“Financial Checkup” is an ongoing series that discusses financial planning options. In this issue, Investment Executive speaks with Christine Butchart, registered financial planner and senior financial planning advisor with Assante Capital Management Ltd. in Hillsburgh, Ont.; and Mark McCooeye, certified management accountant, certified financial planner and senior financial consultant with Investors Group Inc. in Ottawa.



The Scenario: Tom and Alice, both 62, have just lost their jobs. Neither wants to go back to work full-time, and they want to know whether they have sufficient assets to generate $30,000 in after-tax income in today’s dollars until age 95, plus $4,000 in today’s dollars for a new second-hand car every six to eight years.

If not, they are prepared to look for low-stress, part-time employment, and want to know how much they would need to earn and how long they would need to work to achieve their goals.

Tom and Alice own a mortgage-free home in Orangeville, Ont., north of Toronto, which is worth about $250,000.

Tom has $200,000 in RRSP assets; Alice, $100,000. Each spouse has $100,000 in non-registered assets, including $15,000 each in their tax-free savings accounts.

Previously, Tom had made $50,000 a year; Alice, $35,000. The couple had lived on $35,000 annually before taxes, RRSP contributions and mortgage payments.

The couple have three children, who live nearby and are financially independent. Tom and Alice are not worried about leaving them money.

Both Tom and Alice are non-smokers in good health, but they worry about losing their home or severely cutting into their income if one of them has to go into a nursing home. They intend to buy long-term care insurance, with the premiums coming out of their investment income.



The Recommendations:
McCooeye thinks Tom and Alice can spend $30,000 a year in today’s dollars, pay for LTC insurance coverage and still have about $520,000 in today’s dollars at age 95 — $270,000 in financial assets and $250,000 for the house, which he assumes appreciates in line with inflation.

Butchart says that the couple should be able to make it to age 95 without running out of assets but doesn’t think they have enough capital should they miscalculate their lifestyle expenses, if there are unexpected future costs or if returns have been overestimated. She also assumes the value of the house appreciates in line with inflation.

Butchart recommends the couple both take part-time jobs that pay $17,000-$18,000 a year until they are 65. That would cover the cost of the LTC insurance, as well as generate much of the $30,000 a year Tom and Alice plan to live on.

If they don’t do this, they will probably have to sell their house at around age 80, and would have only $200,000 left at age 95. Butchart assumes that the couple will be able to rent for about the same cost as they were paying for utilities, property taxes and house maintenance.

Both financial advisors suggest a 40% fixed-income/60% equities asset mix for the couple’s investments. But Butchart’s assumptions are the more conservative of the two, assuming an average annual return, after fees, of 4.5% vs McCooeye’s 5%.

As it is possible that such an asset mix will deliver a higher average return than either advisor is assuming — many advisors believe 6% to be a conservative assumption — Tom and Alice may be in much better shape than these projections suggest. But neither McCooeye nor Butchart would count on such an assumption.

McCooeye recommends Tom and Alice invest their assets in a portfolio of eight to 10 mutual funds that are diversified by geography, industry, market capitalization and investment style. This would probably include some high-yield fixed-income and exposure to real estate. Of the equities, less than 40% would be Canadian and about 8% would be in emerging markets.

Butchart also suggests managed products, recommending the multi-manager approach. She wouldn’t suggest individual securities, given the clients’ low level of assets, but might include some exchange-traded funds and real estate investment trusts. She agrees about the benefits of geographical diversification, splitting the equities between Canadian and foreign, perhaps with a slight tilt toward Canadian. Butchart also recommends some emerging-markets exposure — even for her risk-adverse clients, Butchart recommends holding 5%-10% of equities in those fast-growing regions.

Both advisors recommend that most of the fixed-income investments be held in the RRSPs or RRIFs to shelter the interest payments from taxes.@page_break@McCooeye suggests T-series, corporate-class funds for the non-registered investments to allow for rebalancing without triggering capital gains and minimizes taxes because a portion of payments are considered return of capital.

Butchart suggests a systematic withdrawal plan for the equities in the non-registered accounts, as that also treats part of the income as return of capital.

In addition, Butchart assumes that inflation, as measured by the year-over-year increase in the consumer price index (used to index Canada Pension Plan and old-age security benefits) will be 2%, while the couple’s personal inflation rate will be 3% — which means they will be losing purchasing power on these benefits every year.

McCooeye assumes 3% inflation for both the CPI and the couple.

Butchart is particularly concerned that Tom and Alice may have more problems than they expect in reducing their annual expenditures to $30,000 from the current $35,000. Her advice to clients who think they can live on less in retirement is to try doing so before they stop working to make sure the goal is achievable.

Butchart also thinks the couple could be underestimating the cost of replacing their car. She would consider $8,000-$10,000 in today’s dollars a more reasonable assumption than $4,000.

McCooeye thinks the couple should start taking their CPP pension now. His theory: “A bird in the hand is worth two in the bush.”

Butchart, on the other hand, is adamant that Tom and Alice should wait until they are 65 to start collecting CPP, arguing that not only will they get 18% less if they start now but they will also experience a compounding loss in purchasing power over time. That is, if they wait and take a full pension of, say, $1,000 a month, they would be receiving $1,776 a month in 30 years, assuming 2% inflation; if they take an $820 pension now, they would be receiving only $1,456 in 30 years — $320 less per month.

Butchart does not recommend that either Tom or Alice make further RRSP contributions. Given their low tax bracket, she suggests the couple consider taking money out of their RRSPs and moving it into their TFSAs or non-registered accounts in any year in which doing so would not push them into a higher tax bracket. If they don’t do this, once they start collecting CPP and OAS — and particularly, after one of them dies — the minimum RRIF withdrawal could push them into a higher tax bracket.

Both McCooeye and Butchart recommend maximum TFSA contributions each year but differ on how they think the accounts should be used. McCooeye favours using the TFSAs for equities, so the couple won’t have to pay taxes on any capital gains.

Butchart isn’t concerned about sheltering capital gains, given the couple’s low tax bracket. Instead, the advisor recommends using high-interest deposits in the TFSAs as the couple’s emergency fund to pay for unexpected expenses and for the car purchases.

Both advisors strongly recommend LTC insurance because Tom and Alice don’t have enough assets to pay the costs related to either spouse needing home care or a nursing home.

McCooeye recommends an LTC policy with a weekly benefit of $1,500 after a 90-day waiting period, with 3% annual inflation protection starting when either or both spouses start claiming. The cost would be $5,300 a year for Tom and $8,400 for Alice.

Butchart suggests an LTC policy with $500-a-week benefits with inflation protection after a 90-day waiting period. Such a policy would cost $1,526 a year for Tom and $2,150 for Alice. She feels the couple can reasonably afford this coverage but notes that they would probably have to use some capital to cover the full costs should the care be needed.

Neither Butchart nor McCooeye thinks Tom and Alice need critical illness insurance. Neither advisor thinks the couple can afford enhanced medical coverage, either.

McCooeye says that life insurance could be considered at some point to cover taxes when the couple’s estate passes to their children. He suggests the children might be willing to pay for this insurance.

Butchart would not charge a fee for developing the plan if she is going to manage the assets. Otherwise, Butchart’s fee is $200 an hour. In a case such as this one, she would charge $1,500-$3,500 for the development of the initial plan. McCooeye would not charge a fee for the initial plan whether or not the couple becomes a client. If they do, he would be compensated for managing the assets. IE