Author: studion

In a small city not far from Toronto, a couple we’ll call Beth and Harvey have retired. Beth, 53, used to work for a bank. Harvey, 55, worked for a public utility. Together they have annual income before tax of about $64,400 a year. They cannot yet qualify for Canada Pension Plan or Old Age Security and are therefore financing their expenses from company pensions and savings. Their goal is to avoid going further into debt. Currently, they have debts equal to 93 per cent of their annual disposable income. “We know where we want to go,” Beth explains. “We’re just not sure if we can get there without going into debt. We want to keep our month each year in Florida and we are planning a trip to Europe for our 40th wedding anniversary in several years.”

WHAT OUR EXPERT SAYS

Facelift asked certified financial planner Michael Cherney in Toronto to speak with Beth and Harvey in order to work out their options. The issue, as he sees it, is whether Harvey will have to do part-time work in order to provide cash flow sufficient for the realization of their plans.

“They can, in fact, realize their dreams provided that they can pay off their debts within the next two to three years,” the planner says.

Beth and Harvey retired in their fifties. Their financial assets consist mostly of registered retirement savings plans with a present value of $109,740. That is not much for two people, each of whom is assumed to live to age 95.

That age exceeds average mortality but allows for a plan that will retain assets into very old age. During the decades ahead, inflation is assumed to run at an average annual rate of 3 per cent, Mr. Cherney notes.

Both Harvey and Beth will take their CPP benefits at age 60, giving up 0.5 per cent of the maximum amount payable for each month prior to age 65 that benefits begin. The benefits payable will therefore be 70 per cent of the full CPP payout of $864.75 a month in 2007 dollars or $605 a month for each. The couple should apply to CPP at age 60 to have benefits split in order to save income tax.

Harvey and Beth will each qualify for full Old Age Security benefits, currently $497.83 a month. The payments are indexed to inflation. The clawback begins at $63,511 but this threshold will not affect the couple, Mr. Cherney says.

Harvey will continue to receive his fully indexed defined benefit pension in the amount of $55,680 a year. When Beth reaches age 65, she will receive a pension of $6,240 a year – or $2,496 a year should she elect to take her pension at age 55. Early application bears a high cost, Mr. Cherney notes. She should wait to age 65 to take her pension, he adds.

Harvey will earn an additional $51,900 for contract work in 2007. That income will enable him to pay off his outstanding line of credit debt of $38,700, which is his largest debt. When Harvey reaches age 65, his company pension will be cut by 16 per cent according to his plan’s agreement. When he dies, it will fall by a further 33.3 per cent, Mr. Cherney notes.

Beth should begin to take funds from her RRSP next year in order to average out income. If she waits until age 60 or 65 to begin RRSP withdrawals, she risks being pushed into a higher tax bracket by CPP and OAS payments, Mr. Cherney notes.

There is a risk that in taking money out of her RRSP, Beth could run afoul of attribution rules. RRSP withdrawals are taxed back into the hands of the contributor if money is taken out within two years of contribution, the planner adds. To avoid that, in 2008, Harvey should open a personal, non-spousal RRSP.

If Harvey and Beth can achieve a 5-per-cent after-tax return in their taxable investments and a similar return on a pretax basis in their registered accounts, then the couple should be able to achieve a pretax, inflation-adjusted income of $70,000 a year for the rest of their lives. That would produce an estimated $54,000 a year after tax. Since Beth and Harvey currently spend only $41,000 a year, they will have a margin for error and ample funds for travel.

In 10 years, when Harvey is 65 and Beth is 63, the couple’s income will consist of $62,767 from Harvey’s pension, $8,629 from Harvey’s CPP, $4,271 from Beth’s CPP, and $8,029 from Harvey’s OAS. That will produce total income of $83,696. They can add $8,680 from their RRSPs to bring total income up to $92,376, close to their inflation-adjusted required income of $94,000, the planner says.

Two years later, when Beth is 65, the couple will add her OAS payments of $8,517. They will have achieved stable income sufficient to pay their estimated expenses.

Their RRSP balances will have been reduced to zero in prior years in order to supply income in the years before Harvey and Beth have qualified for CPP and OAS payments. Depletion of their RRSPs is the necessary consequence of early retirement, Mr. Cherney notes.

Harvey and Beth can use pension splitting and division of their CPP pensions to avoid the clawback of OAS, Mr. Cherney says.

Even though their RRSPs will be depleted by 2017, there is a good deal the couple can do to raise returns in the next 10 years.

The couple are almost entirely invested in stocks. They have provided growth and inflation compensation, the planner says, but insufficient security for a portfolio that will provide vital income before other pensions begin to be paid. Harvey’s company pension will be a base for the couple’s retirement income, but it would still be helpful to reduce equity weight and to add fixed income to the portfolio.

Harvey has two financial services stocks that have had substantial gains in the last five years and should be considered for sale, Mr. Cherney says. Higher returns could also be achieved by eliminating high-fee mutual funds in favour of low-fee funds or perhaps some exchange-traded funds that have management fees a fourth or even a tenth of those of mutual funds.

Harvey has worked for a large organization with a fine pension plan. “Defined benefit, indexed pensions of the kind he has are getting to be rare,” Mr. Cherney notes. “Harvey is in a shrinking group of Canadians who can capitalize on this good fortune.”

“We are very happy with this analysis,” Harvey says. “We decided to retire early and Mr. Cherney has shown us how we can maintain our income until each of us is 95 or gone.” Adds Beth, “we see how to use income splitting to add to our disposable income. It was a good exercise.”

What our expert says

Facelift asked Michael Cherney, a certified financial planner in Toronto, to work with Charles and Susan in order to plan their retirement and to budget for their postretirement travels.

“This is a couple with many opportunities and, as well, many responsibilities,” Mr. Cherney observes. “They have a blended family but have not made a financial plan and, while they do not face any great difficulties, they do need to assess their retirement resources.”

