CASE STUDY MULTIPLE INVESTMENT ACCOUNTS FOR MULTIPLE GOALS

CASE STUDY MULTIPLE INVESTMENT ACCOUNTS FOR MULTIPLE GOALS KNOWLEDGE EXPECTED OF: CFP Professionals Only Version 1.0.0, Updated 20170907 Richard retired last year to help raise his granddaughter, Devon, after his son and daughter-in-law were killed in a car accident. In their wills, he and his wife, Yvonne, were named joint trustees of a testamentary trust valued at $500,000, of which Devon is the sole benefi ciary. Richard has $350,000 invested in his Registered Retirement Savings Plan (RRSP). Currently, $262,500 is invested among the following: three, Canadian dividend-focused equity mutual funds ($94,000); three U.S mutual funds covering small-, mediumand large-cap companies ($99,000); and one exchange-traded fund that invests in the broad Europe, Australasia and Far East (EAFE) index ($69,500). Richard also has $25,000 invested in each of three bonds: a 25-year Government of Canada bond, a 25-year bond offered by a Crown Corporation and a 25-year bond issued by a provincial government. The remainder of his retirement assets are held in cash. Yvonne s RRSP holds $60,000 in a mutual fund comprising real return bonds and $200,000 in a balanced equity mutual fund. The latter consists of 42 percent in Canadian equities, 31 percent in U.S equities, seven percent in international equities and 20 percent in Canadian bonds. The couple has no further RRSP contribution room remaining. Both are 65 years old. This past month, Yvonne sold her business at a net gain of $1 million. The net proceeds are being held in a savings account in Yvonne s name until the couple decide how to invest. While their fi nancial plan suggests that they should be able to retire using only these funds, Yvonne still worries about outliving her money. Yvonne is more risk-averse than Richard. She would prefer that no more than half of her portfolio is invested in equities (20 percent in Canadian equities, 20 percent in U.S. and 10 percent in international equities). Richard is comfortable holding up to 75 percent of his assets equally spread across Canadian, U.S. and international equities, with the remaining 25 percent in fi xed-income investments. The couple has maximized contributions to their Tax-Free Savings Accounts (TFSAs). The accounts are held in cash for emergencies and travel over the next 10 years. Yvonne acts as treasurer for the condo corporation that oversees the property in which she and Richard live. The condo corporation has $250,000 in a bank account and is required to hold $25,000 in cash for emergencies. It is also required to hold $25,000 at the end of each of the next fi ve years for repairs and upgrades to the property. The remaining $100,000 may be invested for up to fi ve years to earn higher rates of return, subject to the corporation s bylaws that prohibit investments in any vehicle that may suffer a loss. There are suffi cient assets in the testamentary trust to cover Devon s education expenses in 16 years and purchase of a home after her graduation. The trust parameters suggest that growth-oriented investments to satisfy Devon s long-term needs would be most fi tting. Richard and Yvonne prefer that the investments within the trust have appropriate growth potential and minimize taxes. They do not plan on distributing any income from the trust until Devon is older. Richard and Yvonne expect to be in a tax bracket of 23 percent going forward. Up to now, the couple has managed their investments and investment decisions on their own. They have come to their fi nancial planner for advice on their accounts and options for professional money management, given the size of their RRSP and trust assets. The couple has a long investment time horizon for these assets, in light of their plans to bequeath them and their home, worth a combined $850,000, to Devon. Page 1

