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George Alves (38) and his wife Marianne (38),

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Scenario: The Alves Family

 

Background Information

 

George Alves (38) and his wife Marianne (38), live with their children Estelle (15) and

 

Jonathan (12) in a neighbourhood of middle- to high-income homes in Capital City.

 

Marianne works at home in a small Internet-based travel business she started 4 years

 

ago. She earns $10,000 per year, after tax. George is an ironworker and frequently

 

works on high-rise buildings. He earns $55,000 per year, after all deductions.

 

Georges father is retired and Georges mother is not able to function independently, so

 

his father must attend to her needs for much of his day. George supports his parents

 

by providing them with a part-time helper, reflected in the parental care section of the

 

Alves familys personal expenses (see Exhibit 1). George does not see this changing in

 

the foreseeable future.

 

George and Marianne have not done major work on their house since they purchased it

 

12 years ago, and they want to put in a new kitchen as soon as possible. They feel the

 

renovation can be done for $10,000, spread evenly over the next 2 years, if George

 

does some of the work himself. They would like to pay for the cost by cashing in an

 

investment. The kitchen renovation is an important goal, especially for Marianne who

 

likes to entertain. The house is fully insured with a named perils policy and the contents

 

are covered for actual cash value. The family purchased this coverage through Georges

 

union because it was the cheapest available.

 

George and Marianne are very interested in providing their two children with a good

 

university education. A local university advises that the cost of tuition and student living

 

expenses, currently $7,000 per year, will increase at least with inflation. George feels

 

the children will value their education more if they contribute to the cost, so he is

 

committed to providing a fund sufficient to pay half of the cost for each child (in actual

 

dollars at the time they are needed), for each year the child is enrolled in a 4-year

 

university program. He wants this entire fund available when the first child begins

 

university. As is customary, the Alves children will start university at the beginning of

 

their eighteenth year, tuition and living costs must be paid at the beginning of each

 

year.

 

The Alves family has always driven used cars. They put a lot of miles on their vehicles

 

because George often works out of town and prefers to drive his own car in case he

 

needs to get home in a hurry. He is also able to load his own tools in the trunk and

 

back seat when he travels by himself. The familys last car was purchased 4 years ago

 

and they made the last monthly payment of $294 just this week. George has been

 

talking to a dealership about buying a new car at a cost of $26,500. He was offered

 

$8,500 for the old car on trade, which seems to him like a reasonable deal.

 

George has also been thinking of leasing a new car. This would be a new venture for

 

him, because he has always borrowed to buy his cars. If he buys, he will borrow over

 

60 months at 7.5%. Leasing would require a 3-year contract at a financing rate of 3%.

 

The monthly lease payment, including tax, would be $135.35. Administration charges

 

on the lease would be $800, paid up front. The same trade-in value would still be

 

applicable to the lease. The best estimate is that the car would be worth $12,000 after

 

5 years and $15,000 after 3 years. The family lives in a province with a sales tax of

 

8.5%.

 

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For planning purposes, George will use the lowest annual payment but he would like to

 

know what else he should consider when deciding whether to buy or lease. After

 

reading a newspaper article about the equivalent annual NPV method, he has decided

 

to use this method to choose the best financial option.

 

Georges carries car insurance with a deductible of $500 and liability coverage of

 

$250,000.

 

Unlike most of their friends, the Alves take no real vacations and only manage to get

 

away camping for a couple of days in the summer. They want to take a 2-week

 

vacation each year for the next 3 years, while their children are still at home. They

 

estimate the cost of such a vacation to be $6,500 per year.

 

Cash and Debt Management

 

George keeps all his cash in a chequing account because he says you never know

 

when you might need it. George also looks to his 5-year GICs and Canada Savings

 

Bonds for emergency funds. Mariannes cash is in a savings account. Georges

 

chequing account has a $15 monthly fee and pays no interest. There is also an

 

additional charge for any cheques he writes.

 

For credit purposes, George has a gold card and a companion card for Marianne. The

 

fee is $125 a year for the main card and $60 for Mariannes card. The yearly interest

 

rate is 18%. The card gives travel rewards and has an insurance waiver for rental

 

vehicles. The Alves never carry a significant credit card balance because they do not

 

like debt.

