“Financial Checkup” is an ongoing series that discusses financial planning options. In this issue, Investment Executive speaks with David Porter, vice president and portfolio manager with Richardson GMP Ltd.in Edmonton; and Doug Warkentin, senior vice president and senior investment advisor with Wellington West Capital Inc. in Winnipeg.



The Scenario: John and Susan, both 68 years old, live near Edmonton on an 80-acre hobby farm. John has terminal cancer and is not expected to live for more than a year. Susan, who had been a nurse, is taking care of John. They have a married son in Ontario who has two stepchildren, and a daughter in Edmonton who is married with two children.

The farm, which is jointly owned, was bought in 1980 and has an adjusted cost base, for tax purposes, of $75,000. It is now worth about $3.5 million, with the house alone valued at $500,000.

John has $1 million in non-registered assets and $550,000 in his RRSP. Susan has $300,000 in non-registered assets and $250,000 in a spousal RRSP that John set up for her. They also have $650,000 in a joint account and $10,000 each in tax-free savings accounts. John has a modest $20,000 a year pension that has 60% survivor rights. Neither John or Susan have life or medical insurance.

John handled the investments, putting 95% into Canadian equities, including income trusts, and has held them for the long term. Susan’s portfolio is similarly invested. There are $200,000 in unrealized capital gains.

Both John’s and Susan’s wills are out of date. John would like to leave $100,000 to each of their children and the rest to Susan, who plans to leave her estate divided equally between the couple’s two children.

The couple are seeking advice on how to handle both John’s death and their financial assets when he is deceased. Susan isn’t sure whether she wants to stay in their home, but knows she doesn’t want to manage the hobby farm.



The Recommendations:
the first thing the couple need to do is get their powers of attorney and wills up to date. John and Susan should also each be named the beneficiary on the other’s registered accounts. Although John is expected to die first, there is no guarantee that something may not happen to Susan beforehand.

Susan can be John’s executor and hold the POAs, but there must be a backup — presumably the daughter, assuming she is capable, who should also be Susan’s executor and hold Susan’s POAs. Porter points out that in some jurisdictions, including Alberta, out-of-province executors may have to post a bond, which could cost 1% of the gross value of the estate. He also does not recommend joint executors because that tends to be time-consuming and expensive.

Porter recommends John consider a spousal testamentary trust for his non-registered assets, which would reduce Susan’s tax burden because the trust is taxed as a separate entity, thereby achieving income-splitting for Susan. In addition, trust assets are protected from creditors.

Warkentin suggests testamentary trusts for the couple’s children in both John’s and Susan’s wills. Assets in such trusts are not be subject to litigation or bankruptcy, and are not divisible upon the breakdown of a marriage. Porter says that these trusts are usually a good idea if at least $500,000 in assets will be involved.

Both Porter and Warkentin say it’s important for the couple to discuss their financial situation with their children in order to make sure the children understand it. With an estate of this size, a lawyer who specializes in wills and estates should be consulted. Richardson GMP’s family wealth planning group has in-house experts, whereas Wellington West will find the experts needed.

If John agrees, Porter suggests that the couple start to change the asset mix to one that’s appropriate for Susan after John’s death. He would recommend a 60% fixed-income/40% equities asset mix.

Warkentin agrees that the current asset mix is too aggressive at this time and points out that restructuring the portfolio could provide opportunities to offset capital gains in one position with capital losses in another.@page_break@Both financial advisors say it’s critical to find out now whether the farm would qualify for the capital gains exemption on “qualified farm property.” If it doesn’t, then the capital gains taxes — when the farm is sold — will be in the neighbourhood of $600,000 to $700,000, assuming its value is $3.5 million at the time.

Porter thinks the odds are that the property won’t qualify because it has been run as a hobby farm — the qualification is based on whether the farm is profitable.

However, Warkentin points out, the rules for farms bought before June 18, 1987, are different — and the property may qualify more easily than farms that were bought later. He emphasizes that care must be taken to make sure the sale is handled in such a way as to claim the exemption.

If the farm doesn’t qualify now, Porter believes, it may be possible to alter the farm so it would qualify at some future date.

Alternatively, the children could take out a life insurance policy on Susan’s life, so cash would be available when they inherit. But careful analysis needs to be done to see if this cost-effective. A policy for $300,000 could cost $30,000 to $40,000 a year at Susan’s age.

Another option is to manage the investments in such a way that there is sufficient liquidity to pay the tax bill when Susan dies.

If Susan wants to stay on the farm for, say, five years, Porter says, she might be able to sell the farm now with the condition that she live on the property for that period of time.

Neither advisor thinks a long-term care insurance policy is needed, noting that Susan has enough money to be self-insured should anything happen.

Both Porter and Warkentin favour leaving the assets in the RRSPs for as long as possible — unless there are tax benefits in not doing so. John’s pension allows him — and then Susan, when he dies — to take advantage of the pension income credit tax deduction, so there’s no need to establish a RRIF for that purpose. Projections would have to be made to find the ideal age at which Susan should establish her RRIF.

Both advisors also recommend that Susan consider donating some of the stocks with very large capital gains to charities after she inherits them, as that could save her a significant sum in taxes .

Porter recommends geographical diversification within Susan’s 40% equities portfolio weighting: 50% in Canadian, 15% in U.S. and 35% in other foreign holdings in individual securities, institutional equities products and exchange-traded funds. He doesn’t think currency hedging is needed when the Canadian dollar is around par with the U.S. dollar, as it is now. He would, however, suggest hedging the C$ if it fell to US80¢.

On the fixed-income side, Porter suggests a balance of investment-grade corporate bonds, government bonds, convertible debentures and, perhaps, some fixed-income ETFs.

Warkentin is less enthusiastic about geographical diversification because of the currency risk and recommends that most of the equities be Canadian. He suggests Susan be on a separately managed account platform geared toward high net-worth individuals. Investments would include preferred shares of blue-chip companies, good dividend-paying securities, commercial paper and/or corporate bonds, and perhaps some balanced mutual funds.

Susan could also look at an emerging markets vehicle, such as a fund investing in the “BRIC” nations of Brazil, Russia, India and China, Warkentin adds, to take advantage of the expected strong growth in those countries.

Assuming a 5% average annual return after fees and inflation of 3%, Porter says, Susan could spend $60,000 a year in today’s dollars after taxes. At age 88, this would leave her with an estate of about $1.7 million in today’s dollars.

Warkentin says Susan could spend $150,000-plus a year, but only if she doesn’t want to leave a large estate for her children. IE