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Lester and Portia.The Globe and Mail

Lester and Portia have an enviable lifestyle – self-employed, good income, a nice house in a desirable city and two children. Lester is age 56, Portia 55. Their children are 17 and 20.

Lester, who works in a creative field, has a company from which he draws a salary of about $180,000 a year. He also pays Portia $60,000 a year for bookkeeping.

“Recently my wife was the beneficiary of an inheritance of $1.3-million,” Lester writes in an e-mail. “With this windfall comes the desire to be responsible and informed.” The question they face now is how to use the money. They have a $974,000 mortgage, so that would be a good place to start.

Lester’s done some reading and has what he thinks is a good plan. They’ll open tax-free savings accounts. They’ll top up their RRSPs. They’ll open TFSAs and first home savings accounts for their children.

They’ll make a lump-sum payment on their mortgage of $200,000.

They plan to retire when Lester is 65 and Portia is 64. Their retirement spending goal is $120,000 a year after tax. In the meantime, they plan to do some work on the house, buy a new vehicle and take a big, once-in-a-lifetime trip for the whole family.

We asked Jason Heath, an advice-only financial planner at Objective Financial Partners in Markham, Ont., to look at Lester and Portia’s situation.

What the Expert Says

Lester and Portia are spending about $120,000 a year, excluding their mortgage, investments and payroll tax, Mr. Heath says. “This is in line with their retirement spending target.”

Despite a large mortgage balance, Lester and Portia have a strong balance sheet with a lot of assets relative to their debt, Mr. Heath says. “This has been padded recently by the significant inheritance. What to do with the inheritance is an important question from them.”

They have used some of the money to max out their RRSPs, contributing $185,000 for Portia and $121,000 for Lester. These contributions exceed their annual incomes so they can consider deducting the contributions over multiple years, the planner says.

Lester, for example, could deduct his contributions over two years, maybe bringing his 2023 income down to about $100,000. If he saves some of his deduction for 2024, he might save tax at 40 per cent or more instead of just 20 to 28 per cent, Mr. Heath says. “So, despite the appeal of a larger tax refund for 2023, he might earn a 20-per-cent-plus after-tax return (the difference in his tax savings) on his deduction by waiting a year to deduct some of it.”

Portia’s situation is a bit trickier, the planner says. Her income is relatively low so her $185,000 of RRSP deductions are not that advantageous. She should work with her accountant to determine how to best claim this over multiple years, he says.

They are planning to pay down $200,000 on their mortgage this year, with the renewal coming up in October. The current 2.49-per-cent rate will increase significantly. If the rate averages 4.5 per cent for the life of the mortgage, they will be paying the debt well into their 80s if they do not pay down more or increase their payments, Mr. Heath says.

“Although they could sustain their mortgage into retirement with their investments, they should consider paying down more of the mortgage rather than investing in a taxable investment account for Portia,” the planner says. She has $495,000 in a savings account.

Or they could pay down the mortgage and borrow back to invest to make the interest tax deductible. “To be clear, I am not recommending they borrow to invest, but if they are going to have debt and taxable investments, they should at least structure things to make the interest a tax writeoff.”

The decision to invest in their tax-free savings accounts instead of paying down the mortgage should be based on an expectation they can earn a higher rate of return in their TFSA than the interest rate on their mortgage, the planner says. “If their risk tolerance is high and their fees are low, TFSAs over debt repayment may pay off.” But paying down the mortgage even further at renewal should at least be considered, he adds. “After all, it can be done at your renewal without a penalty,” he says.

The plan to give the kids money to contribute to their TFSAs and first home savings accounts is a good one, he says.

“One thing that sticks out to me about the insurance advice that Lester and Portia have received relates to the massive life insurance policy they own and their minimal disability insurance coverage,” Mr. Heath says. Their company pays $50,000 a year into a universal life insurance policy for Lester. “A policy like this paid a large commission to their financial adviser.” Meanwhile, they have about $4,000 a month of disability insurance coverage if Lester becomes disabled.

Lester’s corporation earns $400,000 a year of income on average. “If he becomes disabled, the family will live off $4,000 per month of disability insurance, an 88-per-cent reduction in their income,” Mr. Heath says.

In preparing his forecast, the planner assumed Lester works until the age of 65 and that his and Portia’s savings are maximum annual RRSP contributions of about $31,000 for him, maximum annual TFSA contributions of about $14,000 for both of them, $50,000 a year to the corporate universal life insurance policy, and about $70,000 a year to their corporate investments, for a total of $165,000 a year.

They are in a position to retire by Lester’s age 65 and maintain $10,000 a month of spending in today’s dollars into retirement, Mr. Heath says, but they could draw down their investments fairly significantly over time. Using conservative assumptions, like a 4.5 per cent return for their investments and a 2-per-cent long-term inflation rate, they would probably not run out of investments until their mid-90s, he says. “This also assumes they leave the corporate universal life insurance policy intact for their kids’ inheritance.” If they were willing to cash in the insurance value, which they are considering, it could mean a financial independence date a few years earlier.

Their house is a big factor. “It’s a very valuable asset and if they plan to downsize in the future or were willing to risk the potential of having to borrow against it, depending how their investments perform in retirement, this could mean the potential to retire in the next few years,” Mr. Heath says.

Lester and Portia plan to invest their own money to reduce investment fees. “They are considering a simple approach, with a couple of exchange-traded funds and a closed-end investment fund,” the planner says. But the ETFs they are considering track only Canadian and U.S. stocks, with no international stock exposure, he notes.

Client situation

The People: Lester, 56, Portia, 55, and their two children, 17 and 20.

The Problem: How to responsibly use Portia’s $1.3-million inheritance.

The Plan: Top up RRSPs, open TFSAs and first home savings accounts for the children. Consider paying more toward the mortgage and maybe cashing in Lester’s insurance policy.

The Payoff: Generational wealth, a legacy from their parents that will pass to their children.

Monthly net income: $14,500.

Assets (after inheritance): Cash $3,500; his stocks $22,000; her high-interest savings account $495,000; her exchange-traded funds $340,000; his TFSA $95,000; her TFSA $95,000; his corporate cash and investments $543,000; his first RRSP $251,000; his RRSP with professional association $115,000; her RRSP $246,000; her spousal RRSP $134,000; registered education savings plan $97,000, residence $3,673,000. Total: $6.1-million.

Monthly outlays: Mortgage $4,000; property tax $1,085; home insurance $390; electricity $225; heating $84; maintenance $200; transportation $415; groceries $1,200; clothing $200; charity $160, vacation, travel $250; dining, drinks, entertainment $450; personal care $150; sports, hobbies $200; subscriptions $35; drugstore $110; disability insurance $300; phones, TV, internet $490; RRSPs $1,750; RESP $200; unallocated expenses $4,060. Total: $15,954.

Liabilities: Mortgage $974,000 at 2.49 per cent.

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

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