Constructed Response Sample Cases 1-8.

Transcription

1 Constructed Response Sample Cases FINANCIAL PLANNING STANDARDS COUNCIL

2 Table of Contents Case 1 2 Solution for Case 1 5 Case 2 10 Solution for Case 2 12 Case 3 15 Solution for Case 3 17 Case 4 20 Solution for Case 4 22 Case 5 27 Solution for Case 5 30 Case 6 35 Solution for Case 6 38 Case 7 43 Solution for Case 7 46 Case 8 50 Solution for Case FINANCIAL PLANNING STANDARDS COUNCIL

3 Case 1 Todd and Nadine Pension Decisions James, a CFP professional, is meeting with Todd and Nadine Paulson, both 58 years of age. Both spouses have worked for ABC Financial, a federally regulated financial institution, for many years. Although Nadine has no plans to retire before age 65, Todd, who suffered a massive heart attack six months ago, is retiring at the end of this year, at age 59. Todd has been presented with the following fully indexed RPP income options: Option 1 $1,960 per month with 60% survivor pension Option 2 $1,890 per month with 75% survivor pension Option 3 $1,820 per month with 100% survivor pension Option 4 Commuted value of $395,000 (CRA maximum transfer value of $257,000) If Todd chooses one of the first three options, he is also eligible to receive a bridge benefit of $798 per month until age 65. With his recent health problems, Todd has thought about estate planning issues and wants to maximize any benefits paid to Nadine should he predecease her. Service Canada has confirmed that Todd will be eligible for a CPP retirement benefit of $880 per month at 65 (Nadine qualifies for the maximum amount) and an OAS benefit of $590 per month. If Todd chooses Option 4, James estimates that Todd would need to withdraw $2,000 (pre-tax) every month from his total available registered investments (RRSP and pension) to meet his retirement income goal. Todd also mentioned he would like the income to last until Nadine turns 90. Todd and Nadine each have basic group life insurance coverage of one times salary, which decreases to $2,000 of coverage on retirement. However, the group health coverage will continue at an unreduced level in retirement provided the monthly pension income option has been chosen. Both Todd and Nadine have concerns about the ongoing viability of ABC Financial. Todd describes himself as a moderate investor and has $125,000 in his RRSP. He has $38,000 in unused RRSP deduction room. To meet their current cash flow needs, Todd will require monthly after-tax income of $2,500. Taxable income up to $39,000 would carry an effective tax rate of 20%, while taxable income between $39,001 and $65,000 would result in an effective tax rate of 31% FINANCIAL PLANNING STANDARDS COUNCIL 2

4 Question 1 List five advantages and five disadvantages of Option 4 for Todd. (5 marks) Advantages of Option 4 for Todd Disadvantages of Option 4 for Todd (0.5 mark each) (0.5 mark each) Question 2 If Todd chooses to receive monthly pension income, identify the most appropriate option for him. Provide two reasons to support your recommendation. (3 marks) Most appropriate pension option (1 mark) Two reasons to support recommendation. (1 mark each) FINANCIAL PLANNING STANDARDS COUNCIL 3

5 Question 3 Assume Todd decides to take the commuted value of his pension. Determine the annual rate of return Todd would have to earn on his total registered investments to meet his retirement income goal. Based on his investor profile, state whether this rate of return is reasonable and provide a rationale to support your answer. Ignore inflation. Show all calculations. (3 marks) Total registered investments (1 mark) Calculations Required rate of return (1 mark) Is this return reasonable? (Yes/No) Rationale (1 mark) N = I = PV = PMT = FV = MODE = BEG 2018 FINANCIAL PLANNING STANDARDS COUNCIL 4

6 Solution for Case 1 Question 1 List five advantages and five disadvantages of Option 4 for Todd. (5 marks) Sample Response Advantages of Option 4 for Todd (0.5 mark each) Indicators 1 to 5 can include the following in any order: It removes uncertainty that ABC Financial may not be able to live up to its future obligations to fund the company pension. The remaining balance would pass to Nadine on a tax-deferred basis on Todd s death. It offers greater flexibility of income stream and the ability to unlock up to 50% of the pension. The unused RRSP deduction room can be funded with the lump sum CV payment. Depending on its investment performance, the CV amount may be able to provide an increased income benefit. Disadvantages of Option 4 for Todd (0.5 mark each) Indicators 6 to 10 can include any 5 of the following: Only a portion of the CV will be paid into a LIRA on a tax-deferred basis ($257,000), so a portion of the balance will be subject to tax at Todd s marginal tax rate. Todd is assuming the full investment risk of his retirement capital. Todd would be giving up full indexation of his pension benefit. Todd would lose his ongoing health benefits. Todd would lose the bridge benefit payment. Todd will pay tax at a higher MTR with this lump sum CV payment. Depending on its investment performance, the CV amount may provide a reduced income benefit. Scoring Table Task # Indicator Marks Competency Identify five advantages and five disadvantages of Option 4 for Todd 1 Identifies first advantage Evaluates 2 Identifies second advantage Identifies third advantage Identifies fourth advantage Identifies fifth advantage Identifies first disadvantage Identifies second disadvantage Identifies third disadvantage Identifies fourth disadvantage 0.5 advantages and disadvantages of each retirement planning strategy 2018 FINANCIAL PLANNING STANDARDS COUNCIL 5

