Move is in store for these clients

Tom is a salesman who earns about $70,000 a year; Jill is a part-time receptionist who earns $30,000 annually. Neither spouse has a pension or medical benefits at work, but Tom has a $500,000 term life insurance policy to age 65. The couple’s three children are financially independent.

Tom has $400,000 in RRSP assets; Jill, $100,000. Neither spouse has unused RRSP room. They each have $15,000 in tax-free savings accounts, and the couple have just paid off the mortgage on their $600,000 house. They believe they can keep their spending to about $50,000 a year before major house repairs and maximum RRSP and TFSA contributions.

The couple think they will be able to buy a two-bedroom condominium for around $300,000 in today’s dollars in Lethbridge, with condo fees of $500 a month.

Tom and Jill plan to visit their children in Calgary once retired, but haven’t planned major trips. Tom will continue leasing a car until he retires, then buy a car for about $20,000 in today’s dollars and replace it every six years.

Tom and Jill aren’t concerned about leaving money to their children or grandchildren. Both spouses are non-smokers in good health; their parents lived into their 80s.

Tom and Jill want to know if they will be able to continue spending $50,000 a year in today’s dollars in retirement — assuming they save the $17,000 a year they had been paying on their mortgage during the next five years.

The Recommendations: both financial advisors think the couple’s goals are achievable; however, Nagy is a little uneasy. Both he and Aubrey use what Nagy calls “straight-line” projections, which use an average return for each year. Because this is not how markets behave in reality, Nagy also did a Monte Carlo analysis, in which returns vary from year to year. This analysis indicates there is a 76% probability that Tom’s and Jill’s goals will be met.

Nagy says 76% is OK, but he would prefer a higher probability. At 76%, there is some possibility that the couple could run out of money a few years before they reach 95. They would still have the condo, though, and could tap into that equity through a reverse mortgage. Nagy strongly recommends continual Monte Carlo analysis so that the couple can make “lifestyle, portfolio or cash flow” adjustments if needed.

There’s more breathing room in Aubrey’s projections because he assumes a 3% real return after fees vs Nagy’s 2%.

Aubrey has tested his financial plan for the couple by running other projections using 2% and 1% real returns — and found that Tom and Jill could still meet their goals. Aubrey thinks a major reason is his recommendation to put all of the couple’s RRSP assets into guaranteed minimum withdrawal benefit plans when they retire. This guarantees an annual income of 5% of the original assets for life. As well, there’s upside potential: if the value of the assets in the GMWB plan has increased as of each three-year anniversary date, the benefit will be increased to 5% of that value. And this 5% return, Aubrey stresses, is “net of fees.

Nagy would resort to GMWBs if he felt the couple’s risk tolerance was conservative. If they have a moderate risk profile, as they say they do, they can handle some variability in retirement.

Aubrey suggests that the $17,000 to be saved annually during the next five years be put in a non-registered account in Jill’s name because she has the lower income tax rate. Both advisors recommend delaying withdrawals from RRSPs until the non-registered savings have been used up — although the couple should put some assets into RRIFs at age 65 so each spouse can qualify for the pension income tax credit. Both advisors think Tom and Jill can delay transferring all their RRSP assets to RRIFs until they are 71.

Both Aubrey and Nagy recommend long-term care insurance for the couple because their assets could be depleted quickly if they have to pay for extended care. Aubrey recommends an LTC policy with a lifetime benefit — rather than the usual 250 months — of $500 a week tax-free, at a cost of about $1,500 a year for Tom and $2,300 for Jill. The premiums would come out of capital.

Nagy’s quote is for an LTC benefit of $500 a week if Tom or Jill are physically dependent, plus another $500 a week if they’re in an LTC facility. Either benefit would be for as long it’s needed. The annual cost would be $2,600 for Tom and $4,500 for Jill for 20 years; premiums would be paid out of the annual $50,000 expenditures, in today’s dollars, plus the rebates from their RRSP contributions while Tom and Jill are still working.

Aubrey suggests a family drug plan, which costs about $1,200 a year, until Tom and Jill are 65. This would cover up to $10,000 in prescription drugs and some other benefits, including travel insurance, accidental dental expenses and some minor medical treatments. At age 65, Tom and Jill should register for the Alberta Blue Cross plan for seniors. It is free, but they have to register. There’s a co-payment of 30% for prescriptions, with a cap of $25 per prescription. Blue Cross covers up to $25,000 in prescriptions a year. This plan also covers ambulance costs.

Tom and Jill should keep wills and property and personal powers of attorney up to date and review them regularly. Nagy notes that if the couple get a significantly higher return than he’s assuming, their children may want to take out a joint last-to-die policy on Tom and Jill to pay taxes on the estate.

Aubrey recommends a 40% equities/60% fixed-income asset mix but says that 50% equities in the GMWBs can be considered because the guaranteed minimum income stream means there is less risk for these assets — and a higher ratio of equities could result in higher “resets” of that income over the years. He also suggests using corporate-class mutual funds that defer capital gains taxes until the couple sell their units in that specific family of funds.

Nagy recommends only 30% equities, but would increase that to 40% if Tom and Jill indicate they are comfortable with moderate risk. Nagy suggests putting as much of the fixed-income as possible into the RRSPs to shelter the fully taxable interest income, and investing the equities portion of their joint portfolio in dividend-paying, corporate-class mutual funds.

Both advisors recommend the portfolio’s equities be well diversified by geography and sector. Aubrey suggests a target of 18% Canadian, 12% U.S. and 10% international, with the foreign content hedged against negative currency movements; Nagy suggests less global content and would focus on dividend and income mutual funds.

In both advisors’ plans, the TFSAs would be used for “long-term wealth accumulation,” as Nagy puts it, although both he and Aubrey say the TFSAs could be used for emergencies. Aubrey would use these accounts for the least tax-efficient assets.

For the fixed-income portion, both advisors would include some high-yield bonds and real estate, along with actively managed bond funds. Nagy also would include some real-return bonds.

Neither advisor would charge for developing, monitoring and updating the plan, provided they are managing the assets, because they would be compensated through trailer fees and insurance commissions. IE