Wme Txt-Vol01-2022 12 en V01 Wcag

VOLUME 1
WEALTH MANAGEMENT
ESSENTIALS
Credentials that matter. ®

THE CANADIAN SECURITIES INSTITUTE
The Canadian Securities Institute (CSI) has been setting the standard for excellence in life-long education for
financial professionals for more than 45 years. CSI is part of Moody’s Analytics Training and Certification Services,
which offers education programs and credentials throughout the world.
Our experience training over 800,000 global professionals makes us the preferred partner for individuals, financial
institutions, and regulators internationally. Our expertise extends across the financial services spectrum to include
securities and portfolio management, banking, trust, and insurance, financial planning and high-net-worth wealth
management.
• CSI is a thought leader offering real world training that sets professionals apart in their chosen fields and
helps them develop into leaders who excel in their careers. Our focus on exemplary education and high ethical
standards ensures that they have met the highest level of proficiency and certification.
• CSI partners with industry regulators and practitioners to ensure that our programs meet the evolving needs
of the marketplace. In Canada, we are the primary provider of regulatory courses and examinations for the
Investment Industry Regulatory Organization of Canada (IIROC). Our courses are also accredited by the
securities and insurance regulators.
• CSI grants leading designations and certificates that are a true measure of expertise and professionalism.
Our credentials enable financial services professionals to take charge of their careers and expand their skills
beyond basic licensing requirements to take on new roles and offer broader services.
• CSI is valued for its expertise, not only in the development of courses and examinations, but also in their
delivery. CSI courses are available on demand in a variety of formats, thus enabling anytime, anywhere
learning. We are continually leveraging new technology and pedagogical tools to meet the changing needs
of learners and their organizations.
TELL US HOW WE’RE DOING
At CSI, we make every effort to ensure that what you learn is accurate, practical, and well written, and we update
our courses regularly. However, we recognize that there is always room for improvement, so please let us know
what you think. Your feedback counts in helping us keep our learning content fresh and accurate. You can submit
comments, suggestions, or concerns to learning_support@csi.ca
© CANADIAN SECURITIES INSTITUTE

WEALTH MANAGEMENT ESSENTIALS
VOLUME 1
PREPARED &
PUBLISHED BY CSI
200 Wellington Street West, 15th Floor • Toronto, Ontario M5V 3C7
625 René-Lévesque Blvd West, 4th Floor • Montréal, Québec H3B 1R2
Telephone 416 • 364 • 9130 Fax 416 • 359 • 0486
Toll-Free 1 + 866 • 866 • 2601 Toll-Free Fax 1 + 866 • 866 • 2660
Website www.csi.ca
Credentials that matter.®

Copies of this publication are for the personal use Notices Regarding This Publication:
of properly registered students whose names are This publication is strictly intended for information
entered on the course records of the Canadian and educational use. Although this publication is
Securities Institute (CSI)®. This publication may not designed to provide accurate and authoritative
be lent, borrowed or resold. Names of individual information, it is to be used with the understanding
securities mentioned in this publication are for the that CSI is not engaged in the rendering of financial,
purposes of comparison and illustration only and accounting or other professional advice. If financial
prices for those securities were approximate figures advice or other expert assistance is required, the
for the period when this publication was being services of a competent professional should be
prepared. sought.
Every attempt has been made to update securities In no event shall CSI and/or its respective suppliers
industry practices and regulations to reflect be liable for any special, indirect, or consequential
conditions at the time of publication. While damages or any damages whatsoever resulting from
information in this publication has been obtained the loss of use, data or profits, whether in an action
from sources we believe to be reliable, such of contract negligence, or other tortious action,
information cannot be guaranteed nor does it arising out of or in connection with information
purport to treat each subject exhaustively and should available in this publication.
not be interpreted as a recommendation for any
specific product, service, use or course of action. CSI © 2022 Canadian Securities Institute
assumes no obligation to update the content in this All rights reserved. No part of this publication may
publication. be reproduced, stored in a retrieval system, or
transmitted in any form by any means, electronic,
A Note About References to Third Party Materials:
mechanical, photocopying, recording, or otherwise,
There may be references in this publication to third without the prior written permission of CSI.
party materials. Those third party materials are not
under the control of CSI and CSI is not responsible
for the contents of any third party materials or for
any changes or updates to such third party materials.
CSI is providing these references to you only as a
convenience and the inclusion of any reference does
not imply endorsement of the third party materials.
Identifiers:
ISBN 978-1-77176-558-9 (print)
ISBN 978-1-77176-559-6 (ebook)
First printing: 2006
Revised and reprinted: 2008, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017, 2018, 2019, 2020, 2021, 2022
Copyright © 2022 by Canadian Securities Institute

Course Introduction
THE WEALTH MANAGEMENT ESSENTIALS COURSE
Congratulations on embarking on the Wealth Management Essentials (WME) course! Your successful completion
of the WME fulfills the 30-month post-registration proficiency requirement for investment advisors, as set out
by the Investment Industry Regulatory Organization of Canada (IIROC). The WME is a significant milestone on
the educational path toward the Personal Financial Planner (PFP®) and the Certified Financial Planner (CFP®)
designations. It is also a first step toward earning the prestigious Certified International Wealth Management
(CIWM) designation and a key component of CSI’s Chartered Investment Management (CIM) designation. The CIM
meets the proficiency standards required to be registered as a portfolio manager in Canada by both IIROC and the
Canadian Securities Administrators.
WHAT IS THE BIG PICTURE?

Prior to the mid-2000s, IIROC’s investment advisors needed to complete either a financial planning course or an
investment management course as part of their 30-month post-registration requirement. The choice was based on
how each individual advisor (or the advisor’s firm) wanted to position his or her practice.
The investment industry gradually evolved toward building deeper advisor–client relationships and taking a more
integrated and holistic approach to managing their clients’ wealth. Around mid-2000, it became apparent that the
post-registration requirement had to change to help advisors make the transition to this new model of advising.
Thus, an industry-wide education committee worked with CSI to assess the previous financial planning and
investment management courses and identify the new elements that had to be integrated in the new post-
registration requirement course. The result was a new course designed to provide the necessary knowledge and
skills: the WME course.
At the same time, CSI began to develop, and ultimately introduced, the CIWM designation to build the foundational
wealth management knowledge of the WME. The CIWM designation provided more advanced courses covering the
life and planning issues that clients (particularly high net worth clients) experience during the four major life stages:
wealth accumulation, wealth preservation, wealth conversion, and wealth transfer.
Much more than a mere end point to meet a regulatory requirement, the WME course provides the foundation from
which you can begin to gain more advanced certifications in financial planning, investment management, or wealth
management. The WME represents the early stages of a learning continuum that ultimately can provide advisors
with more specialized knowledge and skills to better meet the needs of their clients.

ii WEALTH MANAGEMENT ESSENTIALS VOLUME 1
WHAT WILL YOU LEARN?

As mentioned, the WME course provides students with a holistic approach to wealth management. It covers two
key areas of knowledge: financial planning and investment management. The two topics are addressed respectively
in Volumes 1 and 2.
In Volume 1, the course begins with an introduction to the wealth management environment, the industry, the
regulatory landscape, and ethical standards. From there, the course moves through the different areas of financial
planning, covering such topics as getting to know the client, budgeting and saving, borrowing, family law, personal
risks, taxation, retirement planning, and estate planning.
In Volume 2, the course focuses on the management of investments and concepts related to investment
management, asset allocation, equities and debt securities, managed products, and portfolio monitoring and
performance.
Some chapters also use the KPMG Tax Planning for You and Your Family guide (KPMG guide) as part of the
examinable course material. The KPMG guide is complementary and is part of the readings for Volume 1.
IMPORTANT MESSAGE
Some content in the WME textbook is also covered in the KPMG guide, in some cases in greater detail. We
strongly recommend that you study the content in the KPMG guide in addition to the textbook, because they
both contain examinable content.
For examination purposes, if the WME textbook differs from the KPMG guide in any respect, precedence will be
given to the WME content.
KEY CHAPTER FEATURES

Each chapter is organized around the following key learning features:
Icons Features Description
Learning Objectives The learning objectives show what you will be able to accomplish after
studying the chapter. Be sure to read the learning objectives before you
begin a chapter.
Key Terms Understanding the terminology and jargon of the financial planning
industry is an important part of your success in this course. To help in this
regard, we provide a list of key terms at the start of each chapter. Each term
is boldfaced in the chapter to help you focus your study efforts effectively.
Online Learning Each chapter has learning activities accompanying the text that are
Activities available online. To access the online components of your course, log in to
your Student Profile at www.csi.ca.
Did You Know? This feature provides important information, including facts, statistics,
clarifications, and insights, that support the chapter content. Make sure
you read the concise material covered in the Did You Know? feature to keep
your knowledge up to date and be fully prepared to write your exams.

COURSE INTRODUCTION iii
Icons Features Description

Dive Deeper This feature takes you into insights that go a little deeper into the content
to help you stay informed about financial markets and the industry, sharpen
your understanding and expand your knowledge. Furthermore, by making
a habit of staying informed, you will find it easier to reach your goal of
becoming a competent and trusted participant in the securities industry.
Review Questions Each chapter and section has a series of multiple-choice questions designed
and End-of-section to test your knowledge of the subject. These are available in the online
Question Quiz course.
YOUR JOURNEY THROUGH THE COURSE

Although each student will develop an individual technique for studying, we offer some suggestions below, that you
may find helpful.
The most important advice we can offer is that all of the content in the textbook is examinable with one
exception: you will not be tested on material labelled For Information Only.
You may be more familiar with some areas of knowledge than others, but we advise strongly against skipping
those sections. You can read the material in any order you choose, depending on your particular needs and level of
familiarity with the content. However, we recommend instead that you avoid shortcuts and read all chapters in the
sequence given.
DID YOU KNOW?
When you practise with our various assessment tools, keep in mind that your journey is not about
finding the right answers and memorizing them. Rather, it is about knowing how to arrive at the right
answers. Three crucial behaviours will help you succeed:
• Build good study habits.

• Turn the page only after you understand the concept.
• Practise to assess your knowledge.
With this method, you should reap the rewards of your hard work and complete the course successfully.
Your registration includes access to online course components, which are designed to reinforce the textbook
content and help you assess your knowledge.
Before you read a chapter, we recommend that you log in to the online course and use the online chapters along
with your textbook. We suggest the following approach:
• Read the Chapter Outline, the Learning Objectives, and the Key Terms sections for each chapter.
• Read the chapter in your textbook or in the online PDF file. Use this first reading to familiarize yourself with the
material. Take notes where necessary, especially if there is a concept you don’t understand.
• Complete the online learning activities for each chapter.
• Read the chapter slowly for at least a second time. Pay particular attention to those areas you found challenging
during your first reading.
• Pay attention to the tables, charts, and figures. These will help you with the practical aspects of the material.

iv WEALTH MANAGEMENT ESSENTIALS VOLUME 1
• Work through all examples and calculations, making sure you understand how we arrived at the correct
answers.
• Complete the online review questions for each chapter, the end-of-section questions, and the integrated case
studies available in the online Putting It All Together section, to evaluate your knowledge and understanding of
the material. Take note that the questions are intended to reinforce your comprehension of key concepts and
to help you identify areas of weakness that may require further study as you prepare for the exam. You should
also know that the online review and end-of-section questions and case studies are designed to supplement the
learning experience for the course. They are learning activities only and are not meant to replicate the questions
in the final exam. They will differ from the exam questions in that may cover different topics and may reflect
different levels of difficulty.
• Read the Summary section to reinforce your learning.
TWO EXAM TYPES

For the regular version of the WME course you must complete two exams:
• Exam 1 consists of 120 multiple-choice questions. Note that the questions cover both Volumes 1 and 2 in
the WME, as well as material from the KPMG guide.
• Exam 2 uses case studies that integrate the application of concepts covered in WME Volumes 1 and 2 and the
KPMG guide. There are 50 multiple-choice case-based questions on Exam 2.
If you enrol in one of the three WME Fast Track versions, please visit the csi.ca website to learn more about the exam
structure for each course.
FINAL NOTE
Although we make every effort to ensure that what you are learning is accurate, practical, and well written, we
recognize that there is always room for improvement. This course is continually updated to better reflect the rapidly
changing financial services industry. You can submit your feedback to learning_support@csi.ca.
This edition of the WME textbook was prepared in May 2022. We thank those students and industry representatives
who helped with this updated version, either through their suggestions or by providing information for the book.

WEALTH MANAGEMENT ESSENTIALS
Content Overview
Volume 1
1 Wealth Management Today
2 Ethics and Wealth Management
3 Getting to Know the Client
4 Assessing the Client’s Financial Situation
5 Consumer Lending and Mortgages
6 Legal Aspects of Family Dynamics
7 Personal Risk Management Process
8 Understanding Tax Returns
9 Tax Reduction Strategies
10 Registered Retirement Savings Plans
11 Employer-Sponsored Pension Plans and Funding Retirement
12 Government Pension Programs
13 Retirement Planning Process
14 Protecting Retirement Income
15 Will and Powers of Attorney
16 Estate Planning Strategies
Volume 2
17 Investment Management
18 Asset Allocation
19 Equity Securities
20 Debt Securities: Characteristics, Risks, Trading and Yield Curves
21 Debt Securities: Pricing, Volatility and Strategies
22 Managed Products
23 Portfolio Monitoring and Performance Evaluation

WEALTH MANAGEMENT ESSENTIALS VOLUME 1 vii
Table of Contents | Volume 1
1 Wealth Management Today

1•3 INTRODUCTION
1•3 WEALTH MANAGEMENT IN CANADA

1•4 The Wealth Management Client
1•5 Client-Driven Changes in the Wealth Management Industry
1•6 WEALTH MANAGEMENT SERVICES IN CANADA
1•6 Wealth Management Channels
1•6 Wealth Management Business Models
1•8 Summary of HNW Advisory Business Channels
1•8 KEY TRENDS SHAPING THE FUTURE OF WEALTH MANAGEMENT
1•8 The Changing Demographics of Investors
1 • 10 The Changing Demographics of Investment Advisors
1 • 11 Competitive Pressures
1 • 12 Technological Changes
1 • 14 REGULATORY ENVIRONMENT
1 • 14 Current Regulatory Environment
1 • 15 Key Regulatory Initiatives Over the Years
1 • 17 COMPETENCIES OF SUCCESSFUL WEALTH ADVISORS
1 • 17 The Nine Competencies of a Wealth Advisor
1 • 19 Traditional Attributes
1 • 21 Emerging Attributes
1 • 22 THE WEALTH MANAGEMENT PROCESS
1 • 23 Understanding the Client
1 • 24 Formulating the Plan
1 • 24 Formalizing and Implementing the Plan
1 • 24 Reporting, Reviewing, and Rebalancing the Plan
1 • 25 BUILDING YOUR TEAM OF SPECIALISTS
1 • 25 Working with In-House Specialist Teams
1 • 26 Working with In-House Product Sales Teams

viii WEALTH MANAGEMENT ESSENTIALS VOLUME 1
1 • 26 Working with Outside Professionals

1 • 29 SUMMARY
2 Ethics and Wealth Management

2•3 INTRODUCTION
2•3 ETHICS IN THE FINANCIAL SERVICES INDUSTRY

2•4 The Concept of Ethics
2•4 Importance of Ethics
2•4 Values
2•5 Ethics and Industry Regulations
2•6 Rules-Based Versus Principles-Based Regulation
2•7 Ethics Defined by Perception
2•8 TYPES OF ETHICAL DILEMMAS
2•8 Right-Versus-Wrong Situations
2•8 Right-Versus-Right Dilemmas
2 • 10 RESOLVING ETHICAL DILEMMAS
2 • 11 A Framework for Ethical Decision-Making
2 • 13 CODE OF ETHICS
2 • 15 Industry Proficiency Requirements
2 • 16 TRUST, AGENCY, AND FIDUCIARY DUTY
2 • 16 Trust
2 • 19 Agency
2 • 20 Fiduciary Duty
2 • 21 WHAT CAN HAPPEN WHEN AN ADVISOR IGNORES ETHICS
2 • 22 IIROC’s Investigation Procedures and Enforcement Process
2 • 22 Disciplinary Proceedings
2 • 22 Penalties for Misconduct
2 • 23 Cases Outlining Consequences of Non-Compliance
2 • 25 SUMMARY

TABLE OF CONTENTS ix
3 Getting to Know the Client

3•3 INTRODUCTION
3•3 INFORMATION REQUIRED BY REGULATION AND LAW

3•4 Federal and International Requirements
3•4 IIROC Know Your Client Rule
3•7 GOING BEYOND THE REGULATORY AND LEGAL MINIMUM
3•7 Client Goals
3•8 Financial Information
3•8 Client Objectives
3 • 13 Investment Constraints
3 • 16 A Common Concern: “Will I Have Enough Money?”
3 • 17 THE CLIENT DISCOVERY PROCESS
3 • 18 The Client Interview
3 • 18 The Art of the Conversation
3 • 19 The Structured Conversation
3 • 21 Asking Good Questions
3 • 24 SUMMARY
4 Assessing the Client’s Financial Situation

4•3 INTRODUCTION
4•3 ANALYZING PERSONAL FINANCIAL STATEMENTS AND SAVINGS PLAN

4•3 Net Worth Planning
4•7 Cash Management Planning
4 • 11 The Projected Cash Flow Statement
4 • 12 Savings Planning
4 • 15 TIME VALUE OF MONEY
4 • 16 Types of Operation
4 • 18 SUMMARY
4 • 19 APPENDIX 4 – FINANCIAL MATH

4 • 21 Approach to Solving Problems
4 • 21 Five Basic Types of Operations

x WEALTH MANAGEMENT ESSENTIALS VOLUME 1
5 Consumer Lending and Mortgages

5•3 INTRODUCTION
5•3 CREDIT PLANNING

5•4 Forms of Consumer Credit
5•6 Assessing a Client’s Ability to Repay Credit
5•8 The Importance of Credit History
5•8 RESIDENTIAL MORTGAGES
5•9 The Primary Mortgage Market
5 • 11 The Secondary Mortgage Market
5 • 12 KEY FINANCIAL FACTORS TO CONSIDER WHEN PURCHASING A HOME
5 • 12 Loan-to-Value Ratio
5 • 13 Debt Service Ratios
5 • 16 Mortgage Stress Test
5 • 17 Term and Amortization Period
5 • 17 Interest Rates
5 • 19 Fees Incurred in Buying a Property
5 • 21 METHODS OF REDUCING INTEREST COSTS AND PENALTIES
5 • 22 Repayment Options
5 • 22 Payment Plans
5 • 22 Payment Periods
5 • 23 Prepayment
5 • 25 RELATED MORTGAGE TOPICS AND FINANCIAL PLANNING ISSUES
5 • 25 Reverse Mortgages
5 • 26 Home Buyers’ Plan
5 • 26 Tax-Free First Home Savings Account
5 • 27 Self-Directed Mortgages
5 • 27 Real Estate as an Investment
5 • 29 SUMMARY
6 Legal Aspects of Family Dynamics

6•3 INTRODUCTION
6•4 FAMILY-RELATED ISSUES

TABLE OF CONTENTS xi
6•5 The Role of the Advisor In Divorce

6•5 FUNDAMENTAL ASPECTS OF FAMILY LAW
6•6 Marriage
6•7 Divorce
6•8 Custody of, and Access to, Children
6 • 10 DOMESTIC CONTRACTS
6 • 11 Formalities of a Domestic Contract
6 • 13 Challenging a Domestic Contract
6 • 14 Alternative Dispute Resolution
6 • 14 PROPERTY ISSUES ON RELATIONSHIP BREAKDOWN
6 • 16 IMPACT OF DIVORCE ON A CLIENT’S FINANCIAL PLAN
6 • 18 SUMMARY
7 Personal Risk Management Process

7•3 INTRODUCTION
7•4 STRATEGIC WEALTH PRESERVATION: THE BIG PICTURE

7•5 Creating a Personal Risk Management Plan
7•6 RISK IN THE CONTEXT OF STRATEGIC WEALTH MANAGEMENT
7•8 Characterizations of Risk
7•8 MEASURING RISK
7•9 Standard Deviation
7 • 12 Shortfall Risk
7 • 13 Pure Risk
7 • 13 Time Diversification
7 • 14 IDENTIFYING RISK WITHIN A CLIENT’S NET WORTH
7 • 15 Family Assets and Liabilities
7 • 18 THE FAMILY LIFE CYCLE
7 • 18 The Life Cycle Hypothesis
7 • 20 THE PERSONAL RISK MANAGEMENT PROCESS
7 • 20 Step 1: Identify Risk
7 • 21 Step 2: Evaluate Risk
7 • 22 Step 3: Control Risk

xii WEALTH MANAGEMENT ESSENTIALS VOLUME 1
7 • 22 Step 4: Cover and Insure Risk

7 • 23 Step 5: Monitor and Revise the Risk Management Plan
7 • 23 A Comprehensive Approach to Risk Management
7 • 25 SUMMARY
8 Understanding Tax Returns

8•3 INTRODUCTION
8•3 FINANCIAL PLANNING AND TAXATION

8•4 Eliminating, Reducing, and Deferring Taxes
8•5 PERSONAL INCOME TAX RETURNS
8•6 How Taxes are Calculated
8•7 Federal Taxes
8•8 Tax Deductions and Tax Credits
8 • 10 Average and Marginal Tax Rates
8 • 12 TAXATION OF INVESTMENT INCOME
8 • 12 Interest and Foreign-Source Dividends
8 • 13 Canadian-Source Dividends
8 • 13 Capital Gains
8 • 14 Return of Capital
8 • 14 TAXABLE AND NON-TAXABLE EMPLOYEE BENEFITS
8 • 14 Private Health and Group Life Insurance Premiums
8 • 14 Car Allowance for an Employee-Provided Car
8 • 15 Business Meal and Entertainment Expenses
8 • 15 Employer-Paid Courses for Employees
8 • 15 Home Purchase and Relocation Loans
8 • 15 Interest-Free Loans to Employees
8 • 15 Reimbursement of an Employee’s Moving Costs
8 • 16 Personal Use of a Company Car
8 • 16 Club Memberships
8 • 16 Employee Stock Option Plans
8 • 17 Salary Continuance Plans
8 • 17 Deferred Compensation
8 • 17 Retiring Allowance for Employees
8 • 19 SUMMARY

TABLE OF CONTENTS xiii
9 Tax Reduction Strategies

9•3 INTRODUCTION
9•4 TECHNIQUES TO MINIMIZE TAXES

9•4 Income Attribution Rules and Income-Splitting
9 • 11 Payment of Expenses by the Higher-Income Spouse
9 • 12 Making Interest Payments Tax Deductible
9 • 13 Tax-Loss Selling
9 • 14 Deductibility of Fees
9 • 14 Whole and Universal Life Insurance
9 • 14 Individual Lifetime Capital Gains Exemption
9 • 16 Charitable Donations Tax Credit
9 • 17 Listed Personal Property
9 • 18 Principal Residence Exemption
9 • 19 Tax Shelters
9 • 19 Labour-Sponsored Venture Capital Corporation
9 • 20 TAX-FREE SAVINGS ACCOUNT
9 • 20 Tax-Free Savings Accounts
9 • 24 REGISTERED PLANS USED FOR NON-RETIREMENT GOALS
9 • 24 Registered Education Savings Plans
9 • 28 Registered Disability Savings Plan
9 • 29 Deferred Profit-Sharing Plan
9 • 31 INCORPORATION
9 • 32 Splitting Income from a Corporation
9 • 32 Non-Tax Advantages of Incorporation
9 • 32 Personal Services Business
9 • 33 Professional Corporations
9 • 33 Specified Investment Business
9 • 33 Corporate Takeovers
9 • 33 Income-Splitting with Family Members
9 • 35 SUMMARY

xiv WEALTH MANAGEMENT ESSENTIALS VOLUME 1
10 Registered Retirement Savings Plans

10 • 3 INTRODUCTION
10 • 3 PREPARING TO FUND RETIREMENT
10 • 5 AN OVERVIEW OF REGISTERED RETIREMENT SAVINGS PLANS

10 • 5 Advantages and Disadvantages of RRSPs
10 • 7 REGISTERED RETIREMENT SAVINGS PLAN CONTRIBUTION RULES
10 • 7 Earned Income
10 • 8 Calculating the RRSP Contribution Amount
10 • 8 In-Kind RRSP Contributions
10 • 9 Carryforward of Unused RRSP Contribution Limits
10 • 9 Overcontributions to an RRSP
10 • 10 Making Lump-Sum Payments to an RRSP
10 • 10 Locked-in Retirement Account
10 • 11 Contributions to a Spousal RRSP
10 • 14 MANAGEMENT OF RRSP ACCOUNTS
10 • 14 Qualified and Non-Qualified Investments for RRSPs
10 • 16 WHAT CLIENTS SHOULD KNOW ABOUT THEIR REGISTERED RETIREMENT SAVINGS
PLANS
10 • 16 Accessing RRSP Funds Before Retirement
10 • 17 Home Buyers’ Plan
10 • 18 Lifelong Learning Plan
10 • 18 Maturing RRSPs
10 • 19 Options for Maturing an RRSP
10 • 19 What Happens to an RRSP When the Plan Holder Dies?
10 • 22 SUMMARY
11 Employer-Sponsored Pension Plans and Funding Retirement

11 • 4 EMPLOYER-SPONSORED PENSION PLANS

11 • 4 Group Registered Retirement Savings Plans
11 • 5 Registered Pension Plans
11 • 5 The Regulatory Climate for RPPs

TABLE OF CONTENTS xv
11 • 7 Defined Benefit Pension Plans

11 • 11 Defined Contribution Pension Plans (Money Purchase Plans)
11 • 13 Hybrid Pension Plans
11 • 13 Retirement Pension Plans—Supplementary Topics
11 • 16 Pooled Registered Pension Plan
11 • 18 Individual Pension Plans
11 • 21 Retirement Compensation Arrangement
11 • 22 Supplemental Executive Retirement Plans
11 • 23 Salary Deferral Arrangements
11 • 23 REGISTERED PLANS FOR FUNDING RETIREMENT
11 • 23 Methods Used to Fund Retirement from an RRSP
11 • 25 Retirement Funding Considerations
11 • 25 Drawing a Retirement Income
11 • 30 Converting to a LIF or LRIF
11 • 31 Annuities and Retirement
11 • 33 SUMMARY
12 Government Pension Programs

12 • 4 CANADA AND QUEBEC PENSION PLANS

12 • 14 Planning for a CPP/QPP Retirement Pension
12 • 15 OLD AGE SECURITY PROGRAM
12 • 23 SUMMARY
13 Retirement Planning Process

13 • 4 PLANNING FOR FINANCIAL SECURITY IN RETIREMENT

13 • 4 Determine Retirement Objectives
13 • 4 Determine the Current Financial Status
13 • 5 Estimate Total Retirement Income Sources and Needs
13 • 5 Establish an Investment Plan to Meet Retirement Needs
13 • 5 Monitor and Evaluate the Progress to Plan

xvi WEALTH MANAGEMENT ESSENTIALS VOLUME 1
13 • 7 Four Key Attributes of Financial Security

13 • 7 RETIREMENT INCOME NEEDS ANALYSIS
13 • 8 A More Holistic Approach
13 • 11 Money as an Enabler
13 • 17 TAX-MINIMIZATION STRATEGIES
13 • 17 Build a Tax-Effective Portfolio
13 • 17 Tax Loss Selling
13 • 17 Pay Quarterly Tax Instalments
13 • 17 Minimize the Lifetime Tax Liability
13 • 18 Transfer the Age Credit to a Spouse
13 • 18 Establish RRIF Withdrawals
13 • 18 Give to Charity
13 • 18 Take Advantage of the Pension Income Tax Credit
13 • 19 Split Spousal Income
13 • 21 QUESTIONS TO CONSIDER WHEN ADVISING CLIENTS ON THE RETIREMENT
PLANNING PROCESS
13 • 23 SUMMARY
13 • 24 APPENDIX 13 – RETURN MEASURES

13 • 24 After-Tax Returns
13 • 25 Real Rate of Return
13 • 26 After-Tax Real Rate of Return
14 Protecting Retirement Income

14 • 3 UNDERSTANDING ANNUITIES
14 • 4 Regulation of Annuities
14 • 4 TYPES OF ANNUITIES
14 • 5 Straight Life Annuity
14 • 6 Joint Life Annuity
14 • 6 Term-Certain Annuity
14 • 7 Deferred Annuity
14 • 8 Annuity Options
14 • 9 Withdrawal Rights and Market Value Adjustments
14 • 10 Structured Settlement

TABLE OF CONTENTS xvii
14 • 11 Issues to Consider when Recommending Annuities

14 • 11 SEGREGATED FUNDS
14 • 12 Standardized Risk Ratings
14 • 12 Maturity Guarantee
14 • 15 GUARANTEED MINIMUM WITHDRAWAL BENEFIT CONTRACTS
14 • 16 Guarantees on a GMWB
14 • 18 Additional Benefits of a GMWB
14 • 18 Costs of a GMWB
14 • 19 Underlying Investments
14 • 19 Tax Considerations
14 • 20 Suitable Investors and Account Types
14 • 22 SUMMARY
15 Will and Powers of Attorney

15 • 4 PASSING ON THE ESTATE

15 • 4 Dying Intestate
15 • 9 Passing on the Estate – Particular Aspects in Quebec
15 • 10 OTHER FACTORS TO CONSIDER WHEN MAKING A WILL
15 • 10 Restrictions on the Testator’s Testamentary Freedom
15 • 11 Choosing an Executor
15 • 13 Revocation of a Will
15 • 13 Assets Covered by a Will and Assets that Do Not Flow Through the Estate
15 • 14 Life Events that Affect a Will
15 • 14 PROBATE PROCEDURES TO VALIDATE A WILL
15 • 15 Probate in Common Law Provinces
15 • 18 Probate in Quebec
15 • 20 POWERS OF ATTORNEY AND LIVING WILLS (ADVANCE HEALTH CARE DIRECTIVES)
15 • 20 Power of Attorney
15 • 22 Living Wills and Advance Health Care Directives
15 • 23 CONSIDERATIONS WHEN DEALING WITH VULNERABLE CLIENTS
15 • 24 Red Flags
15 • 26 SUMMARY

xviii WEALTH MANAGEMENT ESSENTIALS VOLUME 1
16 Estate Planning Strategies

16 • 4 TRUSTS
16 • 5 Duties of the Trustee
16 • 6 Types of Trusts
16 • 8 Reasons for Creating Inter Vivos Trusts
16 • 8 Provisions in Trust Agreements
16 • 10 Legal Aspects of Trusts in Quebec
16 • 11 Taxes and Trusts
16 • 12 Deducting Versus Designating Trust Income
16 • 14 TAXATION
16 • 14 Disposition of Capital Property Before Death
16 • 15 Transfer of Capital Property to a Spouse or Spousal Trust During the Settlor’s Lifetime
16 • 16 Estate Freeze
16 • 18 Taxes at Death
16 • 18 Minimizing or Deferring Taxes on Death
16 • 23 GENERAL ISSUES TO CONSIDER FOR ESTATE PLANNING
16 • 25 SUMMARY

Wealth Management Today 1
CHAPTER OUTLINE
This chapter provides an introduction to wealth management as a distinct practice in today’s financial services
environment. You will learn about the key trends in the industry and the skills and traits you need to be a successful
wealth advisor. We also explain how changes in the regulatory environment are likely to affect advisors in the
wealth management industry. Furthermore, we provide a process with which you can create a financial plan and
manage the diverse wealth management needs of your clients. Finally, we explain the importance of assembling a
team of specialists you can rely on to help provide holistic wealth management services to your clients.
LEARNING OBJECTIVES CONTENT AREAS
1 | Outline the scope of the wealth management Wealth Management in Canada

industry in Canada.
2 | Explain how the wealth management industry
is shaped by wealthy clients and their needs.
3 | Describe the different wealth management Wealth Management Services in Canada

channels and business models.
4 | Discuss the key trends that are influencing the Key Trends Shaping the Future of Wealth
wealth management industry. Management
5 | Identify the key regulatory initiatives affecting Regulatory Environment

the wealth management industry.
6 | Identify the competencies and desired Competencies of Successful Wealth Advisors

attributes of a successful wealth advisor.
7 | Describe the wealth management process. The Wealth Management Process
8 | Explain how wealth advisors can work Building a Team of Specialists

effectively with a team of specialists.

1•2 WEALTH MANAGEMENT ESSENTIALS VOLUME 1
KEY TERMS
The Key Terms list targets some significant concepts covered in the textbook. Key terms appear
in bold text in each chapter to help you focus your study efforts on these important topics.
artificial intelligence full-service brokerage
Autorité des marchés financiers fully integrated firm
Canadian Securities Administrators mono-line firm
Client Relationship Model Mutual Fund Dealers Association of Canada
competition between channels private investment counsel
competition in the mass market private wealth management
competitive pricing robo-advisor
cryptocurrencies semi-integrated firm
fintech transition specialist
Foreign Account Tax Compliance Act

CHAPTER 1 WEALTH MANAGEMENT TODAY 1•3
INTRODUCTION
In today’s competitive investment advisory landscape, you must have a clear business strategy in order to succeed
as a wealth manager. With the ever-increasing availability of new and better technologies, clients have access to
a great deal more information and services than they did a few years ago. Clients expect more from their advisors
than the mere ability to recommend and execute trades. The services they look for are holistic wealth management
and access to specialists. As the wealth management industry evolves to meet the more complex needs of Canada’s
broad population, your knowledge must also evolve.
Before you begin, read the scenario below, which raises some of the questions you may have as you begin your
advisory practice. Think about these questions, but don’t worry if the answers don’t come easily. At the end of the
chapter, we will revisit the scenario and provide answers that summarize what you have learned.
BREAKING INTO THE BUSINESS
You are a new advisor presently establishing yourself in your community. As you consider your strategy to lay
the foundation and grow your practice over time, you know you must decide which kinds of clients would be
best to target. Drawing on your experiences, you understand that the key to growing your business is to identify
those clients who can best benefit from your broad background and financial planning expertise. How you
engage these clients and use your personal attributes to attract additional clients will be crucial to your success.
• How would you describe your role as an advisor in today’s wealth management industry?
• Who are your potential clients and what do they expect from you as their wealth advisor?
• What is the impact of the key demographic, industry, and technology changes on the role of today’s wealth
advisor?
• What are the traditional and emerging attributes that you need to have or need to develop in order to fulfill the
needs of today’s wealth management client?
WEALTH MANAGEMENT IN CANADA
1 | Outline the scope of the wealth management industry in Canada.
2 | Explain how the wealth management industry is shaped by wealthy clients and their needs.
The term wealth management is widely used by various Canadian financial institutions to describe an approach to
managing the affairs of clients holding significant assets. The approach consolidates the broad range of financial
services that these institutions offer to high net worth (HNW) clients.
In an effort to better understand the wealth management industry in Canada, the Canadian Securities Institute
collaborated with Investor Economics to develop a white paper titled Defining the Wealth Management Industry
and Practice in Canada (referred to in this chapter as “the White Paper”). This authoritative and comprehensive
report, released in October 2015, is based on extensive industry research. It benefits from insights discovered during
consultations and interviews across the Canadian wealth management industry. The White Paper first provides a
picture of the wealth management client in Canada. It then describes the characteristics of the various businesses
in the Canadian financial services industry that serve these clients. The report concludes by describing the role of a
wealth advisor and the competencies required to successfully serve HNW clients.

