“Financial Checkup” is an ongoing series that discusses financial planning options. In this issue, Investment Executive speaks to registered financial planners Kyle Richie, senior executive consultant with Investors Group Inc. in Oakville, Ont., and Russell Todd, senior financial consultant with Todd & Associates Financial Knowledge Inc. in Calgary.



The Scenario: The clients are a couple in Toronto. The 58-year-old husband has just lost his $150,000-a-year job in the risk-management division of a bank. He is receiving $300,000 in severance and full benefits for 18 months. He is tired and stressed, and doesn’t plan to find a similar job — if the couple can afford it.

His 53-year-old wife is a nurse earning $70,000 annually with full family medical and dental benefits, including disability and term life insurance to age 65. She believes her job is secure and plans to work until she turns 65. She has an indexed pension for 60% of her final salary.

The wife has $100,000 in non-registered assets invested in Canadian banks and insurance stocks. The husband has $700,000 in RRSPs — $250,000 in fixed-income and $450,000 in equities that are broadly diversified by sector and geography. He also has $300,000 in non-registered assets — $100,000 in fixed-income and $200,000 in the shares of the bank at which he previously worked.

The couple have three independent children living in Toronto. The couple have also just paid off their home, worth $800,000 in the current market; $1 million before house prices recently declined.

Up until the husband lost his job, the couple had been spending about $100,000 a year after paying taxes and making mortgage payments and the husband’s maximum RRSP contributions. They believe they could live on $70,000 after taxes in today’s dollars but would welcome additional income. They don’t plan to leave their children an estate but would be happy if they could.

They would consider moving to a smaller city in southwestern Ontario, where real estate is cheaper. They could buy a satisfactory house for $500,000 and free up more capital. The wife can easily get a transfer.

They also want to know if they should take out critical illness, long-term care or life insurance.



Recommendations: Rich-ie says the husband can afford to retire. Assuming a conservative average annual return of 6.2% after fees and 3% inflation, the couple’s savings will generate enough income to meet their $70,000-a-year goal. Add in 2% annual appreciation in the value of their home and, Richie projects, they will have an estate of almost $4 million in today’s dollars when the wife is 95. He uses a very conservative amount for real estate appreciation; he doesn’t want clients to fall into the trap of depending on selling their homes to generate sufficient income.

Richie says the husband will take the severance for 18 months and after that recommends a minimum withdrawal of $10,000 from his RRSP each year.

Todd is prepared to say only that the couple have enough financial assets to generate $70,000 a year to age 95 and keep their home. He is assuming an average annual return of 4%-6% and inflation of 2.5%. He admits 4%-6% is very conservative but prefers not to overestimate the projected future income stream.

To ease the couple’s financial situation, Todd recommends the husband take a low-stress job paying $25,000-$30,000 a year for the next five years. The husband is too young to retire, Todd says, and would benefit from a new focus. This would also minimize withdrawals from investment capital for that period, a positive strategy in today’s markets. A further point: once the husband isn’t working, the wife may want to retire as well. So, it makes sense for the husband to earn money in the interval.

In five years, the husband can access Canada Pension Plan benefits and withdraw from his non-registered account, allowing his RRSP to continue to grow until age 71.

Todd suggests the husband transfer as much of the severance as possible — probably $200,000 — into his RRSP. The remaining $100,000 can be taken in monthly instalments for 18 months. Or, the rest of his severance could be paid out in 12 months or less, provided his wife’s benefits package provides adequate coverage.

Richie notes that RRSPs are not a tax-savings strategy but rather a tax-deferral strategy; there are other ways to save and invest money, he says, that will yield higher returns in the long term. He recommends the clients consider a $300,000 investment loan, as long as they clearly understand the risks. Interest would be tax-deductible and payments would come from the husband’s non-registered account.

@page_break@Even assuming a 6% interest rate on the loan (vs the current 4%) and a 6.2% average annual return after fees, this would significantly increase the husband’s non-registered liquid assets over time. Richie’s calculations suggest that this will result in a mix of 40% RRSP assets and 60% non-registered assets by 2020, vs the current 64%/36% mix.

