APPLIED FINANCIAL PLANNING CERTIFICATION EXAMINATION

August 2012 Appendix Page 1

APPLIED FINANCIAL PLANNING CERTIFICATION EXAMINATION

Sample Case Scenario

General Instructions

This sample is provided as a resource for AFP Exam 2 candidates for them to create a financial plan

around a client scenario. This sample also provides information on the depth and complexity of questions

on the actual AFP Exam 2; however, this case scenario and questions should not be used as a diagnostic

tool or indicator of performance on an actual AFP Exam 2.

Read the case provided for Greg and Janice Bright that reflects their previous financial plan and changes

to their family and financial situations beginning on page 2. Answer the questions beginning on page 7. The

actual AFP Exam 2 will include space for your responses. Examples of acceptable answers are provided at

the end of this document. CSI encourage candidates to answer the questions prior to reviewing the

sample answers.

Format

Exam questions will relate to all of the following components of a financial plan:

1. Review of Current Situation and Objectives

a. Family Demographics.

b. Financial Goals.

c. Overview of Current Finances.

d. Investor Profile.

e. Other Pertinent Financial Data.

f. Potential Gaps.

2. Financial Management Analysis

3. Retirement Planning Analysis

4. Risk Planning/Management Analysis

5. Tax Planning Analysis

6. Asset Management Analysis

7. Estate Planning Analysis

8. Recommendations and Implementation Strategies

Mathematical Calculations

Candidates will be evaluated on the application of financial math and the use of financial calculators to

create accurate client advice. In order to reap full marks, the steps (calculator calculations) required to

arrive at conclusions must be shown. Where applicable, this requires that candidates show the process of

their calculations in detail. The sample answers provided for Greg and Janice Bright illustrate this for

clarity.


CASE SCENARIO: Greg & Janice Bright

Read the case study on pages 2 to 6. Answer questions 1 to 9 beginning on page 7.

Background

Greg Bright, a long-time client of financial advisor Megan Chu, informs her that he has just lost his job.

Greg reports that the job loss was due to financial difficulties at the company and that several other

people in different departments lost their jobs that day as well.

Greg received a severance package and would like to review his existing financial plan with Megan in light

of the changes to his situation. Megan asks Greg to fax the details of the package to her office so that

she can review it before they meet. In the meantime, Megan tells Greg that she will review the last

financial plan they completed together. They agree to meet in two days. Megan reviews the plan prior to

the meeting to refresh her memory and recalls the following information:

Greg is 53 years old; he is married to Janice and has one child. Janice is 53 years old and has not

worked outside the home. They have one son, Dillon, who is 14 years old.

Janice recently completed a training course in office management in anticipation of finding a job.

They are planning for Dillon’s university education and have saved some money for that purpose.

Part 1: Financial Details from Previous Financial Plan: Greg & Janice Bright

The following information is extracted from Greg’s and Janice’s financial plan, which was completed two

months prior to Greg’s job loss.

Financial Management

Greg was a senior manager of a large technology firm. He earned a $120,000 annual salary and

received a bonus of $30,000 last year.

The Brights live in a home valued at $600,000 that they jointly own and on which they have a

$20,000 closed mortgage at an interest rate of 2.5%. They had planned to pay off the mortgage

within the next two years prior to Greg’s layoff. They have taken advantage of all available lump-

sum prepayment options.

Greg owns a U.S. condo valued at $100,000.

They own two cars with a combined value of $40,000.

The Brights have a $30,000 credit card debt and they make interest-only payments. Currently,

the interest rate on the credit card is 28%.

They also have $26,000 in a joint bank account. They do not receive any interest on this amount.


Education Plan

They are planning for Dillon’s university education and have saved some money for that purpose.

They have accumulated $45,000 in an RESP and have invested the funds in a three-year GIC

earning 3%. They contribute $4,800 to the RESP each year.

University education is expected to cost $15,000/year for Dillon for three years.