DIVE DEEPER
We refer to the White Paper throughout this chapter, and the entire report is available in the online
version of this course. If you want to further explore the concepts presented in this chapter, go to your
online chapter and read the following document:
Defining the Wealth Management Industry and Practice in Canada
THE WEALTH MANAGEMENT CLIENT

The most common (but not universal) measure of high net worth in Canada is the value of assets available for
investment. An HNW client is an individual or family that owns at least $1 million of investable assets. The term
investable assets refers to liquid assets only; it does not include real estate or equity in a private company. Nor does
it consider short or long-term liabilities that, in determining net worth, would be offset against the client’s total
assets.
In recent years, there has been tremendous growth in the number of HNW clients in Canada and a corresponding
growth in opportunities for financial institutions. Consequently, those institutions are creating more effective and
profitable approaches to integrate the various channels that cater to this client base. This effort is most apparent
within large firms.
For example, private banking now largely operates with or under private wealth management (PWM) divisions
that offer integrated services to HNW clients. Furthermore, full-service brokerages (FSBs), particularly the bank-
owned ones, increasingly target HNW clients. They are now being structured to offer a full range of products and
services that cater to this segment. In some cases, these wares include credit and treasury products offered through
referral programs with the commercial banks. Finally, even private investment counsel (PIC) firms are adding
increased expertise in trust services and advanced financial planning to serve the HNW market.
The major occupational groups that make up the HNW client segment are entrepreneurs, professional service
providers, senior business executives, and media, entertainment, and sports professionals. Included in this segment
are wealth inheritors, wealthy immigrants, and wealthy retirees. Individuals from each of these groups bring
particular challenges and problems that you should know how to address as a wealth advisor. In fact, it is generally
accepted that the two fastest-growing groups within the segment are entrepreneurs and retirees, two sub-segments
with dissimilar financial goals.
In aggregate, these various HNW groups were associated with approximately 653,000 households in Canada
at the end of 2013. Together, they represent 4.2% of total Canadian households. Based on analysis done by
Investor Economics, there were 15.4 million households in Canada in 2013. This number is projected to increase
to 17.4 million, or approximately 14%, by 2022. During the same nine-year span, the number of HNW households
is expected to grow from 653,000 to 1,147,000, for an increase of 76%. The number of households and the wealth
they control is identified in Table 1.1.

Table 1.1 | Canadian Households and Wealth by Wealth Segment
2013 2022
Wealth Number of Total Wealth Number of Total Wealth

Segment Households (millions of dollars) Households (millions of dollars)
Total 15,420,577 3,409,548 17,438,606 5,460,389
$0–100K 12,194,157 246,050 12,376,427 271,029
$100–250K 1,103,000 172,480 1,617,111 263,714
$250–500K 766,769 270,811 1,157,896 429,830
$500K–1 million 703,066 510,307 1,140,276 893,557
$1 million + 653,585 2,209,900 1,146,896 3,602,260
CLIENT-DRIVEN CHANGES IN THE WEALTH MANAGEMENT INDUSTRY

The changing nature of the HNW demographic has helped to shape the wealth management industry’s offerings.
These changes have resulted in a broader market for wealth management, a wider range of services available, and
deeper advisory relationships with clients.
BROADER MARKET FOR WEALTH MANAGEMENT

Wealth management service providers do not focus solely on HNW clients. They also target market segments that
have the potential to quickly grow their investable assets and become HNW clients. Two client groups in particular
have this potential: mass affluent families growing their wealth and selected individuals such as recently graduated
professionals. Furthermore, they target the small number of HNW clients with the potential to become highly
favoured, ultra-high net worth investors.
WIDER RANGE OF WEALTH MANAGEMENT SERVICE OFFERINGS

Wealth management today encompasses much more than the provision of investment management solutions to
wealthy clients. In 2004, the IDA Wealth Watch1 defined wealth management as something that “integrates the
provision of financial instruments and advisory services in assisting clients in the accumulation, preservation, and
transfer of wealth throughout the life cycle.” Much of this definition still has relevance today.
To provide a full range of services, wealth advisors call on specialists in related fields, including risk management,
investment management, tax planning, and estate planning. Wealth advisors integrate the recommendations of
these experts into a coherent wealth plan tailored to meet their clients’ needs. Many large financial institutions have
created in-house teams of specialists to support their advisors.
DEEPER CLIENT-ADVISOR RELATIONSHIPS

To meet the needs of clients, several service channels and business models have emerged, each with its own
approach to wealth management. What they have in common is the range of services they provide. Each service
channel strives to enhance and deepen relationships with HNW clients by offering a wide array of integrated
services.
1
The IDA Wealth Watch is a publication of the Investment Dealers Association of Canada, one of the predecessor organizations that joined
together to become the Investment Industry Regulatory Organization of Canada (IIROC).

WEALTH MANAGEMENT SERVICES IN CANADA
3 | Describe the different wealth management channels and business models.
Service providers to HNW clients recognize that those client relationships tend to be more lasting and profitable
(in an absolute sense) than relationships with mass- and mid-market households. The relationships also tend to be
fee-based rather than commission-based, and therefore are less capital intensive.
WEALTH MANAGEMENT CHANNELS

The three main channels dedicated to the HNW segment are briefly described as follows:
Private wealth Integrated PWM services consist of private banking, investment counsel, and personal
management trust services offered by the banks and other deposit-taking organizations. It is one of the
fastest-growing channels in terms of clients and account balances.
Full-service brokerage The FSB channel is dominated by the large, bank-owned dealers, which increasingly focus
their product and service offerings on the HNW segment.
Private investment Most PIC firms are mono-line firms offering only investment management. Others
counsel have broadened their offering to include financial planning, along with trust and estate
services. These firms are outside of PWM and focus entirely on the HNW segment.
Among the three delivery channels, there is no single channel in Canada that dominates the HNW segment.
However, approximately three out of every four HNW households maintain a relationship with at least one
FSB firm.
WEALTH MANAGEMENT BUSINESS MODELS

Each delivery channel falls under one or more of three business models active in Canada: fully integrated, semi-
integrated, and mono-line. The models are roughly, but not entirely, parallel to the wealth management delivery
channels. Each model is discussed in detail below.
FULLY INTEGRATED: THE PRIVATE WEALTH MANAGEMENT MODEL

Fully integrated firms include the major banks and some other large financial institutions that offer a
comprehensive range of private wealth services.
Banks and other deposit-taking financial institutions use the term PWM to describe an integrated set of services
offered to HNW clients. In addition, a few major foreign banks offer some domestic services, as well as various
cross-border services associated with business units within their global networks.
PRIMARY PWM SERVICES OFFERED

High net worth bank clients can access services through multiple bank channels. However, private banking
(or PWM) is the only dedicated, fully integrated channel. Through this channel, eligible clients have access to
the following products and services:
• Credit and treasury products

• Discretionary investment management
• Trust and specialized planning services
• Estate administration

• Business succession planning

• Philanthropy strategies
• Concierge services
The only wealth products not available to HNW clients through private banking are those with insurance features.
(However, the Bank Act does permit banks to own insurance subsidiaries.) The banks’ focus has shifted from deposits
and lending to discretionary investment management and other fee-based services. In addition, customized banking
services, such as those used to assist with cash flow management, remain an important aspect of the bank channel’s
offerings.
Among the major banks, integrated teams are frequently used to handle all client issues. They usually include a
banker, investment counsellor, and trust officer. Other relationship structures used are co-located relationships
(where teams are not formalized but emerge as the result of intra-private-banking referrals within the group) and
referral-based relationships.
SEMI-INTEGRATED: THE FULL-SERVICE BROKERAGE MODEL

Semi-integrated firms offer a limited range of HNW services. This group includes FSB firms, financial advisor firms,
a limited number of foreign banks, and a few PIC firms that provide financial planning or trust services.
Semi-integrated offerings targeting HNW individuals and households are becoming a core part of the business
activities of leading FSB firms and some other large firms in the financial advisory channel. The FSB channel,
particularly at the bank-owned firms, has aggressively turned its attention toward the higher end of the retail
market to maximize profitability. Because of this shift in focus and the extensive national coverage enabled by the
network of FSB offices, it is estimated that 78% of all HNW households, or a little more than 500,000, have a
relationship with at least one FSB firm.
PRIMARY FSB SERVICES OFFERED

To attract HNW households, FSB firms and their advisors have found it necessary to enhance their investment
offerings and broaden the range of services available to clients. They do this through three means:
• Developing in-house capabilities

• Leveraging the expertise of other divisions within the financial institution they work for
• Pursuing referral arrangements with outside professional services firms
Additionally, through compensation strategies, FSB firms are attempting to eliminate low-balance accounts while
focusing efforts on clients with significant investable assets.
The primary services offered by FSB firms to HNW households continue to revolve around investment planning and
investment management services, both discretionary and non-discretionary. With a focus on the HNW segment
becoming more intense, the industry has worked hard to develop competitive fee-based and discretionary services.
The goal is to compete on price and features with those offered by the fully integrated PWM and mono-line
PIC channels.
MONO-LINE: THE PRIVATE INVESTMENT COUNSEL MODEL

Mono-line firms offer a single set of services, such as discretionary management. This group includes most PIC
firms, family offices offering advice only, and other foreign banks.
Most PIC firms fall within the mono-line model because they focus solely on investment management. Mono-line firms
include small, independent, regional boutiques catering to the HNW segment and small not-for-profit organizations.
They also include large asset management firms with a national focus. The larger firms might also manage assets for
pension plans and sub-advise on mutual funds. Some wealth management firms and institutions, including mutual fund
companies and insurance companies, have acquired or built PIC divisions to target the HNW client.

PRIMARY PIC SERVICES OFFERED

Most counsellors at PIC firms offer discretionary investment management to their clients through segregated
accounts and pooled funds, typically with traditional mandates. In many firms, segregated accounts are offered only
to clients with assets above a certain threshold, which can range between $1 million and $5 million.
Financial advisors, as a group, have seen their share of HNW investors decline in recent years, despite attempts to
meet competition with attractive pricing. They have attempted to strengthen their product range with initiatives
involving fund manufacturers and dealers. However, they have not yet been proven successful in preventing a loss
of market share, because the investors they target prefer more sophisticated services. High net worth investors
generally want to work with highly qualified advisors who specifically focus on clients with significant financial
resources. Nevertheless, mono-line firms continue to strengthen their value proposition for HNW investors to
prevent further erosion of market share.
SUMMARY OF HNW ADVISORY BUSINESS CHANNELS

Increasingly, HNW advisory business models feature common characteristics. As the market matures, successful
firms within each of the three main channels—PWM, FSB, and PIC—will have to offer comprehensive, family-
focused wealth planning and discretionary investment management. Firms serving the Canadian HNW market
recognize that their clients want service from experts. Those clients will not typically expect a single individual to
meet their needs in distinct but related areas. However, they will require their primary relationship manager, in
whichever channel they choose to concentrate their relationship, to provide access to experts qualified to handle all
aspects of their financial lives.
Given these expectations, and regardless of channel, as a wealth advisor, you will need both broad and specialized
competencies to serve the demands of the HNW segment. The depth of specialization may differ depending on the
channel, but you should have a standard base of knowledge to completely service the HNW client.
KEY TRENDS SHAPING THE FUTURE OF WEALTH MANAGEMENT
4 | Discuss the key trends that are influencing the wealth management industry.
The wealth management industry is currently characterized by several key demographic and technological trends.
The combined effects of an aging population and changing technology are having an impact on all areas of society.
This competitive environment has prompted firms to introduce new business models that are changing the way
wealth management is delivered to all generations.
THE CHANGING DEMOGRAPHICS OF INVESTORS

Changes in the wealth management industry in Canada can be discussed generally in terms of four roughly defined
demographic segments in the adult population:
• Those born between 1925 and 1945 (the “silent generation”)

• Those born between 1946 and 1965 (“baby boomers”)
• Those born between 1966 and 1980 (“generation X”)
• Those born between 1981 and 2000 (“millennials”)

BABY BOOMERS AND THEIR PARENTS

There are approximately 9.5 million baby boomers in Canada and 4.5 million people in the preceding generation.
Most of the older group are now in their retirement years, and the vanguard of the baby boom generation is
entering or has already entered retirement.
Much has been written on the aging population and its effect on virtually all aspects of life, including education,
delivery of products and services, and health care. As the Canadian population ages, we are becoming a society
heavily influenced by the needs and attitudes of the 50-plus consumer. One trend to watch is the growth in the
Canadian population over age 65, especially now that the leading edge of the baby boomer population has reached
this milestone retirement age. As a wealth advisor, you will be expected to adjust your service offering to reflect the
needs of a client base increasingly made up of this group.
In Canada, at least two out of every three HNW households are led by either baby boomers or people from the
preceding generation (although many from the preceding generation have passed away or are at advanced ages).
From your perspective as a wealth advisor, these groups are attractive because of their more concentrated wealth.
Table 1.2, sourced from the White Paper, shows that a large number of HNW households are dominated by
Canadians aged 55 and over.
Table 1.2 | Canadian Households by Wealth and Age
Number of Total Wealth Number of HNW Total HNW Wealth

Age Households (millions of dollars) Households (millions of dollars)
Total 15,420,577 3,409,548 653,585 2,209,900
0–24 867,481 21,065 2,344 3,725
25–34 2,215,397 125,910 25,436 61,072
35–44 2,649,253 368,139 73,748 247,865
45–54 3,180,615 781,677 145,311 558,365
55–64 2,770,559 902,365 164,192 622,430
65+ 3,737,271 1,210,391 242,553 716,443
High net worth households are dominated by those aged 55 and older because they have had the most time to
earn income, save, and invest. Many have also been able to pay down their debts, especially the mortgages on their
homes, which provides additional available cash flow for investment purposes.
A high proportion of your clients are likely to be from the baby boomer generation or the one preceding it. You
should therefore attempt to understand the way people’s view of the world tends to change as they get older.
Psychologists have found that, as people approach retirement, they start to pay more attention to their hopes,
dreams, emotions, relationships, and life meaning. Accumulating assets and preparing for the future take on less
importance, and they begin to view money as a part of a greater purpose.
Your business approach as a wealth advisor should be relevant to the needs of your baby boomer clients, while
simultaneously appealing to new clients. To be successful in the long run, you should market your practice in a way
that connects with both groups. In part, you will have to help clients gain perspective on their lives. In a sense, you
must become a transition specialist by helping clients understand the major issues they will face in their later
years. This role does not mean you should stop talking about financial concerns; each life transition has a financial
consequence. What it means is that money discussions should more closely relate to life meaning. For example, as

1 • 10 WEALTH MANAGEMENT ESSENTIALS VOLUME 1
clients age, they move away from accumulating assets and begin searching for ways to use those assets to meet
their needs and bring meaning to their lives.
GENERATION X AND THE MILLENNIALS

Most HNW wealth is concentrated in the hands of the baby boomers and their parents (but to an increasingly
smaller degree, as stated above). However, for two reasons, you should also pay attention to the younger
generations. First, the millennial generation now outnumbers both its older and younger cohort in the Canadian
workforce. Furthermore, both younger groups (generation X and millennials) stand to inherit wealth from both
parents and grandparents in the future.
The younger generations’ experience with precarious employment such as gig and freelance work has made them
somewhat more risk-averse than previous generations. Without the security of defined benefit pension plans
through their work, most members of these groups must plan and save for their retirement through different means
than previous generations, in many cases on their own. Also, many tend to prefer investments that address their
social and environmental concerns.
These demographic conditions provide new opportunities for wealth advisors. You should be able to establish
relationships that will flourish over the long term, as long as you look for ways to meet the needs of your younger
clients.
EXAMPLE
Elizabeth, a 52-year-old investment advisor, has built a successful practice at one of the large, full-service
brokerage houses. Analysis of her current book of business shows that her clients, on average, are almost five
years older than the firm average. Elizabeth has had great success prospecting medical and dental professionals
in her first several years in the business. However, over the past few years, she has not done as much networking,
and so her book has grown at a much slower pace. As a consequence, the demographic distribution shows a high
concentration of clients between the ages of 60 and 75, but very few clients under 45.
To help address this gap, Elizabeth’s manager suggests she host an evening seminar to encourage her clients to
bring in their children and grandchildren. Her manager explains that some of the support materials created by
head office apply equally to all generations. By hosting such an event, she can meet her clients’ family members
and demonstrate that she is aware of their concerns and can provide solutions. Over the next two months,
Elizabeth hosts two seminars on the following topics:
• Helping your adult child buy a first home without affecting your retirement
• Passing your professional practice to the next generation
THE CHANGING DEMOGRAPHICS OF INVESTMENT ADVISORS

Baby boomers are the largest generation in Canadian history entering retirement, and the population as a whole
has reached an average age of almost 42. Aging even faster than the overall population is the investment advisor
population. The average age of advisors in Canada is just over 50, and those over age 60 manage most financial
assets held in their firms. As these advisors retire, new opportunities will open up for younger advisors. Their clients
will also come from the younger generation but may include baby boomers.

CHAPTER 1 WEALTH MANAGEMENT TODAY 1 • 11
DID YOU KNOW?
One of your goals as a wealth advisor should be to establish long-lasting relationships with the
children of your clients. By doing so, you have a greater likelihood of retaining investment assets over
the long term. This goal is especially important given that adult children frequently receive support
or inheritances from their parents, which reduces the parents’ assets. Moreover, in many cases, adult
children have influence over their parents’ financial decisions, especially as their parents get older.
Admittedly, it is not always easy for older advisors to establish strong relationships with their clients’
children. The younger group may have existing advisory relationships, or they may wish to find an
advisor of similar age or interests.
COMPETITIVE PRESSURES
Aside from the pressure to attract younger family members of baby boomers, the wealth management landscape is
characterized by several competitive factors:
• Competition between channels

• Competition in the mass market
• Competitive pricing
COMPETITION BETWEEN CHANNELS

In response to demographic trends, competition between channels has increased, and financial advisors have
fundamentally changed the way they deliver services to their clients. Furthermore, the practice will continue to
evolve in anticipation of future trends. For example, many organizations offering wealth management services now
pursue strategies that involve greater integration between their business units to serve HNW clients.
The largest companies have representation across both PWM business lines (i.e., private banking and investment
counsel) and FSB firms. Although both channels aim to attract HNW clients, they are differentiated by the range of
services and investment options they provide. Through PWM, clients have greater access to products such as credit
solutions, whereas full-service brokerage offers a wider range of investment and insurance solutions. Among the
largest companies, this differentiation has led to opportunities for wealth advisors in PWM and FSB business units
to work together. This type of collaboration is supported in many large firms through compensation models that
reward teamwork. Both business channels typically have access to in-house specialist teams that allow them to
provide a full suite of products and services. Included in their offerings are financial planning, business succession
planning, will and estate reviews, and high-end tax planning.
COMPETITION IN THE MASS MARKET

Competition in the mass market is also increasing. Although the major banks have established leading positions
in the wealth management industry, a small- and medium-size financial advice segment of significant size also
operates in Canada. This segment has approximately four times the number of advisors as those serving the larger,
integrated companies. They mainly serve the mass-market customer base. Given this focus on the mass market,
average assets managed per client are much lower than comparable amounts for the PWM and FSB businesses.
DID YOU KNOW?
The demographic characteristics of the HNW clients that the integrated and mass-market channels
attract are similar. However, growth in the size of the market means that both models have a growing
client base they can pursue. According to the White Paper, by 2022, the number of HNW households
will increase by 76% to almost 1.15 million households.

COMPETITIVE PRICING
Concerns over the fees and management expense ratios (MERs) associated with mutual funds have encouraged
some clients to move toward exchange-traded funds (ETFs). Many mutual fund organizations have responded to this
fee pressure by lowering their MERs to become more competitive. Lower MERs resulting from competitive pricing
(i.e., setting one’s pricing for products and services at the same level as or slightly lower than one’s competitors) will
likely lead to reduced compensation for wealth advisors over time.
TECHNOLOGICAL CHANGES
Another form of competition in the wealth management landscape is created by changes in technology. Of
particular concern are the online, automated, algorithm-based investment management services known as robo-
advisors. Other changes include the increasing ease of access to information, which allows new service models to
flourish, and the increasing technical literacy of wealth management clients. Finally, the relatively new digital assets
known as cryptocurrencies are rising in popularity and are likely to have a major effect on the industry. Artificial
intelligence is also making inroads in the wealth management industry.
ROBO-ADVISORS
The rise of robo-advisors in the investment industry has been made possible by constant improvements in online
technology and the work of numerous so-called fintech companies. These services help online investors create their
own customized portfolios to save for specific goals. The investments typically used within robo-advisor portfolios
are low-cost ETFs.
Robo-advisor technology primarily appeals to younger, fee-conscious investors who have smaller amounts to invest,
are comfortable with online technology and prefer a self-service model.
The largest financial institutions have entered the robo-advisor market in an effort to compete for clients with less
complex investment needs. They are not intended to compete with the firms’ PWM or FSB business.
CRYPTOCURRENCIES
Cryptocurrencies are a decentralized form of digital cash that eliminates the need for intermediaries, such as banks
and governments, to make financial transactions. The introduction of cryptocurrencies, and their merging with
derivative products, have forced financial institutions to evaluate the competitive risk associated with this virtual
form of money.
Financial institutions and securities markets around the world are grappling with new concerns around volatility,
transparency, valuation, custody, and liquidity. In response, the Investment Industry Regulatory Organization of
Canada (IIROC) has imposed some requirements for dealer members involved in cryptocurrency transactions.
Specifically, it prescribes higher margin requirements for cryptocurrency futures contracts than the margin required
for regular commodity futures contracts and futures contract options. IIROC later introduced guidance on how to
comply with securities laws for firms that offer crypto-asset trading platforms. Some financial institutions have
banned cryptocurrency purchases made with their credit cards because of the virtual currency’s volatile nature
and the high credit risk. Cryptocurrencies can also be difficult for banks to monitor for signs of money laundering.
Furthermore, banks must keep money secure and transaction records safe while not slowing down the verification
process. The anonymous nature of cryptocurrency transactions creates challenges for banks in this regard.
ARTIFICIAL INTELLIGENCE
Artificial intelligence (AI) has applications in the financial industry in areas such as fraud detection and auditing.
AI-based applications can augment human expertise by handling low-value tasks and proactively taking on more
strategic roles for businesses. In wealth management, the use of AI technologies enhances the ability of advisors and
their firms to anticipate client attitudes and foresee their needs, preferences, and behaviours with greater accuracy.
More precisely, in terms of asset management, AI algorithms can increase accuracy in forecasts significantly by

analyzing billions of different scenarios and data points. By analyzing vast quantities of data and other factors, AI
allows businesses to select the best stocks and other assets in the financial markets. Wealth management also has
a wider scope of AI applications in areas such as tax planning, estate planning, and other financial matters. All these
applications allow advisors to build financial plans with a greater degree of efficiency and customization.
INFORMATION AVAILABILITY
In the past, investment advisors were the primary source of up-to-date investment information. However, over
the past few years, the amount of investment and wealth management information available over the internet
has increased substantially. For some clients, access to so much information has enabled them to make informed
decisions and choose self-directed investment options.
For many HNW clients, though, a point is reached when they are overwhelmed by too much information. Rather
than seeing their wealth advisor as a source of investment and wealth management information, many investors
now look to them to help make sense of the information available. Wealth advisors must also be able to apply and
customize the available information to the specific situations and needs of their clients.
Innovations in the technology used to manage investment and wealth management functions have also led to
increased efficiency for wealth management teams. Information required to efficiently manage client relationships
and portfolios and to provide reporting is now cheaper and easier to use. Therefore, many wealth management
businesses can do more with fewer people. This convenience allows for a greater focus on client relationship
management, even as investments under management have continued to grow.
In short, the most successful advisors are those who are most willing to embrace new technology as a means to
communicate effectively with their clients.
EXAMPLE
Elizabeth and her team were happy with the seminar she delivered to her clients and their family members. More
than 80 guests were present at each seminar, of which almost half were younger clients accompanying their
parents and grandparents.
Because the perspective of the younger group differed substantially from that of her existing clients, Elizabeth
knew she needed a separate communication strategy to engage the younger guests. With the older generations,
she communicated through planned phone calls and mailings of the firm’s latest portfolio suggestions. Rather
than relying on the same techniques, Elizabeth decided to reach out through social media to inform and
engage her potential new clients. She planned an ongoing series of messages to be delivered over appropriate
social media channels. The content of the messages was either developed or approved for use by the firm and
was tailored to address the needs and concerns of the younger demographic. The firm’s engagement in the
communication strategy ensured compliance with its policies around social media and retention of client
communications.
The strategy proved to be a success, based on the potential new clients that agreed to meet with Elizabeth. Most
wanted to discuss not only issues that they shared with their parents, but also their personal financial situations
and concerns.
TECHNICAL LITERACY
As the pace of technological innovation increases, wealth advisors must become proficient with technology and
use these new skills to communicate effectively with clients. This proficiency is especially important with younger
clients who often initially prefer to use electronic means of communication rather than face-to-face contact.
As you adapt to communication through the newer technologies, you will benefit by having more efficient and
frequent communications with clients. Furthermore, you may be able to earn the loyalty of your clients’ children,
rather than being viewed by them as their “mom and dad’s advisor”.

REGULATORY ENVIRONMENT
5 | Identify the key regulatory initiatives affecting the wealth management industry.
As the wealth management industry moves toward greater convergence, financial institutions are functioning more
and more as one-stop financial shopping centres. Nevertheless, regulation is still segmented by product, service
line, and geography. In future years, however, regulation will likely become more integrated as, in typical fashion,
it reacts to market forces.
CURRENT REGULATORY ENVIRONMENT

In this section, we discuss the current regulatory environment under which the various financial institutions operate.
BANKS
Under the Bank Act, the federal government is responsible for the regulation of the banking sector in Canada.
However, some bank activities carried out by bank subsidiaries, such as trustee services and securities dealing, are
provincially regulated.
CREDIT UNIONS
Desjardins Group and credit unions in Canada are provincially incorporated. Therefore, the powers of these
institutions do not extend beyond provincial borders. Consequently, this sector is almost exclusively regulated at
the provincial level for both prudential soundness and market conduct.
INSURANCE COMPANIES
The Government of Canada largely regulates the life and health insurance sector under the Insurance Companies Act.
Provinces have the power to ensure that federally incorporated insurance companies conducting business in their
respective jurisdictions are financially sound. However, all provinces except Quebec accept federal regulation in this
regard. All insurers are subject to market conduct regulation by the province in which they carry on business.
TRUST AND LOAN COMPANIES

Trust and loan companies can be regulated by both levels of government. Market conduct is regulated at the
provincial level, but the Government of Canada regulates federally incorporated companies under the Trust and Loan
Companies Act.
MUTUAL FUND COMPANIES

The Mutual Fund Dealers Association of Canada (MFDA) is the mutual fund industry’s self-regulatory
organization (SRO) responsible for regulating all sales of mutual funds in most of Canada. As an SRO, the MFDA
is responsible for regulating the operations, standards of practice, and business conduct of its members and their
representatives. The MFDA does not regulate the mutual funds themselves; this responsibility remains with the
provincial securities commissions.
In Quebec, the mutual fund industry is regulated by the Autorité des marchés financiers (AMF). An agreement
has been signed between the AMF and the MFDA to avoid regulatory duplication for mutual fund firms operating
in both Quebec and elsewhere in Canada.
The Chambre de la sécurité financière (CSF) is Quebec’s SRO of the mutual fund and insurance industry. The CSF
is responsible for setting and monitoring continuing education requirements and for enforcing a code of ethics for
licensed representatives.

SECURITIES DEALERS
The securities sector is governed by provincial legislation regulating the underwriting, distribution, and sale of
securities, with a major emphasis in the provincial Acts on full disclosure. The Canadian Securities Administrators
(CSA) brings together securities regulators from all ten provinces and the three territories with the goal of
developing a harmonized approach to securities regulation across Canada. Although each province has its own
legislation, provincial regulators meet regularly with the CSA to coordinate and harmonize provincial regulation of
the securities industry and markets.
Industry self-regulation is overseen by IIROC, the national SRO that oversees all dealer members and trading
activity on equity and debt marketplaces in Canada. IIROC is responsible for enforcing the rules and regulations
regarding sales, business and financial practices, and trading activities of individuals and dealer members under its
jurisdiction. It also interprets existing rules, develops recommendations to amend them, and establishes new rules.
KEY REGULATORY INITIATIVES OVER THE YEARS

Several important regulatory initiatives have been implemented and have even evolved over the years. These key
regulatory initiatives had a significant impact on the wealth management industry when they were launched.
Some of the more important initiatives relate to concerns over income reporting, privacy, anti-money laundering,
conflicts of interest, transparency about the fees charged, and investment performance reporting. These concerns
are discussed below.
FOREIGN ACCOUNT TAX COMPLIANCE ACT

The Foreign Account Tax Compliance Act (FATCA) was enacted in 2010 by the United States in its efforts to
reduce tax evasion by U.S. taxpayers holding financial accounts outside the country. The objective is to have all
income earned by U.S. taxpayers reported to the Internal Revenue Service (IRS) so that appropriate federal taxes
may be collected. This initiative affects all foreign financial institutions (FFIs) globally.
Under FATCA, FFIs must report to the IRS certain financial information about accounts held by U.S. taxpayers or
by foreign entities in which U.S. taxpayers hold a substantial ownership interest. In Canada, institutions affected
include banks, mutual fund companies, brokerages, private equity funds, and insurance companies.
In the absence of sufficient identifying information to determine whether an account is held by a U.S. person or
entity, a 30% withholding tax is required on any U.S.-source income. The tax also applies on the gross proceeds
from the sale of any U.S. securities.
CANADA–U.S. INTERGOVERNMENTAL AGREEMENT

In 2014, the governments of Canada and the United States signed an agreement that provides an alternative
way of meeting U.S. objectives to increase tax compliance under their domestic legislation. Rather than requiring
Canadian financial institutions to provide information about their U.S. clients directly to U.S. authorities, the
intergovernmental agreement allows those institutions to provide it to the Canada Revenue Agency (CRA). The
CRA then transfers the required information to the IRS. Canadian tax authorities benefit from the reciprocal sharing
of similar information about Canadians holding financial accounts in the U.S. In addition, this approach alleviates
privacy concerns the Canadian financial institutions had regarding the personal information of their clients.
CLIENT PRIVACY
In Canada, the primary legislation governing privacy issues is the Personal Information Protection and Electronic
Documents Act (PIPEDA). This piece of federal legislation governs how private sector companies may collect, use,
and disclose their clients’ personal information in the course of their commercial activities.
In the financial services industry, adherence to PIPEDA is necessary for compliance with other federal legislation,
namely, the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA). The PCMLTFA requires
financial institutions to implement protocols to detect and deter money laundering and terrorist financing activities.

The information you collect as a wealth advisor during the account opening and Know Your Client (KYC) processes
is used to meet suitability requirements and to comply with the PCMLTFA. At the same time, client privacy must
always be protected under the PIPEDA rules. Therefore, the way you collect, store, and use the personal information
of your clients is of critical importance.
CLIENT RELATIONSHIP MODEL 1

In March 2012, IIROC released its Client Relationship Model (CRM1) guidelines, which were built on a foundation
developed over several years by the CSA.
The purpose of the guidelines was to provide greater transparency regarding the relationship between advisors
and their clients and between advisors and their clients’ dealers. Requirements included communicating in plain
language, disclosing conflicts of interest, and taking greater care to assess suitability before making or accepting
portfolio recommendations.
CLIENT RELATIONSHIP MODEL 2

In 2017, IIROC implemented CRM2, which raised transparency standards and required additional information to be
disclosed about all fees and charges associated with the purchase or sale of a security before the transaction takes
place.
The most significant change implemented in CRM2 was the requirement to provide two new reports relating to
client accounts: a fee statement and a performance report. Each of these reports must be provided to clients once a
year. The fee statement must disclose all commissions and charges incurred by the client during the period covered.
It must also contain details of any third-party compensation, such as trailers, received by the firm in relation
to holdings in the client account. In the performance report, performance must be calculated using prescribed
methodologies, including the money-weighted rate of return, to ensure comparability. Performance reports must
also show historical performance for the previous year and the previous three, five, and 10 years.
CLIENT FOCUSED REFORMS

On October 3, 2019, the CSA released its final amendments to National Instrument 31-103 Registration
Requirements, Exemptions and Ongoing Registrant Obligations. In an initiative called Client Focused Reforms (CFR),
the CSA proposed changes to the requirements for registrant conduct to better align the interests of securities
registrants with the interests of their clients. The initiative was intended to improve outcomes for clients and make
clearer to them the nature and terms of their relationship with registrants. IIROC amended its rules for consistency
with the CFRs, which resulted in changes to requirements in four areas:
• KYC
• Suitability
• Know-your-product
• Conflicts of interest
MUTUAL FUND POINT-OF-SALE DISCLOSURE

Fund Facts documents for mutual funds are designed to give investors information about a fund they are
considering in a clear and easy-to-understand format. These documents must be posted to the fund company
websites, and the relevant document must be delivered to every buyer of Canadian mutual funds. Where once
the document was delivered just after purchase, it must now be provided to the client before you accept their
instruction to purchase the mutual fund.

FUTURE REGULATORY INITIATIVES

The CSA continues to work on several other regulatory initiatives with the overall goal to protect Canadian investors
and promote efficient capital markets. Current initiatives include work on a variety of compensation issues,
including payments relating to certain types of investments and accounts.
COMPETENCIES OF SUCCESSFUL WEALTH ADVISORS
6 | Identify the competencies and desired attributes of a successful wealth advisor.
The White Paper describes in detail nine different competencies required to be successful in the role of a wealth
advisor. In addition, wealth advisors require a set of traditional attributes commonly known as “soft skills”.
Furthermore, experts recognize a set of emerging attributes that will be necessary for success in the ever-changing
wealth management environment.
THE NINE COMPETENCIES OF A WEALTH ADVISOR

Of the nine required competencies, five relate to technical competencies and four relate to general practice
responsibilities. Table 1.3 provides more information about the competency domains and the required expertise
specific to each domain.2
Table 1.3 | Technical and Professional Practice Competencies of a Wealth Advisor
Technical competencies Areas requiring specific expertise
1. Assist clients in growing, protecting, • Lending

and monetizing a closely held business.
• Treasury management (including cash management, trade
finance, foreign exchange, and risk management)
• Pros and cons of different business structures
• Insurance
• Taxation and corporate finance services (valuation and sale
of a business)
2. Establish and facilitate tax- • Asset allocation

efficient wealth accumulation and
management strategies that may
• Investment analysis
include sophisticated and complex • Portfolio construction using both traditional and alternative
approaches to achieve life goals. investments
• Use of leverage
• International investing
• Performance evaluation, attribution, and rebalancing
• Managing portfolio risk
2
These core competencies are from the CIWM Professional Competency Profile, which was developed by the Association of International
Wealth Management (AIWM) and CSI to support the Certified International Wealth Manager (CIWM) designation.

