“Financial Checkup” is an ongoing series that discusses financial planning options. In this issue, Investment Executive speaks to Gillian Stovel Rivers, a certified financial planner and financial planning advisor with Assante Financial Management Ltd. in Mississauga, Ont., and Noel Tilley, a certified financial planner and consultant with Investors Group Inc. in Halifax.

The Scenario: David and Elizabeth are a couple living in London, Ont. Both are 55 years old. David has just lost his job as a middle manager at a retail firm. He would like to retire and do some volunteer work. He needs to decide whether to take out the commuted value of his pension or leave the pension with his former employer. Elizabeth, who works for a non-profit organization, is prepared to continue working until she turns 65.

David’s salary with his former employer was $100,000 a year — and he received $208,000 in severance for 25 years of service. If he leaves his pension assets with the company, he would get an annual pension of $50,000 (indexed up to 3% a year for inflation) at age 65; or he could start collecting $50,000 a year now, but that would drop to $44,000 when he turns 65.

David would also continue to get company benefits.

Alternatively, he could take the $700,000 commuted value of his pension assets and invest it himself. He also has $100,000 in an RRSP to which he contributed in his previous job, and $300,000 in non-registered assets he had received from an inheritance. All these assets are invested in Canadian balanced mutual funds.

Elizabeth earns $50,000 annually at her job and has $200,000 in RRSP assets (also invested in Canadian balanced mutual funds). Her mother is 83, but in a nursing home and may leave no estate.

The couple owns their home outright, which was worth $700,000 in 2007 but is now probably worth about 10% less than that.

Both spouses have term life insurance to age 65: $500,000 for David and $200,000 for Elizabeth.

The couple were spending about $100,000 a year, not including Elizabeth’s RRSP contribution. They think they could reduce their expenditures to about $75,000.



The Recommendations: Stovel Rivers and Tilley say the couple should be able to achieve their retirement goals as long as Elizabeth keeps working until age 65 — regardless of whether David keeps the pension assets with his former company or takes the commuted value.

However, if David chooses to take the commuted value, Tilley notes, David would end up with just $589,600 in investible assets rather than the full $700,000. That’s because he would be able to transfer only $462,000 to a locked-in registered account, with the remaining $238,000 considered an “excess amount” that would be taxable at a rate of 46.4%.

The annual income generated by the $589,600 would be less than the pension — particularly in after-inflation terms. In addition, the couple would continue to get health benefits through the company if the pension monies are left with the former employer.

Stovel Rivers agrees, in general, that the pension monies should be left with the company. But she notes that if David’s family has a history of short lifespans; or, if he is ill, it could be better to take the commuted value because, should he die within five to seven years, his estate would probably be larger that way than if he leaves the pension assets with the company.

However, this advice assumes David wouldn’t spend all those pension assets on medical care, which would no longer be covered through his former company’s benefits. To mitigate that risk, Stovel Rivers suggests that the couple take out extended health-care coverage if the commuted value is taken.

Without such coverage, the couple should budget a minimum of $2,500-$3,000 a year for basic medical and dental costs, which should increase at inflation plus 1.5%-2% annually. But if the couple take out extended health coverage, Stovel Rivers says, it would more than adequately protect them against catastrophic health-care costs. This strategy would cost about $3,100 a year, assuming they are non-smokers in good health.

One other possibility worth exploring is whether David’s former employer or pension benefits administrator would allow David to leave the pension assets that would be taxable with the company pension plan, says Stovel Rivers. If so, that would avoid the tax bill and David might be eligible for continued health benefits.

@page_break@If the commuted value is taken, both advisors note that under the new unlocking rules for locked-in retirement accounts, half of the value can be transferred immediately into David’s RRSP; they urge that this be done because the rules regarding withdrawals from locked-in registered accounts are more restrictive than for RRSPs.

Both advisors note that David can put some of his severance into his RRSPs without affecting his maximum contributions for the year. This would amount to $2,000 for each year he had worked for his former company before 1996, or $22,000 in total. There would be an additional $1,500 a year for each year he had worked for the company before 1986 if he wasn’t a member of the company’s pension plan at that time; this could potentially amount to another $6,000.