Retirement Plan

Greg had planned to retire at age 60 with a net after tax income of $40,000. At age 60, Greg

would have been with the company for 25 years. However, Greg does not have a pension plan.

Greg has an RRSP, which has $70,000 invested in a Canadian balanced fund.

Greg’s annual CPP payment will be $10,000 at age 65.

To date, Janice does has not earned any CPP-eligible income.

Greg and Janice are each eligible to receive a $5,000 OAS pension.

In retirement, Greg plans to rent out the U.S. condo for C$10,000 after-tax per year.

Greg currently has $30,000 of unused RRSP contribution room, including his contribution limit in

the current year.

The Brights would like to continue living in their home for as long as possible in their

retirement.

Risk Management

Greg’s employment benefits include medical and dental coverage; the company pays for 90% of

his medical and dental bills.

He also has short and long-term disability coverage. The company pays the premiums for the

short-term and long-term disability coverage.

Greg currently has a $120,000 group life insurance policy that is paid by his employer.

Through Greg’s company’s group plan, Janice has life insurance in the amount of $50,000 (paid

for by Greg).

Greg Janice

Group Insurance Policy Coverage: $120,000

Beneficiary: Janice

Cost: Covered by Employer

Coverage; $50,000

Beneficiary: Greg

Cost: Greg pays $20/month

Group Disability

Insurance

Benefit: $6,000 after-tax

Elimination period: 3 months

Cost: Paid by employer

None

Group Medical & Dental

Insurance

Benefit: Covers 90% of family

medical and dental costs

Cost: Paid by employer

Covered under Greg’s employer

plan


Investment Plan

The Brights’ asset allocation is based on their moderately aggressive investment risk tolerance.

The portfolio is expected to generate an average annual 5% compounded rate of return to

retirement.

A tactical asset allocation is employed from time to time. The portfolio is currently overweight

common stocks, particularly industrial and commodity stocks.

Strategy Agreement

Return Objectives: 5%

Risk Tolerance: Moderately Aggressive

Time Horizon: 7 Years

Strategic Asset Mix

T-bills Bonds Equities

5% 40% 55%

Current Asset Mix

5% 30% 65%

Estate Plan

Greg and Janice completed their wills 14 years ago when Dillon was born.

They are executors for each other. Each will leave everything to the other spouse.

In the event of their joint deaths, Greg’s mother, Eunice, is named as the contingent executor and

guardian for Dillon. Everything is left to Dillon by way of a trust that will be managed by Eunice

until Dillon reaches the age of majority. If Greg and Janice die after Dillon turns 18, he will

receive the proceeds of their estate.


Part 2: New Information

Details of Greg’s Severance Package

1. Greg has the choice between salary continuance or a lump sum payment, as follows:

a) Salary continuance for 18 months, which includes benefits, with the exception of short- and

long-term disability. Salary continuance will stop if Greg finds a new job. Greg would be

allowed to earn up to $60,000 if he became self-employed; otherwise salary continuance

would stop. Salary and benefits would stop after 18 months if Greg could not find a job.

b) A lump sum pre-tax payment in the amount of $135,000. Benefits would stop immediately.

He would have the option to convert the group life insurance to a private plan without the

requirement of a health assessment for either himself or Janice.

2. A lump sum pre-tax bonus of $30,000 payable immediately, regardless of whether he chooses

the salary continuation or the lump sum payment.

Goals

Greg has met with a lawyer who has advised him the lump-sum payout in lieu of salary

continuance is the best option, given the uncertain financial state of his company. Consequently,

he advised his employer of his intended choice and has received the payment, which he has

invested in a redeemable GIC at 5% interest. He has also received the bonus payment which he

has contributed to his RRSP.

Greg reveals that he is tired of corporate life and would like to try self-employment. He is a

highly specialized engineering consultant and his skills are much in demand. He has been in touch

with a firm that has offered him a one-year consulting engagement for $100,000, which will

require Greg to work only 20 hours per week.

