Financial Planning Case Study: Advice for Lee Parker

Employment Information

Case Study

You are an independent financial planner working in Ontario. It is April 2020 and you just finished your meeting with Mr. Lee Parker and, after reviewing all of your notes, compiled the following summary:

Employment Information

Lee works as an operations manager at a manufacturing plant which makes plumbing supplies. His income was $71,000 in the 2019 tax year and he is expected his income to remain the same for the next three years due to the Covid economic downturn. Based on his most recent tax return he has the following deductions:  CPP/EI $3,754; Federal tax $9,142, Provincial Tax $4,521. Lee expects his average income to remain the same for the next 3 years, then it will increase at 2% p.a. for the following 5 years until he retires at age 68. He receives an income tax refund of $800 every year. He has to pay an annual fee for his union membership which costs $1,420.  His employer deducts this amount automatically from his pay slip for him.  

Personal Expenses

Lee’s mortgage payments are $1,500 per month, property taxes are $400 per month.  Keeping up a home is quite costly.  Other expenses for the house include utilities such as gas, hydro, water of $220 a month; property insurance costs $240 a year, and lastly property maintenance is $40 a month.  

Car expenses (which include gas, oil, licenses etc.) average $300 per month.  On top of that car insurance costs $120 a month.  

Lee loves to watch and gamble on sports.  He follows baseball in the summer and watches football in the winter.  He gambles $100 a month on this hobby but says he wins back about $500 each year.  He needs to buy a cable TV channel to watch the sports, which comes with an internet connection.  This communication bundle costs him $140 a month.  He also likes to head away on annual fishing trips with his friends which costs $2,400.

Other regular expenses include groceries of $300 a month and going to bars which is $180 a month.  

It appears that Lee does not have a budgeting system in place to manage his expenses.  He doesn’t really know where his money goes but seems to have about $80 a month which he spends on other items. 

Investments

During his divorce, Lee kept his house but has paid a considerable amount of his savings to his ex-spouse in order to do so.  He has $1,350 in his bank account and has $250,055 in his Registered Retirement Savings Account (RRSP account). Lee’s Notice of Assessment from CRA indicates that he has $85,000 of unused RRSP contribution room.  All of the money in his RRSP account is invested in GICs because Lee does not really understand stocks.  He also has a Tax Free Savings Account (TFSA) with a current value of $15,012 which he wants to use on a 6 month trip to Alaska when he turns 68. The funds are invested in an the TFSA paying 1.2% p.a. with interested compounded monthly. He deposits $100 per month to his TFSA with an automatic withdrawal at the bank.  

Personal Expenses

Although Lee has indicated that he doesn’t mind a risky investment, when it comes to his investments, his lack of understand drives what he does with his money. Having never sought investment advice before, he holds only holds low risk fixed income products (GICs and Interest paying bank accounts).  A properly diversified investment portfolio for Lee’s investor profile will earn 6% per annum.

Lee inherited a corporate bond from his mother last week. The bond has a face value of $30,000, with a 4% coupon rate paid twice a year until 2028. Lee’s friend told him to sell the bond because he might get a good price for it. The yield on similar bonds in the market is 1.5%. Lee has come to you for advice as he wants to know if he should sell the bond or hold it. Lee also wants to know if he has to pay tax on the inheritance.

Other Assets

Lee’s house (Principal Residence) is currently valued at $1,000,000 (purchased for $300,000 20 years ago). 

His car is a pickup truck and is only worth $3,000.  He is considering replacing it with a new one costing $27,000.  He could get a good deal from his dealership. They would allow a $3,000 down payment, then charge 4.99% APR compounded monthly and with monthly payments for a 4-year term.  He is wondering if taking on a new debt is feasible since he always feels like his money just disappears. 

Debts 

There is an outstanding mortgage on Lee’s house of $85,500. The mortgage has 5 years remaining and was just renewed for a 5-year term at 2% fixed rate. The monthly mortgage payments are $1,500 per month and are expected to stay the same for the remainder of the mortgage.

