Financial Checkup: Can a 40-something couple retire?

The couple also own five residential rental properties in Calgary and Vancouver, worth about $2.8 million collectively, with a cost base of $650,000 and mortgages totalling $300,000. After expenses, the properties provide the couple with net after-tax income of $3,500 a month.

Jen has been making $280,000 a year, including stock options, as a senior executive in a major technology company. She will qualify next year for an inflation-indexed, defined-benefit (DB) pension of $3,200 a month plus continued medical, dental and vision benefits for both herself and Marc.

Jen holds $800,000 in stock options with an average cost base of $500,000, and $270,000 in her RRSP. She also has $900,000 in non-registered assets, $300,000 of which is in cash.

Marc is an artist. He has only $10,000 in RRSP assets and $200,000 in non- registered assets. However, he owns three of their real estate investments, which he purchased using an inheritance.

Marc also supervises all the properties – finding properties to buy, arranging financing and supervising the property managers.

Jen and Marc don’t have children, and Jen would like to retire in another year so the couple can enjoy together the many physical activities they love. These include hiking, biking, sailing, swimming and skiing.

The couple’s goal is to be able to spend $8,500 a month, after taxes, in today’s dollars until age 95. Jen and Marc also want to know if they should purchase life, critical-illness (CI) or long-term care insurance, none of which they have.

THE RECOMMENDATIONS: NEITHER Cansino nor Shoemaker foresees any problems with Jen retiring in another year and, indeed, would expect the couple’s net worth to continue to climb.

Shoemaker’s projections show an estate of about $8 million in today’s dollars when Marc is 95. The projections include the purchase of the life insurance policy he recommends.

Cansino’s figure is similar: $7 million.

Both advisors used an average annual return of 6% with 3% inflation.

However, Cansino and Shoemaker are concerned about the concentration of the couple’s assets. Both advisors strongly recommend selling some of the rental properties and reducing Jen’s holdings in her employer’s stock.

These sales must be planned with regard to both tax implications and finding the right time to sell. There will be substantial capital gains on the sales of both the stock and the rental properties. That means sales of assets in Jen’s name should be delayed until she has retired and her income is substantially reduced. The aim is to keep her income, including capital gains, low enough to keep her out of the highest tax bracket.

One way to help achieve that, according to both Cansino and Shoemaker, is for Jen to make an investment loan to Marc, so that he can purchase some or all of her non-registered assets. A loan between spouses can be made using the prescribed rate set by the Canada Revenue Agency (CRA). This rate currently is 1%.

If Marc’s loan is for $900,000, he would have to pay Jen $9,000 a year, which would be added to her income. Marc would get all the income generated by the $900,000 – $54,000 a year if the return is 6% – but he could deduct the $9,000 in interest payments to Jen, which would leave him with $45,000 in net earnings from this source.

This strategy would even out the couple’s income in retirement, as well as provide significant tax savings in the first year. While Jen is still working, the $54,000 in investment income, if it is in her name, would be taxed at 49% vs Marc’s tax rate of around 20%.

The CRA imposes heavy penalties if income is not properly attributed, so the couple must put such a loan in place if they want to split income. The CRA’s penalties can be substantial, amounting to as much as 50% of the taxes that should have been paid with correct attribution.

Marc doesn’t have to wait to sell any of his rental properties, as his income is very low. Cansino and Shoemaker recommend that the couples’s rental properties be reduced to two, with Marc selling two of his and Jen selling one of hers.

Cansino says real estate exposure, outside of a principal residence, ideally should be no more than 20% of a portfolio.

The timing of the real estate sales will depend upon market conditions. However, Shoemaker says, despite the negative impact of the plunge in oil prices on Alberta’s economy, Calgary house prices appear to be holding up quite well.

So, the sooner the couple reduce their real estate holdings, the better. The reason is not just the overexposure to the real estate sector, but also the relatively poor returns on this type of investment once all the costs are accounted for.

For example, Shoemaker says, appreciation in the value of the properties of 6% a year is likely to be reduced to 3% after property taxes, maintenance, insurance, real estate commissions on selling, legal costs, capital gains taxes and so on are taken into consideration.

Shoemaker also suggests that the couple put the rental properties in an incorporated entity to eliminate the potential for personal liability from claims derived from the rental operations.

Both advisors recommend that Jen exercise her stock options when she retires and begin selling a good chunk of the shares.

Cansino says, ideally, no more than 5% of a portfolio should be invested in any one company’s stock.

Shoemaker agrees, and especially in Jen’s case, because her exposure to this company is more than the shares she owns, given that the company also is the source of her DB pension.

With the proceeds of the real estate and stock sales, Jen and Marc should open and maximize tax-free savings accounts and continue to contribute as much as possible to these accounts each year.

The couple also could pay off all their mortgages, with the first priority being the mortgage on their principal residence. As Shoemaker points out, mortgage interest on the rental properties is a tax deduction while interest on a principal residence is not deductible.

However, with mortgage rates low, the couple may want to continue holding the mortgages until interest rates rise significantly.

The couple have little need for insurance as long as Jen is alive, but Marc could find his lifestyle severely restricted if Jen dies fairly young. Shoemaker suggests a permanent 20-year-pay life insurance policy with a death benefit of $750,000 on Jen’s life.

This policy would cost about $21,000 a year. Shoemaker also suggests additional deposits into the policy of $4,000 a year to create an additional asset to generate retirement income. With the additional deposits, the policy would have a cash value of $870,000 in 20 years. Up to 80% of the value of the policy can be borrowed in retirement to provide additional income tax-free.

Cansino also suggests life insurance, but in the form of a joint first-to-die 20-year term policy for $570,000. This policy would cover paying off the mortgage on the principal residence should one of the spouses die in the next 20 years. Because Jen and Marc are quite young and this recommended policy is term insurance, the premium would be much less than the permanent life policy recommended by Shoemaker, at about $1,700 a year.

Jen and Marc should make sure their wills and powers of attorney for both property and health are kept up to date. The couple also should consult an estate lawyer to determine whether there are any issues resulting from owning property outside Ontario that should be addressed in their wills.

Assuming Jen and Marc are moderate, conservative investors, both advisors suggest a 50/50 equities/fixed-income asset mix for long-term investments. Cansino and Shoemaker both recommend that the equities be broadly diversified by geography, sector and investment style.

Both Cansino and Shoemaker also think establishing a separate account for short-term needs would be a good idea, specifically to provide income of $5,000 a month for three years. These assets would be invested mainly in fixed-income and the account would be replenished yearly.

In the current low interest-rate environment, any bonds held in the portfolios would be short-term. Cansino would stick to high-quality bonds, mainly corporate.

Shoemaker says he might suggest some high-yield mutual funds. He also recommends that the fixed-income portion include 5% of the total portfolio in Investors Group Real Property Fund, a unique product that invests directly in real estate.

Both advisors recommend that the non-registered assets be invested in products for which the advisory fee is separate from the management expense ratio fee, as advisory fees are tax-deductible.

As long as each advisor would be managing the couple’s assets, the development and monitoring of a financial plan of this type would not be subject to a charge.

Cansino would charge 0.9% of assets under management (AUM) for managing this amount of AUM. As Jen and Marc’s net worth rises, that percentage would drop. For example, with the portfolio worth $3 million, Cansino’s fee would be 0.8% of AUM.

Shoemaker gets his compensation through trailer fees and commissions.

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