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portfolio makeover

Wendy and Richard, both Alberta professionals, have lived under the same roof for more than 30 years, but when it comes to their finances they've lived separate lives.

The married couple, who have two independent adult children, are increasingly anxious about whether they've saved enough to fund their lifestyle in retirement. When it comes to retirement planning, they feel like fish out of water.

"Wendy and I have never maintained joint finances," says Richard, 63, who works for the government and has a defined benefit pension. "We simply split up joint expenses, and we're free to spend, save or invest the rest of our income as we see fit."

After recently tallying up their cost of living, they now realize they spend a tremendous amount of their $18,000 after-tax monthly income. Excluding individual discretionary spending, savings and insurance, their joint expenses are $9,384 a month including $1,086 payments on a $79,000 mortgage on their home worth $500,000.

"I'm kind of shocked at adding up our total expenses," Richard says, adding they often spend as they please.

While he plans to retire a few months before he turns 65, retirement is about six years away for Wendy, in her late 50s. Both are aiming for a pretax income of $71,000 each in retirement to avoid Old Age Security (OAS) clawbacks, and Richard has just started collecting CPP, about $818 a month.

He also will draw a work pension of about $2,700 a month once he retires. In contrast, Wendy is self-employed and will have to rely on her RRSP and other investments.

All told, she has more than $800,000 in her portfolio, mostly invested in equities. In contrast, Richard is a conservative investor with most of his $575,000 portfolio in GICs and bonds.

Despite having accumulated substantial portfolios, they've never developed a detailed retirement plan to use their assets.

"We feel we're all right, but we just don't know."

Investment adviser Chris Turnbull, a portfolio manager with Index House in Edmonton, and CIBC Private Wealth Management team Jennifer Tweddle, a financial planner, and Tracy Nenasheff, investment counsellor, analyzed Richard and Wendy's situation and had this advice.

The basics:



RRSP: $385,509

Unregistered investment account: $162, 069

TFSA: $25,595


RRSP: $564,712

Unregistered investments: $216, 202

TFSA: $33,686

Ms. Tweddle and Ms. Nenasheff's tips

1. Develop a co-ordinated retirement plan. Although this couple has managed to get along quite well living separate financial lives, they will need a more co-ordinated approach once they retire to draw upon their considerable RRSP and non-registered assets. To make the most of their money, they need a professional wealth planner who can develop a tax-efficient strategy to meet their income needs while taking into account other concerns such as estate planning.

2. Aim for a retirement income that suits their needs. "They have targeted their incomes based on OAS clawback rules, not their actual forecasted need," says Ms. Tweddle, adding the benefit is reduced at $71,000 annually and upward. The couple currently have joint spending of about $98,000 a year, excluding money for the mortgage and other expenses they won't have once they are both retired. Based on Alberta tax rates, a combined $140,000 in annual retirement income would be leave them with $116,000 net to spend – more than they likely will need. Instead, they should build an after-tax income that covers their expenses, $98,000 annually, indexed to inflation. To accomplish this, they each need a pretax income of $63,000 a year, enough to provide a steady cash flow until age 90. These numbers represent a significant drop in income from what they earn today, so Richard and Wendy will have to be much more mindful of spending in retirement, Ms. Tweddle says. "Agreeing on a joint budget based on their projected income is necessary to ensure they are financially successful once retired."

3. Diversify their portfolios. Richard's portfolio is almost entirely invested in fixed income because he is worried about losing money. But bonds and GICs aren't risk-free. A more balanced approach would actually be less risky over the long term because the purchasing power of his savings will not be eroded by inflation.

"Investing in too much of any one holding increases risk in a portfolio, even fixed income, whose primary purpose is to provide stability and income," Ms. Nenasheff says. "Using historical index returns, a portfolio comprised of 70 per cent fixed income and 30 per cent equities has better risk-return profile than a portfolio with 100 per cent fixed income."

Furthermore, the couple has too much exposure to the Canadian market. Richard's holdings are entirely invested in Canada while only about 10 per cent of Wendy's portfolio is invested abroad. "Canada represents less than 5 per cent of the global economy and is heavily concentrated in financials and commodities," Ms. Nenasheff says. Investing beyond Canadian borders will diversify their portfolios into sectors including technology, health care and consumer staples, and ultimately provide steadier returns.

Mr. Turnbull's tips

1. Richard should stop collecting his CPP until he retires. "With an after-tax income of over $8,800 a month, which clearly puts him in the highest tax bracket, an additional $818 a month appears to be unnecessary income and will be taxed at the highest marginal rate," Mr. Turnbull says. Richard still has six months to cancel CPP payments, a move that makes sense for two reasons. His postretirement income will be substantially lower so future CPP payments will be taxed at a lower rate. "Second, CPP payments received at age 65, when he needs income, will be about 13 per cent higher than those received at age 63."

2. Skip the fancy GIC products. Many of the GICs Richard owns are market-linked or escalating GIC products that appear to offer a higher return than a typical GIC. Market-linked GICs provide a guaranteed rate but are also linked to the stock markets. If markets increase, the rate of return on the GIC also increases. The problem is these investments often have limits on the upside and the calculation formula is difficult to understand. "Most advisers would be hard pressed to explain them."

The bottom line is these products may appear to pay a higher rate than normal GICs, but more often than not, they don't. If Richard wants additional yield from his investments, he should consider other income-oriented securities such as corporate bonds and dividend stocks. They do involve more market risk, but a little professional investment advice can help manage the potential price volatility.

3. Design portfolios for tax efficiency when they retire. Richard and Wendy's investments that produce interest income, which is fully taxable, are mostly held in non-registered accounts while their investments that produce capital gains and dividends, which are taxed at much lower rates, are mostly in their RRSPs. For tax efficiency, interest-bearing investments should be held inside tax-sheltered accounts, especially RRSPs where withdrawals are fully taxable. In contrast, holding dividend and growth stock largely inside their RRSPs negates the benefits of dividend and capital gains income, which are taxed at about half the rate of normal income.

From a retirement tax planning perspective, their portfolios are set up the wrong way, with Richard's interest-bearing investments in his non-registered portfolio while Wendy's equity investments are mostly inside her RRSP where capital losses cannot be used to offset taxes on taxable capital gains. A better strategy for the couple is a total return approach that would provide tax-efficient, retirement income.

After first adding up all sources of income from pensions, non-registered dividends and interest, and required registered account withdrawals, they can sell stocks in their non-registered accounts next, triggering capital gains which are taxed at half their marginal (highest) rate. In contrast, if they sold equity investments in an RRSP or RRIF to provide that additional income, the capital gains would not receive this preferential tax treatment because all income withdrawn from a registered account is considered fully taxable, be it capital gains, dividends or interest.