The couple has relatively modest financial assets, Mr. Cherney notes. However, assuming that Susan retires in 2010 at the age of 63 and Charles in 2015 at the age of 64, there is still time to build up their investments, he says.

Assuming that Charles lives to age 91 and Susan to age 95, that inflation runs at an average annual rate of 3 per cent and that each partner begins to receive benefits from the Canada Pension Plan on retirement, Susan can expect an initial CPP payment of $7,974 a year and Charles $9,244 a year. The benefits are indexed to inflation.

Each partner will receive full Old Age Security benefits at age 65. Currently, OAS pays $491.93 a month and is indexed to inflation. Recent federal tax law changes allow pension splitting, so Charles’ OAS payments will probably not be subject to the OAS clawback that currently starts at $63,511.

Charles can expect an annual employment pension of $57,699 in pretax, 2007 dollars. Susan can expect $37,056 a year. The pensions are paid by the Ontario Teachers Pension Plan and are indexed to inflation, Mr. Cherney notes.

Registered retirement savings plans will not contribute a great deal to the couple’s pensions, but each partner should convert RRSP balances to registered retirement income funds at retirement and then begin to withdraw the minimum permissible amount, he recommends. Any RRIF withdrawals in excess of spending should be saved in a non-registered account. Early withdrawal accomplishes income averaging, though it sacrifices maximum accrual of gains within tax-deferred plans, the planner notes.

Even with their modest RRSP/RRIF balances, the couple should be able to attain a retirement income of $115,000 in pretax 2007 dollars, Mr. Cherney estimates. That will work out to after-tax income of $7,500 a month made up mostly of their school pensions, CPP and OAS. In 2015, Charles’ retirement year, total RRIF income would be only $4,000.

There is a good deal that Charles and Susan can do to adjust to the costs of retirement. They could sell one of their two cars, for example. They can also use what may be a cash surplus generated by expense reduction to give $1,000 a year to each of their seven children and $400 a year to each grandchild. They may want to contribute to wedding costs for several children who are not married at present.

Charles and Susan need to do some work on their current finances, Mr. Cherney notes. They have $62,900 outstanding on lines of credit used to pay for their children’s weddings. They can use their substantial savings of nearly $4,000 a month to pay down those balances and reduce them to zero within two years. Thereafter, they can direct those savings to investments. They have little RRSP room, the result of having generous pension contributions through their work.

The couple can also use their cash surplus to build up a taxable investment account. To date, the couple have used blue-chip stocks for their RRSPs and put relatively small amounts of money into speculative stocks in their taxable investment accounts. Later in their retirement, they could also sell their townhouse and move to a smaller apartment, potentially freeing up what is already an $800,000 asset, the planner says.

Given the limited room Charles and Susan have in their RRSPs, they will have to make most of investments in their taxable account. With their foundation of indexed pensions, they can afford to put most of their new, discretionary investments into stocks or mutual funds. They can reduce portfolio risk by diversifying by style – value and growth, capitalization and domicile (Canadian and global). It is possible to reduce fees by using exchange-traded funds that have management expense ratios a small fraction of those charged by managed mutual funds.

Charles and Susan made wills 15 years ago but have not revised them since. They need to review the wills to ensure that their designated executors and trustees are still available. They have numerous potential heirs in their several children and in the relationships that come with blended families. They may wish to use trusts to divide income. They may want to consider the disposition of their house, provide investment suggestions to trustees or look after the interests of their growing brood of grandchildren, Mr. Cherney says.

The transition to retirement should not be difficult, the planner explains. The couple’s retirement income will not be appreciably less after tax than their present income. Most of their retirement income will be from their employer, CPP and OAS. In that respect, they can have a more secure retirement than many people, Mr. Cherney adds.

They may want to use their substantial savings to start a business that would occupy their time and provide income during their retirement. Charles, who was in business before he became a teacher, could be a consultant and employ Susan in the business. Were he to do that, their business income could be shared between them as employees of the company, Mr. Cherney says.

“Charles and Susan are in the fortunate position of being able to rely on secure incomes in retirement,” he notes. “They can use their substantial savings to travel to see their children and grandchildren, to visit foreign countries or to create a small business. As long as they are in good health, they can expect that their retirement will be fulfilling.”

“I find it reassuring to have this analysis,” Charles says. “I figured we’d be okay in retirement, but I have never gone through this sort of planning exercise to test retirement income and expense. The process provides peace of mind and a map of how we can use our resources. In a sense, this is a baseline for our future.”

In Ottawa, a couple we’ll call Jerry and Sue are in the process of building a good life for their family. They have two teenage children and one about to enter the teens. With an annual combined income of $147,000, and net worth of $664,900, they should be feeling secure about the future. Nevertheless, Jerry, 46, a high tech manager who has no corporate pension plan, and Sue, 43, who is employed by the federal government, worry that they will not have enough savings for the retirement they have planned and for their children’s university expenses. “Would it not be smart to earn money outside of an RRSP, perhaps in real estate investments, so that I can use the funds to spend on a car, fix up the house or lend to family members?” Jerry asks. “But before I do that, I have to know if I have enough in my RRSPs to stop contributing.”

What our expert says

Facelift asked Michael Cherney, a certified financial planner in Toronto, to work with Jerry and Sue to determine if, indeed, they do have enough saved in their registered retirement savings plans and if the plan to invest outside their registered plans is feasible.

“You say that you have been staying up nights worrying about your investments,” Mr. Cherney says. “I would like to put your mind at ease. You are doing nicely in retirement savings and debt reduction, though there is more that you can do for education savings.”

The couple’s issues centre around how to allocate savings, Mr. Cherney notes.

Currently, the family has $300,000 in RRSPs and $24,400 in registered education savings plans and accounts for the children. Jerry and Sue already have a real estate investment of $300,000 in the estimated market value of their house. “Real estate investment is a supplement to financial assets in RRSPs, not a substitute for them,” the planner insists.

