Case study #3. Robert establishes a plan to generate retirement income and realize a life goal. Solutions that click.

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1 Making Retirement Case study Better #3 Solutions that click Case study #3 Robert establishes a plan to generate retirement income and realize a life goal For advisor use only. This document is not intended for public distribution. Standard Life 1

2 Robert asks you to help him understand where his retirement income is going to come from and if he is positioned to meet his financial objectives. He also wants to manage his exposure to market volatility and make sure he has enough money to fulfill a lifelong dream.

3 At 58, Robert is a hard worker, happy with his current lifestyle but also looking forward to enjoying his retirement. He wants to retire at 65, and plans to mark the milestone by achieving a life goal: Robert intends to buy a Harley Davidson. While he has been building his retirement savings since he began working, recent market fluctuations have prompted Robert to take a closer look at his retirement plans. He wonders what the impact would be if he were to retire during a year with a dramatic downturn, and suspects his financial losses would be magnified. Robert decides that it s time to make his plans more concrete. He wants to understand where his retirement income will come from, how much he can expect to receive, and how to make sure that his planned retirement gift to himself (the much anticipated Harley-Davidson) becomes a reality. Robert also wants to make sure that he can retire on the date of his choosing, no matter what the markets are doing at that time. Objectives: Understand where retirement income will come from Generate desired retirement income Reduce exposure to market volatility Make sure attaining life goal is financially feasible Standard Life 1

4 Robert s financial snapshot Registered Savings RRSP: $450,000 (with a mutual fund company) LIRA: $190,000 (with a bank) TFSA: $5,000 (with a bank) Assets House: $400,000 (mortgage free) Non-registered Savings $15,000 (with a mutual fund company) Income Current income: $85,000 Projected government benefits at age 65: $15,967 ($1, per month) The company Robert currently works at does not offer a pension plan, but he did have one with a previous employer. When he changed jobs, Robert transferred the pension money that had accumulated into a Locked-in Retirement Account (LIRA) with his bank. His LIRA is now invested in a growth-oriented portfolio, in accordance with his risk profile. Robert has put some money aside to protect himself against rainy days. He wants to use some of this money to buy the motorcycle he has always wanted. Until the beginning of 2009, this money was kept in a non-registered account with a mutual fund company. When he learned about the benefits of Tax-Free Savings Accounts (TFSA), Robert opened a TFSA at his bank, and contributed $5,000 to it instead of putting this money into his non-registered account. Until he reaches 65, Robert plans to continue contributing $5,000 per year to his RRSP, and to put another $5,000 per year towards his motorcycle savings. He wants to be sure he is better off putting his motorcycle savings in a TFSA rather than a non-registered account. Robert is planning to retire at age 65. If he retired today, he estimates he would need $60,000 per year (70% of his current income). Robert has savings and a goal in mind. What he lacks is a plan. How are you going to help him? 2 Standard Life

5 Things to consider Risk tolerance Robert has been investing in the market for some time and understands the risks of equity investing. He has, however, mentioned that the recent market uncertainty concerns him. Does Robert s portfolio still reflect his risk tolerance? Market risk Robert has enjoyed the higher returns on his equity portfolio. He astutely noted that if he retired in a year of a market downturn, it could significantly disrupt his plans. How can you put a plan in place to help protect him if there s a downturn when he does decide to retire? Life goals Robert wants to buy a Harley-Davidson when he retires. He has opened a TFSA for this purpose and wants to know how much he will accumulate by age 65. Tax implications LIRAs are locked-in accounts usually established with previous pension money. At age 58, Robert is eligible to transfer his LIRA to a LIF and start drawing an income. Should he begin withdrawing now, or wait until he retires? What would the impact be on his tax rate? Consolidation Robert has various different types of accounts in a couple of different places. Is this the best way to handle his assets? Should the same investment philosophy guide all of his holdings? Can the amount of money he has available to invest help him qualify for lower management fees? Standard Life 3

