“Financial Checkup” is an ongoing series that discusses financial planning options. In this issue, Investment Executive speaks with Gerardo Cappelli, a certified financial planner, Canadian investment manager, senior investment advisor and financial planner with Wellington West Capital Inc. in Toronto and Mick Jackson, a branch manager with Assante Wealth Management (Canada) Ltd. in Sarnia, Ont.



The Scenario: John, 48, and Susan, 42, are a couple who live in London, Ont., who have had a second, unexpected child; their eldest child has just turned two. They would like Susan to be at home with the children until the youngest child is 12. They want to know if they can afford this and still pay for both children’s university educations in other cities — and have retirement income of $50,000 in today’s dollars from ages 65 to 95.

John is a bank branch manager who earns $75,000 a year and has full benefits and a pension equal to 60% of his final year’s salary. Medical, dental and vision benefits continue in retirement, and the pension has 60% survivor benefits.

John’s salary goes up, at the very least, with inflation each year. He expects to be promoted to a bigger branch in the next five years and says his salary is likely to go as high as $110,000, eventually, in today’s dollars.

John is also eligible to purchase shares in the bank he works for, with the bank picking up half the cost; he plans to continue participating in this program.

John and Susan don’t want to move from London. They not only grew up in the city, they also have lots of family and friends there and want to bring up their children in that environment. But staying in London precludes further promotions for John.

Susan had been working in marketing, earning $70,000 a year. She believes she would be able to get another marketing position in 12 years, albeit at a lower salary in today’s dollars — probably around $50,000 annually.

John and Susan have been spending $50,000 a year after mortgage payments and taxes, and believe they can continue to live within that sum in today’s dollars. They have one car, purchased last year, that they anticipate replacing every 10 years at a cost of $30,000 in today’s dollars.

The couple have a home worth $600,000 and a $75,000 mortgage that’s scheduled to be paid off in four years.

John has $200,000 in RRSP assets and Susan has $300,000. They have $50,000 in non-registered assets — $20,000 in cash and $30,000 in John’s bank’s stock. All their parents are alive, but John and Susan don’t want to count on inheritance in case all those assets are eaten up with health-related costs. Both John and Susan have term insurance to age 65 — $800,000 for John and $400,000 for Susan.



The Recommendations: Cappelli and Jackson both say John and Susan should have no trouble meeting their goals — even if Susan stays at home for the next 12 years.

Jackson’s projections indicate that if the couple stick to their plan, they would have about $1.3 million before taxes in financial assets, in today’s dollars, when John is 95, based on Jackson’s assumed 3% real rate of return (average 5.5% return and 2.5% inflation).

Cappelli comes up with a somewhat lower figure of $1.2 million — reflecting his lower real rate of return at 2.6% (return of 5.6% and inflation of 3%).

Cappelli also warns that if either John or Susan needs in-home or institutional care, the assets could shrink quickly. Thus, he strongly recommends long-term care insurance, although he says the couple could wait until John is 60 before purchasing it. If they take out policies now for $700 a week with a 90-day wait period, John would pay $1,044 a year and Susan $1,128 — assuming they are non-smokers and reasonably healthy. The cost will rise if they wait.

Jackson doesn’t think the LTC insurance is that necessary because the couple have so much in assets. However, he agrees that LTC insurance should be discussed when John and Susan are closer to retirement — particularly if family health history suggests that institutional care could be needed.

Both financial advisors suggest critical illness insurance. Cappelli recommends $50,000 each in 10-year CI insurance, which would cost John about $520 a year and Susan $310, assuming both are non-smokers and in good health. If Susan becomes ill, the $50,000 would allow them to hire the help they need without imposing too much of a burden on John, as it’s important that he continue to pursue his career. If John becomes ill, the $50,000 would allow Susan to hire additional help while she nurses John.

Jackson thinks $40,000 each in CI insurance would be sufficient.

Jackson also recommends that John get an additional $400,000 in term insurance, which would cost about $1,450 a year, to provide Susan with enough income if John dies before retirement.