7 Task # Indicator Marks Competency *Complexity: Moderate 10 Identifies fifth disadvantage 0.5 Total Marks 5.0 Rationale Given Todd s age and the fact that he is a moderate investor, it is unlikely that he would invest the commuted lump sum in a way that would provide higher income than he would get from the monthly pension payments. In addition, a portion of the amount above the CRA maximum would have to be taken in cash and would be taxable. Todd s available RRSP deduction room ($38,000) could shelter some of the difference. Todd s life expectancy is likely shorter than average, which means he needs to be concerned about the management of the funds if he dies. His health concerns could be an argument for the monthly pension option, because health benefits disappear if he takes the lump sum. However, because Nadine intends to continue working, her benefit plan would continue to cover the couple. Reference Clark, Coleen. Retirement and Estate Planning in Canada, 2 nd edition. Captus Press, pp Question 2 If Todd chooses to receive monthly pension income, identify the most appropriate option for him. Provide two reasons to support your recommendation. (3 marks) Sample Response Most appropriate pension option (1 mark) Option 3 $1,820 per month with 100% survivor pension. (Indicator 1) Two reasons to support recommendation (1 mark each) This option provides the maximum survivor benefit for Nadine, and given Todd s health, this is a key consideration. (Indicator 2) With the bridge benefit, his RRSP and government benefits, he can meet his income goal with this payment amount. (Indicator 3) 2018 FINANCIAL PLANNING STANDARDS COUNCIL 6

8 Scoring Table Task # Indicator Marks Competency If Todd chooses to receive monthly pension income, identify the most appropriate option for him. Provide two reasons to support your recommendation. 1 Identifies Option 3 as the best option 2 Explains it will maximize survivor income for Nadine 3 Explains he will be able to achieve his income goal with this option and other payments Assesses tradeoffs necessary to meet retirement objectives Assesses the specific needs of beneficiaries assesses financial requirements in retirement *Complexity: Basic Total Marks 3.0 Rationale Given Todd s health, Nadine may receive survivor pension income sooner rather than later. With option 3, the maximum income amount will be payable to her. Reference Clark, Coleen. Retirement and Estate Planning in Canada, 2 nd edition. Captus Press, pp Question 3 Assume Todd decides to take the commuted value of his pension. Determine the annual rate of return Todd would have to earn on his total registered investments to meet his retirement income goal. Based on his investor profile, state whether this rate of return is reasonable and provide a rationale to support your answer. Ignore inflation. Show all calculations. (3 marks) Sample Response Calculations Total registered investments CV eligible to transfer = $257,000 $420,000 (Indicator 1) RRSP = $125,000 Ineligible CV contributed to RRSP = $38,000 = $420, FINANCIAL PLANNING STANDARDS COUNCIL 7

9 Required rate of return Solve for I = = 4.14% annual rate N = 372 months (12 x 31) Solve for I = % 4.14% (Indicator 2) PV = $420,000 PMT = $2,000 FV = 0 MODE = BEG Is this return reasonable? Yes Rationale 4% is a reasonable required rate of return for a moderate investor and should be achievable with an acceptable asset mix suitable for this type of risk tolerance. (Indicator 3) Scoring Table Task # Indicator Marks Competency Determine the annual rate of return Todd would have to earn on his total registered investments to meet his retirement income goal. Based on his investor profile, state whether this rate of return is reasonable and provide a rationale to support your answer. 1 Identifies the amount of registered investments available after transfer 2 Determines the required rate of return to meet income goal 3 States that required rate of return is reasonable and provides supporting rationale Collects details of potential sources of retirement income Develops financial projections based on current position formulates retirement planning strategies Total Marks 3.0 *Complexity: Moderate Rationale If Todd elected to take the commuted value of his pension, only $257,000 would be eligible to be transferred to a registered plan (LIRA or locked-in RRIF). He would be able to shelter a further $38,000 by using part of the ineligible amount to make an RRSP contribution. Therefore, the maximum registered investments that Todd could have available at retirement to withdraw from would be $420,000. This is equal to the $257,000 eligible amount plus the $38,000 RRSP contribution and the $125,000 of existing RRSPs. Starting at age 59, he would have 31 years of required income from his registered investments FINANCIAL PLANNING STANDARDS COUNCIL 8

10 The item stem states that Todd is a moderate investor. Based on this fact, a required rate of return of 4.14% is reasonable since he should be able to earn this return without taking on more risk than he would be comfortable with. General note regarding TVM calculations: There are numerous financial calculators available, and different education providers teach TVM differently, making it difficult to come up with a keystroke template that addresses them all. The templates are provided as a general guide to candidates, but ultimately it is up to the candidate to understand the operation of his or her calculator. In general, in our sample responses we use "I/YR" to denote a nominal annual rate compounded accordingly, and "I" to denote the rate that applies to each individual compounding period. So, for example, a 4% annual return compounded monthly can be expressed either as I/YR = 4%, or I = 4%/12 = %. In this question, candidates were asked to calculate the required annual rate of return, so even though the candidate might first calculate I = , remember that I is the rate that applies to each monthly compounding period. Therefore, the candidate must take it one step further, by multiplying this by 12 to obtain the annual rate of 4.14% compounded monthly. Reference Advocis. CFP Education Program Course 3, Comprehensive Practices in Risk and Retirement Planning. CCH Canadian, p FINANCIAL PLANNING STANDARDS COUNCIL 9

