*Advisor USE ONLY CaSE Study JEAN Meet Jean Jean is almost 64 years old and has established and run her own successful tool and die business for the last 20 years. She is thinking about selling the company (a qualified small business corporation) to one of her children and transitioning into retirement. Jean is a single mother and has two adult children, Shawn, 40, and Brandon, 36. Brandon and his wife Emily have a one-year-old daughter, Rose, and they hope to have more children. Brandon is passionate about his job as a teacher, and his role as husband and father. Shawn is single and has his mother s drive for business. RETIREMENT GOALS Jean would like to completely retire in the next five to seven years.
Jean s financial situation Investments $160,000 in RRSPs, in balanced funds (40 per cent fixed income, 60 per cent equity) $11,000 in a TFSA, in a conservative bond index Assets and liabilities $320,000 home in Burlington, Ontario with $75,000 mortgage $360,000 cottage with an adjusted cost basis of $85,000, to pass on to Shawn and Brandon $750,000 business value, entire gain can be sheltered by capital gains exemption Insurance $100,000 existing 20-year term policy, bought at age 60, with premiums of $100/month Income No pension Eligible for maximum CPP and OAS benefits at age 65 Selling the business Jean would like Shawn to take over the business, but she cannot afford to gift it to him, because it forms the bulk of her wealth that will finance her retirement. Shawn is willing to buy the business for its fair market value (FMV) of $750,000, but he can only come up with $450,000 for the down payment. Upon the advice of her accountant, Jean has agreed to sell the business to Shawn for an initial amount of $450,000. The balance is to be paid in annual instalments of $30,000, plus interest of four per cent with payments beginning on her 65th birthday. Transitioning into retirement To help transition the business to Shawn, Jean plans to continue to work with Shawn full-time until age 65. She will then continue to work half-time for the first three to five years of her retirement at a salary of $50,000. Although Jean thought that she had enough money for retirement, she decided it would be best to get some professional advice. Retirement lifestyle Jean s advisor asked her to describe what her ideal retirement would look like and how much it would cost, keeping in mind that her needs and wants will likely change with age. Jean said that although she enjoyed her life as an entrepreneur, she was looking forward to scaling back her hours, travelling and spending lots of time with Rose, maybe even caring for her while Brandon and Emily continue to work. She would also like to spend time pursuing her other interests, which include painting, hiking, volunteering at a women s shelter and acting as a mentor for young female entrepreneurs. Once she completely retires at age 70, she would like to sell her house and move into her cottage, which is very close to where Brandon and Emily live. Upon her death, she would like the cottage to pass to Brandon and Shawn, without them having to pay any resulting income tax. She also would like to leave a bequest to the women s shelter. Based on these plans, Jean estimates she will need the following after-tax income, excluding any mortgage payments (all amounts in current dollars): Period Basic income Discretionary Total From 65 to 69 $55,000 $15,000 $70,000 From 70 to 74 $50,000 $15,000 $65,000 From 75 to death $45,000 $5,000 $50,000 In addition to this regular income, Jean would like to help with the education expenses for Rose, and for any other children Brandon and Emily might have.
