Retirement Planning Case Assignment
We have completed the review of the elements in the retirement planning process. We will conclude Part I with a case assignment, which requires you to apply what they have learned so far.
Chapter 1 shows how the savings needs of Margot and Craig were identified, and how Francesca, their
financial planner, estimated their retirement savings needs and how much they would need to save each year. To do so, Francesca has done a number of calculations:
1. How much they need after tax.
2. How much this is before tax assuming they are able to perfectly split their retirement income. This also
provides their average tax rate in retirement.
3. The present value at retirement of their annual retirement income.
4. The present value at retirement of government and employer-sponsored pension plans.
5. The future value at retirement of their present RRSP balances.
6. The future value at retirement of the amount they plan to save each year.
Having completed Chapters 2 to 7, students are now ready to prepare their own financial plan.
THE CASE – LEONARD AND ROSE DOMINO
You have recently been awarded the CFP designation. This is the first retirement plan that you will work on independently (or as a group of up to five individuals). You have met with the clients, Rose and Leonard and have come away with the following information. As is the case with real clients, the information may be incomplete or unclear. Your clients will respond to the best of their ability. Like real clients, they may not know the answers to all of your questions so you will need to make assumptions. You must clearly state assumptions in your final report in your final report to the clients. Use generic rates throughout your analysis and refer to the OMERS defined benefit information (Ch. 4) for details on the defined benefit pension plans.
Background Information
Leonard and Rose Domino, both age 52, have been married for 15 years. They live in London, Ontario.
Leonard and Rose have one child, Charlotte age 13. The Dominos came to see you in early January 2014 and provided you with the following information.
Employment Information
Leonard works as a chartered accountant with a large insurance company in London. His income was $172,000 (including his $24,000 performance bonus) for 2013 and has been that for several years. He expects his income will remain about the same in real terms until retirement, although there is a possibility that his salary will fall by $24,000 if he does not receive his annual bonus. There is a defined benefit pension plan at the firm. Leonard has been in the plan for 7 years. In addition, Leonard contributes the maximum possible to his RRSP every year, although he is confused because he has only had about $600 of contribution room for the last few years. The firm has a group insurance plan – a benefits package that provides him with life insurance coverage for twice his annual income after expenses, short-term disability coverage, as well as an extended health care for his family. He pays the premium of $155 a month for family coverage. This amount is not tax deductible for him. In addition, Leonard pays, at work, $960 p.a. in long-term disability insurance premiums which would provide him with 2/3 of his base salary should he become totally disabled. Because Leonard pays the premiums which are not tax deductible, the 2/3 would be received as non-taxable income.
Rose works as a manager for the City of Cambridge. She has worked for the city for 23 years. Her gross annual salary for 2013 was $91,000. She has been getting regular raises that reflect the increase in the cost of living, but in $ real, her salary has been this for a few years and she expects it to remain unchanged in real terms until retirement. Rose also has group insurance which pays extended health care, disability benefits and life insurance equal to her gross salary. Her employer pays the premiums and the taxable benefit portion of the amount paid by her employer is $1,750 a year. She is also a member of a defined benefit pension plan.
Assets and Liabilities
Liquid Assets
The Dominos pay their household bills and everyday expenses from their joint chequing account, which has a current balance of $14,200. They view the large balance in the chequing account as an “emergency fund” should anything happen that requires quick access to cash. The chequing account pays 0.25% interest annually.
They both opened Tax Free Savings Accounts in January 2013 and are making monthly deposits of $400 each. They both have the TFSA funds invested in equity mutual funds that they hope will generate 6% annually. (This is before inflation- you will need to determine an appropriate inflation rate, if you feel you need one.) Leonard has $30,000 in GICs that mature equally over the next 5 years (i.e $6,000 yearly). Leonard does not plan to use these until retirement, so he will continue to invest in a new 5-year GIC each time a GIC matures. He earns 2.5% on his GICs.
Non-Registered Investment Assets
They have a joint balanced mutual fund account that has $250,000 in it. They are putting $4,000 into this account each month, and plan to do so until they retire. These funds are currently earning 6% nominal. Rose and Leonard plan on purchasing a new truck in June 2014 for $40,000 and will use some of the funds for that purpose.
Leonard has $60,000 in non registered mutual funds that he earns 6% on. They are in an aggressive growth mutual fund sold by the bank. He does not intend to add to this fund or use it, unless there is an emergency.
