The last Reader Mail article on which account to place Canadians ETFs drew quite a bit of attention which resulted in a number of financial questions. Here is one of them about a Reader who is worried about his mother’s financial situation.
Five years ago, my mother immigrated to Ontario, Canada in the hope to find safe and better life. As most immigrant, she was brave, and decided to return to school after so many years. She finished school last year and landed a job in her field of study.
I’m starting to worry about her future since she has no pension, RRSP, Life insurance, or investment for that matter. She is getting older (she’s 53). Here’s her situation:
- Income: $37,500 (Annually)
- Student loan: $16,000 ( probably at 5.5% . Grace period ending as of November 2013)
- Credit Card debts (she uses around 25% of her available credit). $6,000. Current balance $4,500
- Rent: $1,075/month (all inclusive). She live with my brother, who will be off living on his own very soon)
Now, she is in the process of selling the family house back home, which would bring approximately $50,000 after paying sales commissions and all those related fees. I know it’s not a lot of money, considered how expensive life is in Canada, but I’m trying to find a better way for her to put that $50K in good use.
Some of the scenarios we came up with:
- Open a high interest investment account, and add sum of money to it on a monthly basis, and let the money grow.
- 20% Down Payment for a house, and rent out the basement (condo avg $175k-230k, house $220k-$250k)
- Down Payment for rental property ( duplex, triplex), with a good ROI
I will welcome any suggestions that will help my loving mom plan her retirement. I’d like her to sustain herself financially.
What to do with the Cash
Pay off Debt!
One of the main questions is what to do with the $50,000 that the Reader’s mother is going to acquire in the near future. If it was me, I would take the cash to pay off the credit card and student debt. It will provide an immediate tax free return, and help with the monthly cash flow since income is relatively low.
Paying off $20k in debt will leave about $30k to play with and it appears that real estate is what they have their mind set on. To me, buying property should not be a priority at this point, especially for a low income individual. A $37,500 salary in Ontario will bring in about $2,300/month after taxes and payroll deductions.
Using the $30k cash on a $200k condo would result in a housing cost of approximately $1,500/month at today’s rates (including condo fees, property tax and heating) or 65% net income. That would leave $800 a month for savings/groceries/entertainment/transportation/shopping/cable/telephone etc. In other words, not a lot.
Another option considered is to purchase a $250k house and rent out the basement. In this scenario, the housing costs (mortgage, property tax, heat/light) would be approximately $1,700/month which does not include insurance and maintenance. The idea is to rent out the basement to subsidize the costs. While collecting $800-1k/month in rent would substantially reduce the housing costs, but what about the months where there aren’t tenants? What about unexpected repairs? As well, being a landlord isn’t exactly passive income where it can turn into another job – at least it did from my experience.
This brings me to the third option, buying a rental property. Personally I would not go down this route unless you know what you are doing, and/or you really want to become a landlord. Unless the Mom is experienced in managing rental properties, I would avoid at this stage.
When it’s all said and done, the Mom has to live somewhere right? I would recommend to continue to rent, but find somewhere that is lower cost. If worse comes to worse, maybe the reader can build an in-law apartment in his own house for Mom. :)
Now that we’ve gotten rid of the real estate idea, lets get down to business. First, we need to take a look at Mom’s budget and see why she has a $4,500 credit card balance. While I do not have the numbers, the Reader needs to work with Mom to stay within her means and generate a surplus. More on this below, but ideally, savings would be enough to max out a TFSA every year (~$500/month).
After budgeting, there is still $30k floating around with nowhere to go. With no retirement funds put away, the first instinct may be to contribute to an RRSP. The problem with an RRSP for a low income individual is that future RRSP withdrawals will affect seniors benefits in the form of clawbacks (in this case, GIS clawback).
In light of this, contributing to a TFSA is the best bet. Starting in Jan 2014, the Mom will be able to put the entire $30k in a TFSA ($31,000 contribution limit). Any income generated from the TFSA portfolio (or withdrawals) will not affect seniors benefits in the future.
Income During Retirement
The main issue is how the Reader’s Mom will sustain herself in retirement. Assuming that the Mom will not contribute to her RRSP’s and no work pension, there are four sources of income.
- Old Age Security (OAS): Using the online calculator for someone who has been in Canada for 18 years results in $2,976/yr (in 2013 dollars) if she starts collecting when she’s 65. (How OAS works)
- TFSA Portfolio: Assuming that the Mom can save enough to max out her TFSA every year and that a indexed portfolio returns 4% after inflation, the balance of the account should grow to about $134k which is a decent nest egg for someone starting late. From this balance, $5,360/yr can be withdrawn from the account sustainably (4% withdrawal rule).
- Canada Pension Plan (CPP): The best method to find out how much you will get from CPP is to check your Statement of Contributions, or call Service Canada 1 800 277-9914. My understanding is that even for new immigrants, the CPP average earnings calculation starts at age 18 which results in a large number of years with zero earnings. Assuming the Mom gets an inflation raise from her work every year, her CPP benefit amount should be about $3,700/year.
- Guaranteed Income Supplement (GIS): This benefit is offered to low income seniors, specifically those that make less than $15,000 per year. This calculation is a bit tricky as there are no clear cut calculators. Again, best bet would be to contact Service Canada. The average GIS recipient is paid approximately $6k per year, in this case, it may be safe to assume that her GIS amount is equal to her OAS amount of $3k/year. (How GIS Works)
Using the numbers above results in a retirement income, at age 65, of about $15,000 per year or $1,250/month with very little or no tax payable. While this sounds low, not all is lost. Her income could increase much greater than inflation, which would hopefully result in higher savings, or she could have a work pension that we do not know about, or she may simply work longer. Or again, she could pack up her things and move in with junior.
- Pay off Debt;
- Create a budget to generate at least $500/month in savings;
- Don’t buy real estate, instead, place the lump sum proceeds into a conservatively invested TFSA (not RRSP);
- Max out TFSA every year with savings; and,
- Look for opportunities for career advancement and higher income.
What advice would you give in this financial situation?