current trends and issues in financial planning 2007 edition

Current Trends and Issues in Financial Planning

2007 Edition

Roxanne Eszes, CFPCleartech Documentation & [email protected]

2007 Edition CE CourseOver 140 pages of new material

Consolidates new developments in one place

Covers a wide range of topics across the CFP syllabus

Qualifies for 12 CE hours with exam

20 question M/C exam

– circle responses on answer sheet (optional)

– go online at www.cifps.ca to submit answers

– obtain a score of 12 out of 20

Course Highlights

Professional Practice Update

– FPSC Competency Profile

– ISO Standards for Financial Planning

More Course Highlights

Economic Update

– Review of Canada’s economic framework

– Recent Canadian economic developments

– External influences

– Overseas economic developments

– Risks to Canada’s economic outlook


Personal Finance Update

– Recent statistics on consumer spending

– Statistics on current trends in inflation, mortgage rates, bond yields, etc.


Personal Finance Update

– Residential Mortgages

• Interest-only mortgages

• 30, 35 and 40-year mortgages

• High-ratio mortgages


Income Tax Update

– Federal personal income tax parameters for 2007

– Synopsis of proposals from Budget 2007 the Tax Fairness Plan (October 2006) of interest to CFPs


Some general tax changes include:

– Working income tax benefit for low-income Canadians

– Tax measures for persons with disabilities

– Charitable donations to private foundations

– Registered Education Savings Plans

– Elementary and secondary school scholarships


More general tax changes

– Child tax credit

– Public transit tax credit

– Lifetime Capital Gains Exemption

– Children’s Fitness Tax Credit

– Changing CCA rates

– Reducing general corporate tax rate


Retirement Planning Update

– Enhanced age credit

– Pension splitting

– Phased retirement

– Age limits for maturing RRSPs and RPPs

– RRSP qualified investments


Retirement Planning Update

– Life Income Funds• Minimum and maximum withdrawals

Annuitization requirements

– Unlocking Pension Funds

– Ending Mandatory Retirement


Investment Planning Update

– Income Trusts

• Enhanced dividend tax credit

• Taxation of income trusts and other flow-through entities (e.g., partnerships)

– Systematic Withdrawal Plans

• Regular SWPs

• T-funds

• Guaranteed Minimum Withdrawal Benefits (GMWBs)

Today’s Presentation

Residential mortgages

RESPs

RDSPs, CDSGs, CDSBs

Pension Splitting

Systematic Withdrawal Plans

Housing Prices

Location 2002 Price 2007 Price 5-year Increase

Vancouver (north)

$360,000 $630,000 75%

Calgary (west) $196,000 $545,000 178%

Regina $110,000 $167,000 52%

Mississauga $265,000 $329,000 24%

Montreal (St. Laurent)

$175,000 $265,000 51%

Halifax $172,000 $222,000 29%

Mortgage Industry Response

Interest-only mortgages

Longer amortization periods

New mortgage insurance policies

Interest-only Mortgages: The BasicsLow monthly payments for a period

of time (usually 5 to 10 years)

Homeowner must qualify at the higher principal plus interest payment level

Example

Linda has $200,000 mortgage:

– at 5.5% amortized over 25 years payments would be $1,228 /month

– Interest-only would be $917 /month

– “Savings” of $311 /month

– Her ability to qualify would be based on payments of $1,228 per month

Interest-only Mortgages: RisksWhat if market declines?

– Asset value could decline but amount owing doesn’t change, even after paying thousands in interest

– With interest-only mortgage, Linda would pay interest of $55,000 over the five years, but would still owe $200,000

– With standard 25-year amortization and P&I payments, mortgage balance would be $178,000

After the Interest-only Period

Converts to a standard mortgage, with balance of amortization– 5 years interest only, then 20 year

amortization– 10 years interest only, then 15 year

amortization

This could result in 50% increase in payments (Example: $200,000 at 5.5% over 20 years $1,376, compared to interest-only of $917)

Who Offers Them?

