Current Trends and Issues in Financial Planning 2006 Edition

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Current Trends and Issues in Financial
Planning2006 Edition

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• Roxanne Eszes, CFP
• Cleartech Documentation Training
• cleartech_at_sympatico.ca

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2006 Edition CE Course

• Over 160 pages of new material
• Consolidates new developments in one place
• Covers a wide range of topics across the CFP
  syllabus
• Qualifies for 10 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

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Course Highlights

• Professional Practice Update
• FPSC Practice Standards now in force
• What happened to Fair Dealing Model?
• CSAs Registration Reform Project

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More Course Highlights

• Economic Update
• Review of Canadas economic framework
• Recent Canadian economic developments
• External influences
• Risks to Canadas economic outlook

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More Course Highlights

• Personal Finance Update
• Recent statistics on consumer spending
• Statistics on current trends in inflation,
  mortgage rates, bond yields, etc.

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More Course Highlights

• Income Tax Update
• Federal personal income tax parameters for 2006
• Synopsis of 2005 and 2006 Budget proposals of
  interest to CFPs

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More Course Highlights

• Retirement Planning Update
• Creditor protection for RRSPs upon bankruptcy
• Pension funding concerns
• Capital Accumulation Plan (CAP) Guidelines now in
  force opportunities for CFPs?
• New stats on retirement life expectancies from
  OAS study

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More Course Highlights

• Investment Planning Update
• Structured Products
• Closed-end funds
• ETFs
• Principal protected notes (PPNs)
• Split Share corporations
• Income trust developments
• LSIF developments

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Todays Presentation

• Income Tax Changes (Budget 2006 and others)
• Principal protected notes
• Split share corporations

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Basic Personal Amount

• 2005 Update increased 2005 BPA by 500 to 8,648,
  with proposals to increase to 10,000 by 2009
• Budget 2006 confirmed 2005 BPA after the fact,
  8,639 for 2006, increase to at least 10,000 by
  2009
• Similar path for spousal amount, to reach at
  least 8,500 by 2009

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Lowest Federal Tax Rate

• 16 in 2004
• Liberals cut this to 15 in 2005
• Conservatives increased it to 15.25 in 2006
• 15.5 in 2007 and later years

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Middle and Top Tax Brackets

• Budget 2005 proposed reductions of 1 to the 2
  middle brackets (22 to 21, 26 to 25, plus an
  increase in the income threshold for the 29
  bracket
• Never passed into law
• Budget 2006 was silent, so these changes are off
  the table

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Child Disability Benefit (CDB)

• Budget 2006 increased CDB to 2,300 effective
  July 2006
• Reduced the phase-out rate for family net income
  in excess of 36,378 from 12 to just 2 (for one
  child)
• Effect is benefits will be available to middle
  and high income earners (up to family income of
  150k plus)
• Corresponding changes for families with 2 or 3
  children eligible for the CDB

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Universal Child Care Benefit (UCCB)

• 100 per month (1,200 per year), starting July,
  2006
• For all children under 6 years old
• Taxable to lower-income spouse
• Enhancement to Canadian Child Tax Benefit of 249
  for kids under 7 in low income families will be
  eliminated

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GST Reduction

• From 7 to 6, July 1, 2006
• No change to GST credit
• No change to GST rebates on new housing
• For house sales where offer was made before May
  2, but closing is after July 1, GST of 7 must be
  paid, but purchaser will get 1 rebate

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Donations of Capital Property

• Taxpayer deemed to dispose at FMV, resulting in
  capital gain
• Donations of publicly listed securities already
  eligible for 25 inclusion rate
• Budget 2006 makes inclusion rate 0
• Also applies to shares acquired via employee
  stock option plans (ESOPs), and environmentally
  sensitive land

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Donations, continued

• 0 inclusion rate, plus charitable donations tax
  credit tax planning opportunities
• Pick and choose what you donate versus what you
  liquidate for your own cash flow
• Donate a portion of the stock you want to
  liquidate, and use the resulting charitable tax
  credit to offset taxes on the remainder

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Dividends from Large Corps

• Ordinary dividends grossed up to 125, then
  13.33 tax credit
• Enhanced scheme will see eligible dividends
  grossed up to 145, then 19 tax credit
• Applies beginning 2006
• Eligible dividends are generally from public
  corporations, resulting from income subject to
  the general corporate income tax rate

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Dividends, continued

• Also can apply to small business income in excess
  of small business limit
• IF provinces come onside, and the corporate tax
  rates are reduced to 19 as proposed, this will
  result in full integration of personal and
  corporate tax systems
• Tax comparable to income trusts

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Dividends, Tax Planning

• The gross up to 145 will affect income-tested
  clawbacks, like OAS, because net income includes
  grossed-up dividend amount
• Small business owners will no longer need to
  bonus down to the small business limit

