“Financial Checkup” is an ongoing series that discusses financial planning options. In this issue, Investment Executive speaks with Linda Hancock, a consultant at Investors Group Inc. in Ottawa and Tony Katarynych, senior financial planning advisor at Assante Capital Management Ltd. in Orillia, Ont.



The Scenario: a woman, recently widowed, age 60, lives in Ottawa and has never worked. She has a $2-million investment portfolio, of which $1.5 million is invested in the technology firm that bought the company her husband started.

The technology stock, which pays no dividend, has increased by 20% since the client inherited it two years ago. The rest of the portfolio is in government and investment-grade bonds.

The client receives an annual pension of $100,000 from the technology firm and has medical and dental benefits. She has a mortgage-free $1-million home.

She also has two independent children and four grandchildren — ages four, six, seven and nine. She wants to pay for four years of university education for each grandchild, which will cost $20,000 a child per year in today’s dollars. She plans to set up RESPs for them.

The client has no long-term care or critical illness insurance but wants to purchase it; she doesn’t want to be a burden to her children should she become ill or incapacitated.

Her annual income goal is $100,000 after taxes in today’s dollars to age 95, excluding education funding for the grandchildren and the cost of critical illness or long-term care insurance. She also wants to leave $3 million in today’s dollars, including the real estate, to be split between her two children.

She is aware that her portfolio is very risky at the moment and wants to know how to diversify it and how to do so quickly.



The Recommendations: Investors Group’s Hancock thinks the goals are achievable, provided the client lives another five years. She must, however, sell the technology stock and invest in a well-diversified portfolio (60% equities/40% fixed-income) that earns a 6% average annual return after fees. Assuming 3% annual inflation, Hancock estimates this would leave an estate of $4 million-$5 million in today’s dollars should the client die at 95.

But Katarynych, who likewise assumes 3% inflation, thinks the client needs a 6.3% annual return to achieve her goals. That would require 60% of her $2-million portfolio be invested in equities and 40% be put into fixed-income. But he prefers a 50%/50% asset mix for this client because it’s less risky. He suggests the client trim her annual income goal to $80,000 after taxes from $100,000. If she does that, she could have a 50/50 mix which would yield a 6% return and produce a $3-million estate in today’s dollars when she’s 95.

Another alternative is for the client to sell her house and spend only $500,000 on another residence. With an extra $500,000 invested, she could meet her goals without trimming expenses.

Hancock’s 60/40 asset mix assumes the client can tolerate the risk. She suggests using pools, specifically Investors Group iProfile pools. The management fee is a relatively low 1.75% for a $2-million portfolio. In addition, the fees paid for pool funds are tax-deductible, unlike those of mutual funds. Hancock would rebalance the asset mix quarterly. Because Hancock would receive trailer fees, she wouldn’t charge any other fee for managing the portfolio.

Katarynych would suggest a 60/40 mix over the preferred 50/50 split only if the client can’t reduce her annual income requirements. For the equities portion, he would recom-mend F-class mutual funds that are structured as corporate trusts for their tax efficiency; rebalancing is allowed among corporate class funds without triggering capital gains. Assante advisors have access to funds from a wide variety of manufacturers, says Katarynych, and he would select the best available. His preference is exchange-traded funds for the fixed-income portion because of their low fees, with some guaranteed investment certificates mixed in.

Because F-class funds don’t pay trailer fees, Katarynych would charge 50 to 100 basis points for his advice. This would result in an overall fee of 1.5%-2%.

As for the equity breakdown, the moderate iProfile portfolio that Hancock recommends would put 28% in a Canadian balanced and growth pool, 17% in U.S. large- and small-cap pools and 15% in an international equity pool that includes Europe.

@page_break@Assuming a 50% equity allocation, Katarynych would recommend putting only 30%-40% of the equity portion of the portfolio into foreign equities. “Given the strength of our economy,” he says, “and rising demand for energy and other resources that Canada produces, we would want to have a significant exposure to Canada.”

He would put one-third to one-half of the foreign equity into U.S. funds and the rest into funds representing Europe, Japan and Brazil, Russia, India and China. About 5% of the foreign equity would be in small-caps.

Both Katarynych and Hancock would include a small-cap fund in the Canadian equity portion of the portfolio.

Hancock favours a combination of growth and value styles in the pools, probably with a tilt toward value. Katarynych prefers a value approach.

On the fixed-income side, Hancock would suggest investing 25% of it in Investors Real Property Fund, 25% in an income fund that includes corporate as well as government bonds and 50% in a mortgage and short-term income fund.

Katarynych would use ETFs for the bond portion of the portfolio and put about 15% of the total portfolio into GICs. He would buy bonds only if interest rates spiked and he could lock in good returns.