The tax advantage of continuing to invest in RRSPs is compelling, Mr. Cherney explains. A few decades of potential tax deferral make a strong case for continuing to use registered savings. Real estate investments, while offering substantial opportunities for growth and deferred gains, lack the immediate tax savings offered by RRSPs, he says.

Real estate investing is riskier than putting money into RRSPs, the planner explains. On a strictly financial basis, the decision of whether to buy an RRSP or a rental property comes down to comparing the return from a portfolio of tax-deferred investments to the return of an investment property bought on a mortgage.

Property management is a matter of details, but in gross terms, the problem is simple. Assume that a property produces gross rents of 10 per cent of the property’s price. Assume further that it is financed with no down payment, just for the sake of simplicity and to avoid estimating what the down payment could have made if invested elsewhere. If the mortgage is 6 per cent and maintenance is 3 per cent, then the net return of 1 per cent is meagre. Depreciation allows cash flow to exceed earnings, but buildings do need repair and eventual replacement. So the greatest part of the return will have to come from a capital gain. That is a speculation on the real estate market, Mr. Cherney says. Moreover, financing a rental property by remortgaging their house would run contrary to the couple’s desire to be debt-free.

Assuming that Jerry and Sue each live to age 95, an assumption that ensures that they don’t run out of money too soon, and that Sue can get by on 80 per cent of the couple’s income after Jerry dies, their retirement should be comfortable.

If the couple suffer no financial reversals, then, by Jerry’s age 65, they can begin retirement on a projected income of $135,900, which is equivalent to about 60 per cent of current family gross income adjusted for inflation that is assumed to run at 3 per cent a year.

In the first year of retirement in 2025, family income will consist of $41,590 of registered retirement income funds converted from Jerry’s RRSP, $25,790 from Sue’s RRIFs, $30,900 of Sue’s defined benefits pension, $10,200 of Old Age Security income for Jerry, $17,780 of Canada Pension Plan income for Jerry and $10,930 of CPP income for Sue. The total, $137,190, should be immune from the clawback, which, if the current start point of $62,144 grows at 3 per cent a year from inflation, will only be triggered in 2025 for individual incomes over $108,970 — more than either Jerry or Sue will be receiving.

Avoiding the clawback will be a problem Jerry and Sue will have to manage very carefully, Mr. Cherney says. Jerry has put all of his spousal contributions into Sue’s plan. For the future, it will be enough for Jerry to put 60 per cent of his contributions into Sue’s plan. But Sue, who has contributed to her own plan in the past, should stop immediately, Mr. Cherney says. He reasons that Sue’s tax bracket, about 31 per cent for combined federal and provincial income tax, is less than Jerry’s, 43 per cent at his income level. “The family will have more money if Jerry does all the RRSP contributions,” the planner says. “After all, at this bracket, the tax savings are much higher than Sue’s.”

Assuming the couple maintain their contributions, then, when Jerry’s retirement begins in 2025, they should have a total of $1.46-million in their portfolios, assuming they have been able to sustain a 5-per-cent annual average rate of return. That rate is conservative. Recently, stock market returns have been higher, but it is not clear they are sustainable, Mr. Cherney says.

Jerry and Sue should give attention to their three children’s RESPs, Mr. Cherney says. The couple have put $600 per child a year into a family plan that allows flexible payments to each child for post-secondary education. Right now, the total in all the plans is $26,400. A university education plan will pay $1,750 per child a year. The first child, age 16, could begin university within two years, the second, age 14, has four years to go. The third, age 10, is eight years from beginning university. The RESPs have to be increased. Mr. Cherney suggests Jerry and Sue can save the $10,500-a-year the family spends on children’s sports, postpone the purchase of new cars, or use the family’s net savings of $480 a month to increase the RESPs.

The children have failed to benefit from the maximum Canada education savings grant of as much as $400 a year for annual RESP contributions of $2,000 per child, Mr. Cherney says. Jerry and Sue can, however, accelerate their RESP contributions by putting up to $4,000 per child a year into RESPs. A provision of the RESP rules allows a Canada education savings grant (CESG) of as much as $800 per child a year for catch-up contributions, the planner notes. If they do this for eight years, then their youngest child would have about $46,000 for university, assuming Jerry and Sue use the $4,000 annual limit and obtain a 5-per-cent return on their contribution and on the $800 CESG that will flow in each year under the special provisions, he adds. The middle child, age 14, could have most of his expenses paid out of current spending for sports, Mr. Cherney adds. “This couple have done a good job of creating a financial base for their retirement,” Mr. Cherney says. “But they have done it partly at the cost of their children’s educations. They have enough money to give their eldest child a good start in university and they have the time to save for their younger children’s educations.”

“I thought I would have enough for my children to go to university, but I agree that we should divert money from sports to education. The money that is going into the mortgage, which we’ll have paid off by 2009, plus the money we spend on sports would put $24,000 per year into their education and that, together with the educational savings we have, should do the job,” Jerry says.

In Toronto, a couple we’ll call Stella and Mark have built a good life on hard work. Stella, 53, runs a small business and nets $84,000 a year. Mark, 49, is an engineer for a large company and nets $64,000 a year. With three teenagers at home, they have lived well but not planned for their future. “We are drifting financially with poor use of our assets,” Mark says. “We need a plan to guide us in managing business opportunities, our investments, saving for our children’s future and our own personal needs.”

What our adviser says

Facelift asked Toronto-based certified financial planner Michael Cherney to speak with Stella and Mark in order to develop a plan. His conclusion: “On a family income of about $150,000 a year, the family has done fine. But for Mark to retire in six years, as he would like, they have to begin making definite plans for the time when their earned income begins to decline. For now, they have more liquidity than they are using profitably.”

Stella and Mark are frugal, but they have substantial outstanding obligations to themselves for retirement and for their kids for their remaining years of dependency and for their postsecondary education, Mr. Cherney says.

Planning for retirement is the largest task Stella and Mark face, the planner says. Assuming that each lives to age 90, that inflation runs at an average 3 per cent a year and that both Stella and Mark begin drawing Canada Pension Plan benefits in 2016, then the couple will have a secure future, Mr. Cherney concludes.

