Financial checkup: Widower focused on daughters

Jacob works as a middle manager for a manufacturing company, earning $80,000 a year with limited benefits, including short-term disability insurance and basic medical coverage.

Using the $100,000 obtained from his wife’s term life insurance policy, Jacob has hired a housekeeper for $35,000 a year who works from 12 noon to 7 p.m., Monday to Friday. The insurance money will last for another two years, at which point Jacob thinks he and the girls will be able to manage on their own.

Including what Jacob inherited from his wife, he has $600,000 in RRSP assets, $300,000 in non-registered assets and $33,000 in a tax-free savings account (TFSA). There also is $90,000 in a family registered education savings plan (RESP). The family home is worth about $500,000, and has a $100,000, 4% mortgage on it. Jacob has a term life policy for $500,000, with a $1,500 annual premium.

Household expenses, excluding the housekeeper’s salary, were around $40,000 in the past year. But Jacob would like to be able to spend up to $45,000 a year in today’s dollars. He wants to retire at age 65 and spend a similar amount annually until age 95.

The Recommendations: Hamilton and Regehr agree that Jacob should be fine, as long as he doesn’t become disabled or get a critical illness before he retires at age 65. The girls will be OK even if he dies before 65, although Regehr suggests that Jacob increase his term life insurance to $750,000 to be sure.

Given this view, the first priority for Jacob is to obtain disability insurance (DI). Both advisors recommend the DI policy provide a monthly after-tax benefit of $4,300. A quote Hamilton received has annual premiums of $2,400; Regehr’s quote has annual premiums of $3,000.

Both advisors also suggest critical illness (CI) insurance. Hamilton suggests a 10-year policy with a benefit $170,000, which would cost about $2,100 a year. This policy could cover paying off the mortgage and two additional years of employing the housekeeper.

Regehr thinks a CI benefit of $100,000 would be sufficient. His quote was for premiums of $1,100 a year, as he doesn’t think the housekeeper will be needed once the girls turn 14 years old.

Regehr suggests that Jacob replace his current term life insurance with a new term life policy for $750,000. Regehr notes that premiums have dropped in the past decade, so a new policy for $750,000 would have premiums of around $1,360 vs the $1,500 Jacob is paying for his current policy.

Neither advisor thinks long-term care insurance is needed. Regehr notes that now that Jacob is single, he could sell the house if he needs to go into an institutional-care facility. If he needs home care, he can sell the house and rent a suitable apartment.

Both advisors project that Jacob should be able to pay for premiums for the recommended insurance and spend $45,000 in today’s dollars to age 95 without using the equity in his home.

Hamilton projects that Jacob could leave an estate of $3.6 million in today’s dollars at age 95, including the house, which she assumes will appreciate by 2% a year.

Hamilton also used an average return of 6.5% after fees. This assumes that Jacob could tolerate the risk inherent in a 80% equities/20% fixed-income portfolio. A “Monte Carlo” analysis that she conducted, which involves multiple projections using random variables, indicates that this return is needed to ensure a 95% probability of reaching Jacob’s goals. But, Hamilton notes, this asset allocation may be too risky when Jacob nears retirement and should be re-evaluated at that time.

The other assumptions Hamilton used are 2.5% a year for inflation, 2% annual salary increases and 4.5% annual increases in educational costs.

However, Regehr thinks Jacob would be fine with a lower average annual return of 5%, based upon a 50% equities/50% fixed-income portfolio. Combined with Regehr’s other assumptions – inflation and annual salary increases of 2.7%, 7% annual increases in education expenses and annual house appreciation of 3% – his projections indicate an estate of $1.3 million in today’s dollars, including the house, at age 95.

Given that Jacob should have more than enough to reach his goals, Regehr ran a few projections to explore Jacob’s options. In the first scenario, Regehr found that Jacob could retire at age 60 and still be able to spend $45,000 a year. In the second, if Jacob works until age 65, he could spend $55,000 in today’s dollars to age 95. In the third, Jacob still would have enough money if he reduces the risk in his portfolio and earns a return of only 4% a year.

Besides DI and CI insurance, Jacob’s other priority is updating his will and powers of attorney (POAs), as his and his wife’s wills probably left everything to each other and designated each other as executor and the holder of the property and medical POAs. So, Jacob needs to appoint people to hold his POAs, along with backups.

The guardian for the girls probably can be left unchanged, but Jacob should consider naming a backup guardian. Jacob also needs to appoint a trustee for the money left to the girls while they are minors. (Both advisors suggest that this be a different person from the guardian to spread out the workload and avoid conflicts of interest.)

It’s very important that Jacob not name his daughters as direct beneficiaries of his insurance policies, RRSP, RRIF, TFSA and RESP, Hamilton says, because those funds will be held by the provincial authorities until the girls reach the age of majority, at which point the money will be paid out to the children in a lump sum. “In most cases, age 18 or 19 is too young to receive a large lump sum of money, so it is recommended that it be held in trust,” Hamilton says.

This means that Jacob’s will should include testamentary trusts for the girls, with their access to capital increased as they get older. Hamilton emphasizes that Jacob should consult a lawyer with estate expertise.

Regehr agrees with all these suggestions. He also thinks Jacob should keep his mortgage because the 4% annual rate is lower than the return he is likely to earn on his financial assets.

However, Hamilton suggests that Jacob consider paying off his mortgage with non-registered assets and that he take out an investment loan for the same amount because interest on investment loans is tax-deductible while interest on a mortgage is not.

If Jacob keeps his mortgage, Hamilton would like to see it switched to a variable rate – generally, prime minus 75 basis points – to reduce Jacob’s monthly payments. Then, she suggests, put those savings into the TFSA.

Both advisors say Jacob probably can stop making RESP contributions because the funds in the RESP should be sufficient to pay for a “typical four-year degree at a Canadian university.” However, they add, Jacob can continue making the contributions and receive the $500-a-year government grant for each girl because if all the RESP assets aren’t needed, he can get the money back. Regehr explains that the key to this latter strategy is to use the government grant and investment income earned for the girls’ education, thus leaving the contributions to be withdrawn tax-free by the RESP’s owner.

Both advisors recommend Jacob continue to make maximum TFSA contributions if possible, but only Hamilton suggests that Jacob continue to make RRSP contributions.

Regehr says that now that Jacob has inherited his wife’s RRSP assets, he will pay the same tax rate on his eventual RRIF withdrawals as he pays now, so the RRSP contribution deduction isn’t saving taxes over the long run. In addition, having more of Jacob’s assets in a TFSA and non-registered accounts will increase his financial flexibility in retirement.

Both advisors note that Jacob can save taxes by investing in corporate-class mutual funds or pooled funds, from which distributions come in the form of return of capital and Canadian tax-preferred dividends. In addition, Jacob qualifies for a $4,000 annual tax deduction for each daughter for as long as he employs a housekeeper/nanny.

Hamilton and Regehr both favour managed funds for the fixed-income component of Jacob’s investment portfolio and equities that are broadly diversified by both geography and sector.

Regehr isn’t a fan of annuities in this low interest rate environment or of guaranteed minimum withdrawal benefit investments, which, he thinks, are expensive.

However, Hamilton thinks Jacob should consider one or the other of those investments when he retires. Another option, says Hamilton, is an insured annuity, in which part of the annuity payments support a permanent insurance policy that can replace the assets used to purchase the annuity when Jacob passes away. This strategy depends upon Jacob being insurable when he is 65.

Neither Hamilton nor Regehr would charge to do a plan like this if they were going to be managing the assets, as both advisors would be compensated through commissions and trailer fees.

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