In times like these, advisors need to focus on their clients, all of whom are asking, “What does this mean to me?” They’re wondering whether their fi nancial plans have been compromised and what they can do to mitigate any negative impact.
Those of us who provide comprehensive fi nancial planning are in a unique position to give clients clarity; to tell them where they are fi nancially and how they can plan going forward. For clients, one of the greatest benefi ts of knowing where they stand is that they’ll have confi dence and will grasp the likelihood of making progress over time.
The Fee Factor
Fee-for-service fi nancial planning can be very rewarding for many reasons. The clients get a highly valued service and the advisor is better able to provide appropriate recommendations. Further, fee-for-service planning generates fee income that’s not product-related (a good thing in these times), and clients are more motivated to act on recommendations because they perceive the advice as objective.
The key to success in this business model is proper disclosure of the fees that are charged and a clear agenda with respect to what the client will take away from the planning process. Placing the focus around fi nancial planning will differentiate you within the advisor world, and broaden your appeal to a client looking for someone to handle his or her entire fi nancial picture, as opposed to just the investments. And, it’s been well documented that the better the relationship between advisor and client, the less important investment returns are with respect to retaining that client.
The best thing about fee-for-service fi nancial planning is you can charge a reasonable sum for a plan and diversify your own income stream, and be unencumbered to give the right advice to your clients.
For most people, there never seems a good time for planning. When the going is good, a majority feel they should be spending their time working and making more money, rather than thinking about the future. But any approach that excludes careful planning is reactionary rather than proactive, and often leads to stress because people don’t know where their fi nances are headed.
Proper planning does two things. It provides clients with a well-deserved pat on the back and shows them how far they’ve come since they set out on their life journey. (And the importance of focusing on positive achievements cannot be understated because that’s what provides people with the confi dence to believe their plans for the future can become reality.)
Second, understanding where they’ve come from lets clients project those successes into the future and gain conviction that they can indeed reach their goals. Such future thinking—based on a positive view of past successes— is one of the most powerful tools advisors can use to help clients weather the storms of doubt that are being swirled up by mainstream media. In this context, a fi nancial plan becomes a benchmark. It provides value both to clients worried about their futures, and to those who long for a roadmap to help remove doubts.
I recently completed plans for two sets of clients motivated by different drivers. One couple (Client A) was concerned they were spending too much and weren’t putting aside enough to have the retirement lifestyle they’d dreamed about. This weighed heavily on their minds and prevented them from enjoying the present.
The second couple (Client B) had accumulated a signifi – cant amount of investments within their company, along with RRSPs and other non-registered savings, and was starting to think seriously about retirement. They set a date and asked the question, “Can we do it?” They thought it might be possible but the transition was a signifi cant change in their lifestyle and they wanted confi rmation.
Overspending Business Owners
The first couple—a self-employed husband and wife team— own a business that earns about $240,000 per year before tax. The income is split between salaries (about $150,000) to his wife and him, with the rest being left in the company to save for retirement and pay down corporate debt. They have three kids ages 11, 14 and 17, and have accumulated personal debt for various reasons, including a renovation to their home. Their expenses exceed their income and they’re concerned if the current economic times worsen they might not have enough income to meet their obligations.
The debt is spread around in various lines of credit and term loans that were taken out over the years to fi nance both expansions to the business and for personal needs. They’re unsure which debt is tax-deductible and whether or not the current amortization of the loans will see them paid off before retirement. The interest rates, between loans and a line of credit, are quite varied so they’re not sure what their total debt service cost is. They also don’t know the exact amount of their personal expenses—they don’t keep track—and have used a line of credit to pay for shortfalls; or simply taken extra dividend from the company.
They have some specifi c goals: › To bring spending under control so they’re not accumulating debt but actually paying it down and saving toward other goals; › To pay for the kids’ educations, which they believe will cost around $15,000 per year, for each of their three children, for four years; › To buy a vacation property in 2020 (when the husband reaches age 60) for $650,000 as well as an apartment in Vancouver worth $800,000 (in today’s dollars); and › At age 85, sell the apartment and invest the proceeds to pay for Long Term Care, or for retirement home fees.
In addition, they’ve said they want to:
› Buy her a new car for around $35,000 in five years;
› Buy him a new car for around $35,000 in three years;
› Buy a new car every 10 years up to age 75;
› Retire at age 65;
› Travel to Europe every year from age 65 to 75, which would cost around $15,000 per year; and
› Sell their business in 2029 for around $1.2 million in 2008 dollars.
Based on these needs, we had some recommendations:
› Consolidate all debt under one easy-to-manage line of credit secured by the principal residence they’ll use for their bank account and lending facility. The interest rate on all debt becomes prime plus 1/2%;
› Set salaries at $75,000 for him and her, increasing until retirement by 2% for inflation;
› Set up home accounting software to record all spending and make sure budgets are maintained. All spending must be reviewed regularly by the couple to maintain a sense of touch with the current situation. No spending is allowed unless pre-approved by both;
› Continue systematic deposits to RRSPs at maximum allowable limits based on salary;
› Incorporate a new holding company to accumulate corporate cash and investments, which will keep the operating company pure so it can be sold at retirement and the Enhanced Capital Gains Exemption can be used to offset capital gains tax;
› Reduce the monthly insurance premium for the corporate Universal Life policy to $300 from the current $900;
› Increase corporate savings to $5,000 per month, in addition to the allocation to pay down corporate debt; and
› During the company reorganization, set up the holding company as a family trust that allows the parents to pay their children dividends to help finance their schooling at low tax rate dollars once the children are over 17 years of age.
