Scott Terrio’s Twitter feed (@CooperTrustee) reads like a financial horror story. Terrio, an insolvency expert at Cooper & Co. in Toronto, uses the 140-character medium to share the multitude of ways seemingly well-off Canadians end up buried in debt and turning to debt consolidation, consumer proposals, and even bankruptcy.
Canada’s record household debt levels have been a cause for concern for years, but Terrio sees a new problem on the horizon. Canadian seniors are the demographic increasing debt at the fastest rate.
Take Dorothy, an 81-year-old widow who owns a home with a 1st mortgage from a secondary lender. She refinanced a couple of years ago to do house repairs ($18,000), assist her son with divorce legal fees ($37,000), and to help her grandson with tuition ($8,500).
When her partner died she was no longer able to make the mortgage payments. A friend from church referred her to a mortgage broker.
The broker suggested a reverse mortgage, which would let her stay in her house without the monthly mortgage payment. But the money from the reverse mortgage wasn’t enough to pay out the 1st mortgage after fees and penalties. She needed a private 2nd mortgage at 12 per cent to pay the balance.
Dorothy co-signed a $26,000 car loan for her nephew and co-signed with her son for funeral expenses ($12,000) for her partner. Her son stopped paying, so Dorothy was pursued (100 per cent).
She then ran into tax trouble by not having tax on her OAS & CPP deducted for the first few years. She owes $21,000 in tax, much of it penalties and interest.
This scenario is becoming more common among seniors today.
“Many are in a unique quandary. They’re asset-rich, but cash-poor. Cash flow is tight. Pensions are fixed, and many have underestimated retirement costs,” said Terrio.
So what do they do? Many seniors cash out assets to make ends meet. Others raid their home equity and take out lines of credit. All have financial consequences.
We asked Terrio to share the top financial traps seniors fall into and how to avoid them:
1.) Tax problems
Most seniors were used to being paid by their employers in after-tax dollars. At pension time, many don’t have taxes deducted to offset their Old Age Security and Canada Pension Plan income and therefore end up spending taxable pension income.
It doesn’t take long before a small $5,000 tax problem balloons into a $20,000 tax bill.
Many seniors also cash out assets to bolster their income. This is taxable income at tax time.
To fix the problem, Terrio says, seniors can arrange to have sufficient tax deducted at source before they’re eligible for CPP and OAS.
“Then you’ll never spend somebody else’s money (the Crown’s).”
2.) Multi-generational funding
Many seniors today are caught between multiple generations: they help fund their adult children, grandkids, and even support elderly parents in care facilities. That’s four generations funded from a fixed pension.
Terrio says the costs of this multi-generational funding often goes well beyond what most seniors can handle.
Avoiding this financial trap means going on a budget and sticking to it; separating family and emotions from finance.
Cash out some assets if it makes sense, said Terrio, but make sure to plan for taxation (see trap #1). Ask a professional. Or just say no. Seniors get into money trouble by saying yes too often.
3. Co-signing/Joint Debt
Seniors are frequently asked by their adult children to co-sign for credit. Many don’t understand the basics: each party is responsible for 100 per cent, not just half the loan. The lender will pursue the co-signer for the full amount upon delinquency.
“That’s why you signed,” said Terrio.
It’s difficult for seniors living on a fixed pension income to handle even minimum payments on a large-balance debt. If that’s the case, just say no. If family can’t qualify without a co-signer, perhaps they shouldn’t borrow at this time.
If you co-sign, first determine the maximum amount you may end up having to pay monthly in the case of a delinquency. Don’t sign if you can’t manage the worst-case scenario.
4.) Home Equity Lines of Credit
Seniors often have significant home equity. It’s tempting to tap that equity to help loved ones, or pay for cars or vacations that regular monthly cash-flow may not allow.
Make a specific plan to pay back the home equity line of credit principal within a reasonable time frame. HELOCs only require you to pay the interest, meaning the balance remains. But the debt also remains against your house. Also, the interest portion, as we’ve seen recently, is subject to rate changes.
Don’t be pressured, says Terrio. “Run the HELOC terms by a trusted advisor before you sign.”
5.) Unexpected medical expenses
Many medical expenses are not covered by the Ontario Health Insurance Plan (OHIP), or by private health care benefits.
“There is an assumption of ‘universal’ health care, yet many things are not covered. Costs can be huge,” said Terrio.
The best defense is to plan ahead and establish a proper savings cushion well before retirement.
Terrio suggests meeting with multiple insurance professionals and comparing coverage options. Ask what may not be covered. Budget monthly amounts that will provide maximum coverage for items you deem necessary, but that are not covered by government insurance.
In addition to running the Boomer & Echo website, Robb Engen is a fee-only financial planner. This article originally ran on his site on September 17th and is republished here with his permission.