“Financial checkup” is an ongoing series that discusses financial planning options. In this issue, Investment Executive speaks to registered financial planner Gayle Harris, senior vice president with T.E. Financial Consultants Ltd. in Calgary; her associate consultant, Paul Gainor; and Doug Lane, RFP, branch manager with IPC Investment Corp. in Burlington, Ont.

Scenario: a 53-year-old single woman in Toronto has just inherited $1 million after taxes.
A middle manager earning $70,000 a year before taxes, she has $300,000 in RRSPs invested 50% in bonds and 50% in Canadian equity mutual funds. Her salary has been sufficient to cover her expenses, including $1,850 a month in rent, taxes and maximum RRSP contributions. She has no pension at work but qualifies for the maximum Canada Pension Plan benefits.

The client doesn’t want to work longer than she has to, but she wants to enhance her lifestyle while working by spending an additional $10,000 a year after taxes in today’s dollars. Once she retires, she wants enough income to travel and pursue cultural and sporting activities. In that case, she would spend $70,000 a year after taxes in today’s dollars until age 80; at that time, she expects her income needs to be about $50,000 a year after taxes in today’s dollars.

That’s assuming she stays healthy. She is concerned about needing long-term health care and wants to know if she should buy insurance or put money away to cover possible health-care expenses.

She also wonders if she should buy a condo, and when she can reasonably expect to retire. Will she have sufficient funds to meet her income goals to age 95, as well as provide for long-term care if needed? She has no estate goals, but anything left over will go to nieces and nephews.

How should she invest her assets to generate sufficient income and minimize downside risk?



Recommendations: given her parameters, Lane says, the client can retire at 57 and still meet her income goals. Assuming she has put her inheritance into a non-registered account, Lane projects an annual return of about 6% after fees on that account, and 4% on her $300,000 RRSP, for an overall average annual return of 5.5%. He is assuming inflation of 2% a year. Buying a condo for $300,000, which clearly appeals to the client, would delay her retirement only until age 59.

Harris, on the other hand, says the client needs to rethink her after-80 income goals; spending requirements may not drop in later retirement as the client anticipates, she says, and, indeed, may increase due to health-care expenses. Accordingly, Gainor’s calculations — which assume an annual return on investments of 6.5% after fees and 3% inflation — lowers the annual income goal to $67,000 after taxes and extends it to age 95. That will allow the client both to buy a condo worth $400,000 and retire at age 60.

In Harris’s view, this is doable. The client has been living on about $21,200 a year, after $22,200 in rent, $12,600 in RRSP contributions, and taxes. That’s $45,800 less than her $67,000 goal. Gainor notes, however, that the client should save some of that $67,000 to create a nest egg for one-time expenditures, such as a new car or a big trip.

As for buying a condo, Harris recommends the client use her inheritance to make the purchase. This would save $16,200 a year (rent offset by condo fees of about $500 a month), providing both the extra $10,000 that the client wants for additional spending before retirement and $6,200 in additional savings.

For his part, Lane suggests that the client purchase the condo with a down payment of $100,000 (from the inheritance) and a $200,000 mortgage amortized over 25 years. The mortgage payments plus condo fees and taxes would be roughly equal to the $1,850 a month she has been paying in rent.

The client will be better off investing most of her inheritance and taking out a mortgage, Lane argues. He notes that the rate on a five-year fixed mortgage is currently low, around 5.25%, and he’s assuming a 6% return on the non-registered investments.

Lane thinks the value of the condo could increase by 4%-5% a year, nicely above his 2% inflation assumption. Harris assumes the condo will appreciate by 4% a year, slightly more than the 3% inflation she and Gainor have assumed. Both Harris and Lane note that a risk of condo ownership is that condo fees and property taxes can go up faster than inflation. But they also note that rent can also go up at a fairly rapid clip.

@page_break@Both advisors recommend that the client continue to make maximum RRSP contributions as long as she’s working. They also think she should put $14,000 into a RRIF when she reaches age 65 and take out $2,000 a year, which would qualify for the $2,000 pension income deduction and, thus, not be taxed. But she should wait until the year in which she turns 71 to put the rest of her RRSP into the RRIF.

Harris suggests the client start to collect her CPP pension at age 60. She feels that although the pension will be reduced by 6% for every year before age 65, or by 30%, the client will need the cash flow. Lane, on the other hand, believes the client can get by without the extra cash and should wait until she turns 65.