11 Case 2 Steve and Brenda Retirement Planning Melanie, a CFP professional, is meeting with her clients, Steve and Brenda, both aged 48. Steve has held management positions in the oil and gas industry for the past fifteen years, while Brenda has stayed at home with their two children. Brenda and Steve have been careful with their money over the years. They are debt averse and conservative with their investments. Steve contributes regularly to RRSPs, currently investing $7,200 each year. Of that amount, half goes to a plan in Steve s name (FMV $85,000), and half goes to a spousal plan for Brenda (FMV $100,000). Steve has unused RRSP contribution room of $30,000, while Brenda has none. Steve has recently been offered a position with a new company, which he intends to pursue. The offer includes a salary of $150,000 per year, along with an annual performance bonus. The company does not offer a comprehensive benefits package, but is willing to provide and administer an Individual Pension Plan (IPP) for Steve. With his current employer, Steve has accumulated $194,000 in a defined contribution pension plan, which is offered by the employer as part of a group benefits package. The couple tells Melanie that they are concerned about the potential change in Steve s employment. In particular, they would like assurance that they can still meet their retirement goal of Steve retiring at age 63. Their plan states that they need $35,000 (in today s dollars) of annual gross income, in addition to any government benefits at that time. Based on their conservative investor profile, Melanie estimates they will achieve a 3% rate of return for their registered assets FINANCIAL PLANNING STANDARDS COUNCIL 10

12 Question 1 Explain one advantage and one disadvantage of Steve s job offer that Steve and Brenda should consider with respect to their financial plan. (2 marks) Advantage (1 mark) 1. Disadvantage (1 mark) 1. Question 2 As an alternative to taking the job offer, Steve is considering starting a consulting business. Assuming he is able to continue the current contributions to their RRSPs, determine if Steve and Brenda s registered savings will provide adequate income to meet their stated objective. Assume an average annual inflation rate of 2%, and life expectancy to age 90. (3 marks) Calculations: Value of registered assets at retirement (1 mark) Income from registered assets during retirement (1 marks) Annual income required at retirement (1 mark) Shortfall/Surplus N = I = PV = PMT = FV = MODE = END N = I = PV = PMT = FV = MODE = BEG N = I = PV = PMT = FV = MODE = END 2018 FINANCIAL PLANNING STANDARDS COUNCIL 11

13 Solution for Case 2 Question 1 Explain one advantage and one disadvantage of Steve s job offer that Steve and Brenda should consider with respect to their financial plan. (2 marks) Sample Response Advantage (1 mark) Indicator 1 can be any of the following responses: The IPP offers many advantages over the defined contribution plan that Steve is currently participating in. Contribution rates are higher for IPP plans than RRSP limits, allowing Steve to accumulate more assets in the plan before he retires. The IPP offers a defined, guaranteed income level in retirement that the DC plan cannot. Steve s employer needs to make up any funding shortfalls in the IPP, not Steve. The IPP offers the ability to index his retirement income while the DC plan cannot. Disadvantage Steve will not have any benefits with the new company, which significantly increases the family s risk exposure. He will possibly need to replace life insurance, disability insurance, health and dental coverage and other benefits that he currently enjoys. (Indicator 2) Scoring Table Task # Indicator Marks Competency Identify one advantage and one disadvantage to the financial plan with respect to Steve s job offer 1 Identifies one advantage Assesses opportunities and constraints across financial planning components 2 Identifies one disadvantage Assesses opportunities and constraints across financial planning components Total Marks 2.0 *Complexity: Basic Rationale See sample response FINANCIAL PLANNING STANDARDS COUNCIL 12

14 References KPMG. Tax Planning for You and Your Family Toronto: Thomson Carswell, 2009 Advocis. CFP Education Program Course 3. Comprehensive Practices in Risk and Retirement Planning. Toronto: CCH Canadian Limited, Question 2 As an alternative to taking the job offer, Steve is considering starting a consulting business. Assuming he is able to continue the current contributions to their RRSPs, determine if Steve and Brenda s registered savings will provide adequate income to meet their stated objective. Assume an average annual inflation rate of 2%, and life expectancy to age 90. (3 marks) Sample Response Calculations: Value of registered assets at retirement. Income from registered assets during retirement Annual income required at retirement Mode = End PV of retirement assets = $194,000 LIRA + $85,000 Steve s RRSP + $100,000 Brenda s RRSP = $379,000 Value at retirement = $724,380 Value of assets at retirement = $724,380 Income required from age 63 to 90 = 27years Annual income = $38,374 Income needed in today s dollars = $35,000 Income required at retirement = $47,105 Shortfall/Surplus Income required at retirement = $47,105 Income received at retirement = $38,374 Shortfall = $8,731 N = 15 (63-48) I = 3% PV = $379,000 PMT = $7,200 FV = $724,380 MODE = END N = 27 (90-63 I = 3% PV = $724,380 PMT = $38,374 FV = 0 MODE = BEG N = 15 (63-48) I = 2% PV =$35,000 PMT = 0 FV = $47,105 MODE = END 2018 FINANCIAL PLANNING STANDARDS COUNCIL 13