Greg informs Megan that his wife, Janice, has been diagnosed with cancer. It is too early for a

prognosis. Based on the experience of a family friend who recently underwent treatment for

cancer, he anticipates that medical expenses for Janice will be $5,000 per year in each of the next

two years.

Greg would like to ensure that the family’s income in the coming year is sufficient to meet all of

their expenses and to make contributions of $5,000 each to a TFSA account for him and Janice.

Eunice sold the family home last year for $250,000 and gifted the funds to Greg. Greg invested

the funds in a GIC earning 5%. They would like to use the income generated from the investment

to pay expenses now and in retirement.

The Brights would still like to pay off their mortgage in 2 years.

They would also like to ensure that they have an emergency reserve to cover 10 months of their

anticipated expenses.

Greg’s mom, Eunice (81), is planning to move in with them. Eunice is in the early stages of

Alzheimer’s and can still function, but is beginning to forget things. Burt, Greg’s dad, died last year

of a heart attack at age 84. Eunice receives Burt’s indexed pension of $25,000 per year. The

pension increases by 1% per year. In addition, Eunice receives medical and dental benefits. Greg

would like to assess how this will alter his financial plan, if at all.


Assumptions

1. Greg will save $10,000 per year in two TFSAs for himself and Janice for seven years, commencing this

year.

2. No additional contributions will be made to RRSP accounts.

3. Greg’s pre-retirement tax payable is based on his average tax rate of 35%. His pre-retirement

marginal tax rate is 40% which should be used to calculate the value of tax deductions. Greg’s

marginal tax rate in retirement will be 30% and his average tax rate will be 25%.

4. Janice’s pre-retirement and retirement marginal tax rate is 15%. She will not pay any taxes on her

estimated income, after allowable deductions and credits.

5. Their retirement plan is based on Greg’s life expectancy to age 90.

6. The inflation rate is 0%.

7. Employer and employee CPP contributions are $2119 annually for each.

8. Greg’s CPP will be reduced by 0.6% per month for each month that he receives the pension prior to

age 65.

9. Source deductions for E.I. are $732 annually.

10. Greg has received a quote of $1,400 to convert his current group insurance policies to private

policies.


Note: Financial calculations are included in the answers in order to illustrate expectations for garnering

full marks. When candidates are asked to show calculations, markers are looking for accurate process

and final answer.

Question 1: Client Profile

Instructions:

Complete the profile of the Bright family according to which you will create a financial plan in the

coming year. Ensure that you consider previous and new information.

Write your answer in the tables provided below.

Greg Janice Dillon

Age:

Occupation:

Years in current position:

Gross income:

Marginal tax rate before retirement:

Marginal tax rate after retirement:

Average tax rate before retirement:

Average tax rate after retirement:

Question 2: Gap Analysis

Instructions:

Identify and explain changes in each financial planning area listed below that should be addressed in

revising the Brights’ financial plan. In listing the required revisions, consider the Brights’ stated goals and

those that a financial planner should bring to their attention.

1. Financial Management

2. Retirement Plan

3. Risk Management

4. Investment Plan


Sample Case Scenario Questions


Question 3: Net Worth Statement

Instructions:

Using the information in the case study, populate this Statement of Net Worth to enable accurate

calculations of the Brights’ Total Assets, Total Liabilities and Total Net Worth. Ensure that you include

previous and new information. Round amounts to the nearest dollar.

Statement of Net Worth

Assets

Liabilities

Total Assets

Total Liabilities

Total Net Worth


Question 4: Cash Flow Statement

Greg has asked Megan to create a projected cash flow statement for next year to determine whether he

will be able to meet his projected expenses and savings goals with his self-employment earnings and

other income. He would like Megan to quantify any short-fall and help him develop options to meet his

goals.

Instructions:

Using the information in the case study, complete this Cash Flow Statement by populating each blank line

with the cash flow item and amount. The statement should reflect cash flow in the 1st year of Greg’s self-

employment. Round amounts to the nearest dollar.

Write your answer in the table provided.