The foundation of the couple’s retirement is Mark’s pension from his employer. That pension will begin its payout in 12 years when he is 61. At that time, the pension will be $3,099 a month in 2005 dollars. At age 61, he will also begin receiving CPP at a reduced rate of $606 a month. Early application for CPP will cost him 6 per cent a year of his maximum benefit. When he reaches age 65, he will receive monthly Old Age Security of $462.47 in 2005 dollars. At Stella’s retirement, which should begin when she reaches age 65 in 2016, she will have monthly CPP payments of $502 a month and monthly OAS payments of $462.47.

There are two sets of problems to be solved in the couple’s pension planning, Mr. Cherney notes. First is the structural problem of avoiding the OAS clawback that begins at an annual income of about $60,000 in 2005 dollars. Second is adjusting investment returns to a reasonable level of risk, he says.

Avoidance of the OAS clawback requires that Mark make maximum contributions to Stella’s registered retirement savings plan. He will thereby shift the risk of the clawback to Stella, who will have lower retirement income. He has $1,600 of unused contribution room, Mr. Cherney says. Stella should maximize her own contributions to her RRSP. She has $15,500 of contribution room, he adds.

RRSP contributions can be invested to produce returns of 5 per cent a year in registered accounts and 4 per cent a year in non-registered accounts subject to taxation, Mr. Cherney says. By maintaining RRSP contributions, Stella will accumulate $620,000 in her RRSP by age 69 and Mark $232,000 in his before he begins to withdraw funds through a registered retirement income fund at age 69. The RRSP must be converted to a RRIF, taken as a lump sum or turned into a life annuity by the end of the year in which one turns 69, the planner notes. At the time of inception, Stella’s RRIF will pay $19,000 a year. Mark’s RRIF will pay $11,600 at inception at age 69, Mr. Cherney says.

Educating the couple’s three children will be a costly undertaking. Recent Statistics Canada data indicate that the cost of tuition and books at a Canadian university is $28,000 for a four-year course if a student lives at home or $48,000 if the student has to pay room and board away from home, Mr. Cherney notes.

Assuming a 5-per-cent annual rate of inflation in the costs of postsecondary education, Stella and Mark will have to finance expenses in the range of $99,000 to $177,000, he estimates. Stella and Mark already have sufficient savings in RESP and taxable investment accounts. If one or more children choose to live out of the home, while at university, then the parents may want to provide additional financing through RESP contributions, the planner explains.

Although Stella and Mark have not focused their goals well enough to make firm decisions on how they can be financed, they can get better returns on their savings. To do that, they must move most of the approximately $250,000 they have in money market funds and cash into equities and bonds. The fees on specialty mutual funds in their portfolios average 3 per cent a year, even though specialty funds tend to have higher volatility than broad market equity funds and plain “vanilla” bond funds that have no foreign currency exposure, Mr. Cherney notes. Stella and Mark have the ability to pick their own assets and save on high management fees. They also have sufficient cash to build a diversified portfolio.

“This couple has, in a sense, an embarrassment of riches,” Mr. Cherney notes. “Their liquidity offers opportunities, yet it also creates problems. Stella and Mark have to decide how they and their children will be able to use their money. The paths lead to early retirement, sending the children to university with all expenses paid, and to bequests to their children or to charities.”

“We agree with the analysis,” Stella explains. “We have a huge portfolio of cash that is not earning much, real estate with the potential to generate large capital gains, and three great kids. We need to set our goals. Then the plan will make more sense.”

In a small city in Ontario, a couple we’ll call Bill and Theresa are raising their one-year-old daughter, Sarah, and paying off their mortgage. Bill, 37, who does market research work for various companies on contract, has a medical condition that makes it hard for him to work continuously. Theresa, 34, a medical technologist, works two days a week, spending the rest of her time caring for Sarah. Bill and Theresa are in a quandary. Should they pay off their mortgage as swiftly as possible or decelerate payments on their mortgage and buy a cottage? They also want to save for Sarah’s university education, her wedding and perhaps establish a trust fund for her. That’s a lot on their combined gross incomes of $120,000 a year. “We try to plan for our future, but the unknown is the state of my health,” Bill says. “A digestive disorder could become more serious and force me to retire early. That would crush any plans we might make. So we save a great deal, perhaps more than others in our income bracket would. It’s really a form of insurance for the future.”

What our expert says

Facelift asked Toronto-based certified financial planner Michael Cherney to work with the couple in order to sort out their options and to establish a strategy for achieving their goals.

Working in their favour, he notes, is the family’s modest level of consumption. They spend just $4,385 a month before registered retirement savings plans and accelerated mortgage payments out of a combined take-home income of $6,885.

“The couple’s immediate question is whether they should pay off their house mortgage quickly or pay it down more slowly and buy a cottage,” Mr. Cherney says. “A cottage would make it tougher to retire at age 60, as Bill would like. But a cottage can be a good investment and may appreciate faster than the stocks and bonds that usually go into RRSPs. Given that Bill and Theresa want to have the freedom to retire early, the cottage — along with its implied reduction of choices to do things other than go to the cottage in the summer — is not the best choice.”

The foundation of Bill and Theresa’s retirement will be their RRSPs, Mr. Cherney notes. If the couple can contribute $16,000 a year to their plans, then, assuming conservatively that assets grow at after-inflation rates of 3 per cent a year in the RRSPs and 2 per cent in the taxable accounts, and that Bill and Theresa each live to age 90, then the couple can achieve an annual income of $40,000 in 2004 dollars, which will be $78,943 in 2027 dollars, when Bill begins retirement, Mr. Cherney says. They will have combined RRSPs with a value of $1,164,000 that generate $72,194 a year. Bill and Theresa will each receive Canada Pension Plan retirement benefits at 70 per cent of the age 65 value, accepting a reduction of 6 per cent a year for each year they cash in before age 65. Bill’s CPP benefits will therefore begin in 2027 at $6,750 a year, compared with the maximum CPP benefits payable of an estimated $19,282 a year, the planner estimates. Theresa’s CPP benefits will begin in 2030 when she reaches age 60 at an estimated level of $7,376 a year, compared with a maximum potential payout of $21,070, Mr. Cherney estimates. Each will receive full Old Age Security benefits at age 65 — Bill in 2032 at a projected rate of $12,698 a year, Theresa in 2035 at $13,875 a year. By 2035, when all pension elements are in place, the couple will have total retirement income of just over $100,000 a year. That’s $40,000 a year pretax income in 2004 dollars.

