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Financial Facelifts

Pair's Careful Plans Hinge on Their Health

By Andrew Allentuck

Originally published November 22, 2003 in The Globe and Mail

Winnipeg residents Stanley and Clare Fern appear to be living the middle-class dream. The Ferns (not their real names) both work as account executives for a major advertising company. With a combined, take-home pay of $7,200 a month, they have recently moved into a large home they bought for $240,000. At the ages of 36 and 32, respectively, Clare and Stanley, who have just had their first child, seem to be on track to move up in their quest for a good life and a secure retirement.

"When Stanley and I realized that we had a child on the way, we realized that we needed to have a look at our finances," Clare says. "We wanted a second opinion on our financial plans."

Their saving to date are modest - just $20,000 each in their registered retirement savings plans and a total of $40,000 in their corporate pension plans. The couple spends modestly, but the cost of furnishing their home, paying Winnipeg's high and ever-rising property taxes, raising their child, and keeping up with the well-heeled residents of their neighbourhood may squeeze their budget.

What Our Expert Says

Facelift asked financial planner Paul Edmond, president of Winnipeg's Edmond Financial Group, to speak with the Ferns and to examine their financial future.

"The couple have been meticulous in making plans, but they will have to do more to increase their financial security during their working years and to build up assets for retirement," he says. To be able to retire when Clare in 60 and Stanley is 56 in 2027, they will have to be able to cover expenses of $115,000 a year, he explains.

Clare contributes $236 a month to her corporate pension plan while Stanley contributes $240 a month to his. When they reach their planned retirement ages, assuming that their balances attain an average nominal rate of return of 8% a year, Clare will have $215,000 and Stanley will have $425,000, Mr. Edmond estimates.

He estimates as well that inflation will run at an average rate of 2.5% a year until they reach retirement. The pensions will provide a total retirement income of $21,500 a year in 2027 dollars, rising each year to $43,200 by 2036 and then will be indexed to the assumed rate of inflation, the planner explains.

Most of their Old Age Security will be clawed back beginning in 2037 for Clare and in 2040 for Stanley. By 2042, their total OAS payments of an estimated $14,251 will be clawed back completely, Mr. Edmond says.

Clare and Stanley's Canada Pension Plan payments could start when Clare reaches age 60 in 2027 at the reduced rate of $12,028 or $6,387 in 2003 dollars. When Stanley reaches age 60 in 2031, their combined pre-clawback OAS and CPP incomes will be $30,174 or $14,851 in 2003 dollars.

After the clawback, they will be keeping only their CPP payouts of $36,620. When Stanley turns 65 in 2035, the couple will be receiving an estimated total CPP of $46,295 in 2035 dollars, Mr. Edmond says. Thus employment and public pensions will leave them far from their $115,000 retirement goal.

Therefore, they should each contribute $200 a month into their RRSPs. Clare should use up her $30,850 space over the next three years, while adding her suggested $200 a month.

Stanley should use up his surplus room of $17,850 as his cash flow permits. Clare and Stanley currently have $20,000 each in their RRSP accounts and should keep the balances equal via spousal contributions so that they will have roughly similar retirement incomes.

If they do this faithfully, they can build up a $900,000 balance in their RRSPs. That amount of capital will support $63,000 of initial payments at an assumed rate of return from dividends, bond interest and capital gains of 7%. If adjusted for inflation, their RRSPs will provide $50,000 of annual income to age 95, which is their assumed date of death, Mr. Edmond says.

There are other things that the couple can do to increase their financial security, Mr. Edmond says. The Ferns have bought a big house at a bargain price but that bargain comes with an annual $4,080 tax bill that is going to rise aggressively when the house is reassessed. Were either partner to die at a young age, maintaining the house could be a challenge, Mr. Edmond points out. The Ferns therefore need more life insurance.

Assuming the survivor would need 70% of a $145,000 current income, or about $100,000 if the other were to die prematurely, Clare needs to purchase a total of $700,000 of life coverage. Stanley needs $400,000. Adjusting for family life insurance currently in force, which is $726,000, Clare should buy $390,000 more coverage and Stanley should get $100,000 of additional coverage.

They can limit their group coverage to double their salaries and buy the additional individually owned term insurance with premiums level for 10 years for $32 a month for Clare and $22 for Stanley. This will guarantee their protection even if they change jobs and lose their group benefits.

Clare and Stanley can later switch to permanent or whole life insurance that will cover them regardless of when they die. That is in contrast to term policies that usually have a maximum renewal age of 75 or 80, Mr. Edmond notes.

Clare has a disability plan through her work and another disability plan that she purchased before beginning employment with her company. If she were to become disabled, both plans would pay her.

Clare can therefore make more money on disability than she can by working. The two plans can function only because she had her own plan in force before beginning her present employment, Mr. Edmond says. On disability, she would receive $30,000 tax-free from her own plan and $39,000 tax-free from her employer's plan. That would provide $69,000 tax-free.

Stanley has a group disability plan that covers 60% of this first $43,000 of monthly income and then is limited to 45% of the excess. He should top up his disability coverage to provide 62% of gross income at a cost of $12 a month for a so-called "group offset" policy that has a relatively generous definition of disability and which provides fuller coverage, the planner adds.

Mr. Edmond warns that the Ferns have leveraged future prosperity on the lives and jobs they have today. "If the assumption that what is now will always be turns out to be wrong, the house might have to be sold. That's why they have to include some tough times in their plans."

The information provided is based on current laws, regulations and other rules applicable to Canadian residents. It is accurate to the best of the writer's knowledge as of November 22, 2003. Rules and their interpretation may change, affecting the accuracy of the information. The information provided is general in nature, and should not be relied upon as a substitute for advice in any specific situation. For specific situations, advice should be obtained from the appropriate legal, accounting, tax or other professional advisors.