$ / Year

Income

Less Expenses and Deduction

Home

Mortgage 13,200

Property taxes 4,800

Utilities 6,000

Maintenance 2,000

Food 6,000

Vehicle Fuel, Maintenance, Insurance 4,800

Personal and Clothing 12,000

U.S. Condo Fees 3,300

Entertainment & Vacation 6,000


Question 5: Financial Management

Instructions:

Based on your analysis of the Brights’ net worth and cash flow statements, provide recommendations for

implementing a plan to achieve their financial management and savings goals.

Question 6: Retirement Analysis

Question 6 includes three parts: Questions 6a, 6b and 6c.

Instructions:

6a. Complete the retirement income calculation for the Brights at age 60 for the sources listed below.

Assume that they can earn a 5% pre-tax rate of return on TFSA and RRSP investment pre-

retirement, and a 5% pre-tax rate of return on all investments in retirement. Use a tax rate of 25%.

Assume income is earned and withdrawals are made at the end of the year. Round your answers to

the nearest dollar.

Write your answer in the table provided below.

Sources of the Brights’ Annual Retirement Income at age 60

After-tax Calculations

Greg’s RRSP

Yearly Income:

Greg & Janice’s TFSAs

Yearly Income:


Greg’s CPP

Yearly Income:

Greg & Janice’s OAS

Yearly Income:

Non-registered yearly income: All investment income is taxable as interest


Question 6 : Retirement Analysis

Instructions:

6b. Calculate the total retirement income available to the Brights. Refer to your calculations in Question

6a.


Total After-Tax Income: Greg

RRSP

CPP

OAS

Non-registered Account

TFSA

Rental income 10,000

Total

Total After-Tax Income: Janice

OAS

TFSA

Total

Total Income: Greg &

Janice

Question 6: Retirement Plan Recommendations and Implementation

Instructions:

6c. Recommend three ways in which the Brights can ensure that their retirement income is adequate for

their desired income needs. Refer to your retirement calculations in 6a and 6b.


Question 7: Tax Analysis and Estate Recommendation

Question 7 includes two parts: Questions 7a and 7b.

Instructions:

7a. Provide Greg with an analysis of the advantages and disadvantages of incorporating his business in

comparison to sole proprietorship. In your answer, ensure that you consider the Brights’ specific

situation.

Instructions:

7b. Provide Greg and Janice with recommendations on how to best construct their wills to ensure that

their estate is distributed according to their wishes. Ensure that you specifically address all major

issues specific to their situation.

Question 8: Risk Analysis

Instructions:

Advise Greg on the best form of insurance in the event that he becomes disabled as a self-employed

individual. Ensure that you consider the nature of his profession, his income needs and variability of

income in considering suitable forms of insurance and features.

Question 9: Investment Management

Instructions:

Advise the Brights on the suitability of their current investment strategy given the changes in Greg’s

employment and family situation, as well as their retirement goals. In your answer, you should evaluate

the suitability of strategic and tactical asset allocation for their specific situation.



Sample Case Scenario Answers

Please find below sample answers (in red) built using the information from the sample case scenario for

Greg and Janice Bright. These responses are provided as possible correct responses; additional

responses could be provided.

Please Note: Financial calculations are included in the answers in order to illustrate expectations for

garnering full marks. When candidates are asked to show calculations, markers are looking for accurate

process and final answer.

Question 1: Client Profile

Instructions:

Complete the profile of the Bright family according to which you will create a financial plan in the

coming year. Ensure that you consider previous and new information.


Greg Janice Dillon

Age: 53 53 14

Occupation: Consultant Homemaker Student

Years in current position: 0 14

Gross income: $100,000/year Nil

Marginal tax rate before retirement: 40% 15%

Marginal tax rate after retirement: 30% 15%

Average tax rate before retirement: 35% 0%

Average tax rate after retirement: 25% 0%


Question 2: Gap Analysis

Instructions:

Identify and explain changes in each financial planning area listed below that you must address in

revising the Brights’ financial plan. In listing the required revisions, consider the Brights’ stated goals and

those that a financial planner should bring to their attention.