6 Did you know? Robert was wise to mention his concerns about market volatility. Retiring during a downturn can significantly magnify the negative impact of a market drop. Market risk Accumulation phase Everyone knows the mantra invest for the long term because it s based on sound investment practice. The laws of mathematics tell us that in multiplication, the order of the factors has no bearing on the resulting product. As the chart below illustrates, if a client starts with $100,000 and leaves it invested for 10 years, it doesn t matter how the returns fall out: at the end of the investment period, the resulting balance is the same. Scenario Accumulation years Average return Balance A % $196,715 B % $196,715 C % $196,715 Payout phase However, in the withdrawal phase, a market downturn early can be bad news. For these clients, the order of investment returns has a significant impact. The table below assumes that the client is withdrawing 7% or $7,000 per year from a $100,000 investment. Even though the returns in all three scenarios average out to 7% over 10 years, the investor in Scenario C, who has a negative return in year one, ends up with $28,942 less than the investor in Scenario B, who has a strong return in year one. What this tells us is that the impact of market volatility is magnified for people nearing or in retirement. Scenario Payout years Average return Balance A % $100,000 B % $112,528 C % $83,586 These illustrations do not reflect any taxation, fees or expenses. Source: Buying Time, D. Diamond, John Wiley & Sons Canada Ltd Standard Life

7 Action plan Risk profile You explain to Robert that the first part of developing a practical, realistic retirement plan is reviewing his attitude towards investing. You ask him to complete an investor profile questionnaire. The result shows that even though Robert has only 7 years until his desired retirement date, he still has a growth investor profile. This is not surprising, given his knowledge of investment products and his comfort with equity investing. Total fixed income = 41% Total equities = 59% Although the market volatility definitely caught his attention, he is not interested in selling, and says he s willing to take risks in order to earn a higher return over the long term. However, Robert still wants to know what can be done to reduce his exposure to market uncertainty particularly when he s about to retire. What should Robert do to prepare for moving from an accumulation strategy to drawing an income from the assets he has accumulated? Standard Life 5

8 Action plan Cash Wedge Strategy An income delivery process After considering his assets, stage of life, investor profile, and goals, you realize that Robert would benefit from a Cash Wedge Strategy a strategy that uses a short term investment, such as a money market fund, to hold between one to three years of income. The investor regularly replenishes this wedge with income and capital gains from other, more growth-oriented and income-focused investments. Any income and capital gains from the other investments that does not need to go towards replenishing the "cash wedge is used to buy additional units and rebalance the portfolio to ensure it stays aligned with its initial asset mix. This is a sell high/buy low process that will likely (although it is not guaranteed) result in higher returns. It creates a portfolio that should, over time, experience a lower degree of volatility. Since actual income is drawn from a money market fund, it is less vulnerable to market downturns. Cash wedge is an income delivery process, not a strategy to time the market. It can help Robert reduce his exposure to market volatility, and will help him rest easy knowing where his income is going to come from. 6 Standard Life

9 Action plan Here s how it works: Positioning Robert to move from accumulation to payout Robert plans to work until he is 65 years old. Since he does not need extra income now, you recommend that Robert delay withdrawing from his LIRA/LIF until he retires. Adding LIF income to his current earnings would move him into a higher tax bracket, which would not be the optimal tax situation for Robert. You recommend that at age 65, he start receiving government benefits, withdrawing the maximum amount from his LIF, and taking the difference from his RRSP/RRIF to reach the annual income he needs. This income strategy will ensure that Robert doesn t end up in a higher tax bracket. Using TFSAs for maximum effect If the minimum RRIF withdrawals are more than he needs to meet his desired income, Robert can put the excess amount into his TFSA, where it will earn tax-free returns. Age LIF maximum 1 ($15,967 in 2009 with 2% inflation per year) 2 ($60,000 in 2009 with 2% inflation per year, rounded) Government Sub-total Gross income benefits 1 needed 2 RRIF withdrawals 65 $ 24,735 $ 18,340 $ 43,075 $ 69,000 $ 25, ,012 18,707 43,719 70,380 26, ,293 19,081 44,374 71,788 27, ,579 19,463 45,042 73,223 28, ,869 19,852 45,721 74,688 28, ,164 20,249 46,413 76,182 29, ,463 20,654 47,117 77,705 30, ,393 21,918 49,311 82,461 33, ,074 24,199 53,273 91,044 37, ,034 26,717 57, ,520 42, ,370 29,498 63, ,982 47,114 Standard Life 7