So far, not the big banks

Available through mortgage brokerage firms

Who Uses Them?Most suited for high net-worth real

estate investors

Interest expense on investment property is deductible, interest expense on personal property is not

Not really suitable for first-time homebuyers

Possible exception of young professional couples with one person on temporary leave for school or children, and in rising house market

30, 35 and 40-year Mortgages

Allow people to

– Enter housing market earlier

– Reduce their monthly payments to free up cash flow

– Make the same level of payments, but buy a more expensive home

Downsides of Longer Amortization

Expensive!

Delays that point in time where mortgage is paid off and the client can divert surplus income to other financial objectives

Payments could continue on into retirement

Ex: Linda with $200,000 at 5.5%Amortization Monthly

Payment

$

Total Interest

$

Total Cost

$ % of Purchase Price

15 years 1,634 94,151 294,151 147%

20 years 1,376 130,185 330,185 165%

25 years 1,228 168,451 368,451 184%

30 years 1,136 208,809 408,809 204%

35 years 1,074 245,721 445,721 223%

40 years 1,032 271,449 471,449 236%

Who Offers Them?

Some of the big banks through mortgage brokers

Other financial institutions like Wells Fargo and ING Direct

Who Uses Them?

Young new homeowners are attracted because they seem affordable…but they need to be made aware of the costs!

More suitable for real estate investors who can deduct the interest expense

High-ratio Mortgages

Homeowners without the required down payment (used to be 25%) are required to buy mortgage insurance

Approximately 40% of all new home purchasers fell into this category in September 2006

Banking legislation in November 2006 reduced the required down payment to avoid insurance to 20%

Mortgage Insurance Providers

CMHC used to be the sole provider

Now at least 4 others, and this has led to competition, innovative structures and reduced premiums

Introduction of risk-based pricing– premiums used to be based on size of

loan– now credit history is being factored in

Mortgage Insurance Surcharges

Longer Amortization Periods– 0.20% on 30-year amortizations– 0.40% on 35-year amortizations

Interest-only Mortgages– 0.25% for a 5-year interest-only period– 0.50% for a 10-year interest-only

period

Mortgage Strategies to StressDon’t necessarily max out on the pre-

approved amount

Try to avoid mortgage insurance by having the minimum 20% down payment

Choose the shortest amortization period affordable

Try to make extra lump-sum payments of 10% to 20% as terms permit

Choose twice a month or bi-weekly payments over monthly payments

RESP Proposals

$4,000 annual RESP contribution limit will be eliminated

Lifetime limit of $42,000 will be increased to $50,000

What this Means…

Parents who have neglected RESPs can still contribute the maximum even if child is only a few years away from school

– not ideal, because less time for compounding

– at least the income will be tax sheltered, and taxed in the hands of the student

CESG Proposals

New CESG room each year will increase from $2,000 to $2,500

Lifetime CESG limit of $7,200 is unchanged

Maximum annual grant is $500 (20% of $2,500), or up to $1,000 if the beneficiary has sufficient carry forward room

What this Means…

Parents who haven’t taken advantage of CESGs can catch-up more quickly

Lifetime CESG limit of $7,200 requires contributions of $36,000

– CESG only payable on the first $5,000 each year (assuming contribution room)

– To take maximum advantage of CESG, start no later than the year child turns 10, spread the $36,000 over 8 years, with max contribution in any one year of $5,000

RESPs for Adults

Adults who plan to return to school can make annual contributions or a lump-sum deposit totaling $50,000

Investment income will be sheltered

EAPs taxable during school, when marginal rate is lower– EAPs payable are limited to $5,000 before

the individual has completed 13-weeks of full-time consecutive study (or $2,500 for each part-time semester)

Registered Disability Savings Plan (RDSP)Tax-sheltered savings plan for persons

eligible for the DTC

Designed like RESPs

Can be established by DTC-eligible person, or their parent or guardian

DTC-eligible individual is the beneficiary

Available in 2008

RDSP Contribution Limits

No annual limit

Lifetime limit of $200,000 for the beneficiary

No restrictions on who can contribute

Contributions permitted until beneficiary turns 59 (end of year)