Both advisors suggest the client put $5,000 a year into a tax-free savings account, which can be set up in 2009. As the return on this money will be tax-sheltered, she should not take it out until needed.

Lane calculates that given a 6% return, this would accumulate about $500,000 in today’s dollars by the time the client is 95, or $190,000 more than the $310,000 the $5,000 annual RRIF withdrawal would have been worth if it was left in her RRSP earning only 4%.

This money could provide an inheritance for the client’s nieces and nephews or a charitable legacy. It would also provide additional assets if she requires long-term care and doesn’t have insurance coverage. The advisors also emphasize the tax efficiency of having most of the fixed-income in the RRSP and most of the equities in the non-registered account.

Neither Harris nor Lane is enthusiastic about long-term care insurance; they think the client has enough assets to pay for care if required. But both advisors think LTC insurance should be explored because the client may want the mental comfort of having a policy. A policy providing $100 a day forever would cost about $1,375 a year for 20 years, assuming the client is a non-smoker in normal health.

As for critical illness insurance, Harris hasn’t been able to make an economically viable case for other clients, but if this client has a family history of any of the illnesses covered by CI insurance, she might want to take out a CI policy. Lane says a 10-year term $250,000 CI policy would cost about $3,100 a year.

In Harris’ view, disability is the client’s greatest risk. Harris assumes the client has disability coverage through her work and suggests she top it up. The problem, though, is that group insurance policies usually provide benefits commensurate with the insured person’s occupation or salary for only two years. After that, depending on the policy, the policyholder may be required to work, regardless of the pay.

Lane thinks life insurance should also be discussed, either now or in the future. People aged 53 often don’t think about their estate, but as the client ages she may change her mind about leaving an estate. A $250,000 term-to-100 or universal life policy would cost about $2,600 a year; Lane notes that the rule of thumb for annual premiums on life policies is about 1% of the policy’s value.

Harris recommends investing the assets — the RRSP and what’s left of the inheritance after buying the condo (in this case, $600,000) — in pooled funds managed by T.E. Investment Counsel Inc., which hires outside money managers.

A balanced asset allocation of 40% fixed-income/60% equities would provide an appropriate level of volatility and growth. Alternatively, if the client is uncomfortable with volatility, a 60% fixed-income/40% equities mix could be considered. The equities would be split evenly among Canadian, U.S. and international equities; the fixed-income portion would be a mixture of passive and active management. Harris believes that both the geographical diversification and the mix of styles used in the pools enhances returns and minimizes volatility.

Harris thinks $540,000 invested in equities (60% of the portfolio) is not enough for the client to own individual securities and still be sufficiently diversified by sector and geography. She also warns against the client purchasing individual foreign securities, noting, for example, that owning U.S. stocks would expose the client to U.S. estate taxes. She doesn’t recommend alternative investments; she considers them too risky.

The client’s money would be held in a T.E. discretionary managed account; fees would be 1.75% on the first $500,000 under management, and 0.75% on amounts above that up to $1.5 million, at which point the fees drop further. Harris points out that this is lower than the 2.5% average management expense ratio charged for Canadian balanced funds. The fees would include ongoing monitoring and adjusting the initial financial plan, as well as annual tax preparation and management. There is no charge for the financial plan if the client invests her money with T.E.; otherwise, the fees would be $3,000-$5,000.

Lane, whose plan would leave the client a portfolio of $1.2 million — he would have her take only $100,000 from her inheritance to buy the condo — similarly recommends a 40% fixed-income/60% equities portfolio. But he suggests a bond ladder for the fixed-income portion, probably going out only five years because the yield curve is so flat. He would also suggest including some Canadian preferred shares in the fixed-income portion. Some of these investments currently yield about 5% and are eligible for the dividend tax credit.

On the equities side, he suggests 20% in Canadian stocks, 15% in U.S., 10% in international, 10% in emerging markets and 5% in real estate. He recommends that much of this be invested in exchange-traded funds but adds that the portfolio manager or investment counsellor chosen may suggest some individual stocks. He doesn’t manage discretionary money himself but would recommend managers in whom he has confidence.

Lane doesn’t recommend alternative investments, either, except real estate, but says the money manager may suggest them. He adds that the money will have to be managed in a way that doesn’t generate big capital gains in any given year.

Lane says a typical fee for this type of money management would be 1% of assets under administration. He would charge for the financial plan, probably $1,500-$2,000 in this case. IE