“Financial Checkup” is an ongoing series that discusses financial planning options. In this issue, Investment Executive speaks to Steven Armstrong, associate portfolio manager for investments, private-client group, and Karen Bleasby, senior vice-president for investments, both with Mackenzie Financial Corp. in Toronto; and Jamie Powell, financial consultant with Investors Group Inc. in Calgary.

The Scenario: Laura is a self-employed bookkeeper in Calgary who has recently lost three of the four businesses that were her regular clients. At 61, she wonders if she should retire: getting new clients will be difficult until the economy has recovered. By that point, she will probably be 63 or 64. She would like to know if she should start collecting her Canada Pension Plan now, while at the same time continuing to do tax returns for individuals for another eight years. She estimates her annual earnings at about $10,000.

Laura had been making $50,000 a year. She has $300,000 in an RRSP, which is evenly divided between fixed-income investments and balanced mutual funds. She also has $100,000 in non-registered assets invested in balanced mutual funds. She owns a house, worth approximately $200,000 and qualifies for only 60% of the CPP pension because she left the paid workforce for 15 years to raise her two, now independent children. Laura has been divorced for 15 years and has four grandchildren, aged eight to 14; she would like to pay for their educations. Her parents are deceased.

Laura’s annual income goal is $30,000 after taxes in today’s dollars to age 95. She would like to leave an estate of at least $100,000, in today’s dollars, to each of her two children. She would also like to know if she should take out long-term care insurance.



The Recommendations: The advisors agree that Laura’s goals are not achievable if she retires now. But they also say that her goals can be achieved if she either phases in her retirement more gradually or lowers either her income or estate targets.

Armstrong’s projections suggest that Laura would not run out of money by age 95; however, she would leave an estate of only around $88,000 in today’s dollars, well short of her goal of $200,000 or more. (All figures are in today’s dollars.) This projection is based on an average annual return of 5%, with inflation of 1.7%, and no appreciation in the value of the house beyond inflation.

Armstrong’s projections assume that the client sells her house at age 80 and that she then begins paying rent of $10,000 a year. He also assumes that she then contributes $500 a year out of her capital to four RESPs.

But Armstrong’s projections also show that if Laura earns $20,000 a year until age 68, or reduces her retirement income goal to $27,000 after taxes, she would probably achieve her goal of leaving an estate of more than $200,000.

Powell’s projections, on the other hand, show Laura running out of financial assets at age 92, although she would still have her house. He’s assuming that she will have annual earnings of $10,000 to age 68, 60% CPP entitlements from age 61, 6% annual return on her invested financial assets, 3.5% annual inflation and 4% appreciation in the value of the house. He hasn’t included RESP contributions because he thinks they could impair her future retirement income.

In order to have $30,000 a year until age 95, Powell suggests Laura phase in her retirement by continuing to service the client she still has, plus doing tax returns for individuals. He notes that about 90% of self-employed people choose the phased-in retirement route, gradually whittling down their client list and not replacing clients who leave.

Alternatively, Laura could reduce her annual income goal to an average of $28,500 in today’s dollars. Powell notes that living expenses tend to decrease as people age, so Laura could plan to spend $30,000 until age 73, then $27,500 until 82 and $25,000 thereafter. The major risk with this approach is that she may have higher health-related costs as she ages.

The advisors disagree on when Laura should start taking her CPP pension. Powell recommends starting immediately because she needs as much income as possible and there is always uncertainty about how long she will live. But Bleasby thinks she should wait until she’s 65 so that she gets as much as possible from the CPP from that point onward. Both advisors suggest that Laura apply for the child-rearing dropout provision, which would increase her CPP pension.

@page_break@They agree that Laura should start a tax-free savings account this year and put the maximum $5,000 in each year, transferring funds from her non-registered assets, preferably interest-bearing investments to help reduce her tax burden.

All three advisors agree that Laura should wait as long as possible before turning her RRSP into a registered retirement income fund and making withdrawals. In other words, she should use up her non-registered assets and TFSA monies first. Armstrong expects she will have to start converting RRSP money at age 69, while Powell thinks the withdrawals can be postponed until 71, the maximum age permitted by the government.

To further reduce Laura’s tax burden, Powell suggests that Laura look at investments that could defer capital gains taxes for assets in her non-registered funds, such as capital-class or T-series mutual funds.