A. Financial Management

1. Added expenses: The Brights will have to incur some expenses for Janice’s medical care, and

possibly Eunice’s, as well as private insurance coverage.

2. Additional income: The Brights will receive investment income from Greg’s severance and

inheritance, in addition to his employment income from contract work.

3. Emergency Reserve: The Brights are in need of an emergency reserve.

Given Greg’s intention to start his own business and Janice’s illness, an emergency reserve

in excess of the usual expense coverage of 3 to 6 months is appropriate.

4. Taxation: The Brights should explore tax credits or deductions that can be transferred from

Eunice to Greg. Greg may also qualify for tax deductions if he becomes self-employed and uses

part of the home for business. Greg should explore tax savings opportunities if he incorporates

his business. These include withdrawing income as dividends rather than salary, and income

splitting by making Janice a shareholder or hiring her to work in the business. Other income

splitting opportunities should be explored, such as holding the U.S. condo jointly in order to split

rental income between Janice and Greg. Any transfer of assets between spouses to achieve

income splitting opportunities should be done in such a way as to avoid attribution of income

back to Greg.

B. Retirement Plan

The sources of retirement funding may change given Greg’s self-employment.

1. Greg will be responsible for his own retirement funding.

i. Greg should explore retirement savings options for self-employed individuals.

ii. Greg will have to make both employer and employee CPP contributions.

2. If Greg incorporates, he may be able to withdraw income in the form of dividends. While

dividends are more tax efficient, they will do not qualify as RRSP-eligible income.

3. Greg must revisit his retirement date and desired retirement income, given the possible change

from salaried to self-employment.

4. Greg and Janice should explore income splitting opportunities in retirement.


C. Risk Management

1. A capital needs analysis is required to reassess the Brights’ life insurance needs to ensure a

sufficient amount of private insurance coverage.

2. Medical and health insurance needs must be reviewed in order to determine the type and

amount of private insurance required, as well at eligibility criteria, in light of Greg’s desire to be

self-employed and the state of Eunice and Janice’s health.

3. Greg must consider the need for professional liability insurance if he becomes self-employed.

Incorporation should be explored from the point of view tax savings as well as limiting liability.

4. Additional home insurance coverage may be required if Greg works at home as a self-employed

individual.

D. Investment Plan

1. The Brights’ risk tolerance should be reassessed given the additional risk that Greg will incur as

a self-employed individual. Given the variability of his employment income and the relatively

short time to retirement, a lower volatility investment portfolio may be more suitable.

2. The asset allocation should also be reviewed to include Greg’s inheritance.

3. Additional portfolio liquidity should be considered in the short-term given the anticipated

medical expenses for Janice and Eunice and the uncertain income for Greg.


Question 3: Net Worth Statement

Instructions:

Using the information in the case study, populate this Statement of Net Worth to enable accurate

calculations of the Brights’ Total Assets, Total Liabilities and Total Net Worth. Ensure that you include

previous and new information. Round amounts to the nearest dollar.

Statement of Net Worth

Assets

Liabilities

Jointly Held Bank Account $26,000

Credit Cards

Interest rate is 28% $30,000

RESP 3% GIC

(3 Year Term) 45,000

RRSP – Greg 100,000

Home Jointly Held 600,000 Closed Mortgage 20,000

Greg’s U.S. Condo 100,000

Greg’s Severance Package 87,750

Greg’s inheritance 250,000

2 cars 40,000

Total Assets $1,248,750 Total Liabilities $50,000

Total Net Worth $1,198,750

Severance calculation: Lump-sum $135,000 – (1 - .35) = $87,750 after-tax

RRSP calculation; $70,000 existing RRSP + $30,000 bonus contribution. Note that Greg had $30,000 in

unused RRSP contribution room.

Question 4: Cash Flow Statement

Greg has asked Megan to create a projected cash flow statement for next year to determine whether he

will be able to meet his projected expenses and savings goals with his self-employment earnings and

other income. He would like Megan to quantify any short-fall and help him develop options to meet his

goals.