10 Action plan You propose steps Robert can take now to make sure that he is ready to transition from accumulation to payout when he retires at 65. 1Consolidation Some companies will take all of an investor s holdings into account and charge lower fees. At present, Robert s LIRA and TFSA are invested with his bank. His RRSP and nonregistered accounts are held with a mutual fund company. By consolidating his assets in one place under the direction of one advisor, Robert can make his finances simpler to manage and potentially qualify for lower management fees. This has the potential to put more money in his pocket over the long term. 2Staying invested Robert s RRSP is invested in a growth portfolio and can stay invested with a 40% fixed income/60% equity asset mix until age 63. As Robert s advisor, you might consider suggesting that Robert immediately transfer his RRSP savings into the same funds you will be recommending for the Cash Wedge Strategy, except for the money market portion which he only needs to set up one to three years prior to drawing an income. This asset mix could be applied from now (at age 58) until Robert is 63. 3Repositioning In order to put the Cash Wedge Strategy into action and start drawing an income when he retires, Robert will need to reposition his RRSP investments starting at age 63. This involves allocating a defined amount of capital from his RRSP to a money market fund. It is from this segment that the actual income amounts are paid out of the portfolio. Robert has decided to hold two years of income in his cash wedge. At age 63, he needs to transfer the equivalent of one year of income into his money market fund within his RRSP, and repeat this exercise when he is 64. At age 65, he will convert his RRSP to a RRIF and start to withdraw income. 8 Standard Life

11 Action plan Each year, the advisor will take a portion of the growth and capital gains from the other funds and transfer it to the money market fund. The goal is to transfer growth and capital gains that are equal to one year s worth of income payments. The Cash Wedge Strategy can also be applied to Robert s LIRA, which he ll convert to a LIF when he is ready to withdraw income. How many years of income go into the cash wedge? Keeping less than one year of income in a cash wedge won t provide much income stability. Keeping more than three years would require such a large portion of capital that it would probably not be worthwhile because the portfolio would not benefit from the equity exposure. The decision to hold one, two or three years is up to the investor. Here are few things to consider: A client who has a very balanced portfolio and other sources of income might be more comfortable with a one-year cash wedge. If market performance leads to a situation in which one year is not enough to replenish the wedge, the client would then have the option of not withdrawing income that year (or withdrawing only the minimum if invested in a RRIF). Clients whose asset allocation reflects a growth profile might be more comfortable with a twoyear wedge. They would need a buffer of greater than one year to make sure that any short-term downturns don t impact their income. An extremely conservative client who wants to do everything possible to reduce exposure to market volatility might be more comfortable keeping three years of income in a cash wedge. Standard Life 9

12 Robert s Cash Wedge portfolio for his RRSP (at age 65) Total Fixed Income = 41% Total Equities = 59% 10% Money Market Fund (Cash Wedge) Global Dividend Growth Fund 30% 15% Canadian Bond Fund Canadian Dividend Growth Fund 20% 15% 10% Corporate High Yield Bond Fund Monthly Income Fund Fixed income = 6% Equities = 9% Robert will draw his retirement income from the cash wedge portion. Income and capital gains from other funds will either go towards replenishing the cash wedge or be used to buy additional units or positions in the investments that are flat or negative. 10 Standard Life

