Mapping out a long-term plan

Zoomer | September 17th, 2006

Malcolm, 59, and Karen, 50, sold their city home when Malcolm was given an early retirement buy-out from his employer. They downsized to a modest home on the lake, which Karen says “turned out to be a blessing because the property has more than doubled in value in eight years.”

They have no debt other than a car loan and live easily on Malcolm’s net pension income of $2,300 a month. His pension has a survivor benefit. When Malcolm draws his CPP this year, their monthly income will remain the same because at that time, they will have a reduction in the pension supplement provided by his employer.

Any extra expenses such as large purchases, home renovations or travel come from the interest earned on their total investment income of about $590,000. Because Karen has no pension income, she claims the maximum amount of interest because she is in a low tax bracket.

Travel is their one passion, and they usually take a big trip every year, spending on average about $10,000. They own a mobile home in Florida, which they rent or use themselves depending on their travel plans. They have out-of-country health insurance and semi-privae long-term care coverage provided by Malcolm’s former employer.

“Our dilemma stems from the fact that we aren’t sure what shape we are in for the long term,” says Karen. “Our friends have two pensions plus investments. But we have only the one pension, and it rather scares us a bit. But other than travelling, we live reasonably frugally. We’re happy with our present lifestyle but we do have some concern whether we’re on the right track.”
Should they have more of their funds in higher risk and higher return investments than they currently do?

At this time, Karen says “Our mutual funds are making about 10 per cent over the long haul, but we have been reluctant to increase the amount of mutual funds in our portfolio.”

Can they safely spend the available interest each year as long as they maintain their principal?

In the long term, what plans should they put in place when it comes time to switch the RSPs to RIFs?

What should Malcolm and Karen do to ensure they have enough income to see them through their retirement? Our adviser, Wayne Baxter from the Investment Planning Counsel, has this advice.

Advice from Investment Planning Counsel
In preparing this report, we requested some additional information from Malcolm and Karen, including an actual breakdown of their investments. We also confirmed Malcolm’s pension is indexed to inflation. And we discovered that they have children, which can have a significant impact on estate planning.

The first area that Malcolm and Karen should evaluate is protection planning. An axiom that Malcolm and Karen could try to live by is “Hope for the best but prepare for the worst.” One rule of thumb is to have four to six months of liquid cash needs on hand for emergencies and other unplanned purposes or opportunities. This can be accomplished by setting aside some of their excess non-registered capital in a high-yield cash account.

When preparing for retirement, another consideration is the potential impact on financial security if either Malcolm or Karen were to become ill and require ongoing care. People are living longer and frequently require care in later years, the costs of which can be staggering. A risk management review is advisable for this couple.

Like many people who retire, Malcolm and Karen are concerned about having sufficient cash flow to last them through their lives. The good news is that Malcolm’s pension is not only guaranteed but also indexed, which will help the couple preserve their spending power over the long term. Equities and other growth-oriented investments also help protect against inflation.

In terms of tax planning, the general guideline is to hold heavily taxed fixed-income investments inside registered plans and equity-based investment outside of registered plans to take advantage of the preferential tax treatment given dividends and capital gains. An analysis of their investment portfolio shows that a significant portion of Malcolm and Karen’s non-registered holdings is in GICs. A more tax-efficient strategy would be to swap the equity-based mutual funds in their registered plan with the GICs in their non-registered plan.

If they wish to increase the growth potential of their registered investments they should also consider an alternative strategy to their GICs when these investments mature. There are a number of conservative options to consider that would provide higher returns with lower levels of risk.

It would also be advisable for Malcolm and Karen to reorganize their non-registered investments to ensure they are maximizing income on an after-tax basis. A portfolio that provides a tax-efficient monthly cash distribution is recommended. Based on their stated requirement of $10,000 a year for travel, they would require only $180,000 to be invested in a tax-efficient income portfolio. The remaining $85,000 can be allocated for their protection plan.

Malcolm and Karen’s non-registered investments will provide them with the additional income they require. From an estate planning perspective, it may be worth while to consider deregistering a portion of their RSPs on an annual basis. While they would have to pay tax now, they would be able to reinvest the capital. Doing so would not negatively impact their standard of living and would reduce the taxation on their estate when their assets are passed on to their heirs, leaving them more.

As always, it is important that Malcolm and Karen sit down with a financial adviser who can help them make intelligent choices with their money based on a full understanding of their goals, needs and financial situation.

NET WORTH STATEMENT

Assets
Home $475,000
Mobile home $80,000 US
Registered investments (mutual funds, GICs, bonds): $325,000
Non-registered investments (GICs, bonds, mutual funds, savings with matching GIC rates): $265,000
Total assets $1,085,000 + $80,000 US

Liabilities
Car loan at 0% interest $8,400
Total liabilities $8,400

CASH FLOW STATEMENT
Net monthly income
pension $2,300

Monthly fixed expenses
Car loan $350
Property taxes $300
Hydro $200
House/boat insurance $150
Car insurance $80
Satellite TV $60
Telephone $25
Total fixed: $1,165

Monthly variable expenses
Food, gas, misc. $1,135
Total variable: $1,135

Total monthly expenses: $2,300