Financial checkup: A year abroad, a cottage and more

Chris and Jessica spend about $75,000 a year after taxes, including RRSP and tax-free savings account (TFSA) contributions and premiums for life and critical illness (CI) insurance. The couple have one car and would expect to buy a new one every four years for about $55,000.

Chris and Jessica own an $800,000 home in midtown Toronto that’s mortgage-free; they have no debt.

Chris has $120,000 in RRSP assets and $38,000 in unused RRSP room.

Jessica will qualify for a pension of about 66% of her average top five years in salary at age 58. She also has $88,000 in RRSP assets and $4,200 of unused RRSP room.

Each partner has $33,000 in TFSA assets, and they have $250,000 in joint non-registered investment assets, with an adjusted cost base (ACB) of $220,000.

Both Chris and Jessica have term life insurance to age 55: $1.4 million for Chris and $800,000 for Jessica, who, through her benefits as a teacher, also has group life insurance worth twice her annual salary. The partners each have $200,000 in CI insurance to age 65. The combined monthly premiums for the life insurance is $120; for the CI, $190.

Jessica’s benefits package includes medical, dental and vision insurance that also covers Chris and the children. The coverage will continue after Jessica retires.

The couple’s goals include taking a year off and living abroad when the twins are 14, which the couple anticipate will cost $100,000 in today’s dollars.

Chris and Jessica also want to save enough to pay for the twins’ post-secondary education entirely, wherever they want to go and for as high a degree as they want. The couple believe this could cost as much as $500,000 in total in today’s dollars, as U.S. schools are a strong possibility.

The couple would like to buy a cottage within 20 years (worth about $500,000 in today’s dollars).

Chris and Jessica want to retire at age 58 and be able to spend $120,000 a year in today’s dollars, after taxes, to age 95.

The recommendations: This is a case in which the real annual average return after fees makes a big difference. Shoemaker assumes a 3.5% real return (nominal return of 5.5% with inflation of 2%). Standon’s view is based on a 2% real return (5% nominal with 3% inflation).

Standon’s projections indicate that Chris and Jessica can reasonably expect to spend only $108,000 in today’s dollars annually during retirement, assuming at least one of them lives to age 95. Standon notes that if the couple eliminate the cottage goal, they would be able to spend around $124,000 a year in today’s dollars. Standon warns that if they still want a cottage, they should be putting $3,600 a month aside for it.

Shoemaker notes that the cottage purchase would have to factor in maintenance costs, which often are higher than those of permanent residences. He suggests the purchase be re-evaluated in 15 years, when the couple will have a good idea of where the twins will be going to university, how many degrees they are likely to seek and the associated costs.

In the meantime, both financial advisors urge maximizing RRSP and TFSA contributions annually, including using up the unused RRSP room.

The advisors also strongly recommend RESPs. Shoemaker suggests annual contributions of $5,000 for each child for the next four years, then $2,500 thereafter to maximize available grants.

Standon recommends a contribution of $5,000 per child now in order to maximize the one-year carry-forward, then about $3,460 annually for each twin thereafter. This would result in maximum lifetime contributions of $50,000 and ensure that the maximum government grant of $500 is received each year, maximizing the tax-sheltered assets in the RESPs.

Standon recommends a family RESP because there may be significant differences in the costs of the twins’ choices. One twin might not wish to go on to higher education, in which case the funds in a family RESP would be available for his brother, minus only the payback of the government grants for the child not continuing his education.

Shoemaker prefers individual RESPs, noting that transfers are allowed between RESPs within the same family.

The RESP(s) won’t cover the full $500,000 in today’s dollars that Chris and Jessica think the education costs could be. So, both advisors suggest a separate savings account be earmarked for education. Shoemaker’s projections assume $1,500 a month, indexed to inflation, will be put into this account; Standon’s assume a fixed $2,560 a year.

Shoemaker also recommends a separate account to save for the year abroad, with $600, indexed to inflation, to be put in each month.

Standon’s projections assume the money for the costs of this trip will be taken out of the non-registered accounts at the time the couple go abroad. Standon notes that the ACB of the non-registered account is reasonably high, so dispositions would have little or no tax consequences during the year abroad, when Chris’s and Jessica’s taxable income will be very low. Standon adds that additional dispositions could also be considered that year in order to raise the ACB.

