FPSC Level 1 Examination in Financial Planning - Please note that the dates cited in this case study are based on the assumption that we are in June

FPSC Level 1 Examination in Financial Planning - Please note that the dates cited in this case study are based on the assumption that we are in June 2011.

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Lifestyle Transitions Marian Turner, age 72, recently met with Carolyn Donaldson, a CFP professional, for financial planning advice at the recommendation of her only child, Frank. Frank has been working with Carolyn for the past year. Marian was widowed two years ago and subsequently suffered a stroke, which has confined her to a wheelchair. Up until her recent stroke, Marian lived in her home and spent the winter months at her condominium in the southern United States, but is now unable to travel. With support of a report from her doctor, a disability certificate for Marian has been filed with CRA. Since leaving the hospital in January of this year, Marian has been living in a retirement home temporarily and Frank and his wife Eileen want her to move in with them. Although Marian values her independence, she realizes that the retirement home would be an expensive option, and Frank and Eileen would likely appreciate her contribution towards their household expenses. If Marian takes them up on their offer, she would require part-time attendant care costing $1,000 per month. Frank and Eileen s home would have to be renovated to provide wheelchair access, at an estimated cost of $50,000. Marian would provide the funds for the renovation, and would also like to help Frank and Eileen out financially, in the most tax-effective way possible. PERSONAL INFORMATION Client Age Month of Birth Occupation Marian Turner 72 January Retiree Frank Turner 43 March Writer Eileen Turner 50 February Photographer Darlene Turner 14 May Student Sheldon Turner 12 February Student Frank and Eileen have not been able to accumulate much in the way of savings. Each is self-employed: Frank earns an income of $50,000 per year, and Eileen earns $40,000. Their debts include a $150,000 mortgage on their home, and a $40,000 balance on their line of credit that carries a current interest rate of 5%. Darlene plans to attend university and pursue a law degree. Sheldon is in a special education class for developmentally disabled students. Frank and Eileen have been advised that, although he will likely be able to live somewhat independently in a group home or supervised apartment setting, he will probably be limited in his ability to earn and manage money. Frank and Eileen have not set aside anything for their children s future needs and last year had asked Marian about the possibility of her helping out with Darlene s education expenses. They estimate the cost of a four year undergraduate program will be $60,000.

FINANCIAL POSITION Marian has $15,000 in a money market fund which she is using to help fund the cost of the retirement home. She also has an investment portfolio comprised as follows: Face Amount Security Cost Current FMV Bonds Annual Income $ 24,000 5.6% Provincial bond Jan 2012 $ 24,700 $ 24,600 $ 1,344 17,000 6.0% Government of Canada bond Jan 2012 17,500 17,600 1,020 24,000 6.25% Provincial bond Dec 2012 24,500 25,600 1,500 18,000 5.5% Government of Canada bond Jun 2013 17,800 19,000 990 10,000 5.75% Municipal bond Jun 2014 10,000 10,700 575 Total Bonds $ 94,500 $ 97,500 $ 5,429 No. of Shares Stocks 2,000 Energy Co. $ 43,700 $ 72,100 $ 2,300 3,600 High Tech Co. 65,200 26,200 500 800 Materials Co. 15,600 56,000 1,600 1,200 Industrial Co. 28,900 56,100 800 1,200 Consumer Co. 64,000 54,000 1,200 3,000 Financial Co. 81,300 148,500 4,800 Total Stocks $ 298,700 $ 412,900 $ 11,200 Total $ 393,200 $ 510,400 $ 16,629