Knowledge Expectations Investment Planning Identify that, based on the most conservative life expectancies provided in the Projection Assumption Guidelines 1, Richard and Yvonne, currently age 65, should plan to live to 100. Identify that the couple should expect a 35-year 2 time horizon for their retirement. Knowledge Expectations Investment Planning Emergency Account and Vacation Asset Allocation and Diversification Explain that Richard and Yvonne may avoid paying tax on interest income by holding their savings for emergency and vacation purposes in their TFSAs. However, they may gain greater value by holding growthoriented investments in their TFSAs, based on their potentially higher growth and associated tax savings. Identify that the couple s TFSAs have an asset allocation of 100 percent in cash. Explain that the couple may consider maintaining cash in a joint, non-registered account with right of survivorship for emergency and vacation purposes. Identify that the couple may diversify their cash holdings by considering safe investments with differing issuers, maturity dates and rates of return. Knowledge Expectations Investment Planning Emergency Account and Vacation Investment Choices Explain that the couple should maintain an amount of cash needed to cover three to six months of living expenses for emergencies. Explain that the couple should maintain enough cash to pay for any vacations they plan to take next year. Explain that the couple should consider investing the remainder of the proceeds available for vacations in guaranteed investment certifi cates (GICs) with different maturity dates. Doing so will enable them to take advantage of higher interest rates on longer term maturities and limit their reinvestment risk. Knowledge Expectations Investment Planning Retirement Goal Asset Allocation and Diversification Identify that maintaining the non-registered assets solely in Yvonne s name puts the couple at risk of higher probate costs. It further complicates the transfer of assets to Richard should Yvonne predecease him. 1 This case study reflects Projection Assumption Guidelines published in 2015. 2 100-65 = 35 Page 2

Explain that the couple may wish to consider changing the ownership of the non-registered funds to ensure that the funds are transferred to Richard in the event of Yvonne s death. They may consider holding the funds in a joint, non-registered account with right of survivorship. Explain that investing the money in a joint, non-registered account with right of survivorship will ensure that the couple avoids paying probate costs on the funds. It will also enable the transfer of the funds to Richard on a tax-deferred basis upon Yvonne s death. Income-splitting advantages are restricted, given that any income received by Richard from these investments during Yvonne s lifetime will be attributed back to her. Identify that the couple s current asset allocation is 100 percent in cash. Explain that the couple may have the time horizon and fi nancial capacity to accept fl uctuations associated with a portfolio consisting of 75 percent in equities and 25 percent in fi xed-income investments. However, Yvonne s risk tolerance does not enable it. Explain that the couple s risk tolerances differ, which is why the asset allocation of the joint account must align with Yvonne s lower risk tolerance. In other words, the account should have a 50-50 split between equities and fi xed-income investments. Knowledge Expectations Investment Planning Retirement Goal Investment Choices Explain that, given the value of the couple s non-registered portfolio, a diversifi ed portfolio of individual securities, containing publicly traded stocks and government and corporate bonds, may be an optimal solution. High diversifi cation, lower transaction costs and the ability to control the timing and size of taxable events are all benefi ts of holding individual securities. A balanced portfolio of individual securities may be a suitable solution for the couple, given their long time horizon, comfort with holding a substantial portion of assets in equities, objective for growth and ongoing need for income. Explain that the couple s immediate and continuing need for income to fund their retirement makes the sequence of returns an important factor in their choice of securities. Explain that using a portion of their non-registered funds to purchase a joint life annuity may alleviate Yvonne s concern of outliving their assets, and ensure a level of predictable income. Knowledge Expectations Investment Planning Bequest to Devon Asset Allocation and Diversification Calculate that the current asset allocation 2 for Richard s RRSP is as follows: 3.57 percent 3 in cash, 21.43 percent 4 in fi xed income, 26.86 percent 5 in Canadian equities, 28.29 percent 6 in U.S. equities and 19.86 percent 7 in international equities. 3 Total equals 100.01 per cent due to rounding. 4 ($350,000 - $262,500 - $75,000) / $350,000 = 3.57% 5 $75,000 / $350,000 = 21.43% 6 $94,000 / $350,000 = 26.86% 7 $99,000 / $350,000 = 28.29% 8 $69,500 / $350,000 = 19.86% Page 3

