“Financial Checkup” is an ongo-ing series discussing financial planning options. In this issue, Investment Executive speaks with Wayne Baxter, elder-planning counsellor and senior associate with In-vest-ment Planning Counsel in Toronto, and David Rouse, certified financial planner and financial consultant with Investors Group Inc. in Fredericton.

The Scenario: David, 48, is a middle manager for a retail clothing chain in Fredericton earning $60,000 a year. His wife, Sally, 45, works part-time in a grocery store, and earns $20,000 a year. David has minimum health benefits and an unindexed pension for 60% of his salary at the time he retires, which will be reduced to 60% of that for Sally if she survives him. Sally has no pension.

Each has $200,000 in RRSP assets invested in mutual funds, with an asset mix of 60% Canadian equities and 40% fixed-income.

Sally inherited $200,000 from her parents two years ago, when her mother passed away at age 70 from cancer; her father had died five years earlier from a stroke, also when he was 70. These unregistered assets are invested in the same way as the RRSP assets.

David’s parents are still alive and come from families with long lifespans. He could inherit $200,000 in today’s dollars when they die, but the money may be needed to pay for his parents’ medical costs beforehand.

David and Sally have a house worth $300,000, with a $100,000 mortgage; and three children, ages 14, 12 and 10.

Both spouses plan to retire when David is 65. Their goals are to have an income of $50,000 after taxes in today’s dollars until Sally is 95. They don’t plan to contribute to their children’s post-secondary education and aren’t worried if they don’t leave an estate. At the same time, they don’t want to be a burden on their children, should the couple run out of money before they die.

David and Sally were very alarmed about the way their mutual funds lost value in the autumn of 2008, even though most of those losses have been recouped. The couple favour putting all their assets into guaranteed products, but are prepared to consider a different plan as long as it gives them confidence they can reach their goals.



The Recommendations: Both advisors say the couple have enough assets to meet their goals. Even with just a 4% average annual return after fees, Baxter’s projections, which don’t include David’s potential inheritance, suggest they would not run out of money until Sally is 95 — and they would still have the house.

This assumes salary increases in line with inflation, which he assumes to be 2.5% a year, and a 30% increase in the couple’s withdrawals from age 85 onward to pay for any medical care that may be needed.

The couple would be in even better shape if the return is higher. Rouse’s projection assumes a 1% annual salary increase for both, a 6% average annual return, and inflation of 3%. Sally would have about $80,000 in RRSP assets, in today’s dollars, and $547,000 in non-registered assets at age 95. (Rouse assumes David dies at 95, and Sally would have inherited his assets.)

This means the couple could afford to contribute funds to RESPs for their children, which Rouse recommends: “I have come across many young clients in the past few years who currently have as much as $50,000 to $80,000 of student debt each. With the education rate of inflation running at approximately 10%, more and more parents are opting to fund RESPs for their children rather than see them graduate with crippling student debt.”

If David and Sally put $5,000 a year into an RESP for each of their three children until the children turn 18 — all from Sally’s non-registered assets — this would amount to $90,000 in contributions. Rouse estimates the children’s RESPs would be worth $24,000, $35,000 and $46,000 for the 14-, 12- and 10-year-old, respectively, in today’s dollars, when they begin attending post-secondary institutions.

Even with these RESP contributions, Sally should have about $365,000 in today’s dollars in non-registered assets at age 95.

Rouse suggests that David continue to make maximum RRSP contributions, although it isn’t needed, as this will lower his taxable income while he’s still working and increase either the couple’s income or their assets in the long run. Putting $5,000 each into a tax-free savings account each year from Sally’s non-registered assets is also recommended.

@page_break@Another major part of the couple’s post-retirement plan should be to split pension income equally between David and Sally, as this should mean a lower tax rate than David is subject to while he’s working.

Sally should also put fixed-income investments into her RRSP to shelter the interest income from taxes and put the equities into her non-registered account because capital gains and dividends are taxed at a lower rate. Both advisors add that the use of tax-efficient investments that distribute capital rather than dividends and capital gains, thereby deferring taxes, could be used for non-registered assets.

