“Financial Checkup” is an ongoing series that discusses financial planning options. In this issue, Investment Executive speaks to registered financial planners Michael Berton, with Assante Financial Management Ltd. in Vancouver, and David Cox, with IPC Investment Corp. in Edmonton.



Scenario: Andrew, 58, sells consumer electronics on commission. He expects his earnings to drop to $40,000 this year from $60,000 in 2008 and $70,000 in 2007. His 55-year-old wife, Joanne, is a self-employed journalist, who also anticipates a drop in earnings this year, to around $15,000 from $30,000 in 2008 and $35,000 in 2007.

Andrew is worried that it could take two to three years before his annual earnings once again reach $70,000 in today’s dollars. Joanne is even more worried; she fears that a couple of the magazines for which she writes may fold. That would make it four to five years before her annual income returned to the $30,000 level.

The Halifax couple have made maximum RRSP contributions each year and have some non-registered investments, the result of inheritances from deceased parents. Andrew has $400,000 in his RRSP and $125,000 in non-registered assets, all invested in balanced mutual funds, which declined by 20% in 2008. Joanne has $250,000 in RRSP assets, all in fixed-income, plus $100,000 in non-registered assets invested in balanced mutual funds, which likewise declined by 20% last year.

Andrew and Joanne estimate that the value of their home has dropped about 30% over the past year to $400,000. They have a $150,000 mortgage with a fixed interest rate of 6% amortized over 15 years and up for renewal in two years. They also have $10,000 each in credit-card debt, accumulated in the past year as a result of the shortfall in both of their incomes.

Both have disability insurance ($3,000 a month tax free for Andrew and $1,500 a month tax free for Joanne) and term life insurance ($400,000 for Andrew and $200,000 for Joanne) to age 65.

The couple have two independent children and five grandchildren. They had expected to retire at age 65 and to have an annual joint income of $50,000 in today’s dollars after mortgage payments and taxes until age 95. They want to know if this is feasible and, if not, how much they need to tighten their belts both now and in the future. They also want advice on critical illness and long-term care insurance. They would like to leave an estate.



Recommendations: Both Berton and Cox agree that $50,000 in today’s dollars can be generated to age 95 — but it will be tight. Cox recommends Andrew and Joanne look carefully at their expenditures and see if they can trim their income goal to about $45,000 a year, in order to build a $100,000 emergency fund.

Berton recommends looking at expenditures that could be postponed for the next few years — such as renovations, appliances, furniture or new cars — until their incomes recover. However, Cox points out, renovations that are needed should be done this year in order to take advantage of the Home Renovation Tax Credit, announced in the Jan. 27 federal budget.

Both advisors strongly recommend that the couple use non-registered assets to pay off credit-card and mortgage debt. The credit-card debt should be paid off immediately and the mortgage as soon as possible without incurring penalties, at the very least, in two years, when the current mortgage expires. Cox notes that, because mortgage payments come out of after-tax income, paying a 6% mortgage is equivalent to a 10% return on financial assets. Since neither advisor believes 10% is a realistic return, it doesn’t make sense to continue the mortgage.

There is one caveat: in most provinces, inherited assets that are used for a family expenditure, such as paying off a mortgage, become family property and would be treated as joint assets in a divorce.

Once the $150,000 mortgage is paid off, Andrew and Joanne could take out an investment loan for up to the equivalent amount. This could make sense since the interest on the loan would be tax-deductible. But neither advisor is specifically recommending this. Rather, they say, the spouses should discuss this option in order to determine whether they have sufficient risk tolerance and whether they feel they really need the additional income that could be generated from an investment loan.

@page_break@The two advisors strongly urge the couple to set up tax-free savings accounts and contribute the maximum $5,000 a piece. They can transfer money from non-registered accounts for whatever they can’t achieve through savings. Cox suggests the TSFAs house the couple’s emergency fund.

Even with the assets they have left after paying off debt, Andrew and Joanne should be able to generate $50,000 in today’s dollars to age 95. Neither advisor is assuming a big bounce back in equities markets because, as Berton puts it, it’s better to assume a worst-case scenario. Then, all the surprises are on the upside. Berton’s projections assume an average annual return of 6%. Cox’s projections use a 5.2% return on the couple’s RRSPs and 6.5% on non-registered assets. Both advisors assume 3% inflation.

