Current Trends and Issues in Financial Planning 2006 Edition

1. This presentation will probably involve audience discussion, which will create action items. Use PowerPoint to keep track of these action items during your presentation • In Slide Show, click on the right mouse button • Select “Meeting Minder” • Select the “Action Items” tab • Type in action items as they come up • Click OK to dismiss this box • This will automatically create an Action Item slide at the end of your presentation with your points entered. Current Trends and Issues in Financial Planning2006 Edition Roxanne Eszes, CFP Cleartech Documentation & Training cleartech@sympatico.ca

2. 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

3. Course Highlights • Professional Practice Update • FPSC Practice Standards now in force • What happened to Fair Dealing Model? • CSA’s Registration Reform Project

4. More Course Highlights • Economic Update • Review of Canada’s economic framework • Recent Canadian economic developments • External influences • Risks to Canada’s economic outlook

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

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

7. 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

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

9. Today’s Presentation • Income Tax Changes (Budget 2006 and others) • Principal protected notes • Split share corporations

10. 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

11. 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

12. 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

13. 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

14. 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

15. 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

16. 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

17. 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

18. 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

19. 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

20. 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

21. 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

22. 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

23. 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

24. Tax Grab Bag • Children’s 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

25. 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)

26. 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

27. 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

28. 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

29. 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

30. 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 low…but 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

31. Value of PPN’s assets Principal Guarantee Notional Strip Value or Floor Time Maturity PPN Guarantee Structures • Constant Proportion Portfolio Insurance

32. 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

33. PPNs – CPPI – Allocation Grid

34. 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.

35. 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 apply…as much as 7% • Redemption fees calculated either as % of original investment or NAV • Each PPN is unique, so ask before buying

36. PPNs – Performance Caps • Gains may be capped, either annually or cumulatively • Annual caps can be particularly disadvantageous • Good performance is capped, bad performance isn’t • One bad year can wipe out earlier capped years, lowering compounded annual return • Some PPNs are callable

37. 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%)

38. 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

39. PPNs - Taxation • Investors generally don’t 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

40. 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

41. 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

42. 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)

43. 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

44. 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.

45. 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

46. 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

47. 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

48. 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

49. 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

50. 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