Table 1.3 | Technical and Professional Practice Competencies of a Wealth Advisor
Technical competencies Areas requiring specific expertise
3. Use advanced risk management • Insurance in the areas of asset and earnings protection
techniques to create an optimal
personalized and integrated wealth
• Use of trusts
preservation plan. • Tax minimization pertaining to executive compensation,

including stock options and concentrated stock positions
• International taxation principles and strategies
4. Collaborate with clients to optimize • Pre-retirement planning

the conversion of assets into income
that will meet lifelong lifestyle
• Tax-efficient executive retirement plans
expectations. • Features and benefits of different conversion strategies

• Managing longevity and health-related financial risks
5. Develop and implement a wealth • Tax-efficient options for transferring wealth before death
transfer plan that reflects the wishes of
the client and the needs of the family.
• Charitable giving strategies, including endowments and
foundations
• Multi-generational estate planning
Professional practice competencies Areas requiring specific expertise
1. Build and manage client relationships • Duty of care through professional, ethical, legal, and moral
that result in successful partnerships. conduct
• Sensitivity to family dynamics
• Interview skills; communication styles related to age, gender,
and ethnicity; verbal and non-verbal communication; and
managing difficult client conversations
2. Evaluate client needs, goals, and • Client’s relationship to money, including emotional and
behavioural biases and link them to cognitive biases
recommendations, leading to the
creation and implementation of
• Investor personality types
an optimal comprehensive wealth • Issues and opportunities related to family dynamics

management plan.
3. Coordinate and engage a trusted and • External and internal professional relationships offering will and
respected team of experts to provide a estate expertise
fully integrated, well-rounded wealth
management service.
• Comprehensive financial plans
• Philanthropic services
• Trust services
• Other specialized wealth management capabilities
4. Use custom business marketing • Creating a unique value proposition

techniques to build a wealth
management practice.
• Managing a practice efficiently and profitably
• Earning the right to ask for referrals

DID YOU KNOW?
It is important to note that you do not need to be an expert in every one of the nine wealth
management competencies. In areas where you lack expertise, you should expect to either work with
an expert or refer your clients to an expert who can best serve their needs. The experts you rely on may
be available in-house, or they may be external experts with whom you have developed a professional
relationship.
TRADITIONAL ATTRIBUTES
The traditional attributes of successful wealth advisors relate to their character and their ability to build good
relationships with their clients. Many of these soft skills were defined for this course in consultation with successful
wealth advisors when the White Paper was created. Their input provided a valuable perspective on how to build
lasting client relationships.
CLIENT TRUST
Trust is the cornerstone of the financial services business. As a wealth advisor, you can foster and maintain trust with
clients by providing excellent service. Clients are more willing to do business with advisors they trust and will often
move assets from another firm once trust is gained. Trust is also the basis for earning client referrals.
EXAMPLE
Wealth advisor Sam considers his client Suzanne a success story. Suzanne initially opened an account with only
a small percentage of her total assets for Sam to manage. As she grew to trust Sam’s advice and judgment, she
transferred increasing amounts of her assets until all her investments were under his management. When her
sister’s children came into a modest inheritance from their grandfather and were looking for investment advice,
Suzanne did not hesitate to recommend Sam.
Sam says, “You have to be trustworthy in this business. Once you’ve earned a client’s trust, it opens many doors.
Trust comes from referrals, longevity in the business, and not being overly aggressive.”
HONESTY, INTEGRITY, AND ETHICAL BEHAVIOUR

Honesty, integrity, and ethical behaviour are essential characteristics of a wealth advisor. Those who do not
demonstrate these values typically do not survive in the business.
Clients should be able to rely on you for straightforward and truthful answers to their questions. If an investment
decision turns out to be wrong, you must accept responsibility where appropriate and take steps to remedy the
situation quickly and efficiently. In time, this attitude should help to build trust, and your clients will be confident
that their affairs are being looked after satisfactorily.
GOOD COMMUNICATION SKILLS

Good communication skills are often cited as a key to success; these skills are directly linked to the ability to gain
client trust. Successful advisors keep their clients well informed on emerging issues and events, often through the
use of newer technology options. Even when the news isn’t positive, they find ways to provide their clients with
alternatives. They make sure that recommendations are clearly worded, and they regularly review the financial and
investment plans with their clients.

KNOWLEDGE, EDUCATION, AND INTELLIGENCE

Successful advisors recognize the importance of the client relationship, but they also know that it is their knowledge
that makes them attractive to clients. The ability to collect, analyze, interpret, and apply information is a task
of ongoing importance. Good advisors do not hesitate to call on people in their extensive internal and external
networks for advice in a specific area. Successful advisors are also committed to continuing education. There is a
competitive advantage in being as knowledgeable as possible and using that knowledge for the benefit of your
clients.
COMMITMENT AND EMPATHY

Successful advisors understand the importance of respecting the emotional relationship clients have with their
money and investments. They must also be committed to an evolving relationship with clients and to dealing
with changes in their demands at different stages of life. Empathy is essential if one is to build trust with
clients.
It is important to develop friendly relationships with your clients because things don’t always work perfectly
in the market. If your clients don’t like and trust you, they may leave when things are not going as well as they
would like.
ENTREPRENEURIAL NATURE
Most successful advisors develop innovative and entrepreneurial ways of building a client base. Initiatives include
radio and television features, articles in financial newspapers and journals, university- or college-level teaching,
seminars, and even investment cruises.
CONSISTENCY AND CONSERVATISM

Many successful advisors consider themselves low-risk investors. This attitude reflects the typical objectives of their
client base. Clients tend to become more conservative as they get older. They are likely to be uncomfortable with an
aggressive advisor who is only interested in speculating.
CAPACITY FOR HARD WORK

Advisors have to focus on their work, especially when they are establishing a business. Most report having spent
long hours at the office in the early years. However, one characteristic of success appears to be working shorter
but more efficient days. Success should come in the context of a life that is well balanced between the personal
and professional sides. It is difficult to conduct business and be there for your clients if you ruin your health with
overwork and stress.
PROBLEM-SOLVING SKILLS
Effective problem-solving skills are crucial to success. A good support team can minimize the risk of mistakes, and
checks and balances should be put in place to avoid errors. When problems do occur, successful advisors address
them immediately and take responsibility.
GOOD ORGANIZATIONAL SKILLS

Maintaining accurate records, keeping track of transactions, and being in control of office administration are
prerequisites for a successful advisor. Time management cannot be an occasional effort.
Organization is closely related to service quality. Clients expect reliable, timely, and personal service. It is not
always in the best interests of the client to have other members of the team call, especially when clients expect the
advisor’s personal attention, expertise, and time.

MOTIVATION, ENTHUSIASM, AND LOVE FOR THE BUSINESS

There are no overnight or accidental success stories in this business; success takes time and a strong desire to
succeed. Success also means different things to different people. What is success for one person might be only
a stop along the way for another. Truly accomplished advisors aim high. They tend to describe their attitude
toward their work with words like “passionate”, “devoted”, and “driven”. Most successful advisors don’t lose their
passion for the job and want intensely to succeed. They set their goals high, and when they reach them, they set
new goals.
EMERGING ATTRIBUTES
While the traditional attributes of successful advisors are as relevant as ever, the traits described below are
becoming increasingly important as wealth management evolves as a distinct practice.
STAYING RELEVANT AS DEMOGRAPHICS CHANGE

As discussed earlier, wealth advisors can enhance their practice by becoming transition specialists. In this role, you
can help your clients understand the major issues they will face in their later years and link money discussions to
these issues.
When dealing with your clients’ transition issues, you should consider the needs and expectations of their children
and grandchildren as well. It may be advantageous to expand your team to include people of similar age and
interests. Consider also whether you should improve your technological proficiency so that you can provide the kind
of service your younger clients demand.
COACHING CLIENTS TO ACHIEVE SELF-FULFILLMENT

The personal coaching profession is growing rapidly in response to demands by aging baby boomers for
someone to help them reach self-fulfillment. Personal trainers, corporate performance coaches, and personal
coaches are becoming life advisors to an increasing number of clients. Baby boomers tend to want a do-it-
yourself approach, but with the help of people who can keep them focused. Coaches don’t provide clients
with new information; they simply work with clients to motivate them and draw on their existing strengths.
To coach someone is to be their partner, providing support and motivation to enable them to make a change
themselves.
If you have the skills and inclination, you can enhance the service you bring to clients by coaching them directly.
Otherwise, you can do so indirectly through referrals. Some advisors have referral relationships with personal
coaches, psychologists, and career transition coaches. Others conduct regular workshops with outside professionals
to expose clients to the work coaches do.
You should be aware that many clients now see personal coaches as their main source of life-planning information
and support. It is to be expected that personal coaches will start to refer their clients to financial advisors to provide
specific financial planning expertise.
To develop your practice in this emerging area, consider the approach you want to take. Do you want to be a wealth
advisor with a focus on personal coaching? Or would you prefer to have a personal coach as a specialist who is part
of the overall service you provide?

DIVE DEEPER
Professor of Psychology Abraham Maslow (1908-1970) explained people’s emotional priorities in terms
of his well-known theory, the Hierarchy of Needs pyramid*. At the bottom of the pyramid, Maslow put
physiological needs, then came safety, then belonging, together with esteem. Finally, at the top of the
pyramid, he put self-actualization.
If you want to explore this topic further, go to your online chapter and click on each level of the pyramid
to learn more.
* Abraham Maslow, “A Theory of Human Motivation”, Psychological Review 5, no. 40 (1943): 430–437.
ORGANIZING AND MANAGING A TEAM OF SPECIALISTS

Clients’ financial lives are becoming increasingly complex, and no one advisor can be expected to have all the
answers. When a higher level of expertise is called for, you should be able to identify and manage the proper
resources. For example, you may wish to refer clients to specialists who can create an alter ego trust, write a
business succession plan, or start a private charitable foundation. You should recognize when your clients need
specialized advice and know who can provide it. Building and managing a team of experts may be as challenging
as putting together an overall financial plan, and it is equally important.
ATTRIBUTES OF A WEALTH ADVISOR
Can you describe the traditional and emerging attributes of a successful wealth advisor? Complete the
online learning activity to assess your knowledge.
THE WEALTH MANAGEMENT PROCESS
7 | Describe the wealth management process.
In this section, we discuss the wealth management process in the following order:
1. Understanding the client
2. Formulating the plan (integrating financial planning and investment management)
3. Formalizing and implementing the plan
4. Reporting, reviewing, and rebalancing
Figure 1.1 illustrates the wealth management process from beginning to end.

Figure 1.1 | The Wealth Management Process
Understanding the Client

Building the Relationship with the Client
Gathering Quantitative Data
Gathering Qualitative Data
Determining the Client's Needs, Objectives, and Constraints
Educating the Client
Formulating the Wealth Management Plan
Advanced Financial Planning Investment & Portfolio Management

Retirement Planning Determining Risk/Reward Trade-off
Tax Planning Asset Allocation
Insurance Planning Understanding & Choosing Managed Products
Estate Planning
Implementing the Plan

Wealth Plan
Investment Policy Statement
Trade Execution
Reporting, Reviewing, and Rebalancing
UNDERSTANDING THE CLIENT

The wealth management process starts with establishing a strong relationship with the client that is built on trust.
Your primary role may involve providing advice on investments, risk management, tax planning, estate planning,
and other financial matters. However, these elements must always be consistent with the client’s needs, goals, and
constraints. It is especially important that you determine the suitability requirements of the client at the outset. This
step involves going beyond what is recorded on the KYC forms; it requires to get a true sense of the client’s most
closely held aspirations and attitudes.
Money brings out emotions of anxiety, security, pride, satisfaction, fear, anger, loss, guilt, joy, hope, greed, lust, and
sorrow in people. These emotions can equally affect the wealthy man who inherited money from his parents and
the self-made woman who has earned every penny from her hard work, independence, and tolerance for risk. It is
your job to help clients articulate these emotions and build a financial strategy to keep them under control.

You must be competent when it comes to managing wealth, using high-level skills in investment and portfolio
management and financial planning. However, to be truly successful, such technical knowledge is often secondary
to interpersonal skills.
FORMULATING THE PLAN

Once a client has articulated his or her needs, objectives, and constraints, you can begin the process of formulating
a plan. The plan should set out the steps that will take your client from where they are financially at the moment to
where they want to be.
The plan will draw on your knowledge and experience in portfolio management and financial planning. These are
not separate steps in the wealth management process; investment decisions affect the financial plan, and financial
planning objectives influence the investment plan.
EXAMPLE
Your client Anita wants to maximize the after-tax income she receives in retirement and make certain there is
no additional tax payable when she dies. Your job is to implement a portfolio with an asset allocation mix that
minimizes the risk for the level of return she needs. With your guidance, Anita must consider various personal
tax-planning strategies and decide where best to place her investments. You must also help her plan the timing
of her withdrawals from her registered and non-registered accounts. While she is still saving for retirement, you
should help her put a plan in place to ensure that an unforeseen disability or serious illness would not adversely
affect her retirement plans.
FORMALIZING AND IMPLEMENTING THE PLAN

Once you have put together the plan, it must be formalized in a written document. Your client may need two
documents. The first document is a financial plan (or a wealth plan); the second is an investment plan or investment
policy statement. Alternatively, the investment plan may be incorporated into the wealth plan. The length of the
document or documents will vary with the complexity of each client’s situation. After the plan is formalized and its
recommendations accepted and endorsed by the client, you can begin to implement it.
REPORTING, REVIEWING, AND REBALANCING THE PLAN

Monitoring a financial plan is an ongoing process. You must evaluate the performance of the plan by analyzing how
closely it meets your client’s objectives. You must also be aware of any changes in the client’s personal situation and
economic conditions that may warrant revision of the plan.
The plan should include a process for closely following the investment policy and monitoring its effectiveness. For
example, some clients may require a monthly portfolio report. The plan may also specify criteria against which each
fund manager or managed product is to be evaluated.
A portfolio should be reviewed at least once a year to confirm that it is achieving the required benchmark and
the objectives it was created for. The annual review is also an opportunity to rebalance the portfolio, modify its
strategies, or find new business opportunities.
WEALTH MANAGEMENT PROCESS
How well do you understand the wealth management process? Complete the online learning activity to
assess your knowledge.

BUILDING YOUR TEAM OF SPECIALISTS
8 | Explain how wealth advisors can work effectively with a team of specialists.
The wealth management process is a comprehensive one requiring specialization on your part in many different
areas. However, as discussed, you do not need to that you be a specialist in every one of the competencies described
in the White Paper.
It is up to you as a wealth advisor to build and manage an expert team that will complement and enhance all of the
knowledge and skills you offer your clients. This team of experts may include specialists in the areas of tax planning
and preparation, money management, alternative investments, risk management, trust preparation, legal issues,
real estate, charitable giving, estate planning, retirement planning, deferred compensation, business succession
planning, financial plan delivery, will preparation, and business valuation. Your team may even include a personal
coach and grief counsellor.
In the future, wealth management will require increased emphasis on a full-service, comprehensive approach. It
will require more than just developing financial plans for clients. It should also involve a team of specialists to help
clients with their overall wealth management needs.
EXAMPLE
Jonathan, a sociable dentist, has been one of Elizabeth’s clients for several years. Over the years, Jonathan has
referred friends and colleagues to Elizabeth. As a wealth advisor, Elizabeth normally recommends that her clients
meet with her firm’s in-house financial planner to benefit from his services. Elizabeth has suggested this service
to Jonathan several times, but he has expressed no interest. Elizabeth is unsure about the reason for Jonathan’s
reaction. She also knows very little about Jonathan’s private life, including whether he has a spouse or any
children.
Elizabeth knows that Jonathan has a winter home in Arizona that he regularly visits, so she suggests that he meet
with Ahmed, her in-house estate planning specialist. Her reasoning is that Ahmed may be able to help Jonathan
with any potential U.S. estate tax concerns.
Elizabeth participates in the meeting with Jonathan and Ahmed. When Ahmed asks about potential beneficiaries,
Elizabeth is surprised to learn that Jonathan has been divorced for many years and that his ex-wife and child are
living in Arizona. Elizabeth’s decision to recommend an in-house expert colleague has helped her client and has
also provided essential information to Elizabeth about her client.
WORKING WITH IN-HOUSE SPECIALIST TEAMS

Investment in internal expert teams has grown considerably over the years, especially in the fully integrated PWM
model and the semi-integrated FSB model. Both business models are found in large financial institutions that have
both the required funding and the necessary economies of scale.
Most in-house expert teams are made up of accredited financial planners, accountants, and legal professionals. They
typically provide the following types of services:
• Comprehensive financial plan preparation and delivery

• Will and estate reviews
• Business succession planning
• Tax and legal advisory services

The large financial institutions generally offer these complimentary services to highly valued wealth clients. These
experts are brought in by the wealth advisor for a single meeting or short series of meetings with the client. They
provide the professional expertise the client requires to answer specific questions or address pressing needs. The
final delivery from these in-house teams is often a customized report written for the client and wealth advisor that
examines the client’s concerns and provides several recommendations.
In-house teams generally do not actually implement any of the ideas they suggest. Instead, implementation is left
to the wealth advisor or an outside professional. The outside professional may be either the client’s own choice or
one recommended by the advisor.
Given that experienced and accredited financial planning, accounting, and legal professionals largely staff
these in-house specialist teams, the cost of providing these value-added services is high. Companies generally
encourage wealth advisors to use these teams with their most important clients or most promising prospects
as leverage to help close the deal. Because of the exclusivity of the offer and the high level of customized
advice, introducing a client or prospect to a member of the specialist team often enhances the client
relationship.
WORKING WITH IN-HOUSE PRODUCT SALES TEAMS

Closely aligned with the in-house expert teams are teams that have expertise in specific HNW solutions that can
be used to help meet a client’s wealth management goals. The types of products these specialized teams support
include the following examples:
• Insurance-based solutions
• Charitable giving solutions
• Trust services and solutions
The difference between these teams and the in-house specialist teams is the ability of the sales teams to sell these
products and services, for which both the in-house team member and the advisor may be compensated.
WORKING WITH OUTSIDE PROFESSIONALS

Although most large financial institutions have a team of in-house specialists the wealth advisor can draw from,
not all specialists can be found internally. This is especially the case if you are aligned with a smaller, mono-line PIC
business, which may provide only limited access to an in-house specialist’s expertise.
For this reason, you may need to create strategic alliances with professionals outside the firm. In the industry,
these outside professionals are often referred to as centres of influence (COIs). Alliances with COIs may begin as
potential reciprocal sources of referrals. Eventually, they can grow into more integrated business relationships.
It often takes time to develop COI relationships. It is important, therefore, that you communicate with them
regularly so that they keep you in mind. It is especially important that you explain your value proposition in
terms that the COI can understand. They will be much more likely, then, to refer potential clients who may need
your services.

EXAMPLE
One of Elizabeth’s longest-tenured clients is a retired doctor named Jonas. Over the years, Jonas had done
very well, building a thriving specialty practice with several clinics. When he retired a few years ago, he sold his
practice and the clinics. However, he retained the buildings so he could have an ongoing stream of rental income.
After he sold his business, he came into Elizabeth’s office and deposited a cheque representing the proceeds of
more than $8,000,000.
Although Jonas had all the income he needed to support the lifestyle he enjoyed, he was eager to reduce the
significant amount of income tax he paid every year. Knowing that he was supportive of charities, Elizabeth
set up a meeting with her in-house charitable donations expert for advice on setting up a private charitable
foundation. Jonas was enthusiastic but unsure how much income he should allocate to the causes he wanted to
support. Elizabeth suggested that he speak with his accountant, with whom she also shared a relationship.
After various calculations of Jonas’s rental income and investment earnings, the accountant suggested an
appropriate donation amount to maximize Jonas’s tax savings for both the current and following year. The
donation amount, which turned out to be larger than either Elizabeth or Jonas had expected, was easily
affordable by Jonas.
Relationships with COIs are reciprocal. You should help your COIs understand the qualities that make a
prospect suitable for you, and, likewise, you should learn what qualities your COIs are looking for. This two-way
communication will result in more effective referrals and will improve your relationships with your COIs over time.
Once a relationship with a shared client is established, you must obtain your client’s permission before you share
any information with the COI. Working with the COI, you can then help your clients meet their wealth management
needs in the areas of taxation, estate planning, financial planning, and other issues.
At the beginning of this chapter, we presented a scenario in which you were starting out as a wealth advisor. We
asked about the types of clients you will encounter and what you need to know to serve them well. Now that
you have read the chapter, we’ll revisit those questions and provide some answers:
• How would you describe your role as an advisor in today’s wealth management industry?
• The wealth advisor’s role is to serve the needs of clients with high net worth and those who have the
potential to become HNW clients.
• Two client groups in particular have the potential to quickly grow their investable assets to become HNW
clients: mass affluent families growing their wealth and selected individuals such as recently graduated
professionals.
• Who are your potential clients and what do they expect from you as their wealth advisor?
• HNW clients and those with HNW potential expect their advisors to provide the following services:
« Consider all their needs as an interconnected whole.
« Take time to fully understand their needs and apply a comprehensive wealth management process to
address those needs.
« Provide appropriate advice and recommend suitable products and services to help your clients meet
their goals.
« Introduce them to a team of specialists who can provide a higher level of wealth management support.

• What is the impact of the key demographic, industry, and technology changes on the role of today’s wealth
advisor?
• Today’s client views, or should view, money as a means to an end. As their advisor, you should do the
same. Therefore, you should transition from a wealth builder in the early years to a facilitator who helps
clients achieve their life goals.
• Each demographic segment has different needs and goals. You should understand current demographic
trends so you can address the needs of the various population cohorts.
• The trend toward holistic wealth management requires the combined knowledge of experts in such areas
as tax advice, estate planning, insurance solutions, and legal matters. You should call on these experts to
provide the specialized knowledge your clients need.
• Through the consolidation and integration of financial services firms, you have access to a broader
spectrum of financial solutions. By nurturing reciprocal referral relationships, you can provide convenient
one-stop shopping for clients.
• Wealth management, and the financial industry in general, are constantly affected by change from many
sources, including regulatory requirements and product sophistication, which require that you remain
current in the following areas:
« Continuously develop and enhance your skills.
« Have the knowledge required to properly advise clients.
« Increase transparency through better communication and reporting.
« Add value through integrated wealth management planning.
• What are the traditional and emerging attributes that you need to have or need to develop in order to meet the
demands of today’s wealth management industry and clientele?
• Successful wealth advisors generally have the following attributes:
« Ability to develop trust and inspire confidence with clients
« Ability to deal ethically and honestly in all client settings
« Ability to communicate effectively and empathetically
« Willingness to embrace continuous learning and accreditation
« Entrepreneurial inclination
« Strong interpersonal skills
« Ability to adjust your business practices to appeal to a wider demographic
« Ability to embrace changes to technology and use them to enhance your business and communicate
more effectively with your clients

SUMMARY
In this chapter, we discussed the following key aspects of a wealth management practice:
• Wealth management has emerged as a distinct practice in the the past few years. The wealth management
approach consolidates a broad range of financial products and services for the growing number of HNW clients
in Canada. The changing nature of these clients has resulted in a broader market, a wider range of services
available, and deeper advisory relationships.
• The three main channels dedicated to the HNW segment are PWM, full-service brokerage, and the PIC model.
Each delivery channel falls under one or more of three business models active in Canada: fully integrated, semi-
integrated, and mono-line. Fully integrated firms include large financial institutions that offer a comprehensive
range of private wealth services. Semi-integrated firms offer a limited range of services, whereas mono-line
firms usually focus on a specific service.
• The key trends shaping the future of wealth management include changing demographics (among both client
base and advisor population), competitive pressures, and technological changes. Key regulatory initiatives
having an impact on the industry include the U.S.-enacted FATCA and the Canada–U.S. Intergovernmental
Agreement. Advisors need to be mindful of regulations governing privacy (i.e., PIPEDA) and anti-money
laundering and terrorist financing (i.e., PCMLTFA). Another initiative is IIROC’s Client Relationship Model.
CRM1 governs disclosure, suitability, and conflicts of interest. CRM2 is designed to increase investor protection
and raise transparency standards.
• The White Paper is an authoritative industry report that describes five technical competencies and four
professional practice competencies required for success. Wealth advisors should also have traditional attributes
such as integrity, empathy, and an entrepreneurial nature. Emerging attributes specific to wealth managers
include coaching skills, skills in building a team of specialists, and the ability to stay relevant as demographics
change.
• In-house expert teams are made up of accredited financial planners, accountants, and legal professionals.
Wealth managers also rely on in-house product sales teams and, at smaller firms especially, outside
professionals.
DISCUSSION BOARD
If you have any questions about this chapter, you may find answers in the online Discussion Board
for Chapter 1.
REVIEW QUESTIONS
Now that you have completed this chapter, you should be ready to answer the Chapter 1 Review
Questions.

Ethics and Wealth
Management 2
CHAPTER OUTLINE
In the previous chapter, we provided an overview of the shifting dynamics in the wealth management industry.
In this chapter, we discuss ethics in the context of that industry. We explain the concept of ethics and describe
the different types of ethical dilemmas. We also provide a framework for ethical decision-making in an industry
where unethical behaviour can destroy careers and harm the reputation of financial institutions and the industry
as a whole. We discuss regulatory infractions and the potential consequences of regulatory non-compliance.
1 | Explain what is meant by ethics, ethical Ethics in the Financial Services Industry
principles, and values.
2 | Identify ethical dilemmas that may arise in an Types of Ethical Dilemmas

advisor’s professional practice.
3 | Analyze different scenarios using a framework Resolving Ethical Dilemmas

for ethical decision-making.
4 | Relate applicable codes of ethics to your Code of Ethics

professional practice.
5 | Distinguish between the concepts of trust, Trust, Agency, and Fiduciary Duty
agency, and fiduciary duty.
6 | Explain IIROC’s investigation procedures and What Can Happen When an Advisor Ignores
the consequences of non-compliance. Ethics

KEY TERMS
agency mandate
agent mandator
beneficiary means values
case assessment power of attorney
contested hearing principal
disciplinary hearing principles-based regulation
end values prosecution
ethical dilemma prudential regulation
ethical principles reputation risk
ethics rules-based regulation
fiduciary settlement hearing
fiduciary duty trading authorization
investigation values
mandatary value system

CHAPTER 2 ETHICS AND WEALTH MANAGEMENT 2•3
INTRODUCTION
In the current financial services industry, there are more rules, regulations, and oversight than ever before. The same
rules apply in the industry as a whole and to wealth management in particular. But whether your advisory practice
is traditional or focused on wealth management, you must do more than simply comply with the rules. A successful
advisor-client relationship is built on a foundation of trust and integrity. To provide appropriate advice and service
to your clients, you must view every situation through an ethical lens to ensure that you are always acting in their
best interests. Only by conducting yourself ethically and doing what is right for your clients can you protect your
integrity, along with the integrity of your firm and the broader industry.
Before you begin, read the scenario below, which is based on a typical client encounter with a wealth advisor. The
scenario raises some of the questions you might have regarding ethics in the financial services industry. Think about
these questions, but do not worry if the answers don't come easily. At the end of the chapter, we will revisit the
scenario and provide answers that summarize what you have learned in this chapter.
DOING RIGHT BY THE MILLERS
Peter and Ruth Miller are introduced to you by their banker after a seminar you delivered on retirement
planning. The Millers feel that their existing advisor has been providing them with advice that is contrary to their
best interests. He has been pressuring them to remain in risky investments that have generated poor returns
over the past decade. Even when they complained to his firm’s management, the advisor offered expensive
managed products that performed poorly. The Millers tell you that their advisor does not listen to them,
focusing instead on generating the most profit for himself and his firm at their expense. They want to establish
a relationship with an advisor and a firm they can trust and that will act in their best interests.
• What is important for the Millers to know about how you conduct yourself in your dealings with clients? What
should they know about your firm’s expectations regarding the conduct of its employees and how it enforces
those expectations?
• How would you describe the principles you abide by in your existing client relationships in a way that instills
confidence in these prospective clients?
• How would you explain the ethical concepts underlying your commitment to accountability to your clients?
ETHICS IN THE FINANCIAL SERVICES INDUSTRY
1 | Explain what is meant by ethics, ethical principles, and values.
Ethics can be generally defined as a set of consistent values that guide individual behaviour. Values may change
over time, but the change is always driven by accepted standards of right and wrong, and not by personal
needs. Commonly agreed-upon ethical values include accountability, fairness, honesty, loyalty, reliability, and
trustworthiness.
More specifically, the study of ethics has three distinct meanings:
1. The standards governing the behaviour of a particular organization or profession
2. A set of moral principles or values
3. The study of the general nature of morals and the moral choices people make
In this chapter, the subject is treated as a continuous process of examining behaviour and making decisions in the
context of moral principles.

DID YOU KNOW?
Morals are the norms of an individual or society that are established according to standards of right and
wrong. Moral standards guide our actions in situations where self-serving decisions may cause harm to
others. These standards are based on reason; they cannot be established or changed by authoritative
bodies, but they may underpin decisions made by those authorities.
THE CONCEPT OF ETHICS

Ethics is a branch of study that serves as a foundation for the rules of the financial services industry. It provides a
structure that allows participants to interpret and evaluate different situations and circumstances. The industry has
many rules and regulations, but following the rules is only the bare minimum required for ethical behaviour. Ethics
provides a more nuanced approach to dealing with the various stakeholders in the industry.
Ethical principles help guide behaviour in situations where no regulation specifically applies. These principles may
be influenced by public opinion, consumer demand, or advocacy groups. Such influences may raise the level of
ethical behaviour above the minimum standards set out by the regulators.
Unethical conduct in the form of insider trading and the misuse of client funds, for example, is often widely exposed
in the news media. Such conduct, when revealed, damages the reputations of all parties involved. Efforts to avoid
ethical misconduct in the first place help safeguard the interests of all, including clients, advisors, organizations, the
industry, and the capital markets. In the long run, ethical behaviour is just good business.
IMPORTANCE OF ETHICS
The underlying reason for any ethical behaviour is obvious: ethical behaviour creates trust, and trust is essential
to almost all business, professional, and personal relationships. The cost of litigation arising from the actions
of unethical staff can be prohibitive; thus, businesses benefit by promoting corporate values throughout the
organization. Companies where strong ethics do not prevail often lose the trust of their stakeholders, incur higher
costs, and suffer significant losses due to employee actions.
The public’s willingness to invest their savings is tied to the reputation of financial institutions and their advisors,
and its trust in the financial services industry. Investors must trust that their advisors will provide competent,
fair, and unbiased advice. They must believe that their assets will be safeguarded and that their accounts will be
managed in their best interests. The public’s confidence in this regard also ensures the integrity of the capital
markets. Without that trust, considerably fewer investors would participate in securities transactions.
VALUES
Morality, integrity, trust, honesty, and competency are values prized by all professionals working in the financial
services industry. The absence of any one of these values may compromise the reputation and public perception of
advisors as individuals and the industry as a whole.
Values have the following characteristics in common:
• They are beliefs, not facts.

• They are long lasting, but not necessarily unchangeable.
• They guide individual and corporate behaviour and goals.
Values that influence personal goals are end values and means values.

End values End values represent the goals toward which we strive and influence how we act today
to achieve tomorrow’s goals. Family security, self-respect, social recognition, wisdom,
and a sense of accomplishment are all end values.
Means values Means values are the actions we take in the present to achieve a future goal. These
values include ambition, competence, honesty, independence, and responsibility.
A unified value system is one in which the means and ends mutually reinforce and support each other. Individuals
and corporations get into trouble when their means values do not support their end values.
For you as an advisor, having a strong value system is important for the following reasons:
• It influences your perception of situations and problems.

• It guides your decisions and solutions to problems.
• It restricts your actions within the bounds of ethical behaviour.
• It helps you resist pressure to do something that you believe to be wrong.
In making any decision, you are faced with more than one choice. Clearly articulated values help guide you in
determining your priorities and goals when making those choices. Your value system also tells the world what you
stand for and what you hold to be important.
At most, if not all, financial institutions, values are articulated in corporate codes of conduct and codes of ethics.
Those stated values must guide the objectives of the firm and its employees, rather than having objectives dictate
values.
ETHICS AND INDUSTRY REGULATIONS

The securities industry is subject to complex and extensive rules and regulations, which may not be clear and
easy to apply in every situation. Ethical conduct comprises more than compliance with those rules. In assessing a
situation, you must also be guided by the norms of ethical behaviour.
Certain securities industry regulations define broad, principles-based requirements. For example, the Investment
Industry Regulatory Organization of Canada (IIROC) requires compliance with the Know Your Client (KYC) rule.
Under the KYC rule, both you and your firm must adhere to the following requirements:
• Observe high standards of ethics and conduct in the transaction of business.

• Refrain from engaging in any business conduct or practice that is unbecoming or detrimental to the public
interest.
• Be of a character and business repute and have experience and training that is consistent with ethical standards.
Similarly, IIROC KYC rules require the handling of client business to be within the bounds of ethical conduct. Your
conduct in this regard must be consistent with just and equitable principles of trade and not detrimental to the
interests of the securities industry.
The industry is also subject to numerous technical and procedural rules that may not have a readily apparent moral
complexion. These rules are in response to a need for clear and consistent standards of conduct for all relevant
persons. They are often adopted to achieve certainty across an industry in which any one of a broad range of
available choices may arguably be right.
Rules can be innocently overlooked, misinterpreted, or misapplied. Furthermore, it may not be readily clear, or views
may diverge on, which ethical value any specific rule violation is contrary to. This lack of clarity, along with the need
to ascertain motive, are typical of the challenges associated with the application of ethics in practice.