Additionally, Marian has a RRIF worth $200,000 invested 50% in a global bond fund and 50% in a Canadian dividend fund. Marian s home is now worth $350,000. In addition to her home, Marian also owns a condominium in the southern United States, currently valued at its ACB of $200,000 CDN. The condominium purchase was financed with a mortgage and the monthly mortgage payments are $680. The cost of utilities, insurance, and condominium fees for her U.S. property is $400 per month. Marian has both her properties listed for sale, and intends to use the proceeds either to fund her retirement home expenses, or to contribute to the renovation of Frank and Eileen s home and fund her on-going expenses, should she decide to move in with them. Marian s income includes CPP and OAS benefits, RRIF withdrawals, and interest and dividend payments from her nonregistered assets. Marian s average tax rate is 18%, and her marginal rate is 31%. Prior to her stroke, her income covered her expenses, and she was not drawing any capital. Since January, however, she has had to draw down on her capital to fund the retirement home expenses. She has been withdrawing funds from her money market fund to cover the increase in monthly costs, but will probably need to sell some investments before long. The monthly fee paid at the beginning of each month for the retirement home is $4,500. Marian is not a knowledgeable investor. Her late husband, Henry, handled all of the investment decisions without her input or involvement. All of Marian s investments are managed by the broker who handled the account while Henry was alive, and no changes in asset allocation have been made since Henry died. Marian would like to have Carolyn take a look at the portfolio to see if it s suitable for her and to recommend any changes. Marian wants her investments to provide a comfortable lifestyle, and would like to be able to provide some financial assistance to Eileen and Frank as well. Marian has no personal health, life or critical illness insurance, or long-term care coverage. She has always covered the cost of any medical expenses herself. Marian s will has not been updated since Henry passed away. The will provides that her assets would be transferred to Henry as primary beneficiary, and lists her son Frank as secondary beneficiary. Although not included in her current will, Marian would like to leave $50,000 to her church, and wants to ensure that Darlene s education costs would be covered. Although she knows that Sheldon will not be pursuing post-secondary education, she wants to provide equally for her two grandchildren. The residue of her estate would pass directly to Frank. Henry and Marian held powers of attorney for property and personal care for each other. Now, Marian would like Frank to help her manage her affairs but is unsure how best to achieve this.

Marian Turner STATEMENT OF NET WORTH at May 31, 2011 ASSETS TOTAL Non-Registered Assets Money Market Fund $ 15,000 Bonds 97,500 Equities 412,900 Total Non-Registered Assets 525,400 Registered Assets RRIF 200,000 Total Registered Assets 200,000 Personal Assets Home 350,000 Personal Effects 60,000 Condominium United States (CDN $) 200,000 Total Personal Assets 610,000 TOTAL ASSETS 1,335,400 LIABILITIES Condominium Mortgage (CDN $) 50,000 TOTAL LIABILITIES 50,000 NET WORTH $ 1,285,400 Note: Assets at market value could have income tax consequences that have not been accounted for in this Statement of Net Worth.

MARIAN TURNER - 2011 CASH FLOW FORECAST (Jan. to Dec.) $/MONTH $/YEAR INCOME (rounded) Investment Portfolio - dividends $ 933 $ 11,200 - interest 452 5,429 RRIF 1,225 14,700 CPP 960 11,520 OAS 524 6,288 Total Gross Income 4,095 49,137 Less Income Tax: Income Tax (327) (3,920) Total Income Tax (327) (3,920) Total Net Income 3,768 45,217 EXPENSES Retirement Home Fees 4,500 54,000 Property Taxes 250 3,000 Utilities 300 3,600 Insurance - General 50 600 Personal 200 2,400 Medical 200 2,400 Entertainment 200 2,400 Donations 100 1,200 Condominium Expenses 400 4,800 Condominium Mortgage 680 8,160 Other/Miscellaneous 200 2,400 Total Expenses 7,080 84,960 NET AVAILABLE FOR SAVINGS (3,312) (39,743) CASH FLOW SURPLUS/(DEFICIT) $ (3,312) $ (39,743)