 

When George and Marianne bought their home 12 years ago, they opted for a 15-year

 

amortization period so the home would be paid off as soon as possible. The payment

 

schedule was heavy, but the additional income from Mariannes business allowed them

 

to continue to make the scheduled payments. They would like pay the mortgage off

 

soon.

 

The mortgage balance was $28,972 when the mortgage term expired last week. The

 

Alves are negotiating the renewal now at the new and lower rate of 6.50%. They would

 

like to pay it off in 2 years, instead of the 3 that remain. (They cannot remember what

 

their new monthly payments would be, the old one was $893.) The house cost

 

$120,000 and it has appreciated at 3.25% per year. While the value of the house is

 

expected to continue to grow at this rate, future inflation is expected to be

 

approximately 2.50% a year.

 

Risk Management and Insurance Issues

 

There is a very high risk of accidents in Georges work. Safety improvements have

 

resulted in fewer accidents, but any accidents are serious. Despite the risk, the

 

company does not offer any disability coverage because accidents are so infrequent.

 

The company does have a 3-month sick leave provision. George feels adequately

 

protected because he has liability coverage against accidents in his homeowners

 

package.

 

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Georges employer provides optional group life insurance in multiples of an employees

 

yearly salary, to a maximum of three times gross salary. George has purchased

 

coverage of $185,000, twice his annual gross salary, though he could take a maximum

 

of $278,000. George and Marianne are not sure if they are carrying the correct amount

 

or type, of life insurance.

 

George and Marianne have discussed expected costs in the event of his death. They

 

feel that personal expenses, excluding loan payments, would drop to about 75% of

 

current levels if either one of them were to die. In 6 years, those expenses would drop

 

to 50% once the last of the two children reached 18 and left home to go to university.

 

They foresee this condition would last until Mariannes death in about 45 years after

 

that. Marianne would continue to live in their home and they feel she and the children

 

should have the new car and the kitchen renovation. The education fund would also be

 

a necessity. Marianne would probably be in a 25% average tax bracket after Georges

 

death.

 

Given the projected expense reductions, they see little need to insure against the event

 

of Mariannes death since George would continue to work.

 

Investments

 

In addition to a pension plan through his employer (see Retirement below) George has

 

$14,200 in his chequing account

 

an RRSP

 

a $10,000, 20-year government bond with a coupon rate of 5.125% (semi-annual

 

payments), a yield of 6%, and 6 years left to maturity.

 

Marianne has a savings account with a balance of $1,300. The familys assets and

 

liabilities are shown in Exhibit 2. When they purchased their home 12 years ago, they

 

also decided to commit themselves to RRSP contributions. Since then, George has

 

contributed $2,000 a year to his RRSP. They decided that Marianne does not earn

 

enough to contribute to an RRSP. Georges RRSP has grown at an annual compound

 

rate of 4.5% over the 12 years. In the future it is expected to grow at 6% (see

 

Exhibit 3). The RRSP is invested in the BlueBell Canadian Fund. George liked the idea

 

that it was a no-load, deferred charge fund, so he also purchased some for his

 

unsheltered account. His latest statement from BlueBell shows that his non-registered

 

holdings are now worth $8,450. The statement also pointed out that the fund has a

 

Beta of 1.26. George doesnt know the significance of that, but it sounds important.

 

The Canada Savings Bonds were bought through a payroll deduction plan at work.

 

Retirement

 

George wants to retire when he is 60, and with enough money to provide for 25 years

 

of post-retirement income. Retirement is a high priority, as he sees his career as a

 

young mans job. George feels that he and Marianne will require an annual net income

 

of 60% of their combined net incomes (currently $65,000 as shown in Exhibit 1 below)

 

to maintain their desired retirement lifestyle. While he and Marianne could continue and

 

expand the Internet business after retirement, they really do not want to, unless it is

 

necessary. Both George and Marianne would take CPP when they each reached age 60

 

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(22 years from now for both of them). They expect they will be in a 25% average tax

 

bracket at that time with minimal income from CPP and their investments.