Educating Sarah to completion of a four-year university degree will be costly, but manageable, Mr. Cherney says.

Sarah’s four-year university degree will cost about $100,000 if she begins her studies when she is 18. If she chooses to live away from home the cost could be as much as $150,000.

Bill and Theresa can save for that cost by making use of a registered education savings plan (RESP) that allows contributions up to $4,000 a year with a Canada education savings grant (CESG) of 20 per cent of contributions up to $2,000 year or $400 per child.

Budgeting for an out-of-town education will cost $5,000 a year or $4,600 after the CESG grant; $600 in excess of the $4,000 annual RESP limit would have to be invested via an in-trust account for Sarah. For an in-town education, the cost would be $2,800 a year in RESP contributions or $2,400 a year after the CESG grant.

Given the low level of spending the family now has, they can readily budget for either level of savings in addition to their RRSP savings, Mr. Cherney says.

“The dilemma the couple began with, whether to buy a cottage, is really a question of financial freedom,” Mr. Cherney says. “Bill and Theresa want to be free of debt and to have more, not less, choice in their lives.

“If they forgo the cottage and invest wisely for their retirements and for Sarah’s education, they should have a secure future. The cottage would leave them more encumbered and less secure, especially in view of Bill’s health. Bill may not be able to work continuously due to illness, so they need freedom and security more than they need a second house.”

“We have to build our retirement savings on our own because I think that, when I reach age 60, the Canada Pension Plan won’t exist any more,” Bill says. “CPP on top of our other retirement income sources would leave us very comfortable, but I feel we have to save aggressively if we are to have a secure retirement.”

What our expert says

Facelift asked Toronto-based financial planner Michael Cherney to speak with Luis and Bettina to determine whether they can, as they wish, build enough wealth to retire in 23 years, after they have paid for the education of their children. At that time, they hope to be able to generate $72,000 a year after tax and to be debt free.

“This couple can recover because they have invested heavily in themselves,” Mr. Cherney says. “They should also realize that steady asset growth based on a realistic strategy is more likely to be fruitful than gambling on hot stocks.”

Assuming that Luis and Bettina split their retirement income evenly, they will need to generate $45,000 each in order to have $36,000 a person after tax in current dollars, Mr. Cherney says. Assuming that they each receive Old Age Security without substantial clawbacks and begin to draw on the Canada Pension Plan at age 60 at 70 per cent of full benefit (CPP reduces benefits by 6 per cent a year for every year before age 65 that one begins to receive payments), then the couple will be able to retire not just at their target age, but a year sooner, postponing the CPP draw for a year, he predicts.

Making the plan succeed will take some careful work, the planner says. Luis’s annual income far exceeds what Bettina earns. Mr. Cherney’s plan provides for income averaging through spousal transfers of registered retirement savings plan credits. Therefore Luis should maximize his annual RRSP contributions, contributing to Bettina’s RRSP through spousal transfers until their plans are equal in value.

The plans should remain in balance thereafter, he adds. That should happen, he says, by 2007. In 2004, the contribution limit is $15,500 and will rise to $16,500 in 2005, $18,000 in 2006 and be indexed thereafter, the planner notes.

Luis and Bettina have a $210,000 mortgage that costs them $24,000 a year to service. They have been paying down principal with additional payments of $42,000 a year, so that, by 2007, the mortgage should be retired. Thereafter, they can put the $42,000 a year into non-registered investments, Mr. Cherney notes.

It is important that the non-registered investments be made with half the money coming from Bettina and half from Luis. If there is an imbalance, attribution rules would shift investment income from one spouse to the other and throw the plan off balance. By 2007, when Bettina has returned to full-time work at what Mr. Cherney assumes will be a six-figure income, they should have sufficient income to add the required $45,000 to $50,000 a year to their non-registered family investments on top of maxing out their RRSPs, he says.

Assuming that the couple can earn 6 per cent a year in their RRSPs and, after paying taxes on growth, 5 per cent a year in their non-registered accounts, and assuming as well that inflation runs at an average of 3 per cent a year, Luis and Bettina will begin their retirement in 2025 with $167,427 total income from RRSPs that each have $1,023,000 in total assets, and $1.7-million in non-registered assets.

At age 60, in 2026, their CPP payouts will begin at what Mr. Cherney projects will be $9,170 a year for Luis and $6,550 for Bettina. Their Old Age Security payments begin at age 65 in 2031, at a projected rate of $9,863 a year for each after a 20-per-cent clawback of the projected maximum benefit of $12,329. By that year, their pretax incomes will have risen with inflation adjustments and investments returns to $199,900 a year.

Luis and Bettina have good prospects of increasing their incomes substantially over their lives. Income gains, which can be assumed but not estimated, should not only finance their investments, but also enable the couple to invest at least $2,000 a year in registered education savings plans for their children and to receive the $400 annual Canada education savings grant.

Mr. Cherney suggests that the best way of achieving their targeted financial goals is for Luis and Bettina to diversify their investments by sector and style. Their principal assets are their educations.

“With their intellectual capital and sound financial decisions, Luis and Bettina should not only be able to reach, but to exceed their goals,” he says.

