“Financial Checkup” is an ongoing series that discusses financial planning options. In this issue, Investment Executive speaks with Jeff Bayne, an MBA, certified financial planner and senior executive financial consultant with Investors Group Inc. in Calgary; and Brad Brain, a registered financial planner, chartered life underwriter, chartered financial consultant, fellow of the Canadian Securities Institute and CFP with Manulife Securities Inc. in Fort St. John, British Columbia.



The Scenario: Ian and Janice are a couple in Calgary who are both 60 years old and have lost their jobs in the recession. They have not been able to find replacement jobs yet due to their age. Ian was a middle manager at a food processing company; Janice was a receptionist for a dentist.

Ian, who was making $70,000 a year, received 12 months salary as severance; however, Janice, who earned $40,000 annually, received only two months severance. They have been on employment insurance for the past year, but that has run out. Neither has a pension or health benefits, and their only life insurance is in term policies that end at age 65 — $500,000 for Ian and $300,000 for Janice. Ian qualifies for 100% Canada Pension Plan benefits and Janice for 75%.

Ian has $400,000 in RRSP assets and $200,000 in non-registered assets, $40,000 of which is left over from his severance. Janice has $200,000 in her RRSP and $100,000 in non-registered assets. They also own their home mortgage-free, which is worth about $500,000.

Ian and Janice cut their expenses as much as possible during the past year, to $50,000 after taxes, and believe they can maintain this level of expenditures. This includes $5,000 for travel that they don’t expect to need after age 80. Both have cars. Ian expects to buy a new car at a cost of $20,000 in today’s dollars in both 2020 and 2030, and Janice will replace her car for $15,000 in today’s dollars in both 2015 and 2025.

The couple have three independent children and aren’t concerned about leaving them an estate.

Ian and Janice want to know if they can afford to spend $50,000 a year in today’s dollars to age 95 and whether they should and can afford to take out long-term care insurance.

T

he recommendations: Both Bayne and Brain believe the couple’s income goal is achievable. But Brain, who is assuming a lower average annual real return after fees — 2% (5% nominal return and 3% inflation) vs Bayne’s 2.5% (6% nominal return and 3.5% inflation) — believes Ian and Janice would have to take some of the equity out of their house in order to meet their targets.

In fact, even Bayne’s projections indicate that the situation is very tight for the couple. Both he and Brain would be happier if Ian and Janice can find a way to cut their spending by $4,000 a year (in today’s dollars) in order to build up a nest egg to be used for unexpected expenses.

Brain’s projections have the couple running out of financial assets at age 92 unless Janice and Ian feel they can reduce their spending by $4,000 a year or they use some of their home equity.

Bayne projects $265,000 in financial assets in today’s dollars at age 95, but cautions that the figure is highly dependent on the couple sticking to their financial plan. If Ian and Janice withdraw significant sums in their 60s and 70s, they could find themselves running out of financial assets before they reach 95. Says Bayne: “Assets withdrawn are gone forever.”

Bayne suggests the couple would be better off if they start withdrawing from their registered assets in 2011. His projections indicate they’d have only 214,000 in financial assets at age 95 if they wait until 2016, when they would have to start withdrawing in any event. He explains that waiting to draw down on registered assets results in future withdrawals at a level higher than required (as higher and higher RRIF minimums kick in each year), thus increasing the tax burden.

Brain generally favours taking money out of non-registered assets first, so the registered monies can continue to grow on a tax-sheltered basis. However, he agrees, it may make sense in this case to look at withdrawing registered assets now while the couple has low taxable income. In any event, he says, Ian and Janice should take at least a small amount of RRIF income at age 65 to qualify for the pension tax credit.

The advisors disagree on when to take CPP benefits. Bayne recommends that the couple wait to age 65 because if they live past 80, they will receive more in total than if they start early. But Brain feels that it’s better to start collecting as soon as the couple can, saying, “A bird in hand is worth more than two in the bush.”

Both advisors recommend LTC insurance. Bayne suggests additional basic medical and dental insurance. Brain isn’t sure on the additional medical insurance but would bow to Bayne’s opinion because he lives in the province in which the couple lives.

According to quotes Bayne has obtained, the LTC premium would initially be about $2,200 a year for Janice and $1,450 for Ian — assuming the couple are in good health and are non-smokers — for a policy providing a $500 weekly benefit, starting 90 days after proof of need and for an unlimited time frame.