15 Scoring Table Task # Indicator Mark Competency 1 Calculates value of registered assets at retirement. position Determine if Steve and Brenda s registered savings will provide adequate income to meet their stated objective, assuming he starts a consulting business instead of taking the job offer. *Complexity: Moderate 2 Calculates income from registered assets during retirement. 3 Calculates the annual income required at retirement Total Develops financial projections based on current Collects the details of potential sources of retirement income Determines the client s retirement objectives Rationale To compare the incomes received on a specific point of time, you need to adjust the dollar amount to their value on that specific point of time. Regardless of inflation, the portfolio will grow at the rate of 3% per year. On the date of Steve s retirement, Brenda and Steve will own $724,380. From that pool of money, they will be drawing retirement income for 27 years based on the calculation until the age of 90. The portfolio will still grow at the annual rate of 3% regardless of inflation. This means that the amount of retirement income (calculated as an immediate annuity) will be $38,374. $35,000 today, adjusted for inflation of 2%, in 15 years, on the retirement date is $47,105. The shortfall is the difference between $47,105 and $38,374($8,731). This shortfall will increase as the inflation will continue to decrease the value of the retirement dollar every year, yet the payments will remain unchanged. References Advocis. CFP Education Program Course 1, 3rd ed. Financial Planning Fundamentals. Toronto: CCH Canadian Limited, 2006 Ho, Kwok, and Chris Robinson. Personal Financial Planning. 4th ed. Toronto: Captus Press, FINANCIAL PLANNING STANDARDS COUNCIL 14

16 Case 3 Retirement Planning for Edith Edith, age 64, is an administrator in a public sector organization and participates in its defined benefit pension plan (DBPP). Now, at the beginning of the year, she is refining her plans for retirement. She plans to retire in October of the following year when she turns 66. Her pension is indexed, based on the last five-year average earnings (FAE) and integrated with the CPP (1.3% up to the five-year average YMPE and 2% of FAE over the five-year average YMPE). Edith can take her pension later this year when she turns age 65 with 22 years of service, or she can continue contributing for the extra year, adding one year s pension benefits. Regardless of what she chooses, she plans to start her CPP at age 66. She does not really want to examine the implications of working until age 67. While she cannot know when she will die, she wants to plan for 25 years of retirement. She currently has $124,700 in her RRSP and no unused RRSP contribution room. She also has $20,500 in her TFSA to cover additional expenses such as a major trip or a new car. Both her RRSP and TFSA are invested in GICs. Heather, Edith s CFP professional, has estimated that in terms of her registered pension plan (RPP), the breakeven point between taking retirement benefits at age 65 versus age 66 is about 20 years FINANCIAL PLANNING STANDARDS COUNCIL 15

17 Question 1 List six variables or calculations that Heather would have used in her analysis of the breakeven point for Edith s RPP. In addition, for each variable/calculation, state whether it would be an actual or estimated figure. (6 marks) Variables/Calculation Used (0.5 marks each) Actual/Estimate (0.5 marks each) Question 2 List two personal and/or economic considerations that are relevant to Edith s decision whether to take her employer pension at 65 or contribute to 66. Provide a rationale to support each. (2 marks) Consideration (0.5 marks each) 1. Rationale (0.5 marks each) FINANCIAL PLANNING STANDARDS COUNCIL 16

18 Solution for Case 3 Question 1 List six variables or calculations that Heather would have used in her analysis of the breakeven point for Edith s RPP. In addition, for each variable/calculation, state whether it would be an actual or estimated figure. (6 marks) Sample Response Variables/Calculation Used (0.5 mark each) Indicators 1, 3, 5, 7, 9 and 11 can be any six of the following: Five-year average earnings (FAE) at age 65 FAE at age 66 Current and five-year average YMPE for the year she is 65 YMPE and five-year average YMPE for the year she turns 66 Pension contribution formula Pension contributions for the year she is age 65 Marginal tax rate for the year she is age 65 Marginal tax rate in retirement Amount of after-tax incremental income if DBPP taken at age 65 Present Value of after-tax incremental income if DBPP taken at age 66 Discount rate Inflation rate Impact of additional RRSP contributions on marginal tax rate Actual / Estimate (0.5 mark each) Indicators 2, 4, 6, 8, 10 and 12 must pair with the responses in the left column Actual Estimate Actual Estimate Actual Estimate Actual Estimate Actual Estimate Estimate Estimate Estimate Scoring Table Task # Indicator Mark Competency Lists 6 variables/calculations 1 Lists first variable Identifies the that would have been used in information required for the the analysis of the breakeven financial plan point for Edith s RPP. 2 Explains if actual or as above estimate 3 Lists second variable as above 4 Explains if actual or as above estimate 5 Lists third variable as above 6 Explains if actual or as above estimate 7 Lists fourth variable as above 2018 FINANCIAL PLANNING STANDARDS COUNCIL 17

19 Task # Indicator Mark Competency 8 Explains if actual or as above estimate 9 Lists fifth variable as above 10 Explains if actual or as above estimate 11 Lists sixth variable as above 12 Explains if actual or estimate as above Total 6.0 *Complexity: Moderate Rationale See sample response. References Clark, Coleen. Retirement and Estate Planning in Canada, 2nd edition. Captus Press, p125, 168. Question 2 List two personal and/or economic considerations that are relevant to Edith s decision whether to take her employer pension at 65 or contribute to 66. Provide a rationale to support each. (2 marks) Sample Response Consideration (0.5 mark each) Indicator 1 and Indicator 3 can be any two of the following: Investment risk RRSP contribution room Economic condition/ pension stability Her health/life Expectancy Rationale (0.5 mark each) Indicator 2 and Indicator 4 must correspond to the responses given for Indictor 1 and Indicator 3, respectively If she takes the extra income and invests it, she will have to make or sign off on investment decisions. Her RRSP and TFSA are invested in GICs indicating she is risk averse. If she waits and gets a higher pension, she leaves the investment risk with her employer. In addition, the plan is administered by a large DBPP which has investment experts in its employ. If she takes her pension at age 65 but continues to work to 66, she will be earning RRSP contribution room. The tax deduction will help offset some of the additional tax she would have to pay on the incremental pension income. While it is unlikely her pension would default, the possibility exists that there could be adjustments down the road; the most likely is that it would no longer be indexed. There is also a possibility that payments could be reduced. This would argue for Edith to take her pension at age 65. Depending on her health/life expectancy, she may want to take her pension as soon as possible to maximize the potential benefit years FINANCIAL PLANNING STANDARDS COUNCIL 18