Going through this process allowed the clients to develop a clearer understanding of their situations and assured them their situation is a bit better than they’d thought. The steps weren’t arduous and they were able to buy into the process.
To help us make our points, we use a software package that allows us to give detailed breakdowns of lifestyle, other expenses and income sources. The program does a good job of projecting assumptions, applies actual prescribed tax rates in each year, and allocates investment income and growth according to detailed input data pertaining to each investment class and type.
The returns are provided by the investment advisor and need to include volatility ratings; composition of capital gains; dividends and interest; and turnover rates within an asset class.
The clients also learned about themselves, particularly how much personal debt they were accumulating. The money they borrowed, and in turn lent their company, created a shareholder loan balance to their credit. However, their accountant had used this shareholder loan credit over the years to offset unscheduled draws made by the couple to meet their personal expense shortfalls.
The exercise was an eye opener, which led them to reassess their spending, get it under control, and enjoy life more once things were sorted.
Cautious Lawyers The second couple, Client B, was concerned their investment returns were essentially fl at over the last fi ve to seven years because of recent market volatility, and they didn’t know what the future held.
They’re both lawyers who run their own practices. They have no debt and own a residence in Vancouver, as well as a vacation property. Their children are studying overseas, and they’d like to pay off all those education costs before retirement. This means they aren’t saving as much for retirement, and given they’re only fi ve years away from stopping work, have become concerned as to whether they’ll succeed in meeting all their objectives; in addition to having enough investments to last their lifetime.
They’ve invested funds in their RRSPs and have non-registered investments in mutual funds, stocks and bonds. They’ve done everything right. And now it’s time for them to fi nd out if they’ve done enough.
The time leading up to retirement can be very stressful, especially for people who’ve gotten used to steady, and large, monthly incomes.
They believe once they pull the plug and retire, there’s no turning back. There may be opportunities that present themselves during retirement, but these clients would rather have the freedom to choose to work (for intellectual reasons if the right opportunities arose) and not be forced to work.
The process of retiring can be emotionally trying for some people and getting engaged in fi nancial planning is one way to prepare mentally for that change. This couple intends to review their affairs on an annual basis to see if the assumptions used in developing their plan are accurate. The goal is to be in good enough shape fi nancially to weather any storm that comes along in the years ahead.
They want to:
› Retire at 65;
› Determine their cost of living before and during retirement;
› Determine how much to contribute to the retirement nest egg to meet their goals;
› Pay for the kids’ education overseas, which will cost approximately $40,000 per year for five years;
› Buy a new car every 10 years up to age 75, at a cost of $40,000;
› Take care of aging parents if they need Long Term Care or other financial support;
› Insure income so as to reach savings goals even in the event of a disability or death of either client;
› Plan affairs to minimize tax payable at death and pass a reasonable inheritance on to their children; and
› Make a reasonable gift to charity upon their death and support a favourite charity during their lifetime.
Based on those needs, we recommended they:
› Track living expenses accurately for the next five years to arrive at a consensus on what they’d require during retirement from age 65 to 75; 75 to 85; and beyond;
› Set up a family trust to split income from their law practices to reduce the tax cost of paying for their children’s educations;
› Bring their parents into the corporate structure as shareholders, so that in the event they should require financial support they can be paid dividends to reduce the tax cost of providing that support;
› Continue systematic deposits to their RRSPs at maximum allowable limits based on salary;
› Redraft their wills to incorporate and maximize the use of trusts for their children’s benefit;
› Purchase Joint-Last-To-Die insurance coverage to pay the capital gains tax liability upon the second of the clients’ deaths; and
› Maximize the use of Tax Free Savings Accounts for themselves and their kids.
The couple’s success will depend on the accuracy of the assumptions used in developing the income projections. They still have time to make adjustments and it’s highly likely they’ll succeed. They’re heavily dependent on the rates of return they’ve actually realized over time, and their confi dence is low given their investment performance to date.
It’s up to the investment advisor to meet the expectations of the client as laid out in the investment policy statement. The intent in this case is to use suffi ciently conservative assumptions so that meeting targets on an annual basis will be achievable. And, again, the purpose is to develop confi dence so when the time comes to retire there will be no hesitation or uncertainty.
The key is to remove as many variables as possible and allow for things we can’t control. Advisors who work with this in mind will still succeed in providing clients with confi dence.
I’ve worked as a fi nancial planner for more than 20 years. And while the form of my planning has evolved over time, one thing has remained constant: Clients value you for your wisdom during diffi cult times. Helping them build confi dence in their futures during these uncertain times is like providing them with a drink in the desert.
In a fee-for-service planning model, an advisor is free to recommend the solutions he or she thinks will work best for the client without having to worry about the bottom line. That’s especially comforting in times like these, but really it’s a level of service advisors should aspire to, regardless of how the economy’s performing.
Bernie Geiss, CFP, CLU, RHU, is President of Cove Financial Planning Ltd. in North Vancouver, BC.