The appropriateness and design of any particular rule may be a subject for legitimate debate. Nevertheless, ethics
and integrity require diligent adherence to all rules in effect, and wilful disregard of a rule can give rise to more
fundamental ethical considerations.
EXAMPLE
Annette, an advisor applying for registration as a supervisor, intentionally fails to disclose a criminal conviction on
the registration application. She then signs a certificate attesting that the form is complete and accurate. There
is no question that Annette has violated a rule by not completing the application truthfully. However, the larger
ethical issue is her willingness to certify incorrect disclosure and what that says about her integrity, honesty, and
moral character.
An inadvertent violation of a rule resulting from a lack of knowledge, without malicious motivation, normally
warrants relatively lenient sanctions. Such instances are often used as an opportunity to assess the awareness of
the individual and across the organization, and to then take corrective measures. Further education may be deemed
necessary for all employees.
A conscious decision to disregard a rule, even one that is seemingly administrative, can call into question the
violator’s personal ethics. For this reason, repeat offenders are usually treated differently from one-time offenders.
Similarly, the employee’s reaction upon being found to have violated a rule may be more significant than the
circumstances of the violation itself. For example, a display of unconcern, bullying, or arrogance, in contrast to
cooperation, regret, and remorse, can be highly revealing of the offender’s personal values and ethics.
Intentional disregard of industry regulations may be considered unethical in almost every situation; however, the
converse does not apply. Technical compliance with the letter of the law (known as checklist compliance) does not
necessarily indicate an ethical stance. Conduct must also be consistent with the spirit and intent of the rules.
RULES-BASED VERSUS PRINCIPLES-BASED REGULATION

Over the past few years, there has been extensive debate over the relative pros and cons of rules-based regulation
versus principles-based regulation, and this dialogue is likely to continue. Arguably, Canadian securities regulations
already incorporate and balance both approaches.
Rules-based regulation is subject to prescriptive, detailed, and technical standards. Principles-based regulation, on
the other hand, parallels and overlaps the ethical decision-making process. In the second case, industry participants
are expected to apply judgment and discretion in determining whether any given activity conforms to broadly
defined values and standards.
Discretionary fee-based accounts are one example where definitive regulatory standards may not exist, but
regulatory expectations in the context of more general principles have emerged. Advisors and firms who are paid
based on a percentage of a client’s assets under administration have a vested interest in the client’s account
increasing in value, which also means that their fee increases in absolute dollar terms over time. Most clients agree
that they share the objective of their accounts appreciating in value. However, regulators have pointed to potential
abuses, such as churning (i.e., trading excessively to generate higher commissions) or reverse churning (i.e., placing
an otherwise low commission account into a fee-based program, without providing advice).

EXAMPLE
Speed limits are sometimes used as an example of rules-based regulation that is distinct from regulation based
on principles. Views may differ on the form of regulation that should be adopted and the appropriate speed limit
that should be imposed. However, most people agree that some form of rule is required to protect the public
from reckless and irresponsible drivers.
Under a rules-based regime (also known as prescriptive regulation or an objective standard), the rule might state
that it is illegal to drive faster than 100 kilometres per hour on a particular road. A clearly defined maximum
speed is thus established by regulation as a threshold applicable to everyone. There may be legitimate arguments
that the threshold is too high or too low. For example, each side may assert that public safety, automotive
capability, road engineering, and fuel conservation justify a different limit. However, as arbitrary as it may be, the
rule ensures that all drivers understand and are held to the same standard.
In contrast, a principles-based rule might state that drivers should not drive faster than is reasonable and prudent
in all circumstances. This rule may sound good conceptually; everyone has full flexibility to assess all relevant
factors and act accordingly. However, the practical difficulty is that different people may assess precisely the
same situation and arrive at very different conclusions. Defending the correctness of such a subjective view after
an accident may be even more difficult.
Minor traffic violations are another example where a principles-based approach may lead to debate. We all
recognize the necessity of parking regulation in congested urban areas and the importance of parking revenues to
fund civic services. However, most people do not view someone who receives a parking ticket as being unethical,
immoral, or lacking in integrity. But what if the offender thoughtlessly blocked a hospital emergency entrance?
Or, worse, what if the driver did so intentionally? A rules-based approach need not take such nuances into
consideration.
ETHICS DEFINED BY PERCEPTION

Integrity is measured by the extent to which a person’s ethical values consistently determine their behaviours and
decision-making. A reputation for integrity, demonstrated over time, leads others to place their trust in that person
and the firm they work for.
It is no small task to achieve such a reputation. Typically, years or even decades of dedicated and consistent
adherence to high standards of ethical business conduct and professionalism are required. One lapse, even if
atypical and isolated, can harm an advisor’s public image and destroy the goodwill that has taken years to build.
This fact is why reputation risk is considered to be one of the most significant risks in the investment and financial
services industry.
Capital and financial solvency are often a starting point for client trust. After all, no one would want to entrust
their savings to a firm that appears unable to safeguard client assets and repay its obligations when due. Capital
adequacy standards (often called prudential regulation) exist to ensure that investment dealers maintain an
appropriate level of capital and have prudent and appropriate internal controls.
As important as financial solvency is, clients typically want more than simple assurance that a firm has adequate
capital. They also expect that ethics will govern their relationship with the firm and its representatives. The
importance of such client expectations is reflected in the extent to which ethics, integrity, and trust feature
prominently in the marketing and advertising campaigns of financial institutions.
Securities regulations require an ethical counter-balance to any desire to convey a positive perception. Financial
institutions are not permitted, for example, to omit or downplay relevant facts in client communications to the
point of deception. What is communicated must not be misleading and must be founded in fact. This requirement
is reflected in the core mandate of securities regulators to ensure “full, true, and plain disclosure”. Various detailed
regulatory standards for marketing, advertising, and sales communications reinforce this mandate.

TYPES OF ETHICAL DILEMMAS
2 | Identify ethical dilemmas that may arise in an advisor’s professional practice.
In most situations requiring an ethical decision, one must choose between right and wrong. Given such a
straightforward decision, no ethical dilemma exists because there is only one right choice. Codes of conduct, codes
of ethics, and compliance policies are mainly concerned with these right-versus-wrong situations.
IIROC’s Sanction Guidelines are useful for assessing rule violations and misconduct. These documents set out in
specific detail the factors that IIROC considers relevant in assessing a range of violations. They also set out the
appropriate penalties associated with specific types of violations.
More problematic, however, are situations where values clash and neither choice is obviously right or wrong.
In many cases, each possibility has some right and some wrong elements to it; the difficulty lies in making the right
decision. Such right-versus-right quandaries reflect the essence of a true dilemma.
RIGHT-VERSUS-WRONG SITUATIONS
Right-versus-wrong situations tend to be unambiguous, and the right choice is usually clear. The decision can be
made on any of the following grounds:
• One choice is clearly illegal.

• One choice lacks a basis in truth.
• The negative consequences of one choice will far outweigh any possible positive results.
• One choice does not conform to the fundamental, commonly held values that define the difference between
right and wrong.
If any doubt remains, four tests can help you determine whether a decision under consideration is right or wrong:
Legal test Does the decision break any laws or rules?
Smell test Does your intuition tell you the decision is wrong, even if you can’t pinpoint exactly what
is wrong?
Front page test Would your reputation or that of the firm suffer damage if the decision were to be
broadcast on the front page of a national newspaper?
Mom test Would you want your mother or any other moral exemplar in your life to know about
your decision?
If the decision fails any of these tests, it is probably wrong and, by elimination, the right choice will be clear. If the
decision passes all four tests, the decision-maker is probably confronting a right-versus-right dilemma.
RIGHT-VERSUS-RIGHT DILEMMAS
True ethical dilemmas occur when the values underlying possible solutions to a problem are at odds. Pursuing any
solution will satisfy one deeply held value but compromise another. Ethical dilemmas of this sort are more difficult
to resolve than right-versus-wrong issues because two or more of the possible choices are right to some degree, and
no choice appears to be clearly wrong.
The four primary types of ethical dilemmas are described below in terms of the values in conflict.

INTEGRITY DILEMMA—TRUTH VERSUS LOYALTY

With an integrity dilemma, the values of honesty or integrity clash with the values of commitment, personal
responsibility, or promise-keeping.
EXAMPLE
You recommend an in-house investment product to a client, and the client asks if it is the best of its kind on the
market. Strictly based on return on investment, the product is fairly competitive with most similar products.
However, some products on the market are currently earning a better return. Truth demands that you tell your
client that higher-performing products exist (which does not mean they will continue to perform well over time).
However, loyalty to your firm demands you support the in-house product.
SOCIETAL DILEMMA—INDIVIDUAL VERSUS GROUP

With a societal dilemma, the rights or values of an individual conflict with those of the group. This dilemma can also
be seen in terms of us versus them, self versus others, or the smaller group versus the larger group.
EXAMPLE
A firm actively solicits retired investors and advertises its sensitivity to seniors’ concerns. A dividend-paying
mutual fund that the company distributes is highly valued and relied on by a small group of these older clients.
However, the fund is only marginally profitable to the firm. The management’s dilemma is whether to distribute
and allocate scarce resources to a broader group of clients.
GOAL-BASED DILEMMA—SHORT-TERM VERSUS LONG-TERM GOALS

A goal-based dilemma exists when immediate needs or desires conflict with future goals, or when the means clash
with the desired end.
EXAMPLE
The senior management of a small firm acknowledges the importance of the revenue generated by an extremely
large producer whose clients make capital gains and incur capital losses mostly through speculative investments.
However, retaining the producer is inconsistent with the firm’s long-term goal of running a conservative business.
FAIRNESS DILEMMA—JUSTICE VERSUS MERCY

With a fairness dilemma, the values of fairness, equity, and righteousness conflict with the values of compassion and
empathy.
EXAMPLE
You are the supervisor of a likeable new employee with a good attitude and strong work ethic, who is just
starting out in the industry. You notice that he is doing a lot of trading in a large automobile parts manufacturing
company, both for his clients and himself. When you ask him about these trades over coffee, he says he
heard about an imminent strike from his father, who is the president of the union representing the company’s
employees. Although a strike vote has not yet taken place, his father is certain that the plant will shut down,
likely for a long time.
When you tell the employee that what he is doing is illegal, he is surprised. He seems completely unaware of the
rules against insider trading.
Your firm has strong penalties for insider trading, which include firing, and the employee has clearly violated your
firm’s rules on that matter.

EXAMPLE
(cont'd)
In this situation, you are faced with two choices:
• Should you act righteously and recommend the employee for dismissal? He clearly did wrong and should be
punished as an example to others.
• Should you show compassion and give the employee a second chance? He clearly did not know he was
acting illegally.
ETHICAL DILEMMAS
Can you identify the different types of ethical dilemmas? Complete the online learning activity to assess
your knowledge.
RESOLVING ETHICAL DILEMMAS
3 | Analyze different scenarios using a framework for ethical decision-making.
Resolving ethical dilemmas requires time and thought. You must never simply rationalize behaviour on the basis of
so-called accepted norms. When you rationalize a wrong decision, you are simply making an excuse for following
a course that conflicts with your values. If you catch yourself thinking along the following lines, you are likely
rationalizing unethical behaviour:
• “If I don’t do it, someone else will.”

• “It doesn’t hurt anyone.”
• “That’s the way it’s always been done.”
• “Everybody else does it, so it must be okay.”
Scenario | Rookie Advisor
As a rookie advisor, you work late into the evening and are usually the last one to leave the office. One night, you
walk past the office of a well-established and successful advisor whom you consider to be your mentor. You notice
that the door is slightly ajar. Wanting to see what it would be like to work in a big office with a nice view of the city,
rather than in a cubicle facing the wall, you take a seat behind the desk.
As you sit back, you notice a thick document with the title Prospect List printed across the front page. You recall a
conversation you had with your mentor earlier in the day, in which he offered to share some of his most effective
prospecting methods with you. You tell yourself that, if he was willing to counsel you on prospecting, he might not
mind it if you take a copy of the list for yourself. Besides, you think, why would a successful advisor need such a big
list of prospects? You need them more than he does. With this list, you might have a chance to be recognized as
rookie of the month, maybe even rookie of the year.
What would you do in this situation? What are your reasons for your choice?

CHAPTER 2 ETHICS AND WEALTH MANAGEMENT 2 • 11
DIVE DEEPER
Can you explain this dilemma? Complete the online learning activity to assess your knowledge.
Ethical Dilemmas Scenario – Rookie Advisor
A FRAMEWORK FOR ETHICAL DECISION-MAKING

Right-versus-wrong situations occur frequently and are generally the most easily resolved. The first step in assessing
such a situation is to determine whether a rule has, in fact, been violated. The challenge usually lies in identifying
the aggravating and mitigating factors of the specific case. IIROC has published Sanction Guidelines that provide a
framework to help financial institutions exercise discretion in determining sanctions when employees break industry
rules.
DIVE DEEPER
To review IIROC’s guidelines for ethical decision-making, go to your online chapter and read the
following document:
IIROC Sanction Guidelines
RESOLUTION PRINCIPLES
Right-versus-wrong issues are usually easily resolved. Where there is any doubt, the IIROC Sanction Guidelines
provide guidance. However, the guidelines do not easily apply in right-versus-right situations. A firm’s code of ethics
must be designed to help employees understand and resolve ethical dilemmas when there are no clear-cut rules.
Ethical dilemmas are typically resolved by applying four principles:
• The ends-based principle states that the action chosen should result in the greatest good for the greatest
number of people. It demands a kind of cost-benefit analysis, determining who will benefit and who will not.
• The rules-based principle states that the action chosen should follow the rule that deals most effectively with
the situation.
• The social contract-based principle views the action in terms of how it affects the well-being of the group.
If followed, it would create harmonious relationships within the group.
• The personalistic principle supports the decision that is most authentic to the decision-maker as a person.
These principles are incorporated into the ethical decision-making process described below and in Figure 2.1.
THE ETHICAL DECISION-MAKING PROCESS

When faced with an issue that requires a moral choice, you can use the following process to guide your decision-
making:
1. Identify the issue and determine whether it represents an ethical issue requiring further analysis.
2. Identify the person who must decide on a course of action. Gain that person’s acceptance of responsibility for
the decision and their accountability for its consequences.
3. Gather the facts, identify potential courses of action, and identify the potential consequences of each action.
4. Test each course of action by applying the legal, smell, front page, and mom tests to determine whether the
issue is a right-versus-wrong situation.
5. If all options pass the tests, analyze the situation to determine which ethical principles are in conflict. (If any
course of action fails the tests, the right choice will be clear.)

6. Apply the four resolution principles to determine the best choice.

7. Make the decision.
8. Reflect on the process.
DID YOU KNOW?
An important part of the ethical decision-making process is reflecting on the decision and learning from
the experience.
Figure 2.1 illustrates the ethical decision-making process as a course of action for guiding behaviour that is rooted in
ethical principles.
Figure 2.1 | The Ethical Decision-Making Process
Recognize that there is an ethical issue. Identify right-versus-right issues:

1. Truth versus Loyalty
2. Individual versus Group
3. Short-term versus Long-term
Determine whose ethical issue it is. 4. Justice versus Mercy
Gather the facts.
Test for right-versus-wrong issue: Apply the resolution principles:

1. Legal test 1. Ends-based
2. Smell test 2. Rule-based
3. Front page test 3. Social contract based
4. Mom test 4. Personalistic
If If
right-versus-wrong right-versus-right
issue: dilemma:
Make the decision. Reflect on the process.

EXAMPLE
A firm has introduced a wrap-fee product that permits investment advisors to convert commission-based
accounts to fee-based accounts. Fee-based accounts require clients to pay an annual fee based on their assets
with the firm, rather than paying commissions on individual trades.
One advisor, Paul, is considering requiring all of his clients to convert their accounts (of which there are more
than 600) to this new product. The wrap-fee product will simplify Paul’s business, eliminate perceived conflicts of
interest, end awkward discussions about trade commissions, and annuitize his revenue.
In some instances, the mandatory new structure will be cost-neutral to clients or may even cost them less. For
others, however, depending on the number of future transactions in a given period, the fee-based account may
cost more.
In analyzing this situation, Paul recognizes that he is facing an ethical dilemma, where the interests of the larger
group conflict with those of the smaller group. In converting all accounts to a fee-based structure, many clients
will either be unaffected or will benefit from the change. However, for a smaller group of clients with smaller or
less active accounts, the change may be detrimental. Furthermore, Paul recognizes that he will personally benefit
from the change to the detriment of the smaller group.
In applying the resolution principles, Paul finds that the ends-based principle applies in this situation. Converting
all accounts to the fee-based model will result in the greatest good for the greatest number of people. However,
from a personalistic viewpoint, he has to admit that the change would be in his own best interests rather than
those of some of his clients. In the end, he abides by the personalistic principle and decides to make the change
on a case-by-case basis. To do otherwise would be to contradict his personal view of himself as an ethical and
trustworthy advisor.
In analyzing this situation, keep in mind the potential value of the wrap-fee product to the clients. Consider
whether Paul’s conclusions might change if the potential loss to each client would never exceed, say, $100,
$500, or $1,000. It is conceivable that clients might place a value on this type of account that is greater than the
aggregate commissions that might otherwise be payable.
DIVE DEEPER
To review a comprehensive scenario involving ethical decision-making, go to your online chapter and
read the following document:
Making Ethical Decisions
CODE OF ETHICS
4 | Relate applicable codes of ethics to your professional practice.
A code of ethics is a set of rules, either written or unwritten, that specifies the rules of behaviour within a group.
The development, communication, implementation, and reinforcement of a code of ethics are crucial in determining
its success.
Every organization has some kind of ethical code, even if it is not a written code. It is often referred to as the
“ground rules” and might best be described as “the way we do things”. In other words, it represents the norms that
guide the behaviour of people working together for a purpose.

A code of ethics within an organization provides the following benefits to the firm and its employees:
• It confirms that the company is prepared to be explicit about ethics.

• It provides a clearly stated, formal, and updateable guide of what is considered to be appropriate behaviour.
A well-written code may strengthen employee perception of the firm’s ground rules. It guides employees in
judging right from wrong, as distinct from effective versus ineffective, when evaluating options.
• It provides a social contract for the workplace and a basis for working together in reciprocal dignity and fairness.
• It supports responsibility and accountability in employees and the firm. Without a code, a wrongdoer can claim
(often with some justification) that there were never any rules or that the rules were not sufficiently explicit.
However, a code of ethics is neither a pre-requisite for nor a guarantor of ethical behaviour. It may also lead to
problems arising from the following weaknesses:
• It may lull management and regulators into a false sense of security. The mere existence of a code is insufficient
to ensure ethical conduct. If it is not well supported and reinforced, it is often ignored.
• It typically deals with resolving conflicts between right and wrong, but not with the more complex and difficult
conflicts between two rights.
• It often focuses on specific situations, explaining what to do, but not why. To be effective, a code should not
simply mirror problems that spurred its creation in the first place. Codes should use broad ethical principles, so
that employees are guided appropriately in their decision-making in all situations, regardless of whether they
are explicitly addressed in the code.
• It may deal only with employees’ obligations to the employer, and not with the employer’s obligations to staff,
such as professional development, personal respect, a fair workplace, and freedom from harassment.
• It may be poorly written in the following ways:
• It may fail to make clear statements about expectations for appropriate conduct, leaving employees and
registrants confused and frustrated.
• It may raise questions about conduct in situations not addressed explicitly in the code’s text.
• It may contain policies that are inconsistent with industry or firm investment philosophies and incentive
strategies.
For a code of ethics to be effective, four elements are necessary:
1. It must be supported by Employees are not likely to abide by a code that management does not follow.
senior management. Senior executives should be seen as having an active role in the development
of a firm’s code of ethics. They should also foster ethics in every message they
convey—in what they say and, more importantly, in what they do.
2. Employees at all levels By actively including employees in the process, the firm garners support for the
must participate in its project. The firm can show that the code of ethics is not simply a directive from
development. management; it is a project that requires input from all levels.
3. Implementation must Advisors should be trained upon entering the firm, and training should be
include training and repeated at regular intervals. The value of reinforcing mechanisms is two-fold:
reinforcement among
i. First, they can give meaning to, and extend specific applications of, the
all employees.
values and rules that reflect expected standards of conduct.
ii. Second, they define how much freedom, responsibility, and trust are vested
in staff and managers to apply these principles daily.

4. It must be reviewed Management and employees should reaffirm the existing code and amend it
periodically and updated when necessary. The code of ethics will thus remain relevant in the current
when necessary. environment.
As an advisor, you must be aware of and thoroughly understand your firm’s code of ethics and conduct yourself
accordingly. The same requirement applies to the industry’s standards of conduct, as outlined in IIROC Rule 1400.
DIVE DEEPER
IIROC Rule 1400 is available in online format on the organization’s website.
INDUSTRY PROFICIENCY REQUIREMENTS

The proficiency requirements to become a registered investment advisor with an IIROC-licensed dealer member
include the completion of two courses:
• The Canadian Securities Course (CSC)

• The Conduct and Practices Handbook Course (CPH)
Both courses are offered by CSI.

The CSC is a baseline regulatory requirement to perform securities and mutual fund transactions in many financial
services positions.
The CPH introduces advisors to industry rules, regulations, and standards of conduct that form the basis for ethical
behaviour in the securities industry. The requirements can be distilled into five standards:
• Use proper care and exercise independent professional judgment.

• Conduct yourself with trustworthiness and integrity, and act honestly and fairly in all dealings with the public,
clients, employers, and colleagues.
• Conduct business in a professional manner that reflects positively on yourself, your firm, and your profession,
and encourage others to do the same. You should also strive to maintain and improve your professional
knowledge and that of others in the profession.
• Act in accordance with the securities acts of the province or provinces in which you are registered. Furthermore,
you must observe the requirements of all self-regulatory organizations (SROs) of which your firm is a member.
• Hold your clients’ information in the strictest confidence.
The standards set out certain required behaviours and foster adherence to the spirit of the law, and not just strict
compliance with the letter of the law.
NOTE
Along with completion of the CSC and CPH, newly hired advisors at IIROC dealer members are subject to the
following requirements:
• A 90-day in-house training period, during which time they are not allowed any contact with clients
• A subsequent 6-month period of close supervision
• Completion of CSI’s Wealth Management Essentials course within 30 months of approval as an advisor

Scenario and Self-Reflection | First Day on the Job
Johan arrives at Pure Profit Securities for his first day as an advisor. After greeting the receptionist, Johan is whisked
away by the branch manager and shown to his new desk. The branch manager gives him many documents, including
the company’s code of ethics and various forms that Johan must sign. The manager stresses the importance of
reading the documents, especially the code of ethics. He tells Johan that, for compliance reasons, he must sign the
acknowledgement stating that he has read the code of ethics. The manager also tells Johan that the code of ethics
should be kept somewhere near his desk; “perhaps in the recycling box,” he suggests facetiously. Johan signs the
acknowledgement form and, being a little confused by the manager’s comment, decides to toss the code of ethics
into the bottom drawer of his desk.
Do you consider this an appropriate treatment of a firm’s code of ethics? Why or why not?
TRUST, AGENCY, AND FIDUCIARY DUTY
5 | Distinguish between the concepts of trust, agency, and fiduciary duty.
Trust is a belief that the people on whom we depend, either by choice or circumstance, will meet the expectations
we have placed on them.
In the wealth management business, the law of agency often applies. Agency gives wealth advisors and their firms
the ability to enter trades on behalf of their clients. There is no need for the client to be in direct contact with the
party on the other side of the trade. Under this law, clients may also give trading authority over their accounts to a
third party.
A person who holds a position of trust with clients often has a legal duty to those clients. This duty is called a
fiduciary duty, and the person in whom trust has been placed is called a fiduciary. The person to whom the
fiduciary owes this duty is called the beneficiary.
The concepts of trust, agency, and fiduciary duty are explained in further detail below.
TRUST
Trust does not happen by accident; clients must make a conscious choice to trust their advisors. Furthermore,
advisors must make a conscious choice to trust their employers, assistants, colleagues, and clients.
A client’s trust is based on the advisor’s reputation, which is acquired through consistently ethical behaviour over
time. Three things must be present for trust-based relationships, as follows:
Specialized knowledge Given the emphasis on proficiency requirements in the Canadian securities industry,
all advisors can be assumed to have more knowledge about investing and securities in
general than the average client.
A well-regulated All properly licensed advisors in Canada are subject to the rules, regulations, and ongoing
industry scrutiny of at least one regulatory body. In many instances, there are multiple levels of
regulatory oversight.
A client-first approach Ideally, all advisors will place the interests of their clients before their own.
Unfortunately, failure to conform to this requirement is the source of most ethical
dilemmas faced by today’s advisors.

Two qualities that advisors must nurture to build a trustful relationship are competence and integrity. Competence
without integrity leaves clients at the mercy of a self-serving professional, whereas integrity without competence
puts clients in the hands of a well-meaning but inept individual.
Keep the following guidelines in mind when meeting with prospective or current clients:
• Listen intently to what the client is saying.

• Refrain from language or actions that are manipulative, exploitative, or deceptive.
• Admit when you do not know something.
• Perform all tasks competently.
Furthermore, clients’ willingness to trust you depends on how you handle three elements in the relationship:
disclosure, influence, and control.
Disclosure of The freer the flow of information between you and your clients, the more likely it is that
information a strong bond of trust will form.
Influence over Clients must know that information they share with you will influence the decisions
decisions you make.
Share of control Clients must feel that they have some control in their relationship with you; they must
not feel manipulated or patronized.
Scenario | An Uncomfortable Meeting
Mai, 72, is meeting with her advisor Rebekah for the first time since her husband’s death last month. Her husband
took care of most financial issues. Mai herself has never invested money in anything other than guaranteed
investment certificates at the bank. Her banker referred her to Rebekah at the bank-owned firm for investing advice.
Mai has limited government sources of income and about $600,000 in a bank account. She is impressed with the
framed degree and designations that Rebekah has strategically placed on the office wall. However, after a half-
hour meeting, she appears to be very uncomfortable. Rebekah describes many complex investment options and
emphasizes the need to time the market by investing today. Mai has said barely a word since she entered the office.
She leaves and does not return.
Where do you think Rebekah went wrong? What would you do in her situation?
DID YOU KNOW?
In determining the trust they are willing to place in an advisor, the key traits clients look for in their
advisor are competence, awareness of the client’s needs, compassion, fairness, openness, and consistent
behaviour.
CONFLICTS OF INTEREST
A conflict of interest occurs when a duty owed to another person is compromised by either a personal interest or a
conflicting duty owed to a third party.
Industry professionals must avoid even the slightest perception that a conflict of interest exists with a client.
Conflicts of interest can damage market efficiencies and distort market outcomes by interfering with the right of the
public to rely on reasonable expectations in business relationships.

In general, conflicts arise between the competing interests of different clients and between the interests of an
advisor working on behalf of both their client and their employer. For example, a conflict might arise when a firm
pressures its advisors to sell a high-risk new issue that it has just underwritten. The firm may have an obligation
to the issuer to sell the issue to a wide distribution of clients. The advisor, on the other hand, may feel that the
investment is unsuitable for a particular client.
EXAMPLE
Consider the number of conflicts that surround a “hot” new distribution of securities. The firm underwriting the
issue is obliged to obtain full value for the issuer of the securities. However, the firm must also ensure that the
price is fair to the purchasing clients. These issues can be complicated by active or overheated markets.
A further conflict is faced by advisors who must allocate the new issue to clients when demand exceeds
availability. The question arises as to which clients should receive the offer – those who generate the most
revenue for the advisor, those who have been with the advisor the longest, those who have called repeatedly
about the issue, or potential new clients? Or should the advisor choose randomly among those who have
expressed an interest? In this situation, there is no applicable rule or clear right or wrong answer; the problem
must be approached using an analytical decision-making process.
Industry rules contain many provisions for dealing with potential conflicts of interest with clients. However, not
every potential conflict can be dealt with by way of rules and regulations. To promote the integrity of the capital
markets, a balance is required between regulatory intervention and practical business considerations. While rules
provide a basic framework for operating in the industry, the financial services business is largely founded on trust
and integrity. As an advisor, you must avoid bringing the industry into disrepute by sacrificing the client’s interests in
favour of your own or those of your employer.
Scenario | Mrs. Layol
Your client Mrs. Layol has recently deposited $100,000 in her account and is looking for advice on which mutual
fund to invest in. You have narrowed down the choices to two funds: the Specter Canadian Equity Fund and
the Tranquility Canadian Equity Fund. Each fund has the same front-end and back-end load structure, so your
commission will be the same regardless of which fund your client chooses.
Your firm’s mutual fund analyst believes that the Specter fund will marginally outperform the Tranquility fund by
about 1%, but only because the Tranquility fund has a higher management expense ratio. The analyst expects the
actual investment performance of the two fund managers to be essentially the same.
A marketing representative for the Tranquility fund has been to your office twice in the last few weeks and has given
you several promotional items, including a golf shirt, an umbrella, and a coffee mug. He has also been trying to
arrange a lunch with you at a new expensive restaurant that you have been eager to visit.
Which fund would you pick for Mrs. Layol? What are your reasons for choosing that fund?
DIVE DEEPER
Can you explain this conflict of interest? Complete the online learning activity to assess your knowledge.
Conflict of interest Scenario – Mrs. Layol

AGENCY
Agency relationships are used extensively in business. In fact, this type of relationship is at the heart of wealth
management and the sale of financial products.
Although there is no universally accepted definition of the term agency, various judicial decisions involving the
law of agency have led to a generally accepted understanding of the term. Accordingly, agency may be defined as
a relationship in which one party is authorized to bring another party into contractual relations with a third party.
The agent is the person authorized to do certain things on behalf of another party. The principal is the other party
on whose behalf the agent acts. And the third party is the person (or entity) who enters into a legal relationship
with the principal by dealing with the agent. In other words, the principal delegates his or her legal authority (called
agency) to an agent who deals with a third party.
EXAMPLE
When Jim, a portfolio manager, buys a security on behalf of his client Lydia, he acts as the agent; Lydia is the
principal, and the firm is the third party. As an agent, Jim makes buy-and-sell decisions and manages the fund in
Lydia’s best interest based on her account objectives in terms of time horizons and risk profile.
Similar to agency, the Quebec Civil Code defines a mandate as a contract in which a principal (known as the
mandator), empowers an agent (the mandatary), to represent him or her in the performance of a juridical act with
a third person. The mandatary, by his or her acceptance, binds himself or herself to exercise the power.
Most agency relationships are created by a contract between agent and principal, in which the agent is given authority to
act on behalf of the principal. Outside Quebec, the contract may be written or oral; however, a written agreement ensures
that the principal cannot argue that the agent did not have the authority to enter into contracts on behalf of the principal.
In the financial services industry, agency relationships are always established by written agreement. For example,
the agency agreement between IIROC dealer member firms and their clients is embodied in the account agreement
that all clients must sign before the firm opens an account on their behalf. The account agreement states the firm’s
and client’s rights and obligations with respect to the operation of the client’s account. Among other things, the
agreement spells out how client instructions will be handled.
With a properly signed account agreement, advisors do not require written instructions from clients every time an order
is placed. The agreement gives them authority to buy or sell products based on verbal instructions from the client. The
law recognizes that advisors are authorized to do what is customary in their business in carrying out instructions. If the
client and advisor have not agreed on such things as the commission on the transaction, the advisor may argue that the
commission is what is ordinarily charged to the client or similar clients in transactions of similar size. The charge may
be perceived by the law as reasonable and within the advisor’s usual authority to charge it to the client. It is, of course,
better to have a mutual agreement on matters such as commission rates or amounts before placing an order.
Another type of agency agreement that advisors frequently encounter is one established by a power of attorney.
Power of attorney may be specific, meaning that the agent has the authority to bind the principal to certain types of
contracts only. It may also be general, in which case the agent has the authority to transact all types of business for
the principal. This common practice often involves the appointment of the son or daughter as an agent for the parent.
EXAMPLE
A client who is going on a four-month Caribbean cruise attaches a power of attorney to a certificate representing
his ownership of 1,000 shares of TRIM Ltd. He names his daughter as the attorney to authorize all transactions
regarding that share ownership. This arrangement permits the daughter to conduct a sale of the shares of
TRIM Ltd. (in her father’s absence) if she thinks it is advisable to do so.
A general power of attorney is common in the securities industry, where it is sometimes known as trading
authorization. It allows a client to give trading authority over his or her account to a third party. The extent of authority
may be restricted to the purchase or sale of securities, or it may also include the withdrawal of cash or securities.

FIDUCIARY DUTY
In Canadian law, a person in a position of trust concerning another person’s personal or financial affairs must act in
that person’s best interests. As mentioned earlier, the law recognizes this duty as a fiduciary duty.
In this respect, two legal terms used:
Fiduciary The person in whom trust has been placed
Beneficiary The person to whom trust is owed
The fiduciary role carries with it the highest standard of care, and the fiduciary relationship is one of confidence
and trust. The role may be in connection with the care of assets or with a position of responsibility for the personal
affairs of others. In such relationships, the beneficiary has a reasonable expectation that the fiduciary will act in his
or her (the beneficiary’s) best interests and on his or her behalf. A fiduciary should not profit at the expense of the
beneficiary.
Fiduciary duties have been found to exist in relationships such as a doctor and a patient, a lawyer and a client, and
between a director of a corporation and the corporation itself.
Courts have concluded that the relationships between many financial services providers and their clients are
fiduciary relationships. Generally, if an advisor provides a client with investment advice and recommendations, and
the client relies on that professional advice, then a fiduciary relationship exists.
Scenario | Hodgkinson v. Simms Fact Situation
The fiduciary duty was aptly demonstrated in the Supreme Court case Hodgkinson v. Simms (1994) where a young
securities professional in a fiduciary relationship with an accountant was not sufficiently advised.
Hodgkinson, a stockbroker who was inexperienced in tax planning, wanted an independent professional to advise
him respecting his tax-planning and tax-sheltering needs. He hired Simms, an accountant, who specialized in
providing general tax shelter advice, and specifically, real estate tax shelter investments. Hodgkinson relied heavily
on Simms’s advice, which Simms strongly encouraged. The relationship was such that Hodgkinson did not question
Simms about the reasons underlying his advice.
Simms advised Hodgkinson to invest in multiple-unit residential buildings (MURBs), real estate investment projects
which, by conventional wisdom, were safe and conservative. Hodgkinson’s bought four MURBs on Simms’ advice
and lost heavily when their value fell during a decline in the real estate market.
The essence of Hodgkinson’s action lay in the fact that Simms was acting for the developers during the structuring
period of the MURB projects and did not disclose this fact. Fraud and deceit on the developers’ part were not at
issue; Hodgkinson received the investments he paid for. However, the same could not be said of his relationship
with his accountant. He looked to Simms as an independent professional advisor, not a promoter. He would not
have invested in the MURBs projects had he known the true nature and extent of Simms’s relationship with the
developers.
Hodgkinson brought an action in the Supreme Court of British Columbia for breach of fiduciary duty, breach of
contract, and negligence. He sought to recover all his losses on the four investments recommended by Simms.
In the Hodgkinson v. Simms case, the Supreme Court of Canada described the variables that determine whether a
relationship is a fiduciary relationship. What is required is evidence of the mutual understanding that one party has
relinquished its own self-interest and agreed to act solely on behalf of the other party. There must be something
more than a simple undertaking by one party to provide information and execute orders for the other for the
relationship to be enforced as fiduciary.

