FINANCIAL PLANNING

FINANCIAL PLANNING Prior to and during retirement

Topics Covered • How much • Sources to fund retirement • Investing • Insurance • Going non resident • Other things you may find of interest

How much That depends!! • Rule of thumb says annual income should be about 70% of pre retirement income • Individual planning should be undertaken, taking into consideration expenses, cash flow and lifestyle choices

How Much • Start with current household budget • Ask what current expenses will no longer apply once retired • What expenses might arise as a result of retirement

How Much • Net worth statement will assist in the exercise • Review desired lifestyle versus what you can reasonably support

Do It Yourself - Websites • https://srv260.hrdc-drhc.gc.ca/English-App/INT_01.asp • http://www.morningstar.ca/globalhome/rrspplanner/index.asp • http://www.fiscalagents.com/toolbox/index.shtml#tb2 Once you have some facts, figures and estimates, consider seeing a specialist

Keep an open mind to options • Working longer before retirement • Reduce retirement needs/expectations (eg. Rent a boat for a week instead of buying) • Save more before retirement • Attempt to earn more on investments • Pay off more if not all debt before retiring • If MSP, dental and/or extended health is currently covered by an employer, alternatives? Do not procrastinate adjusting your retirement plan or putting the plan into action

Sources to fund retirement • Government – Old Age Security/Canada Pension • RRSP/RRIF/Annuities • Registered pension plans • Part time work/contracting • Non registered investments and other assets

Old Age Security (OAS) • For eligible Canadian residents and certain former residents of Canada commencing at age 65 • Current maximum monthly payment $491.93, indexed every calendar quarter based on CPI • Qualify for full pension if resident in Canada for 40 or more years after age 18 • If do not meet the 40 year test, may be eligible for pro-rated payment • Human resources suggest you apply six months before your 65th birthday • Can receive retroactive payments for up to 12 months if you apply after age 65

Old Age Security (OAS) • As long as have lived in Canada at least 20 years after age 18, then payments will be made even if you leave Canada. If you fail 20 year test, payments can be suspended after 6 months absence from Canada, restarting upon return to Canada • Guaranteed income supplement over and above OAS payments if income low enough (current threshold $14,256 before any OAS) • Watch out for claw back – kicks in at net income above $62,144 (threshold rate for 2006, indexed annually) and is calculated as net income less threshold x 15% to a maximum of OAS paid for the year.

Canada Pension Plan (CPP) • Contributions generally required from business and employment income to this federal plan • Each calendar year, currently first $3,500 of earnings exempt from contribution • Current total annual contribution rate 9.9% of annual pensionable earnings • Contribution requirement is either split between employee and employer or paid in full if self employed

Canada Pension Plan (CPP) • Current maximum pensionable earnings $42,100 • Therefore total current annual contribution ($42,100 - $3,500) x 9.9% = $3,821.40 • To collect, must have contributed, reached at least 60, substantially ceased working if under 65 (must not work month before and during month benefits commence – can go back to work after) • For each month you commence collecting before age 65, benefits reduced by ½ of one percent • Therefore if commence collecting at age 60, monthly receipt will be 30% less than what would be paid if waited until 65

CPP (cont) • For each month after age 65 that you wait to retire and collect, monthly receipt is increased by ½ of one per cent to a maximum of 30% (age 70) • Once you commence to collect you do not make any further contributions to the plan • Current maximum monthly benefit $1,031.05 ($12,372.60) • Can share benefits with spouse such that each will end up receiving even monthly amounts

CPP (cont) • Sharing can be applied for any time after both spouse reach age 60 and at least one in receipt of benefits • Credit splitting will normally apply upon separation or divorce based on time together • Survivor benefits continue for spouse and orphaned children • Death benefit to a maximum of $2,500 paid to the estate upon application

Registered Retirement Savings Plan (RRSP) • Generally three types – Life insurance company plans, other financial institution plans and self directed • Life insurance plans normally offer deferred life annuities • Other financial institution plans normally invest in savings deposits, term deposits and GIC’s. Some add certain mutual funds and pooled fund trusts

Registered Retirement Savings Plan (RRSP) • Self directed or self administered – you can select the qualifying investments to be made • Contributions based on “earned income”, the most common inclusions being employed and self employed income • Limit for deductible contribution in a year is determined according to the following slide

RRSP’s (cont) • Maximum deduction for 2006 is $18,000, increasing to $19,000 for 2007 • Contributions can be made during the year or within 60 days of year end • 1% excess contribution penalty can apply • Can contribute certain property such as stock or bonds