Questions for Lifestyle Transitions Case Study QUESTION: 1 If Marian moves in with her family, which of the following options would provide the most tax-efficient financial support for Frank and Eileen? Marian: a) pays rent to Frank and Eileen. b) eliminates a portion of Frank and Eileen s debt. c) pays Frank and Eileen a salary for personal care. d) transfers her investment holdings into a joint account with Frank and Eileen. QUESTION: 2 If Marian fully funds a RESP for Darlene, which of the following options would be most appropriate to meet her estate planning objective regarding her grandchildren? a) Bequeath funds to Sheldon in her will. b) Establish an inter vivos family trust with Sheldon as the beneficiary. c) Purchase a life insurance policy with Sheldon as the beneficiary. d) Provide for a testamentary trust with Sheldon as the beneficiary. QUESTION: 3 Which of the following options is the most appropriate and tax-efficient in achieving Marian s charitable bequest? a) Gift the amount from the sale proceeds of her properties. b) Donate equities with accrued gains to her church on her death. c) Purchase a life insurance policy with her church as beneficiary. d) Use her investment portfolio to fund a charitable remainder trust. QUESTION: 4 If Marian sells both properties by year end to receive net proceeds of $450,000 once debt, property taxes and fees are paid, and moves in with Frank and Eileen in January with the anticipated costs, what will be her cash flow position next year? Assume the same values for her bond and equity holdings, RRIF and pension income remain unchanged, the sale proceeds are added to her investment portfolio and her entire investment portfolio earns 4%. 1. annual gross income of $67,137 2. annual gross income of $68,924 3. annual expenses of $22,800 4. annual expenses of $30,960 a) 1 and 3 only b) 1 and 4 only c) 2 and 3 only d) 2 and 4 only

QUESTION: 5 Which combination of the following options would be most tax-efficient in meeting Marian s objective concerning the management of her affairs? 1. Transfer her non-registered assets to a family trust with Frank as trustee. 2. Transfer her non-registered assets to an alter ego trust with Frank as trustee. 3. Gift her non-registered assets to Frank. 4. Name Frank as attorney in an enduring/continuing power of attorney. a) 1 and 3 only b) 1 and 4 only c) 2 and 3 only d) 2 and 4 only QUESTION: 6 Which of the following asset management recommendations is most appropriate for Marian s current investment holdings? a) Sell some of her non-registered equities to purchase a laddered bond portfolio. b) Use her current money market balance to purchase a one year GIC. c) Swap her non-registered bonds for the Canadian dividend units. d) Swap some of her non-registered equities for the global bond fund units. QUESTION: 7 While Marian decides on her living arrangements, which combination of the following options should she implement first? 1. Revise her power of attorney. 2. Gift funds to Frank and Eileen. 3. Rebalance her investment holdings. 4. Open and fund a RESP for Darlene. a) 1 and 2 only b) 1 and 3 only c) 2 and 4 only d) 3 and 4 only

QUESTION: 8 Assume Marian decides to remain in the retirement home and will require a gross annual income of $70,000, indexed at a 2% inflation rate, to age 90. In January, with investment assets of $1,160,400 (including her RRIF) earning 4% annually, what is the maximum lump-sum amount that Marian could afford to give Frank and his family? Assume CPP and OAS income are fully indexed to inflation and annual payments are made each January. a) $139,160 b) $274,739 c) $399,560 d) $500,051

Questions with Solutions and Rationales QUESTION: 1 If Marian moves in with her family, which of the following options would provide the most tax-efficient financial support for Frank and Eileen? Marian: a) pays rent to Frank and Eileen. b) eliminates a portion of Frank and Eileen s debt. c) pays Frank and Eileen a salary for personal care. d) transfers her investment holdings into a joint account with Frank and Eileen. Rationale: a) is incorrect. The rental income would be taxable to Frank and Eileen. b) is correct. This will reduce Frank and Eileen s regular monthly expenses, and save them interest expense with no tax consequences. c) is incorrect. The salary payments would be taxable to Frank and Eileen. d) is incorrect. With this transfer, she would realize taxable capital gains on a portion of her investment holdings. This is not tax efficient. Also, she relies on these investments to provide income to support her living costs. Investments transferred to a joint account would give Frank and Eileen full access to this asset. Element of Competency: 3.101 Develops recommendations to help optimize the client s situation Financial Management Formulates financial management strategies Linked Technical Knowledge: 100. Taxation 102. Employment Income, 104. Property Income, 111. Income Splitting

