“Financial Checkup” is an ongoing series that discusses financial planning options. In this issue, Investment Executive speaks to Carlo Cansino, financial planning advisor with The McClelland Financial Group, a unit of Assante Capital Management Ltd. in Thornhill, Ont.; and Don Fox, senior executive financial consultant, and Jay Llewellyn, associate consultant, both partners with Fox Group Private Wealth Management, a unit of Investors Group Inc. in Hamilton, Ont. All three advisors are certified financial planners.

The scenario: Susan is a 72-year-old widow in Hamilton, Ont., who has just been notified that her pension is going to be reduced by 25% as of June 1, 2014. She needs to know what impact this will have on her financial future.

Currently, Susan is comfortable financially. Her unindexed pension is $45,000 a year; however, this will be reduced to $33,750 for 2014. She gets the maximum Canada Pension Plan (CPP) and old-age security (OAS) benefits. She has $500,000 in RRIFs, mainly inherited from her husband; $500,000 in non-registered assets; and $28,000 in a tax-free savings account (TFSA.) Susan also owns her home, which is worth around $600,000. She has no life or long-term care (LTC) insurance.

Susan has been spending about $70,000 a year after taxes, including house costs of about $8,000 – excluding major repairs. She thinks she could fairly easily reduce her after-tax spending by about $5,000 a year and might even be able to cut it by $10,000.

In fact, Susan has been thinking of selling her house and buying a condo or renting an apartment while she still has the energy to move and before the house maintenance becomes too much for her. This seems the ideal time to do this, but she needs to know what she can afford.

Susan’s goals are to leave the house, or its equivalent value, and her non-registered assets to her two financially independent children. Susan also doesn’t want to be a burden to them if she requires LTC. She is in good health and doesn’t smoke.

The recommendations: All three advisors say that Susan can survive the pension cut and continue to spend $70,000 a year before taxes in today’s dollars to age 95 and meet her estate goal. Even with the reduced pension, Susan’s annual income will cover most, if not all of what she has been spending.

Indeed, Cansino suggests that Susan could do this even if she adds $5,000 a year to her travel budget. Even with this change, Cansino’s projections indicate that Susan would still leave an estate of slightly more than $1 million in today’s dollars if she doesn’t have to encroach on capital for other reasons, such as LTC.

Llewellyn’s projections show an estate of $1 million in today’s dollars at age 95 if the capital is not encroached upon.

(Both Llewellyn and Cansino assume a 5% average annual return with a 9%-10% standard deviation and inflation of 3% a year.)

If Susan curtails her spending to $65,000 or $60,000 a year, she potentially could leave an even bigger estate; in the meantime, she would be in better shape financially in case some unforeseen large expenses come up, such as the need for extensive and expensive home care.

Susan doesn’t need to sell her home for financial reasons, but if she wishes to do so because of lifestyle considerations, the advisors suggest she could buy a condo for about $500,000.

Spikes or big increases in condo fees are always possible, but Fox points out that Susan could face some hefty major repairs if she remains at home. In his experience, the cost of maintenance and major repairs on a home often matches what people pay in condo fees. So, if she wants the convenience of a condo, Fox doesn’t believe she’s running a big risk by buying one.

None of the three advisors recommend downsizing to a smaller house because Susan still would have to do maintenance, something she does not want to do.

Renting is a possibility. But Cansino points out that not only would the rent rise annually, but Susan would be paying more in taxes because of her higher investment income when the house proceeds are invested. Cansino notes that if Susan goes this route, the higher taxes could result in OAS clawbacks, which start at income of $70,954 in 2013.

It can be cost-prohibitive to purchase LTC insurance at age 72 – if, indeed, Susan could qualify. For example, Llewellyn found a quote for a $700 weekly comprehensive lifetime benefit with a 90-day waiting period for premiums of about $9,200 a year for a 72-year-old non-smoker in good health. But all three advisors think that’s too expensive – particularly given the amount of Susan’s assets.

Llewellyn notes that Susan could sell her house – or condo, if she chooses to purchase one – to pay for institutional care if necessary.

Furthermore, Cansino points out that Susan wouldn’t have a lot of other expenses if she needs institutional care, so she could pay at least $4,500 a month in today’s dollars out of her annual income for such care without dipping into her capital. As well, these expenses wouldn’t encroach on her CPP and OAS benefits.

Life insurance is a “viable option” for Susan, in Fox’s view: it would augment her estate, diversify her investments and ensure that her taxable income doesn’t get high enough to trigger OAS clawbacks. Fox suggests a whole-life policy with a death benefit of $250,000 and the option of increasing the cash value through additional deposits. Fox found a quote for such a policy with premiums of $18,000 a year, which would come out of Susan’s non-registered account, reducing those assets and, thus, the taxable income generated in that account.

Susan should make sure she has an up-to-date will and both medical and property powers of attorney (POAs). Fox says that Susan could make her two children joint executors and holders of the POAs if they reside locally. This would allow unified joint decisions.

In addition, Fox suggests that Susan should look at her portfolio in terms of potential large capital gains upon her death and reduce such liabilities gradually as her tax situation permits.

All three advisors recommend strongly that Susan continue to make maximum TFSA contributions. As Llewellyn says, this is “a great [vehicle] for sheltering funds from current and future taxes.”

Making TFSA contributions as early as possible – for example, in January of each year – is a good way to minimize taxes. Other tax-reducing strategies include putting most of the equities investments into Susan’s non-registered account or TFSA, and her interest-paying investments into her RRIF. Moving assets into a whole life policy, Fox notes, also will reduce Susan’s taxes.

All three advisors think that a moderate-risk portfolio is the right investment strategy for Susan. Fox and Llewellyn recommend an asset allocation of 55% equities/40% fixed-income/5% cash; Cansino suggests a 60% equities/40% fixed-income mix.

Cansino recommends that the equities be divided equally among Canadian, U.S. and international exposure and that one-sixth of these investments – 10% of the total portfolio – be invested in real estate to provide further asset-class diversification. Cansino also would include small-cap exposure and suggest a “value” tilt to the investments. He favours passive investments, such as exchange-traded funds or indexed funds because he doesn’t think the returns on actively managed funds justify their cost.

On the fixed-income side, Cansino suggests short-term global government bonds. He views fixed-income as the anchor of portfolios and doesn’t believe “riskier” fixed-income investments, such as corporate issues and preferred shares, are needed.

Fox suggests the Canadian equities component of his recommendation be 40% of the total portfolio, with 30% in U.S., 15% in European and 15% in Asian and emerging markets. He recommends broad sector exposure, including financials, resources, consumer goods, telecommunications and health care. In contrast to Cansino, Fox favours active management and would use mutual funds that are rebalanced regularly and have moderate fees.

For the fixed-income component, Fox suggests 10% of the total portfolio be in Canadian mortgage funds, 10% in Investors Group’s unique Real Property Fund and 20% in a mix of government bonds, corporate bond funds and global and Canadian high-yield funds.

As a member of the McClelland group, Cansino, a fee-based advisor, charges an annual fee of 1.2% of assets for a portfolio of $1 million-$1.25 million.

Fox and Llewellyn receive their compensation from fees paid on the funds in which the assets are invested. None of the advisors charges for developing, monitoring and updating the financial plan – so long as they’re managing the assets.

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