20 Scoring Table Task # Indicator Mark Competency List two personal and/or 1 Lists first consideration Considers the impact of economic considerations that economic, political and are relevant to Edith s decision regulatory environments whether to take her employer 2 Provides rationale as above pension at 65 or contribute to 3 Lists second as above consideration. 66. Provide a rationale to support each. 4 Provides rationale as above Total 2.0 *Complexity: Basic Rationale While the decision to take the employer pension at 65 may produce a better mathematical result, there are many other factors that should be taken into consideration. Many people assume they should take their RPP and CPP at age 65 without looking at the option of postponing it and receiving a larger annual income. While the numbers on the RPP may suggest taking it at age 65, the pensioner is then faced with decisions about investing the extra income either inside an RRSP or in nonregistered investments. The investment expertise and economies of scale provided by a large DBPP should not be ignored. With the retirement funds in the DBPP and not in Edith s personal investment account, her employer has to manage the investment risk. If Edith was managing the funds, she would likely not take any risk, thereby decreasing her overall retirement income. The world economic situation is also relevant at this time and has to be taken into consideration. Canada is likely fine and her pension, being managed by a large DBPP replete with expertise is likely stable, but may face adjustments down the road. This risk needs to be acknowledged. References Clark, Coleen. Retirement and Estate Planning in Canada, 2nd edition. Captus Press, p125, FINANCIAL PLANNING STANDARDS COUNCIL 19

21 Case 4 Stephanie s Estate Plan Stephanie, age 50, has come to see Bill, a CFP professional, to ask for advice regarding her estate planning. Stephanie is a widow and mother of one child, Emily, age 30. Emily, a single mother of one daughter, is financially independent and lives in a rental apartment. Stephanie has just found out that she has terminal cancer, with an estimated life expectancy of one year, and is thinking about how she can effectively pass on all her assets to Emily. Currently, all of her assets will go to her estate and will be distributed to Emily as stated in her will. Her assets have the following fair market values: House: $800,000 (ACB = $250,000) Cottage: $900,000 (ACB = $300,000) RRSP: $250,000 (ACB = $300,000) TFSA: $25,000 (ACB = $20,000) Non-registered stock portfolio: $300,000 (ACB = $125,000) She has owned both the house and cottage for 20 years, since she inherited them on her mother s death. She hopes that Emily will keep both properties in the family. She also has a term life insurance policy for $500,000 with her estate as the named beneficiary, to help pay for final expenses in settling the estate. The remaining term of the policy is five years. She lives in a province where probate fees are high, and would like to take any costeffective steps possible to minimize probate and taxes upon her death FINANCIAL PLANNING STANDARDS COUNCIL 20

22 Question 1 Assuming Stephanie were to die today, calculate the minimum amount that would be added to her taxable income to reflect the deemed disposition of her assets. Show your calculations and/or provide a brief comment to support the value of your income inclusion. (7 marks) Asset Addition to Taxable Income Calculation/Comment House (2 marks) Cottage (1 mark) RRSP (1 mark) TFSA (1 mark) Non-registered Portfolio (1 mark) Life Insurance Policy (1 mark) Total Question 2 For each of the assets listed below, show the current value that is subject to probate, assuming that Stephanie dies today. If possible, identify one cost-effective strategy that Bill should recommend for each asset in order to minimize Stephanie s exposure to probate fees while still ensuring the assets will transfer as she wishes. She also wants to ensure that no strategy she employs adds additional current income. If there is no cost-effective strategy that accomplishes both these goals, state not applicable. (6 marks) Asset House Cottage RRSP TFSA Non- registered Portfolio Life Insurance Policy Total Value Currently Subject to Probate (0.5 mark each) Strategy to Minimize Probate/Taxes (0.5 mark each) 2018 FINANCIAL PLANNING STANDARDS COUNCIL 21

23 Solution for Case 4 Question 1 Assuming Stephanie were to die today, calculate the minimum amount that would be added to her taxable income to reflect the deemed disposition of her assets. Show your calculation and/or provide a brief comment to support the value of your income inclusion. (7 marks) Sample Response Asset Addition to Taxable Income Calculation/Comment House (2 marks) $247,500 [( ) ((1+1)/20 x 550)] x 50% - reduced by (1+1)/20 for remainder of PR exemption (Indicators 1 and 2) Cottage (1 mark) nil Designate as principal residence since CG/year of ownership is higher than that of the house. Designate 19 years of ownership. (Indicator 3) RRSP (1 mark) $250,000 Full amount is taxable upon death. (Indicator 4) TFSA (1 mark) nil The FMV of the TFSA at the time of death is not taxable. (Indicator 5) Non-registered Portfolio (1 mark) $87,500 (300, ,000) x 50% (Indicator 6) Life Insurance Policy (1 mark) nil Life insurance proceeds are not taxable. (Indicator 7) Total $585, FINANCIAL PLANNING STANDARDS COUNCIL 22

