“Financial Checkup” is an ongoing series that discusses financial planning options. In this issue, Investment Executive speaks with registered financial planners Sandra Nass, investment advi-sor with RBC Dominion Securities Inc.’ s Nass Wealth Advisory Group in Richmond, B.C., and with Jeff Young, senior manager of financial planning support with Royal Bank of Canada in Toronto.

The Scenario: a couple in Halifax have just retired at age 65. Their goal is retirement income of $80,000 a year after taxes in today’s dollars. They also want to be sure that — should either or both become seriously ill and require expensive care — they won’t become financial burdens to their three children.

In their last year of employment, the husband had annual earned income of $75,000; and the wife, $50,000. This more than covered their $80,000 in living expenses. They have a mortgage-free $700,000 home and their children are independent. They have no insurance.

Neither has a workplace pension, but both have worked since their early 20s and qualify for full Canada Pension Plan benefits. They also have considerable savings.

The husband has $500,000 in RRSPs — $200,000 of which is in fixed-income and $300,000 in Canadian equities — and $800,000 in non-registered assets, all in equities. The latter assets consist of 80%, or $640,000, in Canadian equities (the cost base is $400,000), and 20%, or $160,000, in global equities (cost base of $140,000). The Canadian equities portion of his overall portfolio is 50% in energy stocks, 25% in financial services and 25% in other sectors, with 25% of the overall Canadian portion in small-cap stocks.

The wife has $300,000 in her RRSP, all in FI, and $200,000 in non-registered accounts. Of the latter, 50% is in large-cap Canadian financial services stocks, 25% is in large-cap energy stocks and the rest is in other blue-chip stocks; the cost base is $140,000.

Both husband and wife have reinvested all investment income after taxes were paid.

They want to make sure they can reach their retirement goals. They are not concerned about leaving an estate to their children.



The Recommendations: Assuming average annual returns of 6% after fees and inflation of 3%, the couple won’t have a problem meeting their income goal of $80,000 a year, say Nass and Young. Nass’s Monte Carlo simulation indicates that income goal was met in 50 scenarios of market returns.

Nass’s projections, which use a 6% return each year, show that if one or both live to age 95, the couple would leave an estate of $1.8 million after taxes in today’s dollars, assuming their home appreciates by 3% a year. Young thinks that figure is closer to $1.3 million, based on the assumption the house will increase in value by 1% a year.

But when Nass factors in the cost of health care, assuming that both husband and wife need long-term care for the last 10 years of their lives at a cost of $6,000 a month for each in today’s dollars, there is a 26% risk they will run out of money. Both Nass and Young suggest long-term care insurance may be a good idea, especially if either of the couple has a family history of conditions that require care.

The annual premium on an LTC policy that provides the policyholder with $200 a day in home-care expenses for two years and $300 a day for facility care indefinitely starts at about $7,500 — $15,000 for the couple. That assumes the two are in normal health and are non-smokers. Nass warns that the premiums could increase after the first five years of the policy.

LTC policies offer additional options, such as a refund of unused premiums at death and cost-of-living increases, but at a price. These benefits can be expensive, Nass says, and should be assessed in the context of the overall plan to determine if they are needed.

Both advisors think the couple’s RRSPs require immediate adjustment but differ on what to do.

Young recommends that the husband turn his $500,000 RRSP into a RRIF now, splitting the current $22,000 in minimum annual withdrawals with his wife. This would save taxes because both would qualify for the $2,000 pension income deduction, and some of his RRIF income would be taxed at the wife’s lower tax rate. In addition, it would minimize or even eliminate the clawback of his old-age security benefits, both now and in the future. The wife, Young says, can and should wait until the end of the year in which she turns 71 to turn her RRSP into a RRIF.