Explain that Richard s RRSP has deviated from the original strategic asset allocation. Calculate that Richard s RRSP should be rebalanced to include $87,500 9 in each asset class as follows: Canadian equities, U.S. equities, international equities and fixed-income investments. Calculate that the following needs to be done to rebalance Richard s RRSP: Redistribute $6,500 10 in Canadian equities, $11,500 11 in U.S. equities and $12,500 12 in cash, to fixed-income investments and international equities in the amounts of $12,500 13 and $18,000, 14 respectively. Calculate that the current asset allocation for Yvonne s RRSP includes the following: 38.46 percent 15 in fi xed income, 32.31 16 percent in Canadian equities, 23.85 percent 17 in U.S. equities and 5.38 percent 18 in international equities. Explain that Yvonne s RRSP has deviated from the original strategic asset allocation. Calculate that Yvonne s RRSP should be rebalanced to include $130,000 19 in fi xed-income investments, $52,000 20 in Canadian equities, $52,000 21 in U.S. equities and $26,000 22 in international equities. Calculate that, to rebalance Yvonne s RRSP, $32,000 23 in Canadian equities and $10,000 24 in U.S. equities should be redistributed to fixed-income investments and international equities in the amounts of $30,000 25 and $12,000, 26 respectively. Explain that rebalancing involves redirecting outperforming assets to underperforming assets. Rebalancing is necessary because different asset classes have different risk-return characteristics. Over time, as each asset class changes in value, the allocation of Richard and Yvonne s investments will deviate from their long-term asset allocation. Large deviations may lead the couple to invest in a portfolio that exceeds the amount of risk they are comfortable taking. Rebalancing assets aligns their portfolios with their individual risk tolerances. Explain that, prior to rebalancing the accounts, the couple should confi rm whether doing so will result in any fees. The fees could include deferred sales charges or early redemption fees for mutual funds, or commissions for bonds and exchange-traded funds. Explain that rebalancing the couple s RRSP assets will not result in any immediate taxes on the assets. 9 $350,000 (0.25) = $87,500 10 0.25 ($350,000) - $94,000 = -$6,500 11 0.25 ($350,000) - $99,000 = -$11,500 12 0.00 ($350,000) - ($350,000 - $262,500 - $75,000) = -$12,500 13 0.25 ($350,000) - $75,000 = $12,500 14 0.25 ($350,000) - $69,500 = $18,000 15 [$60,000 + (0.20)($200,000)] / $260,000 = 38.46% 16 (0.42)($200,000) / $260,000 = 32.31% 17 (0.31)($200,000) / $260,000 = 23.85% 18 (0.07)($200,000) / $260,000 = 5.38% 19 $260,000 (0.50) = $130,000 20 $260,000 (0.20) = $52,000 21 $260,000 (0.20) = $52,000 22 $260,000 (0.10) = $26,000 23 0.20 ($260,000) - (0.42)($200,000) = -$32,000 24 0.20 ($260,000) - (0.31)($200,000) = -$10,000 25 0.50 ($260,000) - (0.20)($200,000) - $100,000 = $30,000 26 0.10 ($260,000) - (0.07)($200,000) = $12,000 Page 4

Explain that, while Richard s RRSP is diversifi ed across the major asset classes, he may consider diversifying further. Given the relatively small number of Canadian dividend-paying stocks, Richard s three Canadian dividend-focused funds may be highly correlated. Redistributing a portion to growth-oriented stocks may reduce the risk of Richard s portfolio. Explain that Richard should diversify his fi xed-income holdings by investing in more than three bonds; purchasing domestic, international, corporate and shorter term bonds will reduce the risk of volatility. Explain that Yvonne should diversify her bond holdings in a similar way to Richard s. While real return bonds can protect against increases in infl ation, they are also susceptible to drops in the rate of infl ation. Explain that Yvonne may consider diversifying her equity holdings, depending on the mandate of the balanced fund, which may differ signifi cantly from her asset allocation. Explain that Yvonne and Richard s TFSAs should be invested according to their respective risk tolerances and strategic asset allocations. Knowledge Expectations Investment Planning Bequest to Devon Investment Choices Explain that, given the value of the couple s individual RRSPs and TFSAs, exchange-traded funds may be an optimal solution because they provide the diversifi cation that individual securities may not. They also tend to have lower management fees. Exchange-traded funds may be a suitable investment choice for Richard and Yvonne, given their long time horizon, growth objectives and ability to ride out market ups and downs. Knowledge Expectations Investment Planning Condominium Corporation Asset Allocation and Diversification Identify that the Condominium Corporation s bylaws restrict investment options to safe investments. As such, its long-term asset allocation is 100 percent in cash. Identify that the Condominium Corporation s current asset allocation is 100 percent in cash. Identify that the Condominium Corporation may diversify by holding safe investments with differing issuers, maturity dates and rates of return. Knowledge Expectations Investment Planning Condominium Corporation Investment Choice Explain that the Condominium Corporation should maintain $25,000 in cash for emergency purposes. Explain that Yvonne can protect the Condominium Corporation from potentially falling interest rates, and help it benefi t from higher interest rates on longer maturities, by implementing a laddering strategy using GICs. Page 5

