Family Finance: Saving for Future Generations


Andrew Allentuck

At 65, an Alberta woman we’ll call Cleo is flourishing as a manager at a large company. She takes home $8,000 a month and adds to it $1,650 of net rental income from three properties and $539 of pre-tax pension income from a former job. Adjusted for tax on the rental income and pension, she has $9,600 a month to spend and invest.

Cleo’s outlook is positive. At retirement, sometime in the near future, she will have $2,642,000 in assets plus an expected $93,000 in a severance package. Take off her liabilities of $520,000 and she has future net worth of $2,215,000, built by hard work and frugal ways. She has several grown children and grandchildren, an SUV for getting around in winter and a BMW motorcycle for the summer.

Most retirees would be happy to have Cleo’s fortune, yet, she admits, “I cannot say that the wealth I have accumulated has brought me joy or feelings of security.” She has worked for the challenge. Now, with the prospect of retirement, she wonders what she must do to keep her money, if not for herself, then for her descendants.

Marketing Feature: Too Much Money is not a Problem

Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Cleo. His view is succinct: “She is old-school. After her day job is done, she works on her investments. She has the means to cut the cord of her present responsibilities, take her motorcycle to the warm air of the southern United States in winter and have fun. I want to help her do that by relieving her financial concerns.”

The Five-Year Plan

Year 1 (2011) Apply for Old Age Security benefits, currently $524 a month, though for most years of her retirement OAS will be lost to the clawback, which begins at $67,668 annual income in 2011. Now deal with underperforming rental properties.

Property No. 1 is half a duplex with an estimated value of $400,000, no mortgage, and $17,400 a year gross rent. After tax, she has $14,679, which translates to a 3.67% yield on market price. That’s not much for the trouble of being a landlord. Capital appreciation could boost returns, but that’s speculation on the Alberta property market. The property should be sold, Mr. Moran recommends. The $400,000 proceeds less $60,000 estimated capital gains can be invested in a corporate bond fund or dividend-paying stocks, either of which would produce a return a few per cent higher and add liquidity. Assume returns at 5% per year are $17,000 before tax. Cleo lives in the other half, which is debt-free and which is her permanent home.

Property No. 2 is a house with an estimated market price of $600,000. Total cost with improvements is $343,000. The mortgage outstanding is $297,000 at 3%. Annual rent is $16,080 after taxes and other costs. The property has a 5.3% return on equity. It can be kept.

Property No. 3 has a $275,000 estimated market price. It is occupied by Cleo’s son. Its rental income does not cover interest expense on the mortgage and maintenance, but the investment is non-financial in nature. It will be kept.

Year 2 (2012) Cleo begins her retirement. She will get a 40-week severance package worth $93,000. For each year of service before 1996, $2,000 of the payout can be rolled into an RRSP plus $1,500 for each year with no pension. Cleo has no liquidity problems, so she should elect maximum tax deferral on the payout. Within the RRSP, given her age, she should buy stocks that have a history of substantial and rising dividends paid without interruption for 10 or more years and corporate bonds within a managed portfolio. It is also time to rebalance the portfolio to reduce exposure to banks and energy companies and to add exposure to regulated public utilities and large telecommunications companies. Her bond allocation should be 30% to 35% of total financial assets, the planner suggests. A managed bond fund that can sustain returns in a time of rising interest rates would be appropriate if its annual management fees are below 1.0%. A financial advisor can help her find mutual funds that meet these criteria.

Year 3 (2013) Time for a trip to the sunbelt to shop for a vacation spot or home where she can invite her children and their children. If she elects to purchase property, she should ensure it’s wrapped in a corporation or a trust so that, at her death, it does not fall victim to U.S. succession tax and potential U.S. taxation of her worldwide assets. She should take tax and legal advice on her exposure to U.S. tax law or avoid the problem by renting rather than owning.

Year 4 (2014) Cleo is now 69. Assuming the economic recovery has continued, she can increase the stability of her income and decrease the time needed to manage what may still be a complicated blend of registered and non-registered financial assets, property and pension income by purchasing an annuity for perhaps a third or half of her non-registered financial assets. If bond interest rates have risen by a few per cent, Cleo should be able to find an annuity that pays 6% to 7% with perhaps 10 years of guaranteed payments that her heirs would receive if she were to die before actuarial tables suggest. That would add to her income security.

Year 5 (2015) Cleo is now 70. She can apply for Canada Pension Plan benefits which, under revised rules, will be 0.7% per month more than the age 65 benefit for each month after age 65 that she has deferred applying for benefits. That’s a total 42% boost over the age 65 monthly benefit. She will therefore receive the $960 benefit for which she has qualified at age 65, plus a $403 boost, for total CPP benefits of $1,363 a month or $16,358 a year.

The Longer Term

Cleo has many income sources. To estimate her average retirement income, several assumptions have to be made. Assuming that she sells property No. 1 and keeps property No. 2, which pays $16,080 in net rent, that its rent does not change, that property No. 3 never pays a return, that she defers CPP benefits to age 70, that OAS is almost zero and then is completely clawed back at 70 and that inflation runs at 3% a year, then from 65 to 70, she will have $99,346 a year before tax in 2011 dollars consisting of pension from prior employment, income from her non-registered investments and TFSA, and cash flowing from money she obtained from selling property No. 1. At 70, she would add $16,358 from enhanced CPP benefits for a total of $115,704 a year. She can be assured of a way of life little different from what she lives now.

Cleo can deal with the potential problem of future incapacity to manage her affairs by establishing a trust that could take over at a moment of her choosing or when a button, such as a physician’s assessment, is pushed. Her children, as trustees, should be able to change the trust company they hire at their discretion, the planner suggests.

Financial Snapshot

Monthly after-tax income $9,600


Home $ 400,000, Property #1 -  400,000, Property #2 - $ 600,000, Property #3 - $ 275,000, Non-reg $ 300,000, RRSPs $ 600,000, TFSA $ 21,000, Cash $ 6,000, Vehicles (2) $ 40,000, Future Severance $ 93,000
TOTAL $ 2,735,000

Lines of credit $ 520,000

Net Worth $ 2,215,000

Monthly expenses
Mortgages (LoCs) $ 1,300, Taxes home $ 220, Taxes rental props. $ 700, Condo fees & maint. $ 300, Utilities $ 275, Food $ 550, Restaurant $ 100, Entertainment $ 120, Fitness & gym $ 50, House & vehicle ins $ 200, Rental prop. ins. $ 260, Clothing & grooming $ 150, Travel $ 350,  Gifts & Charity $ 600, Misc. $ 400, Savings $ 4,025
TOTAL $ 9,600

(C) 2012 The Financial Post, Used by Permission