@page_break@Nass, however, says it should be the wife who turns her $300,000 RRSP into a RRIF now, while the husband should convert $20,000, enough to generate $2,000 in income a year (which would qualify for the $2,000 pension exemption). He would then leave the rest in his RRSP until he is 71. Nass argues that because they can’t split non-registered investment income and they don’t need more income from the husband’s RRSP, they would be better off having those assets grow as long as possible. Nass adds that her projections indicate that by using this strategy, neither the husband nor the wife would incur OAS clawbacks as long as OAS thresholds increase with inflation.

As for the asset allocation of the couple’s portfolios, Nass recommends the couple lower the equity portion as soon as possible and diversify globally, both of which will help minimize downside risk and enhance returns. She recommends a balanced asset mix, with a target of 5% cash, 40% FI and 55% equities (20% Canadian, 20% U.S. and 15% international). No sector or country outside of Canada would have more than 25% of the assets.

The asset mix in their combined portfolio will vary, depending on economic and market conditions, Nass notes. It will probably take a few years to restructure the portfolio, spreading out the capital gains and thereby minimizing taxes. She also notes that for tax efficiency, the FI portion will be in the RRSPs/RRIFs and equities in the non-registered segment, in order to benefit from both the dividend tax credit and the lower capital gains tax rate. Nass also recommends low turnover in the non-registered segment.

Young agrees in general terms that restructuring is needed — he doubts the couple have the aggressive risk tolerance to match their current portfolios — but he takes a different approach. He doesn’t start with an overall investment stance, but rather ties the investment strategies to the income needs they service.

He suggests dividing income needs into three categories — basic needs, such as food and housing; lifestyle needs, such as entertainment and vacations; and estate needs — and then assigning assets so that they generate the income to meet those needs.

This results in separate investment strategies for each set of assets. For example, if the couple finds that they need only $25,000 a year to cover basic needs, this could be covered by CPP and OAS income. That would allow them to accept more risk in the investment of their assets and take advantage of growth opportunities. Alternatively, if they need more than $25,000 for basic needs, they could buy an annuity to cover this, or could put sufficient assets into a very conservative portfolio product to generate that income.

Both Nass and Young note that goals can change in retirement, including the desire to leave an estate. “As people get older, they tend to want to leave more,” says Nass. That’s one argument for life insurance, she adds; a joint last-to-die whole life or universal policy ensures that some money is left when the last parent dies and can be used to pay capital gains taxes if a sizable estate is left.

Given this couple’s strong cash flow, Nass suggests that the couple take out a 10-year-pay insurance policy for $500,000, with premiums of $15,000 a year. Such a policy allows them to build an investment account within the policy; the returns on the investments within the policy is then used to pay the premiums for the rest of their lives. Assuming a 3.5% investment return, the policy would have a value of around $288,000 in today’s dollars at age 95.

Both advisors add that the couple needs to ensure they have property and personal-care powers of attorney in place, with backups. Retirement is also a good time to review wills.

Nass recommends transaction accounts for the RRSPs because there will be low turnover. Most of the investments should be in FI, specifically a bond ladder of short-term bonds going out about five years — at least, until the U.S. and global slowdown ends and the yield curve gets steeper.

Nass suggests a tax-efficient equity wrap account for the wife’s non-registered assets. The 1.75%-2% fee would be tax-deductible under current tax rules. The husband’s non-registered assets would be best in a fee-based account, Nass adds. She suggests segregated stock holdings that follow a model portfolio but which can be adjusted based on the clients’ tax situation. The overall cost for such accounts are about 1.25% before taxes and 0.9% after taxes. Nass would not charge for developing the financial plan or for ongoing monitoring.

Young says a Royal Bank planner, likewise, would not charge for the development of the plan. He favours managed solutions and would discuss a number of options with the clients. One would be RBC Managed Payout Solutions. There are three versions, each paying specified monthly distributions. The most conservative, comprising 25% equities/75% FI, pays an annual rate of 5%; the enhanced version (35% equities/65% FI) pays 6%; and the enhanced-plus version (55% equities/45% FI) pays 7%.

The clients could use two or even all three of these for portions of their assets. The fees would be 1.55%-1.85% before taxes. IE