24 Scoring Table Task # Indicator Mark Competency Assuming Stephanie were to 1 Calculate the taxable die today, calculate the capital gain on the house minimum amount that would death be added to her taxable 2 Reduce the CG on the house for remainder of income to reflect the deemed PR exemption. disposition of her assets. *Complexity: Moderate Rationale 3 Identify that the cottage should be designated as the principal residence to minimize taxable income. 4 Identify that the full amount of the RRSP is included in taxable income. 5 Identify the tax treatment of the TFSA on death. 6 Calculate the taxable capital gain on the nonregistered portfolio 7 Identify that life insurance proceeds are not taxable Total Calculates potential expenses and taxes owing at Optimizes strategies to make tax planning recommendations Optimizes strategies to make tax planning recommendations Calculates potential expenses and taxes owing at death Calculates potential expenses and taxes owing at death Calculates potential expenses and taxes owing at death Identifies taxable nature of assets and liabilities This question requires the candidate to calculate/identify the amount that will be included in taxable income on the deemed disposition of these assets on death. For the house and cottage, only one property can be fully exempted from tax through the principal exemption rules. At the time of deemed disposition, the executor has to choose the property to designate as principal residence for 19 years of ownership. This will fully exempt that property from tax. In order to minimize taxes, the property which has the greatest capital gain per year of ownership should be designated as principal residence first. In this case, both properties were owned for 20 years, so the cottage, which is the property with the higher overall capital gain (900K 300K = CG = 600K), should be designated as principal residence for 19 years of ownership. Due to the plus 1 rule, the cottage only has to be designated as the principal residence for 19 years in order to fully exempt the property. [(19+1)/20 x 600 = CG exemption of 600K]. Candidates should also be able to identify the fact that the house can be designated as the principal residence for 1 year, resulting in a partial exemption, calculated as (1+1)/20 x 550K. The tax implications associated with the remaining assets are as follows: RRSPs when RRSPs are transferred to a non-spouse beneficiary, the full fair market value (250K) is subject to tax on deemed disposition. Currently her estate is the beneficiary of the RRSP. TFSAs when a TFSA is transferred to a non-spouse beneficiary, the fair market value of the TFSA at the time of death is not taxable. However, any growth that takes place after death and before the asset is distributed is taxed in the hands of the beneficiary. Currently her estate is the beneficiary of the TFSA FINANCIAL PLANNING STANDARDS COUNCIL 23

25 Non-registered portfolio the unrealized gains/losses in the portfolio are taxable. In this case, the taxable capital gain is (300K 125K) x 50% = 87,500. Life insurance Proceeds of life insurance are not taxable. References Clark, Coleen. Retirement and Estate Planning in Canada, 2nd edition. Captus Press, p125, 168. Van Cauwenberghe, Christine. Wealth Planning Strategies for Canadians Carswell. Ch. 15, Vacation Properties. Question 2 For each of the assets listed below, show the current value that is subject to probate, assuming that Stephanie dies today. If possible, identify one cost-effective strategy that Bill should recommend for each asset in order to minimize Stephanie s exposure to probate fees while still ensuring the assets will transfer as she wishes. She also wants to ensure that no strategy she employs adds additional current income. If there is no cost-effective strategy that accomplishes both these goals, state not applicable or n/a. (6 marks) Sample Response Asset Value Currently Subject to Probate (0.5 mark each) Strategy to Minimize Probate/Taxes (0.5 mark each) House $800,000 (Ind 1) N/A (Ind 2) Cottage $900,000 (Ind 3) Gift the cottage to Emily today or transfer it into joint ownership. Although there will be a deemed disposition at FMV, there are no tax implications because the cottage is protected by the principal residence exemption. (Ind 4) RRSP $250,000 (Ind 5) Name Emily as designated beneficiary of RRSP. (Ind 6) TFSA $25,000 (Ind 7) Name Emily as designated beneficiary of TFSA. (Ind 8) Non- registered $300,000 (Ind 9) N/A (Ind 10) Portfolio Life Insurance Policy $500,000 (Ind 11) Name Emily as designated beneficiary of life insurance policy. (Ind 12) Total $2,775, FINANCIAL PLANNING STANDARDS COUNCIL 24

26 Scoring Table Task # Indicator Mark Competency show the current value that is 1 Identifies probate value Calculates potential subject to probate, assuming for house expenses and taxes owing at that Stephanie dies today. If death possible, identify one costeffective strategy that Bill 2 Indicates no strategy Develops estate planning strategies 3 Identifies probate value of as above should recommend for each cottage asset in order to minimize 4 Identifies reduction as above Stephanie s exposure to strategy probate fees while still 5 Identifies probate value of as above ensuring the assets will RRSP transfer as she wishes. 6 Identifies reduction as above strategy 7 Identifies probate value of as above TFSA 8 Identifies reduction as above strategy 9 Identifies probate value of as above non-reg portfolio 10 Identifies reduction as above strategy 11 Identifies probate value of as above life insurance 12 Identifies reduction strategy as above Total 6.0 *Complexity: Moderate Rationale The first component of this question requires candidates to identify the current values that will be subject to probate. With all assets, including life insurance, going to the estate, the full FMV of the assets will be subject to probate in all cases. The second component requires candidates to recommend strategies for transferring assets to Emily, given Stephanie s three goals: to minimize probate, to avoid immediate tax implications, and to carry out any actions in a cost-effective manner. House: Because the cottage should be designated as principal residence, there is no strategy that will not trigger tax implications today. Registering in joint tenancy with Emily or gifting to Emily today would have tax implications on the deemed disposition at FMV of 50% or 100% of the property respectively. Selling the property to Emily today and taking back a promissory note would still result in at least 20% of the gain being brought into Stephanie s income in the year of the sale. Transfer to an inter vivos trust will avoid probate, but tax on the deemed disposition will still apply FINANCIAL PLANNING STANDARDS COUNCIL 25