QUESTION: 2 If Marian fully funds a RESP for Darlene, which of the following options would be most appropriate to meet her estate planning objective regarding her grandchildren? e) Bequeath funds to Sheldon in her will. f) Establish an inter vivos family trust with Sheldon as the beneficiary. g) Purchase a life insurance policy with Sheldon as the beneficiary. h) Provide for a testamentary trust with Sheldon as the beneficiary. Rationale: a) is incorrect. An outright distribution of funds to Sheldon would be inappropriate given his limited ability to handle money. b) is incorrect. Marian is more concerned about equitable treatment on her death. There is no objective to provide current financial support for Sheldon with the use of an inter vivos family trust. c) is incorrect. Given her age and health, the policy would be expensive if she is insurable. She has assets that could fund a $50,000 amount for Sheldon. Also, proceeds should be held in trust for him, and not paid out directly as this policy would do. d) is correct. Marian wants to provide equally for both children. If she has already funded a RESP for Darlene, a testamentary trust for Sheldon would ensure that both grandchildren are treated equally, a future value calculation can be done to ensure equality. Element of Competency: 3.122 - Develops recommendations to help optimize the client s situation Estate Planning Evaluates advantages and disadvantages of each estate planning strategy Linked Technical Knowledge: 500. Law 502. Wills, 505. Personal Property Ownership and Transfer Rules, 508. Trusts; 200. Insurance 201. Life Insurance

QUESTION: 3 Which of the following options is the most appropriate and tax-efficient in achieving Marian s charitable bequest? a) Gift the amount from the sale proceeds of her properties. b) Donate equities with accrued gains to her church on her death. c) Purchase a life insurance policy with her church as beneficiary. d) Use her investment portfolio to fund a charitable remainder trust. Rationale: a) is incorrect. Marian wants to make this donation on her death, not now. b) is correct. The accrued gain is not taxable if these shares are donated to charity. c) is incorrect. Marian has sufficient assets to fund this $50,000 donation, so it is not necessary to purchase a life insurance policy. Also, she is likely uninsurable. No tax deferral on accrued gains is provided with this option. d) is incorrect. She wants to donate only $50,000 to her church, not all of her investment assets. Also, a disposition would result if her investments were transferred to fund a charitable remainder trust, resulting in a current tax liability. Element of Competency: 2.118 Considers potential opportunities and constraints to develop strategies Estate Planning Considers potential estate planning strategies Linked Technical Knowledge: 100. Taxation 106. Capital Gains and Losses 500. Law 508. Trusts 200. Insurance 201. Life Insurance QUESTION: 4 If Marian sells both properties by year end to receive net proceeds of $450,000 once debt, property taxes and fees are paid, and moves in with Frank and Eileen in January with the anticipated costs, what will be her cash flow position next year? Assume the same values for her bond and equity holdings, RRIF and pension income remain unchanged, the sale proceeds are added to her investment portfolio and her entire investment portfolio earns 4%. 1. annual gross income of $67,137 2. annual gross income of $68,924 3. annual expenses of $22,800 4. annual expenses of $30,960 a) 1 and 3 only b) 1 and 4 only c) 2 and 3 only d) 2 and 4 only

