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No mystery here: Slash debt, build nest egg

So worried are Kathryn and Bob about their $418,000 line of credit that they're planning to cash in their registered retirement savings plan investments when they mature in two years to help pay it off.

They enjoy a good income, earning a combined $7,200 a month after taxes, between Bob's contract work and Kathryn's salary. That's on top of Bob's government pension of $4,225 a month after tax plus his medical pension of $930, which is not taxable. Both Bob's pensions are indexed for inflation.

But contract work is uncertain and interest rates will rise at some point. At 61, Bob has an eye to retiring completely in a few years. Kathryn, who is 53, has no company pension at all. If anything was to happen to Bob, and Kathryn was left on her own, she would be entitled to half his pension, but would that be enough?

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"Without our mortgage [line of credit] living expenses would be considerably less," Kathryn writes in an e-mail. Besides, they'd like to travel and enjoy life a bit.

Except for Bob's defined-benefit pension plan, their assets are modest. They have a home in Ottawa valued at $560,000 against which they borrowed the credit line, and $110,000 in mutual funds in their RRSPs. They also have $27,000 in the bank.

We asked Adam Weinstock, associate portfolio manager with ScotiaMcLeod in Pointe-Claire, Que., to look at Bob and Kathryn's situation.

What the expert says

Despite their heavy debt burden, Bob and Kathryn are in sound financial shape mainly because of Bob's pension, Mr. Weinstock says. With Bob's pensions and contract work as well as Kathryn's salary, their income exceeds their expenses by about $4,000 a month.

They should use this money to repay their debts and build a nest egg for Kathryn to supplement her Canada Pension Plan and Old Age Security benefits.

Mr. Weinstock does not recommend they cash in their RRSPs to pay off their line of credit. Any withdrawal from the registered plans would come with tax implications so the net funds available to pay down their debt would be considerably less than desired.

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Instead, they could take $20,000 of the $27,000 they have in the bank and make a lump-sum payment against their current debt. That would leave a balance of $398,000 on their line of credit and they would still have some funds available for emergencies.

If they are really concerned about interest rates rising, they could lock in to a five-year fixed-rate mortgage. "If they were to amortize the remaining debt over five years on a weekly basis, their payments (assuming a 4.49-per-cent mortgage rate) would be $1,701.36 a week," the adviser notes. Their excess cash flow would support these higher debt repayments.

The debt would be retired in about five years, Mr. Weinstock says. That would require Bob to work a few months past his 66th birthday.

Alternatively, they could keep the line of credit and increase their current payments from $1,000 a week to closer to $2,000 a week, but this would leave them vulnerable to changes in interest rates.

The process of building Kathryn's nest egg spans two time frames in Mr. Weinstock's plan: from now until the line of credit is paid off (4½ or five years); and from that point until she retires at age 65.

Even with surplus cash flow being used to pay down debt, they still have about $500 a month of available funds to invest, the adviser says. The money can be invested either in an RRSP or a tax-free savings account to provide tax benefits and shelter the growth from taxes. Assuming a 5-per-cent rate of return after inflation, they would have saved about $33,000 in five years' time.

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In year five, once the debt has been retired, Bob will be free to retire as well. Bob's retirement will lead to a decline in household income. But with Kathryn still working and the debt payments gone, they should be able to save an additional $3,300 a month on top of the $500 they had been saving.

The funds should be directed first to their RRSPs and TFSAs up to their allowable limits, after which they would begin investing in non-registered accounts.

Saving $3,800 a month from Kathryn's age 58 to her age 65, in addition to the $33,000 saved earlier and assuming the same 5-per-cent rate of return after inflation would yield a nest egg of about $417,000.

"At Kathryn's age 65, adding the above savings to their RRSPs, which have remained invested and growing at the same 5-per-cent rate of return, they would have a little more than $600,000 in liquid savings," Mr. Weinstock calculates. He recommends they build a portfolio of high-quality dividend-paying stocks with a history of rising payouts.

"A nest egg of this size should be sufficient to cover any shortfalls in the budget that would occur after Kathryn retires and if Bob passes away."



The people

Kathryn, 53, and Bob, 61

The problem

Paying off the line of credit or mortgage by the time Bob retires fully at age 65 and building a nest egg for Kathryn, who has no pension.

The plan

Make a lump-sum payment to the line of credit, consider switching to a five-year mortgage and use cash flow surplus to retire debt in about four-and-a-half years. Then begin building Kathryn's savings.

The payoff

A secure and worry-free retirement with no debt and a comfortable investment cushion.

Monthly net income



Cash in bank $27,000; RRSPs $110,000; home $560,000; estimated value of Bob's pensions $1.5-million. Total: $2.2-million.

Monthly disbursements

Mortgage payments $4,000; property taxes $600; hydro $377; heating/air conditioning $127; house insurance $150; house maintenance $150; security system $25; cable/phone/Internet $200; home furniture/upgrades $280; entertainment $200; gifts $150; car insurance $130; bus pass and gas for car $160; pet care $350 (two Golden Retrievers); clothing, grooming $100; groceries $1,000; vacation $120; medical and dental $150; professional fees $30; newspapers/magazines $50. Total: $8,349. Savings capacity $4,006.


Line of credit $418,000.

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