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FINANCIAL FACELIFT

How to make an inheritance windfall count Add to ...

Andy and Cora live comfortably in their mortgage-free home in London, Ont., where he teaches at a nearby university. He is 50, she is 47.

Recently, some urgent house repairs wreaked havoc with their budget, forcing them to borrow on their line of credit. Despite Andy’s $130,000 salary, they’ve been struggling to pay it off.

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“We seem to spend more each month than we take in,” Andy writes in an e-mail. Still, “life is good,” he adds. Financially at least, their lives are about to get even better thanks to a $260,000 inheritance from Andy’s father. They’re wondering what to do with the money.

“Should we use up our RRSP contribution room?” Andy asks. “How can we put the remainder of it out of reach so we don’t slowly spend it month over month?”

Andy, who enjoys his job, plans to work to the age of 65 and perhaps longer. When he retires, he will get a pension from the university. For the past 15 years, Cora has stayed home to take care of their daughter, so she has little in the way of savings.

We asked Matthew Ardrey and Warren Baldwin of T.E. Wealth, in Toronto, a fee-only financial planning firm, to look at Peter and Cora’s situation. Mr. Baldwin is regional vice-president, Mr. Ardrey manager, financial planning.

What the experts say

“Andy and Cora are trying to find that magic balance between enjoying their life today and enjoying it tomorrow,” the planners note. Borrowing for unexpected expenses “is not a pattern they want to continue.”

While Andy’s pension plan will be the “backbone of their retirement,” the inheritance will enable them to pay off their $37,000 line of credit and catch up on their savings. Together, they have about $65,200 of unused contribution room in their registered retirement savings plans. The planners assume the couple will open tax-free savings accounts and contribute $25,500 each. This will leave them with $106,800 to invest in a non-registered portfolio.

In preparing their retirement projection, Mr. Baldwin and Mr. Ardrey assume Andy retires in January, 2028, soon after his 65th birthday and that Cora does not return to work. They assume an average investment return of 5 per cent a year and an annual inflation rate of 2 per cent. The $1,200 a month that is freed up by paying off the line of credit will be used for future TFSA contributions of $5,500 a year each, and Andy will continue to contribute $100 a month to a spousal RRSP for Cora.

When Andy retires, he will get a pension of $85,558 a year, which will not be indexed to inflation. Andy and Cora will split the pension income between them. Andy will receive full Canada Pension Plan benefits at age 65 and Old Age Security at 67. Cora will get 50 per cent of the maximum CPP at age 65 and OAS at age 67. Any further money that is needed will be drawn from their investment portfolio, first the income, then the capital. The planners assume Andy and Cora will live to the age of 90.

As it turns out, they are on track to have more disposable income than they have now, the planners conclude. Andy and Cora’s current lifestyle expenses of $72,000 a year will have risen to $96,903 when Andy retires, and to $115,807 at Cora’s age 72. By then, they will both be making mandatory withdrawals from their registered retirement income funds, lifting their combined after-tax income at that point to $141,123. At Cora’s age 90, they would still have $895,755 in investment assets.

Looking at the situation another way, Andy and Cora may want to spend more when they retire for travel or other recreational activity, the planners say. If they wanted to use up all of their investment assets, they could spend as much as $83,985 a year in today’s dollars. Adjusted for inflation, that would be $113,033 a year when Andy retires and $135,085 at Cora’s age 72.

From a tax-planning perspective, the planners suggest Cora hold the non-registered investments in her name instead of Andy’s because he has a high marginal tax rate. To accomplish this, Andy would make a formal loan to Cora to ensure the income is taxed in her hands and not his.

As their portfolio grows, the couple will need to keep a sharp eye on fees, the planners say. By the time they retire, their portfolio will have risen to $816,991, according to the planners’ calculations. “A one-percentage-point difference in fees at retirement would result in an income or growth reduction of $8,170 each and every year.”

The planners recommend the couple hire a fee-only money manager and invest in low-cost exchange-traded funds or pooled funds designed for institutional and high net worth investors. They recommend an asset mix of 60 per cent stocks and 40 per cent fixed income, including some corporate bonds.

 

The people

Andy, 50, Cora, 47, and their daughter, who is 14.

The problem

They’ve been managing well, but an inheritance windfall of $260,000 is coming their way. What should they do with the money to ensure it doesn’t slowly slip through their fingers?

The plan

Pay off the line of credit, catch up on unused RRSP room, open TFSAs and contribute the maximum. Invest the balance in a low-cost portfolio of stocks and fixed-income securities.

The payoff

Financial security and the peace of mind it brings.

Monthly net income

$7,163

Assets

Inheritance: $260,000; house $350,000; Cora’s locked-in retirement account and group RSP from previous employers $64,158; daughter’s RESP $44,528; estimated commuted value of his pension plan $585,263. Total: $1.3-million

Monthly disbursements

House maintenance and repair $480; utilities $245; property tax $300; property insurance $75; transportation $545; groceries $765; clothing $375; line of credit $1,200; gifts $345; charitable $20; vacation, travel $665; other discretionary $395; dining out $485; entertainment $150; grooming $130; club membership $130; pet expenses $100; sports, hobbies $260; subscriptions $10; disability and critical illness insurance $165; life insurance $70; dentists, drugstore $60; telecom, TV, Internet $380; RRSP $100; RESP $210; group benefits $185; pension plan contributions $1,055. Total: $8,900

Liabilities

Line of credit (for house repairs) $37,000.

Special to The Globe and Mail

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Some details may be changed to protect the privacy of the persons profiled.

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