If there is any good that comes from an economic downturn and stock market crash it is that it is a wake-up call that forces people to more seriously consider the frailty of their financial future. Many affected will change their financial habits by cutting back on spending, reducing debt and increasing their savings. But, for many Canadians, especially those in the X and Y generations, it is a life as usual? as the pursuit for the optimal life style, here and now, continues to win out over concerns for future financial security.
It's not uncommon for successful people in their 30s and 40s to conduct their financial lives under the delusion of a vast time horizon masked by chronic procrastination. Many people at that age have a difficult time envisioning retirement much less planning for it as it can only detract from their current consumption of life. So, it's not unusual to find a couple like James and Linda, ages 44 and 43 respectively, who have thus far lived a charmed life, suddenly faced with some fairly drastic decisions over their financial future. After telling their new financial planner that they intend to retire at an early age (58 and 57), they weren't prepared for what their advisor had to tell them.
Back to the Beginning
James, 44, and Linda, 43, developed a pattern of unfettered consumption early on once they were both securely settled in their well-paying jobs. James, now an executive with a fast growing energy transportation company, and Linda, now with 15 years of tenure with a government agency, had always expected their pension plans and James' company stock to lift them to retirement security.
Even in the face of the global economic meltdown of a few years ago, they forged ahead with a life of consumption taking advantage of low interest rates to refinance into a bigger mortgage and double-down with two big auto loans. Virtually everything that adorns their well-appointed home is financed. They live comfortably off of their current income of $8,100 a month, but it is paycheque to paycheque as nearly all of it is paid out each month to cover debt (30%), living expenses (30%), all taxes (35%) leaving nearly nothing for savings.
Because James has relied on his employer's 13% contribution to his defined contribution plan, he has made minimal contributions to his RRSP, as has Linda who is counting on her pension plan which is expected to generate 60% of her current income level as a monthly income. They have also made minimal contributions to their two children's RESP, again, thinking they had more time. Both James and Linda admitted that savings were the last dollars allocated from their paycheques which didn't seem to stretch as far as the month.
While they have managed to save some money, their non-registered assets of $156,500 are dwarfed by their total outstanding debt of $293,200 which includes a mortgage that has been reset for another 30 years. They have $21,200 in cash savings and the rest in a mutual fund. While they aren't insolvent, they are certainly on a path that can lead there unless some drastic changes are made. Their dreams of an early retirement are a pipe-dream at best. They must salvage what they can just to be able to retire on time at age 65.
The Path to Retirement Security
After letting James and Linda down easy on their hopes for early retirement, it was suggested that they target the normal retirement age of 65. They simply don't have the personal resources to bridge the gap between an early retirement and the time at which they could begin to draw from the government pension and Old Age Security at the full rate, which they will need.
From this point forward, their focus needs to shift to debt payoff. As it stands, their mortgage will extend well into their retirement years, and the loan payments on their cars and their household accoutrements preclude them from increasing their savings rate. By focusing on paying down their expensive debt, they could free more cash flow that could be applied to paying down other debt.
Once their debt is eliminated, they could then apply the additional cash flow to their mortgage principle. They could reduce the amortization period substantially and just in time for their retirement.
Finally, it was suggested that they strive for a new balance of consumption and savings by gradually adopting lifestyle changes that will enable them to transition more smoothly into retirement. This could be accomplished through downsizing their home, their cars and their entertainment. The combination of current lifestyle changes and accelerated debt payoff should enable James and Linda to sail into retirement with enough income from their government pensions, Old Age Security benefits, Linda's pension and James' retirement fund to generate nearly 90% of their current income in today's dollars.
This couple's situation is a clear example of the downsides of how too many present day consumer purchases can rob couples of their financial security in the future. However, this example became a manageable one due to the direction of a trusted advisor.
Fictional characters were used in this article for illustrative purposes only.