However, Cappelli doesn’t believe this need exists, although he does point out that term policies can sometimes be converted to term-to-100 or universal life policies. He adds, though, that if the couple’s current term policies can be converted to term-to-100 or universal life policies, John and Susan should consider doing so to provide liquidity and financial flexibility at the time of death. Furthermore, the funds can also be used to pay capital gains taxes.
@page_break@Estate planning is important for this couple. They need to have up-to-date wills and both personal and property powers of attorney. They also need to appoint guardians for their children. Both advi-sors agree that testamentary trusts for the children should be included in the wills — at least, while they are minors.

Cappelli strongly recommends including those chosen as executors, guardians and holders of the powers of attorney in detailed discussions of what would be involved because certain people may not be comfortable with those duties. Guardians, for example, may not wish to handle the children’s money.

A list of key people, such as lawyers, doctors, financial advi-sors and accountants — as well as the location of important papers, such as wills, powers of attorney, property deeds, insurance policies and other financial documents — should be put in a location known to all those involved in the estate plan. All estate arrangements and insurance policies should be reviewed every five years or so.

Setting up RESPs immediately for the children is important. Cappelli recommends contributing $3,500 per child each year. That should cover the costs of four years of out-of-town post-secondary education for each child, assuming that tuition goes up by an average of 5% a year, and living expenses increase annually by 3%.

Jackson, however, thinks $2,500 per child a year — the amount needed to qualify for the Canada education savings grant of $500 — should be adequate.

Both advisors suggest a family RESP because of the flexibility it provides. Cappelli notes that the education expenses of children in the same family may differ significantly.

Cappelli would recommend a conservative approach to investing the RESP assets, even though there is a fairly long time horizon, as in this case. He suggests a 70% fixed-income/30% equities asset mix, so the fixed-income portion can preserve capital while the equities portion will provide some growth.

Jackson recommends life-cycle funds for the RESP. For these, a term is picked — 25 years, in this case — and the asset mix changes from aggressive (80% equities at the beginning) to more moderate; the equities portion would fall to around 50% of the assets when the term is up.

John and Susan should also set up tax-free savings accounts as soon as possible and contribute the maximum to them. Cappelli recommends investing entirely in fixed-income and using the funds as an emergency fund.

Jackson recommends investing 100% in equities in the TFSAs and leaving the money there. He feels this is a better use of TFSAs, as it avoids capital gains taxes, and he urges John to move the bank stock into both of his and Susan’s TFSAs.

Cappelli suggests that John set up a spousal RRSP for Susan and put as much as he can into it. Because John has a good pension, the contribution will probably be only $1,500-$2,000 a year. But the spousal RRSP will provide assets that could be used if the couple need money before they will be able to split income, allowed once John is 65.

Jackson doesn’t see any need for this because Susan already has some RRSP assets and the couple can split John’s pension when he’s 65.

In general, Cappelli thinks people should leave assets in their RRSPs until they need to withdraw them — and, in this couple’s case, there would be no need to withdraw the assets before John and Susan each turn 72.

Jackson’s projections have John and Susan converting their RRSPs to RRIFs at age 65, but he agrees that the couple could wait as long as possible. One reason to convert earlier is to avoid larger withdrawals down the road that could put them into a higher tax bracket. An accountant can be helpful here.

Cappelli suggests the couple’s RRSP and non-registered assets both be invested with a 70% equities/30% fixed-income asset mix; John’s pension will provide a reliable income stream, so the couple can afford to invest more in volatile equities to take advantage of their growth potential.

For the fixed-income portion, Cappelli recommends exchange-traded funds and some guaranteed investment certificates; for the equities portion, he suggests ETFs and some mutual funds with active managers who have good track records or in niches that require active management, such as emerging markets or specific sectors.

Cappelli favours predominantly Canadian investments to minimize exchange-rate risk. He suggests that almost all the fixed-income portion and 70% of the equities portion be in Canadian investments. The 30% in international assets would give exposure to sectors in which there are few, if any, publicly traded companies in Canada.
Jackson also likes a good proportion of Canadian investments, but his recommendation of 50%-55% is somewhat lower than Cappelli’s. Jackson suggests mutual funds, and would use corporate-class funds for tax efficiency. However, he adds, some individual holdings would be fine. He would, for example, suggest keeping some of the bank stock, which John will continue to receive.

Neither Cappelli nor Jackson would charge for the couple’s financial plan if managing the money. Otherwise, Cappelli would charge a $1,500 fee for setting up the financial plan and $500 for regular reviews; Jackson’s fee would be negotiated but similar to Cappelli’s. IE