Can John retire and meet his goals?

John and his ex-wife, Adrienne, each make around $80,000 a year and have joint custody of their 14-year-old son Ricky, so there’s no alimony or child support involved. Adrienne is supposed to pay half of Ricky’s expenses, including four years at university out of town. But John is worried that she won’t come up with the money. There is $40,000 in a registered education savings plan, but that will cover only part of Ricky’s university expenses.

The couple have sold their $900,000 mortgage-free Vancouver-area home and John is renting a two-bedroom apartment close to downtown Vancouver for $2,000 a month. He has $400,000 in RRSPs, $600,000 in non-registered assets (including his share of the proceeds from the house) and $20,000 in a tax-free savings account. His term-65 life insurance has just run out; he has no other insurance and thinks he has no prospect of getting any because he has a heart condition.

John is receiving full Canada Pension Plan and old-age security benefits, and believes he can keep his personal annual expenditures to $40,000 after taxes. But he also will need to contribute about $7,000 annually (including his half of the RESP contribution) to Ricky’s expenses and might have to come up with the full $14,000 during the next four years. John will have to contribute even more when Ricky goes away to university.

John wants to know how long he needs to work full-time in order to: pay for the full cost of Ricky’s support now, as well as his university education if necessary; spend $40,000 a year in today’s dollars; and have enough assets to cover basic institutional care if John needs it. He’d like to leave Ricky some money, but doesn’t feel it will be necessary if Ricky gets a good education.

John is prepared to consider options such as buying a condo if that is advisable, getting Ricky to contribute to his expenses with a summer job or possibly even part-time work during the school year, and, if necessary, have Ricky take out a student loan.

The recommendations: Doyle says John will need to work full-time until he’s 71 to ensure he meets his goals if he continues to rent. However, he would be able to quit working at 68 if he buys a condo for $350,000. Doyle estimates that would reduce John’s monthly expenses by $1,400.

Doyle is assuming a 5% average annual return after fees on all financial assets except the RESP, for which he uses a 3.5% return, given the relatively short time line before the money will be needed. He assumes inflation of 3% for everything but education costs, which he increases at 5% a year. He assumes John lives to age 90, and says the plan works even if his ex-wife doesn’t contribute and John needs to pay the total cost of Ricky’s university expenses, which Doyle’s assuming will be $20,000 a year in today’s dollars.

Widdifield thinks John could retire at 70. His projections use a 5% return for all accounts and 3% inflation for all expenses except education, which he also has increasing at 5%. He ensured there would be sufficient funds should John need to shoulder all of Ricky’s expenses now and through university. Widdifield is assuming John will continue to rent because he thinks buying a condo would have a negative impact on John’s lifestyle.

“In Vancouver, you get a lot more bang for your buck by renting,” says Widdifield, who points out that a $350,000 condo almost certainly would be less pleasant and less convenient than the apartment John is renting now. Furthermore, Widdifield questions whether there will be much future appreciation in a condo, given that the Vancouver market “really shot the lights out in the past 10 years.”

In Widdifield’s projections, he is assuming the rent will rise with inflation but, he notes, the increases could be even less. He particularly likes the fact that John won’t have to worry about repair costs, pointing to the unexpected expenses that can come with home ownership.

However, to cover all the bases, Widdifield suggests that John develop a backup plan should it turn out John is unable to work full-time for another five years, either for health reasons or because the work isn’t available. One possibility might be working part-time in his 70s, assuming that he can find the work.

Both advisors think it would be good for Ricky to contribute to his own expenses – and not just to alleviate the burden on his parents. As Doyle puts it: “Parents often wish to pass good money values along to their children.”

Widdifield suggests John sit down with Ricky and explain the reality of the financial situation. Even with maximum RESP contributions, an additional $6,000 a year in today’s dollars will be required for four years of university. That’s a manageable goal for Ricky, as he could earn that much working summers during his university years. Even if he makes just $3,000-$4,000 per summer, that would lessen considerably the amount in student loans he might have to borrow. In the meantime, while he’s still in high school, he could consider a summer job to provide pocket money and perhaps some savings for university.

Both advisors recommend that a testamentary trust be created in John’s will for his son. Most parents don’t want to see their children having access to a large amount of money when they reach the age of majority, which is 19 in British Columbia.

A testamentary trust would allow John to choose an older age or to dictate gradual access to the funds. This would allow John to choose a trustee to take care of Ricky’s money until he gets control of it. In the absence of such a trust, Adrienne likely would control whatever John left for Ricky while Ricky is a minor. (See story on page B6.)

In addition, the trust would protect Ricky from possible financial demands from his mother, as it would be the trustee who would make such decisions. Widdifield notes that a trust strategy also would protect these assets from future creditors or spouses, including common-law spouses.

Doyle points out that the trust income would be taxed separately from Ricky’s other income, potentially providing a great benefit for him once he’s working.

Doyle recommends that John speak to a family lawyer about his rights and options should his ex-wife not meet the divorce settlement’s conditions. It’s good to be prepared so he can act quickly if the need arises.

Doyle doesn’t think John should rule out life insurance. A heart condition doesn’t necessarily preclude getting life or medical insurance. Coverage is possible, although premiums can be 150%-300% higher than regular premiums, says Doyle: “Some heart conditions are rateable. It’s important that John explore all the options, as sometimes expensive coverage is still far better than no coverage at all.”

Doyle also notes that some ratings are temporary and may be removed after a certain length of time. For example, a client of his had suffered a transient ischemic attack (sometimes called a “mini-stroke”) as a result of a congenital heart condition. The condition was repaired through surgery and, following a series of tests, the insurance company was satisfied that the risk no longer existed and removed the rating.

Another possibility for John to explore, Doyle says, is group insurance if he belongs to an association that offers that or other benefits.

Doyle also suggests that if John’s heart condition is hereditary, he might explore critical illness coverage for Ricky.

Widdifield suggests a 55% fixed-income/45% equities asset mix for John. The fixed-income portion would have more of a slant toward corporate bonds than in the past, reflecting today’s low yields on government bonds. The equities portion would be fairly evenly diversified among Canada, the U.S. and international. In addition, Widdifield might include some dividend-paying stocks.

Doyle’s asset-allocation suggestion is similar, but the fixed-income would include a mix of corporates, government bonds and preferred shares. And, depending on John’s exact risk profile (which would be revealed through a detailed discussion) and prevailing conditions in the financial markets, the fixed-income target could be as high as 60% and as low as 40% (with the balance in equities). Doyle’s projections assume a 50/50 fixed-income/equities mix.

Doyle also thinks a guaranteed minimum withdrawal benefit plan could be a good solution for around 30% of John’s non-registered portfolio, especially if John doesn’t anticipate having to touch those assets over the next 10 years, which would maximize the bonuses in the GMWB.

Widdifield is less enthusiastic, saying he doesn’t think a GMWB is needed unless John is really nervous about equities markets or worried about running out of money.

Both advisors recommend investing in corporate-class mutual funds, as capital gains taxes are deferred until John sells his units in a fund. When John needs to start withdrawing money, Widdifield would suggest tax-efficient, systematic withdrawal plan funds, in which the income initially comes as return of capital. For example, John could purchase $600,000 in TSWP funds that distribute 8%, so he would pay almost no taxes in the early years on the $48,000 he would receive.

Neither Doyle nor Widdifield would charge for developing a financial plan of this type because they would get their compensation through the fees and commissions received when managing John’s assets. IE

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