13 Cash Wedge fund criteria for RRSP Here s a typical allocation to achieve a Cash Wedge Strategy: Money Market Fund (10%) Your client will need some type of short-term investment to act as the cash wedge from which the retirement income is drawn. A money market fund is a good choice as it provides the stability and liquidity needed for regular withdrawals. Canadian Bond Fund (15%) The objective of a bond fund is to stabilize the fixed income portion of the portfolio and give the client access to long-term Canadian bonds. These typically offer low volatility, income and relatively stable performance. Negative annual returns are rare. Corporate High Yield Bond Fund (10%) The objective of this type of fund is to provide clients with diversification within the fixed income portion of their portfolio. These funds typically take advantage of higher yields, higher income and capital gain opportunities available through corporate bonds. Monthly Income Fund (15%) A monthly income fund is typically split 40% fixed income and 60% equities. While the equity portion focuses on dividend paying securities, the fixed income component rounds out the fixed income portfolio. The fund also pays a monthly distribution that can be used to replenish the Cash Wedge or reinvest it until needed. Canadian Dividend Growth Fund (20%) This ties the majority of the portfolio to the Canadian market, which is important for Canadian clients paying bills with Canadian dollars. The fund focuses on dividend paying securities that have proven to outperform non-dividend paying companies over the long-term. Dividend paying securities are also historically less volatile, enhance performance and provide a steady stream of dividends and income. Global Dividend Growth Fund (30%) This type of fund should give clients greater access to sectors not widely available in Canada. A geographically diversified portfolio reduces risk and enhances performance potential. Standard Life 11

14 Other elements to consider: Low fees make all the difference! Because Robert has $450,000 in his RRSP and $190,000 in his LIRA, he can be considered for funds that have lower fees. Investing in funds with lower fees can result in a significant increase to his portfolio value over time. Take a look at this example: $700,000 Impact of MERs on Robert s RRSP Investment value $600,000 $500,000 $400,000 Median MER 2.29% 1 Y Series 1.90% Z Series 1.21% Age Assumptions: Rate of return before fees and expenses: 7% If at age 58 Robert invested in a growth portfolio with a median MER 1 (2.29% in this example) his portfolio would be worth $621,054 when he reaches age 65. If Robert chooses a growth portfolio with a lower MER like Z Series (1.21%), his assets could reach $667,306 by the time he turns 65. That s a difference of $46,252 just for selecting a portfolio with a lower MER. 1 Source: PALTrak, August 31, Standard Life

15 Achieving Robert s lifetime goal All too often, people have positive but hazy ideas of what they would like to do when they retire. The surest route towards achieving a lifetime goal is to clarify what that goal is, and then put in place a plan to make it a reality. Robert has mentioned several times that he would like to buy a Harley-Davidson when he retires at 65, but he has not specified how much he plans to spend on it. Encourage him to decide which model he wants, what it is likely to cost, and develop a plan to make sure he has that amount in an account set up for just that purpose when he turns 65. This will ensure that Robert will be able to realize his dream, and will not be at risk of having to dip into the funds meant to generate retirement income. Robert already has $5,000 in a TFSA. You encourage him to consider this his motorcycle money, and recommend that he continue to put the $5,000 per year he is allocating to this purchase into a TFSA, not a nonregistered account. Robert will likely be withdrawing his TFSA investments all at once and in full to pay for the motorcycle, and this type of investment will give him the freedom to do that. He will not be impacted by market performance at the time he is withdrawing. Finally, term fund interest is taxed at the highest interest rate, but since Robert is holding this within his TFSA, he will not be taxed at all. Since Robert will be opening up significant contribution room when he withdraws the money at 65, you ll want to make sure he knows he can then transfer his non-registered emergency fund of $15,000 (plus investment gains) into his TFSA. This will mean his emergency funds will accumulate tax-free. This will help him accumulate approximately $39,491 by the time he reaches age 65 ($5,000 per year for 7 years at a 4% rate of return). You recommend that Robert s TFSA be invested in a term fund with an insurance company. This will give him security with no exposure to the market, a worthwhile consideration because this is a goal that is important to Robert s enjoyment of his retirement years. Standard Life 13

