Financial checkup: Couple should consider insurance

Tom earns $90,000 a year; Patricia, $60,000. They have been spending $60,000 a year after mortgage payments and maximum RRSP contributions but would like to increase that to $70,000 in today’s dollars in their early retirement years (ages 60 to 75) as well as spend an additional $100,000 in today’s dollars on extensive travel over a couple of years soon after they retire. The couple think they could manage on $60,000 in their late 70s and $50,000 thereafter until age 95.

Neither spouse has critical illness (CI) or long-term care (LTC) insurance. The couple don’t want to be a burden on their two financially independent children and would like to leave $300,000 to each child in today’s dollars.

THE RECOMMENDATIONS: Both Freeman and Grady say Tom and Patricia should have no problem in achieving their retirement income and estate goals.

Freeman ran four scenarios. In each case, he assumed that inflation and the appreciation in their house’s value was 2.5% a year, but he varied the return and included or excluded a joint last-to-die life insurance policy for $600,000.

In the worst-case scenario (a return no higher than inflation at 2.5% after fees and no life insurance), the couple’s estate, including the house, would be worth around $600,000 in today’s dollars when they are 95 – enough to leave $300,000 each to their children. If Patricia and Tom take out the life insurance, the estate would be $1.3 million.

If the return is 5% a year, the estate would be about $1.6 million without life insurance or $1.9 million with life insurance.

Thus, Freeman strongly recommends that Tom and Patricia buy a universal life policy. Assuming both spouses are non-smokers and in good health, the premiums would be around $1,500 a month for 40 years. As well, the couple could make additional deposits of up to $24,000 a year.

Grady’s projections are based on 6% annual return with inflation of only 2%. This results in an estate of $2.4 million without life insurance. However, he agrees that Patricia and Tom should consider a life insurance policy to save taxes and to ensure their legacy goal.

Both advisors say that CI and LTC insurance also should be considered. As Grady puts it, both a CI and LTC pose a risk to the overall success of the plan and the couple can easily afford both CI and LTC insurance premiums, so why not eliminate the risk? Grady got a quote of $160 a month for Tom and $120 a month for Patricia in premiums for $50,000 of CI insurance each. The LTC insurance premiums of $2,000 a month each in benefits would cost $130 a month for Tom and $182 a month for Patricia.

Freeman suggests an LTC policy with an unlimited benefit of $52,000 a year. Assuming both spouses are non-smokers and in good health, the combined premiums would be around $560 a month; and, assuming those premiums are paid out of capital, they would reduce the estate by around 5% at age 95. Freeman believes that expense would be worth it because if one of the spouses needed $52,000 a year from age 80 to 95, the estate would be reduced by roughly 40% if the spouses’ portfolio gets an average return of 5%.

Freeman notes that CI insurance is better suited for people younger than Patricia and Tom, who typically require a lump sum of cash and don’t have substantial savings that they can access.

Grady suggests enhanced medical insurance with included travel insurance, given the amount of travelling the couple are planning. This coverage will cost $275 monthly, rising to $350 at age 65. Freeman agrees that enhanced medical insurance be considered.

Tom and Patricia won’t need to withdraw RRSP/RRIF income until they are 72 years old. Grady thinks the couple should wait until they’re 71 to establish their RRIFs: “There’s no need to voluntarily pay additional income taxes by taking withdrawals earlier.”

But Freeman says it might make more sense to establish RRIFs as soon as the couple retire. This would be particularly beneficial if one spouse dies early and unexpectedly. A death can put the survivor into old-age security (OAS) clawback territory and/or a higher tax bracket, as income-splitting opportunities cease.

Freeman recommends that Tom and Patricia defer their CPP and OAS benefits, which will increase those benefits, for as long as possible – i.e., to age 70. But Grady thinks the couple should start taking CPP at 60 and OAS at 65 on the theory that “a bird in hand is better than two in the bush.”

Both Freeman and Grady recommend using corporate-class and T-class mutual funds to defer taxes for as long as possible. In addition, Freeman suggests the couple share their CPP benefits to reduce Tom’s taxable income.

Both advisors recommend that the couple’s wills establish testamentary trusts for the children to reduce the children’s tax burden. Freeman adds that doing this also protects those assets in the event of marital breakdown. Grady adds that Tom and Patricia should state in their wills that their RRSP/RRIF and TFSA assets should go directly to these trusts. This will mean the assets will be outside of their estate and not be subject to probate fees.

Freeman recommends a 60% equities/40% fixed-income portfolio; Grady suggests a 50/50 split. In each case, real estate investments are included in the fixed-income portion.

Both advisors recommend broad geographical and sectoral equities diversification. Freeman suggests about half in Canadian equities while Grady recommends a lower 25%-30%. In both cases, the rest would be split between the U.S. and international equities, with a bias toward the U.S.

Grady suggests that most of the fixed-income be in government bonds, including some global, with some investment-grade corporate bonds. Freeman recommends fewer government bonds and would include both high-yield and investment-grade bonds. Both advisors would include high-yield in the fixed-income component to increase the yield in the current very low interest rate environment.

For the real estate investments, Freeman suggests Investors Group Real Property Fund. Grady recommends global real estate investment trusts, with 60% exposure to the U.S. and 40% to Europe.

Both advisors recommend a managed portfolio rather than individual securities. Doing so not only gives access to professional money management but also allows for tax deferral through corporate-class and T-class mutual funds.

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