Explain that, as GICs mature, Yvonne may reinvest them to take advantage of higher rates if they are available. Alternatively, she may reinvest only a portion of the portfolio if the rates fall. Explain that the Condominium Corporation should invest in fi ve separate GICs of $25,000 each, due every year. Explain that the remaining $100,000 27 of the Condominium Corporation s funds should be invested across index-linked GICs that differ in maturity, and the underlying assets they track. Explain that, where possible, a maximum of $100,000 should be invested with any member of the Canada Deposit Insurance Corporation (CDIC). This will ensure that the Condominium Corporation s money is fully protected if one of the fi nancial institutions holding its GICs becomes insolvent. Knowledge Expectations Investment Planning Devon s Education and Home Purchase Asset Allocation Identify that the trust has a current asset allocation of 100 percent in cash. Explain that the trust s asset allocation will be based on parameters articulated in the trust, including risk level, investment objectives and time horizon for the assets. Explain that the trust has an initial time horizon of 16 years. This aligns with Devon s need for funds to cover her education expenses. Explain that the trust has a second time horizon of 20 years. This aligns with Devon s need for funds to cover the cost of an expected home purchase. Identify that Richard and Yvonne do not plan on distributing any income to Devon in the short term. They prefer to grow the assets within the trust. Explain that, based on the couple s long-investment time horizon, risk tolerance and growth objective, they may invest a portion of the assets held in trust for Devon in securities that fl uctiuate in value. Knowledge Expectations Investment Planning Devon s Education and Home Purchase Investment Choices Explain that Richard and Yvonne may benefi t from lower, graduated rates of taxation on the funds held in the trust for the first 36 months following the death of Devon s parents. After that, any income earned and held in the trust will be taxed at the highest marginal tax rate. While the couple may wish to maintain the income earned in the trust to enable its growth, there may be greater benefi t to distributing some, or all, of the income to Devon to maximize after-tax income. Explain that investments focused on capital appreciation, such as individual stocks or equity exchange-traded funds, are ideal investment choices for the couple, because they defer taxable gains until the investments are disposed of by the trust. Once they are sold, the capital gains may be distributed to Devon, where they will be taxed at her lower marginal tax rate. 27 $250,000 - $25,000-5($25,000) = $100,000 Page 6

Explain that, when dividends in the trust are distributed to a benefi ciary, tax credits such as the basic personal amount and the dividend tax credit can be used to offset taxes owing on income of up to $50,000 in some provinces. Using dividend-paying investments will enable Richard and Yvonne to use the tax-free distributions from the trust as contributions to a Registered Education Savings Plan (RESP) in Devon s name to attract Canada Education Savings Grants (CESGs). Explain that, in addition, tax-free cash distributions of dividend income may be used to cover premiums on a joint, last-to-die life insurance policy for Richard and Yvonne. This insurance can be used to settle tax and probate liabilities expected upon the death of the last surviving spouse. It can also be used to ensure that Devon receives full benefi ts of the couple s RRSP assets, which was one of their original goals. Knowledge Expectations Investment Planning Discretionary Money Management Explain that Richard and Yvonne may benefi t from discretionary money management, given the couple s desire to have a professional money manager who can make investment decisions on their behalf. Explain that the advantages of discretionary money management for Richard and Yvonne will include receiving professional advice about their investments, and the management of those investments. The investment manager can make trading decisions on their behalf without receiving prior approval of either Richard or Yvonne. The investment manager has to, however, work within the confi nes of an investment policy statement, which the couple must agree to at the beginning of their relationship. Explain that a discretionary money manager will charge Richard and Yvonne a fee for this service, generally based on the value of assets under management. CFP, CERTIFIED FINANCIAL PLANNER and are certifi cation trademarks owned outside the U.S. by Financial Planning Standards Board Ltd. (FPSB). Financial Planning Standards Council is the marks licensing authority for the CFP marks in Canada, through agreement with FPSB. All other are registered trademarks of, unless indicated. 2017 Financial Planning Standards Council. All rights reserved. Page 7