Rouse is fine with the couple investing in guaranteed products, although not guaranteed income certificates, which don’t pay enough to meet their income goals; segregated funds are a better solution. Rouse recommends that the couple take the enhancement rider that increases the guarantee to 100% of the principal from 75%. The range of fees for Investors Group seg funds with the enhanced rider is 1.32%-3.4%, compared with 1.27%-2.9% for seg funds without the rider.

Baxter doesn’t recommend seg funds; rather, he suggests a very conservative, low-risk portfolio. In his view, there’s no point in paying higher fees for guarantees that aren’t needed and he would want the couple to have liquidity and flexibility. He says you can’t take money out of guaranteed products without losing the guarantee, and the couple could need more income at certain periods because of major expenses or higher than expected inflation.

Rouse notes, however, that the couple would be able to withdraw some money from Investors Group seg funds and keep the guarantee for the rest of the money in the fund.

Rouse would keep the 60% equities/40% fixed-income asset mix, which matches David and Sally’s existing risk tolerance and portfolio mix. Baxter would reverse it because the couple don’t need to take on the risks associated with an equities allocation of more than 40% .

Baxter would include foreign investments to get some geographical diversification, but with most of the currency risk hedged out. Currently, he would suggest that Canadian large-cap equities account for 11% of the total portfolio; foreign equities, divided equally between the U.S. and international, for 21% combined; small-cap equities, divided equally between Canadian, U.S. and international, for a total of 4%; and global real estate, which would have minimum Canadian exposure, for 4%. The large-cap equities would be managed 50/50 in the growth and value styles.

Rouse suggests the couple stick with Canadian investments — at least, for now — because he doesn’t see any need to add to their anxiety about equities investing by pushing them to invest in foreign equities, particularly because Canadian stocks currently offer more stable returns and no currency risk. He would recommend mostly large-cap companies in financial services, materials, information technology and energy. Investment style would be a mix of growth, value and blended.

On the fixed-income side, Rouse suggests mostly government and investment-grade corporate bonds. He recommends that as David and Sally move closer to retirement, they rebalance this aspect of their portfolio in order to have two to three years of income requirements in cash or money market funds.

Baxter recommends mainly Canadian government, corporate and convertible bonds rated at least BBB and some income trusts for the fixed-income component. High-yield bonds would compose no more than 5% of the fixed-income.

Baxter does not suggest long-term care or critical illness insurance because his projections include a 30% increase in withdrawals, from age 85, to pay for such care if needed.

However, Rouse believes the couple should have a “thorough insurance needs analysis.” He suspects they may need LTC and critical care insurance for Sally, given her family history, and for David because he is the family’s main breadwinner. The couple may also need to top up David’s disability insurance and possibly purchase life insurance for him. Says Rouse: “To incorporate a properly structured insurance portfolio typically requires 3%-6% of gross family income.”

Baxter recommends the couple review their wills and powers of attorney, both personal (medical) and property, every two years and meet with a lawyer to discuss them every five years. Baxter also recommends an estate directory, listing the location of all relevant documents and items. He further suggests the couple hold both the home and non-registered assets jointly so that when one of them dies, the survivor has immediate access to funds.

Rouse notes that the couple should speak with the guardian(s) and back-up guardian(s) for the children to make sure they are comfortable with their positions. The couple also need to have proper controls for the management of any funds left to the children. It’s best to appoint a trustee and choose an appropriate age at which the children will receive funds. “Many parents choose 25 to 30 for the first payout of capital,” Rouse says, “and 30 or above for the rest. Under no circumstances would it be recommended that the children be designated as beneficiaries of the RRSPs or insurance. Generally speaking, it would be best if those assets went through their parents’ estates, and then were managed by a trustee. If these assets were to go directly to the children while they are still minors, the government authorities would step in to manage the assets, which is not what most families want.”

David and Sally also need powers of attorney in place in case of disability. “If one of them were to be in a car accident or suffer from a serious illness,” Rouse says, “their inability to manage their affairs could cause the other person significant inconvenience if no power of attorney is in place.”

Neither Baxter nor Rouse would charge a fee to develop a financial plan, as they would be compensated by commissions on investment products. Baxter would charge a minimum of $1,000 if he was not going to be managing the assets. IE