An Inheritance Plan, and a Feeling of Relief

10/06/2010 2:52 pm EST

Focus: MARKETS

John Heinzl

Reporter and Columnist, GlobeInvestor.com

John Heinzl, reporter and columnist for GlobeInvestor.com, shares specific recommendations from two financial planners.

Yesterday we met Susan Middleton, a part-time cashier who is about to inherit $280,000 from her mother who passed away in March. Today we’ll hear specific recommendations from two financial planners.

Even though the 64-year-old Ms. Middleton (whose name we have changed) is looking forward to enjoying the cash, she’s also “overwhelmed” by what to do. With no investing experience and a husband, 63, on disability, she fears making a costly mistake.

That’s understandable. Ever since her husband’s quadruple-bypass surgery 10 years ago, the couple have been living close to the bone. They’ve been getting by on about $22,000 annually, largely from her cashier’s job and husband’s disability checks, but they’ve also run up a credit line of about $20,000 to make ends meet.

With little in the way of savings—their combined RRSPs are worth about $15,000—their biggest asset is their home, which has a market value of about $300,000 and is mortgage-free.

Given the couple’s modest income, Ms. Middleton wants her inheritance to last as long as possible. But after struggling for years, she’s also feeling a pent-up desire to do something nice for herself, her grown kids, and grandkids.

“We haven’t done anything for the last 10 years,” she said. “We don’t need to travel around the world, but we would like to live a little bit.”

The inheritance money will arrive in two stages—roughly $180,000 now, and the balance of $100,000 in about two years. Here’s what two financial planners recommend.

Derek Moran, president of Smarter Financial Planning, Kelowna, B.C.

Mr. Moran, a registered financial planner, says the Middletons needn’t worry. They may not be able to afford a trip to the French Riviera every year, but they won’t be eating cat food in their old age, either, thanks largely to government pensions.

By the time both are 65, he estimates that their combined Canada Pension Plan and Old Age Security benefits will total $25,550 annually, indexed to inflation. When one spouse dies, the surviving spouse will be left with pension income of $17,432.

“Bottom line here is that no one will go hungry, no matter what,” he said.

With the initial inheritance money, he recommends paying off the $20,000 credit line immediately and putting an additional $20,000 into a cashable guaranteed investment certificate for emergencies, such as a new furnace or roof for their house.

With the remaining $240,000, he suggests investing two-thirds in a balanced mutual fund from a low-cost provider such as Phillips Hager & North or Mawer Investment Management.

PH&N’s Balanced Fund, for instance, has a management expense ratio of just 0.86 percent, holds a mix of common stocks and investment-grade bonds, and has a low to moderate risk profile.

For the other one-third, he suggests augmenting the portfolio’s yield by putting the funds into a conservative mortgage investment corporation that focuses on residential first mortgages with low loan-to-value ratios.

Assuming a projected return of 5 percent, Ms. Middleton could withdraw more than $18,000 annually from her nest egg, which would deplete her portfolio by age 85.

“Their home equity will become their insurance policy against unknown health care costs or if she should live past 85,” Mr. Moran said.

John DeGoey, certified financial planner and investment adviser with Burgeonvest Bick Securities in Toronto.

When the first $180,000 arrives, Mr. DeGoey also recommends paying off the $20,000 credit line “no matter what.” He also advises Ms. Middleton to have a “serious talk with your spouse about lifestyle, now and in the future. Can you maintain it? Do you want to improve it?”

He expects that Ms. Middleton will continue working, at least until the remaining $100,000 arrives. At that point, she has two main options for the $260,000, depending on her risk tolerance.

Many people with no investing experience are unable to handle stock market volatility, so this needs to be taken into consideration when deciding what to do with the money. A good financial planner or adviser can assess a person’s risk tolerance with a questionnaire.

Option #1: Keep the money in cash, GICs and/or a high-interest savings account. While interest will be minimal—five-year GICs are currently yielding 3 percent or less—the portfolio’s value won’t fluctuate.

Even assuming no growth at all, Ms. Middleton could withdraw $13,000 annually and the money would last until she’s 85, although inflation would erode her purchasing power.

Option #2: Invest the money in a conservative, balanced portfolio: 50 percent in bonds and 50 percent in dividend-paying stocks.

“The expected return might be about 7 percent—2 percent inflation and 5 percent growth—over many years and cycles,” he said. “Some years would see double-digit gains; other would see single-digit losses. How would you feel about that?”

While this option would entail more volatility, the added growth should allow Ms. Middleton to maintain her purchasing power.

Mr. DeGoey also recommends that the Middletons begin discussing the option of downsizing to a smaller residence, whether they make the move now or in the future.

“Many people tell me they ‘just know’ when it’s time to move. Others …elect to move when they are healthy and can choose the timing, rather than being forced into something,” he said.

What Ms. Middleton says

“This has been amazing for me, because I’ve learned not to be afraid,” she said. Knowing that she and her husband can depend on government pensions, and can tap the equity in their home if necessary, makes her feel more secure about the future.

She isn’t ready to make any decisions just yet, but no longer feels overwhelmed. Perhaps the biggest benefit of this exercise is that she feels like she can afford to enjoy life, even if it’s just an occasional trip to Florida or treating her grandkids to McDonald’s.

“I feel like they have given me a plan and a road to go on, and we’ll be able to accomplish what we want to do,” she said.

IF YOU INHERIT MONEY:

DO

* Take time to weigh your options. Parking the money in a separate account for six months or longer will help you resist the temptation to fritter the cash away while you decide what to do.

* Interview two or three financial planners or investment advisers. Fee-only planners who don't sell investment products are a good source of unbiased advice

* Pay off non-deductible, high-interest loans such as credit card debts.

DON'T

* Be swayed by the first sales pitch you get. Only by comparing options—the more, the better—can you find the investment solution that's most appropriate for you.

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