Adam and his wife raised three children, put them through university and "lived life very frugally" throughout their working years, he writes in an e-mail. "I have maintained and still wear the ugly black brogue shoes that are now almost 25 years old," he adds. "Similarly, my wardrobe does not generate many dating opportunities." He is 62 and a widower.
After his wife died last year, Adam decided he would sell the family home in the Toronto area soon and move to a waterfront property where he can enjoy his kayak. When he sells, the proceeds will cover the cost of the new property. He plans to spend winters in Costa Rica snorkelling, playing tennis and cycling.
Looking back over his professional career, Adam says his "biggest win" was having the family's expenses paid during various overseas assignments that spanned more than 15 years. Though he has no work pension and no employment income, he is sitting on investments and cash totalling roughly $2.6-million, much of it in registered accounts (his and his late wife's).
His objective now is to live comfortably, spending $60,000 a year when he is in Canada and another $9,000 a year for his winters in Costa Rica.
But his key goal is to arrange his affairs to leave as much of his estate as possible to his three children, now in their mid-to-late 20s. So he is looking for ways to lower the eventual tax bill.
"Does it make sense to buy a term to 100 insurance policy to cover the inevitable tax?" Adam asks.
We asked Matthew Ardrey, manager of financial planning at T.E. Wealth in Toronto, to look at Adam's situation.
What the expert says
After Adam became a widower last year, the combined RRSPs left him with about 75 per cent of his investment assets in these registered vehicles, Mr. Ardrey notes.
"This leaves him or his heirs, as the case may be, with a tax problem." If the assets were not in the RRSPs, then the only tax issue would be a deemed disposition or capital gain on death, the planner says. "With the funds in the RRSPs, it is like taking the whole portfolio into income at once."
In drawing up his forecast, the planner assumes an average annual return on investments of 5 per cent, an inflation rate of 2 per cent and a lifespan of 90 years. Adam will get maximum Canada Pension Plan benefits.
Mr. Ardrey ran two projections, one in which Adam draws down his RRSP by $100,000 a year until age 72 (when it becomes a registered retirement income fund and he begins making minimum withdrawals) and one in which he does not. The latter scenario, leaving the money in the RRSP, proves the better strategy.
"The growth of the assets on a tax-deferred basis over the next 28 years more than offsets the tax bill due at death," Mr. Ardrey says. At age 90, Adam would be left with $1,919,000 in his RRIF and non-registered investments of $732,000.
The planner assumes the estate will pay a tax rate of 50 per cent on income – and that 25 per cent of the non-registered portfolio's value is capital gain.
By keeping the money in the RRSP, the after-tax value of the estate increases by $230,000. "Though keeping the money in the RRSP produces about a 6-per-cent increase in the overall estate value, it represents a 16-per-cent increase in the value of the estate investment assets after tax," Mr. Ardrey says.
Next, the planner explores the question of using an insurance policy to fund the tax burden. Adam says a term to 100 policy to fund an estimated $1-million tax liability would cost about $25,000 a year.
The insurance policy would deplete his assets more than it would compensate them in the future, Mr. Ardrey says. Adam would be left with $1,002,000 of registered assets and no non-registered assets. After tax, this would leave him with $501,000 plus the $1-million in insurance, for a total of $1,501,000. The estate would be $145,000 worse off than if Adam had bought no insurance at all, the planner calculates.
The extra cost of the premiums causes Adam to deplete his non-registered assets entirely and then have to take extra payments from this registered accounts to maintain his lifestyle. This upfront loss of capital is not entirely replaced when the insurance benefit is realized.
The insurance policy would cost him $700,000 over 28 years.
Adam is paying a portfolio manager a fee of 1 per cent a year to manage his investments, but he may not be taking into account the costs of some of his funds, the planner says. "In some of the names he holds, the management expense ratio was in excess of 2.5 per cent," he says. "There are lower-cost alternatives available."
The person: Adam, 62.
The problem: How to plan his estate in the most tax-efficient way so he can leave as much as possible to his children.
The plan: Maximize the tax deferred growth in the registered plans and ignore insurance to leave the largest estate possible.
The payoff: The value of his estate is enhanced.
Monthly net income: $5,000
Assets: RRSPs $2-million; TFSAs $77,000; non-registered investments $525,000; residence $750,000; vacation property $125,000. Total: $3.5-million
Monthly disbursements: Property tax $580; insurance $65; utilities $350; maintenance $450; garden $125; transportation $515; groceries $385; clothing, dry cleaning $50; gifts, charitable $155; vacation, travel $835; other discretionary $380; dining, drinks, entertainment $250; grooming $15; memberships $30; pets $40; sports, hobbies $50; subscriptions $45; other personal $50; drugstore $20; life insurance $60; telecom, TV, Internet $135; RESP $415. Total: $5,000
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