“Financial Checkup” is an ongoing series that discusses financial planning options. In this issue, Investment Executive consults Mike Carter, a certified financial planner and president of MC Planning Ltd. in Toronto; and Dustin Regehr, a CFP and financial planner with Assante Financial Management Ltd. in Edmonton.



The Scenario: Tom, 55, and Anne, 45, are having to reassess their lifestyle. Tom, an advertising executive in Winnipeg, expects his income to fall by 33% this year, to $80,000 from $120,000. Anne has lost the marketing job she has held for the past 20 years with a manufacturing firm. She loses $70,000 in annual income, although she did receive $60,000 in severance.

The couple have a number of financial obligations. They have three children aged 8, 10 and 12 and they pay a nanny $30,000 a year to care for them. The 10-year-old has a learning disability and attends a private school that costs $15,000 a year; the couple’s greatest desire is to keep him in the private school until he finishes high school.

They also want to pay for the university education of all three children, if possible. They do not have RESPs.

Two years ago, Tom and Anne bought a new home for $600,000. They estimate it is now worth $400,000 — equal to their mortgage, which is financed at 6% amortized over 25 years. They do pay for mortgage insurance.

In terms of savings, Tom has $300,000 in his RRSP, invested in balanced mutual funds; Anne has $150,000 in her RRSP, in fixed-income. The couple also have $100,000 in non-registered assets and each expect to inherit $500,000 (in today’s dollars) when their parents are deceased. Tom’s parents are 80 and Anne’s are in their early 70s. All four are in good health.

Both Tom and Anne have term insurance to age 65: $500,000 for Tom and $250,000 for Anne. Tom has disability insurance through his employer.

Anne would like to stay at home until economic conditions improve and she can get an equivalent job. She expects that will take a couple of years.

Until the change in circumstances, Tom and Anne had been spending $115,000 annually after taxes. They believe they can live on $70,000 a year by cutting the expensive family vacations (which cost $15,000 a year), firing the nanny and selling Anne’s car. That does not include the $15,000 they need for their son’s private-school fees or $10,000 for an emergency fund.

The Recommendations: Carter believes the couple can meet their goals without counting on inheriting from their parents, provided:

> Tom’s income returns to $120,000 in today’s dollars in 2010 and he works until he is 65;

> Anne receives employment insurance benefits of $20,000 in 2010. (Her EI benefits will not kick in until then because of the severance benefits she received this year);

> Anne gets a job paying $70,000 in today’s dollars in 2012 and works until she is 55;

> expenditures, excluding the private school fees, are held at $80,000 a year in today’s dollars — $70,000 for regular spending and $10,000 for the unexpected;

> their house is downsized in 2034 when Tom is 80, resulting in $150,000 in assets in today’s dollars, which would be invested;

> their investments have an average annual return after fees of 3% for cash, 4.5% for fixed-income and 7% for equities, with inflation averaging 3% a year.

Regehr isn’t as optimistic as Carter, even though he assumes a 7% average annual return and 3% inflation. The reason: he thinks Tom and Anne’s spending will bounce back to $115,000 when their incomes bounce back.

If that is the case, the couple will be able to spend only $70,000 a year in retirement, provided they inherit $500,000 each from their parents. If they don’t inherit, they will need to lower annual expenditures to $60,000. Like Carter, Regehr doesn’t recommend counting on inheritances.

Regehr does believe, however, that keeping expenditures to $60,000 — excluding private-school fees — should be feasible. In his view, Tom and Anne have been spending far too much; when they do serious, detailed budgeting, they will probably find that they can reduce their expenditures more than they think.

Both Carter and Regehr recommend that Anne roll $10,000 of her severance into her RRSP using a retiring allowance — as is allowed, given her 20 years with her former employer. In addition, Carter suggests Anne use another $12,600 of the severance for an RRSP contribution based on her 2008 earnings.

@page_break@The rest of Anne’s severance, plus most of the couple’s non-RRSP assets, will be needed to cover the anticipated shortfalls in income they will experience during the next three years.

In Carter’s scenario, the $100,000 in non-registered assets will be replaced in the future seven years that they will both be working and making 2008-level salaries.

But Regehr suspects the non-registered assets won’t be replaced if Tom and Anne go back to spending $115,000 a year. So, one option for Tom and Anne is to take out a home-equity line of credit on their home, which they could do if they pay $80,000 on their mortgage principal. This would give them an extra $20,000 a year and reduce the amount needed from non-registered assets over the next three years.