The cost of the enhanced medical insurance is $1,200 a year for each partner.
@page_break@Bayne assumes a 1% increase in the LTC premium, effective every five years, but no increase in the medical/dental insurance premium. Both advisors’ projections have the premiums are paid out of capital and not included in the $50,000 the couple are spending each year.

Because Ian and Janice don’t necessarily want to leave an estate, neither advisor suggests replacing the term insurance when it expires.

Both advisors recommend keeping the house, assuming Ian and Janice like the neighbours and neighbourhood, and if the house isn’t too big for the couple. They can afford to maintain the property, and it’s an asset that they can sell or use to take out a reverse mortgage when they are older, should they need additional funds for health care or to support their lifestyle.

If Ian and Janice sell the house and have to rent, they will face rent increases and may find that the income realized from both the sale of the house and saving the home-maintenance costs might eventually fail to cover the rent fully, meaning that the couple would have to dip into capital.

Furthermore, real estate provides a desirable diversification of their investments. Bayne notes that the Calgary market has appreciated by an average of 4% a year since the late 1960s.

Brain notes that if the couple need to access their home equity, that income is tax-free.

Both advisors suggest a full review of wills and of property and personal powers of attorney if this hasn’t been done recently. Using one or more of their adult children for the POAs could be a good idea.

Bayne also suggests the couple consider testamentary trusts for their children and/or grandchildren, as these could provide significant tax savings for the children/grandchildren and provide protection of assets in the event that any of them have a marriage breakdown.

Brain adds that the couple should name beneficiaries for their registered savings plans to avoid probate fees, and suggests they talk to their children about their plan.

Besides starting to use the registered assets in 2011, Janice and Ian can reduce taxes by establishing tax-free savings accounts immediately and putting in $10,000 each, then put in the maximum of $5,000 a year thereafter.

Bayne notes that Ian has $40,000 in severance remaining that could be used for this. Once that’s used, the couple will have to consider the capital gains tax implications of moving money to TFSAs; however, this is usually manageable, given enough planning time.

Once Ian and Janice are 65, they can take advantage of pension income-splitting and the pension income credit. Bayne notes that pension income-splitting will be important to the couple because Ian has more registered assets in his name than Janice does.

Both advisors point out that using corporate-class and T-series mutual funds would save taxes — part of their distributions are considered return of capital, and taxes on income kick in only when the funds are sold. Bayne says if the couple do this with their non-registered assets, they may both qualify for the guaranteed income supplement.

Both advisors recommend a 40% fixed-income/60% equities asset mix.

For now, Bayne suggests mainly large-cap Canadian equities because of the turmoil and uncertainty in the rest of the world and the strength of Canadian government finances; the strength of resources prices, which are so important for Canadian economy; and the appreciating Canadian dollar, which has a negative effect on foreign investment income when turned into C$.

However, once the global economy shows signs of a sustained recovery, Bayne would look at U.S. and European equities — both for the potentially higher return from geographical diversification and for the opportunity for greater sector diversification.

Brain favours always having a geographical diversification. Currently, he’d suggest 18% in Canadian large-cap equities, 12% in Canadian small-cap, 16% global equities, 14% in international equities, 15% in real-return bonds and 25% in other fixed-income.

Bayne suggests using mutual funds that are regularly rebalanced. There wouldn’t be much price savings in using pools or wraps, and he doesn’t see the advantage of segregated funds — with or without a guaranteed minimum withdrawal benefit — given the cost of the insurance wrapper because the current return on annuities, at only 3.5%, is too low.

Brain thinks a GMWB plan would be a good idea for Ian and Janice because they have so little leeway should the return on their investments decline; plus, there is a real possibility the couple could outlive their assets. A case could be made for putting all their registered assets into seg funds with GMWBs, which would generate a guaranteed lifetime income. If the couple did this, Brain would recommend a 30% fixed-income/70% equities asset mix for additional upside potential.

Annuities are another option, but Brain agrees that they aren’t an attractive option for Ian and Janice right now. When the couple is older and/or when interest rates are higher, both advisors would suggest looking at these products.

Neither advisor would charge for developing and monitoring the financial plan if they were managing the assets, as they would be compensated through fees and charges on the funds in which the couple is invested. IE