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Tax Grab Bag

• Canada Employment Credit (2006)
• 15.25 of 250 in 2006 38.13
• 15.5 of 1,000 in 2007 155.00
• Self-employed people would have to incorporate
  and become employees to receive this

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Tax Grab Bag

• Tools Tax Deduction (after May 2, 2006)
• tools required by employer, over 1,000 but under
  1,500 max. 500 deduction in any one year
• Textbook Tax Credit (2006)
• 15.25 of eligible amount
• 65/month full time study, 20/month part time
  study
• max credit of 9.91/month or 118.95/year
• transferable, like education and tuition amounts

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Tax Grab Bag

• Scholarship income (2006)
• Full amount tax free (used to be only first
  3,000)
• Mineral exploration expenses tax credit
• 15 of expenses passed on through flow-through
  shares (agreements after May 2, 2006 but before
  March 31, 2007)
• Pension credit (2006)
• pension income amount increased from 1,000 to
  2,000 new credit of 152.50 for 2006

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Tax Grab Bag

• Childrens Fitness Tax Credit (2007)
• 15.50 on up to 500 of eligible expenses tax
  savings of 77.50
• Public Transit Passes (July 1, 2006)
• 15.25 on cost of monthly or annual transit
  passes
• Adoption Expenses Tax Credit (2005)
• 15 on up to 10,000 (2005), indexed
• only in year adoption is finalized

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Tax Measures for Disabled

• Expanded eligibility for DTC, and thus for the
  disability supports deduction
• Expanded eligible expenses for disability
  supports deduction, or the medical expenses tax
  credit
• Clarified eligible medical expenses (no more hot
  tubs)
• Caregivers can claim METC on 10,000 of expenses
  for dependent relatives (used to be 5,000)

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Business Income Tax Changes

• General Corporate Tax Rate
• Full-rate taxable income currently taxed at 31
  less 10 provincial abatement 21
• Reduce this to
• 20.5 on Jan. 1, 2008
• 20 on Jan. 1, 2009
• 19 on Jan. 1, 2010
• Eliminate corporate surtax of 4 of federal tax
  for all corporations, effective Jan. 1, 2008

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Business Income Tax Changes

• Small Business Limit
• Deduction reduces tax rate on first 300,000 of
  active business income to 12
• Limit to increase from 300,000 to 400,000
• Must still be shared between associated
  corporations

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Business Income Tax Changes

• Small Business Tax Rate
• Rate to decrease from 12 to
• 11.5 in 2008
• 11.0 in 2009
• Non-capital Losses and ITCs
• Carried back 3 years
• Carried forward 20 years (up from 10 years), to
  be deducted from all sources of income

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Principal Protected Notes

• Combine exposure to underlying securities with a
  principal guarantee
• Maturity 7 to 11 years
• Sold via offering memorandum
• Trade on exchange or secondary market facilitated
  by issuers
• 43 issues on the TSX

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PPN Guarantee Structures

• Zero coupon bonds 60 to 70 of investors
  capital, depending on term to maturity and
  interest rates
• Leaves only 30 to 40 of the capital for
  underlying investments
• PPNs are most attractive when prevailing interest
  rates are lowbut this means the price of zero
  coupon bond increases, and less is available for
  investment
• Use leverage, including loans and call options,
  to enhance returns

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PPN Guarantee Structures

• Constant Proportion Portfolio Insurance

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PPNs CPPI

• Difference between current value of portfolio and
  notional strip value is the cushion, expressed
  as a of original portfolio value
• This , along with an allocation grid, determines
  the allocation to underlying assets
• Requires constant supervision and quick action if
  things go sour

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PPNs CPPI Allocation Grid
Cushion ( of original PPN assets) Allocation to Underlying Assets Allocation to Strip Bond
40 200 0
40 lt50 150 0
30 lt 40 100 0
20 lt 30 75 25
15 lt 20 50 50
10 lt 15 25 75
5 lt 10 15 85
0 lt 5 10 90
lt 0 0 100
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PPNs Underlying Investments

• Originally (1992) used well know stock market
  indices
• Progressed to broader indices
• Mutual funds and foreign markets in late 1990s
• During last 5 years income trusts, hedge funds,
  commodities, futures, options, other derivatives
• Minimum investment of about 5,000 gives
  investors access to hedge funds, etc.

