*Advisor. case Study david and theresa. Meet David and Theresa

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1 *Advisor use ONLY case Study david and theresa Meet David and Theresa David, age 69, and Theresa, age 67, live in Edmonton, Alberta. Their daughter, age 40, and granddaughter, age 16, live nearby. David and Theresa have been retired for a few years. Recently, David has experienced early symptoms of Alzheimer s disease, which is quite prevalent in his family. So far, they have been taking an ad hoc approach to their retirement spending. They ve now come to realize that they really have no idea how much money they can afford to spend, or how to manage their retirement income effectively. They initially received advice from David s older brother, Keith, who has a background in accounting. Keith said that they seemed well-funded, and proposed the following: consolidate their investments in two or three bank-affiliated balanced mutual funds so they maintain some conservative equity exposure to hedge inflation when possible, withdraw from non-registered accounts before registered accounts to maximize the tax-deferral offered by the registered accounts delay the conversion of registered retirement savings plan (RRSP) assets to registered retirement income funds (RRIFs) to age 71, and base the RRIFs on Theresa s younger age, so they can take lower minimum withdrawals and make the funds last longer

2 David and Theresa s financial situation Income and benefits David receives $45,000 annually from his pension plan (indexed at three per cent). This will decrease by 40 per cent (or $18,000 in current dollars) upon his death David and Theresa receive 90 per cent and 80 per cent respectively of the maximum CPP benefits They both receive full OAS benefits David has basic family health benefits from his employer Investments $100,000 in David s RRSP $200,000 in Theresa s RRSP Both RRSPs are invested in 60 per cent equity, 40 per cent fixed income $10,000 each in their respective TFSAs, in cash equivalents Assets $225,000 house, no mortgage Worried about market volatility, David and Theresa wonder if Keith s recommendations are enough to protect their retirement income from market risk, and they worry that simply reducing their mandatory RRIF withdrawals by using a lower age will not be enough to ensure their assets last their lifetime. As a result of these concerns, they asked for a second opinion from an advisor. Retirement goals The first thing David and Theresa s advisor asked them to do was be very specific about what they needed to spend and what they wanted to spend, and how these might change over time. After giving this some thought, David and Theresa said they really enjoy travelling, and because David has exhibited some of the early symptoms of Alzheimer s disease, they would like to do as much of this as possible during the early years of their retirement. They came up with the following annual income estimates: Period Basic income Discretionary Total From now until $55,000 $20,000 $75,000 David is 75 After David is 75 $55,000 $5,000 $60,000 They would also like to help with their granddaughter s college costs, if possible. The challenge David and Theresa need to get a handle on their expenses, so they can understand if they can afford to indulge their love of travel while David still has his health, and to determine if Theresa will be financially comfortable if David dies before her. David may have an elevated risk of needing long-term care services in the future. However, his age coupled with his symptoms and his family history likely make him ineligible for long term care insurance (LTCI), so they will have to self-insure this risk. They should also consider the possibility that, if Theresa were to need care in the future, David may not be in position to provide that care.