Instructions:

Using the information in the case study, complete this Cash Flow Statement by populating each blank line

with the cash flow item and amount. The statement should reflect cash flow in the first year of Greg’s

self-employment. Round amounts to the nearest dollar.


Write your answer in the table provided.

$ / Year

Income

Greg’s self-employment income 100,000

Greg’s investment income (severance

package) $87,750 x 0.05 4,388

Greg’s GIC investment income

(inheritance) $250,000 x .05 12,500

Total Gross Income (A) 116,888

Less Expenses and Deduction

Greg’s Income Tax 40,911

CPP (x 2 for self-employed) 4,238

EI Premiums 732

Insurance Premiums 1,400

Medical 5,000

Credit card expense 8,400

Home

Mortgage 13,200

Property taxes 4,800

Utilities 6,000

Maintenance 2,000

Food 6,000

Vehicle Fuel, Maintenance, Insurance 4,800

Personal and Clothing 12,000

U.S. Condo Fees 3,300

Entertainment & Vacation 6,000

Total Expenses (C) 118,781

Net Cash flow - 1,893


Question 5: Financial Management

Instructions:

Based on your analysis of the Brights’ net worth and cash flow statements, provide recommendations for

implementing a plan to achieve their financial management and savings goals.

Mortgage Goal

The Brights will be able to pay off their mortgage in 19 months if they continue to pay $1,100

per month against it.

At this point, since the mortgage balance is so low, almost all of their payments are going

towards the principal.

Consequently, the elimination of the mortgage would reduce overall expenses by $13,200 per

year ($1,100 X 12 months).

Expense Coverage and Savings Goals

Education Funding: The Brights have already met their goal of 3 years of education funding for Dillon.

No further RESP contributions are required.

Emergency reserve funding: The Brights would like to ensure that they have an emergency reserve

to cover 10 months of expenses. They have sufficient liquid assets to fund an emergency reserve, which

include Greg’s after-tax $87,750 severance payment and $26,000 in a joint bank account

Retirement Savings: The Brights do not have sufficient cash flow to make their $10,000 TFSA

contribution. They have a short-fall of $1,893 after expenses. The Brights can meet their savings goals in

the following ways:

1. Reduce discretionary expenses

The two discretionary expenses are Entertainment & Vacation and Personal and Clothing.

If discretionary expenses are reduced by 50%, then the Brights would save $9,000 a year.

2. Reduce interest expense

Use the tax rebate that will result from $30,000 RRSP contribution to pay off a portion of

their credit card expense or contribute to their TFSA accounts.

Tax rebate due to the RRSP contribution = $30,000 x .40 = $12,000.

Payoff $12,000 of $30,000 credit card expense = $18,000 remaining.

Interest savings = $3,336 (12,000 x . 28).



Instructions:

6a. Complete the retirement income calculation for the Brights at age 60 for the sources listed below.

Assume that they can earn a 5% pre-tax rate of return on TFSA and RRSP investment pre-

retirement, and a 5% pre-tax rate of return on all investments in retirement. Use a tax rate of 25%.

Assume income is earned and withdrawals are made at the end of the year. Round your answers to

the nearest dollar.


Sources of the Brights’ Annual Retirement Income at age 60

After-tax Calculations

Greg’s RRSP

Yearly Income:

100,000 +/- PV

5 I/Y

7 n

COMP FV = $140,710

This will provide a net after tax income of $6,865/year calculated as follows:

$140,710 +/- PV

0 FV

30 n (from age 60 to age 90)

5 I/Y

COMP PMT = $9,153 gross income

$2,288 tax (at 25%)

= $6,865 net income


Greg & Janice’s TFSAs

Yearly Income:

Future contributions to a TFSA ($5000/year/TFSA)

0 +/- PV

5 I/Y

7 n

5,000 +/- PMT

COMP FV =$40,710

This will provide an income of $2,648 /year, calculated as follows:

$40,710 +/- PV

0 FV

30 n (from age 60 to age 90)

5 I/Y

Comp PMT $2,648

Total income from 2 TFSA’s would be $5,296. ($2,648 x 2) with no tax payable.

