Sylvain Brisebois, senior vice-president and portfolio manager at BMO Nesbitt Burns in Ottawa.
Ralph Lopez, 55, is a divorced, self-employed advertising consultant. He planned a ski trip to Park City, Utah with his children over March Break, and his advisor urged him to purchase travel insurance before departing. Ralph shrugged it off (he doesn’t have disability insurance, either).
Both are mistakes. While hot-dogging a tough hill, he veered into a tree and suffered major injuries. Fortunately, his children are better skiiers. Since Ralph didn’t have insurance, he owes a local hospital about $50,000, even after estimated reimbursements from his provincial plan (see “Claiming health expenses,” below).
The hospital will accept payment in full or in $1,000 monthly installments. Recovery time will hurt his earning power to the tune of about $30,000, so the total shortfall is around $80,000. Ralph has a $500,000 portfolio with half in equities, half in fixed income. His house is paid for. His advisor has to determine how to fund the medical bills while minimizing the impact on his client’s long-term goals.
Degree of difficulty
6 out of 10. Brisebois says Ralph’s situation is similar to what clients face when laid off for a year. The greater the lost income, the more likely it is the client can run out of money in retirement.
Advisors need to be especially careful when forecasting the impact of adjustments to a long-term plan. “You’re building in 35 years of predictions,” says Brisebois. “If your expected rate of return or inflation assumption’s off by 1%, things could go horribly wrong. [Ralph] is self-employed so he has no pension to fall back on. You’d better brainstorm a variety of possible outcomes.”
Issues and options
Ideally, a client should have a buffer in his portfolio to cover this kind of emergency.
If he doesn’t, then liquidating a second property, such as a cottage, can allow someone in Ralph’s position to meet the expense without changing his financial plan.
Ralph has neither.
Sylvain Brisebois, SVP and portfolio manager at BMO Nesbitt Burns in Ottawa, says that there are two parts to this dilemma:
- With $80,000 less to work with ($50,000 for the hospital bills plus $30,000 in lost earnings), how will Ralph’s goal of retiring at 60 change?
- How does he get the cash to handle the short-term issue of paying $50,000 in hospital bills?
Brisebois suggests four answers to the first question:
- Work longer
- Save and invest more every month
- Accept a lesser retirement (less travel, etc.)
- Alter the asset mix (more risk)
He cautions against choosing only one and making drastic changes. And that’s especially true for option four. “The client may say buying a lot more equities will fix the problem. I would challenge that conclusion.”
Brisebois says going from 50% equities, 50% bonds to, say, 60%/40% or 75%/25% could worsen Ralph’s predicament. With that much equity, a major downturn would make it extremely difficult to recover, given his age. So, if he’s going to alter the allocation, he shouldn’t go beyond 55%/45%. Most clients opt for small changes to all four categories, adds Brisebois. If you tell them they’ll have to start saving $1,200 a month instead of $500, you’ll get pushback. The same will happen if you say they’ll have to retire at 67 instead of 60.
So Ralph may, for instance, consider retiring at 62 instead of 60; saving $650 instead of $500 per month; vacationing once per year instead of twice, and increasing his equity allocation to 55%. If the client owns a home, a fifth option would be downsizing a few years earlier than planned. Another idea is to integrate the home’s sale into the above approach. For instance, if Ralph’s unable to work longer than planned, he can make up for it with gains from his home.
The remaining question: how can Ralph come up with $50,000 to pay the hospital? There are three options:
- Sell portfolio assets
- Take out a line of credit
- Do a mix of both
Market conditions can affect this decision. And advisors need to approach the first option with tax in mind. If you’re not careful, says Brisebois, taxes can add thousands to a $50,000 withdrawal. If conditions make it a good time to sell, he can offset harvested gains from one sector with capital losses from another. That would minimize his tax bill.
The second option is to take out a line of credit for $50,000. He can pay it off by saving a bit more every month; working longer than planned; selling assets in the portfolio as opportunities arise; or a combination of all three.
The third option combines the first two, but assumes the market’s had a good run. Say Ralph’s accident happened in November. “He can take $25,000 from the portfolio and $25,000 from a line of credit; then the following January he can take another $25,000 from the portfolio and pay off the line of credit. This allows him to split taxes over two years.”
If Ralph is set on paying the bill monthly, essentially the same strategies apply. For instance, if he takes out a $50,000 line of credit, he can draw $1,000 a month and then pay it down with portfolio withdrawals months later when the market is better suited to selling. He will, however, be required to cover monthly interest on the loan.
Market conditions are mediocre, so Ralph’s advisor suggests he use a line of credit to pay the hospital bill in $1,000 monthly installments, covering the debt with assets from the portfolio once it’s a good time to sell. Interest rates are low by historical standards—around 3.5%—so a $50,000 loan is relatively cheap.
Ralph accepts his advisor’s suggestion for paying the hospital, but he doesn’t like the idea of downsizing early. He has a large backyard and sitting by the pool helps ease the stress of a hectic professional life. Saving and working more, spending a little less and tweaking his asset mix are far more palatable.
Dean DiSpalatro is a Toronto-based financial writer.