 

Georges employer has provided a defined contribution pension plan for the past 11

 

years. An employee can contribute up to $6,000 per year and the employer will match

 

the employees contribution to a maximum of $3,500 per year. George contributed

 

$2,000 in each of the first 2 years that the plan was available. Every year since then

 

he contributed $3,500. The plan has earned a compound average rate of 5.25% per

 

year since inception. The future rate of return is expected to be slightly higher (see

 

Exhibit 3). George plans to continue to contribute $3,500 of his own money up until he

 

retires. His contributions are deducted at source.

 

For planning purposes, George considers that only the money in his pension plan and

 

RRSP will be used for retirement purposes. It is very likely that they will have other

 

financial assets by the time they retire, but they will use these for the extras, such as

 

trips and maybe even health care.

 

Hint: To create a retirement plan for the Alves, calculate

 

annual retirement needs in todays before-tax dollars

 

annual retirement income available from Canada Pension Plan

 

current annual shortfall (from the numbers above)

 

inflation-adjusted shortfall

 

funds needed at retirement to cover the shortfall

 

future value of retirement assets (RRSP and Pension Plan)

 

total future value of retirement assets needed at start of retirement

 

shortfall at time of retirement

 

yearly contributions needed to make up shortfall.

 

Estate Issues

 

One of Georges main concerns is caring for his parents. He worries that if anything

 

happens to himthe only childhis parents will not have the extra income of $6,000

 

a year that he provides them. George estimates that he will probably continue to

 

subsidize his parents for the next 15 years.

 

George is also concerned about his mothers inability to look after her investments if

 

anything were to happen to Georges father. Georges father is keen about managing

 

his investments, unlike his son, and while he is alive, there is no problem. Since

 

Georges father is interested in finance, George named his father as executor of his

 

own will when he and Marianne got married. A great deal has happened since then.

 

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Exhibit 1

 

The Alves

 

Income and Expenses (for last year)

 

Income (net)

 

George

 

Marianne

 

55,000

 

10,000

 

Total

 

65,000

 

Expenses (yearly)

 

Housing

 

Mortgage Payments

 

Property Taxes

 

Property Insurance

 

Maintenance

 

Utilities, heat, phone, etc.

 

Automobile

 

Payments

 

Gas, insurance, repairs

 

Parental Care

 

Health and Hygiene

 

Groceries

 

Clothing

 

Miscellaneous (charitable donations, gifts, etc.)

 

RRSP contribution

 

Leisure and Travel

 

Total Expenses1

 

Surplus (deficit)

 

1

 

Does not include all scheduled payments

 

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1,200

 

700

 

2,000

 

5,600

 

4,445

 

6,000

 

4,100

 

3,200

 

3,500

 

8,500

 

2,000

 

4,000

 

45,245

 

Exhibit 2

 

The Alves

 

Assets and Liabilities (as of today)

 

George1

 

Assets

 

Liquid

 

Chequing Account

 

Savings Account

 

Investments

 

Registered (RRSPs)

 

BlueBell Canadian equity fund

 

Non-registered

 

Government of Saskatchewan bond

 

Canada Savings Bonds

 

GICs3

 

BlueBell Canadian Equity Fund

 

Personal

 

Residence4

 

Household furnishings

 

Car

 

Marianne1

 

Combined

 

14,200

 

1,300

 

24,000

 

10,0002

 

5,200

 

8,000

 

8,450

 

120,000

 

35,000

 

8,500

 

Liabilities

 

Current

 

Credit Cards overdue

 

Line of Credit Mariannes business

 

Personal Loans - car

 

Long-Term

 

Mortgage5

 

Total Liabilities

 

1,800

 

100,000

 

Net Worth

 

1

 

George and Marianne have their investments registered in separate names

 

Face value

 

3

 

Just renewed for 5 years

 

4

 

Historic cost

 

5

 

Original value

 

2

 

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Exhibit 3

 

The Alves

 

Other Financial Information

 

CPP death benefit

 

Maximum CPP benefit at age 65

 

(current, but indexed to inflation)

 

Expected annual inflation rate

 

Expected average, pre-tax, nominal return on

 

all sheltered and unsheltered investments

 

Estimated Funeral Expenses

 

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George

 

2,500.00

 

801.00

 

2.5%

 

6.0%

 

10,000

 

Marianne

 

800.00

 

165.00

 

Paper#27166 | Written in 15-Dec-2015

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