The couple need to monitor each of their incomes every year to determine how much to take out of whose RRSP in order to minimize their taxes. David should also assign $2,000 of his pension income — or RRIF withdrawals, if he chooses to take the commuted pension value — to Elizabeth each year until she stops working, so that she can use the $2,000 federal pension income deduction. The couple should also contribute $5,000 a year each to tax-free savings accounts, which can come out of their non-registered assets.

Given the importance of Elizabeth’s earnings in the next 10 years, both advisors recommend that Elizabeth retain her term life insurance. Stovel Rivers suggests that David’s term insurance be cancelled, assuming the couple is in good health, and be replaced with a joint first-to-die term policy for $200,000-$300,000. A 20-year policy, which would span the period during which their spending is likely to be higher than later in life, would cost about $2,400-$3,100 a year if both spouses are non-smokers and in good health. Such a policy would also produce instant liquidity for the survivor if one of them dies.

Stovel Rivers also recommends that David try to find volunteer work that involves useful skills should he want, or need, to return to work.

Tilley thinks critical illness and long-term care insurance should be considered. He believes it would be affordable and anticipates that the couple would want to look at these products after witnessing how the cost of medical care has eroded Elizabeth’s mother’s financial assets.

Stovel Rivers thinks that, at the couple’s age, CI insurance may be advisable — and she strongly recommends LTC insurance. The best, albeit more expensive option would be a convertible policy, under which benefits not needed for CI would be available for LTC.

One option is a $100,000 CI/LTC policy, with maximum LTC benefits of $1,000 a month if the $100,000 CI payment is not used, in combination with a traditional LTC policy that provides up to an additional $1,000 a month. The CI/LTC policy would cost about $9,100 a year; the LTC policy, $2,300 a year (both over 15 years).

Alternatively, the couple could take out an LTC policy with benefits of up to $2,000 a month, which would cost about $4,600 a year over 15 years.

In all cases, Stovel Rivers suggests a policy with return of unused premiums on death. The couple might also consider policies that return premium on surrender, as these would provide potential emergency funds down the road.

Stovel Rivers also suggests that the couple consider holding their non-registered assets jointly, as this allows for income-splitting, simplifies management of the assets and provides ready access to cash as well as avoiding probate fees when the first one dies. This should only be done if the couple is confident that their marriage is solid, as any assets held jointly would be considered community property in the event of a divorce. This is important because David’s non-registered assets were received from an inheritance.

In terms of investment strategies, Tilley recommends a balanced asset mix of 55% equities/45% fixed-income invested in a portfolio program that uses mutual funds and rebalances twice a year. He would suggest putting most of the fixed-income into the RRSP so the interest income would be tax-sheltered.

Stovel Rivers suggests a similar asset mix and program, but recommends using corporate-class mutual funds or pools that capitalize passive investment income into deferred capital gains. This eliminates the need to put most of the fixed-income into RRSPs. It also keeps the couple’s taxes low because of the deferral of investment income, thereby minimizing the possibility of clawbacks on the income-tested Canada Pension Plan and old-age security benefits, as well as keeping more funds on the family’s balance sheet to grow tax-deferred.

Both advisors would recommend some geographical diversification of about 30% of the equities to minimize risk. But Tilley says the couple shouldn’t have too much foreign currency exposure, given their age and need for steady income.

Tilley would stick to large-cap U.S. and European equities. Stovel Rivers agrees, but would suggest Asian and emerging markets exposure as well in the current environment. She would recommend a managed program that also uses currency-hedging protection where available. She also suggests the couple consider putting 10%-15% of their assets in equities into investments that have a low correlation to large-cap equities, such as global real estate, infrastructure and funds aimed at producing absolute returns.

Both advisors also believe style diversification among the couple’s assets is very important, including value and growth funds.

Tilley assumes an annual average return, after fees, of 6%. Stovel Rivers uses a 5% return for planning purposes, although her investment strategy would aim for a 6%-8% return. Both advisors assume annual inflation of 2.5%.

Tilley’s fees would come from mutual fund commissions. Stovel Rivers charges a service fee based on assets under management; she would also get commissions from the insurance policies she is recommending for the couple. IE