However, Bleasby doesn’t think there would be an advantage to using these vehicles because most of Laura’s assets are in her RRSP and the proportion that are registered will increase over time. The best way for Laura to minimize her taxes, Bleasby suggests, is for her to hold off withdrawing from her RRSP for as long as possible. All the advisors recommend that she make maximum RRSP contributions and use up any unused RRSP room.

Although Powell does not recommend that Laura make RESP contributions from her non-registered assets, he does suggest that Laura contribute to one if she can save enough from her annual spending target of $30,000 or $28,500, whichever ends up as her goal, or if she makes more than $10,000 a year.

There are additional grants for RESPs for the children of Alberta residents born in 2005 or later: those amount to $500 at birth, and $100 at ages eight, 11 and 14.

Bleasby notes that the federal RESP grants depend on the tax situation of the parents of the children in question. For the 2009 tax year, the grant on a $500 contribution would be $200 if the parents income is less than $37,885, $150 if their income is $37,885-$75,758 and $100 if their income is higher.

In Powell’s view, Laura probably can’t afford to take out critical illness insurance, given a cost of about $3,800 per year for $100,000 of coverage, payable to age 100. But he would strongly recommend long-term care insurance, which would cost about $210 a month, or $2,500 a year. Those premiums would entitle her to an unlimited $500 per week tax-free benefit, assuming she is a non-smoker in good health. Laura would have to find this money out of her annual income.

Armstrong and Bleasby don’t have expertise in this area. They suggest that Laura talk to an insurance agent about her options.

The advisors note that Laura should make sure that she has a current and valid will that has been prepared by a lawyer to make sure that there are no matrimonial issues outstanding from her divorce. Adult beneficiaries should be listed for her RRSP, to avoid probate taxes and ease the transition. A personal memorandum indicating who should receive specified personal assets is also a good idea. Powell also recommends ensuring that there is a current enduring power of attorney and personal directive.

Powell suggests that Laura could ensure that the education needs of her grandchildren are met if she passes away before they finish their schooling by establishing testamentary trusts for them in her will. Or she could establish testamentary trusts for her children, in order to lower any tax burdens created by their inheritances, as such trusts are taxed separately.

Other estate-planning possibilities, says Powell, include prepaying for funeral expenses or buying a life insurance policy for, perhaps, $20,000 to cover the costs of her funeral and estate administration expenses. The annual premium would be about $1,200. The big issue for Laura is going to be cash flow and whether or not there is going to be sufficient spending room to afford such insurance.

In terms of investments, Powell suggests a target asset mix of 40% fixed-income/60% equities in a portfolio mutual fund that automatically rebalances the asset mix. He prefers that fixed-income investments be in a managed product rather than individual bonds, which will reduce the interest rate risk. He recommends focusing on the standard deviation of funds to ensure that those that are chosen have a risk/return balance that is appropriate for the level of risk Laura is comfortable with. He would also recommend that 20% be kept in funds with foreign content. A global fund is best for this purpose, he says.

Armstrong and Bleasby take a much more conservative approach to investments: they recommend that 80% be held in fixed-income investments in a non-registered account, with 60% fixed-income in the RRSP. Like Powell, they recommend managed mutual funds for both fixed-income and equities.

The two Mackenzie advisors believe the portfolio should be as diversified as possible — by sector, geography and investment style. For the fixed-income RRSP assets, Armstrong suggests 40% in a Canadian bond fund consisting of federal and high-quality corporate issues; 6% in a corporate bond fund; 7% each in real-return and global bond funds; 12% each in Canadian, U.S. and international large-cap equity funds; and 4% in total in real estate, infrastructure and/or precious metal funds to further diversity the portfolio.

For the non-registered assets, Armstrong suggests 54% in a diversified Canadian bond fund, 8% in a corporate bond fund; 9% each in real-return and global bonds; and 10% each in Canadian and global equity funds.

Bleasby adds that programs that create portfolios by putting a number of mutual funds together would be appropriate because of the ongoing rebalancing that takes place.

At both IG and Mackenzie, advisor fees would come from mutual fund commissions, and there would be no charge for the preparation and monitoring of Laura’s financial plan. IE