Greg’s CPP

Yearly Income:

At age 65, Greg’s CPP will be approximately $10,000 per year.

At age 60, CPP will be reduced by 0.6% per month, so that Greg will receive 64% of his regular

pension.

This is calculated as follows:

$6,400/year

- $1,600 tax (at 25%)

= $4,800 net income from CPP


Greg & Janice’s OAS

Yearly Income:

OAS is only available at age 65.

Non-registered yearly income: All investment income is taxable as interest

$250,000 inheritance X .05

= $12,500 gross income

- $3,125 tax (at 25%)

$9,375 net income



Instructions:

6b. Calculate the total retirement income available to the Brights. Refer to your calculations in Question

6a.


Total After-Tax Income: Greg

RRSP $6,865

CPP 4,800

OAS 0

Non-registered Account 9,375

TFSA 2,648

Rental 10,000

Total 33,688

Total After-Tax Income: Janice

OAS 0

TFSA 2,648

Total 2,648

Total Income: Greg &

Janice

36,336


Question 6(c): Retirement Plan Recommendations and Implementation

Instructions:

6c. Recommend three ways in which the Brights can ensure that their retirement income is adequate for

their desired income needs. Refer to your retirement calculations in 6a and 6b.

The Brights will have an annual shortfall of $3,664 at age 60.

1. They can increase their rate of return by 2% by increasing their risk.

2. They can reduce their expenses by $3,664 annually between the ages of 60 and 65. After age 65,

both of them will be entitled to OAS, which will eliminate the shortfall.

3. They can consider income splitting techniques, such as spousal RRSPs. Greg can also make Janice

a shareholder of the business if he incorporates, allowing her to earn non-registered income in

the form of dividends, or an employee, allowing her to earn RRSP-eligible income.

If Greg hires Janice as an employee, he must pay her the same type of salary that he would

pay an unrelated person for doing the same type of work. Therefore, he needs to keep

documentation of the type of work she does and her hours in the event that he gets

audited by the Canada Revenue Agency.

4. They can invest the inheritance in more tax-efficient income investments, such as dividend-paying

stocks or real estate investment trusts (REITs). However, they must ensure that the variability of

these income sources is conducive to their risk tolerance.

Question 7: Tax Analysis and Estate Recommendation

Instructions:

7a. Provide Greg with an analysis of the advantages and disadvantages of incorporating his business in

comparison to sole proprietorship. In your answer, ensure that you consider the Brights’ specific

situation.

A key benefit of incorporation is the lower rate relative to sole proprietorship, assuming that

income remains in the corporation.

A key consideration in deciding between a sole proprietorship and a corporate form of business

is whether income is required to cover living expenses.

Since Greg will require all of his income to pay for living expenses in the coming year, it is not

advisable for him to incorporate in the first year of business.

Eventually, when the business generates enough income, such that most of it exceeds personal

expenses, it may be more tax efficient for Greg to set up a corporation.

The chief advantage of a corporation is that Greg can determine when and how income will be

received.

If Greg incorporates his business, he and family members can receive a salary and/or dividends.

Dividend income is more tax efficient than salary and income splitting with family members can

reduce the family’s overall tax payable. However, dividends are not RRSP-eligible income.

If Greg sets up a corporation, he will have to pay legal and accounting fees for the annual

corporate tax return. For a sole proprietorship, professional fees will be substantially lower.


Operating a corporation will limit Greg’s liability to the assets owned by the corporation, unless

he gives a personal guarantee for business loans. If Greg operates a sole proprietorship, he will

have unlimited liability.

Greg should consult an accountant so that he can fully appreciate what is involved in being self-

employed.

Instructions:

7b. Provide Greg and Janice with recommendations on how to best construct their wills to ensure that

their estate is distributed according to their wishes. Ensure that you specifically address all major

issues specific to their situation.