Canada Disability Savings Grant (CDSGs)Government matches contributions to

RDSPs

Family Net Income

Up to $74,357 Over $74,357

300% on first $500 annually

100$ on first $1,000 annually

200% on next $1,000 annually

CDSGs, continued

Lifetime limit of $70,000 per beneficiary

Can receive CDSGs until the end of the year that the beneficiary turns 49 years of age

There is no carry forward of CDSG room, so contributions should be spread over time

Canada Disability Savings Bond (CDSB)CDSB of up to $1,000 will be paid annually to

RDSP of a low or modest-income beneficiary

CDSBs are not contingent on contributions

Maximum CDSB paid when family net income does not exceed $20,883

Phased out for incomes between $20,883 & $37,178

Lifetime limit of $20,000 of CDSBs per beneficiary

Payable until age 49

Tax Treatment

Contributions are not tax deductible

Investment income accrues tax free while in plan

When beneficiary makes RDSP withdrawal, the taxable portion includes:– investment income– CDSGs and CDSBs– NOT contributions

Payments from an RDSP

Must start by age 60 (end of year)

Maximum withdrawals (details yet to be specified)

Contributors cannot receive a refund of contributions, only beneficiary may benefit

Repayments of CDSGs and CDSBs (and associated income) may be required upon death or cessation of disability

Pension Splitting/Eligible Pension IncomeTax Fairness Plan of October 31, 2006

proposed sharing of up to 50% of eligible pension income

Decision to share must be done annually, it is not automatic

Both spouses must consent

May have to plan to create eligible pension income

Eligible pension income does not include CPP or OAS benefits

Eligible Pension Income Before 65

Life annuity payments from an RPP

Full amount of annuity payments from an RRSP, RRIF or DPSP, but only if the payments are a result of death of taxpayer’s previous spouse, and taxpayer has remarried

Income component of unregistered annuity payments, under same conditions as above

Only planning opportunity is perhaps to take early retirement under RPP

Eligible Pension Income After 65

Term or life annuity payments from a registered pension plan (RPP)

Creation Opportunities

– Payments from a term or life annuity purchased with funds from an RRSP or DPSP

– Withdrawals from a RRIF, LIF or LRIF

– Income element of an unregistered annuity payment

Systematic Withdrawal Plans (SWPs)Regular SWPs involve a systematic

redemption of mutual fund units

Investor can change withdrawals as needed

Redemption can result in capital gains– 50% taxable outside of registered plan– 100% taxable if coming out of RRSP

T-FundsT-version of mutual fund or T-SWPs

Distributes a pre-determined % of assets each year

Distribution % is set by company, not investor

Distribution % does not equal return

Some companies allow customization of cash flow by switching between T-Fund and non-T-fund

Taxation of T-Funds

A large portion of each distribution is a return of capital (tax efficient)

Reduces ACB

Increases capital gain upon disposition (deferral until then)

Distribution in excess of return of capital retains character as interest, dividends, capital gains

More Taxation of T-Funds

Advantages are lost within RRSP because 100% of distributions are taxable

Return of capital is not income for purpose of calculating OAS clawback

Great choice for charitable giving because capital gains inclusion rate is 0%

Guaranteed Minimum Withdrawal Benefits (GMWBs)Insurance version of T-funds

A segregated fund with a guaranteed income stream, instead of maturity guarantee

Guaranteed 5% a year for 20 years

Deferral bonus of 5% a year for up to 10 years– Could increase distributions by 50%

GMWBs, continued

Three-year reset to lock in growth

Withdrawals in excess of the 5% will reduce future guaranteed payments

Death benefit guarantees still apply (75% or 100%)

GMWBs, continuedIncome is only guaranteed for 20 years,

not life

Fees are higher than for mutual funds– 0.25% to 0.35% more for fixed income funds– 0.55% to 0.75% more for balanced or equity

funds

Minimum investment is $25,000 to $50,000

Payments are treated as regular seg fund redemptions

Estate planning and creditor protection benefits

current trends and issues in financial planning 2007 edition

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