27 Cottage: Gifting the cottage to Emily today or transferring it into joint ownership with her eliminates probate fees without any immediate tax cost, since the cottage should be designated as the principal residence. Selling the property to Emily and taking back a promissory note achieves the goal of eliminating probate without immediate tax cost. Similarly, transferring the cottage to an inter vivos trust avoids probate without immediate tax cost because of the principal residence exemption. However, because of the complexity of these solutions, additional cost would be involved in implementing them. Because Stephanie is looking for a cost-effective strategy, these solutions would not be acceptable. Non-registered Portfolio: If Stephanie transfers legal ownership of the funds to Emily today, there will be an immediate tax implication, but probate will be eliminated. On the other hand, she could transfer beneficial ownership only, which would eliminate tax on the transfer, but would not eliminate probate. A transfer to a trust or sale of assets today will also trigger tax implications. RRSP: If Emily is the designated beneficiary, probate will not apply. However, the fair market value of the RRSP at the time of Stephanie s death will be included on her final tax return. TFSA: If Emily is the designated beneficiary, probate will not apply. Life Insurance Policy: Probate on the life insurance policy can be avoided by naming Emily as the designated beneficiary. Life insurance proceeds are tax-free. References Clark, Coleen. Retirement and Estate Planning in Canada, 2nd edition. Captus Press, p125, FINANCIAL PLANNING STANDARDS COUNCIL 26

28 Case 5 Life insurance for Kaley and Mark Kaley, age 40, is a senior manager for a design company. She and her husband, Ted, age 38, are meeting with Mark, a CFP professional, for a review of their financial situation. Ted is a full-time homemaker who cares for the couple s two young daughters, ages 3 and 5, and his 13-year-old son from a previous relationship. Mark asked Kaley and Ted to complete a cash flow statement, on which they indicated their monthly expenses as follows: $2,500 housing expenses, $900 utilities and insurance, $2,000 food and clothing, $500 entertainment and $1,500 miscellaneous. They are on track to pay off their mortgage in nine years. Kaley has an annual income of $150,000. Ted s only income is $1,200 he receives monthly for child support from his ex-spouse. Kaley s average tax rate is 38%. Ted s average tax rate is 10%. Mark has determined that Kaley would need $1.5 million in life insurance to have enough capital to discharge their mortgage ($300,000), to pay for all three of their children s education ($100,000 each) and to support Ted and the children to age 23 ($900,000) in the event of her death. Kaley has group life insurance through her employer of two times salary. Mark has researched coverage options and has the following data available for Kaley, who is insurable at standard risk. Coverage Annual Cost per $1,000 New term 10 policy $0.75 (renewable at $1.65) New term 20 policy $0.98 (renewable at $2.45) New term 65 policy $1.44 New whole life participating policy $1.95 New AD & D policy $0.35 In addition to their insurance needs, Kaley would like to discuss saving for retirement. She plans on retiring at age 60. When asked about current assets for this purpose, she mentions that other than her employer pension, they haven t started saving. She tells Mark that after expenses every month it seems there is very little left for saving FINANCIAL PLANNING STANDARDS COUNCIL 27

29 Question 1 Assess Kaley s coverage options and propose a strategy that ensures sufficient coverage until her retirement, at the lowest overall cost. Calculate the annual premium that would result from the proposed strategy in the first year. Provide an explanation to support the proposed strategy, including your choice of policy types and amounts. (4.5 marks) Policy Type (0.5 mark each) Amount of Coverage (0.5 mark each) Annual Cost First Year Total Cost (0.5 mark) Explanation: Choice of Policy Types and Amounts (2 marks) 2018 FINANCIAL PLANNING STANDARDS COUNCIL 28

30 Question 2 Part A Complete a monthly cash flow statement for Kaley and Ted showing their monthly surplus/deficit. Show all calculations. Part B Considering the outcome of the cash flow statement, briefly explain the main concern that needs to be addressed before they can begin a savings plan for retirement. (3 marks) Part A Income Source Net Monthly Amount (1 mark) Total Net Income Expense Monthly Amount Total Expenses (1 mark) Monthly Cash Flow Surplus/(Deficit) Part B Concern to be Addressed (1 mark) 2018 FINANCIAL PLANNING STANDARDS COUNCIL 29

31 Solution for Case 5 Question 1 Assess Kaley s coverage options and propose a strategy that ensures sufficient coverage until her retirement, at the lowest overall cost. Calculate the annual premium that would result from the proposed strategy in the first year. Provide an explanation to support the proposed strategy, including your choice of policy types and amounts. (4.5 marks) Sample Response Policy Type (0.5 marks each) Amount of Coverage (0.5 marks each) Annual Cost New Term 10 policy (Ind 1) $400,000 (Ind 2) (400 x $0.75) = $300 New Term 20 policy (Ind 3) $800,000 (Ind 4) (800 x $0.98) = $784 First Year Total Cost (0.5 mark) $1084 (Ind 5) Explanation: Choice of Policy Types and Amounts (2 marks) Kaley requires total coverage of 1.5 million dollars and has group coverage of $300,000, leaving her coverage needed at $1.2 million dollars. (Ind 6) After ten years the mortgage will be discharged and the oldest son will be age 23, eliminating the need to cover his education; meaning that $400,000 of the coverage ($300k mtg + $100k education funding) is most cost effectively covered by the ten-year policy. The remaining $800k ($1.5 million - $300k group - $400k term 10) is best covered by a T20 policy to ensure coverage for a suitable time period. (Ind 7) 2018 FINANCIAL PLANNING STANDARDS COUNCIL 30