At the age of 41, a Toronto-based comic performer and writer who calls herself Ginger Beef is finding that there aren’t too many gags in her ongoing struggle to make ends meet. With an annual income that varies from $15,000 to $50,000 a year, averaging $30,000, she lives modestly in downtown Toronto in a $600-a- month apartment. Single and without dependents, she has been able to build up $96,000 in financial assets, but worries that she will be unable to support herself in retirement. Moreover, in her business, careers tend to be brief. Ginger’s choice of career remains firm, in spite of what amounts to a financial cost that she bears, for were she to be employed in steadier work on a salary, she might well make more money. There are some saving graces in her line of work and form of self-employment, she insists. “I get to write off a lot of expenses and I’m lucky in one way — I love what I do,” she explains.

What our expert says

Facelift asked Mike Cherney, a financial planner and lawyer with Michael Cherney Associates in Toronto, to speak with Ginger to determine what she can do to add security to her retirement plans.

“What is impressive about this lady is that on an income of $30,000 a year, she is able to save $8,000 a year,” Mr. Cherney said. “There are many people making four times that amount who are not able to save that much.

“Planning a comfortable retirement is nevertheless possible,” Mr. Cherney said. Assuming that Ginger works to age 67, she should be able to maintain a retirement income of $30,000 in 2003 dollars, he said. Assuming further than Ginger lives to age 95, that inflation averages 3 per cent a year for the next five decades, that she receives her Canada Pension Plan retirement benefit at age 67 at 112 per cent of the age 65 value and that there will be no clawback of the Old Age Security benefit, currently $453.36 a month indexed to inflation, she can meet her target with a small surplus.

At age 67, as she begins her retirement, Ginger’s target, an inflation-adjusted income of $30,000, will have risen to $64,698, the planner said. She will then have estimated annual payments of $11,613 from CPP, $11,732 from OAS, $19,794 from her registered retirement income fund and $26,266 of non-registered income, for a total of $69,405, leaving $4,707 available for further savings.

Ginger currently has $41,000 in her registered retirement savings plan and she can add to this by $3,500 a year. As well, she can add $4,500 a year to her non-registered assets with the amount of the contribution indexed to inflation, Mr. Cherney said.

Ginger’s non-registered portfolio should have an annual rate of growth of 5 per cent while her registered portfolio can grow at 6 per cent a year, the difference a reflection of tax erosion. After taking into account the effects of inflation, the two portfolios should produce real growth averaging 3 per cent a year, the planner said.

At age 67, Ginger can convert her RRSP to an RRIF and withdraw the minimum permissible amounts, currently 4.2 per cent a year and growing each year thereafter.

She can redeem minimal amounts of her non-registered investments beginning at 5 per cent each year as well to boost her retirement income. By the time she reaches age 90, she will be able to increase her draw from remaining non-registered assets. It is important to note that as long as Ginger’s draw from her non-registered assets is less their rate of growth, she will not be eroding her nominal asset base.

There is a problem, however, with her investment mix as between RRSPs and unregistered assets. Mr. Cherney noted that at her average annual income of $30,000, Ginger gets a tax deduction of only 22 per cent, which is much less than the deduction available at the top marginal tax bracket in Ontario, 46 per cent.

Saving with an RRSP does provide an annual incentive or target, but when the money is taken out, it will all be taxed as income and will cause forfeiture of any tax advantages that would come from capital gains or dividends held as non-registered investments. Nevertheless, given Ginger’s age and her projected life span, there is much to be said for the postponement of taxation within an RRSP if Ginger does live 54 more years to her projected age of 95, Mr. Cherney said.

The registered or non-registered issue is vital, for Ginger’s cautious investment strategy has resulted in her holding $16,000 in cash out of $96,000 in financial assets. That’s a portfolio with 17-per-cent cash, too much for any long-term strategy, the planner insists.

She should shift a good deal of her money market fund of $13,000 to bonds or bond funds. Mr. Cherney prefers actual bonds because they involve no annual management fees, they turn into cash when mature, and with interest rates expected to rise in the not too distant future, she need only buy short-term bonds with maturities of no more than three to five years. The bonds should be held in her RRSP to defer taxes on their interest, which is treated as income, he adds.

There remains an issue that Ginger should examine, Mr. Cherney said, and that is disability insurance. If Ginger can buy such coverage, she should ensure that it is non-cancelable and guaranteed renewable, has inflation protection, defines disability in a way that is relevant to Ginger’s career, offers partial disability protection, and has few exclusions.

“Ginger’s prospects for attaining her goals without undue hardship along the way are very good,” Mr. Cherney said. “She has limited means, but lives far below them. And she has the saving grace that, even if she were unable to continue her stage performances, she could remain a writer a very long time. This is one comedian who is playing her life very seriously.”

“It’s reassuring that I have enough money as a freelance comedy writer that I don’t have to get a real job,” Ginger said.

Grace, born in Italy, came to Canada 50 years ago and through hard work, she and her late husband built their fortune. Now, her problem is taxation. On top of her own $80,000 investment income estimated for 2003, she will receive payments from her husband’s registered retirement income fund. The payments would add to her income and impose additional taxes on money that she does not need right away.“I was shocked to realize that, as a result of inheriting my husband’s RRIF, I will have to pay a huge tax bill on money that law compels me to take,” Grace says.“I don’t need this money for myself, but I have a real need to preserve the capital for Monica after I am gone.”Grace has three choices for her husband’s $400,000, which, as the named beneficiary, she inherits.

She could roll it into her own RRIF with no tax due. This allows her to receive payouts from the RRIF, with minimums set by law. At age 75, for example, she is obliged to take 7.85 per cent, which works out to $31,400 this year.

Grace could turn the entire RRIF or any part of it into an annuity, and receive whatever payments she can obtain in the annuity market.

Or, she could collapse the RRIF in whole or in part. If she collapses the entire RRIF, she would take $400,000 into income and pay about $186,000 in tax at the peak Ontario rate of 46.41 per cent. It is an option seldom taken.

Grace’s situation is complicated by the different tax rates applicable to her non-registered portfolio and her and her late husband’s RRIFs. While sales of stocks and dividends generated in her non-registered portfolio will be at preferential tax rates, the $400,000 in her husband’s RRIF will be taxed at Grace’s top marginal rate on top of other income, whether the money is taken out in a lump sum or is spread over a period of years.

