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By Andrew Allentuck
Special to the Globe And Mail,
Saturday, November 17, 2007
In southwestern Ontario, a couple we'll call Tom and Maureen are planning their retirement. Tom, 63, owns a consulting company that works for various industrial firms. Maureen, 48, does part-time work for Tom's company and looks after their two children aged 13 and 17.
Adrian Mastracci, fee-only portfolio manager at KCM Wealth Management in Vancouver, says, "They are taking risks now but they are not getting proportionate returns."
Tom and Maureen have let others manage the financial assets in their registered retirement savings plans, registered education savings plans, and various business accounts. The result is that they have little grasp of the risks they face. They are concerned their finances aren't in order for their retirement and that they may not be able to afford the costs of paying for their children's postsecondary education. Their assets, including their home and car, total $1.21-million.
"Our retirement goal is to stay in a similar home to the one we have now with room for my hobbies and a garden for my wife," Tom explains. "We like to travel and would like to have a yearly vacation in retirement."
WHAT OUR EXPERT SAYS
Facelift asked financial planner and portfolio manager Adrian Mastracci of KCM Wealth Management in Vancouver, to work with Tom and Maureen. Sorting through the records of Tom's company and his pensions, he has outlined the couple's basic finances.
"This couple's entire portfolio of personal and company assets is a hodgepodge of risks and sectors," Mr. Mastracci says. "Their return in last year's very strong stock market was below index performance. They are taking risks now but they are not getting proportionate returns."
Tom and Maureen take salaries out of the company totalling $85,000 a year. The couple also have investment income of $35,000 a year.
When Tom turns 65, he will receive two British pensions that total $24,000 a year. He will receive Canada Pension Plan payments of about $7,200 a year and Old Age Security payments of $3,600 a year. He can also draw $13,200 from personal investment accounts to reach his desired retirement goal of $72,000 a year in 2007 dollars before tax, Mr. Mastracci says.
There is a lot more that Tom and Maureen can do to increase their retirement incomes. Their $276,000 of RRSPs plus $325,000 of cash still in his company are held in mutual funds with lacklustre returns of about 5 per cent a year after annual management fees between 2 to 3 per cent a year. That's a lot to pay for performance well below benchmarks, Mr. Mastracci notes.
They will have to boost their investment funds' returns if they are to fulfill their plan to have $72,000 in 2007 dollars of pretax income each year after Tom turns 65. There is time to achieve these goals by improving returns. Mr. Mastracci assumes Tom will live another 23 years, which is five years beyond his current life expectancy, and Maureen will live another 40 years, five years beyond her life expectancy.
If their investment portfolios can generate returns of 6 per cent a year after fees, and assuming inflation runs at 2.5 per cent a year with government pensions indexed at 2 per cent a year, then Tom and Maureen will need $700,000 of investment assets to finance their retirement in addition to the cash flow they'll receive from CPP, OAS and Tom's pensions. Their present assets after $90,000 of projected education costs are close to the sum needed for retirement, the planner notes.
Reducing management fees, perhaps by using low-fee exchanged-traded funds, could significantly increase portfolio value, assuming the mutual funds merely provide performance equal to their indexes. Based on past performance, that would be an increase of 2.5 per cent a year or 25 per cent in a decade. Small annual gains add up to large future growth. It will make a large difference in the couple's wealth, the planner says.
There are several steps Tom and Maureen can take to increase their portfolio returns. First, Tom should not use joint accounts for taxable investments. Keeping accounts in a single name will make it easier to track ownership and tax liability in taxable accounts, the planner says.
Tom should pay as much as he can of household expenses, allowing Maureen to save her investment cash flow.
Tom's annual RRSP contributions of $13,980 should be made to Maureen's spousal plan. This will add to her retirement income while providing Tom with deductions at his appreciably higher tax rate. Maureen should make her annual $6,000 RRSP contribution directly to her account.
The couple's children can benefit from changes to registered education savings plan rules. The couple have contributed about $10,000 to their family RESP. They can add as much as $90,000 over the next four years. But it has to be done carefully.
The $90,000 should come from Tom's capital with contributions spread between 2007 and 2011 in order to maximize the grants from the Canada Education Savings Grant. They can contribute up to $70,000 in 2007 via a catch-up provision in the 2007 federal budget and $5,000 in each of the next four years for their younger child. The elder child, now 17, can only get the CESG grant for this year, since the grant stops when he reaches 18, Mr. Mastracci says.
This manoeuvre will reduce taxable income from Tom's hands and divert it to the untaxed growth of the RESP. When withdrawn, the capital and income from the RESP will be taxed at what are assumed to be lower rates in the children's hands. The 17 year old can also receive money for providing services to Tom's company. The pay must be appropriate for the work done, but the pay-for-services method allows even more money to be reserved for education, Mr. Mastracci explains.
Tom and Maureen's finances are in disarray. They should take their financial records to a portfolio manager and rebalance to 60-per-cent fixed income and 40-per-cent equities, Mr. Mastracci recommends. The fixed-income portion should be 45-per-cent laddered bonds coming due in one, two, three and four years and 15-per-cent dividend-paying stocks or portfolios that can provide dividend increases to pace inflation. The equity portion should be about 20-per-cent Canadian assets, 10-per-cent American equities, and 10-per-cent global assets, he suggests.
"What the couple has to do is to increase their rate of return for the long run," the planner says. "They have market exposure but with the conservative asset mix I am recommending, Tom and Maureen should be able to raise their return to at least 6 per cent per year before inflation adjustments. That will keep them at their retirement income goal. If they devote time to studying capital markets, they should be able to do even better. This is a case of people with the means to have a comfortable retirement but who have risked losing it by failure to understand their finances."
"Tom and I came from homes where we had almost nothing," Maureen says. "That's the source of our insecurity. This report provides a sense of relief, and, yes, we will crack some books on finance and learn to understand our investments and to make asset choices."
CLIENT SITUATION
THE COUPLE
Husband 63, wife 48, moving toward retirement.
THE PROBLEM
Learn what their assets are doing and rebalance to achieve retirement goals.
THE PLAN
Adjust asset mix and reduce fees with direct stock purchases and exchange-traded funds.
THE PAYOFF
Higher retirement income and money for their two teenaged kids' postsecondary studies.
NET MONTHLY INCOME
$7,100.
ASSETS
House $450,000, RRSPs $276,000, RESP $10,000, business value $325,000, cash $134,000, car $15,000. Total: $1,21-million
MONTHLY EXPENSES
Property taxes $370, food $1,000, dining out $800, entertainment $200, clothing $200, RRSPs $1,665, RESP $200, car fuel & repair $170, vacations $850, car insurance $75, house insurance $60, charity & gifts $20, miscellaneous $500, savings $990. Total: $7,100.
LIABILITIES
None.
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