Leonard’s RRSP Investment Assets
Leonard currently has $80,000 in his personal RRSP, which is invested in a Canadian equity fund. He has contributed the maximum possible each year in his personal RRSP, but lately, his contribution room has been $600. These contributions are made from the bank account at tax time. He is fairly knowledgeable about investing and the score from his investor profile questionnaire categorizes him as an “aggressive growth” investor. He has no unused contribution room.
Leonard has $30,000 in a locked in RSP from a previous employer. He has never really thought about this money, since it is locked-in. It is sitting in a cash account at his brokerage.
For simplicity, you can assume that Leonard’s DB pension follows the OMERS pension plan outlined in the text in Chapter 4.
Rose’s RRSP Investment Assets
Rose considers herself a relatively conservative investor and the score from her investor profile questionnaire categorizes her as an “income and moderate growth” investor. She has been with the City for 23 years and has been a member of OMERS for the entire time. She took some time off when Charlotte was born, but she bought back all of her pension credits. She has been able to contribute the maximum possible each February and currently has $63,000 in her RRSP invested in a Canadian dividend fund earning 5% a year.
For simplicity, you can assume that Leonard’s DB pension follows the OMERS pension plan outlined in the text in Chapter 4.
Personal Use Assets
Their principal residence is valued at $265,000 and the house is held in joint tenancy by Leonard and Rose.
Household contents are valued at $75,000 while their clothes are estimated to be worth $35,000. Rose has a 2-year-old automobile, which is worth approximately $24,000. Leonard has a 4-year old car that is valued at $11,000. Both cars are paid off. They are considering the purchase of a third automobile, a $40,000 truck that Rose and Leonard will use to pull their trailer when they go camping.
Short-term Liabilities
Leonard and Rose each have a VISA card with an interest rate of 18.25% p.a.
They currently have a balance of $4,205 and always pay off the outstanding balance each month. (So, they will pay $4,205 this month).
Long-term Liabilities
Rose and Leonard bought have no long-term liabilities. .
Expenses
Leonard and Rose Domino are not good about tracking their expenses, but in response to your questions, they have provided the following estimates, in addition to those mentioned above.
House-related expenses in 2013 were: $2,799 for property taxes, $2,302 for heat, hydro and water, $612 in home insurance premiums and $1,100 for home maintenance.
Transportation expenses were $1,790 for automobile maintenance and licence, $2,980 for gas and oil, and $2,724 p.a. for insurance premiums.
Food, personal care, beer and wine are currently about $18,000. Leonard and Rose go out often, to
the movies and dinners.
They spent about $4,800 on the family recreational activities and allowances to Charlotte, $1,500
for gifts, $500 for charitable donations, while clothing was $1,275 in 2013. Other costs were $700 a year on the garden, $370 on the Globe and Mail, $400 for miscellaneous computer expenses and $1,867 for all their cell phones, land lines, Internet service and cable.
Child-care expenses were $5,000 in 2013. (costs for sports and music lessons, clothing, etc )
While they expect Charlotte will get a part-time job when the time is appropriate, Leonard and Rose are expecting that this cost will remain pretty constant until they retire.
The family spent $5,500 on a vacation this year. Rose and Leonard feel that it is important to travel with Carlotte and want to budget for a $5,000-$7,000 vacation every other year. (But not this year because they plan to buy a truck)
In 2013, they spent $800 on furniture and small appliances and expect to do so in the future.
In response to your question about priorities, they say their current level of spending reflects their
family’s priorities and life-style choices. They are not, for instance, willing to get rid of their vacations or decrease their donations in order to save more for their retirement.
Retirement Planning Information
Rose and Leonard hope to retire when they are 62, 10 years from now. If they are unable to retire (because they have not saved enough) then Rose will retire and Leonard will continue working since he has the higher salary. They have read in the Report on Business in the Globe and Mail that financial advisors estimate a couple will need approximately 70% of their current gross annual salaries during retirement to meet their retirement expenses on a before-tax basis. Rose is unsure if this is enough and she is conservative by nature. She would like to know what options she has. For example, what happens if they delay retirement, or if they save more etc.
Government Pensions
They estimate that both Rose and Leonard will be eligible for the full amount of the CPP (or more precisely the full amount a person could expect at age 62) They have both been contributing to the CPP for 30 years. Rose and Leonard will each be eligible to receive an old age security (OAS) pension. However, they are unsure about whether they will be subject to an OAS clawback.
Other Retirement Planning Assumptions
Again, based on an article in the Globe and MailReport on Business, they understand that the average retiree faces a lower tax burden in retirement and following the advice in the article, they think their tax rate in retirement will be about 30%.
