“Financial Checkup” is an ongoing series that discusses financial planning options. In this issue, Investment Executive speaks with the financial advisory team of Richard Heinrich, certified financial planner and financial management advisor, and Mark Parlee, FMA, fellow of the Canadian Securities Institute and holder of the elder planning counsellor designation, with the Toronto-based Beaches Financial Team, an affiliate of IPC Securities Corp. ; and Brent Jamael, CFP, registered financial planner and financial consultant with Investors Group Inc. in Frederiction.



The Scenario: Sandra is a 50-year-old woman in Frederiction who has been recently widowed. She has three children, ages 16, 13 and 10, and she has been at home raising them for the past 16 years. Sandra is now prepared to take on a low-stress job as a receptionist, preferably on a part-time basis. She thinks she could make $30,000 working full-time and $18,000 working three days a week.

Sandra’s deceased husband left her $500,000 in RRSP assets, invested in Canadian balanced funds; $200,000 in non-registered assets, invested in Canadian equities; as well, he had had a $1-million life insurance policy. Sandra also has $100,000 in RRSP assets invested in fixed-income. There is also $80,000 in a family RESP.

She has a $500,000 term life policy to age 65, which costs $1,000 a year, but no extended medical, critical-care or long-term care insurance. Sandra is a non-smoker in good health; however, there is a history of heart disease in both of her parents’ families, although both of her parents are still alive and in good health at age 80.

Sandra wants to continue living in their $400,000 home, which has a $100,000 mortgage, because she enjoys the garden. She has a second-hand car that cost her $4,000 five years ago and will probably be good for another three years. She plans to replace it with one that costs $5,000 in today’s dollars, and continue doing the same every eight years.

Sandra also wants to pay off her mortgage, pay for university education for the children and have $50,000 a year after taxes in today’s dollars until age 95. If possible, she would like to be able to spend $100,000 on a number of major trips in the 10 years after her youngest child has started university. Sandra would also like to leave at least $100,000 to each child when she dies.



The Recommendations: the advisors agree that Sandra should be able to meet her goals if her investment portfolio’s annual average return is at least 6% after fees and she works part-time to age 65. If the return is just 5.5% after fees, Heinrich says, Sandra will not have enough to do all she wants.

Using a 6% average return on Sandra’s financial assets, Heinrich’s projections show an estate at age 95 of around $400,000, plus the house, if Sandra works three days a week until age 65, which both he and Parlee recommend Sandra do to provide a cushion.

Jamael assumes a 6.5% average annual return — but on fewer assets, as he recommends Sandra puts all of the $1 million from her husband’s life insurance into a prescribed life annuity with a 15-year guarantee that pays 5.5%. The annuity will be used to cover Sandra’s core expenses related to the house, its maintenance, utilities, food and clothing. As a result, Jamael’s projections result in Sandra having $200,000 in financial assets in today’s dollars when she is 95.

Prescribed annuities are tax-efficient because some of the income earned in the early years is taxed in the later years. The payouts are calculated based on the amount of income and return of capital that will be paid out over the life of the annuity, which means the income — the taxable portion — of the annuity payout stays the same throughout the life of the annuity, regardless of how much income and how much return of capital there is in any given year. In Sandra’s case, she would get $30,000 in non-taxable return of capital income and $25,000 in taxable income every year.

The drawbacks to the prescribed annuity are that Sandra will no longer have the capital and the payouts are not indexed to inflation. However, Jamael says, Sandra has other assets and sufficient other income to offset the loss of purchasing power due to rising inflation: inflation-indexed survivor benefits from her husband’s Canada Pension Plan entitlement until Sandra is 65 years old; old-age security and whatever CPP Sandra is entitled to, both indexed to inflation, from age 65; and RRIF withdrawals, which, all advisors say, Sandra should delay collecting until age 72.@page_break@The three advisors recommend the mortgage be paid off right away. Jamael assumes the house will appreciate by 4% a year, or by 1% in real terms; Parlee assumes appreciation of 5% a year, or 2% in real terms. Both advisors assume average annual inflation of 3%.

Jamael and Parlee also recommend that Sandra continue to make maximum RESP contributions. Jamael calculates that this will result in $11,000 a year in today’s dollars for each child for four years of post-secondary education. He believes this would cover the costs if the children continue living at home during their post-secondary education.

The advisors don’t think further RRSP contributions are needed because Sandra isn’t going to be earning enough to make it worthwhile. Jamael notes that Sandra is going to be in a fairly low marginal tax bracket while working and that she gets a combined tax credit for the children as dependents, currently $10,352. Thus, Sandra’s first priority should be to maximize her tax-free savings account contributions. However, Jamael says, if the deceased husband had left substantial RRSP room, Sandra could reduce the taxable income in his final return by contributing to her spousal RRSP.

Jamael recommends enhanced medical insurance, which costs about $300 a month; and LTC insurance with a premium of slightly more than $100 a month for a $500-a-week benefit that would be paid over 20 years.

Parlee doesn’t think the enhanced medical or LTC insurance is necessary. He says that paying for dental coverage, for example, could be more expensive than paying for dental visits and claiming the cost on Sandra’s income tax return. However, he suggests revisiting the question regularly.

Sandra must immediately update her will, personal and property powers of attorney, named beneficiaries on any accounts or insurance policies, and appoint guardians for her children. Parlee says it is usually better that people other than the guardians look after the money. Both Jamael and Parlee suggest Sandra establish a testamentary trust for her children in her will, dictating when they will get access to the capital.

Jamael recommends a moderate-risk, balanced portfolio of mutual funds with a target asset mix of 60% equities (with 25% of that in foreign assets) and 40% fixed-income. He would put all the fixed-income in the RRSPs and use tax-efficient corporate-class funds for the equities.

Parlee and Heinrich recommend a tactical approach using individual securities, exchange-traded funds and mutual funds; the asset mix would change depending on market conditions and prospects. The target would be 55% equities — 30% in Canadian, 10% in U.S., 10% in international, 2% in global small-caps and 3% in global real estate — and 45% fixed-income. But in this current low interest rate environment, there would be more equities and less fixed-income.

Jamael and Parlee would invest the RESP assets in the same manner, except that Jamael would put the assets needed within two years for the eldest child into fixed-income or money market funds. Parlee would not do this because Sandra has enough other sources of income and assets in case there are periods in which it would be disadvantageous to make RESP withdrawals.

The Beaches team charges a 0.7% annual fee for managing assets; this covers developing, monitoring and revising the financial plan. Jamael is paid through mutual fund management expense ratios and commissions on annuities and insurance. IE