“Financial Checkup” is an ongoing series that discusses financial planning options. In this issue, Investment Executive speaks to Andy Martin, professional financial planner and senior investment advisor with Wellington West Capital Inc. in Toronto; and Mark Parlee, fellow of the Canadian Securities Institute, financial management advisor and an investment advisor with Investment Planning Counsel, also in Toronto.



The Scenario: George, who is based in Vancouver, had owned and run an independent computer store. He went bankrupt and lost everything, including his home and savings, because he was the sole director of the company.

His bankruptcy has now been discharged and he has just landed a $100,000-a-year job at a company that provides computer systems for businesses. The job comes with full medical and dental benefits up to retirement, plus disability insurance. There is no pension or life insurance. The company has a policy of increasing wages in line with inflation and usually provides a yearly bonus of $5,000-$10,000, depending on the firm’s profitability.

At 50, George believes he could live on $40,000 a year for the next five years. After that, he would like to move up to $50,000 annually in today’s dollars. He separated from his wife at the time of the bankruptcy and will contribute $5,000 a year, indexed to the consumer price index, for each of his two children, aged 12 and 14, until they are 18. He would like to contribute a total of $5,000 in today’s dollars per year for the children’s post-secondary educations.

George has no RRSP, so he has $300,000 in unused room. He will qualify for full Canada Pension Plan benefits.

George is a non-smoker in good health and comes from a long-lived family. But his grandparents both ended up in nursing homes in their mid-80s. As a result, he wants to ensure that his children will not bear the financial brunt of nursing-home costs should George eventually need to move into this type of facility.

George wants to know if he can save enough in the next five years to achieve a lifestyle based on an annual income of $50,000 (in today’s dollars) from age 55 to 95.



The Recommendations:
Both Martin and Parlee say that George can meet his goals.

Parlee, however, thinks that things could be tight for George, given the advisor’s assumption of an average annual return after fees of 6%. He recommends a conservative asset mix: 50% of George’s savings be placed in fixed-income and 50% in equities.

Martin, on the other hand, assumes an average annual return of 6.5%. He suggests 40% fixed-income and 60% equities.

Both advisors assume that inflation will average about 3% a year. Neither has included any compensation in the form of a bonus in their calculations.

In Martin’s projections, there is the potential for George to spend more than $50,000 annually, in today’s dollars, during his first 10 years of retirement: these are the years when retirees are normally more active and many like to have additional income.

In Martin’s projections, the amount of that extra income varies, depending on the minimum withdrawal required from George’s RRIF. According to Martin’s current projections, George’s minimum withdrawal at age 71 could leave him with $13,000 more in today’s dollars in income than his $50,000 target. Martin usually counsels clients to see what the first two to three years of retirement living is like before determining how much income they need for that lifestyle. When this is determined, Martin reruns his projections to see what is feasible and a new plan is created.

On the other hand, Parlee, with his lower return assumption, thinks George has more downside risk than upside. That is, Parlee suspects that the odds that George will have problems reaching his income goals are greater than the likelihood that he will have excess income to play around with.

As a result, Parlee thinks George should consider spending less while he is still working in order to have more flexibility and options should something unexpected happen, such as losing his job or wanting to provide more support for his children.

Furthermore, spending less now might make it possible to spend more in retirement. For example, if George limits his spending to $45,000 for the last 10 years of his working life, he could spend $55,000 at ages 66 to 75. Another option would be for George to continue working part-time once he retires.

@page_break@This is an option some of Parlee’s clients are choosing — and not necessarily for the additional income. Rather, they want to continue with some work because it helps keep them engaged and part of the community. At the same time, part-time work still allows them to enjoy their retirements.

Both advisors suggest a family registered education savings plan, with contributions of $2,500 per child annually until they are 18. Such contributions would qualify for the maximum $500 government grant. A family RESP is preferred because the children are close in age and one may decide for a more expensive education than the other.