Rationale: Her investment capital will consist of $510,400 in equities and bonds plus $450,000 from property sales less $50,000 renovation costs to their home = $910,400. Income Items Annual Amount Investment Income ($910,400 @ 4%) $36,416 RRIF $14,700 CPP $11,520 OAS $6,288 Total $68,924 Cash Flow Expenses Annual Amount Current expenses 84,960 Less Retirement Home fees (54,000) Less Home costs (7,200) Less US property costs (12,960) Sub-total 10,800 Plus Attendant care cost 12,000 Total 22,800 1. is incorrect. This amount is capital of $450,000 at 4% = $18,000 plus $49,137 current income = $67,137. Capital has not been reduced by the $50,000 renovation cost and a 4% return has not been used on her total investment portfolio. 2. is correct. Investment income is based on capital of $510,400 plus $400,000 ($450,000 proceeds less $50,000 renovation costs) = $910,400 at 4% = $36,416 plus pension income (RRIF, CPP and OAS) of $32,508 = $68,924. 3. is correct. As detailed above, retirement home expenses and property expenses are removed to yield annual costs of $10,800 plus attendant care cost of $12,000 = $22,800 annual expenses for next year. 4. is incorrect. This amount is her current expense total of $84,960 less retirement home fees of $54,000 = $30,960. Property expenses are still included and attendant costs are ignored. Element of Competency: 2.201 Assesses information to develop strategies Financial Management Assesses the impact of potential changes in income and expenses Linked Technical Knowledge: 600. Financial Analysis 601. Analysis of Financial Information, 603. Budgeting

QUESTION: 5 Which combination of the following options would be most tax-efficient in meeting Marian s objective concerning the management of her affairs? 1. Transfer her non-registered assets to a family trust with Frank as trustee. 2. Transfer her non-registered assets to an alter ego trust with Frank as trustee. 3. Gift her non-registered assets to Frank. 4. Name Frank as attorney in an enduring/continuing power of attorney. a) 1 and 3 only b) 1 and 4 only c) 2 and 3 only d) 2 and 4 only Rationale: 1. is incorrect. If assets are transferred to a family trust, capital gains tax may result. 2. is correct. Marian s assets can be rolled over at her cost base to an alter-ego trust, so there is no immediate tax liability. Frank would be able to manage these assets if required while Marian is alive and on her death. 3. is incorrect. A deemed disposition of her non-registered investments and capital gains tax would result if these assets are gifted to him. 4. is correct. An enduring/continuing PoA would allow Frank to deal with Marian s assets while she is alive and in the event of her incapacity. Element of Competency: 3.101 Formulates and evaluates strategies to develop a financial plan Develops financial management strategies Linked Technical Knowledge: 500. Law 503. Powers of Attorney for Property, 508. Trusts 100. Taxation 106. Capital Gains and Losses

QUESTION: 6 Which of the following asset management recommendations is most appropriate for Marian s current investment holdings? a) Sell some of her non-registered equities to purchase a laddered bond portfolio. b) Use her current money market balance to purchase a one year GIC. c) Swap her non-registered bonds for the Canadian dividend units. d) Swap some of her non-registered equities for the global bond fund units. Rationale: Asset Cash Fixed-Income Equities Total Non-reg investments 15,000 97,500 412,900 525,400 RRIF 100,000 100,000 200,000 Totals 15,000 197,500 512,900 725,400 % of assets 2% 27% 71% 100% a) is correct. Her current asset allocation is 2% cash, 27% fixed income and 71% equities. With a current overweighting in equities, Marian should change her current asset allocation with the purchase of more fixed income vehicles. A laddered bond portfolio will provide liquidity and minimize interest rate risk. b) is incorrect. She needs her current cash balance to fund retirement home expenses. c) is incorrect. Although this swap would reduce the tax on her investment income, it would not alter her current asset allocation and does not address her current over-weighted position in equities. Her current asset allocation is 2% cash, 27% fixed income and 71% equities. d) is incorrect. This option would increase her taxable interest income and move dividend income into her RRSP. Also this option does not address her current over-weighted position in equities. Her current asset allocation is 2% cash, 27% fixed income and 71% equities. Element of Competency: 3.105 Develops recommendations to help optimize the client s situation Investment Planning Formulates investment planning strategies Linked Technical Knowledge: 100. Taxation 104. Property Income 300. Investments 305. Portfolio Management Techniques