Scenario | Hodgkinson v. Simms Fact Situation
The relationship between an investor and a discount broker does not usually qualify as a fiduciary duty. A broker is
simply a conduit of information and an order taker. In other advisory relationships, however, elements such as trust
and confidentiality exist in the context of complex and consequential matters. In such cases, it may be reasonable
for a client to expect that the advisor is acting in the client’s best interest, and not the advisor’s own. Otherwise, the
advisor is expected to disclose that fact.
Source: “Hodgkinson v. Simms,” Judgments of the Supreme Court of Canada, September 30, 1994, accessed April 30, 2018,
https://scc-csc.lexum.com/scc-csc/scc-csc/en/item/1181/index.do.
DID YOU KNOW?
The existence of a fiduciary relationship imposes the highest standard of care on you as an advisor.
Where it exists or is presumed to exist, you must act carefully, honestly, and in good faith in dealings
with the client; you must not take advantage in any way of the trust the client has placed in you.
FIDUCIARY DUTY
Can you explain the concept of fiduciary duty? Complete the online learning activity to assess your
knowledge.
WHAT CAN HAPPEN WHEN AN ADVISOR IGNORES ETHICS
6 | Explain IIROC’s investigation procedures and the consequences of non-compliance.
Despite every effort by investment firms to attract trustworthy advisors into the industry, enforcement activities
by IIROC and other SROs indicate a constant level of complaints, investigations, and prosecutions each year. Heavy
sanctions are imposed on advisors in the form of fines, cost reimbursements, and disgorgement penalties, as well as
suspensions, permanent bars, and conditions imposed on future activities.
According to IROC's 2020-21 report, complaints totalled 1,396, with nearly one-third of cases being unsuitable
investment complaints from clients. Unauthorized and discretionary trading contributed to an additional 19%
of complaints. A total of 113 investigations were completed, with 25% leading to prosecutions. Most of the
prosecutions were handed to advisors (as opposed to firms), and hearings in the majority of cases led to an
early settlement, rather than a contested disciplinary proceeding. Combined monetary sanctions totalling
nearly $1 million were imposed on 21 advisors in 2021, accompanied by 13 suspensions, two permanent bars,
and 12 conditions imposed on future activities.
Needless to say, IIROC’s enforcement plays an important role in promoting compliance by sending a strong
regulatory message to deter potential wrongdoers and helping build investor confidence in Canadian Capital
markets.
Advisors should be aware of IIROC’s investigation procedures from the outset, before possibly running afoul of a
rule or regulation. They should also understand the consequences of non-compliance with the regulations in terms
of jeopardizing their reputation, career, and financial resources.

IIROC’S INVESTIGATION PROCEDURES AND ENFORCEMENT PROCESS

Advisors are subject to IIROC’s rules and regulations, as well as provincial securities laws of their particular province,
and they should understand the penalty powers of both. IIROC can impose penalties for infractions on an employee
of a dealer member, whereas provincial regulators can penalize any member of the public within its jurisdiction.
IIROC is empowered by its rules to conduct routine examinations, and investigations can also be initiated by complaints
from the general publicand other securities regulators, ComSet Reports1, and IIROC Whistleblower Services2. It is a
condition of membership that dealer members and their employees fully cooperate with the investigator appointed by
IIROC. Failure to cooperate puts both the firm and its employees at risk of termination of membership.
The IIROC Enforcement process consists of four stages: case assessment, investigations, prosecutions, and
disciplinary hearings.
A case assessment is an initial review to determine whether sufficient evidence exists warranting the opening of
a formal investigation. If an investigation is warranted, a collection and review of relevant evidence establishing a
breach of IIROC’s rules is forwarded to Prosecutions. If there is evidence of criminal activity, a referral is made to
appropriate securities commissions, regulators, or police.
Prosecution involves formal disciplinary action against an advisor. The formal hearing will take place before an IIROC
hearing panel consisting of an independent chair (usually a retired judge) and two independent industry members.
Disciplinary proceedings can take the form of either a settlement hearing or a contested hearing.
DISCIPLINARY PROCEEDINGS
A settlement hearing is when enforcement staff and the advisor agree in writing on the rules violated by the advisor,
as well as the underlying facts and the penalties for the agreed-upon violations. Both parties present the settlement
agreement to the hearing panel, which must accept or reject it. Most disciplinary matters resolved by way of
settlement are final and generally contain a waiver of any right to appeal or review. Once accepted by the hearing
panel, the matter becomes public, and the results of the hearing are published on IIROC’s website.
A contested hearing is when the advisor does not admit to the alleged violation of IIROC rules. Enforcement
staff must prove the allegations set out in the Notice of Hearing and Statement of Allegation. These are formal
documents initiating disciplinary action and stating the conclusions drawn by IIROC to support the allegations. As
in traditional court proceedings, the IIROC hearing involves staff presenting documentary and oral evidence through
witnesses to make its case. All hearings take place in front of hearing panels. They resemble formal proceedings that
take place in front of a judge in a courtroom.
The hearing panel decides whether IIROC has proven its case against the advisor and determines the appropriate
penalty. A majority vote is sufficient to constitute the hearing panel’s decision. Most hearings are open to the public
with the exception of settlement hearings, which are open to the public when the panel accepts the settlement
conditions. Respondents can appeal a decision within 30 days.
PENALTIES FOR MISCONDUCT

If an advisor is found to have violated IIROC rules, the following penalties may be imposed:
• A reprimand
• Fines up to a maximum of $5 million per contravention, or an amount equal to three times the profit made or
loss avoided
1
IIROC requires firms to report client complaints and disciplinary actions, including internal investigations, denial of registration and
settlements reported through IIROC’s computerized Complaints and Settlement Reporting System.
2
IIROC’s Whistleblower Service allows a person to provide first-hand knowledge or evidence of misconduct or illegal activity occurring in an
organization by IIROC regulated individuals.

• Imposition of conditions of registration

• A period of suspension
• A permanent ban
Investigation costs are usually assessed against any advisor found guilty of a violation. Commonly imposed
conditions of approval or continued approval include a requirement to rewrite industry examinations and to
disgorge commissions. IIROC may commence proceedings against advisors up to six years after the date of
occurrence of the last event on which the proceedings are based.
Once a written decision is released, IIROC issues a bulletin summarizing the decision, which is circulated to dealer
members, commissions, other regulators, and the media. The decision itself is published on IIROC’s website as a
public document.
CASES OUTLINING CONSEQUENCES OF NON-COMPLIANCE

Below are two IIROC cases where advisors were prosecuted and a settlement was reached. The first case involves
unsuitable investments, and the second relates to unauthorized discretionary trading. As mentioned earlier, these
are among the top two regulatory violations received by IIROC Enforcement. Both cases use fictitious names.
CASE 1 INVOLVING UNSUITABLE INVESTMENTS

John Doe made recommendations to 10 of his clients who were approaching or in retirement and for whom
he managed most of their liquid assets. He recommended that these clients invest in a number of corporate
debentures deemed by himself and (understood by his clients) to be low-risk investments. Despite warnings from
his dealer member about the high risk these debentures entailed, Doe continued to recommend them to his clients
over a two-year period, earning over $65,000 in commissions. Other holdings in TSX Venture issuers, the oil and gas
sector, and the industrial sector heightened the risk of these accounts.
When Doe’s compliance department indicated that the clients’ investments were outside the risk tolerance levels
and objectives outlined in the clients’ account applications, Doe increased the risk tolerance to match the high-risk
holdings, in some cases from 20% and 30% to 90% and 100%. The clients incurred significant losses for which
some were reimbursed by Doe’s Firm. Penalties imposed on Doe as conditions for reinstatement included a fine
of $100,000 (inclusive of disgorgement), a prohibition on approval for two and a half years, close supervision
for 12 months, and an obligation to rewrite the CPH course. In addition, costs amounting to $3,000 were charged to
cover the IIROC investigation and hearings.
CASE 2 INVOLVING UNAUTHORIZED AND DISCRETIONARY TRADING

Joe Smith Sr. and Joe Smith Jr., a father and son team working at a full-service brokerage firm, managed a number
of non-discretionary accounts over a period of four years. Early on, Joe Sr. proposed discretionary account
management to clients without informing Joe Jr. When Joe Jr. noticed a number of trade tickets submitted by the Joe
Sr., he began to question his father’s activity. Despite Joe Sr.’s acknowledgement that he did not obtain his clients’
consent regarding the trades, Joe Jr. agreed to continue to have the accounts managed in this manner.
At the time of this activity, Joe Sr. was not approved by IIROC for discretionary management, and Joe Jr. was only
approved years after the activity began. A total of 7,000 discretionary trades were executed in about 100 client
accounts during the four-year period. To avoid detection by their compliance department, trades were spaced out
over several of months, which indicated that the clients were not contacted. A client complaint unrelated to the
discretionary trading ultimately led to an internal investigation by the firm. Both advisors were dismissed following the
complaint. The discretionary trades were consistent with the clients’ investment profiles and did not incur any losses.
Joe Sr. agreed to a fine of $40,000, a prohibition of approval for 30 months, 12 months of close supervision, and
an obligation to pass the CPH course prior to reapproval. He also agreed to cover IIROC’s costs amounting to
$2,500 for the investigation and hearings.

Joe Jr. agreed to a fine of $30,000, prohibition of approval with IIROC for 16 months, six months of close supervision
in the event of reapproval by IIROC, and the obligation to rewrite and pass the CPH course within six months of
renewal of registration. He also agreed to pay $2,500 to cover IIROC’s costs for the investigation and hearings.
DOING RIGHT BY THE MILLERS
At the beginning of this chapter, we presented a scenario in which your clients Peter and Ruth Miller were unhappy
with their current advisor. We asked some questions about how to advise these clients in a way that builds a
foundation of trust. Now that you have read this chapter, we’ll revisit those questions and provide some answers.
• What is important for the Millers to know about how you conduct yourself in your dealings with clients?
Furthermore, what should they know about your firm’s expectations regarding the conduct of its employees and
how it enforces those expectations?
• As an advisor, you should make sure that your clients are fully aware of the following aspects of your
practice:
« All codes of ethics (which generally govern decision-making) and codes of conduct (which generally
govern actions taken) that you are bound by
« Your own principles and values
« Your firm’s commitment to ethical behaviour, ongoing training, and regular review of your performance
• How would you describe the principles that you abide by in your existing client relationships in a way that instills
confidence in these prospective clients?
• Consider how you would articulate your principles and standards of conduct when dealing with clients:
« Are you prepared to be honest with clients if you disagree with their investment choices and decisions?
« Are you willing to keep a low-activity individual client account that generates little commission revenue,
rather than placing the client in a more expensive fee-based account?
• How would you explain the ethical concepts underlying your commitment to accountability to your clients?
• Clients who feel they have been mistreated or taken advantage of are looking for reassurance that you will
not do the same. To build trust with these clients, consider the following key items:
« Reassure the clients that you will always put their interests ahead of your own. For example, you can
build trust by recommending mutual funds that pay lower trailer fees so clients gain through higher
returns.
« Demonstrate your knowledge. Your ultimate goal is to help them earn a profit and reach their goals.
Doing so with the utmost integrity will be one of your key challenges.
« Demonstrate your understanding of fiduciary duty. Although a true fiduciary relationship may not exist
by definition, you should conduct yourself as if one exists. This approach can be a true differentiator
between you and other advisors. Fiduciary duty carries with it the highest standard of care. By holding
yourself to that standard, and letting clients know you do, you can meet their high expectations and
gain their trust.

SUMMARY
In this chapter, we discussed the following key aspects of ethics:
• Ethics is a continuous process of examining behaviour and making decisions in the context of moral principles
and a strong set of values. These principles and values help guide behaviour in situations where the rules are not
specific.
• To create relationships with your clients that are based on trust, you must conduct yourself ethically, in a way
that is consistent with both the letter and the spirit of the law. You must apply a unified value system, where
the ends and means mutually reinforce and support each other. By demonstrating ethical behaviour, you
protect your integrity, along with that of your firm and the broader industry.
• Securities industry regulations such as IIROC’s KYC rules are principles-based, rather than rules-based. In other
words, you are expected to apply judgment and discretion in your actions, rather than following a set of strict
rules. An inadvertent violation of the rules on the part of an advisor normally warrants lenient sanction and
further education. However, repeat violations or malicious intent can call into question the advisor’s personal
ethics.
• Right-versus-wrong situations tend to be unambiguous, and the right decision is relatively easy to make. True
ethical dilemmas occur when the values underlying possible solutions to a problem are at odds. To resolve such
dilemmas, you must first identify which values are in conflict: truth vs. loyalty, individual vs. group, short-term
vs. long-term goals, or justice vs. mercy.
• Ethical dilemmas are typically resolved by applying four principles: ends-based, rules-based, social contract-
based, and personalistic. When faced with an issue that requires a moral choice, you should use the ethical
decision-making process in the context of your firm’s code of ethics.
• Through the law of agency, advisors and their firms are able to enter trades on behalf of the client without the
client being in direct contact with the party on the other side of the trade. In all your interactions with clients,
you should presume that you have a fiduciary duty to the clients, even if that duty does not exist in law. Where
a fiduciary relationship exists or is presumed to exist, you must put your client’s interests ahead of your own and
not take advantage of the trust the client has placed in you.
• Finally, you learned that IIROC can impose penalties against the advisors, and it can examine, investigate, and
discipline those members for breaches of its rules. It has the power to issue reprimands, levy fines, suspend
or terminate registration and membership, and set conditions on the continued approval of registration and
membership. On the other hand, a provincial regulator may impose penalties on any member of the public
who is found to have acted within its jurisdiction. An IIROC investigation may result in disciplinary proceedings
before a hearing panel. The panel’s decisions are summarized in IIROC bulletins, which are public documents.
DISCUSSION BOARD
for Chapter 2.
REVIEW QUESTIONS
Questions.

Getting to Know the Client 3
CHAPTER OUTLINE
In this chapter, we provide a process for getting to know everything necessary about your clients. You will learn the
federal legal requirements regarding business conduct and the collection and sharing of client information. We also
discuss the account-opening requirements of the Investment Industry Regulatory Organization of Canada (IIROC).
Finally, we explain how to engage in a probing dialogue with clients to collect and document information beyond
the minimum required by law.
1 | List the minimum amount of information that Information Required by Regulation and Law
an IIROC-licensed advisor must obtain from a
client.
2 | Collect financial and non-financial data Going Beyond the Regulatory and Legal
that goes beyond the regulatory and legal Minimum
minimum to develop a wealth plan.
3 | Apply the client discovery process to assess a The Client Discovery Process
client’s wealth planning needs.

KEY TERMS
account application net worth
asset location required return
client discovery process return objective
fixed expenses risk objective
goal shortfall risk profile
home bias tax management
Know Your Client rule time horizon
liquidity requirements

CHAPTER 3 GETTING TO KNOW THE CLIENT 3•3
INTRODUCTION
Wealth management is more than a regular advisory practice. The discipline demands a client-centred approach
and a comprehensive understanding of each client’s situation. For this purpose, the industry’s established account-
opening process provides an important source of basic information. However, to truly understand your clients and
ensure that you are providing appropriate advice, you need much more than basic information.
Your role as a wealth advisor is to do everything possible to help your clients set objectives and achieve their goals.
Only with a thorough understanding of their financial circumstances can you perform this role effectively. You
should know, though, that clients do not always clearly state their central concerns about their financial planning
and investment management needs. It is your job to discover what they are not telling you and help them articulate
their needs and prioritize their goals. This process is necessary to develop a comprehensive wealth plan.
Before you begin, read the scenario below, which raises some of the questions you might have about getting to
know the client. Think about these questions, but don’t worry if the answers don’t come easily. At the end of the
GETTING TO KNOW THE MILLERS
Peter and Ruth Miller were introduced to you by their banker after a seminar you delivered on retirement
planning. The Millers feel that their existing advisor has been providing them with advice that is contrary to their
best interests. They have met with you and have decided that you will be their new advisor.
In this scenario, you are meeting the Millers to open their investment accounts. During the account-opening
process, you must establish a rapport and learn about the Millers’ goals and needs. You must also review their
situation to attain a clear understanding of their financial resources and general financial position.
• Beyond the essential facts you are required to collect from your clients under regulation, what other important
information do you need to obtain a clear picture of the Millers’ situation?
• Considering the difference between goals and objectives, what must you understand to build an effective
investment plan and provide this couple with the right advice?
• How can you establish a comfortable rapport and gather the information you need during what may be an
emotionally charged discussion?
NOTE
Some content in this chapter is also covered in Chapter 1 of the KPMG book Tax Planning for You and Your Family,
in some cases in greater detail. We strongly recommend that you study the content in the KPMG guide in
addition to this text, because they both contain examinable content. For examination purposes, if the content in
this chapter differs from the KPMG guide in any respect, precedence will be given to the this content.
INFORMATION REQUIRED BY REGULATION AND LAW
1 | List the minimum amount of information that an IIROC-licensed advisor must obtain from a client.
As a wealth advisor, you must follow certain procedures during the account-opening process to comply with
government and industry regulations. In this section, we briefly discuss the federal legal requirements regarding
business conduct and the collection and sharing of client information. We also explain IIROC’s account-opening
requirements.

FEDERAL AND INTERNATIONAL REQUIREMENTS

When opening a client account, financial institutions and their advisors must comply with federal legislation,
particularly the 2002 Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA). This Act requires
that firms and their advisors verify the identity of every client. For example, advisors must request valid picture
identification, such as a driver’s licence or passport, and follow proper cheque-clearing procedures. In addition, firms
must report any large cash or otherwise suspicious client transactions to the Financial Transactions and Reports
Analysis Centre of Canada (FINTRAC). This information is needed to help prevent unscrupulous clients from using
the financial system to hide the proceeds of crime or to finance terrorist activity.
Furthermore, firms and their advisors must comply with any agreements Canada has with other countries.
IIROC KNOW YOUR CLIENT RULE

IIROC regulations set out the minimum amount of information that firms and their advisors must collect from their
clients. The requirements are collectively known in the industry as the Know Your Client rule (KYC rule). The KYC
rule is one of the cornerstones of the investment industry. It originated when the business of investment dealers
mainly involved buying and selling securities on behalf of clients.
The information gathered allowed investment firms and their advisors to determine the suitability of each proposed
client trade, whether it was initiated by the advisor or the client. IIROC-licensed advisors are also bound by
suitability requirements, as well as specific aspects of PCMLTFA, to obtain certain information from their clients.
DID YOU KNOW?
Discount brokers are generally exempt from suitability determination requirements because they
provide execution-only services and do not make recommendations.
As an advisor working for an IIROC dealer member, you must comply with the requirements described below.
IIROC Rule section 3202 A Dealer Member must take reasonable steps to learn and remain informed of the
Know-Your-Client states: essential facts relative to every order, account, and client that it accepts.
IIROC Rule section 3102 A Dealer Member must take reasonable steps to ensure that all orders or
Business Conduct states: recommendations for any account are within the bounds of good business practice.
IIROC Rule section 3402 Before a Dealer Member purchases, sells, withdraws, exchanges, or transfers-out
Retail client suitability securities for a retail client’s account, takes any other investment action for a client, makes
determination a recommendation, or exercises discretion to take any such action, the Dealer Member
requirements states: must determine, on a reasonable basis, that the action is suitable for the retail client.
DID YOU KNOW?
You must advise customers against proceeding with orders that appear unsuitable for them. It may be
that the customer’s situation has changed, in which case an update to the KYC information is in order.
Otherwise, if the customer insists on proceeding with an unsuitable order, you should seek guidance
from a supervisor or from your legal or compliance department.
Consider the following variables to determine whether a proposed trade is suitable for a particular client:
• Personal circumstances, such as marital status, age, occupation, and number of dependants
• Financial circumstances, such as income and net worth

• Risk profile
• Investment needs and objectives
• Investment knowledge
• Investment time horizon
The same information is required when soliciting orders and recommending trades to clients.
Dealer members must also review their retail clients’ accounts and the securities in those accounts for suitability.
They must take reasonable steps within a reasonable time after any of the following events occur:
• Securities are received or delivered into the client’s account

• A registered individual is designated as responsible for the client’s account
• The dealer member or registered individual becomes aware of a change in a security in the account or in the
client’s KYC information that could render a security or the account unsuitable for the client
• The dealer or registered individual has undertaken a review of the client’s KYC information
ACCOUNT APPLICATION
The primary form used to collect client information, as required under the applicable rules, is the account
application. Each investment dealer uses its own variation on the application, the content is always similar.
Table 3.1 categorizes that information according to the due diligence factors for supervision of accounts. You must
obtain this information whenever you open a new account for a client.
Table 3.1 | KYC Information on the Account Application
Personal Information • Name, address, phone numbers

• Date of birth
• Social Insurance Number
• Citizenship
• Occupation and employer’s name, address, and type of business
• Whether the client is an insider as defined by securities laws and subject to insider
trading rules
• If married, spouse’s name, occupation, employer, and employer’s type of business
• Number of dependants, if any
Financial Situation • Estimated net liquid assets and net fixed assets
• Approximate annual income from all sources
• Whether the client has other accounts with the firm or has trading authority over
such accounts
• Whether the client has any accounts at other firms
• Bank reference
• Investment knowledge, which is ranked as sophisticated, good, limited, or poor/nil
Investment Objectives • Account objectives: percentage allocated to income and to short-, medium-, and
long-term capital gains
Risk Profile • Account risk factors: percentage allocated to low-, medium-, and high-risk

In addition to completing the account application for all new clients, you should update existing account
applications periodically. You should also update the application whenever there is a major change in a client’s
circumstances, including any of the following events:
• A change of account name (e.g., from “Marie Roy” to “Marie and Robert Roy”)
• A change of address that takes the client out of your jurisdiction
• New marital or employment status
• Another person taking a financial interest in or gaining control over the account
• New trading authorization
• A major change in financial circumstances
• A change in investment objectives or risk factors
• Any amendment to items in the regulatory section (such as insider status)
• Any major change in circumstances that affects the client’s investment objectives, creditworthiness, or
risk profile
The information listed in Table 3.1 is the minimum requirement for identification and verification of all clients.
Depending on the type of account, IIROC requires firms and their advisors to gather the following additional
information:
• If the account is a joint account, gather complete personal information from everyone named on the account.
• The following steps must be taken if the account is a corporate account:
• Establish the identity of any individual who is the beneficial owner of 25% or more of the voting rights
attached to the outstanding voting securities of the corporation.
• Obtain the names of all directors of the corporation within 30 days of opening the account.
• Establish the existence of the corporation and the nature of its business.
• If the account is a partnership or trust account:
• Establish the identity of each individual who exercises control over the affairs of the partnership or trust.
• Establish the existence of the partnership or trust and the nature of its business.
• In the case of a trust, obtain the names and addresses of all trustees and all known beneficiaries and settlors
of the trust.
In addition to the account application, specific additional documentation is required when a client opens or trades
in any of the following types of accounts:
• Joint account • Trust account

• Margin account • Registered account
• Discretionary account • Investment club account
• Managed account • Options or futures account
Furthermore, IIROC rules require that dealer members provide each client with a copy of his or her KYC information.
With the investment industry moving further toward true wealth management, the requirement to collect client
information has become more far-reaching. The information required by regulation and law provides a good
foundation of knowledge about clients. However, the account application and other required documentation are
insufficient for building an integrated wealth plan. In the next section, we discuss the additional information you
need for a complete picture of the client.

GOING BEYOND THE REGULATORY AND LEGAL MINIMUM
2 | Collect financial and non-financial data that goes beyond the regulatory and legal minimum to
develop a wealth plan.
To build a comprehensive wealth plan for a client, you must go beyond the effort required to fill out the account
application. You need enough information to create a complete picture of the client’s current situation, short-
and long-term goals, and attitude toward investing. The methods you use to gather this information can be as
important as the information you collect. Good communication skills and effective interviewing techniques will help
you establish strong, trusting relationships in which your clients are comfortable sharing the information you need.
That information falls under four categories:
• Client goals
• Financial information
• Client objectives, including risk and return
• Investment constraints
CLIENT GOALS
A defining principle of wealth management is the need to discern a client’s life goals and aspirations. With this
knowledge, you can begin to build a wealth plan to help them achieve those goals.
IIROC member firms and their advisors must document account objectives on the account application in terms of
time horizons and risk profile. However, from a wealth management perspective, objectives alone are not enough.
As an advisor, you must also understand your clients’ goals—that is, what they want out of life.
Individual clients are complex beings; they seldom have only one goal. Young clients may envision a distant
retirement but are more likely to have their hearts set on a home and a university education for their children. Older
clients might be concerned about their income today and tomorrow, as well as the financial well-being of their
children and grandchildren.
Clients generally have goals for the following life issues:
• Family and lifestyle

• Protecting lifestyle
• Planning for the future
• Managing life savings
• Building a legacy
You must help your clients distinguish between the various goals and establish primary, secondary, and third-level
goals. Occasionally, clients will need different strategies for different pools of money. It may be more convenient,
although not essential, to think in terms of savings and investing objectives for each pool.
Of course, your clients’ goals can change over time, and you must make every effort to recognize and respond
sensitively to these changes. Common events that can trigger a change in goals include the birth of a child,
marriage, divorce, and the death of a spouse. Furthermore, a client’s employment situation and income may change
because of a promotion, a career switch, or a job loss. Finally, a client’s goals may change as they become more
familiar with financial markets or simply because they are drawing closer to retirement.

FINANCIAL INFORMATION
In addition to knowing your clients’ goals, you should understand their current financial situation beyond the details
provided in the account application. For a comprehensive wealth plan, you need accurate and detailed information
about the client’s assets, liabilities, income, and expenses. You should then organize these details into net worth
and cash flow statements. This information gives you a clear picture of the client’s situation and provides valuable
insight into whether their goals are achievable.
Some financial information is easy to obtain. For example, clients who receive a salary or pension can readily
provide information on their income. Most clients also have information readily available on expenses such as
mortgage, rent, or loan payments. Other expenses, however, are harder to pin down, such as how much they spend
on clothing, entertaining, or eating out.
When you arrange a meeting with new clients, you should ask them to bring a summarized list of their assets,
liabilities, income, and expenses. Alternatively, you may ask them to collect all relevant documentation needed to
create net worth and cash flow statements.
Your clients must feel comfortable giving out information that they may consider confidential and personal.
You must therefore establish a good rapport with each client and explain why you need the information you are
asking for.
There are several approaches to gathering additional information. Many advisors use a questionnaire, either paper
or electronic, provided by their firm. Questionnaires are especially helpful if you have not yet developed your own
methods to gather information from all important areas.
DIVE DEEPER
To see a typical questionnaire you can use on the job, go to your online chapter and open the following
document:
Client Questionnaire
CLIENT OBJECTIVES
In creating a wealth plan, it is important that you distinguish between your clients’ goals and their objectives. Goals
are a client’s life needs and aspirations. For example, a 33-year-old client’s goals may be to buy a four-bedroom
home within the next three years and retire at age 63. Objectives refer to the investment return the client requires
and the risk he must tolerate to achieve his goals. Any actions that help the client achieve his desired return are also
considered objectives.
Goals and objectives are interdependent. For example, some clients may have lofty life goals requiring high returns
on their investments. If they depend on those returns to achieve their goals, they must be willing to accept the
higher risk and must be able to endure potential financial loss that goes along with seeking high returns. For clients
who cannot or will not accept the potential for financial loss, the return they can expect must be lowered and
their life goals moderated. In other words, clients must set return objectives that are compatible with their risk
objectives.
SETTING A RETURN OBJECTIVE

The return objective is a measure of how much the client’s portfolio is expected to earn each year on average. This
measure depends primarily on the return required to meet the client’s goals, but it must also be consistent with the
client’s risk profile. The return objective is a measure of the portfolio’s expected annual total return. This number
is comprised of all forms of investment income, including interest and dividends, as well as realized and unrealized
capital gains.

Total return objectives can be stated in absolute or relative terms. For example, in absolute terms, the objective
might be 7% per year. In relative terms, it may be stated as “the expected annual inflation rate plus 3% per year”, or
“the annual benchmark return plus 2% per year”.
Return objectives may also include the expected effects of inflation, taxes, or both, and may be stated as follows:
• An inflation-adjusted basis (i.e., before taxes, but adjusted for expected inflation)
• An after-tax basis (i.e., before inflation, but adjusted for expected taxes)
• An after-tax, inflation-adjusted basis (i.e., adjusted for expected inflation and taxes)
MEASURING REQUIRED RETURN

A client’s required return is an estimate of the average annual return needed to meet his or her goals. It should take
into consideration the client’s current and expected financial situation, which means it should include the following
elements:
• Current amount of investable assets

• Timing and size of any expected additions to the portfolio (i.e., savings or any other expected new assets)
• Current and expected future spending levels
EXAMPLE
The primary goal of Angelo, a retired client, is to receive an income from his portfolio to pay for living expenses.
Angelo does not plan on adding more funds to the portfolio, nor does he expect his spending level to change.
Therefore, portfolio additions and future spending levels do not affect the required return.
On the other hand, Angelo’s wife, Tina, plans to work for five more years, and her primary goal is saving for
retirement. Tina’s required return depends on the amount of her investable assets, her expected future savings,
and her expected spending levels during retirement.
In addition to the client’s current and expected financial situation, the required return must be sensitive to the
effects of expected inflation and taxes. For example, a client’s expected spending levels are often stated in terms
of today’s dollars, even though the actual money spent will be in future dollars. To take the effect of inflation into
account, expected spending should be adjusted, or else returns should be expressed as real returns.
Calculating a required return that takes into account taxes, inflation, additional savings, and anticipated
withdrawals is a complex task. Many advisors use software programs in which they input an estimated inflation rate
and marginal tax rate. The program then calculates the average annual return needed to meet a specified sum or a
series of income requirements on specific future dates.
STAYING CONSISTENT WITH RISK PROFILE

Before you accept a client’s required return as the return objective, you must validate it for consistency with the
client’s risk profile. This step requires a basic understanding of the historical risk-return trade-off of investing in
capital markets, as well as expectations about future risk and return levels.
EXAMPLE
Your client needs an average annual return of 15% to meet her goals, but she has a low risk profile. You should let
her know that her return objective is unrealistic.
When a client’s required return is inconsistent with his or her risk profile, something must change. Assuming the
client’s risk profile is fixed, the typical solution is to increase contributions to the portfolio or decrease expected
future spending.

DID YOU KNOW?
Even when a client has a very high-risk profile, the return the client requires may not be realistic. A
required return can be accepted as the objective only if it makes sense in light of historical and expected
capital market returns. For example, a return objective of 30% is simply not reasonable in any situation.
When clients have such unrealistic expectations, you must educate them about achievable goals.
SETTING A RISK OBJECTIVE

A client’s risk objective is a specific statement declaring how much risk the client can sustain to meet his or her return
objective. The risk objective is based on the client’s risk profile. According to NI 31-103, establishing a client’s risk
profile involves understanding the client’s willingness to accept risk (sometimes referred to as risk tolerance) and
their ability to endure potential financial loss (sometimes referred to as risk capacity). Risk tolerance and risk capacity
are separate considerations that together make up the client’s overall risk profile. The risk profile for a client should
reflect the lower of two figures: their willingness to accept risk and their ability to endure potential financial loss.
DETERMINING A CLIENT’S WILLINGNESS TO ACCEPT RISK

Determining a client’s willingness to accept risk (i.e., risk tolerance) is a subjective exercise because different
clients think about risk in different ways. Unlike investment professionals, most investors do not think of risk as the
volatility of returns. Furthermore, most people find it difficult to verbally express their attitudes toward risk.
To determine how a client defines risk, and exactly how much risk the client is willing to accept, you must ask
the right types of questions during interviews and in questionnaires. In fact, one of the primary goals of a client
questionnaire is to answer these questions. Questionnaires are generally based on common perceptions of risk,
which are defined as follows:
Risk defined in terms Most people view risk in terms of portfolio performance and the probability of losing
of losses money. For example, some clients might say they do not want to lose more than 10%
of their portfolio in any given year. They consider losses in excess of 10% to be too
risky. Other clients might say that they do not want their portfolios to have a greater
than 10% chance of losing more than 25%.
Risk defined in Some clients define risk as the possibility of not meeting a personal or financial goal. In
qualitative terms other words, they see risk in terms of a goal shortfall. For these clients, meeting their
goals is of critical importance, and their willingness to accept risk is limited by that need.
For example, if a client has a goal of paying for a child’s university education, the
consequences of not meeting this objective are stark. The child will either not go to
university or will have to go in debt to do so. Another example is the risk of a retiree’s
investment portfolio not generating enough return to meet fixed expenses, such as rent
or groceries.
Risk defined in terms Some clients deem a particular market or investment to be too risky simply because they
of uncertainty lack experience in that area. For example, advisors often meet potential clients who have
invested only in conservative products such as guaranteed investment certificates that
are protected through Canada Deposit Insurance Corporation. These clients may find any
type of equity investment too risky.
Other clients do not take full advantage of opportunities outside Canada because
they are unfamiliar with how international markets operate. They favour domestic
investments, despite ample opportunities to increase the efficiency of their portfolios
through foreign investments. This attitude is called a home bias.

CHAPTER 3 GETTING TO KNOW THE CLIENT 3 • 11
Risk defined in terms Clients sometimes dwell on past investing mistakes, which can make them more
of regret timid toward future investment strategies. Such regret may translate into a general
unwillingness to accept risk.
Risk defined in terms Some clients fear being excluded from a rally in a particular investment or asset class;
of exclusion therefore, they view risk in terms of missing out on an opportunity.
DETERMINING A CLIENT’S ABILITY TO ENDURE POTENTIAL FINANCIAL LOSS

Compared to willingness, the ability to endure potential financial loss (i.e., risk capacity) is a more objective
measure. To some extent, a client’s ability to endure potential financial loss depends on the same factors that
determine the required rate of return.
Assessing a client’s capacity for loss requires an understanding of other factors, such as the client’s financial
circumstances, including liquidity needs, debts, income, and assets. Another consideration in determining risk
capacity is how much of a client’s total investments an account or a particular securities position represents. Age
and life stage can also be important considerations when assessing a client’s ability to endure potential financial
loss.
Once you have established these two facts, you can refine your assessment by determining the relative importance
of each goal and the consequences if one or more of those goals are not met.
If all the client’s goals are equally important, and if the consequences of not meeting them all will be severe, the
client’s ability to endure potential financial loss is low. On the other hand, if some of the client’s goals are less
critical, and if the consequences of not meeting them will not be serious, the client has a higher ability to endure
potential financial loss.
A client’s degree of financial security also affects their ability to endure potential financial loss risk.
EXAMPLE
Your client Laurence is a provincial government employee with a generous defined benefit pension plan. Another
client, Tomas, works for a 20-person machine tools shop and has no employer pension plan. Tomas’s employer
recently laid off three employees when the company lost an important client.
Both clients earn the same salary and have similar spending and asset levels. However, Laurence has a higher
ability to endure potential financial loss because his job is more secure and because he has a better benefits
package.
ESTABLISHING RISK PROFILE

A client’s risk profile is a measure of that client’s combined willingness to accept risk and ability to endure potential
financial loss. As mentioned previously, according to NI 31-103, the risk profile for a client should reflect the lower
of the client’s willingness to accept risk and their ability to endure potential financial loss.
If both willingness to accept risk and ability to endure potential financial loss are low, your client’s risk profile is
low; if both willingness and ability are high, your client’s risk profile is also high. Problems can occur, however, when
willingness and ability are at odds.
A client’s expectations for returns may be in line with their investment needs and objectives but may conflict with
the level of risk that they are willing and able to accept. A desire to meet unrealistic expectations may lead such
clients to ask the advisor to invest in higher-risk products that are unsuitable for them. A detailed discussion of
the relationship between risk and return may be necessary to reconcile such conflicts and establish more realistic
expectations.