16 Wrap up You took the following steps to create a well-defined retirement income plan that will reduce Robert s exposure to market volatility, and set money aside to realize a lifelong goal: Revisited Robert s entire portfolio, beginning with asking him to complete an investor profile questionnaire. Recommended that Robert consolidate his assets with one advisor to make them easier to manage and to take advantage of lower fees. Repositioned Robert s RRSP and LIRA investments to take advantage of a Cash Wedge Strategy. Starting when Robert reaches age 63, he ll gradually transfer money into a money market fund (his cash wedge ) Agreed that when Robert reaches age 65, he ll convert the RRSP into a RRIF and the LIRA into a LIF account. Once the Cash Wedge Strategy is in place, Robert will withdraw the maximum income available from his LIF, and make up any shortfall in income with withdrawals from his RRIF. Encouraged Robert to invest his TFSA in a term fund with an insurance company and continue adding money to it until he wants to use the savings to buy a motorcycle. Pointed out to Robert that he should transfer his non-registered savings into his TFSA once he has opened up contribution room by using the savings to buy a motorcycle. 14 Standard Life

17 Standard Life s solutions Real-life events require distinct planning concepts using creative product solutions. Standard Life offers a full range of investment and protection solutions to meet these needs. Here are the products specific to this particular case: Cash Wedge Strategy The cash wedge is an income delivery process, not a strategy to time the market. It takes advantage of the characteristics of different asset classes to put in place a sell high/buy low approach. Although results are not guaranteed, it is likely to result in higher returns, and works to help protect clients from market volatility. Standard Life Mutual Funds Choice of 23 funds covering fixed income, monthly income, dividend and equity fund families Opportunity to build a well-balanced, diversified portfolio that allows clients to benefit from investment opportunities around the world Offer consistent long-term performance potential and controlled exposure to risk Standard Life Mutual Funds E-Series and Legend Series Minimum initial deposit: E-Series: $100,000 Legend Series: $250,000 Choice of 22 funds Opportunity for high net worth clients to enjoy very competitive management fees Standard Life TFSA Choice of products to hold within the TFSA, including Standard Life Mutual Funds Standard Life Ideal Segregated Funds Signature Series Ideal Term Funds an ideal solution for clients looking for a stable, high-interest alternative to GICs. Offers terms from 30 days to 10 years, including customized terms, plus a Daily Interest Fund Collect investment income tax-free Make withdrawals tax-free Withdrawals create additional contribution room the following year Ideal Segregated Funds Signature Series While this case study points to Standard Life Mutual Funds as a solution, the Cash Wedge Strategy works equally well using Standard Life s Ideal Segregated Funds Signature Series Standard Life 15

18 Standard Life Mutual Funds are managed by Standard Life Investments Inc. (SLI) By investing in Standard Life Mutual Funds stand-alone or Portrait Portfolio Funds, your clients will gain access to proven investment expertise the same expertise that was once primarily available to major pension funds and institutional investors. In Canada, a team of 40 investment professionals manage assets of CDN $25.9 billion 1, while SLI s global team of over 200 manages CDN $232.6 billion 1 of assets for clients worldwide. SLI is a first-class investment company with offices throughout the world that view investing from a truly global approach. 1 Assets under management as at end of June Take the CE course. 16 Standard Life

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20 Retirement Investments Insurance Talk soon. This document is for general information only. It should not be construed as legal, accounting, tax or specific investment advice. Clients should consult a professional advisor concerning their situations and any specific investment matters. Our analysis is based on the tax legislation in effect on September 2, While reasonable steps have been taken to ensure that this information is accurate, The Standard Life Assurance Company of Canada and Standard Life Mutual Funds Ltd. make no representation or warranty as to the accuracy of this information and assume no responsibility for reliance upon it. The Standard Life Assurance Company of Canada Standard Life Mutual Funds Ltd. 18 Standard Life 6587A