“Financial Checkup” is an ongoing series that discusses financial planning options. In this issue, Investment Executive speaks with Michael Berton, CLU, RFP, FMA, RHU, CFP, with Assante Financial Management Ltd. In Vancouver; and with Kevin Hannay, CFP, with Investors Group Inc. in Moncton, N.B.



The Scenario: Tanya, 60, is separ-ating from her husband, Donald, and will receive an after-tax cash settlement of $500,000, which includes her share of their house. She needs to find accommodation in Vancouver and wants to make sure she will have enough income if she lives to age 95.

Tanya earns $70,000 a year as a teacher, has full benefits that will continue into retirement and will get a pension of about 54% of her average salary over the five years preceding her time of retirement. She has $100,000 in RRSP assets.

Tanya is thinking of buying a condo, but is open to renting. She needs two bedrooms and wants to be in the city, not in the suburbs. She believes she can live on $30,000 in today’s dollars after taxes — excluding accommodation costs — until age 65, when she will retire. However, she would like to have $36,000 for the 10 years after that, so she could do some travelling. After that period, she believes $24,000 a year, excluding medical expenses, would be adequate.

Tanya has a new car, which she would expect to replace in 10 years at a cost of about $30,000 in today’s dollars. She doubts she’ll need another car after that. She isn’t worried about leaving an estate.



The Recommendations: Berton and Hannay both think Tanya should be able to meet her goals. What enables her to do so is her pension. Even though it isn’t indexed to inflation, it will provide enough cash flow to allow her to spend $30,000 a year, after taxes, in today’s dollars until she is 95 — even if she has to have long-term institutional care for an extended period.

Berton’s projections assume an average 5% return on investment after fees and 3% inflation. His projections also assume Tanya will need to go into an institution at age 83 and require $60,000 a year in today’s dollars to cover her nursing-home expenses. Should this happen, she would still have about $335,000 in today’s dollars at age 95.

To play it safe, Berton recommends Tanya buy long-term care insurance with a benefit of $3,000 a month, at a cost of $5,000 a year. This would increase her estate at age 95 to about $445,000 in today’s dollars.

Twelve years in a nursing home would be an unusually long stay; most people are in for only two years. Thus, Hannay doesn’t think Tanya needs an LTC policy, as she has plenty of assets to pay for a two-year stay or even quite a bit longer. And if she runs out of assets, the government will pick up the tab.

Hannay also looks at whether Tanya should buy a condo or rent, running projections for both options. In the first, he assumes Tanya will buy a $650,000 condo with a 20% down payment and a 30-year mortgage at 4.5%, leaving her with $370,000 from her divorce settlement to invest. If she does this, she would run out of financial assets at age 84 and would need to start using the equity in her home through a reverse mortgage, a homeowner’s line of credit or even by selling the condo and moving to a rental.

Hannay assumes rent of $2,000 a month in his second projection. In this case, Tanya would have a smaller estate at age 95 of around $28,000 in today’s dollars vs $326,000 with the condo purchase, assuming the condo appreciates by 3% a year. This makes buying the more attractive option, as it gives her money for travel or other luxuries. He points out that Tanya is still young and should enjoy life.

Berton also recommends buying rather than renting, pointing out that owning a home is an investment that grows tax-free and also means that Tanya’s income would be lower because significant assets would be tied up in the condo, so there would be fewer taxes to pay — and thus her old-age security benefits may not be clawed back.

Further, Berton doesn’t think Tanya has to spend as much as $650,000 because Vancouver’s condo market is currently a buyer’s market. Recently, there were 21 pages of available condo properties in the $350,000-$500,000 price bracket, he notes, which means she could get a nice, modern, two-bedroom condo downtown for $500,000. His projections assume that she spends $500,000; however, given the tightness of Tanya’s situation — should she need long-term care — Berton suggests that Tanya try to find a condo she likes at the lower end of that price range. This would allow her to meet unexpected expenses comfortably, or to spend money on luxuries such as travel, theatre tickets, clothing, and so on.@page_break@Berton warns that Tanya should be careful in buying her condo, investigating whether there is a risk of major repairs down the road. He points to the “leaky condo syndrome” — a lot of Western-style condos built in the 1970s and 1980s in Vancouver have developed interior wall rot because of all the rain in the region. Some condo owners have had to pay special assessments of $50,000-$60,000 after the provincial insurance plan that was supposed to protect them went broke.

Both financial advisors urge Tanya to set up a tax-free savings account immediately for the obvious tax advantages. In Berton’s projections, Tanya will use this money to buy her new car at age 70. However, Hannay says, it may be better to finance the car if the finance rate is lower than the return Tanya is expecting on her investments.

Hannay notes that, as a teacher, Tanya will get a severance package when she retires, which is usually one week’s pay for every year of service. Both he and Berton are assuming this will amount to around $45,000, assuming Tanya’s salary increases by 1% a year until she retires; she will then be eligible to transfer about half of those assets into her RRSP, which she should do.

Berton favours Tanya turning her RRSP into a RRIF at age 65 to minimize any OAS clawbacks. Hannay would prefer Tanya wait until age 71 in order to allow her RRSP assets to continue to grow sheltered from taxes.

With the divorce, Tanya needs to review her will and her powers of attorney, and determine her new estate goals. If she doesn’t need expensive medical care, she will have a sizable estate. An estate lawyer could help her work through her decision.

Because Tanya has secure pension income, she can afford moderate risk in her RRSP/RRIF, says Berton. He suggests a 40% equities/60% fixed-income portfolio with geographical diversity. He explains that although Canadian equities have done better than foreign stocks in the past five years or so, a reasonable exposure to foreign equities and bonds is important. He notes the currency risk with foreign investments, should the Canadian dollar continue to climb, but points out that many investment funds employ currency hedging, either when the fund managers deem it appropriate or in separate versions of the funds.

Berton recommends that Tanya invest in tax-efficient corporate-class mutual funds or in tax-efficient systematic withdrawal programs, which are corporate-class wraps in which distributions come out of capital first, thereby delaying the payment of taxes.

Hannay also suggests a 40%/60% asset mix. The fixed-income portion would be in bonds, guaranteed income certificates, mortgage funds and perhaps some preferred shares. Blue-chip, dividend-paying Canadian stocks would comprise half of the equities portion, with the other half in foreign equity funds. He also suggests corporate-class funds.

If Tanya is quite risk-averse, Berton would recommend investing all or part of her non-registered assets into a life annuity, ensuring some continuing income. He notes that a segregated fund with a guaranteed minimum withdrawal benefit might be an option; however, the yield will most likely be lower than for other investments and the potential excess withdrawals would negate the principal guarantee. Another option is to put part of her RRSP assets into a life annuity now and the rest at a later age.

Hannay notes that the guarantee on the principal for GMWBs is usually only 75%, and the return currently offered on annuities is very low. He suggests that if Tanya is very conservative, she might prefer investing 100% in fixed-income, but her annual average return on that would be only 3.5%. Thus, she would have to cut back on both her income goals and the value of her condo.

Berton charges about $1,000 for a basic retirement plan and would be paid the annual trailer fee portion of the management expense ratio on the funds Tanya would own.

Hannay would not charge anything for the Tanya’s financial plan as long as he’s managing the money, taking his compensation through mutual fund fees. IE