Martin and Parlee both recommend George open an RRSP but differ on the size of the contributions. Parlee suggests contributing all the “savings” portion of George’s income into the RRSP. He also suggests putting the resulting tax refunds back into the RRSP. He points out that the more George puts into the RRSP, the greater the rebate he receives. In this way, he saves taxes and increases his assets at the same time. And he has plenty of RRSP room to use up. Parlee wouldn’t, therefore, recommend a tax-free savings account. If, however, George does receive bonus money, Parlee suggests placing those funds into a TFSA.

Martin, on the other hand, recommends that George’s annual savings be divided as follows: $19,000 in an RRSP; $5,000 into a TFSA; $3,500 into premiums for life, critical illness and long-term care insurance; and $3,800 into a non-registered account.

This is a major difference in the two advisors’ approaches. A key factor in the financial plan that Martin has constructed is the purchase of an annuity when George is 65 that would pay $1,073 a month in today’s dollars ($12,876 a year) for 30 years. Martin says George should have the $187,900 in today’s dollars that this annuity would cost in his TFSA at that time. Combined with George’s CPP pension, old-age security and his RRIF withdrawals, Martin says, this should allow George to spend $50,000 in today’s dollars to age 95.

Martin’s choice of an annuity is based on the fact that the cash flow is both guaranteed and tax-efficient. He points out that some of the cash flow is considered return of capital and is, therefore, not taxed. Annuity payments do not, of course, rise with inflation but, Martin says, George can take increasing amounts out of his RRIF to make up for the lost purchasing power from inflation.

Parlee’s approach is for George to rely on his RRSP assets to provide the income he needs when he retires. His argument is that money in an RRSP will continue to grow at a rate that exceeds inflation by a significant amount — in Parlee’s projections, by three percentage points, given a nominal return of 6% and inflation of 3% — thereby providing inflation protection. Both advisors recommend life insurance.

Martin suggests a 10-year term life policy with a payout of $600,000, costing about $1,100 a year. This would allow George to provide his children with additional income as they complete their educations and establish themselves. Parlee suggests a 10-year term policy with a benefit of only $125,000 because George’s financial situation is so tight that he can’t afford to pay higher premiums out of the $40,000 he’s living on. A $125,000 policy would cost around $28 a month ($336 a year).

This type of policy would cover the $5,000 a year in child support for each child while they are under age 18 and the $5,000 George wants to contribute for each year of their university educations. It would also provide $25,000 to cover expenses related to George’s death. In terms of CI insurance, Martin suggests a 20-year, $100,000 return-of-premium CI policy, which would cost $1,565 a year and, again, come out of the savings portion of George’s income. Martin points out that George has no assets to fall back on in the event of a critical illness and he needs to save if he’s going to have a comfortable retirement.

Parlee doesn’t disagree with this argument, but he feels George can’t afford the CI premiums. Martin also suggests an LTC policy that provides $500 a week or $2,000-$2,500 a month for 250 weeks (with a 90-day waiting period), which costs $840 a year.

Parlee also recommends LTC insurance but not until George is 56 — at which point, he will no longer be paying child support. Parlee suggests a $300,000 LTC policy providing $3,000 a month if George is in an institution or $1,500 a month if he is able to live at home.

George needs an up-to-date will and personal and medical powers of attorney, and these should be reviewed every few years. In terms of fixed-income allocation in George’s investment portfolio, Martin recommends 15% real-return bonds, 10% in one- to five-year guaranteed income certificates and 25% in a managed fixed-income portfolio consisting mainly of government bonds, but with some exposure to emerging-market government bonds.

The equities portion would be in managed equity portfolios, with 40% Canadian equities and 20% international (with 20%-40% of that in emerging markets). There might be some investment style diversification but not necessarily much. Says Martin: “I lean toward managers who have a track record making money.”

Parlee suggests putting George’s assets into pools, with 50% in fixed-income and 50% in equities. The equities allocation would be 25% Canadian, 12.5% U.S. and 12.5% international. The equities would include some preferred shares and a lot of stocks that pay dividends. The fixed-income would be predominantly Canadian bonds, mainly investment-grade corporates, but also some higher-yield bonds. Parlee would not charge for the financial plan and ongoing monitoring if he was investing the money; he would get 25% of the estimated 2% management expense fee for the pools.

Martin would charge 2% of the assets to manage the money, and George would have to pay an MER of about 1% for the managed portfolios. IE