Regehr doesn’t recommend the LOC, however, because Tom and Anne won’t be reducing the principal owed on the house and, furthermore, it might encourage them to spend the extra money. Much better, he says, if Tom and Anne don’t take a financial hiatus and continue to deal with their liabilities.

Carter suggests that a home-equity loan might be worth considering after they pay off the mortgage. That would allow them to continue living in their home until Anne is 95.

Still, Carter does not recommend such a loan; he feels that downsizing will make more sense. He notes that the house will probably be too big once the children move out. He also points out that even when there are no financial reasons, many people downsize when they are around 70, so they won’t have to do as much work around the house and the yard.

Regehr feels strongly that Tom needs to increase his term insurance to $900,000 to ensure that if anything happens to him, Anne has enough income if she can’t find another job, not only for living expenses but also to pay for their son’s private school.

The cost of the additional $400,000 in coverage would be about $118 a month, or $1,416 a year.

Carter also thinks Tom should have higher life insurance coverage; $800,000 would be sufficient.

Tom and Anne don’t have enough income to pay for critical illness or long-term care insurance, and neither advisor recommends such policies.

The couple also won’t have enough income to contribute to their RRSPs or to set up and contribute to RESPs during the next three years. Carter recommends they resume RRSP contributions and set up a family RESP in 2012. Family RESPs provide more flexibility than individual accounts for each child, allowing the money to be divvied up according to each child’s choice. For example, one child might not pursue post-secondary education, while another may want to pursue a post-graduate degree.

Regehr agrees that both types of registered plans are important and suggests splitting any savings the couple have in any given year between the two plans.

Regehr assumes that Tom and Anne will have enough income to contribute to an RESP after 2012. If in each year after 2012 they put in the maximum contribution of $4,000 per child under the age of 18, they should have enough to pay the tuition, books and associated fees for four years of post-secondary education for each child.

Their middle child won’t qualify for the disability tax credit because it doesn’t appear that his learning disability is severe and prolonged enough to meet the Canada Revenue Agency’s guidelines. Tom and Anne should ensure, however, that they claim the child tax credit and any qualifying fitness tax credits.

Carter also suggests that the couple check with the private school their son attends to see if any portion of the tuition fee is eligible for the tuition fee credit or qualifies as a charitable donation.

In addition, Carter recommends that the couple pool all medical expenses and that Anne claim them, in order to maximize the couple’s medical tax credit.

(Medical expenses can be used for a credit calculation when they exceed the lesser of 3% of taxable income or a specified figure, which is $1,962 for the 2008 tax year. As a result, explains Carter: “There is often a greater credit when the lower income-earning spouse does the calculation.”)

Tom and Anne need to have up-to-date wills, including designated guardians for the children and powers of attorney and personal directives, all with appropriate backups should something happen to any of the people named in these documents.

Tom and Anne also need to have a detailed discussion with their financial advisor to establish each spouse’s risk tolerance. Regehr suspects this will show that Tom’s holdings in balanced investment products are appropriate, but that Anne’s fixed-income holdings are more conservative than her tolerance level requires.

Anne should probably be in a more balanced portfolio, Regehr says, with an asset mix of 40% fixed-income and 60% equities. His projections are based on this equities asset mix for the couple’s combined assets.

Carter agrees that Anne could use an asset mix similar to Tom’s, but says the couple will still have enough money if Anne sticks to 100% fixed-income. Thus, there is no reason to increase her portfolio risk.

If the couple find that they want or need to increase expenditures, they could allocate a portion of Anne’s portfolio to equities.

Carter recommends that Tom gradually eliminate his equities holdings over the next 10 years. In his view, once Tom and Anne are retired, they need to preserve all their assets, and should stick with fixed-income.

Carter also recommends that the couple always have sufficient funds in cash-like investments to cover three to six months of family expenses.

Both advisors suggest the RESP monies be 50% fixed-income and 50% equities — although, again, Carter suggests that the equities portion be reduced over time, so that when the third child is ready to start post-secondary education, the RESP is 100% in cash equivalents or high-quality, short-term bonds.

Regehr favours managed wrap programs for both equities and fixed-income. He suggests that the equities portion be split evenly among Canadian, U.S. and international equities.

Carter says Tom and Anne have two options. If they are comfortable with managing investments on a “passive” basis and have sufficient knowledge, they can use very basic index funds or exchange-traded funds.

If they prefer seeking advice, they qualify for private investment management and pooled funds, which offer lower management fees than for mutual funds.

Regehr does not charge for financial plans if he is managing the money. Carter, who doesn’t manage money, charges $150 an hour for developing a plan, which usually takes 15 to 20 hours, and for ongoing monitoring, which is usually three to five hours a year. IE