Financial checkup: Are this couple’s goals attainable?

David’s practice is incorporated, with income of $325,000 a year. He takes $300,000 in salary each year and leaves $25,000 in the holding company. He has $600,000 in RRSP assets, $31,000 in a tax-free savings account (TFSA) and $800,000 in the holding company’s non-registered corporate account. The holding company is structured with a trust that can pay dividends to the beneficiaries: David, Andrea and the children. David contributes $20,000 a year to his RRSP and $5,500 to his TFSA. He has $35,000 in unused RRSP room and hasn’t made his 2015 contribution yet.

David has a $500,000, 10-year convertible term life insurance policy, inflation-indexed disability insurance (DI) that would pay $10,600 a month and health-care insurance that covers the family.

Andrea makes $150,000 a year, has $250,000 in an RRSP, $21,500 in a TFSA and $40,000 in non-registered assets. She contributes 10% of her salary to her RRSP. She has $15,000 in unused RRSP room and $15,000 in unused TFSA room.

She has DI that would pay $3,000 a month, which is not inflation-indexed, and a $100,000 whole life insurance policy. She also expects to inherit a family cottage, worth $375,000, and $200,000 in financial assets when her parents die.

The couple own a $700,000 home on which there is $240,000 owing. Their monthly mortgage payments are $2,000 and they make $15,000 in prepayments each year.

There is also $65,000 in a family registered education savings plan.

The couple currently spend about $195,000 a year but could reduce this to $150,000 and still maintain a comfortable lifestyle. This expenditure is after taxes, mortgage payments ($39,000, including the $15,000 prepayment), and RRSP and TFSA contributions ($40,500). The annual expenses include $25,000 for vacations.

The couple, who are moderate-risk investors, want to know if they can meet their goals. Andrea also is concerned about the possibility of her business running into problems due to a prolonged absence of either herself or her business partner.

The recommendations: The financial advisors say David and Andrea should be able to spend $150,000 a year in today’s dollars during their retirement to age 95. The couple could spend more, particularly if David takes advantage of the tax benefits of leaving earned income in his holding company for investment purposes. Income he earns as an incorporated doctor is taxed at 19.9% before it goes into his holding company while money withdrawn as salary above $139,000 is taxed at 49.7%. David needs only $240,000 in salary to meet the family’s current lifestyle needs, so an additional $60,000 can be left in the holding company. This will result in tax savings of $17,880 a year.

Once the home’s mortgage is paid off, a further $54,000 can be left in the holding company, increasing the annual tax savings to $33,972.

Further savings will be possible when the children reach age 18. As long as they are pursuing post-secondary education, they won’t be liable for much, if any, taxes. They could get as much as $38,000 in dividends from the holding company’s trust without paying taxes; this money could be returned to their parents.

To protect the children, Oroc recommends a 10-year term life insurance policy for $240,000, which would pay off the mortgage, and a 20-year term life policy of $1.3 million. Both policies would be joint last-do-die policies, with annual premiums of $462 and $3,350, respectively.

Oroc also suggests increasing the couple’s DI policies to provide an additional $7,300 a month for David and $6,500 for Andrea, at an annual cost of $1,870 and $2,943, respectively.

In addition, Oroc recommends $100,000 in critical illness (CI) insurance to age 75 for both spouses, costing $1,560 per year for David and $1,130 per year for Andrea.

Ardrey recommends that David increase his term insurance by $700,000 to $1.2 million and extend the term to 20 years, at which point he should have enough assets to not need insurance. This would cost about $950 in additional annual premiums, assuming David is a non-smoker and in good health. Ardrey thinks Andrea’s current term insurance is adequate.

Ardrey also thinks CI should be considered, but not long-term care insurance, as there will be sufficient assets when the couple are in their 70s or older to cover those costs.

The advisors also recommend that Andrea contribute the maximum she is able to her TFSA. She can start by transferring assets from her non-registered account. When that is depleted, she can get what she needs through a dividend from the holding company.

Neither Ardrey nor Oroc suggests that David’s and Andrea’s unused RRSP room be used up. They don’t want to have to take too much out of RRIFs during retirement, as that income is taxable.

The advisors say that, with two principals, Andrea’s business should have a partnership agreement that sets out how the business is run, including who does what and how decisions are made. The agreement also should set out what happens if one of the partners becomes disabled, dies or wishes to withdraw from the business. Oroc suggests that there also should be a non-disclosure agreement to prevent the partner who is leaving from taking clients or using the firm’s “unique” ideas.

Insurance also could be helpful, including buy/sell insurance to provide bridging financing to the partner buying out the other principal, as well as key person insurance to cover expenses until the departing partner can be replaced.

The couple’s wills and powers of attorney should be updated, and the advisors suggest testamentary trusts for the children in the wills. Such trusts no longer offer tax benefits, but do allow for graduated access to assets should David and Andrea die while the children still are relatively young.

Ardrey also suggests that David consider an estate freeze by adding another level to the holding company’s structure that would permit the use of both preferred and common shares. David and Andrea would hold the preferred shares; the children, the common shares. This strategy locks in the capital gains at the present-day level for David’s and Andrea’s estates, while all future growth and, thus, the taxes owing on it due to capital gains are deferred to the children.

For financial assets, the advisors recommend an overall initial asset mix of 75% equities/25% fixed-income, even though David and Andrea are moderate-risk investors. “Research shows that you reduce long-term volatility and risk with this asset mix, assuming the portfolio is regularly rebalanced,” explains Goodridge.

As the couple nears retirement and their investment time horizon becomes shorter, a smaller equities portion should be considered. However, Ardrey says that the equities portion shouldn’t fall below 60% until the couple are “well into retirement” because stocks provide inflation protection.

The advisors also recommend that the investments be broadly diversified by geography and sector.

Goodridge favours a “growth at a reasonable price” investment style. He also thinks there’s a place for hedge funds for the couple, but not for more than 5% of their total assets.

Ardrey suggests that the couple consider investing up to 10% in a mortgage investment corporation that focuses on one- to two-year secondary commercial loans, which typically yield 7%-9%.

Ardrey and Goodridge are fee-based advisors who charge a percentage of assets under management – in this case, 1%.

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