Kevin, 55, owns a wholesale business in Winnipeg. His two adult sons live at home. He has a monthly income of $10,000 gross, $6,250 net.
|Cash Value of Life Insurance||$123,000|
|Gas for Cars||$350|
|Gas, Electricity and Water||$240|
|Total Monthly Expenses||$6,250|
By Andrew Allentuck
Originally published September 24, 2005 in The Globe and Mail
In Winnipeg, a man we'll call Kevin is finding it challenging to plan for his retirement. At age 55, he's twice divorced.
He has two sons, 18 and 23, one of whom is expected to take over the family wholesale business.
Kevin's business is successful, netting $400,000 a year after expenses. Kevin draws $120,000 annually, but his investment portfolio is deeply troubled. On the advice of a financial adviser, he invested $211,000, a fifth of his financial assets, into the defunct Portus Alternative Asset Management Inc.'s fund of hedge funds.
Kevin has other financial assets, including $650,000 in registered retirement savings plans, $70,000 in cash and $250,000 in his own holding company. His house, worth an estimated $325,000, is mortgage-free, and he has two cars worth $60,000 each, fully paid for.
Even with the Portus debacle, it would seem that Kevin's future won't be bleak. He has a good income that he could easily boost with the stroke of a pen, as well as assets other than Portus that exceed $1-million, not including a value for his business. Yet he worries that he could wind up broke.
"We are financially comfortable, but I could be out of a job tomorrow," Kevin explains, noting that he operates in a very competitive market. "I have no company pension, and I still have two children living at home."
Facelift asked financial planner Paul Edmond, president of the Edmond Financial Group in Winnipeg, to work with Kevin to clarify his finances and determine how he can reach his goal of a $130,000, after-tax income in 2015, when he plans to retire.
"What Kevin should do is improve his income security," Mr. Edmond says. "He has maximized his annual RRSP contributions in order to defer taxes. He has also been wise to use segregated funds that have maturity and death benefit guarantees. "Segregated funds, really mutual funds wrapped into life-insurance products called variable annuity contracts, provide guarantees of return of 75 per cent or 100 per cent of sums invested if held for 10 years. At death, the proceeds of these seg fund investments can go to properly designated beneficiaries without probate.
Seg funds provide a considerable amount of creditor protection if the beneficiaries are named, Mr. Edmond adds. For these benefits, seg funds usually charge higher management expenses than the mutual funds that they enclose. Seg funds, in spite of their higher costs, have value for self-employed people like Kevin, Mr. Edmond says.
In order to achieve his targeted $130,000-a-year retirement income, then, in addition to Canada Pension Plan benefits that will flow at an estimated $9,945 in 2005 dollars, Kevin will need to ensure that his investments produce approximately $120,000 a year.
Kevin has contributed to the maximum limit of his RRSP. However, if he uses an Individual Pension Plan, he can add $134,500 of room in excess of his RRSP cumulative limit, Mr. Edmond says. The space is available through a past service pension adjustment for his business income for the period beginning with incorporation of the company in 1991. The Individual Pension Plan, which is a defined benefit pension plan that provides creditor protection, can be set up at a cost of about $800 a year for actuarial services and plan administration, he explains.
IPPs work best for people older than 40 with pensionable earnings of $100,000 a year or more. The downside is that IPPs lock in some funds and reduce the investor's liquidity. Still, an IPP will be worth $430,000 more than the RRSP would be at age 65 when he retires, Mr. Edmond stresses.
By age 65, Kevin's IPP will be worth $530,000, assuming his assets grow at 8 per cent a year. In total, his financial assets will be worth $3.4-million, including $1.2-million in non-registered accounts, $1.6-million for his RRSP and his new IPP, $200,000 cash value of life insurance and $370,000 for selling his holding company.
At age 65, those assets will produce after-tax income of $130,000, including $57,000 from non-registered assets, $55,000 from registered assets including the IPP, and $18,000 a year after tax from his holding company.
Kevin's retirement income already exceeds his $130,000 after-tax retirement target. He could add an additional $6,000 to $8,000 from the cash value of his life insurance at age 65. He will be unable to retain any of the present $5,724 annual payout from Old Age Security because his net income will exceed the present level of $98,793, at which all the benefit is clawed back. Kevin will be able to receive net, after-tax benefits from Canada Pension Plan which, Mr. Edmond says, should be $7,300 a year in 2015.
Before his anticipated retirement, Kevin should improve his income security, Mr. Edmond says. His retirement plan could be devastated by a critical illness, for instance, which would reduce his income, add to health care costs and make it hard for a son to purchase the business at a robust valuation.
It would be wise for Kevin to consider buying a critical-illness insurance policy that would be set up on a group basis through his company at an annual cost of $18,000. A CI policy would provide a lump-sum benefit 30 days after Kevin is diagnosed with one of 23 designated illnesses. If no benefit is claimed, the policy can be structured to return some or all of the premiums paid, Mr. Edmond explains.
Kevin should also purchase disability coverage with premiums of $4,400 per year for Kevin and $700 a year for his son, Mr. Edmond advises. He can increase his salary payout to cover the added expense. Coverage would provide $3,000 a month tax free at 67 per cent of income for the son and $5,500 a month at 55 per cent of income for Kevin, also tax free.
Those premiums include a provision for return of premiums at age 65 for Kevin if no claims have been made or less any claims that have been made.
Kevin should also consider buying key person insurance coverage for his company, Mr. Edmond advises. The policy should also cover the health of his son, whose continuity in the business will be required if the son is to be able to complete the buyout of his father's interest, the planner adds.
Once the buyout is complete, the policy can be changed to benefit the company with most of the premiums deductible by the firm, Mr. Edmond explains. For $1-million coverage on the son's life, premiums would be $60 a month for the next 10 years, the planner adds. What's more, most of the payments would be a deductible expense, he says.
Kevin's retirement will depend substantially on taking charge of his advisers, learning what assets he holds, becoming familiar with his insurance policies, and knowing how his money is going to be handled in the future, Mr. Edmond says.
"Kevin is a bright man who has been letting himself down financially," Mr. Edmond says. "Fortunately, he has time to set things right."
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 September 24, 2005. 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.