RRSP’s (cont) • Spousal plans can be established to make the spouse the annuitant of the plan, but the total contribution limit above applies • Qualified investments in a plan can include GIC’s, bank deposits, most bonds and debt obligations, shares and units traded on prescribed stock exchanges, gold and silver • Most common non qualified investments are real property, commodity futures, listed personal property, precious gems and shares of most private companies • Can invest in your own mortgage but this is not necessarily a good thing to do

RRSP’s (cont) • By December 31 of the year you reach age 69, you must either collapse plan, transfer to a Registered Retirement Income Fund (RRIF), an annuity or any combination of the three • Complete withdrawal will likely attract large income tax liability • RRIF essentially carries on like the RRSP except there is a required minimum annual withdrawal, but no maximum • Annuity usually guarantees some fixed stream of income, usually for some guaranteed period or the rest of your life • Annuities can be indexed, have surviving spouse entitlements amongst other options

Registered Pension Plan (RPP) • Can be an extremely lucrative benefit of employment • Pension administrator can provide options and amounts based on anticipated retirement date • Plans include defined contribution, defined benefit and individual pension (IPP) plans • IPP may make a better choice than an RRSP for an incorporated professional who is at least 45 and has regular personal income in excess of $75,000 • If at least one spouse has a RPP, keep in mind the desire to build up assets evenly

Part time work As John Kenneth Galbraith suggested when asked about making returns from investments, it is tough to beat a steady pay cheque • Assuming you genuinely want (or need) to work past “normal” retirement age, consider some or all of the following: • Impact on CPP • Impact on pensions • What you will net based on marginal tax rate after all other income • Capital outlays if you are starting your own business/working as a subcontractor • Your health • Are you really going to enjoy working versus time for leisure • Start planning 1 to 5 years before taking on the new role

Investments, non registered and otherwise • Investments built up before and during retirement can provide income and as needed return of your capital (normally upon sale) • Keys to keep in mind over and over again – Diversification and Allocation

Investments, non registered and otherwise • Assets accumulated can include: • Your interest in your practice • Stocks • Bonds • Commodities • Real estate • Precious metals • Collectibles Unless you are Warren Buffet, you should normally plan on diversifying your assets amongst most if not all of the above

Investments, non registered and otherwise • The purpose of diversification and allocation is to reduce risk • Risk from currency, inflation, interest rates, politics, market amongst others • Be brutally honest with yourself and your tolerance for risk

Example of risk Date Trading Days P/E at high T-bond yield Decline 09/03/1929 719 20.6 3.8% -40.0% 03/10/1937 654 11.3 2.5% -14.9% 05/29/1946 1020 16.2 2.1% -23.2% 01/05/1953 617 9.4 2.8% -13.0% 07/12/1957 960 13.0 3.7% -19.4% 02/09/1966 912 17.6 4.6% -25.2% 08/25/1987 780 19.7 8.9% -36.1% 07/16/1990 657 13.6 8.6% -21.2% 08/06/1997 1723 23.7 6.4% -10.6% 10/13/2006 906 18.3 4.8% Investments (cont) The last line in the above table has been left blank as the story is still unfolding

Investments (cont) • Looking at the last period, we note the Dow has now gone over 900 days without even a 10% correction • Current advance is among 5 longest advances without correction ever recorded • Above table summarizes advances of 600 days or more before at least a 10% correction • Declines listed are not necessarily bear markets but extent of drop before the next 10% increase • Lower price earnings (pe) ratios and interest rates than current are more the norm • Some pundits suggest even if current market advances further 10% or higher, likelihood of retention is extremely remote

Investments (cont.) • If diversifying into real estate, this is over and above your principal residence • Consider carrying costs such as annual property taxes and any upkeep • If going to earn rental income, do you really want to be a landlord with the inevitable calls at 2 am concerning the blown hot water tank or do you hire a property manager

Investments (cont.) • Real estate as we have seen recently can appreciate quite nicely, but it is nowhere as liquid as stocks or bonds and can be just as subject to corrections, if not more so • Consider the tax consequences well ahead of any anticipated sale and year to year compliance costs if earning rental income • For precious metals, as a hedge and for further diversification, consider holding up to 5% of your assets in the actual metal and/or stocks/mutual funds dealing solely with this category

Investments (cont.) • Examining brokerage account, a rule of thumb is that cash/bond component as a percentage of total should equal your age • Therefore an account worth $1 million held by a 55 year old could hold up to $550,000 in bonds/cash with the remaining $450,000 in equities

Investments (cont.) • The equity component would likely be spread across manufacturing, resources, consumer, financial, utility and multi sector stocks and trust units • No one sector would normally be more than 20% of the total equities or less than 5% and no one stock would mirror these percentages within a sector

