“Financial Checkup” is an ongoing series that discusses financial planning options. In this issue, Investment Executive speaks to Brad Brain, certified financial planner and registered financial planner with Manulife Securities Inc. and Manulife Securities Insurance Service Inc. in Fort St. John, B.C., and Warren Baldwin, CFP, RFP and regional vice president of T.E. Financial Consultants Ltd. in Toronto.



Scenario: a 55-year-old Vancouver couple recently agreed to pay $20,000 a year for four years so that their 13-year-old grandson, who has a learning disability, can take his secondary-school education at a private school starting next fall.

Now, the couple has discovered that their eight-year-old grandson, the son of another of their three children, also has a learning disability. This child also should take his secondary-school education at a private school, but not until the fall of 2014. For fairness reasons — and because the parents can’t afford the school fees themselves — the couple feel they must pay for the younger grandchild’s education as well. The client couple would also like to pay for the post-secondary education of both grandchildren.

The husband earns $90,000 a year as a commissioned salesman and has disability, medi-cal and term life insurance through his work. His earnings just cover the couple’s living expenses, including maximum RRSP contributions on the husband’s income. He has $500,000 in RRSP assets invested 50% in fixed-income and 50% in Canadian equities, and $200,000 in non-registered assets in Canadian equities. His Canadian equities mirror the S&P/TSX composite index. The wife has $100,000 in her RRSP, all invested in fixed-income. They also have a mortgage-free home worth $1 million.

Earlier in their marriage, the wife worked for 10 years as a bookkeeper. She believes she could return to this and earn about $30,000 a year in 2009 and 2010, and then $45,000 a year for the next eight years.

The couple are non-smokers in good health. They have wills but haven’t updated them since their youngest child started working full-time.

The couple want to know what they need to do so they can pay for the education of their two grandsons and still have reasonable income in retirement. They had hoped to have annual retirement income of $70,000 after taxes in today’s dollars and would like to remain in their home, if possible. They would also like to leave as much as possible to their three children, split evenly.



Recommendations: Both Brain and Baldwin think the goals are achievable. For retirement income, Brain recommends the couple put the $600,000 in RRSP assets into segregated funds that guarantee a minimum withdrawal of 5% a year — a more conservative approach than Baldwin, who suggests they put this money into a balanced pool fund from which they can expect a 7%-8% return after fees. As a result, Baldwin thinks the couple could leave an estate, while Brain’s projections suggest the couple may run out of financial assets by age 95, although they will still have the 5% guaranteed minimum withdrawal and their residence.

But that is the worst-case scenario, and the couple may well leave some financial assets. They may also receive death benefits from the income-plus funds; if the average annual return on the minimum income withdrawal funds is more than 5% plus the management expense ratio, there will be money left at death.

And the estate could be even larger. In Baldwin’s experience, people don’t spend more in retirement than they spent while working. So, he thinks, the couple may have overestimated their retirement income needs, leaving more for their estate.

As for paying for the education of their grandsons, both advisors point out that the private-school costs can be covered by the wife’s income when she returns to work, and they suggest that a family RESP be set up for the two grandsons’ post-secondary education, with maximum contributions, including catch-ups, being made each year.

As well, Brain suggests that $130,000 of the husband’s non-registered assets be put into a separate account — from which RESP contributions are made — invested to produce a return of 4% a year. That account would be invested primarily in fixed-income — for example, a corporate-class money market fund, a guaranteed income certificate ladder or stripped bonds — with, perhaps, 20%-30% invested in equities to provide some growth.

@page_break@With the RESP assets similarly invested, Brain says, this should generate sufficient funds to cover the education costs, assuming a 10% annual increase in school/university fees and a 4% increase in living costs. He estimates that the 13-year-old grandson will need the proceeds from $60,000 of the invested funds and the eight-year-old will need the proceeds from $70,000.

Baldwin agrees with the strategy but not the execution. He suggests that the money, both in the separate account and the RESP, be invested in a balanced pool fund comprising 60% equities.

Both advisors agree that the husband and wife should each put $5,000 a year into tax-free savings accounts. In the husband’s case, this could be part of his non-registered assets that have been set aside for the private-school fees, says Brain. He adds that some of the wife’s TFSA money could also be used for this purpose.

