Jill’s dream job means less pay

Jill is single and owns a mortgage-free house worth $300,000. She has $20,000 in a tax-free savings account (TFSA) and $300,000 in her RRSP. She has been living comfortably on her salary, including the expenses of a car, and has been able to make full RRSP and TFSA contributions. She believes she can cut her expenses by about $6,000 a year by dispensing with her car, but knows that her RRSP contributions will drop and that she should purchase disability insurance if she takes the new job.

The recommendations: Both Hope and Taglieri say that Jill should be able to meet her goals – assuming she can keep within her budget and save as much as she thinks she can.

“The proposed reduction in income and increase in expenses point to the importance of her current lifestyle cost as a crucial factor in the potential for success,” says Hope, who offers a series of six questions to help establish Jill’s financial characteristics and lifestyle pattern:

1. How did Jill eliminate her mortgage and accumulate her retirement savings? Assuming that she has always been single and that her income has steadily increased over time to the current $60,000, she either must have lived a very frugal lifestyle or experienced a significant infusion of capital, perhaps by inheritance. If it was the former, Jill’s transition to a lower income may be easier. If it was the latter, she may have difficulty adjusting to her lifestyle in her new job and in retirement.

2. What does Jill do with her annual income-tax refund? Does she use it to maximize her TFSA or is the money put to other uses?

3. What is Jill’s current lifestyle like? This question isn’t just about whether she can manage without a car but involves all aspects of how she spends money in order to determine whether she faces serious challenges adjusting to a lower income. “The objective is to discover Jill’s state of mind,” Hope says, “and to gain insights into her lifestyle objectives.”

4. How important is it for Jill to continue living in her current house? Has she considered downsizing now to create more potential growth in her assets than the increase in the value that her current home offers?

5. Where does Jill see her future in the new job compared with where she is likely to be if she stayed in her current job? Why is the job at the veterinarian clinic her dream job? Does Jill just like cuddly animals or is she an animal activist? Does she think the clinic has strong growth prospects, making the job secure and with potential increased responsibility, good wage increases and perhaps the possibility of a partial ownership in the clinic?

6. Why does Jill think she needs $30,000 in today’s dollars during retirement when she will no longer be contributing to her RRSP?

If Jill can provide assurances that she is indeed the saver she appears to be and can continue to maximize both her RRSP and TFSA contributions, Hope sees no problem with Jill taking the new job. Indeed, his projections, based on an average annual compound rate of return of 5%, annual inflation of 2.8% and Jill retiring at age 65, suggest that Jill will probably be able to spend $30,000 a year in today’s dollars into her 90s without relying on the Canada Pension Plan (CPP) and old-age security (OAS).

With CPP and OAS factored in, Jill’s position is even better, although Hope notes that Jill will be affected by proposed changes to the age of eligibility for OAS, so the level of income from this “should not be considered guaranteed.”

Taglieri also would explore Jill’s financial and lifestyle parameters by having Jill work through a cash-flow document. This would help Jill track her monthly spending and also paint a realistic picture of her spending and saving habits. For example, Jill expects to save $6,000 a year with no car; but has she taken into account the transportation costs she would incur for public transportation, taxi fare, etc.?

Taglieri’s projections indicate that Jill can reasonably expect to meet her retirement income goal. This advisor has, though, included OAS benefits, which will be needed, given his lower assumed average annual return of 4% and slightly higher inflation rate of 3%.

Hope, although not licensed to sell insurance, obtained a quote on Jill’s behalf for $3,000 in monthly disability insurance with a 120-day waiting period for about $200 a month. He also obtained quotes for $25,000 in critical illness (CI) insurance for 15 years for about $75 a month and enhanced health and dental insurance, which would cost $125 a month.

These costs would have to come out of Jill’s cash flow, underlining the importance of understanding her lifestyle. Says Hope: “Jill needs to understand fully the value of the benefits she is surrendering if she takes the new job and the true cost of continuing them through private coverage.”

Hope also suggests that Jill, in her role as office manager at the clinic, explore the possibility of the clinic providing benefits for its employees. Because of the small staff, there might not be much savings in cost compared with the price of individual policies, but there is the possibility that the clinic could pick up part of the cost. In addition, Jill should see if there is a provincial or national body that the clinic might be able to affiliate with in order to offer these benefits at lower cost to both the employer and employees

Taglieri’s rule of thumb for disability insurance is 65% of gross income. In Jill’s case, that would be about $2,700 a month of coverage at a cost of $150-$200 a month, which Jill must pay out of her employment earnings. He doesn’t suggest CI, long-term care or enhanced medical and dental insurance unless Jill is confident that she can find the money for the premiums out of her employment income.

Jill should have a will and both medical and property powers of attorney. If she wants to leave money to charities related to animals, she can do so in her will and also could consider life insurance if she can find the money for the premiums. Hope also notes that Jill may be able to convert her current term policy to a personal policy without having to requalify for coverage.

Both advisors say it’s very important that if Jill uses money from a savings account, her TFSA or a lending institution to cover unexpected expenses such as a new roof or furnace, she repays those funds. Hope would like to see Jill set aside an emergency fund but would be OK with her borrowing from her TFSA. Taglieri would prefer Jill set up a home-equity line of credit as a backup to use for such expenses after establishing a reasonable emergency reserve.

Taglieri would advise Jill to focus her TFSA account on the long term and not use it as a short-term funding vehicle unless absolutely necessary. Positioning a TFSA for long-term growth enables Jill to take full advantage of the tax-free earnings available.

Because all Jill’s assets are in tax-sheltered investments, there’s nothing that she can do to save taxes now. However, if she finds herself with some non-registered money from, say, an inheritance, Taglieri would suggest Jill invest those assets in corporate-class mutual funds, in which the lion’s share of capital gains taxes are deferred until the fund units are sold.

Both advisors recommend a multi-manager investment program with broad geographical and sector diversification.

Hope suggests a 40% fixed-income/60% equities asset mix as the beginning strategy in a program utilizing F-series mutual funds, in which advisor compensation is stripped out. Fees would be no greater than 1%, with management expense ratios not exceeding 1% for equity funds and 0.75% for bond funds.

“Attention to costs is imperative for client success,” Hope says. For example, he adds, a 0.5% per year reduction in costs, assuming a 5% average rate of return, could increase the value of Jill’s RRSP by $50,000 over the next 15 years, not including the increase due to future contributions.

Taglieri recommends 60% fixed-income and 40% equities.

Neither advisor would suggest Jill invest in a guaranteed minimum withdrawal benefit (GMWB) fund, noting that fewer and fewer GMWBs are being offered by insurance companies and that the fees for GMWBs still available have risen.

Neither advisor would charge to develop a plan of this kind, as they would be compensated through either fees or commissions for managing Jill’s assets. IE

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