Planning for illness: managing the future cost of an irreversible condition
By Andrew Allentuck
Situation: Retired couple faces future of long term care, high nursing costs
Strategy: Raise returns on invested capital, manage costs of long term care
Solution: Increased income and a backup for potentially devastating future costs
A couple we’ll call Barry, who is 66, and Violet, who is 65, live in British Columbia. They are prosperous for now, spending less than the $5,820 per month after tax that they earn from pensions and investments. But their future is a problem, for Barry has a neurological illness that incurable and likely to worsen, reducing his mobility, affecting his judgment, and likely to increase his cost of living. The problem may not worsen for several years, but they want to deal with it now to ensure their financial survival. They are in a race with time, even if they cannot see the clock or be sure when Barry will no longer be able to look after himself.
"My main concern is that our cash flow won’t keep up with our monthly expenses,” Barry says. “I am also concerned that I do not have the right asset mix to optimize our investments.”
Family Finance asked Adrian Mastracci, a financial planner and portfolio manager who heads KCM Wealth Management Inc. in Vancouver, to work with
Barry and Violet. “We can’t increase Barry’s pension and we don’t want to dip into registered funds before each person is 71, so the only thing left to do is to raise investment income of about $1,000 per month. And that requires restructuring the portfolio,” he explains.
Investing is both emotional and rational, as most experienced investors know.
Dissatisfied with his investment returns, Barry, who makes the decisions, has put $185,000 into GICs that yield less than 4%. Those safe but low-yield instruments make up more than a third of the couple’s non-registered capital. The remainder of the registered and non-registered accounts are a blend of stocks like BCE Inc and Transcanada Corp. that pay solid dividends, resource companies like Sherritt International Corp., and some old ideas including worthless shares in Nortel Networks Corp. that could have been sold when they had value. There are also holdings in solid, income-oriented mutual funds that have good management and good performance but high management fees.
Barry has no investment plan, no goal other than a a wish to push his $879,600 of financial assets up to $1-million, inadequate diversification, no system for shedding losers, and no clear way of getting to an income goal of $100,000 per year. Worse, lurking in the background is Barry’s condition that, though only an inconvenience now, could eventually immobilize him. That could make it necessary to arrange for costly long-term care.
They already have $81,840 per year total pre-tax income including $22,000 in non-registered investment income. To push income up to their goal, they will need a new asset mix, Mr. Mastracci notes.
They should aim for a 6% yield on their $528,700 of non-registered financial assets, Mr. Mastracci advises. To get that return, they would need to put half their money in stocks with an average 8% return consisting of 3.5% dividends and 4.5% appreciation and half in bonds and other fixed-income assets that return 4% per year. The two portfolios would annually return $21,148 and $10,574 respectively for a total of $31,172. On top of Barry’s existing $43,200 annual company pension and combined annual CPP benefits of $8,880 and Old Age Security benefits of $12,504, they would have total pr-tax income of $95,756 per year before they begin to access registered funds at age 71. The pre-71 shortfall could come from tax-free withdrawals from their TFSAs that would easily cover them for 5 or 6 years, the planner notes.
Building the new portfolio has to be done with design rather than ad hoc tips and ideas of the moment. The concept is to target returns and, with the target in place, then to develop a strategy to get to it.
If the new portfolio is 25% Canadian stocks, 15% U.S. stocks, and 10% global stocks, it will participate in growth of world markets. The foreign stocks can be in mutual funds or exchange traded funds hedged to the Canadian dollar. The fixed-income portion of the portfolio should be 35% in a ladder of three to four year bonds and 15% in corporate bonds rated A or better, Mr. Mastracci suggests. Violet should also shop for a long-term care policy. At-home private care can cost $1,000 to $5,000 per month in British Columbia. Institutional care in a private nursing home can be $4,000 to $8,000 per month, Mr. Mastracci says. A decade of such care could cost $120,000 at home to $960,000 at a private facility. At the high end, the costs would wipe out their assets.
A long-term care policy could look after Violet. If she were to cover half of her long-term care costs, she might be able to buy a suitable policy with a 6-month waiting period for benefits and up to $300,000 of long-term care expenses for $3,000 per year. That money could come from their increased returns on their financial assets. Barry would not be likely to qualify for long-term care insurance due to his existing condition, so he should investigate a life insurance policy that could provide money for such care. The cost of his policy and any care expenses could come from a line of credit secured by their house. The total costs could be covered by downsizing the house.
For the future costs of Barry’s illness and for just good financial sense, it would be beneficial for the couple to split Canada Pension Plan benefits. CPP will do this on request. Barry and Violet should also split qualifying pension income.
The couple can set aside a fixed amount of money per month to cover the co-pay or deductible amount of any long–term care policy they may buy. One may argue that cash is just cash, but this fund could be held in guaranteed investment certificates laddered to mature at six-month intervals, thus providing cash for any contractual delay period in the long-term care policy.
Finally, Barry should consider use of a professional portfolio manager. For a portfolio of his size, the manager would be likely to charge a fee of 1.0% to 1.5% per year. If he prefers to continue to manage the portfolio himself, Barry would be wise to take a course in investment management. The goal should be to stabilize returns, to develop a plan for rebalancing and shedding losses and to manage taxes, the planner says.
“Risk management has a special meaning in this case,’ Mr. Mastracci says. “Increasing their rate of return is important, but so is containing the potential future cost of illness.”
©Financial Post
Need help getting out of a financial fix? Email andrewallentuck@mts.net for a free Family Finance analysis
Financial snapshot
Monthly after-tax income $5,820
Assets
House $ 740,000
Vehicles (3) $ 30,000
Trailer $ 10,000
RRSPs $ 318,700
TFSAs $ 32,200
Non-reg $ 528,700
TOTAL $1,659,600
Liabilities
Nil
Net Worth $1,659,600
Monthly expenses
Property tax $ 155
Utilities, phone, etc. $ 380
Food $ 475
Restaurant $ 60
Travel $ 283
Entertainment $ 30
Clothing, grooming $ 90
TFSA $ 833
Car & home insur. $ 240
Car fuel, repairs $ 515
Charity & gifts $ 510
Uninsued medical $ 410
Misc. $ 300
Savings $1,539
TOTAL $ 5,820