They expect inflation to be 2% p.a. for the entire planning period. Unless otherwise stated, before retirement, they expect their mutual fund investments will earn 6% ; During retirement, Leonard and Rose will drop their expectations to 5%.
They want to continue their present practice of holding $15,000 to $20,000 as a liquid “emergency reserve”, and do not consider the chequing account to be part of their retirement savings since these funds provide the security they need to sleep at night. They intend to remain in their present home during retirement and hope to leave the house as an inheritance to Charlotte.
Rose and Leonard agree that they should plan on Leonard living to 88 and Rose living to her 92nd birthday.
Education Funding for Charlotte
They want to make provision for Charlotte’s education funding, taking maximum advantage of the
Canada education savings grant (CESG). They expect that Charlotte will complete her education at an Ontario university outside of London, and they want to be able to pay for tuition, residence and books. They made contributions of $25,000 so far, and are putting $400 monthly into the RESP. They have received CESG grants totaling $4,000 so far and hope to get the maximum grant by the time Charlotte goes to university in 5 years. The RESP investments earns 4.2875% . Leonard and Rose have no idea how much it costs to go to University of Chicago and live in residence (or near campus) but they are both adamant that they will cover ALL of Charlotte’s undergraduate expenses for 4 years. They don’t know how much they need, but they know it is a priority for them.
ASSIGNMENT
You have been asked to prepare a financial plan for Leonard and Rose Domino together with a covering letter, which summarizes your key recommendations.
Several hours will be required to review the case and to develop the financial plan. Your analysis for
the financial plan should address the issues listed below.
Covering Letter
Write a brief covering letter to Leonard and Rose Domino summarizing your key recommendations, together with a suggested action plan.
Action Plan
Answer the following questions for them. State any assumptions and show all calculations. Your covering letter and action plan should reference the calculations so your report can easily be read by them after they leave your office.
1. Goals and objectives. Determine their financial goals and prioritized objectives.
2. Current position. Construct the following two statements to ascertain their current financial position:
a. Statement of Financial Position as at December 31, 2013, and
b. Cash Flow Statement for 2013. Use generic rates for taxes, CPP and EI.
3. Analyse their current financial situation. In order to provide Rose and Leonard with sound advice,
your report should take into account and following and provide the rationale for your answer:
a. Are the Dominos maximizing their retirement contributions? Are they making the optimal choices?
b. Do they have enough emergency savings?
c. Do they have enough disability insurance?
d. Do they have enough life insurance?
e. Can they retire at 62? If not, when can they retire? How much more (less) do they need to save to meet their retirement goal?
4. Annual budgets. Prepare cash flow budgets for 2014 to 2016.
Prepare also the Statement of Financial Position for 2014, to 2016. (USING EXCEL)
5. Education funding for Charlotte. Construct a time line of education spending requirements and
provide them with a savings strategy, including the CESG grant that will enable them to meet their goal
6. Retirement planning. Calculate how much they will be able to save in non-registered investments each year until their retirement. This is Rose and Leonard’s first look at a retirement plan. Will they be able to save enough to meet their retirement objectives or do they need to revisit some of their assumptions and plans?
7. Investment planning. Outline an investment strategy which will give them a well-diversified
investment portfolio for both their registered and non-registered assets, based on the outcome of the
retirement plan and your recommendations from above. You are going to refer them to a colleague who
is licensed to sell securities to implement your strategy. In general, what types of securities should they
be buying to meet their objectives? Since you are not licensed to sell securities, you cannot recommend
specific investments. However, you can recommend categories, levels of acceptable risk and provide
them some examples of securities which would meet their objectives and risk-tolerance.
8. Retirement Spending. Construct a timeline for the drawdown of funds in retirement. Based on Leonard’s desire to maintain his standard of living in retirement (including the trip every other year, when will the money run out?
9. Contingency plans. Evaluate a range of “what if” retirement planning scenarios in order to assess
“best-case” and “worst-case” scenarios. For example, what if one of them becomes disabled, dies or
loses his/her job? This should be a central part of your presentation to the client. If the assumptions that Rose and Leonard made are not correct, then what happens when you change key inputs? What happens when they save more? Less? Work longer? Retire earlier? Get sick? Use your judgment about what is appropriate.
Notes on Presentation: This is a professional financial plan. It should look like one. However, all of the supporting calculations, tables etc, should be in included in a well formatted set of appendices. If Rose and Leonard want the details they should be able to find them.
