
Although I hope the family can pay off all their debt by summer 2019, I think the $26,000 understated tax on the voluntary leave payment might push their debt-free target back into 2020 or later. It depends, of course, on how quickly they find work in Ontario, at what income level, and how the expenses all shake out from the move. But I would definitely focus my attention on debt repayment as their short-term goal.
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I would prioritize debt repayment as follows: credit card debt, bank overdrafts, bank loan, line of credit debt, student loan, car loan, loan from family. The order has to do with interest rates primarily, so I’d pay off the debt with the highest rate first.
I think once the family has paid off most or all of their debts, they should turn their attention to investing. The exception might be if either of them has a group plan at work with a matching contribution from their employer. If that’s the case, I’d take advantage of those plans right away.
From there, I think they need to look at their incomes, tax deductions and extra cash flow. If they both have incomes in the $60,000 range, they might have other tax deductions like employer pension contributions, union dues or child care expenses (though they stated child care expenses would drop). If their taxable incomes fall much below $50,000, RRSP contributions may be less beneficial. In Ontario, tax brackets jump from 20% on taxable income up to $43,000 to 24% on income between $43,000 and $47,000 and 30% on income in excess (all the way up to $76,000). So RRSP contributions that bring their taxable incomes down below $47,000 or even $43,000 won’t yield tax refunds that are quite as high as if their incomes were higher.
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Assuming both their incomes are up into the 30% tax bracket, I’d lean toward RRSP contributions over TFSA contributions. If one of them has a lower income, focus the RRSP contributions in the higher-income spouse’s name. Despite some of the criticisms of RRSP contributions over TFSA contributions, most people with modest and certainly high incomes are better off contributing to an RRSP than a TFSA over the long run. It would be great to contribute to and maximize both, but in the real world, that’s not possible for most Canadians.
They mentioned the prospect of renting for the foreseeable future. Once they have their debt paid off and start to accumulate a down payment—which could come from their RRSPs under the Home Buyer’s Plan—I think I would consider buying a home. I’m familiar with the Oshawa area, and rents are actually fairly high relative to the cost of buying—at least right now. Other parts of the Greater Toronto Area are arguably renters’ markets. But that’s an assessment to make when the family’s balance sheet is stronger and they can consider their finances and their long-term plans. By the time they’re in a position to buy, their kids will be that much closer to going away to school. It may not make sense to buy a house for four of them when they could be empty nesters shortly thereafter.
Their goal to have $50,000 in an RESP for their kids in eight years is a good one to have. It would probably require $4,500 to $5,000 in annual contributions going forward. If no RESP contributions have been made by them or anyone else for their children, they could contribute up to $10,000 per year and get 20% government grants on the full contribution. But before they rush to accomplish their long list of goals, I would settle into life in Ontario, secure jobs, set a budget and pay off debt. I’d hate to see them accumulate $50,000 in an RESP at the expense of not paying down debt or saving for their own retirement. Developing a long-term plan on their own or with a financial planner could help them set reasonable savings targets for their children’s education and their own retirement. They may need to make sacrifices, including how much they are able to contribute to education costs for their kids.
Investing in their RRSPs or RESPs should always match their risk tolerance. A balanced fund is the typical “not too hot, not too cold” choice for an investor, but lots of people can and should invest more or less aggressively. There are risk-tolerance questionnaires available online that people can take to determine how much exposure they should have to risk assets like stocks. The good news is bond interest rates are becoming a little more competitive for low-risk investors. The bad news is they are still very low historically.
Given the family has $104,000 in retirement accounts currently, they could work with an investment advisor. Some advisors require larger minimum investments, but these days, robo-advisors have little to no investment minimums, and Steadyhand offers low-fee mutual funds starting at $10,000. So they should have an array of options to choose from to suit their investing and financial planning needs. They should aim to balance low fees and client service. Not everyone is going to be a DIY investor and not everyone needs four meetings per year, either.
David and Julie mention leaving his $93,000 defined contribution pension plan and $21,000 RRSP with the insurance company where they are currently invested. The DC pension is actually locked in and generally can’t be accessed before the age of 55. So they don’t really have a choice with that account—at least whether or not they access it. They do have a choice as to whether or not they leave the accounts with the insurance company or move them somewhere else, though. Some group plans provide decent investment options and modest fees for departing members. Some don’t. They should assess if there are better options to move the DC pension and RRSP elsewhere after David’s departure.
David and Julie’s situation definitely helps reinforce for others the need for disability insurance and access to an emergency fund. High-income earners like David often have less than satisfactory group disability packages with their employers. Self-employed people are even more at risk, as many of them have no private disability coverage. During the course of your career, there’s a higher chance of disability than death—yet more emphasis seems to be placed on life insurance.
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