In Shoemaker’s projections regarding the cottage, a down payment of $100,000 in today’s dollars would come out of Chris’s and Jessica’s non-registered accounts to purchase the cottage. That assumes that interest rates are relatively low at that time. If they are high, Shoemaker would recommend a higher down payment or even outright purchase.

Since this goal is so far into the future, Standon’s projections assume the cottage will be purchased with cash.

Regarding insurance, Standon thinks more life insurance is needed. Shoemaker agrees that the couple’s current term insurance could be increased.

Standon notes that Chris and Jessica will be relying heavily on disciplined saving and investing in order to meet all their goals. None of this will happen without income, so he sees the need for significantly more term insurance. He suggests a total of $5 million on Chris’s life, held in a combination of a $4-million term-10 policy, and a $1-million term-20 policy. The cost would be around $3,700 a year for the first 10 years, at which point the 10-year term would be dropped and the 20-year would remain, costing $1,600 a year until the end of the 20 years. He also suggests a $3.5-million policy on Jessica’s life, held as a $2.75 million term-10, and a $750,000 term-20. The annual premiums would be about $2,700 for the first 10 years, then $1,000 for the second decade. (These figures are based on standard, female non-smoker rates.)

Standon also recommends permanent insurance to fund taxes upon death. This can be accomplished through the use of a joint last-to-die, guaranteed 20-pay participating life insurance policy. The premiums for this policy would end after 20 years, which closely coincides with the couple’s planned date of retirement. Chris and Jessica then would have an asset that is fully guaranteed, regardless of market performance, with the potential for an increasing death benefit and cash values through non-guaranteed dividends. About $12,600 in annual premiums would obtain $500,000 of coverage today, which is likely to grow to about $2 million each by age 95. (Standon’s projections assume a current dividend scale minus 1%.)

A participating life policy also would provide the option of accessing the cash in the policy. While the cost of taking out this insurance would lower the amount of assets available for retirement, accessing policy cash values would provide Chris and Jessica with the opportunity to supplement their income in retirement if needed.

Standon notes that there could be tax consequences, depending on how the cash values are accessed. Tapping into the policy’s cash value also would lower the eventual death benefit, so any plan to access the cash value would need to ensure that there will be sufficient assets to cover any outstanding tax liabilities at death.

Shoemaker agrees that participating life insurance would be a good idea, particularly because Chris and Jessica are considering purchasing a cottage. Shoemaker would suggest a policy with the option for additional deposits, as a possible way to generate retirement income down the road

Standon thinks Chris and Jessica will need long-term care (LTC) insurance, as there is a good chance at least one of them will need care at some point. Standon recommends that the couple buy 20-pay policies now that provide benefits of $1,000 a week with a 30-day waiting period and an unlimited benefit period. The annual combined premiums would be around $5,000 if purchased now.

Shoemaker agrees that an LTC policy would be a good idea. He suggests similar policies but doesn’t think the couple need to purchase them until age 50.

On the estate planning side, Shoemaker suggests Chris and Jessica consider a testamentary trust in their wills for control of the assets intended for the children after the death of both partners. This trust also could provide for income-splitting opportunities for the surviving partner – if that is still allowed at the time; the federal government has initiated a consultation on eliminating the graduated taxation of trusts.

Stanton agrees that a spousal trust is a good idea.

Assuming a moderate risk profile, Shoemaker recommends an overall asset mix of 50%-60% equities and 40%-50% fixed-income, but notes that the separate accounts for education and the trip abroad should become more conservative as the time for those funds to be spent draws near. For the equities portion, Shoemaker suggests mutual funds that provide geographical, sector, capitalization and investment-style diversification.

He also suggests mainly corporate and some high-yield bonds in the fixed-income portion for the time being but would include exposure to Investors Group’s unique Real Property Fund, which Shoemaker considers a fixed-income investment because of the steady returns from the properties the fund owns.

Standon’s suggestions for the portfolio mix are similar. He also recommends some real estate or infrastructure investments, but would count them as equities.

However, Standon also suggests that the couple consider putting the assets needed to generate income to meet core needs into mutual funds with guarantees, such as target-dated funds. He notes that target-dated funds would be particularly useful for the money earmarked for the twins’ education.

Both advisors are compensated through both product fees and commissions.

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