According to NI 31-103, an advisor should not override the risk a client is willing and able to accept on the basis
that the client’s expectations for returns cannot otherwise be met given the risk profile associated with their
KYC responses. You should identify any mismatches between your client’s investment needs and objectives, risk
tolerance, and capacity for loss. You should then revisit questions at the source of this conflict with the client. If
the client’s goals or return objectives cannot be achieved without taking greater risk than they are able or willing to
accept, you should present alternatives, such as saving more, spending less, or retiring later.
If, after clearly explaining the alternatives, you determine that the client does not have the capacity or tolerance
to sustain the potential losses and volatility associated with a higher-risk portfolio, you should explain to the
client that their need or expectation for a higher return cannot realistically be met, and, as a result, the higher-risk
portfolio is unsuitable. The interaction with the client and end results should be properly documented.
DEFINING THE RISK OBJECTIVE

Once you and your client have determined the appropriate risk profile, you must explicitly state the risk objective.
You will need this information to recommend an appropriate asset allocation for the client. Many advisors identify
several potential asset allocations, each with a different level of expected return and risk. The risk for each asset
allocation is usually stated in terms of its standard deviation. As the advisor, it is your job to determine which
standard deviation is consistent with the client’s risk objective.
DID YOU KNOW?
Standard deviation measures the extent to which returns vary from the expected return. The more
individual returns differ from their expected return, the greater the volatility of returns, and the greater
the standard deviation. For example, a junior mining stock would have a high standard deviation,
whereas a blue-chip bank stock’s standard deviation would be low.
Usually, the client’s risk objective is stated in terms such as “average or moderate risk profile” or “lower-than-
average risk profile”. When the statement is consistent with the client’s return objective, it is relatively easy to
determine the appropriate standard deviation and asset allocation.
If a client’s risk profile is stated as “average” or “moderate”, the asset allocation with a standard deviation in the
middle range is likely to be most appropriate. For example, suppose the standard deviations of the available asset
allocations are 8%, 10%, 14%, 18%, and 20%. In this case, the asset allocation with a standard deviation of 14%
would likely be an appropriate option.
For clients who fully understand the concept of standard deviation, the risk objective can be stated as a specific
standard deviation. With a specific risk objective, such as “a standard deviation of not more than 10%”, it is easier
to identify the appropriate asset allocation. Or, if the client does not want the portfolio to decline more than a
specified percentage, the risk objective can be stated as a maximum tolerable standard deviation. For example,
the risk objective might be stated as “no more than a 20% decline in portfolio value in any given year”. Again, it is
relatively easy to identify an appropriate standard deviation based on this risk objective.
DID YOU KNOW?
Generally, the higher the potential return on an investment, the higher the risk the investor will face.
However, there is little assurance that an investor will actually earn a higher return by accepting more
risk. It is also possible that a high-risk investment could backfire. Instead of earning a higher rate of
return, the investor could lose the original amount invested. Risk is something you should consider when
discussing the trade-off between risk and return with your clients.

INVESTMENT CONSTRAINTS
Even clients who are willing and able to accept risk face several constraints that must be factored into their wealth
plan. Common constraints include the client’s time horizon, liquidity requirements, and tax situation. The unique
circumstances particular to each client may affect their ability to earn high enough returns to meet their goals.
TIME HORIZON
A time horizon is the length of time expected to elapse before a client can meet a significant goal. When that period
is over, the client will either withdraw some of the portfolio’s assets or enter a new stage of planning that requires
an update to the wealth plan.
DID YOU KNOW?
As clients approach a defined time horizon, you should review their wealth plan more frequently. The
impact of the looming change in the wealth plan is usually managed in steps until the horizon is reached.
All clients have at least one significant goal, but many have several. Many clients, therefore, have multiple time
horizons, and the wealth plan must deal with each of them.
Time horizons can generally be classified as short-term, medium-term, or long-term. There is no agreed-upon
definition of how many years define a specific term, but the following rules generally apply:
• A short-term time horizon is less than three years.

• A medium-term time horizon is more than three years and less than 10.
• A long-term time horizon is 10 or more years.
Long-term time horizons are generally associated with a greater ability to endure potential financial loss. Because
market cycles last several years, clients with long-term horizons can better sustain the ups and downs of the
markets than those with short-term horizons. However, not all clients with a long-term time horizon should be
exposed to higher risk.
EXAMPLE
Harriet, age 40, wants to accumulate a retirement nest egg in 20 years. Because her primary goal has a long-
term time horizon, she can probably afford to assume a sizable amount of risk to maximize the long-term return
potential. However, Harriet also wants to pay for her 16-year-old daughter’s university education starting in two
years and continuing for four years thereafter.
As Harriet’s advisor, you must balance the two time horizons and set risk and return objectives for each goal. The
objective for the long-term goal should not be set so high that it impairs Harriet’s ability to meet the shorter-
term goal. Factors to consider include which goal is more important to Harriet and how much of her net cash
flow she can divert to accomplish these goals.
The time horizon for a particular goal is usually not difficult to determine. For example, clients investing for their
retirement usually know the age at which they plan to stop working. Determining the length of the retirement
horizon is a straightforward exercise: simply subtract the client’s age from the desired retirement age.
However, clients do not always precisely state other significant time horizons. For example, they may state a desire
to buy a house “in three to five years”. In general, the sooner the goal must be met, the more precise the client
should be about its timing. It is more difficult to plan for a goal that must be met “within the next five years” than
it is to plan for a goal whose time horizon is “20 to 25 years from now”. The client can estimate a time horizon for
shorter-term goals, but the estimate should cover a reasonably narrow range—for example, “four to five years from
now” rather than “within five years”.

DID YOU KNOW?
To define constraints around time horizons, or around each goal specified by the client, you should
always ask, “When must this goal be met?”
LIQUIDITY REQUIREMENTS
Liquidity requirements represent a client’s actual and potential cash needs. They may dictate a need for
some investments that can be converted to cash quickly, at little cost. Cost includes not only commissions and
transaction fees but also implicit costs. For example, the bid-ask spread is an implicit cost, as is a price decline
caused by selling an investment (known as market impact).
Clients usually require liquidity in their portfolios for any or all of three reasons: ongoing income needs,
emergencies, or significant purchases they anticipate having to make in the future.
Ongoing income needs Some clients, typically those who are retired, rely on regular instalments of cash from
their portfolio as a source of income. The need for liquidity in such cases may dictate a
low risk profile, but not always.
For example, if the regular instalments are small enough that the portfolio can provide
the income even after a substantial loss of value, the client’s ability to endure potential
financial loss will be higher. Of course, clients’ attitudes toward risk and their goals play
a big part in determining their risk profile.
Emergencies Many wealth management experts recommend that people have three to six months
of living expenses in cash (or near cash) on hand. This fund provides for emergencies
that might arise, such as a job loss, an uninsured medical expense, an illness, or an
urgent home repair. Different clients need different amounts of cash for emergencies.
You should inquire whether the portfolio will be the source of the emergency reserve, or
whether the need can be met by another source, such as cash in a bank account.
Anticipated significant Anticipated significant purchases often coincide with a time horizon. If the nearest time
purchases horizon is long term, the current need for liquidity is minimal. Examples of significant
purchases are a house, cottage, car, or boat.
However, funds must be available for certain relatively large purchases such as major
household appliances. For example, for a stove or refrigerator that needs replacing
urgently, the money would most likely come out of the fund for emergencies; in some
cases, from an existing line of credit.
You should find out as precisely as possible the dollar amounts associated with known liquidity requirements,
including ongoing income needs and anticipated significant purchases. These amounts can help you take
appropriate measures at appropriate times.
Because the cost and timing of emergencies cannot be predicted, planning for them is difficult. The recommended
reserve for emergencies may or may not be enough to cover the unknown cost of an actual emergency. When
emergencies occur, they may require drastic changes to the client’s wealth plan. For example, a job loss might
stretch over two or more years, or a shift to precarious employment can occur due to unforeseen circumstances.
TAX SITUATION
To create a comprehensive wealth plan, you must have a complete understanding of the client’s tax situation.
Among other things, you must know the client’s marginal tax rate, contribution limit to registered accounts, and
any investment income being earned in accounts not under your management.

When reviewing your client’s tax situation, consider the following factors:
• Taxes on investment earnings reduce the amount of money available to meet the client’s goals.
• For clients who need regular income from their portfolios, taxes reduce the amount of money available to pay
current expenses.
• For clients with investments in non-registered accounts, taxes reduce the amount of money that can be
reinvested to meet longer-term goals.
When you understand everything about the client’s tax situation, you can suggest or implement techniques to
reduce the amount of tax the client must pay. This aspect of wealth management is known as tax management.
Several tax management techniques are described below.
Make optimal use of Canadian investors should contribute to a registered retirement savings plan (RRSP) or,
tax-deferred and tax- if appropriate, a registered education savings plan to the maximum limit allowed. Your
free accounts. clients should also make use of a registered retirement income fund when their RRSPs
must be terminated. Finally, they should maximize their contributions to a tax-free
savings account (TFSA).
Optimize the location Asset location concerns the tax-efficient distribution of assets between registered
of assets. and non-registered accounts. Interest income outside a registered account is taxed
at a higher rate than capital gains and dividend income. It may therefore appear that
investors should hold all their interest-bearing investments in their RRSPs and TFSAs,
where earnings are tax deferred or not taxed at all. However, there may be good reason
to hold capital gains-producing investments and dividend-producing securities inside
registered accounts. In many cases, clients do not have enough savings to invest in both
registered and non-registered accounts. Instead, they focus on registered accounts for
the known tax benefits and invest in capital gains-producing and dividend-producing
securities within those registered accounts.
Make optimal use of In non-registered accounts, only net realized capital gains are taxable. Therefore,
capital losses. investors can reduce their tax bill by using realized capital losses to reduce realized
capital gains. This does not necessarily mean offsetting all realized capital gains with
realized capital losses to avoid all capital gains tax. Realized capital losses not used to
offset capital gains in the current year can be applied against capital gains from the
previous three years. They can also be carried forward indefinitely to offset capital gains
in future years. But sometimes an investor faces a potentially large tax bill from large
realized capital gains. It may be beneficial in such cases to sell some securities that have
declined in value and that no longer meet the criteria for inclusion in the portfolio. In
doing so, the investor is able to generate capital losses that can be offset against the
large realized capital gains.
Keep turnover low Another way to reduce net realized capital gains is to follow a low-turnover strategy
in non-registered whenever possible. This strategy involves minimizing trading in an account to lower the
accounts. amount of taxable capital gains.
Use life insurance Upon death, tax on income (including capital gains) and probate fees become payable.
proceeds to pay estate For many clients, the tax bill they face at death (i.e., the final tax bill) will be the largest
taxes and probate fees. tax bill ever. When tax-free proceeds of a life insurance policy are used to pay these
potentially large expenses, the value of the estate is not depleted. More of the estate is
thus left to the beneficiaries.

Make use of income Income splitting can be used to minimize current taxes or as part of a plan to transfer
splitting, keeping assets to one’s spouse or children. To be effective, income should be diverted from a
attribution rules in person in a high tax bracket to a family member who is in a lower tax bracket. However,
mind. several restrictive attribution rules apply. You should inform your clients about the
advantages of splitting income and present some techniques they can use. A tax expert
can advise them on how to split income in such a way that it is not attributed back to
the earner.
Make use of tax Tax shelters have been curtailed considerably over the last years by changes in tax
shelters where law and administrative practice. However, limited opportunities remain available. Tax
permissible and shelters should only be considered for taxpayers in a high tax bracket who have satisfied
advisable. basic consumption needs such as food and shelter. The risks are high, and proper
accounting and legal advice are essential before a commitment is made.
A client’s wealth plan should summarize the client’s current tax situation and may include specific ways to deal with
their tax situation. Keep in mind that, as an advisor, you should keep your advice within your sphere of knowledge.
When necessary, you should recommend a professional, such as an accountant, to cover more in-depth needs.
UNIQUE CIRCUMSTANCES
Unique circumstances specific to each client must be considered to create an effective wealth plan.
An example of a unique circumstance is the desire for responsible investment. Responsible investment refers to
the incorporation of environmental, social, and governance (ESG) factors into the selection and management of
investments. There is growing evidence that incorporating ESG factors into investment decisions can reduce risk and
improve long-term financial returns. Issues related to ESG factors are also some of the most important drivers of
change in the world today. And these are not just societal issues; they are critical economic issues with significant
implications for businesses and investors. In recent years, responsible investing has come to encompass ethical
investing, socially responsible investing, sustainable investing, green investing, community investing, mission-based
investing, and, more recently, impact investing. They are all components of responsible investing and have played a
part in its history and evolution.
A COMMON CONCERN: “WILL I HAVE ENOUGH MONEY?”

The overwhelming concern of many clients is whether they will have enough money to support themselves during
retirement. This concern is expressed by clients who are saving for retirement and by those who are already drawing
retirement income from their investments. In most cases, it is not an easy question to answer because of the many
variables involved. However, many software programs are available with which you can manipulate the variables
that help determine whether your clients will achieve their goals.
For example, suppose you and your client are exploring the savings and investing options available to achieve
financial independence in retirement. Six variables are involved in this exercise:
• The number of years to retirement (and therefore the time available to accumulate wealth) and the likely
number of years in retirement
• The annual income required during retirement (based on the lifestyle the client expects after leaving the
workforce)
• The amount of retirement savings already in place
• The amount of money the client can save each year
• The inflation rate between now and the date of retirement and the likely inflation rate during retirement
• The expected return on the client’s savings over the years

Most clients can control four of these variables, as follows:
• They can pick the age of retirement, which may be earlier or later than the traditional age of 65.
• They can increase or decrease the annual income required in retirement by altering their lifestyle expectations.
• They can adjust the amount of income they can save each year before retirement with changes in their lifestyle
today.
• They can control, to some extent, the returns they can expect by adjusting the asset allocation of their portfolio
and, therefore, the level of risk.
The two variables that are beyond your clients’ control are their existing savings and the inflation rate.
Clients who depend on their investment portfolios to provide steady income are able to control fewer variables.
Beyond their control are the pool of savings, the number of years the income must last, and inflation. The required
amount of income might also be beyond control if your clients are unwilling to accept a lower standard of living
in retirement than what they are used to. Furthermore, conservative clients often need both a steady income
and some growth to ensure that the purchasing power of their income does not decline over the years. For these
reasons, it can be difficult for some clients to meet all their goals.
A low risk profile or investment constraints can sometimes force your clients to make compromises. The calculations
may call for a more aggressive investment strategy than they would like. If so, your clients have three choices: learn
to live with more risk, relax the constraints, or establish more modest goals.
Some software packages can accommodate several goals in addition to the goal of saving for financial
independence in retirement. For example, your clients may also want to buy a home, cottage, or boat, establish
a business, or pay for their children’s post-secondary education. It is up to you, as their advisor, to make them
aware of the financial impact of decisions made today on their goals for the future. Of particular importance is the
compromise between risk and return.
DID YOU KNOW?
Software projections can allow your clients to explore various scenarios; however, projections are
guidelines only, not precise measures. It is important to review the projections every year to ensure that
your clients’ finances remain on track.
THE CLIENT DISCOVERY PROCESS
3 | Apply the client discovery process to assess a client’s wealth planning needs.
The method used to collect and document all the information you need to create a comprehensive wealth plan
is often called the client discovery process. This process is used to find out what the client wants to accomplish
through a wealth plan. The answer requires a probing dialogue during which you must ask personal, emotionally
charged questions that may be difficult for the client to answer. It is this early—perhaps first or second—conversation
with the client that distinguishes the truly skilled advisor from the inexperienced. With the right process, you should
be able to establish both the profile of the client and the approach you should take as the advisor. A comprehensive
interview reveals more than the client’s goals, financial situation, objectives, and constraints. It also helps determine
the strategies and products that will truly meet the client’s needs. Simply stated goals, such as the desire to retire
early or to buy a house, will be defined within a set of objectives and constraints. From there, you can create a set of
guidelines, which both you and your client will agree to follow.

Both you and your client must be completely honest during the discovery process. You may discover that you are
not comfortable with each other’s style. For example, if you are unfamiliar with complex tax strategies, you may
find it difficult to work with a client who wants to concentrate on such strategies. Similarly, it may not be best, in
the long run, for an aggressive investor to have an advisor with a conservative philosophy. In such cases, it is better
to suggest that clients seek an advisor with whom they will be more compatible.
THE CLIENT INTERVIEW

Information gathering usually begins with an interview, the purpose of which is to identify the client’s issues and
problems. This first interview is the beginning of what may be a long-term relationship with the client. At this point,
you should determine whether you are able to deal with the client’s requirements and whether you are both likely
to be compatible.
During the interview, you should describe how you operate and explain that the client will have to make choices
about alternative strategies and products. You should also mention that the client may have to consult with
specialists in particular areas, such as risk management and estate planning.
If you and the client decide to pursue a relationship that involves wealth management, you should both sign a letter
of agreement or a formal contract. This document ensures that the client understands the services you will deliver
and their obligation to provide accurate and complete information in return. The contract also ensures that the
client understands the cost of your services and that any other professionals retained must be compensated.
THE ART OF THE CONVERSATION

The wealth management process is designed to ascertain clients’ emotional concerns and offer financial solutions
that answer them. It is these concerns that ultimately drive the wealth plan. Because of the emotional nature of the
conversation, you will likely face challenges in collecting information beyond the minimum required in the account
application. You will find that clients are not always willing to share private information with people they do not
know well. Furthermore, they do not always understand all of the issues that should concern them. For your part,
you may be uncomfortable asking personal questions that do not appear to relate directly to a financial solution
(e.g., “Are your parents in good health?” or “Do any of your children have special needs?”).
Most of us are able to carry on meaningful conversations with people we meet in social settings because we
understand the art of conversation and the rules of social etiquette. In our advisor role, however, we often adopt a
business-like attitude; we tend to drop the social graces that allow us to get to know people. Successful advisors are
able to transfer their social skills to the office and know how to make their clients feel at ease sharing information.
They personalize the planning process, rather than subjecting the client to a barrage of predictable KYC questions.
By tradition, advisors usually open the interview with small talk before moving quickly on to the formal KYC process.
In the wealth management approach, however, friendly conversation plays a large role throughout the discovery
process. This dialogue with clients serves several important purposes:
• It puts clients at ease and helps create an atmosphere of trust.

• It creates a space in which you and your client can discover what you have in common.
• It personalizes the financial and investment planning processes.
• It helps you identify the areas where you will need to ask more focused questions later in the process.
Keep in mind the following guidelines when talking to clients:
• When clients share personal information, don’t hesitate to respond with similar details about your own life.
For example, if you both have small children, you can exchange stories about the joys and challenges of
parenthood.

• Do not start selling products too soon. Especially in the initial interview, you do not want your clients to feel you
are trying to sell them something before you understand their concerns. Allow them time to feel comfortable
enough to confide in you.
• Do not get carried away in pleasant conversation to the point that the interview loses purpose and structure.
Make sure your clients understand where the interview is going and that you are not simply engaging in small
talk. For example, open the discussion by saying something like, “Mrs. Petrowski, bear with me for a few minutes
because I would like to get to know you a little better.”
• Pay attention to your own body language, eye contact, and facial expressions. They must all convey the
message that you are interested in the client and care about what they have to say.
• Use active listening techniques to get clients to expand on what they have just said. For example, ask open-
ended questions like “Can you tell me what you mean by that?” or “Can you give me an example?”
• Make notes as you go along; it helps to add structure to the interview and reassures clients that you will not
forget their concerns. However, do not let note-taking get in the way of conversation.
THE STRUCTURED CONVERSATION

The wealth management approach to client discovery has three distinct phases:
1. Setting the stage and building rapport
2. Conducting emotional discovery
3. Bridging to financial discovery
The processes used in each phase are described below.
PHASE 1: SETTING THE STAGE AND BUILDING RAPPORT

At the outset, you should explain the wealth management approach, so the client understands that you provide
more than simple investment management.
EXAMPLE
One advisor positioned his wealth management approach, using a team of professionals, as follows:
“Before we begin, I would like to explain how we work with our clients so that you can get a sense of how we might be
able to help you.
“First, we take a lot of time to understand your entire situation before we make any recommendations. You will find
that we ask you a lot of questions that you may not have been asked by other advisors. We always have a reason for
asking, and we want you to feel comfortable sharing information with us.
“Second, we will spend much of our initial time clarifying your goals so that we can see the whole picture, rather
than just pieces of it. We will help you with the financial plan, but only after we appreciate what you would like to
accomplish. Is that okay with you?”
Building rapport is necessary because, as the advisor, you need your clients to feel comfortable. In the past, advisors
were trained to talk about the weather or about common interests as a way of engaging the client’s trust. The
wealth management process takes a similar approach, but it goes a step further. Rapport-building is used in this
process to uncover potential areas of concern that you should explore later in the conversation.
In general, rapport-building involves talking about family, work, interests, passions, dreams, plans, and goals. During
this conversation, you can quickly establish that you are interested in the client’s life as a whole. This approach
helps you prepare the client to talk about life issues throughout the discovery process. When done successfully, the
conversation puts the client at ease and alerts you to issues that you should explore later.

PHASE 2: CONDUCTING EMOTIONAL DISCOVERY

Emotional discovery is the art of replacing talk of financial solutions with a discussion of life issues. Most major life
issues have a financial consequence that can be addressed through financial planning and investment management.
Consequently, life issues have always been a secondary focus of those processes. However, the wealth management
approach to client discovery focuses the discussion on the life issues first, rather than financial issues.
Table 3.2 categorizes the life issues you should address in conversations with clients. It also provides a visual
overview of the scope of wealth management, which can serve as a tool to help you uncover needs that may not
have been addressed.
Table 3.2 | Life Issues in Wealth Management
Family and Children’s needs Parents’ needs Entertainment Health and Education
lifestyle home
Protecting Income Lifestyle Change Asset protection Long-term care

lifestyle maintenance maintenance management
Planning for Retirement plan Future income Housing options Change Future lifestyle
the future management
Managing Financial comfort After-tax income Saving for future Lifestyle income
savings maximization
Building Passing on estate Preserving estate Charitable giving Wills and trusts Living legacy
a legacy
PHASE 3: BRIDGING TO FINANCIAL DISCOVERY

Each life issue discovered in the wealth management process carries with it multiple possible solutions. You should
bring these solutions into the discussion only after fully exploring the extent of the client’s needs and concerns.
Four general planning issues flow from emotional discovery: accumulation, protection, conversion, and transfer of
financial wealth. For each issue, you should ask certain questions, as described below.
Accumulating When discussing this issue, the focus should be on the client’s need to grow assets.
financial wealth
Ask the client:
• What areas will be helped by an asset growth strategy?

• What do you want?
• How much money will you need?
• How much can you put aside?
• How much have you currently saved?

Protecting Protection of wealth (i.e., risk management) is an emotional need, as well as a planning
financial wealth issue.
Ask the client:
• How do you feel about risk?

• What level of risk are you comfortable with?
• What do you need to protect?
• What protection by way of personal, property, and liability insurance do you already
have in place?
• What life changes do you anticipate?
Converting financial Creating an income stream is particularly important in retirement, but it can also be
wealth to income necessary in the case of disability, unemployment, or family emergencies.
Ask the client:
• How much income do you consider to be enough?

• Where will the income come from?
• What do you have in place currently to deal with unforeseen expenses resulting from
job loss or disability?
Transferring Wealth transfer relates to an estate plan, as well as to building a living legacy.
financial wealth
Ask the client:
• What are your plans for the future?

• Do you foresee having to help your children, parents, or both?
• Are you planning charitable donations?
• Do you want to create a living legacy?
• Do you need to protect your estate?
ASKING GOOD QUESTIONS

There is an art to asking good questions. When you master this art, you can obtain valuable information in a way
that is natural and yet fits into a structured conversation. Good questions keep the conversation moving in the right
direction to help you gain a complete understanding of the client’s financial and personal situation.
The wealth planning discussion should focus on total needs, rather than products. You should not assume the client
knows all the issues and that your role is simply to talk about solutions. You should first focus the discussion on
helping the client understand the issues before you discuss any solutions. This approach is designed to create an
emotional connection with the client.
The most effective way to conduct an interview is to ask questions that elicit good information and help the client
think through the issues. You should ask about the client’s current situation and the possible implications of that
situation in the future.
Table 3.3 provides some examples of useful questions you can ask to help your clients focus on their current and
future issues.

Table 3.3 | Questions for Wealth Planning
Wealth Planning Area Current Situation Future Implications

Family and • Do you have children? How old • What are your goals for your children?
lifestyle are they? Tell me about them.
• What are the biggest concerns that you
• Are your parents still alive? have for your family in the future?
• How is your parents’ health? • What challenges do you see to your
lifestyle in the future?
• Who would be most affected by
the financial decisions you make? • Will you be in a position of becoming a
caregiver for your parents?
Protecting • What insurance protection do you • Will your family be looked after if
lifestyle have in place? anything happens to you?
• What does your current insurance • How much of your family’s income
coverage provide? depends on your continued health?
• How knowledgeable are you on the • What are the biggest concerns that you
insurance strategies available to you? have about your family’s health?
Investment • What kinds of investment strategies • Have you considered whether you
planning do you consider to be too risky? will have enough money to meet your
future goals?
• Can you give me a snapshot of where
your assets are right now? • What are the biggest worries that
you have about how your money is
invested?
• What is the best investment decision
that you have ever made?
Retirement • Have you and your spouse talked • What concerns you most about
planning about what you want your retirement retirement?
to look like?
• What changes do you see happening in
your retirement life?
Legacy and • When did you last update your will? • Are you confident that your assets will
estate planning be distributed in the way you want
• What is your view on charitable
when you die?
giving?
• Do you have an enduring or • What plans do you have in place to
continuing Power of Attorney for protect your assets from taxes and
Property and a Power of Attorney for probate fees when your estate is
Personal Care? settled?
THE STRUCTURED CONVERSATION
Can you conduct an interview that is structured around the four planning issues that flow from
emotional discovery? Complete the online learning activity to assess your knowledge.

GETTING TO KNOW THE MILLERS
At the beginning of this chapter, we presented a scenario in which you had to establish rapport with the Millers
during the account-opening process. You had to learn about their goals and needs and get a clear understanding
of their financial resources and general financial position.
Now that you have read this chapter, we’ll revisit the questions we asked and provide some answers.
• Beyond the KYC information required by regulation, what other important information do you need to get a clear
picture of the Millers’ situation?
• You should be able to perform an effective client discovery to determine the Millers’ goals. You should be
able to articulate those goals in meaningful terms, rather than numbers alone.
• By understanding, prioritizing, and connecting goals together, you can create a holistic plan. The plan
should have real meaning for the Millers so that they are likely to stick to it over time.
• Considering the difference between goals and objectives, what must you understand to build an effective
investment plan and provide this couple with the right advice?
• Most clients can tell you in a general way what they want to achieve. They may also have an idea of
what they can afford to invest to achieve it. However, few clients are able to connect their goals to
realistic savings objectives and time horizons. It is your role as their advisor to educate your clients about
reasonable expectations regarding investments and savings plans.
• How can you establish a comfortable rapport and gather the information you need during what may be an
emotionally charged discussion?
• Clients often do not know what information they should provide, so an effective client discovery process is
important for both you and your clients.
• Establishing rapport with the client and asking relevant and meaningful questions are all part of the art of
the conversation.
• A phase often overlooked is the emotional discovery phase, where you focus on life issues. In some cases,
rather than focusing on restructuring their portfolio, you can help clients achieve their goals by helping
them come to terms with the physical and mental changes brought about by aging.

SUMMARY
In this chapter, we discussed the following key aspects of building a client relationship:
• To help your clients create a financial plan, you must get to know them beyond the legal and regulatory
minimum requirements. The process begins when you open a client account. At that point, you must comply
with various rules and laws, including federal legislation, some international agreements, and IIROC’s KYC rule.
• The account application is used to collect basic information, but it is not enough on its own to build a
comprehensive wealth plan. You must also use the client discovery process to learn about your clients’ goals
and current financial situation, their risk and return objectives, and their investment constraints.
• Goals are a client’s life needs and aspirations. Objectives refer to the investment return clients require to
achieve their goals based on their willingness to accept risk and ability to endure potential financial loss.
• Several constraints must be factored into every client’s wealth plan, including the client’s time horizon, liquidity
requirements, and tax situation. Constraints can sometimes force clients to make compromises such as
establishing more modest goals.
• The purpose of the client discovery process is to find out what your clients want to accomplish through a wealth
plan. Emotional discovery relates to life issues such as family and lifestyle, planning for the future, managing
savings, and building a legacy. Financial discovery is the process of setting a plan to accumulate, protect,
convert, and transfer wealth.
NOTE
this chapter differs from the KPMG guide in any respect, precedence will be given to the this content.
DISCUSSION BOARD
for Chapter 3.
REVIEW QUESTIONS
Questions.

Assessing the Client’s
Financial Situation 4
CHAPTER OUTLINE
Once you have collected all necessary financial and non-financial data, you must use that information to assess
your clients’ wealth planning needs. In this chapter, you will learn how to create a budget and savings plan based
on the client’s net worth and available cash flow. Every plan should incorporate savings strategies that suit the
individual client. It should also incorporate funding strategies for any emergencies that might arise. Finally, we
highlight the importance of the time value of money for wealth managers.
1 | Analyze a net worth plan for a client. Analyzing Personal Financial Statements and
Savings Plan
2 | Analyze a cash management plan for a client.
3 | Outline savings strategies for a client.
4 | Solve various calculations involving the five Time Value of Money

variables of time value of money using a
financial calculator.

KEY TERMS
current expense control dollar-cost averaging
debt restructuring non-discretionary expenses
discretionary expenses time value of money

CHAPTER 4 ASSESSING THE CLIENT’S FINANCIAL SITUATION 4•3
INTRODUCTION
Consider the types of questions a travel agent might ask a client:
• When would you like to start your trip?
• Where would you like to go?
• Can you afford the type of trip you want?
• If not, would you rather have a longer trip on a smaller budget or a shorter trip on a luxury budget?
If a person’s life is analogous to a journey, your role as an advisor can be compared to that of the travel agent. As
such, you need to ask very similar questions of your clients.
It is important to know where your clients are right now financially, where they want to be in the future, and what
financial resources they have available to reach their destination. To continue the analogy, the client’s travel budget
represents their current net worth, available financial resources represent their cash flow, and the final destination
represents their goals and objectives.
Various types of credit play a vital role in the overall economy and also in the daily lives of clients. Advisors need to
know about the wide range of credit products available and how a client’s ability to borrow is evaluated. Credit (or,
more accurately, debt) has a direct impact on a client’s budget and savings plan.
LEARNING MORE ABOUT THE MILLERS’ FINANCIAL SITUATION

Peter and Ruth Miller were introduced to you by their banker after a seminar you delivered on retirement planning.
The Millers feel that their existing advisor has been providing them with advice that is contrary to their best
interests. They have met with you and have decided that you will be their new advisor.
You have met with the Millers and gone through the account opening process. Now, you must also review their
situation to attain a clear understanding of their financial resources and general financial position.
• Why is it important to establish the Millers’ current net worth?

• By examining their cash flow to determine how they spend their income, what important goal are you supporting?
NOTE
this chapter differs from the KPMG guide in any respect, precedence will be given to this content.
ANALYZING PERSONAL FINANCIAL STATEMENTS AND SAVINGS PLAN
1 | Analyze a net worth plan for a client.
2 | Analyze a cash management plan for a client.
3 | Outline savings strategies for a client.
NET WORTH PLANNING

Put simply, net worth is the difference between the total assets and total liabilities of an individual, family unit, or
business. The purpose of net worth planning is fourfold:
• It helps to establish financial discipline.

• It sets out a strategy to achieve a future financial target.

• It provides a means to measure financial progress at regular intervals.
• It provides reassurance about future financial security.
The first step in the planning process is to prepare a net worth statement, which represents a snapshot of the
client’s current net financial assets. This snapshot provides a basis for comparison as net worth grows over time to
fund future spending needs. Current net worth is not as important in financial planning as the rate at which it grows.
The amount of net worth should be calculated periodically to see whether it is growing toward a specific goal.
Because the trend toward the goal is most important, a part of the planning process is the setting of a net worth
goal for the next year and future years. You must then help your client develop specific strategies for meeting those
goals. Then, your client must commit to annual reviews to confirm that benchmarks are being met.
CALCULATING NET WORTH

The starting point of net worth planning is the calculation of net worth. For an individual or family, net worth is the
basic measure of financial health. It is the total fair market value of all assets owned minus all outstanding liabilities
owed. Assets may include a house, cottage, savings accounts, mutual funds, plus stocks and bonds. Liabilities may
include a mortgage, credit card balances, and other loans. Simply stated, net worth is the amount by which assets
exceed liabilities at a specific point in time.
To begin preparing a client’s financial plan and the initial calculation of net worth, you may need to pull together the
following financial records:
• Recent tax returns • Real estate closing records

• Bank statements • Life insurance policies
• Cancelled (i.e., paid) cheques • Disability insurance coverage
• Credit card information • Property insurance policies indicating fair market
value (or replacement cost) of personal property
• Itemized living expenses
• Brokerage account and mutual fund records • Pension account records
• Mortgage payments • Loan repayment schedules for automobile and other

big-ticket items purchased on credit
DID YOU KNOW?
Regarding pension account records, a defined benefit pension plan can be valued on the net worth
statement at the commuted value. However, in the case of a defined contribution pension plan, the
assets are locked in and cannot be withdrawn from the pension plan until retirement. The current value
of these assets can be recorded on the net worth statement in the same manner as RRSP assets.
Although your client may find it daunting to gather all the necessary documents, they are essential for net worth
planning. Beyond helping you calculate net worth, they also lay the foundation for savings, credit, debt, investment,
tax, risk management, retirement, and estate planning.
Most net worth statements have the following features in common:
• Assets are categorized as liquid, investment, or personal assets.

• Investment assets are further classified as short-term and long-term.
• Long-term assets are further classified as equity, fixed income, or miscellaneous assets.
• Liabilities are categorized as short-term or long-term.