Neither Hancock nor Katarynych thinks alternative investments are appropriate for the client. Hancock considers them too risky and Katarynych thinks there is no reason to complicate the portfolio, noting the difficulty in figuring out risk in these vehicles.

If Katarynych couldn’t persuade the client to trim expenses or downsize her residence, he would recommend universal life insurance, which is the “most cost-effective way to replace any shortfall in the estate goal,” he says. He suggests that a $1-million policy would be enough.

If the client put an additional lump sum — say, $300,000 — into the policy at the start, she could use the income generated by the policy to pay the annual premium and get some tax-protected asset growth as well. The premium would be around $18,000 a year, assuming she’s a non-smoker in normal health.

Hancock agrees on universal life but recommends the widow purchase a $2-million policy, which would cost about $36,000 a year.

Both advisors emphasize that the client should sell the technology stock as soon as possible. In her high tax bracket, there is no advantage to taking the capital gains into income over two years rather than one — and the sooner she sells and reduces the risk in her portfolio, the better.

However, if the client sets up a charitable foundation with $100,000 of the proceeds of the sale of the technology stock, Hancock adds, the tax receipt would offset most of the approximately $70,000 in capital gains taxes arising from the sale of the stock.

Katarynych agrees that charitable donations are a good way to reduce tax liability. He notes that charitable donations made in the year of a death can completely eliminate tax liability. Any tax deduction room left over can be applied to the previous tax year.

Neither Hancock nor Katarynych thinks the client needs critical-illness or long-term care insurance. “It’s fairly expensive at older ages,” says Katarynych. A $100,000 CI policy would cost about $2,500 a year; a $200,000 policy, $4,800 a year. A $100-a-day long-term care insurance would cost $2,800 a year; long-term care insurance that pays $2,000 a week would cost $5,900, assuming she is in normal health and a non-smoker.

Hancock notes that if the client were to increase the premiums by one-third, she could purchase a return of premium rider, and get her premiums back if she didn’t make a claim.

“Given her level of assets, it may be a viable alternative for her to set aside her own funding for any health issue,” says Katarynych.

Hancock agrees but puts it differently, saying that with the client’s assets, she is essentially self-insured; her income would cover whatever care she required and her house could be sold if she had to go into an assisted-living facility. Hancock adds that if the client buys a $2-million life insurance policy, that would free up $2 million of her assets to pay for these costs in her lifetime without cutting into her estate.

As for CI insurance, both Han-cock and Katarynych say it is probably not appropriate at her age. People in their 40s and 50s are most vulnerable financially when they suffer strokes, heart attacks or develop cancer.

For the grandchildren’s education, Hancock recommends individual RESPs because the money is then earmarked for each grandchild. She’s not worried about flexibility because of the ease in changing beneficiaries for RESPs.

Hancock further suggests the money be given to the client’s children, who would set up the RESPs. This ensures that the funds are not part of the grandmother’s estate if she dies while the RESPs are still in operation. As well, each of the client’s children would be responsible for his or her own children’s education funding and for making decisions about what to do with the money should a grandchild decide not to pursue higher education.

Hancock also recommends putting aside an additional $2,500 a year a child in non-registered accounts because education costs are rising faster than overall inflation; more than the $20,000 a year a child in today’s dollars may be needed.

These accounts could be in the grandchildren’s names, in the children’s names or jointly in the grandmother’s and children’s names. It depends on how much control the grandmother wants and whether she is prepared for the money to go directly to the grandchildren if they don’t go to university.

Katarynych says that if RESPs are set up now and catch-up payments are made, most of the grandchildren’s education costs will be covered. He suggests making an initial lump-sum contribution of $24,000-$28,000 depending on the age of the child. He thinks it’s important that the money all be put into the RESPs to make sure it’s used for education costs.

Katarynych also suggests using family plans, which would allow more flexibility when dispersals are made. He notes that it’s important that the grant and investment income portion of the RESP be withdrawn first so that all the education assistance payments — which are taxed in the grandchildren’s hands — are exhausted first. That would leave the original contributions, which are not taxable.

Both Hancock and Katarynych suggest the client set up testamentary trusts in her will because of the significant tax savings they produce. Any withdrawals would be taxed to the trust and not added to her children’s incomes. The trust files separate tax returns for disbursements to each beneficiary and for income left in the trust. So, if each beneficiary received $10,000 a year, the trust would be taxed separately for each of those disbursements, resulting in a lower overall tax bill.

Beneficiaries could be grandchildren as well as children. Both Hancock and Katarynych warn that spouses of beneficiaries should not be included to ensure they don’t get any of the assets in the event of a marital breakdown. IE