Next generation

Planning for the next generation

Financial Post July 18, 2009

The client: A single woman in her late serventies. She owns her home and has children in their forties.

The portfolio: $2.7-million, 20% in fixed-income and 80% in stocks, concentrated heavily in banks and utilities. (30% is with only two companies.) Most is in non-registered, fully taxable funds. Estate worth $5-million.

The problem: The client has become nervous since the economy sunk. The crisis depleted her portfolio by $1-million. She worries she will run out of money before she dies. In addition, the client is in the highest tax bracket but lacks tax efficiency. Her lifetime tax bill. (Her estate tax and yearly taxes if she lives to 95 is currently calculated at $1.6-million.)

The fix: The first step for certified financial planner Ted Rechtshaffen, president and chief executive of Toronto’s TriDelta Financial Partners, was to assure the client that she was fine financially. She is wealthier than most people, he says, with a (now) $2.7-million portfolio and an estate worth $5-million. But he sees the same fears and emotions in most people who lose money, regardless of how well off they are. “It’s especially common in retired people, who feel they don’t have any options to make money,” he says. “And when people get older they tend to get a bit more paranoid.” Besides, he says, “most people at a certain age were born and grew up in a time when things were a lot tougher for people financially.”

To address the tax problem, Rechtshaffen suggests clients start giving money to their children each year, instead of waiting until the will is read. That way, she can fulfill a future goal today, with tax benefits, while her children still have a mortgage and young children. “The money is otherwise sitting around doing nothing but getting taxed, and then goes to the kid when you die. By that time they’ll be 60 and won’t need the money.” Since the client has some stock with large capital gains, selling them would trigger a large tax. But donating them to charity kills the tax and allows you to enjoy that good feeling while you’re still around.

Finally, Rechtshaffen needed to protect the portfolio from future loss. Why did the portfolio shed $1-million? “Not because it was a crazy or bad portfolio, but because it was 40% in banks. Canadian banks have been great — except for last year. The lesson is that having great stocks doesn’t protect you from loss, especially when they’re all in the same industry.”

Rechtshaffen changed the portfolio mix to 48% fixed-income and 52% stocks. He sold off any equity that was higher-risk and not good-quality (such as speculative, high-growth small-cap funds) and put most into preferred shares instead of bonds. Preferred shares earn dividends and are taxed at half the rate bonds are, he says, because she is in the 46% tax bracket. But as a rule for most people, preferred shares are taxed at 23%. He made sure to put most of the RRIF funds into bonds, because they are tax-sheltered there. All these changes cut the tax bill down by 55% to $715,000 or less.

The stocks are now only 25% in bank shares. That’s still a higher percentage than Rechtshaffen would like, but it’s important to spread the sales over several years, he says. That way, you’re not getting a huge tax hit each year, and you’re not selling valuable bank stock that is currently undervalued. “Some people would argue that because of the client’s age, the portfolio doesn’t need risk at all,” he says. “But a big part of the portfolio isn’t for her, it’s for the next generation. It doesn’t make sense to have too short-term or too safe a view, when probably it’s a 40-year portfolio.”

The outcome: This plan was enacted during the worst of the financial crisis. Partly because of the market recovery, the portfolio is up 10% ($369,000) from when they brought it in six months ago. “But more importantly, the portfolio is in much better shape if we have another major downtown,” Rechtshaffen says. “The client can feel confident in good times and bad.”

———

THE NEW PORTFOLIO

TOTAL PORTFOLIO – 10% cash – 17% corporate bonds – 6% GICs – 15% Preferred shares – 52% stocks

BREAKDOWN

RRIF ($189,000) – 22% cash – 71% corporate bonds – 7% stocks

Non-RSP ($2.8-million) – 9% cash – 7% GICs – 13% bonds – 55% stocks (25% banks) – 16% preferred shares

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