QUESTION: 7 While Marian decides on her living arrangements, which combination of the following options should she implement first? 1. Revise her power of attorney. 2. Gift funds to Frank and Eileen. 3. Rebalance her investment holdings. 4. Open and fund a RESP for Darlene. a) 1 and 2 only b) 1 and 3 only c) 2 and 4 only d) 3 and 4 only Rationale: 1. is correct. Marian wants Frank to help with the management of her affairs if need be. A revision to her PoA can appoint him as attorney. 2. is incorrect. Until Marian decides upon her living arrangements, she should continue to hold her assets. 3. is correct. Marian relies on her investment capital to provide income. Her current overweighting in equities exposes her to a level of investment risk that can be reduced with a change in asset allocation. 4. is incorrect. The contribution to a RESP should wait until Marian decides on her living arrangements. Continued payment of retirement home expenses could curtail the amount of her gifts to Frank and family. Element of Competency: 3.001 Synthesizes information to formulate and evaluate and finalize strategies to develop a financial plan Fundamental Financial Planning Practices Prioritizes recommendations from the financial planning components to optimize the client s situation Linked Technical Knowledge: 300. Investment 305. Portfolio Management Techniques 500. Law 503. Power of Attorney for Property 600. Financial Analysis 603. Budgeting

QUESTION: 8 Assume Marian decides to remain in the retirement home and will require a gross annual income of $70,000, indexed at a 2% inflation rate, to age 90. In January, with investment assets of $1,160,400 (including her RRIF) earning 4% annually, what is the maximum lump-sum amount that Marian could afford to give Frank and his family? Assume CPP and OAS income are fully indexed to inflation and annual payments are made each January. a) $139,160 b) $274,739 c) $399,560 d) $500,051 Rationale: Mode = begin N = 17 (age 90 less age 73 in January) I = 2% (4% return less 2% inflation) FV = 0 PMT = $52,192 ($70,000 less $17,808 CPP and OAS) Solve for PV = 760,839.80 Current assets of $450,000 plus $510,400 plus $200,000 RRIF = 1,160,400 less capital required of $760,840 leaves surplus capital amount of $399,560. Note: If the Fisher equation (r = (interest rate inflation rate) / (1 + inflation rate)) is used to calculate I, then the solution will result in a different number, but close to the correct response provided above. a) is incorrect. This amount ignores receipt of her CPP and OAS income with PMT = $70,000. Using Mode = begin, N = 17 (age 90 less age 73 in January), I = 2% (4% return less 2% inflation), FV = 0, PMT = 70,000, solve for PV = 1,020,440. Current assets $1,160,400 less capital required of $1,020,440 = $139,960. b) is incorrect. This amount has ignored inflation with I = 4, and ignored CPP and OAS income with PMT = 70,000. Using Mode = begin, N = 17 (age 90 less age 73 in January), I = 4%, FV = 0, PMT = 70,000, solve for PV = 885,661. Current assets of $1,160,400 less capital required of $885,661 = $274,739. c) is correct. Using Mode = begin, N = 17 (age 90 less age 73 in January), I = 2% (4% return less 2% inflation), FV = 0, PMT = $52,192 ($70,000 less $17,808 CPP and OAS), solve for PV = 760,839.80. Capital of $760,840 will be required to meet her income needs to age 90. Current assets of $1,160,400 less capital required of $760,840 leaves surplus capital amount of $399,560. d) is incorrect. This amount has ignored inflation with I = 4. Using Mode = begin, N = 17 (age 90 less age 73 in January), I = 4%, FV = 0, PMT = $52,192 ($70,000 less $17,808 CPP and OAS), solve for PV = 660,349. Current assets of $1,160,400 less $660,340 capital required = $500,051. Element of Competency: 2.003 - Assesses the client s current situation and identifies and evaluates appropriate strategies Fundamental Financial Planning Practices - Assesses opportunities and constraints across financial planning components Linked Technical Knowledge: 600 Financial Analysis 601 Analysis of Financial Information