Retirement concerns Jean is in excellent health now, but she s concerned that her health care expenses will increase as she ages. There have been several occurrences of stroke in her family, but otherwise the family has a history of long life, well into their 90s. Jean is particularly concerned about what might happen if she has a stroke because she does not want to be a burden to her family. Jean is also worried about whether the sale of her business in this manner will allow her to sustain her standard of living over her lifetime, given inflation and her family history of long life. The challenge The bulk of Jean s wealth is tied up in her business and her property. She wants Shawn to have the business, but she cannot afford to sell it to him for less than fair market value and she cannot afford to take great risks with her capital. Given her family history, she should plan for retirement income to age 95 and protect herself from inflation and health care risks. The solution Jean can sell the business to Shawn for its full value of $750,000 with a down payment of $450,000 now and the remainder to be paid in 10 annual instalments starting at age 65, at four per cent interest. One of the conditions of the sale should be that Shawn obtain life insurance to cover his debt with Jean named as the beneficiary. Those annual payments, together with her part-time consulting income and Canada Pension Plan (CPP) benefits, will not be quite enough to sustain her desired lifestyle during the first few years of her retirement. Before her Old Age Security (OAS) benefits kick in, she will have to draw about $10,000 per year from her registered funds during this time. Jean could use a portion of the immediate business proceeds to pay off her mortgage, and use the remaining $375,000 to buy a guaranteed minimum withdrawal benefit (GMWB) (70 per cent equity, 30 per cent fixed income) with payments to begin at age 70. The bonusing from now until age 70 will result in annual non-indexed after-tax payments of $17,988 for life 1. When she sells her house, she could use the proceeds 2 to buy a prescribed life annuity, which would result in annual income of $29,218 for life (with a taxable amount of $6,983 per year). Jean could keep her Tax-Free Savings Account (TFSA) as an emergency fund using conservative investments. In years where she has excess income, she could maximize her TFSA contributions to further shelter her investment income. 1 SunWise Elite illustration tool run May 12, 2010, using the scenario historical model with a portfolio of 70 per cent equity and 30 per cent income. For the purpose of modeling the GMWB in the SunVision Financial Analyzer tool, it is assumed that the entire GMWB proceeds are subject to an average tax rate of 25 per cent. 2 House proceeds in 6 years estimated to be $358,000, used to purchase a prescribed life annuity. Payout annuity illustration run May 11, 2010, for a single life, prescribed taxation using non-registered money with a zero guarantee period for a total income of $28,218 per year, of which $6,983 is taxable.
The tax liability on the cottage could be over $60,000 upon her death 3. Jean could keep her existing term insurance policy, which would cover this tax liability if she dies prior to the policy s expiry at age 80. This gives Brandon and Shawn time to plan to self-insure the liability if Jean dies after the policy expires. Alternatively, Brandon and Shawn could convert Jean s existing policy to a $100,000 universal life policy with a premium of $2,396 per year 4. This would cover the tax liability regardless of when Jean dies. Jean should also have the value of the cottage appraised when she moves into it full time. Any appreciation that occurs after that time can be covered by the principal-residence exemption. Provided she meets underwriting requirements, Jean could obtain long term care insurance, a $1,000 weekly comprehensive benefit, to a lifetime maximum of $250,000, for an annual premium of $6,606. 5 She should also consider buying personal health insurance (PHI) with dental and semi-private hospital coverage, for an annual premium of $2,820. 6 The result Using these strategies, Jean will be able to meet all of her essential and discretionary expenses until age 90 with a high degree of protection from market risk, longevity risk and health care risk. By drawing on her remaining assets, she should be able to sustain her purchasing power until age 92. After age 92, her income would fall short of essential expenses by about 25 per cent. Her advisor indicates they will continue to revisit her plans and revise them as her needs change. $180 K $150 K $120 K $90 K $60 K $30 K $0 K 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 Government sources Earned income RRIF minimum withdrawals TFSA distributions Other registered funds Proceeds from sale of business Previous year's surplus used Annuity income Total needs The strategies above do not address her desire to help with Rose s education or provide a bequest to the women s shelter upon her death. If these objectives are important to Jean, she should consider either working full-time a few years longer or scaling back on her discretionary expenses so that she can direct some of her cash flow into a registered education savings plan (RESP). 3 $360,000 inflated at two per cent over 6 years = $405,418. Capital gain on cottage after age 70 is covered by principal residence exemption. Taxable capital gain upon death = [($405,418 - $85,000) 50 per cent] = $160,209. If marginal tax rate is 39 per cent, tax liability is $62,482. 4 Quote for a minimum-funded universal life policy for a woman 63 years old in good health, run on May 17, 2010. 5 EOS illustration run May 8, 2010, purchased at age 65, $1,000 weekly benefit amount, 30-day waiting period, benefit for 250 weeks, inflation protection of two per cent annually, increasing to three per cent while on claim. 6 PHI illustration run on May 12, 2010.
