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The cautious grandma

Senior considers pulling plug on mutual funds to preserve wealth

Hey there, time traveller!
This article was published 7/6/2013 (1533 days ago), so information in it may no longer be current.

Nellie doesn't need much to get by.

The 76-year-old grandmother lives quite easily on her federal government pension, OAS and CPP -- about $1,700 a month.

Nellie must weigh her "desire to preserve her money and enjoying peace of mind against her desire for growth so she can leave more money for children."


Nellie must weigh her "desire to preserve her money and enjoying peace of mind against her desire for growth so she can leave more money for children."

She also receives a few thousand dollars a year from her registered retirement accounts and some interest from savings.

"I don't really need that income," she says. "I have lots left over from my pensions."

So Nellie saves and saves some more.

She has accumulated almost $47,000 in a savings account, transferring the annual maximum to her TFSA, which she invests in GICs.

"I'm trying to see if there's any way to get a better return than GICs," she says. "With inflation, you might as well bury it in the backyard."

Nellie says she's concerned about investing in more risky assets and losing money, something she already worries about with the $85,000 she has invested in mutual funds outside her RRSP and TFSA.

"I feel that I need to place the money somewhere more secure than mutual funds," she says. "I don't need the money, but I've got a lot of hands to help after I'm gone."

Nellie wants advice. Is moving most of her money to GICs to preserve wealth a good idea? At the moment, she's not sure it's the right choice and worries about capital-gains taxes.

Still, the safety of GICs is attractive.

"Even if I make less, at least I've got my principal."

Certified financial planner Jan Fraser says Nellie is facing a dilemma like many other seniors.

"The financial crisis was such that many seniors are still quite traumatized from it," says the adviser with Fraser and Partners in Winnipeg. "They don't know where to invest their money."

Like Nellie, their money sits in savings and GICs, but GICs don't earn much after taxes and inflation.

After five years, for example, $1,000 in a GIC paying two per cent annually is worth about $1,008 after inflation. At Nellie's marginal tax rate of 25.8 per cent, it's a losing proposition.

Fraser says Nellie's asset allocation for her non-registered portfolio does appear to be a little aggressive at first glance given her age. All non-registered assets are invested in the stock market. This isn't the right asset mix if her main concern is capital preservation.

Yet Nellie is also worried about the capital gains she might owe and fees or penalties that could be charged if she closes the funds. Fraser says the withdrawal charges should be negligible.

Two of the three funds Nellie owns have front-end load (FEL) fees. She's already paid the commission up front, meaning she shouldn't pay any fees upon withdrawal. The remaining fund is open. It has no apparent deferred sales charge (DSC), so she should be able to cash it out too with little or no cost.

The capital-gains taxes are another matter, which may cost her a few thousand dollars upon withdrawal. To calculate the taxes, she needs to know the capital gain. To do that, the adjusted cost base--what she paid for the funds initially -- is subtracted from the fair market value at the time the funds are sold. Figuring out the exact adjusted cost base for mutual funds, however, can be complicated.

Capital losses within the funds may reduce the overall gain, decreasing the final tax bill. And because two-thirds of her investments are held in corporate-class mutual funds, which are designed to provide tax efficiency, in part by converting interest distributions into capital gains, there could be other factors that affect the capital gains calculation.

Still, Fraser says Nellie's adviser can provide her with the accurate adjusted cost base.

Once she knows the gains, she can calculate the taxes. Fraser says the taxable gain that is reported is half of the actual gain, and it is taxed at her marginal tax rate.

To give her an idea of what she might pay, Nellie can use a rough guide for two-thirds of her non-registered money, invested in a well-known Canadian equity mutual fund that has been around since 2003 and averaged 6.7 per cent a year net of fees.

"That's not the best for an equity fund over the last 10 years," Fraser says.

"But it certainly beats the returns she'd get on a GIC."

If her initial investment was about $32,000 in 2003 and today is worth about $61,000, her gain -- as a rough estimate -- is $29,000.

This more than doubles her current annual income. Her marginal tax rate would be 34.75 per cent for income from $43,562 up to $54,800. And it would be 27.75 per cent for income $31,000 up to $43,561.

Nellie should keep in mind, however, that only half the gain -- $14,500 -- is taxable, so her taxes on the profit would be about $4,367.

But Nellie has a couple of other considerations. She lives within her means, even accumulating wealth in her retirement years.

Her non-registered investments are essentially for her family. If she moves her money to GICs, it won't grow at the same pace it has, it will be more affected by inflation and interest is fully taxable unlike capital gains. If she lives into her 90s, the difference between 6.7 per cent a year and two per cent would be tens of thousands of dollars.

An alternative to GICs is investing in less volatile funds. Because most of her assets are invested in corporate class, Nellie could even switch from equity funds to more conservative bond, income and balanced funds without triggering taxes.

"In this respect, her adviser gave her good advice."

The problem with switching to bond funds today, however, is interest rates are expected to rise, which could decrease their value -- the opposite of her intent -- while the stock market rises.

"So, in a way, she may in fact be quite nicely positioned to avoid the volatility that is expected to affect income funds when interest rates increase."

Staying put might be better in the short and long runs, providing the markets don't melt down like they did in 2008 and 2009.

It's a calculated risk, Fraser says, one she could discuss with her children.

One other consideration, however, is the estate tax bill. If she remains in mutual funds, those gains will be realized in her final year, along whatever taxable assets remain, meaning those gains could be taxed at an even higher rate than today.

Then again, the money will likely have grown substantially if she remains invested, so while the tax bill is higher, so too are the profits.

Needless to say, Nellie has a lot to consider, and her adviser should help her crunch the numbers to compare the scenarios.

In the end, Nellie may decide moving to all GICs means she will sleep better at night.

In that case, inflation and taxes are the main concerns. But if she wants the money growing tax efficiently and outpacing inflation, the status quo may be a better option.

"It's a matter of weighing her desire to preserve her money and enjoying peace of mind against her desire for growth so she can leave more money for children."


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