Todd points out the clients have an uneven distribution of financial assets and suggests an asset swap to shift taxable investment income to the wife. Assuming the house is jointly owned, the wife could swap her half in exchange for $400,000 of her husband’s non-registered assets. In addition, Todd suggests the husband set up a spousal RRSP and fund it to the maximum allowable to facilitate with income splitting in retirement.

Neither advisor recommends the couple move to a smaller city. While downsizing their residence could free up capital to invest and provide additional income, the couple have enough assets that they can keep their home. As well, says Todd, the couple should carefully consider the ramifications of moving away from their children, any grandchildren and friends, as well as favourite activities. Richie is also a bit skeptical of the benefits of downsizing their residence.

“In theory,” he says, “they could end up with $300,00-$500,000 in financial assets, but I’d like to see it happen before I believe it.”

Richie and Todd agree the couple’s insurance needs are limited. They have adequate investment capital and personal real estate value to provide for the survivor and no stated estate goal. However, both advisors agree that the clients could consider a limited amount for peace of mind.

Todd recommends a joint first-to-die policy for about $100,000 and thinks the couple should explore CI insurance, which has “some merit at their ages.” He considers LTC coverage unnecessary at their stage of life.

Richie, on the other hand, thinks the wife should look at CI and that the couple should explore the cost-effectiveness of an LTC policy.

Both advisors agree that the couple’s wills and personal and property powers of attorney need to be reviewed and updated.

Todd also suggests a standard spousal trust, ensuring the home and investment capital are retained for the surviving spouse’s use before distribution to the adult children upon that spouse’s death.

Richie recommends including an option for a spousal trust in their wills; it could be used if it benefited the surviving spouse’s tax situation. He also suggests testamentary trusts for each of the three children. Each child would be the trustee for his or her own testamentary trust and the beneficiaries in each case would be the child and his or her issue. Testamentary trusts are taxed separately, which in many cases means neither the trust nor the beneficiary ends up in the top tax bracket.

Both advisors suggest the husband reduce the number of bank shares he holds. How fast he does this will depend on capital gains considerations and market conditions.

“The long-term strategy is to get that holding down to less than 10% of the total portfolio,” says Todd. Even if it takes time to reduce the position, the shares are producing income and the dividends may rise, given the bank’s record of dividend increases. In addition, banks are a core part of the world economy, so his portfolio shouldn’t be damaged by holding them. The strategy, Todd adds, is to “sell systematically rather than a fire sale.”

Richie recommends that no stock be more than 5% of the portfolio, but he can live with 10%. He notes that if the shares are exchanged for a financial services equity fund or an exchange-traded fund, that would increase diversification.

Todd suggests an asset mix of 35% Canadian and global fixed-income, 5% cash, 30% Canadian equities and 30% global equities, including the U.S., Europe, other industrialized countries and emerging markets. Two-thirds of the time, the average annual return over 20 years for this asset mix is 8.7% before fees. He also recommends sector as well as geographical diversification for the equities. The global fixed-income could range from 5%-20% of the fixed-income portion and global equities would be divided 50/50 between the U.S. and the rest of the world.

With more than $1 million in assets, Todd says, the clients have enough for professional discretionary management using pooled funds or segregated securities. The fee for this would be 1.1%-1.4%.

As a fee-only planner who doesn’t manage money, Todd would charge $4,000-$4,500 to develop their retirement security plan and investment strategy. Fees for ongoing advisory services would be charged annually.

Richie recommends a 20% fixed-income/80% equities asset mix in the near term to take advantage of market pricing anomalies. The fixed-income would be in the RRSP, except what the couple need to live on in the next five years. Once markets bounce back, Richie suggests moving to a 35% fixed-income/65% equities asset mix. He wouldn’t rush to add more foreign equities because, he says, Canadian equities still look relatively attractive.

Neither advisor suggests alternative investments in this case because a third of the couple’s net worth is already in real estate.

Corporate-class mutual funds are Richie’s investment vehicles of choice; they are tax-efficient because interest, dividends and capital gains aren’t taxed until the funds are sold.

Those he would suggest would have management expense ratios of around 2.5% for the equities and 1.5% for the fixed-income. Assuming he ends up managing the money, Richie would not charge a separate fee for developing the financial plan. IE