Action plan What When Result Sell business to Shawn Now Immediate proceeds of $450,000, plus $30,000 per year for ten years starting at age 65 Use $75,000 of business proceeds to pay off mortgage Now Elimination of all debt Use $375,000 of business proceeds to buy GMWB Purchase now, with payments to commence at age 70. Payments of $17,988 for life starting at age 70 Continue to work full-time From now until age 65 Income of $100,000/year Work half-time For 5 years after reaching Income of $50,000/year for five years age 65 Start CPP and OAS At age 65 Receive maximum CPP and OAS benefits Sell house and move to cottage Use house sale proceeds to buy prescribed life annuity Buy long term care insurance (LTCI) Buy personal health insurance At age 70 At age 70 Now Now Generate proceeds of about $358,000, reduce expenses associated with maintaining two properties Payments of $29,218 for life (with a taxable amount of $6,983 per year) Transfers morbidity risk Transfers morbidity risk Risk management matrix Retirement risk Longevity risk Sequence of returns risk (poor market returns early in retirement) Market risk Inflation risk Mortality risk Morbidity risk (medical expenses and long-term care) Unanticipated expenses Management strategy and outcome By purchasing a GMWB and a life annuity to supplement her CPP and OAS benefits, Jean is guaranteed to have a lifelong income Jean has significantly reduced her exposure by using the business proceeds to buy a GMWB and the house proceeds to buy a life annuity Jean has significantly reduced her exposure to this risk by using the business proceeds to buy a GMWB and the house proceeds to buy a life annuity. Her RRSP is still exposed to market risk, but her exposure to equities in that account may also help offset her remaining inflation risk Although only a portion of Jean s retirement income will be indexed to inflation (primarily her CPP and OAS), she has sufficient assets to maintain her lifestyle until about age 92 if inflation is three per cent during retirement Jean s primary mortality risk lies with the capital gains tax arising on the cottage upon her death. She can address this to age 80 by maintaining her existing life insurance policy. Alternatively, her sons can take over the policy and convert it to permanent insurance at their own expense Jean can purchase LTCI and personal health insurance to cover these risks This risk is somewhat reduced by allocating her TFSA of $11,000 to an emergency fund, and adding excess income to that fund over time
Other options Jean could use her registered retirement savings plan (RRSP) funds when she reaches age 71 to buy a life annuity which may boost her income further. If she is eligible for life insurance, she may be able to use an insured annuity strategy to provide her with more guaranteed income along with a tax-free life insurance benefit to the women s shelter. The preceding solution included LTCI coverage of $1,000 per week for 250 weeks, with inflation protection of two per cent annually, increasing to three per cent while on claim. Other options include: $1,400/week for 250 weeks with no inflation coverage, at a cost of $6,599 per year $1,000/week for 250 weeks with no inflation cover, for $4,757 per year $1,000/week for unlimited duration, with no inflation coverage, for $8,796 per year If Jean is not concerned about inflation, she could obtain a 40 per cent increase in benefit (from $1,000/week to $1,400/week) for about the same premium ($6,606 vs. $6,599) by opting out of the inflation coverage. Assumptions The SunVision Financial Analyzer (SVFA) tool was used for all projection and tax calculations, including the SVFA defaults for investment returns and inflation (three per cent general, two per cent real estate). Historical model 1980-2008. Historical market performance is not an indicator of future performance. For more information, call us between 8:30 a.m. and 4:30 p.m. (ET) at 1 800 800-4SUN(4786), option 4 or email wealth.of.solutions@sunlife.com Life s brighter under the sun Sun Life Assurance Company of Canada, 2010. 810-3621-10-10