When the statement is complete, total liabilities are subtracted from total assets to provide the net worth amount
for the client as of a given date.
Scenario | The Roberts’ Net Worth
You recently had a conversation with prospective clients Jim and Helen Roberts. They told you that they have
been planning to take a trip to Hawaii in two years. They expect that the trip will cost $6,000, and they have saved
$2,000 in a non-interest-bearing account.
Jim and Helen are both young professionals, each earning $75,000 per year. Their home is worth $700,000 and has
a $400,000 mortgage. They also have a premium credit card with a limit of $5,000 and a current balance of $1,200.
They pay the balance in full monthly.
The Roberts currently have $32,000 in RRSPs. They want to develop a strategy to accumulate $1,000,000 before
they retire in 30 years. Neither of them has a pension plan.
Helen tells you that she is hoping to talk Jim into buying a bigger house because they want to start a family
sometime in the not-too-distant future. Jim tells you that he is hoping to talk Helen into buying a luxury car.
The information below is based on your notes from your meeting with the Roberts:
Bank account: $2,000
House: $700,000
Mortgage: $400,000
RRSPs: $32,000
Outstanding credit card balance: $1,200
Based on your notes, the couple’s net worth statement indicates a net worth of $332,800 on the date of your
meeting, as shown in Table 4.1.
Table 4.1 | Net Worth Statement for Jim and Helen Roberts—Draft
ASSETS LIABILITIES
Liquid Assets Short-Term
Liquid Assets $2,000 Credit Card $1,200
Investment Assets Long-Term
RRSP $32,000 Mortgage $400,000
Personal Assets
Total Liabilities $401,200
House $700,000
NET WORTH $332,800
Total Assets $734,000 Total Liabilities and Net Worth $734,000

Scenario | The Roberts’ Net Worth
Three weeks after your meeting, Jim drops by your office and leaves an envelope, dated March 31, containing their
financial statements. He also drops off a pile of debit and credit receipts and mentions in passing that they owe
$18,000 on a line of credit.
After reviewing the new information, you revise the Roberts’ net worth from $332,800 to $287,800, as shown
in Table 4.2.
The Roberts’ example illustrates why it is important to get full and accurate disclosure of financial information from your
clients. In their case, revised information submitted by the Roberts resulted in a lower net worth amount. The amount was
lower by $45,000 because they disclosed additional debt of $48,000 and a higher RRSP amount of $3,000.
Table 4.2 | Net Worth Statement for Jim and Helen Roberts as of March 31, 20x8
ASSETS LIABILITIES
Liquid Assets Short-Term
Liquid Assets $2,000 0.3% Credit card $3,000 0.4%
Line of credit $18,000 2.4%
Other debts $28,200 3.8%
Investment Assets Long-Term
RRSP $35,000 4.7% Mortgage $400,000 54.3%
Personal Assets
Total Liabilities $449,200 60.9%
House $700,000 95.0%
NET WORTH $287,800 39.1%
Total Assets $737,000 100.0% Total Liabilities and Net Worth $737,000 100.0%
Based on their retirement savings objective, the Roberts will need to develop a strategy to grow their investments to
$1,000,000. Their net worth of $287,800 is their starting point. In reality, they need a plan to grow $35,000 (their
RRSP value) to $1,000,000 because the net worth figure includes $300,000 of equity that they have in their home.
The couple will need to control their spending, raise their income, or both if they expect to attain their goal.
Every year, they should recalculate their net worth and evaluate their RRSPs to ensure that they are progressing
toward their goal. They can expect to have to adjust their strategy along the way, given that no one can predict the
future with certainty.
DIVE DEEPER
To see net worth statement you can use on the job, go to your online chapter and open the following
document:
Net Worth Statement

ASSETS VERSUS LIABILITIES AND CALCULATING NET WORTH
Can you categorize a client’s assets and liabilities to calculate the client’s net worth? Complete the two
online learning activities to assess your knowledge.
THE PLANNING STRATEGY

The net worth amount provides the basis for developing an appropriate net worth planning strategy involving a
target growth rate. The net worth amount at the end of a given year (or on any other date) should be compared
with the amount on the same date of the previous year.
• If the annual rate of growth meets the target rate, the client may choose to maintain the existing growth rate or
devise improved strategies to accelerate growth.
• If the current rate of growth falls short of the target rate, the client must either develop new strategies to
correct the situation or set a more realistic net worth goal.
• If net worth has declined, the client may have to revise some goals and develop more aggressive strategies to
reduce debt, reduce expenses, increase income, and increase investment return.
DID YOU KNOW?
There is little benefit to calculating net worth unless it is done at least annually. Only by making regular
comparisons can you tell if the savings, credit, investment, and related programs measure up to the
client’s short- and long-term financial objectives.
CASH MANAGEMENT PLANNING

The net worth statement determines the value of assets and liabilities at a specific point. A cash flow statement, on
the other hand, shows how much money flows in and out of a household or business over a set period (generally
not exceeding one year).
One of the primary ways net worth can grow is through positive net cash flow or savings. Net worth also increases
if asset values rise while liabilities decline. A prime example is one’s principal residence. In a rising market, the
property’s value goes up, and the mortgage balance declines as regular payments are made. Therefore, net worth
can increase even when net cash flow remains at zero if the client is paying down debt.
When annual cash inflow exceeds annual outflow, savings increase. That result is precisely the basis for using cash
management planning as a dynamic wealth management tool. If total savings during a given year are not enough to
achieve the targeted growth in net worth, the client must act to correct the situation. The two options are to reduce
spending or increase income. If either strategy (or both combined) fails to generate sufficient net cash flow, the
client may have to re-evaluate the net worth goal.
EXAMPLE
Jim and Helen have a goal of raising $2,000 for their annual vacation to Mexico by February 15. However, their
savings rate fell short of meeting the goal by that date. To resolve their issue, Jim and Helen now have three
options to consider:
• They can reduce some other expenses and put more funds toward their annual vacation goal.
• They can increase their earnings by raising funds through another source (maybe through part-time work).
• They can adjust their goal by delaying the trip for a year or two, until the $2,000 goal is reached.
Depending on the severity of the shortfall, the couple may opt for two, or even all three, of these choices.

Even in those cases where adequate savings are generated, cash management planning is valuable. It can help
clients set a higher net worth target, which they can meet by increasing their savings.
In brief, clients with inadequate savings can improve their current cash flow situation by one or both of two
methods: reducing expenses or increasing income.
REDUCING EXPENSES
Clients who opt to reduce expenses must first carefully analyze their current expenses. Flexible expenses that can be
reduced without seriously affecting the desired lifestyle are called discretionary expenses. These types of expenses
may include clothing, personal care, and entertainment. In some cases, clothing and basic appliances are not
entirely discretionary, but the amount one chooses to spend on these items may be flexible. Discretionary expenses
may also include some high-cost items such as home remodelling and vacations.
Fixed expenses that may affect the desired lifestyle if reduced are called non-discretionary expenses. These items
may require more effort to reduce without a serious impact on basic comfort or lifestyle. For example, lowering
non-discretionary expenses may require moving to a different neighbourhood or a smaller home.
DID YOU KNOW?
Many retired seniors move from major cities to much smaller communities, where the cost of living
is significantly lower. Often, their quality of life improves, rather than declining, with more outdoor
recreation opportunities and a healthier environment.
Any serious effort to reduce expenses requires that monthly expenses be tracked, preferably over a year. Yearly
expenses can then be totalled and a percentage calculated for each expense category. Clients can then identify the
categories where spending appears to be too high and set targets to reduce their spending in those areas.
Other ways to reduce expenses are through current expense control and debt restructuring, which are described
below.
Current expense This method requires some restraint in spending on largely discretionary expenses. The
control ultimate objective is to institute a workable, long-term plan of expenditure control.
Debt restructuring Debt restructuring may take several forms, including the following measures:
• Consolidate multiple high-interest credit card balances into one low-interest

personal loan or line of credit.
• Refinance the personal residence.
• Discontinue the use of credit cards.
• Defer the purchase of big-ticket items.
After debt is restructured, a budget can be prepared to guide future spending. Discretionary spending should be
reduced in the short term. Over the longer term, the client may also have to reduce non-discretionary expenditures.
Financial planners and advisors use an expense reduction worksheet to break household expenses down into discretionary
and non-discretionary expenses. Budgeting for many non-discretionary items can be reduced to some extent if necessary.
DIVE DEEPER
To see an expense reduction worksheet you can use on the job, go to your online chapter and open the
following document:
Expense Reduction Worksheet

INCREASING INCOME
Clients should consider the following options to increase their income (although not all options are realistic for
all clients):
• Work extra hours or do some consulting work.

• Negotiate a salary increase.
• Take a higher paying job.
• Expand a business.
• Change the asset allocation to increase investment income.
The first four of these strategies are self-explanatory. To increase income by changing asset allocation, consider the
following strategies:
• Switch to investments that offer the highest consistent returns at a risk level acceptable to the investor.
• Reduce the chequing account balance to the minimum, then shift the rest of the liquid funds into higher-
yielding money market funds and premium savings accounts.
• Move funds from low-risk investments into investments in the highest-risk categories acceptable to the client
(e.g., from GICs to balanced mutual funds).
• Convert a growth-oriented stock portfolio into either an income-oriented stock portfolio or a bond portfolio,
thereby swapping potential capital gain for more income.
• Reposition assets (to increase cash flow) as follows:
• Postpone the purchase of non-essential consumer items, such as a boat or luxury car.
• Dispose of negative cash flow properties (such as leveraged real estate and limited partnerships requiring
long-term periodic payments).
• Move non-income-producing investments, like gold, art, coins, and antiques, into income-producing assets.
The second and third repositioning strategies will increase current cash flow but at the risk of sacrificing future
potential capital gains. There may also be adverse tax consequences.
DID YOU KNOW?
It is generally accepted that risk and reward are positively related; therefore, an investor may obtain
higher returns by moving funds from low-risk to higher-risk investments. However, there is no assurance
that this strategy will have the desired results. Its success depends, in part, on an accurate assessment of
the investor’s risk tolerance.
PREPARING THE CASH FLOW STATEMENT

Just as net worth planning begins with a net worth statement, the starting point of cash management planning is
the preparation of a cash flow statement.
For those who maintain a regular budget or who currently track cash flow, filling out the statement should present
few problems. For those who do not maintain a budget, a review of bank account statements and credit card
statements can provide a record of historical cash receipts and expenditures.
Many financial institutions allow for detailed cash flow information to be downloaded from their clients’ online
accounts to their accounting software. Using this as a starting point, you can estimate annual cash inflow and
outflow figures. Although not completely accurate, these estimates may provide the necessary data for cash flow
planning.

The first objective of cash flow management is to ensure that sufficient funds are available for savings and
investments. Prudent management of funds is required if clients are to achieve their prioritized financial goals and
increase their net worth over the long term. A current cash flow statement shows cash inflows and outflows for the
past year. A projected cash flow statement is an estimate of future cash inflows and outflows. It provides a plan for
expenditures and savings for the coming year to ensure that clients are able to achieve their financial goals.
CASH INFLOW AND CASH OUTFLOW
What is the difference between cash inflow and cash outflow in cash flow planning? Complete the online
learning activity to assess your knowledge.
ANALYZING THE CASH FLOW STATEMENT

As mentioned, the primary motivation for undertaking cash management planning is to determine whether the rate
of savings is adequate to meet the desired growth in net worth. For better results, you can further refine the net
worth growth target by setting up separate streams of funds for investment, children’s post-secondary education,
and retirement. By earmarking adequate funds for specific goals, you can help clients create a more efficient system
for achieving them.
Cash flow planning can also be used as an important diagnostic tool. For example, when cash flows are negative, it
means that more money is going out than coming in. You should scrutinize the client’s flexible and fixed expenses
to determine how the current situation can be reversed. The cash flow diagnostic tool can also be used to identify
areas of excess spending. Clients can then change their spending patterns to reduce cash outflow. For example, a
couple could easily spend $25 to $30 a day buying lunch at a restaurant, which adds up to $500 to $600 a month.
They could easily reduce that amount by making lunches at home at least three days a week.
After preparing an initial statement, you should ask clients what their savings are over the period covered by the
statement. Don’t be surprised if the savings estimate does not correspond to the amount on the statement. Most
likely, there will be items not reflected in the statement. You should keep in mind during the planning process that a
great deal of money can be spent on untracked “other” or “miscellaneous” items.
In preparing a cash flow statement, you are providing your clients with a means to recognize and track where they
are spending money so that they can reprioritize, if necessary. It is not your role to tell your clients how to spend
their money. Rather, you should provide information and guidance to help them recognize problems and adjust
their spending patterns.
Most people who maintain a monthly budget focus primarily on the budget itself. In fact, preparing a monthly
budget is only a means toward achieving a much broader, and far more valuable, objective. The key to long-range
financial success is the development of a systematic savings plan. Such a plan can be used for two purposes:
• To generate the necessary savings to achieve set goals

• To systematically direct these savings toward targeted areas to achieve specific financial goals
DIVE DEEPER
To see a cash flow statement you can use on the job, go to your online chapter and open the following
document:
Cash Flow Statement

CHAPTER 4 ASSESSING THE CLIENT’S FINANCIAL SITUATION 4 • 11
Scenario | The Roberts’ Cash Flow
Your clients Jim and Helen Roberts left an envelope containing many debit and credit receipts. When you open the
envelope, you find evidence of overspending by both Jim and Helen. You also find a mortgage document showing
that the mortgage is on an accelerated repayment plan.
Table 4.3 shows the Roberts’ present financial situation.
Table 4.3 | Cash Flow Statement for Jim and Helen Roberts
Jim Helen Joint Total
INCOME
All Sources of Income $75,000 $75,000 $150,000
EXPENSES
Income Taxes $32,400 $32,400 $64,800
Family Needs
Home $44,000 $44,000
Insurance Premiums $5,000 $5,000
Payments on Other Debts $2,000 $2,000 $4,200 $8,200
Appliances & Major Expenditures $10,000 $10,000
Miscellaneous $22,000 $22,000
Savings $2,000 $2,000
TOTAL EXPENSES $156,000
Total Income $150,000
Total Expenses $156,000
Net Cash Flow ($6,000)
The statement indicates that the Roberts have most likely used other debt, including their line of credit, to finance
a portion of their lifestyle. You should ask more questions regarding their spending habits; the $22,000 they have
included under “Miscellaneous”, in particular, needs further investigation. It seems the Roberts will need to take
control of their spending if they want to attain their goals.
THE PROJECTED CASH FLOW STATEMENT

A client’s projected cash flow statement is a planning tool that forecasts the amounts and the timing of the client’s
cash inflows and cash outflows for a specified period, usually one year. The projected cash flow statement, which is
based on a client’s current cash flow statement, provides a comprehensive forecast of future income and expenses.
To develop a realistic and workable projected cash flow statement, clients must understand the financial trade-offs
required. In other words, they must decide to what extent they are prepared to adjust their current lifestyle so that
they may achieve their financial objectives.

A projected cash flow statement is a vital financial planning tool that helps you determine whether your
recommendations are both realistic and feasible. It is important to make realistic and conservative assumptions
regarding the stability and growth of a client’s future cash inflow and outflow.
The projected cash flow statement gives you a structure with which to integrate key recommendations for each
of the financial planning elements. Your task, as the advisor, is to strike a balance between competing financial
objectives and to integrate the key recommendations into the projected cash flow. In this way, you enable your
client to implement the financial plan and achieve their objectives in order of priority. In short, the client will not be
able to implement the financial plan unless the projected cash flow is both realistic and feasible.
A projected cash flow statement can be used as a planning tool to help clients in the following areas:
Control spending Clients can gain control of their spending if they keep careful track of their expenses.
They must also compare those expenses to the projected cash flow statement and
continually adjust their spending accordingly.
Ensure liquidity The projected cash flow statement can help to ensure that clients can meet their current
expenses without borrowing. If a client has insufficient liquidity, the projected cash flow
statement will need to be revised to control spending.
Implement the The projected cash flow statement should integrate the financial planner’s key
financial plan recommendations relating to all of the financial planning elements. With this tool,
clients should feel confident that they can implement a workable financial plan.
SAVINGS PLANNING
The construction of the net worth and cash flow statements is not an end in itself. These statements are powerful
tools for undertaking effective financial analysis.
Most clients dream of owning a comfortable home and providing post-secondary education for their children. Many
also wish for exotic vacations, financial independence by age 60 or 65, and a large estate to pass on to their children.
However, these desires are usually more vague aspirations than clearly articulated objectives. Planning in the areas
of net worth, savings, cash management, and credit converts aspirations into well-planned objectives.
SETTING GOALS
As discussed earlier, a client’s current net worth is the base on which a savings plan is built. The annual savings
are the pieces that, when added to the foundation, will grow the client’s net worth to support their goals. In other
words, a savings plan begins with goal-setting at the net worth planning stage. Financial planners and advisors use a
goal-setting worksheet for this purpose.
DIVE DEEPER
To see a goal-setting worksheet you can use on the job, go to your online chapter and open the following
document:
Goal-Setting Worksheet
To finance each of the stated objectives in the worksheet, you must specify the amount of savings required. You
must also commit future monthly savings amounts to those objectives. The next step is to calculate the amount of
savings required to achieve each of the specific goals and record them in the last column.

EXAMPLE
Your clients Sven and Marta have the objective to save $50,000 by the end of 10 years to finance their children’s
post-secondary education. The couple earns 3% compound interest on monthly savings, net of inflation and
taxes, and are putting that money into savings at the end of every month. Using a financial calculator, you
determine that the monthly savings amount required to achieve the couple’s objective is $357.80, calculated as
follows:
FV = +/−$50,000; N = 120; I = 0.25; PV = 0; solving for PMT = $357.80
You can use the technique shown in the example to determine the monthly savings required to meet all your clients’
financial goals, as stated in their goal-setting worksheet. Next, multiply that amount by 12 to determine the total
annual savings required. This figure should then be compared with the total annual savings available (net cash flow)
shown in the cash flow statement.
If total available savings are greater than or equal to the savings required, the client may want to consider increasing
the savings objective. If total available savings fall short of savings needs, the client must take steps to correct the
problem.
DID YOU KNOW?
An overall savings target is a necessary component of a savings plan. However, it is the lower-level
strategies that are at the heart of the plan. Clients can increase their net worth either by increasing their
assets or decreasing their liabilities, or through a combination of both tactics. Ideally, they will set goals
in both areas.
EFFECTIVE SAVINGS STRATEGIES

Whether or not your clients are meeting their savings objectives, they should take advantage of savings strategies
wherever they can. Some clients may need strategies to bring their savings up to the target levels. Others may
simply want to refine their savings plan.
Most of us have never been taught to treat savings as a fixed expense. We are generally unfamiliar with the idea
that we must pay ourselves first in the form of savings to ensure our own financial security. As a result, many of us
spend our entire means from month to month. When a financial crisis arises, or even a predictable need for a new
appliance or home repair, we borrow money. A practical strategy is to treat savings as a fixed, non-discretionary
expense, rather than an amount left over after all other needs have been met. This strategy can help to prevent
shortfalls in cash flow and generate additional savings. If properly channelled, those savings can accelerate the
growth rate of net worth.
Clients can use the savings strategies described below to accelerate their savings plan.
Set realistic goals Unrealistic goal-setting is perhaps the most common reason why savings plans fail. For
example, a savings objective of 20% of income for a client having trouble making ends
meet is bound to fail.
The best rule is to start with a small savings goal the client can easily meet. After some
time, the goal can be increased. Once the client becomes accustomed to the new
expenditure and savings level, the goal can be increased.
Set up an automatic A relatively painless but effective way to save is to arrange for an automatic deduction
savings plan of money from a paycheque or bank account, which is then deposited in an appropriate
savings vehicle. A good amount to consider is 10% of the client’s net pay.

Resist buying on credit We live in a consumption-oriented society, where it is extremely easy to buy on credit.
Few of us realize that our savings rate would dramatically increase if we avoided buying
items on credit. We would not only save the interest charges, but we could also benefit
from investing those savings. This is especially true if credit card balances are not paid off
promptly.
Reward yourself Saving for children’s education, retirement, vacations, or big-ticket items is a long and
difficult undertaking. When a family manages to exceed a targeted savings goal, family
members should reward themselves by spending a portion of the extra savings. The
reward can be an incentive for the family to work to meet a savings goal.
DID YOU KNOW?
Dollar-cost averaging is an investing strategy that could dovetail nicely with an automatic savings plan.
It involves purchasing a particular security (such as the shares of one company or units of one mutual
fund) on a regular schedule with a fixed dollar amount (e.g., $500 per month). The purchase is made
whether the market is low or high. Over time, this strategy can potentially lower the investor’s average
cost per share or unit.
The dollar-cost averaging approach eliminates the effort to time the market and buy a security at the
lowest price. This strategy is readily available through dividend reinvestment plans and mutual fund
reinvestment plans.
EMERGENCY FUNDING STRATEGIES

Occasionally, even the best-structured budgetary plans can face temporary difficulties due to circumstances beyond
a client’s control. For this reason, it is important that the client have liquid fund reserves set aside for emergencies.
One of your important duties, as an advisor, is to make sure that your clients are aware of the need to have such a
fund set up.
Appropriate vehicles for an emergency fund are savings accounts, cashable GICs, and money market securities.
Investments of this type are easily cashable and do not fluctuate in value with changes in interest rates or the stock
market. Ready access and stable value are necessary because the timing of emergencies is unpredictable.
As for the size of the emergency fund, many advisors recommend the equivalent of three to six months of living
expenses.
Some clients do not want to have their funds tied up in very liquid investments, which typically have low returns.
In such cases, you can recommend that they set up a line of credit with their financial institution.
DID YOU KNOW?
When a line of credit facility is to be used as a source of emergency funds, it should be set up when
family finances are in good shape, rather than when an emergency arises. Your clients will find it much
easier to qualify for credit when their financial situation is strong and stable.
If a client has not had time to build up an adequate emergency fund, or if the initial emergency funds are exhausted,
other sources of funds can be used, as described below. Clients should be aware of these alternative resources, but
they should use them only with great reluctance.

Home equity loan A home equity loan is a loan advanced against the equity built up in a principal
residence. Clients should apply for such a loan before the need arises to use it. If they
apply after a job loss, for example, the lender may consider them unqualified to carry
the debt.
Life insurance Part of the premium paid on a permanent life insurance policy is set aside in a policy
reserve (or cash value), which can be withdrawn upon surrendering the policy. Clients
may also borrow against the accumulated cash value or policy loan value of the reserve.
RRSP Withdrawing RRSP savings is the least advisable option because of the negative long-
term impact on a client’s retirement assets and lifestyle. When funds are withdrawn, the
institution holding the RRSP is required to deduct a withholding tax for federal purposes.
The initial amount withheld is 10% to 30% of the amount withdrawn (20% to 30% for
Quebec). When the client files an income tax return, the taxes payable may increase or
decrease, depending on the client’s income for the year. Higher taxes can result because
the entire amount withdrawn from an RRSP must be brought into income in that year
and becomes taxable. A large withdrawal from an RRSP can also push the client into a
higher tax bracket.
EXAMPLE
Your client Sara withdraws $5,000 from her RRSP, which is held at her bank. The bank withholds $500 (at the
federal level) and pays Sara $4,500.
The income from the RRSP withdrawal, added to her other income for the year, puts Sara in a 40% tax bracket.
Therefore, when she files her income tax return for the year, she must pay an additional $1,500 in taxes on the
RRSP withdrawal.
Clients should also be aware that they cannot borrow from their RRSP except under special programs, such as the
Home Buyers’ Plan and Lifelong Learning Plan. Except within these programs, when funds are withdrawn from an
RRSP, the client permanently loses the benefit of tax-deferred growth on the funds. Clients should take this factor
into account when deciding to withdraw RRSP funds during an emergency.
SCENARIO: PAULA AND PAT
Assess your understanding of a budget and savings plan by resolving a client scenario. Complete the
TIME VALUE OF MONEY
4 | Solve various calculations involving the five variables of time value of money using a financial
calculator.
As an advisor working in wealth management, you will need to perform various calculations to forecast future
performance based on past events. Ultimately, your objective should be to help your clients maximize their wealth
without exceeding their risk tolerance and constraints.
A good example is retirement planning, which should be a part of every client’s financial plan. The sooner a
retirement savings plan is implemented, the more effective it will be. You will need to determine the desired
retirement age, estimate life expectancy, and apply expected rates of return before and during retirement. You

must also project the amount of income from different sources while considering the client’s desired lifestyle and
the effects of inflation. Knowing how to assess your clients’ needs and then calculate the necessary savings to meet
those needs is an essential aspect of your role.
These tasks require financial calculations that account for the time value of money (TVM). This means that a dollar
held or received today is worth more than a dollar received at a later date, given that today’s dollars can be invested
to generate some type of return. This concept is especially important to wealth managers, who must attempt to
estimate, calculate, and match various cash flows for years into the future.
In most cases, you will use a financial calculator or a financial planning software program to perform the
calculations. You can expect to face many questions involving the TVM. All TVM calculations involve solving for one
of five variables:
N = The number of years or compounding periods
I/Y = The annual or periodic interest rate, discount rate, or rate of return
PV = The present value of the asset or liability
PMT = The periodic payments required, if any
FV = The future value of the asset or liability
The goal of all TVM calculations is to solve for one of these five variables, given values for the other four.
TYPES OF OPERATION
Problems involving TVM are one of five types (or a combination of any or all types in more complex problems):
• Future value of a single amount

• Future value of an annuity
• Present value of a single amount
• Present value of an annuity
• Solving for time periods, interest rates, and payments
FUTURE VALUE OF A PRESENT AND SINGLE AMOUNT

The money you have today is worth more than the money you will receive in the future because of the interest you
can earn by putting that money in a savings account or investing it in other securities. This concept becomes even
more important when you introduce compound interest, where the interest earned starts earning interest itself.
The interest is not always compounded annually; it may be compounded semi-annually, monthly, weekly, or even
daily. This frequent compounding has an impact on future values.
Another consequence may be that the quoted annual interest rate is different from the effective annual interest
rate, which is the actual interest rate earned. The difference can be significant. For example, the effective annual
interest rate on some credit cards is usually much greater than the quoted rate because the quoted rate is combined
with daily compounding.
FUTURE VALUE OF AN ANNUITY

The future value of an annuity (i.e., an equal, annual series of cash flows) answers the question, "How much money
would I have after a given number of years if I were to invest a certain amount regularly?" The future value of an
annuity is based on regular, equal deposits or investments at the end or at the beginning of each period for a certain
number of periods while allowing those cash flows to grow.

PRESENT VALUE OF A SINGLE AMOUNT

Think of present value as future value in reverse. For example, assume you already know the future value of your
investment and want to know what your starting principal will have to be to reach that amount in the desired
length of time. In other words, present value is the value in today's dollars assigned to an amount of money in the
future based on some estimated rate of return over the long-term.
PRESENT VALUE OF AN ANNUITY

Knowing the present value of an annuity (or other series of cash flows) allows you to calculate the value today of
an annuity in the future. In other words, if you were to invest $100 a month for the next five years, what would the
total amount be worth in today’s dollars? Again, remember that an annuity is based on regular, equal deposits or
investments at the end or beginning of each period for a certain number of periods.
SOLVING FOR TIME PERIODS, INTEREST RATES, AND PAYMENTS

The previous four operations are focused on finding present and future values. However, as an advisor, you may be
presented with a situation in which you know the present and future values and must find another value. You may
need to determine the payments, the interest rate, or the number of time periods it will take for the present value to
grow to the future value.
The above operations are covered in the Financial Math Appendix located at the end of this chapter.
IMPORTANT
The Financial Math Appendix is examinable. It is important that you review the Appendix because the
concepts and calculations presented may be required to answer questions related to some chapters
covered in this course. We place emphasis on solving problems using a financial calculator.
FINANCIAL MATH CALCULATIONS
Can you calculate the five variables of time value of money? Complete the online learning activity to
LEARNING MORE ABOUT THE MILLERS’ FINANCIAL SITUATION
At the beginning of this chapter, we presented a scenario in which you had to get a clear understanding of the
Millers’ financial resources and general financial position.
Now that you have read this chapter, we’ll revisit the questions we asked and provide some answers.
• Why is it important to establish the Millers’ current net worth?

• Establishing net worth and then building a net worth strategy will put you in a better position to advise
your clients. It will help you determine the best way to work together to build their net worth toward
specific annual targets and ultimately achieve their goals.
• By examining their cash flow to determine how they spend their income, what important goal are you
supporting?
• By examining the Millers’ spending patterns and building a cash flow statement, you can help them realize
where they are overspending on discretionary items. The cash flow statement can also help them manage
their income to provide more after-tax cash flow, which they can set aside for their retirement years.

SUMMARY
In this chapter, we discussed the following key aspects of assessing the client’s financial situation:
• Wealth planning requires both a budget and a strategy. The basic tools used to build the plan are the net
worth statement and the cash flow statement. The net worth statement determines the amount of assets and
liabilities at a specific point. A cash flow statement shows how much money flows in and out of the client’s
accounts over a set period.
• Clients with inadequate savings can improve their current cash flow situation by reducing expenses or increasing
income. They should also have effective savings strategies in place. One such strategy is to have money
deducted automatically from every paycheque and deposited in a savings vehicle.
• Occasionally, even the best-structured plan can face temporary difficulties due to circumstances beyond a
client’s control. For this reason, it is important that clients have liquid fund reserves set aside for emergencies.
• As an advisor, you can expect to face many questions involving the five variables of the time value of money.
NOTE
DISCUSSION BOARD
If you have any questions about this chapter, you may find answers in the online Discussion Board for
Chapter 4.
REVIEW QUESTIONS
Questions.

APPENDIX 4 – FINANCIAL MATH

Time Value of Money This Appendix is a review of basic TVM calculations, which are used extensively in wealth
management. In most cases, a financial calculator or computer software program will be used to calculate an
answer. However, before you input data, you must understand the type of calculation required. In other words, you
must first identify the problem and then perform the appropriate calculations to find the answer.
In this context, you will learn about the many variables that can affect your calculations. We show the underlying
formulas, but we emphasize the use of a calculator that can perform financial functions.
As an advisor, you can expect to face many questions involving the TVM. All TVM calculations involve solving for one
of five variables:
N = The number of years or compounding periods
I/Y = The annual or periodic interest rate, discount rate, or rate of return
PV = The present value of the asset or liability
PMT = The periodic payments required, if any
FV = The future value of the asset or liability
The goal of all TVM calculations is to solve for one of these five variables, given values for the other four.
EXAMPLE
The following questions are typical of the problems you can solve using TVM calculations:
• If a client invests $1,000 today at 4% compounded annually, what will the investment be worth in 10 years?
• If a client invests $15,500 in her registered retirement savings plan (RRSP) each year for 20 years at 6%
compounded annually, how much will she have saved toward financing her retirement?
• How much would a client have to set aside today to finance four years of university for his child? Assume
that the child will start in five years and that all deposits will earn 5% compounded annually. Each year of
university will cost $10,000.
• A department store advertises that it charges 20% on overdue accounts, but the store compounds this
amount daily. How much is the store actually charging?
• Your bank will lend your client money at 10%, spread over a four-year period, but compounded monthly.
What will the client’s monthly payments be? How much will they be if the client wants to pay off the loan in
two years?
• A client wants to buy a house using a $50,000 down payment. His family budget can support payments of
about $2,000 per month, and the bank will give him a 25-year mortgage at 3.5%. What is this client’s price
limit?

DID YOU KNOW?
Solving TVM problems with a financial calculator is a relatively straightforward exercise. On most
financial calculators, data for TVM questions are entered using five keys labelled: N, I, PV, PMT, and FV,
which correspond to the five variables in all TVM calculations. We refer to the keys throughout this
chapter as “TVM functions”.
For our calculations, we used the Sharp EL-738 financial calculator. Note that methods may differ
for other calculators; the TVM functions may not be available or may be labelled differently. Refer to
your instruction manual to learn how your calculator operates and what labels are used to identify the
various functions.
Some general rules for using financial calculators are shown in Table A.1.
Table A.1 | General Rules for Using a Financial Calculator
1. Always clear the calculator before each operation.

To clear answers or variables stored in your calculator’s memory (including TVM variables), follow these steps:
• Press M-CLR (press 2ndF ALPHA)
• Press 0
• Press 0 (or “=”)
2. Be aware of small differences between solutions arrived at through formula calculations compared to those
arrived at using TVM functions. These are likely due to rounding errors. When solving problems using formulas,
always use your calculator’s memory function to store interim calculations.
In addition, set your calculator to display the maximum number of decimal places allowed. Then round off
your final answer with two to four decimal places. Refer to your manual for the steps required.
We recommend you not round off your calculations while you are working through a problem; round only your
final answer. Otherwise, you may have rounding errors in your results.
3. Before you start a TVM calculation, determine whether the first periodic payment starts at the beginning or
end of the first period. For example, the end mode (END) is used for ordinary annuities and most mortgages
and loans. The beginning mode (BGN) is used for such vehicles as annuities due, where cash flows start
immediately. The end mode is the default mode for most calculators.
4. Enter future values, present values, and payments as positive numbers if they are cash inflows or as negative
numbers if they are cash outflows. To determine whether a cash flow is an inflow or an outflow, take the
perspective of the client. For example, the present value of a client’s mortgage is an inflow (a positive number)
because the client receives the money to buy the house at the start of the amortization period. The payments
are an outflow (a negative number) because the client pays them out.
5. Use the second function (2ndF) key to access functions with labels on the body of the calculator (just above
the keys). (In this chapter, we assume that the exponent function Yx is accessed through the 2ndF function key.
On most calculators there are several 2ndF functions that can help solve interim steps in TVM calculations.)
6. Enter data into the TVM functions in any order.
7. Enter data for the I/Y variable in percentage rather than decimal form. For example, enter 10 for 10% rather
than 0.10.
8. On some calculators, you must select the compute (COMP) key to see a solution to a TVM calculation.

APPROACH TO SOLVING PROBLEMS

It is important that you develop a logical approach to solving TVM problems. The following steps are recommended:
1. Identify the type of problem. With complex problems involving more than one type, you must identify the
type for each part.
2. Draw a timeline to visualize the problem, which will help you grasp the issues involved in the solution.
3. Determine the data given, including the known variables and any other information.
4. Identify the unknown variable that must be calculated.
5. Perform the calculation to solve for the missing variable.
EXAMPLE
Susan Smythe deposits $5,000 in her RRSP, which earns 6% a year. What sum of money will she have when she
retires after 9 years?
1. Type of problem
Find the future value of a single amount ($5,000).
2. Timeline
3. Data given
Present value of $5,000; interest rate of 6% per year; number of years: 9.
4. Unknown variable
Future value.
5. Calculation
Find the future value of Susan’s lump sum deposit in 9 years.
FIVE BASIC TYPES OF OPERATIONS

Problems involving TVM are categorized into five basic types of operations:
• Future value of a single amount

• Future value of an annuity
• Present value of a single amount
• Present value of an annuity
• Solving for time periods, interest rates, and payments
FUTURE VALUE OF A SINGLE AMOUNT

The future value of any investment is its value today (the principal) plus any amount earned as interest over the life
of the investment.