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PPNs - Trading

• Many trade on an exchange, but could trade at
  less than NAV
• Others trade via secondary market, via FundSERV
• Some offer redemptions on specified dates
  (monthly)
• Early redemption fees or deferred sales charges
  may applyas much as 7
• Redemption fees calculated either as of
  original investment or NAV
• Each PPN is unique, so ask before buying

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PPNs Performance Caps

• Gains may be capped, either annually or
  cumulatively
• Annual caps can be particularly disadvantageous
• Good performance is capped, bad performance isnt
• One bad year can wipe out earlier capped years,
  lowering compounded annual return
• Some PPNs are callable

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PPNs - Fees

• PPNs repackage mutual funds, hedge funds, etc.,
  which have their own fees
• PPNs add another layer, could include
• Sales charges (4 to 7)
• Risk transfer and management fees (1)
• Advisory fees (1.5 to 3 of investment exposure)
• Incentive fees (10 to 20 of growth)
• Swap fees (0.2), Servicing fees (0.65)
• Redemption fees (up to 5)

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PPNs Risks Despite Guarantees

• Inflation Risk !!!
• Credit risk not covered by CDIC
• Investment risk
• Liquidity and marketability risks
• Leverage can magnify losses
• Lack of disclosure

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PPNs - Taxation

• Investors generally dont receive payments until
  maturity
• Accrued interest
• must be reported annually
• interest is only accrued if it is certain to be
  paid
• Payments at maturity
• Excess of amount received over investment (less
  accruals) is taxed as interest income
• Disposition prior to maturity
• Difference between proceeds (less accrued
  amounts) and cost results in capital gain/loss

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Do-it-yourself PPNs

• Invest a portion of your capital in a strip bond
• Use the balance to purchase investments of your
  choice
• Advantages
• Lower fees
• Greater transparency
• Greater liquidity
• Disadvantages
• Investment knowledge
• Not all investments are accessible (e.g. hedge
  fund minimum purchase limits)
• Must accrue interest income on the strip annually

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Split Share Corporations

• Mutual fund corporation that issues 2 types of
  shares capital and preferred
• Each type issued in equal numbers
• Each pairing (1 capital 1 preferred) 1 Unit
• Initial offering price of capital and preferred
  shares can be different
• Afterwards both shares trade on exchange

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Split Share Portfolio Investments

• First split share corps invested in a single
  underlying company (20 years ago)
• Now invest in common shares of more than one
  company, usually in the same industry
• 5Banc Split Corp 5 big Canadian banks
• Financial 15 Split II Corp 15 banks and
  insurance companies (Canada and US)

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Split Share Preferred Shares

• Receive fixed cumulative dividend Return of
  capital upon maturity
• Sometimes Corp has to sell underlying assets to
  pay these dividends return of capital
• Do not share in capital growth of underlying
  assets
• Have first claim on assets upon maturity

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Split Share Capital Shares

• Exposure to the capital appreciation of
  underlying investments
• May benefit from an increase in dividends paid by
  underlying investments
• Dividends earned in excess of preferred
  shareholders entitlement are paid to capital
  shareholders to avoid tax within the Corp.

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Split Share Corps - Leverage

• Built-in, low-cost leverage
• Preferred shareholders get access to twice the
  dividends they would have received by investing
  in underlying shares directly
• Capital shareholders get exposure to twice the
  capital growth of underlying shares
• No interest charges or margin calls

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Split Shares Option Writing Income

• Many split share corporations try to boost
  returns by selling covered call options on
  underlying stock
• Premiums accrue to capital shareholders
• If options are exercised, the corporation will
  forego future capital appreciation

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Split Shares Redemptions upon Termination

• Corporation terminates after 5 or 10 years
• Sells underlying investments
• Distributes proceeds (net of expenses)
• preferred shareholders get first claim, return of
  original investment
• balance goes to capital shareholders

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Split Shares - Retractions

• Most corporations provide for periodic
  retractions/redemptions
• Must maintain an equal number of preferred and
  capital shares outstanding
• Retraction of preferreds is conditional on corp.
  being able to buy capital shares in secondary
  market, and vice versa

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Split Shares - Fees

• Front-end sales charges (3 to 6), may differ
  for preferred and capital shares
• Retraction fees (0 to 5 of NAV)
• Administration fee paid to manager
• Base management fee paid to manager
• Performance fee paid to manager
• Service fee paid to dealer
• Initial offering expenses, ongoing operating and
  administration expenses

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Split Shares Risk Factors

• Leverage magnifies losses as well as gains
• Interest Rates if interest rates rise, value of
  preferred shares will decrease
• Market and Economic Risks affect performance of
  underlying shares
• No voting rights
• Lack of diversification
• Call options may be no market for them, may
  result in foregoing capital appreciation

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Split Shares - Taxation

• Ordinary dividends subject to gross up and tax
  credit scheme
• Return of capital not taxable, but reduces
  investors ACB
• Capital gains/losses prior to maturity
• If corp. sells underlying investments prior to
  maturity, capital gain will be allocated to
  capital shareholders. If no cash is distributed,
  this will increase investors ACB
• Losses cannot be distributed
• Capital gains/losses at maturity normal rules
  apply