Brain recommends putting the remaining $70,000 of the husband’s non-registered assets into a 10-year term annuity. This would pay about $8,000 a year, of which only $1,000 would be taxable because most of the income is return of capital. He suggests using this income to fund critical illness and long-term care insurance and/or life insurance.

Term 10 CI policies covering each client for $70,000 in the event of a critical illness, with return of premium on death or surrender, would cost about $2,600 a year for 10 years, leaving $5,400 (pre-tax) for other needs. For example, the couple could take out a joint last-to-die universal life policy for $250,000. This would cost about $4,600 a year for 10 years and would enhance the value of the estate they leave.

An LTC policy, with $300,000 of shared lifetime benefits to age 100, protected against inflation and with return of premium on death, would cost about $4,500 a year to age 100, likewise leaving money for other needs.

A permanent CI policy with return of premium on death or early surrender, covering each client for $70,000 and convertible to LTC coverage at age 75 to age 100, would cost roughly $8,000 a year to age 100.

Baldwin agrees that CI insurance, particularly one with a return-of-premium clause, should be considered. But he thinks LTC policies are expensive and believes the couple has sufficient assets to fund any long-term care needs they might have. Nor does he think they need life insurance; they will be able to leave a sizable estate without it.

Both advisors recommend that the couple review and update their wills and powers of attorney. They will probably want to make provisions in their wills to ensure that the education costs of the two grandsons are covered before their estates are split evenly between their three children.

Baldwin suggests a testamentary trust holding sufficient funds to pay the remaining education costs of the grandsons, but with the proviso that the trust ends at a specific date — say, when the youngest grandson is 25 — and then be divided among the couple’s children.

Baldwin suggests the couple invest both their RRSP and non-registered assets in balanced pools managed by T.E. Investment Counsel Inc. These hold 40% in fixed-income, 20% in Canadian equities, 20% in U.S. equities and 20% in international equities.

But he also suggests the couple have some fixed-income assets in their non-registered account, so that they have liquid assets on which they can draw for emergencies, such as major house repairs or income shortfalls. The husband is a commissioned salesman, Baldwin points out, so his income may be lower during the next couple of years as the credit crisis resolves itself.

Baldwin admits this is a poor market in which to be selling equities, but he believes that the sooner the couple move their funds into balanced funds, the better their long-term returns will be. With $450,000 in Canadian equities, they are too exposed to resources and don’t have the sectoral and geographical diversification to provide the best long-term returns. He suggests that sales of their current holdings be staggered over a six-month period.

Brain feels that both Manulife’s and Sun Life Financial Inc. ’s guaranteed income products are “head of the class,” but he prefers Manulife’s. Although Sun Life has more selection, some of its funds are costly. In addition, Manulife’s income guarantee is not pro-rated. Thus, the clients’ guaranteed income base will go up by at least 5% in 2008, even if the deposit is made late in the year.

Brain suggests that RRSP assets for both the husband and wife be split evenly between Manulife GIF Select Harbour Growth and Income Fund and Manulife GIF Select Trimark Global Balanced Fund. Both funds have good managers and are conservatively managed, so their fees aren’t particularly high. In addition, using two funds provides some manager diversification. The Trimark fund also provides geographical diversification, which Brains feels is important, given the small size of the Canadian market relative to world markets.

If both the husband and the wife make maximum RRSP contributions while working and both invest their RRSP assets in guaranteed income products, then, starting at age 65, the husband should have $49,000 a year in guaranteed income in 2018 dollars, or $33,000 in today’s dollars, assuming average annual inflation of 4%. The wife would have $7,750 in 2018 dollars, or $5,200 in today’s dollars. When Canada Pension Plan benefits and old-age security benefits are added, about 86% of the couple’s retirement income objective will be met, even in the worst-case scenario.

But even if the worst-case scenario happens, Brains suggests, the couple could make up the shortfall by spending less or taking out a reverse mortgage.

The couple doesn’t need to withdraw money from the guaranteed income products until age 65, Brains says, and shouldn’t do so. If they start withdrawing early, the income guarantee will last for only 20 years; if they wait until age 65, it will continue as long as they live.

Brain suggests transaction accounts would be the most cost-effective way to fulfil his recommendations. He would not charge a fee for the financial plan.

Baldwin recommends a “fee for service” account, noting that T.E.’s fee for managing the money would be about 1.5% of assets under management. He would charge $3,000-$5,000 for the couple’s initial financial plan, but there would be no fee for ongoing monitoring. IE