Lee owes $4,000 on his Visa and he makes the minimum payments every month ($80 per month). The interest rate on the Visa card debt is 13.25%.

He took out a line of credit to do a backyard renovation.  He has gotten really into The American Barbecue showdown on TV and wants to recreate their smoked BBQ dishes.  So, he is building a BBQ deck to have a cooking and eating place for him and his guests.  The balance owing on the line of credit is $12,000.  He makes monthly payments of $250.  The interest rate is 2.99% p.a.

Tax Information

The following tax information applies to Lee:
Average Tax Rate:    25% 
Marginal Tax Rate:    29%

Investments

Insurance

Lee’s employer provides him with extended health care insurance.  He has no life insurance or disability insurance.

Retirement Planning

As indicated above, Lee has $250,055 in his RRSP, and is currently contributing $300 to this account each month. He informs you that his goal is to retire in 8 years (at age 68), with no debts.  Lee realizes that he has not contributed much to his RRSP, but he will make amends to this in the next eight years.  He also informs you that another goal is to have about 70% of his current income in his retirement years to maintain a good standard of living.

Once he retires, Lee will require $50,000 per year - before taxes and indexed for inflation of 1.5%, for 15 years in retirement in order to maintain his current lifestyle. During retirement, Lee anticipates that he can earn an annual rate of return of 4% on his investments, compounded annually, and that he will incur a 29% marginal tax rate.

Estate Planning

Lee does not have a Will or any Power of Attorneys. Lee understands the purpose of each of these documents, but he does not know which of his children he should nominate.

Family Matters

Lee’s parents, are both deceased and his mother passed away recently.  After Lee had settled his parents estate, the only asset left for Lee to inherit was the bond mentioned above.  

Lee’s children are both living independently.  Lee’s daughter, Fiona, is in a stable job situation as she has been working as a baker at the local supermarket.  Lee’s son Simon is in a less stable job situation, as he started his own business 2 years ago. His business sells pickles and preserved meat at local markets.  During the covid close down, Simon’s business is facing hard times and he may have to declare bankruptcy soon.  

Lee is also seeing a girlfriend.  They live separately at the moment, but have start talking about moving in together.  Lee is worried that if she moves in with him, then she could be entitled to half of the house should they separate, or should he pass away.  Lee ideally wants his family home to be shared by his two children.  

Assumptions

•    Lee is in good health and is expected to live until age 82.
•    The rate of return on investments to be 6% (pre-tax).
•    Inflation is 1.5%
•    Retirement income will be paid annually from the RRSP account at the beginning of each year, starting when he retires at age 68.
•    Lee plans to live in his current home through retirement.
•    Lee will not commence CPP payments until age 68. 
•    Lee’s entitlement to Old Age Security payments will commence when he reaches age 68. He will be entitled to the maximum amount.

REQUIRED: 

a)    Identify Lee’s goals.  (5 marks)
b)    Create a cash flow statement for Lee. (15 marks)
c)    Create a net worth statement for Lee. (10 marks)
d)    Calculate the following ratios and explain them to Lee.  The ratios are:
a.    Liquidity Ratio 
b.    Asset-to-Debt Ratio 
c.    Investment Asset-to-Total Assets 
d.    Debt Payments-to-Net Revenue Ratio (20 marks)
e)    If Lee does buy the new truck and takes on the loan offered, how will this impact his debt payments to net revenue ratio?  Explain whether he should take the loan or not? (10 marks)
f)    Explain two reasons for and two reasons against Lee using an investment loan to save for his retirement.  Would you advise him to use one? (10 Marks)
g)    Provide an overview to Lee of the implications of his girlfriend moving in with him under common law (10 marks)
h)    How much will Lee have in his TFSA at age 68? (5 marks)
i)    Provide 3 financial planning suggestions not mentioned already that you think are important or Lee based on the information presented in the case.  (15 marks) Total: 100 Marks.