3 The solution Combine their private and government pension income, purchase long term care insurance (ltci), and plan to save for future care as well as for their granddaughter s education. Income David s existing pension, when combined with their Canada Pension Plan (CPP) and Old Age Security (OAS) benefits, is more than enough to meet their stated essential and discretionary income needs. All of these sources are indexed for life, so the income should be able to keep pace with inflationary increases in their basic expense needs. In fact, they will have a moderate surplus of cash flow once their RRSPs mature at age 71. LTCI While their essential and discretionary lifestyle needs are met, David and Theresa need to address their morbidity and mortality risks. They could obtain LTCI coverage for Theresa, which would protect them if she needs care and David is unable to provide it. Assuming she is insurable, she could acquire LTCI coverage of $1,500 per month for an annual premium of $6, Savings/TFsa Given David s family health history and the fact that he has exhibited some of the early symptoms of Alzheimer s disease, they should direct any surplus income back into savings, to prepare for the possibility of potentially higher medical or long-term care expenses in the future. Their TFSAs would be excellent vehicles in which to keep these excess funds. Survivor pension They were concerned about the reduction in pension income if David dies before Theresa and his pension drops by 40 per cent. Their advisor reminded them that Theresa would not have to replace the entire lost pension income, because research has shown that a household s essential expenses (other than rent or mortgage payments) drop by 20 per cent to 40 per cent after the death of one spouse, and discretionary expenses tend to drop by 50 per cent. In addition, Theresa would receive a CPP survivor s pension that would increase her CPP benefit from 80 per cent to 100 per cent of the maximum CPP pension. Finally, Theresa could use any money they had set aside for David s potential long-term care to buy a life annuity and help boost her income. Asset allocation David and Theresa are exposed to more investment risk than they need to be and, if they are travelling extensively, they don t want to have to worry about how their retirement savings are invested. For this reason, they should reallocate their RRSP portfolios to 60 per cent GICs and 40 per cent domestic fixed income. 1 EOS quote run May 17, 2010, for a comprehensive benefit of $1,500 per month for 150 weeks, without inflation protection, with a 30-day waiting period.

4 Education savings They currently have $20,000 in their TFSAs for emergencies, which would cover about four months of expenses. Given their guaranteed sources of income, they could afford to use $10,000 of this to contribute to their granddaughter s education. If she already has a registered education savings plan (RESP) that has received contributions in the past, they may want to stagger this over two years, to take advantage of the available Canada Education Savings Grant (CESG). If it is too late for her to be CESG eligible, or if her RESP is already maxed out, they may want to gift money to her instead but should consider waiting until she turns 18, so that any investment income their granddaughter earns is not attributed to them. Regardless of how the funds are held, they should choose conservative investments, such as GICs, because of the short time remaining until she starts her post-secondary education. The result David and Theresa can have some assurance that they can afford to travel extensively over the early years of retirement, without jeopardizing their future retirement income. They can also afford to make a generous contribution to their granddaughter s education fund $180 K 0000 $150 K 0000 $120 K 0000 $90 K 0000 $60 K 0000 $30 K $0 K Government sources Pension income RRIF minimum withdrawals Registered withdrawals as needed Total needs David s brother, Keith, and the advisor both concluded that David and Theresa are well-funded. However, Keith was only looking at things from an investment risk perspective, and he only recommended market-based solutions. The advisor took a broader risk management approach and considered how David s premature death or illness could affect their financial situation.

5 Action plan What When Result Adjust the asset allocation of their RRSPs Now They won t have to worry about their investments during their travelling years, and their market risk and sequence of returns risk is minimized Buy LTCI for Theresa Now Transfers Theresa s morbidity risk to the insurer Reinvest excess income Once done travelling Accumulate funds to cover David s potential need for long-term care, and/or to offset the drop in David s pension upon his death Contribute $10,000 towards granddaughter s education Now if it can be made to an RESP, otherwise once granddaughter reaches age 18 Satisfaction of helping their granddaughter Risk management matrix The following table indicates how the recommended solutions will address the risks that David and Theresa face in retirement. Retirement risk Longevity risk Sequence of returns risk (poor returns early in retirement) and market risk Inflation risk Mortality risk Morbidity risk (long-term care) Unanticipated expenses Management strategy and outcome This is addressed by their high level of lifetime income from CPP, OAS and David s retirement pension Reallocating their RRSP portfolio to 60 per cent GICs and 40 per cent domestic fixed income products will mitigate the risk David s pension and their CPP and OAS benefits are all indexed to inflation, and this income covers their essential expenses, so they are protected from inflation risk Theresa will continue to receive 60 per cent of David s pension if he dies before her, but her expenses would decrease and her CPP pension would increase, so her risk is only modest and one she can afford to retain Purchasing LTCI covers Theresa s morbidity risk. They will have to self-insure David s morbidity risk Investing $20,000 in their TFSAs provides protection for emergencies Assumptions The SunVision Financial Analyzer (SVFA) tool was used for all projections and tax calculations, including the SVFA defaults for investment returns and inflation (three per cent general, two per cent real estate).

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