Collapsing her late husband’s RRIF would allow the money to be invested in a non-registered account in which it would produce tax-advantaged capital gains and dividends. Should she pay the tax now in full and receive tax-advantaged returns in dividends or capital gains, or keep the RRIF and go with partial deferral of income within the plan?

What our expert says

Facelift asked Michael Cherney, a Toronto-based certified financial planner and lawyer, to work with Grace on her tax issue. As he sees it, the complexities of her situation boil down to a few facts.

Grace says she can get by on $47,000 a year after tax, or $62,000 before tax, he explains. The problem now is to minimize taxes so that Monica will have the fullest benefits possible from Grace’s estate.

A complex tax minimization strategy could help Grace to cut her taxes, Mr. Cherney notes. She can borrow $186,000, the tax that would be due if she collapses the RRIF in one tax year, and then use the loan to replace the $186,000 of assets she had to sell to pay those taxes. This way, the RRIF is restored to $400,000. Grace then need pay only interest on the $186,000 as well as, of course, paying that money back to the lender.

Since Grace’s assets already generate more income than she spends, it should not be hard to divert some of that income, as well as the tax savings realized from her scheme, to pay down the loan, Mr. Cherney says.

Thus the advantage of Grace’s plan to collapse the $400,000 RRIF is that she will be able to reduce the income of this money from $31,400 this year to perhaps just the dividends on a diversified stock portfolio that could average 2.5 per cent, or $10,000. That move would reduce her net income, thus allowing her to receive $2,850 a year more in Old Age Security payments that would be clawed back if she took the required minimum payouts from the $400,000 in her husband’s RRIF.

As Mr. Cherney notes, if Grace can generate a return on assets above the interest she pays on the $186,000 and if that return is taxed at lower rates than the payments from the RRIF, she will have lowered taxes while maintaining the integrity of her husband’s fortune.

Mr. Cherney says that the Canada Customs and Revenue Agency has recently lost court cases in which it denied interest deductibility for certain loans. Now CCRA will allow deductibility of interest on the loan that is used to pay for new investments that would be purchased to replace the assets sold to pay the taxes. CCRA is reviewing its position and legislation on interest deductibility. While CCRA would not reach back to reassess Grace’s taxes already paid in respect of the plan, it could challenge her treatment of them going forward after its position is revised.

Assuming that Grace follows the collapse, borrow and reinvest plan, then she should hold income-producing assets within her own $500,000 RRIF in order to postpone taxation, the planner recommends. She should hold assets that produce capital gains and dividends subject to preferential tax rates outside her registered plan, the planner says.

There is a serious down side to Grace’s plan, however.

As Mr. Cherney notes, when one takes on debt, one adds risk to the portfolio. If the returns on Grace’s investments after the RRIF collapse don’t at least cover interest due on the loans she has taken out to replace assets sold to pay taxes, she will face a shrinking asset base, he warns.

As Grace ages, she might lose some of her considerable financial skills. Adding yet another layer of complexity to the sophistication of her investments could ultimately backfire, Mr. Cherney warns. In future, she may find it useful to buy annuities to pay her income during her life and to pay her daughter for the rest of her life.

There is risk in levering her investments on her financial acumen, Mr. Cherney warns. “I find it hard to recommend that anyone at any age should add debt and potential risk to a portfolio when it is not necessary. Grace already has $2-million of assets for the remainder of her very frugal life and what will probably a growing asset base to support her daughter. With so much money, why take chances?”

Complexity has another down side for Grace, the planner says.

Since her daughter has demonstrated no ability to handle finances and, indeed, has had a tendency to spend beyond her means, it would not be advisable to leave her with a complicated estate. If Grace does follow through on her plan to change the character of the $400,000 asset, she will have to consider use of a trust and to find trustees for money that may be left to her daughter.

Air Canada pilot Claude Forestier, 38, and accountant Carol Forestier, 39, are parents of three preschoolers, one of whom is handicapped.“I hardly know what to ask about my future,” Claude says. “I used to think that my six-figure salary would just be a starting point for building wealth. Now it seems that income security for the family is what matters most.”

What our expert says

Facelift asked Toronto-based financial planner Michael Cherney to speak with Claude and Chantal about their situation. Currently, he notes, the situation is grim.

“Claude’s partially indexed pension plan is underfunded and there is no assurance that he will keep his job,” the planner says.

Claude earns $100,000 a year while Chantal, an accountant, works part time for $9,000 a year when Claude can relieve her from caring for their handicapped daughter, Agnes, age six.

To build up an asset base to allow them to retire when Claude reaches age 65 in 27 years, Mr. Cherney assumes that the couple can live on $55,000 a year before tax in 2003 dollars. He also assumes that they will need another $10,000 in 2003 dollars each year for Agnes’ care.

To provide the total of $65,000 they will require in 2003 dollars, they will need to have an asset base of $1.8-million at the start of their retirement, the planner says.

Old Age Security payments should rise at an assumed annual indexation rate of 3 per cent to $12,084 in 2030 dollars for each parent and Canada Pension Plan annual payments should rise to $21,360 for Claude and $5,340 for Chantal or an amount similar to Claude’s if she returns to full-time work. Those sums would bring the couple’s annual income to $144,400 as retirement begins in 2030.

That’s the equivalent of $65,000 in 2003 dollars with a surplus to carry forward to future years when pension income falls short of that target, Mr. Cherney says.

Claude and Chantal’s current registered retirement savings plan balance of $120,000 would grow to $579,000 by 2030 at an annual rate of 6 per cent. After Claude and Chantal die at an assumed age of 90, the residue of their funds could be transferred to their children with the presumption that most would go to Agnes who would then be 58.

Additional retirement income is assured if Claude can invest $1,000 a month in his RRSP at an assumed growth rate of 7 per cent a year. Half of Claude’s contributions should go to a spousal plan for Chantal, the planner suggests. That would reduce chances of future Old Age Security clawbacks.

