The McLeans – Julie, age 45, and Simon, age 44 – are a mid-career, Vancouver-based couple who recently became card-carrying members of the sandwich generation. With three children aged 16, 14 and 12, they know large educational expenses are just around the corner but have saved just $15,000 in RESPs. Meanwhile, Julie’s mother, Beth, had a stroke early last year at age 74 and the couple had to borrow $25,000 from a secured line of credit to help pay for modifications to her home to accommodate her more limited mobility. They are also providing her with $1,500 in ongoing, monthly financial support. Beth, who was widowed five years ago, isn’t in a position to repay this money and Julie and Simon are steeling themselves for the potential for long-term care costs not too far down the road. Thankfully, Simon’s parents are significantly younger than Julie’s and are currently in very good health.
Also on the upside, Julie and Simon both have good salaries. Julie is a successful freelance photographer who works primarily in advertising and earns $150,000 each year. Simon is a human resources manager for a software company earning $90,000 annually. Neither has an employer-sponsored pension plan, but they have saved just over $150,000 in their RRSPs. Furthermore, they worked diligently over the years to pay off their mortgage and are, as of 2012, mortgage-free on a home valued at $800,000. Despite that, however, Julie and Simon are struggling to manage day-to-day costs – and, in late 2013, they hit a cash flow crunch and started letting credit card balances pile up to the point that they now carry $15,000 in credit card debt.
Here is a snapshot of their monthly cash flow:
- $8,351 + $5,524 = $13,875 in after-tax income from two salaries
- $73 to service line of credit debt at 3.5%
- $238 to service credit card debt at 19% (plus minimum payments)
- 205 in property taxes
- $12,566 in additional household expenses including support for Beth
What can they do to strengthen their financial position today and in the future?
Stuart Kirk, CIM
Wealth Advisor, Precision Wealth Management Inc.
- Streamline budget to control future costs
- Consolidate debts to reduce payments
- Borrow to fund a family RESP and maximize CESGs
- Build retirement savings
- Minimize taxes
A good starting point for this couple would be to put together a list of monthly expenses to determine if there are any unnecessary costs and to assess where cash flow is going. Then they should draw up a budget to control future costs. This couple seem to be asset-rich but cash-poor, and this is probably the result of very little or no budgeting. With just $793 left after they pay all their monthly expenses, they aren’t in a good position to manage unexpected costs, such as those associated with Beth’s stroke. But they may be able to boost their free cash flow by carefully managing their expenses.
To reduce interest costs, they can consolidate their loans by applying for a Manulife One account on their home. With a 3.5%* interest rate, they would immediately start saving $195 per month. They can withdraw from Manulife One to fund a family RESP and take full advantage of the few years they have to collect Canada Education Savings Grants (CESGs) for their three children. By borrowing $7,500 at 3.5%, they can attract a 20% CESG for each child for a guaranteed gain of 16.5% – without taking into account any return on their investment. Add a 6% average annual compounded return and the math becomes even more compelling.
They can also borrow from their Manulife One account to make RRSP contributions** to build their retirement savings; at their income level, the tax savings will exceed the interest cost. Alternatively, or in addition, they could defer their property tax payments and use this cash plus the interest savings they achieved by consolidating their debt to make RRSP contributions.
Finally, another way they may be able to improve their cash flow is by reducing taxes. Julie and Simon may be able to get some tax relief based on the cash they spent to modify Beth’s home since those costs were associated with a disability. They should also make sure that Beth is claiming all disability tax credits and disability income payments that she is eligible for.
Julie and Simon face challenges common to many sandwich generation families – namely, competing financial priorities – but appropriate financial planning can help to get them back on course towards a more financially secure future.
* As at February 19, 2014, the Manulife One variable base rate is 3.50%. Interest is calculated on the daily closing balance and posted to the account monthly. The monthly administration fee is $14.00 ($7.00 for seniors). Rates and fees are subject to change.
** Borrowing to invest may be appropriate only for investors with higher risk tolerance. Your clients should be fully aware of the risks and benefits associated with investment loans since losses as well as gains may be magnified. Preferred candidates are those willing to invest for the long term and not averse to increased risk. The value of your client’s investment will vary and is not guaranteed however they must meet their loan and income tax obligations and repay their loan in full. Please ensure clients read the terms of their loan agreement and the investment details for important information. Manulife Bank of Canada solely acts in the capacity of lender and loan administrator and does not provide investment advice of any nature to individuals or advisors. The dealer and advisor are responsible for determining the appropriateness of investments for their clients and informing them of the risks associated with borrowing to invest.
The persons and situations depicted in this case study are fictional and their resemblance to anyone living or dead is purely coincidental. This case study is not intended to provide legal, accounting, tax or financial planning advice. Clients should consult their own advisor with respect to their particular circumstance. The opinion expressed by the advisor does not necessarily reflect the opinion of Manulife Bank.