The Brights need to update their contingent executors, trustee and the guardianship for Dillon,

since Greg’s mother is not able to perform these functions. They should consider appointing

someone who is willing and able to do the job if they both pass away at the same time. The

person should be of an age to outlive the Brights.

The Brights should consider creating a trust to secure the financial care of Dillon beyond the age

of majority. Typically, most young adults are not able to manage an inheritance. A testamentary

trust can be created to distribute the Brights’ estate to Dillon at different ages, beyond the age

of majority.

For example, some parents will leave their children 1/3 of their estate at age 21, 1/3 of their

estate at 27, and the remaining balance at age 30. A trustee can be given discretion to distribute

more of the estate to Dillon for important events in his life, like pursuing higher education.

In order to reduce probate fees on the estate, Greg should name Janice the direct beneficiary of

his RRSP and all assets should be jointly held. Joint assets can be rolled over on a tax-deferred

basis to a spouse, if the assets are transferred at the deceased spouse’s adjusted cost base.

Greg owns a U.S. condo that could be subject to inheritance tax upon your death. He should

speak with a US tax specialist to confirm whether such a tax is in fact payable.

Question 8: Risk Analysis

Instructions: Advise Greg on the best form of insurance in the event that he becomes disabled as a

self-employed individual. Ensure that you consider the nature of his profession, his income needs and

variability of income in considering suitable forms of insurance and features.

Since Greg is a highly specialized professional, it is unlikely that he will be able to earn the same

level of income in another profession.

Therefore, it is advisable for Greg to purchase “own occupation” insurance, which will pay him

replacement income in the event that he is unable to perform the duties of his occupation, even

if he can be employed in another capacity.

The alternative form of insurance is “any occupation”, which will only pay Greg replacement

income if cannot perform the function of any occupation, not just his own.

The greater benefit of “own occupation” insurance should be weighed against the higher

premiums charged for this type of insurance as compared to “any occupation” insurance.


Greg might consider a relatively short elimination period due to the fact that he is the only

income earner. Typically, the shorter the elimination period, the greater the insurance cost.

Therefore, in determining a suitable elimination period, Greg should consider that he has an

emergency reserve to cover 10 months of expenses. If he chooses a longer elimination period,

he can cover his expenses with his emergency reserve until he begins to receive disability

payments. Alternatively, if he chooses a short elimination period, he might not need as much of an

emergency reserve, so that the excess funds can be invested at higher rates of return to achieve

longer term goals.

Additional forms of business insurance that might be useful to an entrepreneur, such as business

overhead and key person, are likely unsuitable for Greg since his operating expenses are minimal

and he is unlikely to find someone to replace him given the specialized nature of his occupation.

Question 9: Investment Management

Instructions: Advise the Brights on the suitability of their current investment strategy given the changes

in Greg’s employment and family situation, as well as their retirement goals. In your answer, you should

evaluate the suitability of strategic and tactical asset allocation for their specific situation.

Strategic asset allocation would be the most suitable investment strategy for the Brights in

retirement.

A strategic asset allocation mix takes into consideration the Brights’ risk tolerance and required

investment return to meet their income needs.

Tactical asset allocation, which is currently used in the Brights’ portfolio, should be discontinued

given the risk that it adds to the portfolio.

A tactical asset mix overweighs a specific asset class or sector in anticipation of capturing

outperformance.

However, the portfolio manager’s outlook may be incorrect or take longer than anticipated to

materialize, thereby increasing portfolio volatility.

Increased portfolio volatility can create permanent losses if retirement income is withdrawn

from capital rather than investment income.

Given that the Brights are only 7 years away from retirement, a relatively short investment time

horizon; it is advisable that the portfolio be rebalanced back to the strategic mix now to reduce

portfolio volatility.

Additionally, a new risk tolerance assessment should be done to determine whether the strategic

asset mix is still suitable, given the change in Greg’s employment and the short time remaining to

retirement.

Documents

APPLIED FINANCIAL PLANNING CERTIFICATION EXAMINATION