Investments (cont.) • Mutual funds should be monitored to meet these parameters in conjunction with individual stocks • A suggested allocation of equities in foreign companies is up to 20% of total equities • It is highly recommended that the overall account be reviewed and rebalanced each year • Preferred you rebalance by allocating new money to required sector or component versus selling

Investments (cont.) • Alternative to holding bonds versus bond mutual funds • Laddered approach useful in holding bonds

Investments (cont.) This entails taking the total bond component, dividing over the number of years you wish to span (normally at least five) and invest that portion of the funds in bonds with the required maturity. Example: • Have $100,000 to invest in bonds • Want to cover bonds maturing up to five years from now • Allocate $20,000 to a bond maturing in one year, $20,000 to a bond maturing in 2 years and so on • When the one year bond matures, invest proceeds in a bond maturing in 5 years

Investments (cont.) • Review bond offerings and respective qualities – Government, high corporate, junk • Bond mutual funds give opportunity for larger diversification of bond holdings and for capital appreciation on the interest swings as well as foreign currency exposure • Some negatives with bond funds are management expenses and possible loss of capital

Investments (cont.) • The closer you get to retirement, the more ready cash (or near cash) you should have on hand • While still working, at least three months of cash or at the very least, a line of credit with a limit of 3 months cash needs should be maintained

Investments (cont.) • As approach retirement, this should grow to 18 months with five years or more covered by bonds or specific fixed income investments • As instruments mature and cash is expended, should be replaced from other investments

Investments (cont.) • Personal preference would be to know that have the next five years of outlays covered with cash and maturing fixed income investments • Options to a savings account which pays next to nothing could include money market funds from companies such as Altamira and Dundee which are accessible within 24 hours and are currently paying approximately 3.75% on your money

Insurance • Purpose is essentially to protect assets • Consider life insurance, particularly if want to replace coverage lost upon retirement • Options for life insurance include term, term to 100, whole and universal plans • Disability coverage • Critical illness • Long term care

Non residency • Canada’s tax system based primarily on residency • If you are resident, then Canada taxes worldwide income with various credits for foreign taxes • Otherwise, Canada will normally only require a tax return if you have income from: • employment in Canada • carrying on a business in Canada • disposal of a taxable Canadian property

Non residency • All other income sourced from Canada normally subject to withholding tax, the most common domestic rate being 25% for which a tax treaty may provide some relief • Example of treaty relief – Canada – US treaty, Canada can only withhold 10% on most interest for resident of US in receipt of interest from Canadian source

Non residency • If you decide to become non resident of Canada, must sever ties • Date of severing ties, deemed to dispose of most properties at fair market value • Any gains as a result of deemed disposition taxed on final part year resident return • Part year resident return filed to date of departure to include all world wide income to that date plus normally any deemed disposition gains and/or losses • Properties exempt from deemed disposition include real property in Canada, RRSP’s, RPP’s etc.

Non residency (cont) Other issues to consider before going non resident of Canada: • medical coverage – you will need to cancel BC MSP on departure • will you maintain OAS entitlement? • do your due diligence on new country concerning laws, tax rules and capital restrictions • ensure you are not caught up in the “grass is greener” thought

Other – Consider Options with RRSP If you are planning on leaving some or all funds in a RRSP/RRIF to beneficiaries of your estate, consider: • Whatever is in the plan at death will likely, for the most part, attract the top marginal rate of tax • In BC, this is currently 43.7% • Assume you are currently 60, will live to 75, have no surviving spouse on death, earn 7% per year on your RRSP which has a current value of $1 million • At death the plan would be worth approximately $2.8 million • After tax, beneficiaries would receive approximately $1.58 million • As an alternative, cash out plan and pay full tax now, leaving approximately $563,000 • Purchase life insurance policy with proceeds • Upon death, beneficiaries could receive in excess of $2 million tax free

Other (cont) • If currently in a partnership, consider your exit strategies well in advance • Draws are charged immediately against your partnership capital account • Income is only credited against the partnership account at the fiscal year end of the partnership • Want to avoid full income inclusion plus a deemed capital gain because of unintended results impacting your capital account

Other (cont) • Incorporation related to a professional practice and/or a holding company for investments can be a desirable alternative to your status quo • If a sole practitioner, it is relatively uncomplicated to convert to practicing through a company • Consider some structures to replace an existing partnership, or if just about to start a partnership, review options for operating through corporate vehicles. • Some structures which have withstood Canada Revenue Agency scrutiny are asfollows:

FINANCIAL PLANNING