Investing $12,000 a year, which is already possible with the family’s monthly savings that exceed $1,000, will be easier if Chantal returns to full-time work at what she estimates would be a starting salary of $60,000 a year.

With that substantial contribution and the RRSP room that her work could provide, the Forestiers can either retire before age 65 or provide more money for Agnes’ care. Structuring that care while preserving her eligibility for future public benefits for the disabled requires legal work. A so-called Henson trust can preserve government benefits for disabled persons even though they have some private funding for their needs. They can receive benefits regardless of income flowing out of the trust.

The key, Mr. Cherney notes, is to direct that payments of income and capital from the trust be entirely at the discretion of the trustees. Thus the special needs beneficiary will not be deemed to have control of the trust, he says.

The appointment of a trustee for the Henson structure is critical, Mr. Cherney notes. A professional trustee, such as a trust company, can manage a trust, but that tends to be a costly solution. The best solution would be appointment of trustees with financial acumen who do not stand to benefit from the trust but who are friends of the family or kin and who, hopefully, will serve without pay.

The Forestiers’ two other children are young and have as much as 16 years of financial dependence on their parents before finishing high school. Were Claude and Chantal to die prematurely, their present insurance coverage of $200,000 in Air Canada group life and an additional $500,000 in term insurance would not be adequate, Mr. Cherney says. They should buy additional term insurance to provide each with $1-million coverage.

Claude and Chantal have already established registered education savings plans for David, two, and Paul, four. They are already contributing $100 per child per month and qualifying for an additional $240 a year of the Canada Education Savings Grant.

After Chantal returns to full-time work, additional contributions can be made. The children will then qualify for the full $400 a year maximum CESG. Claude expects that the contributions and returns on them will provide for half the expected $120,000 cost of four years of university education in Canada in 2003 dollars.

“I understand this analysis, but part of me does not want to face the reality that in this economy and with this airline, my employment is not a sure thing,” Claude says.

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High above Bay Street, corporate lawyer Suzanne Richter (not her real name) has the feeling that writing weasel words for mergers and acquisitions is not the goal of her life. She laments the 80 hours a week she must investin her profession and the target she must meet of 1,900 billable hours a year.At the age of 31, she is on track to make partner at her firm. She earns $110,000 a year. Her credit card debt, student loans and a modest line of credit at her bank total about $45,000.“I am at the crossroads between deciding to stay or moving into something very different,” she explains. “If I stay, I will get annual salary increases of $10,000 a year and that will be a chain that’s hard to break.“If my standard of living rises, I will be stuck paying for it. I have freedom now. I am getting to a stay-or-flee point in my career.”

What our expert says

Facelift asked Michael Cherney, a certified financial planner in Toronto, to meet Suzanne and to examine her career plans and goals. He’s well qualified because he’s a non-practising lawyer who left the profession to work in finance.

Suzanne’s plan is to shift her work to human resources consulting in the area of diversity management or becoming a director of a philanthropic organization. “That work is more about people and less about paper,” she said.

Suzanne should be good at it, but she will have to take a temporary salary reduction to $75,000 to $80,000, Mr. Cherney says. “That would entail significant changes to her spending plans.”

Currently, Suzanne spends about $7,480 a month including taxes, Employment Insurance, Canada Pension Plan, temporary career counselling and debt repayment. That level of spending will require management if Suzanne is to make a smooth move to another career, the planner says.

Suzanne’s rent, $2,005 a month less $300 from her sister who is attending university, is reasonable, Mr. Cherney says. A car Suzanne leases for $500 a month for use on weekends is costly. He wonders if Suzanne might be able to terminate the lease with a reasonable penalty payment and buy a used car.

There are a lot of other expenditures, including $235 for phone calls— many to her family on the West Coast. Those high phone bills might be cut by shopping for lower-cost digital phone plans and long-distance providers, he suggests.

Suzanne is generous to a fault: she spends $270 a month on gifts and charitable donations. Mr. Cherney recommends that they be cut by a half or two-thirds. Once Suzanne’s new career blossoms, she can restore her gift-giving to its former level, he says.

Car insurance that costs $141 a month is pricey for a female professional with a good record. Ms. Cherney recommends that Suzanne shop for better deals. They are hard to find, but he is confident she can do it.

At her $110,000 income level, Suzanne can pay down her debts if she develops a systematic plan, but if her income declines to $75,000 a year and if she continues to spend at her present rate, she will be in trouble, Mr. Cherney says.

“Suzanne’s current spending would not be sustainable if she makes a career move,” he explains. “It may be necessary to find a smaller apartment that Suzanne can split with her sister, each paying $600 to $700 per month.”

To prepare for a career move, Suzanne should begin by paying down debt with high interest rates, Mr. Cherney urges. That includes a $2,500 Visa balance that bears a 16-per-cent annual rate of interest, a $13,000 line of credit with a 7-per-cent interest rate, a $1,000 balance at a department store with a 24-per-cent interest rate, and student loans that total $28,800 with interest at 7 per cent.

Once debts are reduced and monthly expenses trimmed, Suzanne should begin a systematic plan to develop savings for retirement or a transitional lifestyle. She has only $7,000 in registered retirement savings plans and $1,200 in cash in the bank.

“What I want is to find a job that I love. My present job pays me very well and would pay a lot more in the future, but I don’t want to become a slave to it. I want personal satisfaction and this exercise has shown me that it is attainable.

“I will have to make some cuts in my budget. First I’d get a smaller apartment, as Mr. Cherney suggests, or ask my sister, who shares the apartment with me, to contribute more. Then I could cut my phone bills, then cut back charity but not gifts, and cut back on entertainment. But I have to preserve a minimum quality of life. The gym, the yoga and the hairdresser are going to stay.”

Interested in being considered for a free Financial Facelift? Drop a

line to the writer at 444 Front St. W., Toronto, M5V 2S9, or at the

address below with details of your situation.

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