In his projections, Berton has Andrew’s employment earnings at $40,000 for 2009, 2010 and 2011, $55,000 for 2012, and $70,000 only in 2013. After that, he assumes Andrew’s earnings will rise by 2% a year. Berton leaves Joanne’s income at $15,000, but with a 2% annual increase from 2011 onward.

Berton’s projections show Andrew and Joanne running out of money at age 95, although they will still have the house. Berton is assuming the house will rise in value by 5% a year; Cox by 6% a year. That will be their estate.

Cox took a different approach, calculating what the couple would need in assets to generate $50,000 a year in today’s dollars. The answer was $1.2 million to $1.3 million in 2016 dollars when Andrew is 65; he projects that they will have $1.28 million at that time.

Andrew and Joanne may not get as much income from the Canada Pension Plan as they expect. To get the maximum pension, you have to have made the maximum amount ($46,300 for 2009) every year you have worked, and you must have worked 40 years. Cox assumes that Andrew will get 85% and Joanne 50%. He suggests that Joanne apply for a child-rearing dropout adjustment, which would increase her entitlements.

To ensure they will have enough income, Cox suggests the couple buy a joint life annuity with 60% of their assets, which will probably pay close to 8.75% annually until they are both deceased. This is better than investing directly in bonds, because the payments would go on if they live longer than 95 and the fee is lower than for guaranteed minimum withdrawal benefit funds.

Berton would use a combination of a life annuity (30%-40% of assets), GMWB funds (40%-50%) and conservative growth mutual funds (20%). He notes that, although GMWB funds may guarantee less income than an annuity, they have the potential to keep pace with inflation through market growth and offer potential increases in future income through resets in the guaranteed withdrawal balance. They also have the potential to create an estate.

Both Berton and Cox recommend that the couple turn their RRSPs into RRIFs at age 65 and start making withdrawals. Not only will they each get the $2,000 pension credit but, as Cox notes, once Joanne is 65, they can split up to 50% of all registered and CPP income.

Berton also suggests that Andrew set up a spousal RRSP and make his RRSP contributions to it, thereby building up Joanne’s RRSP to the same level as his. Although Andrew can split RRIF income with Joanne, Berton feels it’s better that Joanne have more assets in her own name.

Cox notes that Joanne, as a self-employed individual, could apply for early CPP benefits at age 60 if she takes a month or two off work. She could then resume working and keep the benefits.

Cox views insurance as a risk-management tool and recommends clients decide what percentage of their budget to spend on it. In this case, Cox would recommend a joint first-to-die permanent life insurance policy for $250,000. He notes that there is a build-up of cash in universal life policies that could be considered as an emergency fund or provision for long-term care.

The cost for such a policy — about $700 a month or $8,400 a year — would be about 10 times what they are paying for their existing term life policies and they would have to make room for this within their $50,000-a-year expenditures.

Berton thinks buying long-term care insurance should be the priority in terms of insurance, because the care, if needed, could seriously erode their assets. He recommends a joint policy providing up to $6,000 a month in facility care and $3,000 a month for home-based care, with up to $300,000 in total benefits.

Ideally, Berton says, Andrew and Joanne should also have life insurance, but only to pay the taxes due upon the death of the surviving spouse, although the house could be sold to cover those expenses. He suggests the couple consider converting their term policies, which are expensive and will expire soon, to a permanent last-to-die life-insurance policy.

Andrew and Joanne could also consider critical illness insurance paying $100,000 each, but this would cost about $235 a month for Joanne and $390 for Andrew — or $7,500 a year for the two policies. That is probably beyond their means unless either their incomes or stock markets recover quickly.

Assuming they purchase life annuities for the fixed-income portion of their portfolios, Berton suggests investing the rest in equity mutual funds or growth-oriented balanced funds, depending on market conditions. He doesn’t favour exchange-traded funds, which he feels have not performed well in recent turbulent markets.

Berton would charge about $1,000 to develop a plan for the couple and would expect to redo the plan every five years, or more frequently if warranted. The fee for ongoing monitoring would be negotiated, with the commissions related to the sale of insurance and investment products taken into consideration.

Cox would expect to charge about $625, including $125 for the initial interview, to develop or redo a plan. As long as he’s managing the money, monitoring would be covered by the commissions he receives. IE