32 Scoring Table Task # Indicator Mark Competency Proposes strategy that provides sufficient coverage with the lowest total cost. Provides an explanation to support the strategy including choice of policy types and amounts. 1 Identifies term 10 option for portion of strategy 2 Identifies correct amount of $400,000 for term 10 3 Identifies term 20 option for portion of strategy 4 Identifies correct amount of $800,000 for term 20 5 Calculates first years premium of $1,084 6 Explanation supporting the total amount required as $1.2 million 7 Explanation supporting the justification of using the correct mix of term 10 and 20 policies Considers potential risk management strategies Considers potential risk management strategies Considers potential risk management strategies Considers potential risk management strategies Considers potential risk management strategies Evaluates advantages and disadvantages of each risk management strategy Evaluates advantages and disadvantages of each risk management strategy Total 4.5 *complexity: high Rationale Term 65 coverage exceeds the stated goals and is more expensive than term 10 or term 20 so it not a suitable answer. Whole life is not acceptable because it also exceeds her time requirements, and adds cost. It does provide an investment component that some may feel applies to the savings issues, but the question is looking for risk management solutions, not retirement solutions. AD & D coverage is inexpensive, but only applies in the case of accidental death and is therefore unsuitable for basic risk management needs. We are then left with two term policies and from the stem it is clear that the time frame for these insurable needs can fall into two distinct categories. One child s education needs and the mortgage will expire within 10 years, making $400,000 most cost effectively covered via the term 10 insurance. Due to the general nature of some of the numbers, we would be prepared to accept no lower than $400,000 in Term 10 coverage, but up to $600,000 would be accepted as correct based on an argument that survivor costs would also be lower after 10 years for Ted and the girls. This should be mentioned in the explanation to get the marks. With $400,000 (or possibly up to $600,000) being accounted for via term 10, the remaining need of $800,000 is best covered using the term 20 policy FINANCIAL PLANNING STANDARDS COUNCIL 31

33 Markers note: In order to ensure fairness in marking, it is important to mark each element individually and not allow for compounding of errors. Indicators 1 and 3 are simply recognizing that term 10 and term 20 should be used. Indicators 2 and 4 correspond with the correct amounts for each of these policies. So if a candidate recommends that term 10 should be used for $300,000 and term 20 for the rest, indicators 1 and 3 would be correct for getting the appropriate policies and 2 and 4 would be wrong because the amounts for both are outside the acceptable parameters. Indicator 5 is based on correctly calculating the premium; this is based on whatever policies are suggested. Therefore, it is possible for the candidate to get 1 through 4 incorrect but still get indicator 5 correct. Indicator 6 is for an EXPLANATION surrounding the policy amount so regardless of the types of policies as long as the explanation supports why $1.2 million of coverage is required (basically it is the need minus existing coverage), then this mark is earned. Indicator 7 is for the EXPLANATION of the types of policies. This is independent of the amounts, so if in the candidate s explanation they are explaining why a mix (of any amount) of term 10 and 20 are appropriate, this mark is gained. The reason that 6 and 7 are marked independently is because they are already being weighted in the earlier part of the question for getting the amounts/types in the correct ratio. So for example if a candidate suggests $300,000 to a term 10 and $900,000 to the whole life they would get the mark for Indicator 1 because they were correct in suggesting a portion of term 10. They would not get indicator 2 correct because the amount is incorrect. Indicator 3 and 4 would be incorrect because it is both the incorrect type and amount. If they calculated the correct premium based on their policy suggestions, then they could earn Indicator 5. Indicator 6 would be correct if they explain why they came up with $1.2 million in coverage, even though using the wrong mix of policies (being penalized for this with indicator 3 and 7). They will not be able to provide a correct explanation for Indicator 7 however, because it is using term 10 and whole life. If the example was different and they did suggest term 10 and 20, however gave the wrong total amount (say $500,000 term 10 and $1 million term 20), they would lose the mark for Indicator 6 because they cannot get a correct explanation for the incorrect total. However, they would get the mark for Indicator 7 because this is the correct mix of policies. References CCH/Advocis course 3, Comprehensive Practices in Risk Management and Retirement Planning, 4 th ed. module FINANCIAL PLANNING STANDARDS COUNCIL 32

34 Question 2 Part A Complete a monthly cash flow statement for Kaley and Ted showing their monthly surplus/deficit. Show all calculations. Part B Considering the outcome of the cash flow statement, briefly explain the main concern that needs to be addressed before they can begin a savings plan for retirement. (3 marks) Sample Response Part A Income Source Net Monthly Amount (1 mark) Kaley Income $150,000 x (1-.38) = $93,000/12 = $7,750 (Ind 1) Ted Child support $1,200 (Ind 2) Total Net Income $8,950 Expense Monthly Amount Housing $2,500 Utilities and Insurance $900 Food and Clothing $2,000 Entertainment $500 Misc. $1,500 Total Expenses (1 mark) ($7,400) (Ind 3) Monthly Cash Flow Surplus/(Deficit) $1,550 surplus Part B Concern to Be Addressed (1 mark) There is a disconnect between the reported cash flow and their actual cash flow. According to the expenses they have provided they should have over $1,500 available for savings however as stated in the scenario they have not started saving as they have little cash flow remaining at the end of the month. This disparity needs to be investigated before any further analysis can be completed on how much is needed to save. (Ind 4) 2018 FINANCIAL PLANNING STANDARDS COUNCIL 33