EXAMPLE
Your client Ibrahim invests $5,000 in a one-year guaranteed investment certificate (GIC) with an annual interest
rate of 8%. At the end of the year, the financial institution will return Ibrahim’s $5,000 principal and pay the
client $400 interest. Therefore, the future value of his GIC investment is $5,400, which can be calculated
as follows:
Future Value = Principal + Interest
= $5,000 + ($5,000 ´ 0.08)
= $5,000 + $400
= $5,400
In the context of TVM calculations, the value of any investment today is known as its present value. For example, on
the day Ibrahim bought the GIC worth $5,000, its present value was $5,000.
In general, the future value of any investment can be calculated using Equation A.1.
Equation A.1 – Future Value
n
FV = PV ´ (1 + i )
Where:
FV = the future value of the investment
PV = the present value of the investment
i/y = the annual interest rate in decimal format
n = the number of years
EXAMPLE
For Ibrahim’s $5,000 GIC, the future value is calculated as follows.
1
FV = $5,000 ´ (1 + 0.08)
= $5,000 ´ (1.08)
= $5,400
DID YOU KNOW?
TVM Rule #1: As long as interest rates are positive, the future value of an investment is always greater
than the present value.
DEALING WITH MULTIPLE YEARS

For an investment with a term longer than one year, for each successive year, interest is earned on the principal and
also on the previously accumulated interest. This “interest on interest” is known as compound interest. (Interest
without compounding is called simple interest. Simple interest is always based on the initial value of the principal,
regardless of how long the investment is held.)

EXAMPLE
Suppose your client invested in a $5,000, three-year GIC with an interest rate of 8.50%. By the end of the third
year, the GIC’s value, including compound interest, would be calculated as follows:
3
FV = $5,000 ´ 1.085
= $5,000 ´ 1.277289125
= $6,386.45
DID YOU KNOW?
TVM Rule #2: Unless otherwise stated, all TVM calculations assume compound interest.
Future value can be calculated over multiple years in any of three ways, as shown in Table A.1. The calculations are
3
based on a $5,000 GIC, with compound interest at 1.085 .
Table A.1 | Calculating Compound Interest: Three Methods
Method 1: Manual Calculation
Key Touch Display
1.085 × 1.085
1.085 × 1.177225
1.085 = 1.277289125
Finally, multiply the result by present value: 1.277289125 × 5,000 = $6,386.45.
Method 2: Using the Exponent Function
Key Touch Display
1.085 2ndF Yx 0.00
3 = 1.277289125
Finally, multiply the result by present value: FV = 1.277289125 × 5,000 = $6,386.45.
Method 3: Using a Financial Calculator
Key Touch Display
3 N 3
8.5 I/Y 8.5
−5,000 PV −5,000
0 PMT 0
COMP FV 6,386.45
Note that, with the first two methods, unless the value of the exponent is 1 or 2, it is much quicker to use your
calculator’s exponent function.
In this calculation, PV is negative (which means that it is a cash outflow) because the initial investment in the GIC
comes out of the client’s pocket. The calculator shows the FV as a positive number, which means that the money is
a cash inflow because the whole future amount is returned to the client.
DEALING WITH FRACTIONAL YEARS

Time value of money calculations can easily handle fractional years, as shown in the example below.
EXAMPLE
A client invests $15,000 at a 7% annual interest rate for two-and-a-half years. At the end of this period it will be
worth $17,764.41, calculated as follows:
2.5
FV = $15,000 ´ (1.07)
= $15,000 ´ 1.184293769
= $17,764.41
To solve this with your calculator, use 2.5 as the exponent and use your calculator’s exponent function,
as follows:
1. Type 1.07, then press 2ndF Yx, displays 0.00
2. Type 2.5, then press =, displays 1.184293769
3. Answer: 1.184293769
Finally, multiply the result by present value:

FV = $15,000 ´ 1.184293769 = $17,764.41
DEALING WITH MORE FREQUENT COMPOUNDING PERIODS

In the previous examples, we assumed that interest was compounded annually; in fact, it is often compounded
more frequently. Interest may be compounded semi-annually, monthly, weekly, or even daily.
For example, an investment may offer an annual interest rate of 10% compounded semi-annually. What this means
is that half the annual interest rate, or 5%, is paid on the principal every six months. To calculate the future value
when compounding occurs more frequently than annually, the values of i and n in Equation A.1 must be adjusted.
Equation A.2 shows the formula.
Equation A.2 – Future Value Adjusted for Frequent Compounding
n´ f
FV = PV ´ (1 + i f )
Where:
i = the quoted annual interest rate
f = the number of compounding periods in one year

EXAMPLE
A client invests $10,000 at an annual rate of 10% compounded semi-annually. At the end of one year, the
investment will be worth $11,025, calculated as follows.
1´2
FV = $10,000 ´ éêë 1 + (0.10 2)ùúû
2
= $10,000 ´ (1.05)
= $10,000 ´ 1.1025
= $11,025
You can also use your calculator’s TVM functions by setting and, as follows:
1. Type 2, then press N, displays 2
2. Type 5, then press I/Y, displays 5
3. Type −10,000, then press PV, displays −10,000
4. Type 0, then press PMT, displays 0
5. Press COMP FV
6. Answer: 11,025
DID YOU KNOW?
TVM Rule #3: Compounding more frequently than annually will always result in a higher future value
than annual compounding at the same interest rate. The more frequent the compounding, the higher
the future value will be.
The next example highlights the impact of frequent compounding on future values.
EXAMPLE
Three investors each invested $100. The three investments were made 45 years ago, as follows:
• The first investor chose Treasury bills, which had an average return of about 6.80% compounded monthly.
• The second investor chose an index fund that tracked the S&P/TSX Composite Index, which averaged
about 9.65% per year over that period, compounded quarterly.
• The third investor successfully moved his investment between Treasury bills and the S&P/TSX Composite
Index every month and in the process earned an average of 2% each month.
How much does each investor have now (at the end of 45 years)?
To solve this problem, you have to make the correct time and interest rate adjustments, as follows:
Investor #1 Investor #2 Investor #3
45´12 45´4 45´12

FV = $100 ´ éêë 1 + (0.068 12)ùúû FV = $100 ´ éêë 1 + (0.0965 4)ùúû FV = $100 ´ (1 + 0.02)
540
= $100 ´ (1.005666667)
540
= $100 ´ (1.024125)
180
= $100 ´ (1.02)
= $100 ´ 21.14413612 = $100 ´ 73.03553521 = $100 ´ 44,064.8962
= $2,114.41 = $7,303.55 = $4,406,489.62

EXAMPLE
Below, we show the steps to solve the first investor’s total. First, we use Equation A.2; then we use the TVM
functions. We leave the other two future values for you to calculate as an exercise.
Using Equation A.2, the solution can be found as follows:
1. Type 45, then press ×, displays 45
2. Type 12, then press =, displays 540 (The number of periods, set aside)
3. Type 0.068, then press ÷ displays 0.068
4. Type 12, then press =, displays 0.005666667 (Interest per compounding period)
5. Press +, displays 0.005666667
6. Type I/Y, then press =, displays 1.005666667
7. Press 2ndF Yx, displays 0.00
8. Type 540, then press =, displays 21.14413612
9. Press ×, displays 21.14413612
10. Type 100, then press =, displays 2,114.413612
Using your calculator’s TVM functions, the solution can be found as follows:
1. Type 540, then press N, displays 540 (or 12 × 45)
2. Type 0.566666667, then press I/Y, displays 0.566666667 (or 6.8% ÷ 12)
3. Type −100, then press PV, displays −100
5. Press COMP FV, displays 2,114.413611
Therefore, at the end of 45 years, Investor # 1’s portfolio will be worth $2,114.41.
CALCULATING EFFECTIVE INTEREST RATES

As the previous examples show, the quoted annual interest rate may be different from the effective annual interest
rate, which is the actual interest rate earned. The difference can be significant. For example, the effective annual
interest rate on some credit cards is usually much greater than the quoted rate because the (already high) quoted
rate is combined with daily compounding.
DID YOU KNOW?
The quoted annual interest rate is sometimes called the annual percentage rate (APR). Accordingly, the
effective annual interest rate is sometimes known as the EAR.
Equation A.3 is used to calculate the effective annual interest rate. This formula is the best measure to use when
comparing the interest rates on different investments or loans.
Equation A.3 – Effective Annual Interest Rate
n´ f
EAR = êëé 1 + (Quoted Annual Rate f )úûù -1
Where n and f have the same meaning as in Equation A.2.

EXAMPLE
Three banks advertise savings accounts with three different interest rates:
Bank 1: 9.75% compounded daily
Bank 2: 10.0% compounded quarterly
Bank 3: 10.25% compounded annually
To determine which bank offers the highest annual return on its savings accounts, you must calculate the
effective annual rate for each bank, as follows:
Bank 1: (1 + 0.0975/365)1 × 365 − 1 = 10.24%
Bank 2: (1 + 0.10/4)1 × 4 − 1 = 10.38%
Bank 3: (1 + 0.1025/1)1 × 1 − 1 = 10.25%
Therefore, the savings account that pays an annual rate of 10% compounded quarterly offers the highest
effective annual rate, and therefore the highest annual return. You can also compare interest rates using a
financial calculator that has a built-in EFF function. The following procedure assumes that the EFF is a second-
level function:
Bank 1
1. Type 365, then press (x,y), displays 0.00
2. Type 9.75, then press 2ndF EFF, displays 10.24
Bank 2
2. Type 10, then press 2ndF EFF, displays 10.38
Bank 3
2. Type 10.25, then press 2ndF EFF, displays 10.25
This example illustrates two facts: First, the highest quoted rate on an investment is not necessarily the best rate.
Second, multi-period compounding can lead to a significant difference between the quoted rate and the effective
rate.
DID YOU KNOW?
TVM Rule #4: When the compounding period is one year, the effective annual rate is equal to the
quoted annual rate. When compounding occurs more frequently than annually, the effective rate is
always greater than the quoted annual rate.
FUTURE VALUE OF AN ANNUITY

As an advisor, you may frequently have to calculate how much a series of regular cash flows will be worth at some
time in the future. For example, a client might ask what his portfolio will be worth at the end of five years if he
contributes $15,000 per year for the next five years.
In TVM calculations, a series of regular cash flows is known as an annuity. By definition, annuities assume a level
cash flow over a specified period, which means that the amount does not change from one payment to the next.

There are different types of annuities, depending on when the cash flows begin, as defined below.
Regular annuity The cash flows of a regular annuity, also known as an annuity in arrears or an ordinary
annuity, occur at the end of each period.
Annuity due With an annuity due, the cash flows occur at the beginning of each period.
Deferred annuity With a deferred annuity, the cash flows begin sometime beyond the first period.
You can use a formula to solve for the future value of an annuity; however, annuities are best solved using your
calculator’s TVM functions. The steps needed to determine an annuity’s future value are shown in the next example.
EXAMPLE
Your client Jamal plans to contribute $15,000 each year to his portfolio over the next five years, making the
contributions at the end of each year. This type of cash flow pattern is an example of a regular annuity. Jamal’s
portfolio, which was initially worth $0, generates a return of 8% per year. The portfolio’s value at the end of the
fifth year is calculated as follows:
3. Type 0, then press PV, displays 0
4. Type −15,000, then press PMT, displays −15,000
Now, let’s consider how much Jamal would have if he made the contributions at the beginning of each year,
starting immediately. This type of cash flow pattern is an example of an annuity due. Note that, as with the
regular annuity, there are still five deposits of equal value. Likewise, the future value of the portfolio is the value
at the end of the fifth year.
To solve this problem, first set your calculator to BGN mode. From there, the steps to solve this problem are the
same as they were when the payments were made at the end of the year, as follows:
DID YOU KNOW?
TVM Rule #5: The future value of an annuity due will always be greater than the future value of a regular
annuity.

A simple relationship exists between the future value of an annuity due and the future value of a regular annuity:
The future value of the annuity due is equal to the future value of the ordinary annuity multiplied by (1 + i).
In our previous example, $95,038.94 was a result of $87,999.01 × (1.08). The investor’s portfolio in the example was
initially worth $0. However, the portfolio could initially be worth some other value. If we were calculating the future
value by hand, we would have to make at least two calculations—one for the future value of the initial value and
one for the future value of the annual contributions. Your calculator’s TVM functions can easily handle this problem
in a single calculation by simply setting the PV equal to the initial value of the portfolio.
EXAMPLE
Your client Aaron has a portfolio worth $100,000. He wants to know how much it will be worth at the end of five
years if he contributes $15,000 annually, starting today. To answer Aaron’s question, first set your calculator to
BGN mode, and then calculate the future value as follows:
Therefore, at the end of five years, Aaron’s portfolio will be worth $241,971.74.
PRESENT VALUE OF A SINGLE AMOUNT

So far, we have focused on calculating future values. However, as an advisor, you may frequently encounter
problems where the future value is known, but you must calculate the present value. To calculate the present value
of a given future value, you must rearrange Equation A.1 to solve for PV, as shown in Equation A.4.
Equation A.4 – Present Value of a Single Amount
n
FV = PV ´ (1 + i )
FV
PV = n
(1 + i )
Where all variables are the same as in Equation A.1.
DID YOU KNOW?
Depending on the calculation, the i in a present value calculation is referred to as the discount rate, the
required rate, or the internal rate of return.

EXAMPLE
An investment opportunity promises to pay $1,480.24 at the end of 10 years. If the required rate on investments
with similar risk is 4% compounded annually, what is the present value of the investment? In other words,
how much should an investor pay for this investment so that it generates a 4% annual return, which is a
return commensurate with its risk? You can calculate the answer either by using Equation A.4 or by using your
calculator’s TVM functions, as follows:
4. Type 1,480.24, then press FV, displays 1,480.24
5. Press COMP PV, displays −999.997 or 1,000.00
Now, let’s consider a slightly more complex situation, where your client is offered $5,000 today or a guaranteed
$7,000 in five years. Currently, a guaranteed five-year term investment can earn 8% annually. Your client has no
immediate need for the funds. Which of the two options should you advise the client to accept?
You can solve this problem in two ways. The first method is to find the present value of $7,000 and compare it
to $5,000. The second method is to calculate the future value of $5,000 and compare it to $7,000. With either
method, you will arrive at the same answer, and in both cases, the client should choose the higher amount.
To compare present values, use your calculator’s TVM functions to find the present value of $7,000 to be received
in five years, assuming an 8% required return, as follows:
4. Type 7,000, then press FV, displays 7,000
5. Press COMP PV, displays −4,764.08
Given that the present value of $7,000, discounted at an annual rate of 8%, is less than $5,000, you should
advise your client to take the $5,000 lump sum amount today.
You can arrive at the same solution by using your calculator’s TVM functions to compare future values, as follows:
Again, given that the future value of $5,000 in five years is greater than $7,000, your client should take the
$5,000 amount today. This is the same result obtained by finding the present value of the $7,000.
DEALING WITH MORE FREQUENT COMPOUNDING PERIODS

As with future values, we can deal with fractional years and multiple compounding periods when calculating present
values. A typical example involving fractional years is the pricing of a strip bond, given its yield and number of days
to maturity. Note that bond prices are quoted on a basis of “per $100 of face value”.

EXAMPLE
An 874-day strip bond is quoted with an annual yield of 3.04%. You want to find the price of the strip bond,
which is equivalent to finding its present value per $100 of face value.
To do so, first convert 874 days into a fraction. Because there are 365 days in a year (ignoring leap years),
874 days is equal to approximately 2.395 years.
874 days/365 days per year = 2.394520548 years
Now, simply enter the known values into your calculator’s TVM functions and solve for the present value,
as follows:
1. Type 2.394520548, then press N, displays 2.394520548
2. Type 3.04, then press I/Y, displays 3.04
3. Type 100, then press FV, displays 100
5. Press COMP PV, displays −93.08018224
Therefore, the price of the strip bond is $93.08 per $100 of face value.
PRESENT VALUE OF AN ANNUITY

In addition to having to find the future value of a series of cash flows, you will frequently encounter problems that
require calculating the present value of a series of cash flows. For example, you may need to calculate the amount
needed to finance a client’s retirement or a child’s university education over a given number of years.
EXAMPLE
Your client Petra anticipates needing $25,000 per year during 30 years of retirement. She expects her
investments to earn 5% per year during retirement, and she will withdraw the money at the end of each year.
Petra is willing to draw down the portfolio to zero at the end of the 30 years. You can calculate how much she
will need upon retirement to generate the necessary withdrawals as follows:
4. Type 25,000, then press PMT, displays 25,000
Therefore, Petra needs to save $384,311.28.
In the example above, the client was willing to draw the portfolio down to zero over her retirement period. In
some cases, however, clients want to maintain the full amount of the portfolio. How much will a client have
to accumulate in savings to be able to withdraw the desired income, while maintaining the principal amount?
Unfortunately, this problem cannot be solved with your calculator’s TVM functions because there are two
unknowns. In fact, both unknowns—the present and future values—are the same amount. However, you can solve
the problem through trial and error using Equation A.5.
Equation A.5 – Present Value when Future Value is Unknown
PV = PMT ÷ i

EXAMPLE
Suppose Petra wants to maintain the full value of her portfolio throughout 30 years of retirement. How much
will she need to save to provide an income of $25,000 each year?
You know that Petra wants to maintain the full value of the portfolio and that she needs to draw from it
$25,000 per year. You also know that her portfolio will earn 5% each year during retirement. The only portfolio
value that will support $25,000 a year in withdrawals is one that will produce a return of $25,000 each year.
Given the 5% return assumption, this amount is equal to $25,000 divided by 0.05, or $500,000.
Time value of money calculations are not always so straightforward, as the next example shows.
EXAMPLE
Your client Dev wants to know how much he must invest today to pay for four years of university education for
his child, beginning in five years. Tuition fees are due at the start of each school year. Dev has estimated the cost
of university at $10,000 annually, and he expects to earn 7% on the invested money.
Right away, you should recognize this as an annuity problem. However, there is one difference that distinguishes
this problem from the others we have seen so far: the payments do not begin for another five years. As you
should recall, this type of cash flow pattern is known as a deferred annuity. The easiest way to determine how
to solve such a problem is to break it down into two parts. It may also be helpful to draw a timeline to help you
keep track of the cash flows and their timing.
Using 0 to signify today, the timeline for this problem would look as follows:
0 .............. 1 ................ 2 .............. 3 ............... 4 ..............5 ............... 6 ............. 7 ................8 ..............9
? 0 0 0 0 10,000 10,000 10,000 10,000 0
The first part of the solution is to solve for the value of the annuity as if the cash flows started today, just as if it
were an annuity due. In the second part, we discount that present value of the annuity due back to today.
The two-step process is shown below.
A. Present Value of the Annuity Due
The annuity due has four cash flows of $10,000 starting at the beginning of the first period, and the
invested funds will earn 7%.
Set your calculator to BGN mode and calculate as follows:
5. Press COMP PV, displays 36,243.16044
Therefore, in five years, Dev needs $36,243.16 to pay for four years of university education.
B. Present Value Today of the Present Value of the Annuity Due
Now, let’s determine how much Dev needs to invest today so that it will grow to $36,243.16 in five years.
This is a straightforward present value calculation, with $36,243.16 as the future value.
Change your calculator back to the END mode and calculate as follows:

EXAMPLE
(cont'd)
4. Type 36,243.16044, then press FV, displays 36,243.16044
Therefore, if Dev invests a lump sum of $25,840.87 today at 7%, he will have $36,243.16 in five years. This
amount will allow the child to withdraw $10,000 per year for four years, starting at the beginning of each school
year. After the last $10,000 withdrawal to cover the final year’s tuition, the balance of the investment will be $0.
UNEVEN CASH FLOWS

So far, we have provided several examples of annuities that involve level (i.e., regular) payments of the same
amount. In some situations, however, it is necessary to calculate the present or future value of a series of payments
of unequal amounts (also called irregular or “lumpy” cash flows).
Unfortunately, it is not possible to use your calculator’s standard TVM functions to calculate the future and present
value of uneven cash flows. Only annuities with level cash flows can be solved with the standard TVM calculations.
To solve for the present or future value of a series of uneven cash flows, you must calculate the present or future
value of each cash flow and then add up all cash flows.
EXAMPLE
Your client, Maria, has an investment that offers cash inflows of $1,000 at the end of year 1, $2,000 at the end
of year 2, and $500 at the end of year 3. The annual interest rate is 10%. She wants to know how much the
investment will be worth at the end of three years.
You can calculate the future value of these cash flows as follows:
2
1. FV of Year 1 Cash Flow: $1,000 × 1.10 = $1,210
1
2. FV of Year 2 Cash Flow: $2,000 × 1.10 = $2,200
0
3. FV of Year 3 Cash Flow: $500 × 1.10 = $500
4. Total Future Value = $1,210 + $2,200 + $500 = $3,910
Therefore, the future value of all cash flows at the end of year 3 is $3,910.
You can calculate the present value of these cash flows as follows:
1. PV of Year 1 Cash Flow: $1,000 / 1.10 = $909.09
2
2. PV of Year 2 Cash Flow: $2,000 / 1.10 = $1,652.89
3
3. PV of Year 3 Cash Flow: $500 / 1.10 = $375.66
4. Total Present Value = $909.09 + $1,652.89 + $375.66 = $2,937.64
Therefore, the present value of all cash flows is $2,937.64.
SOLVING FOR TIME PERIODS, INTEREST RATES, AND PAYMENTS

Our discussion thus far has focused on finding present and future values. However, as an advisor, you may be
presented with a situation in which you know the present and future values and must find another value. You may
need to determine the payments, the interest rate, or the number of time periods it will take for the present value to
grow to the future value. As we discussed earlier, you must have four of the five TVM variables to solve for the fifth.

The problems in this next section are typical of the types you might encounter. The easiest way to solve them is to
use your calculator’s TVM functions.
SOLVE FOR THE NUMBER OF PERIODS

In some cases, you may have to solve for the number of time periods (i.e., years) it will take to grow a specified
future value. Two different situations that require solving for a number of periods are explained in the next
example.
EXAMPLE
Your client Lucas invests $10,000 at a rate of 10% compounded annually. He wants to know how long it will take
for his investment to be worth $50,000. In this case, you know all of the TVM variables except N, which you can
easily solve for as follows:
5. Press COMP N, displays 16.88631703
Therefore, it will take 16.89 years for Lucas’s investment to be worth $50,000.
Another client, Hannah, is investing $15,000 per year in an annuity at 10% compounded annually. She wants to
know how long it will take her to accumulate $200,000. Again, you know all the variables except N, including, in
this case, regular payment amounts. You can solve for this question as follows:
5. Press COMP N, displays 8.889898877
Therefore, it will take Hannah almost nine years (8.89 to be precise) to accumulate $200,000.
SOLVE FOR THE INTEREST RATE

In some cases, you may have to solve for the rate of return that will grow an investment to a specified future value.
Two different situations that require solving for the rate of return are explained in the next example.
EXAMPLE
Your client Daisy has $50,000 today and wants to grow it to $300,000 in 20 years. What average annual rate of
return will she have to earn to achieve her goal? Knowing all the variables except the interest rate, you can solve
for this question as follows:
5. Press COMP I/Y, displays 9.372354773

EXAMPLE
(cont'd)
Therefore, Daisy must earn an average of 9.37% annually to reach her goal. Depending on how high her tolerance
for risk is, this return may not be realistic, given the historical correlation between risk and returns. As her advisor,
you may have to tell her that her desired return is inconsistent with her tolerance for risk. She may have to adjust
either her expectations or her risk tolerance.
Now, consider another annuity situation where a client, Victor, wants to invest $18,000 each year into an
RRSP. Victor wants his contributions to grow to $1 million in 20 years. What rate of return will Victor require
to reach his goal? Again, knowing all the variables except the interest rate, you can solve for this question as
follows:
4. Type 1,000,000, then press FV, displays 1,000,000
Therefore, Victor would have to earn 9.73% every year for 20 years to reach $1 million. Like your other client,
Victor would also very likely have to tolerate a relatively high amount of risk to earn this return.
SOLVE FOR PAYMENTS

In some situations, you may have to solve for the value of the periodic payments that will grow a specified
investment to a specified future value, given the rate of return and the number of periods.
EXAMPLE
Your client Veronika has an RRSP worth $100,000 today. She wants to know how much to contribute each
year so that the RRSP is worth $2 million in 25 years. The annual return is assumed to be 8%. Knowing all the
variables except the payment amounts, you can solve this problem as follows:
4. Type 2,000,000, then press FV, displays 2,000,000
5. Press COMP PMT, displays −17,989.6802
Therefore, Veronika must contribute $17,989.68 annually to save $2 million in 25 years.
LOANS AND MORTGAGES

Borrowing money to achieve personal goals is a common strategy for many investors. For example, most people
cannot afford to buy a house for cash at the time of purchase. They typically need financing to bridge the gap
between the purchase price and the available down payment. Whether your clients are borrowing to make a
large purchase or for business needs, it is important that they understand the terms and conditions offered by
the lender.
LOANS
Time value of money calculations can be used to determine the amount of loan payments, the interest charged on
loans, and the payout on a loan.

EXAMPLE
Your client Ella wants to borrow $5,000 from the bank today and agrees to pay it off in equal annual instalments
over the next five years. The bank charges an annual interest rate of 12%. Ella wants to know the dollar value of
each annual instalment. You can calculate that amount as follows:
3. Type 5,000, then press PV, displays 5,000
Therefore, Ella must pay annual instalments of $1,387.05.

Ella tells you that a competing bank is offering her the same loan amount of $5,000, with annual instalments of
$1,527 over the same five-year period. She wants to know what interest rate the competing bank is charging. You
can calculate the rate as follows:
Therefore, the competing bank is quoting a rate of 16%.

Ella decides to take the loan offered by your bank. After two years, she decides to pay off the entire loan. How
much will she have to pay at that time? To calculate the final payment, you must find the present value of the
remaining three payments, as follows:
3. Type −1,387.05, then press PMT, displays −1,387.05
Therefore, it will cost Ella $3,331.46 to pay off the remaining loan at the end of the second year.
MORTGAGES
Mortgage calculations present a variation on the standard present value calculations we have shown thus far. In
Canada, mortgage payments are typically paid every month, but mortgage rates are compounded semi-annually.
For this reason, the interest factor must be adjusted in calculations. In the next example, we start by assuming
that the compounding frequency equals the payment frequency; in the example that follows, we relax this
assumption.

EXAMPLE
Your clients Ravi and Sabina are a married couple interested in buying a house. With their budget, they can afford
payments of about $2,000 per month. Their bank has offered them a mortgage amortized over 25 years at an
annual rate of 8.5%. What size mortgage can Ravi and Sabina afford?
To calculate the answer, we ignore semi-annual compounding and monthly payments, assuming instead that
Ravi and Sabina will make a single annual payment of $24,000 at the end of each year. From there, you can
determine how large a mortgage the family can afford, as follows:
5. Press COMP PV, displays 245,621
Therefore, your clients can afford a mortgage of about $245,000.
Now let’s revise our assumptions. To calculate precisely how large a mortgage the family can afford, we must adjust
for semi-annual compounding and monthly payments. It is easy to figure out the number of months; we simply
multiply the number of years by 12. Figuring out what interest rate to use, however, requires careful consideration.
In this case, the formula for calculating the monthly mortgage interest factor is shown in Equation A.6.
Equation A.6 – Mortgage Interest Factor
2 12
Mortgage Interest Factor = (1 + i 2) -1
In the above formula, interest divided by 2 (calculated as i 2) represents a semi-annual rate. If the compounding
frequency were semi-annual, we would find the correct mortgage interest factor by taking (1 + i 2) to the power
of 2 and subtracting 1. By taking (1 + i 2) to the power of 2 12 (or 0.166666667) and subtracting 1, the mortgage
interest factor becomes a monthly factor compounded semi-annually. Note that rounding to less than four or five
decimal places will significantly alter the results.

EXAMPLE
In the previous example, your clients Ravi and Sabina were given an annual mortgage rate of 8.5%, the mortgage
interest factor is then calculated as follows:
æ ö2 12
çç1 + 8.50 ÷÷ = 1.0425(
0.166666667)
= 1.006961062
çè 2 ÷
ø
Please note that 1.006961062 is calculated on your calculator as follows:
3. Press −, displays 1.006961062
Therefore, the mortgage interest factor is 1.006961062 − 1, or 0.006961062.

Alternatively, you can solve the mortgage interest factor using the interest rate conversion feature on your
calculator, as follows:
1. Type 2 (x,y) 8.5, then press 2ndF EFF, displays 8.680625
2. Type 12 (x,y) 8.680625, then press 2ndF APR, displays 8.3532745
3. Type 8.3532745 / 12, then press =, displays 0.6961062
You can use the financial calculator to estimate more precisely how much Ravi and Sabina can afford, as follows:
1. Type 300, then press N, displays 300 (or 12 months × 25 years)
2. Type 0.696106212, then press I/Y, displays 0.696106212 (or 0.006961062 × 100)
Therefore, the clients can afford a mortgage of just over $250,000.
DID YOU KNOW?
When using a financial calculator, you must multiply the interest factor by 100 because the calculator
automatically reduces the number to a percentage.
You can also calculate the monthly mortgage payments, given the annual interest rate and the amount of
the mortgage.

EXAMPLE
Your client Noah wants to buy a new house with a mortgage of $200,000 and wants to know how this will affect
his monthly budget. The mortgage rate quoted by Noah’s bank is 8% for an amortization of 25 years. To answer
Noah’s question regarding the effect on his monthly budget, you can calculate the mortgage interest factor,
as follows:
Therefore, the mortgage interest factor is 0.655819694.

Then, you can calculate your Noah’s monthly payments, as follows:
Therefore, Noah’s monthly payments are $1,526.43.

Consumer Lending and
Mortgages 5
CHAPTER OUTLINE
In this chapter, we discuss various forms of credit and describe the steps taken to evaluate a client’s
creditworthiness. We discuss the two different mortgage markets—the primary and secondary markets. We also
explain the financial factors used to qualify a client for a residential mortgage. To further help you work with clients
seeking credit, we explain the methods used to reduce interest costs and penalties. Finally, we discuss several
mortgage-related topics, including real estate investing, reverse mortgages, self-directed mortgages, and the use of
funds in registered retirement savings plans to purchase a home.
1 | Differentiate between the various types of Credit Planning

credit available.
2 | Explain how the Five Cs of Credit are used to
evaluate a client’s ability to borrow.
3 | Distinguish between the primary and Residential Mortgages

secondary mortgage markets.
4 | Explain the key financial factors required to Key Financial Factors to Consider When
qualify the client for a residential mortgage. Purchasing a Home
5 | Explain the methods of reducing interest costs Methods of Reducing Interest Costs and
and penalties. Penalties
6 | Explain reverse mortgages, self-directed Related Mortgage Topics and Financial

mortgages, real estate investment trusts, the Planning Issues
Home Buyers’ Plan, and tax-free First Home
Savings Account.

KEY TERMS
bridge financing loan-to-value (LTV) ratio
charge accounts mortgage-backed security
closed mortgage mortgagee
conventional mortgage mortgagor
credit bureau NHA-insured mortgages
credit limits not in advance
credit score open mortgage
Five Cs of credit overdraft
gross debt service ratio personal line of credit
high-ratio mortgage real estate investment trusts
home equity line of credit semi-annual compounding
lien total debt service ratio

CHAPTER 5 CONSUMER LENDING AND MORTGAGES 5•3
INTRODUCTION
Debt management is an important component of financial wellbeing. Borrowing can be used to build your clients’
asset base, including their principal residence. It can also allow for leverage, which is the strategy of investing
borrowed funds to potentially increase returns. However, too much debt can have devastating consequences, and
leverage can amplify losses on poor investment decisions. As an advisor, you should therefore be familiar with the
general provisions of mortgage loans, including prepayment options. You should also be able to advise clients on the
benefits and drawbacks of property ownership from both a capital and cash flow perspective.
Before you begin, read the scenario below, which raises some of the questions you might have regarding residential
mortgages. Think about these questions, but don’t worry if the answers do not come easily. At the end of the
chapter, we will revisit the scenario and provide answers that summarize what you have learned in this chapter.
BUYING A FIRST HOME
At your account opening meeting with the Millers, they tell you about their son, Andy, who is 30 years old.
Andy is a newly established lawyer who has finished his articling with a major Toronto law firm and has been
invited to remain as an associate. At his father’s urging, Andy is looking to purchase his first home. His years
as a poorly paid articling student have left him with some credit card debt, but he has managed his financial
affairs well. Consequently, Andy’s parents have agreed to gift him a substantial amount for a down payment.
He has also saved up around $20,000 in a registered retirement savings plan. Andy makes a decent income,
which he expects will rise significantly over the coming years as he advances at his firm. The Millers have asked
you, in your capacity as their advisor, to meet with them and Andy and tell them what they should know about
managing debt and buying a home.
• How can you advise Andy and his parents to ensure that Andy qualifies for a mortgage and can manage his debt
responsibly?
• What direction can you provide to ensure that he gets the right type of mortgage and can manage the various
costs associated with the purchase of a home?
• Apart from gifting the funds, are there other ways the Millers can help Andy purchase a home? What implications
might there be if they were to use those options?
CREDIT PLANNING
1 | Differentiate between the various types of credit available.
2 | Explain how the Five Cs of Credit are used to evaluate a client’s ability to borrow.
Clients borrow money for various reasons. Two common reasons are to purchase goods or services they could not
otherwise afford and to invest the borrowed funds to increase their standard of living. Using consumer credit to
purchase goods or services is a way of redistributing spending power over time at the expense of interest costs.
Consumer credit must be used judiciously. The immediate access to funds that consumer credit provides can lead to
monetary challenges in a client’s monthly cash flow. Debt could create a temporary imbalance where spending may
even exceed the borrower’s savings or income. Furthermore, borrowing to invest makes sense only when the assets
that the borrowed funds are invested in yield higher returns than the rate paid on the loan.

Consumer credit has both advantages and disadvantages, as follows:
Advantages of • It reduces the need to carry large amounts of cash.

consumer credit
• It simplifies payment for diverse purchases, and in some cases extends the
manufacturer’s warranty.
• It can be used for cash flow planning by providing a monthly statement that allows
expenses to be monitored.
• It allows the borrower to take advantage of bargains when cash is limited.
• It can provide a temporary fund for emergencies (e.g., drawing money from a
personal line of credit).
Disadvantages of • It increases the temptation to spend as soon as credit is available, rather than saving
consumer credit for or forgoing a purchase that one cannot immediately afford.
• It may lead to the impulsive purchase of items that are not needed.
• If credit is used to its maximum, its use as an emergency reserve is nullified.
FORMS OF CONSUMER CREDIT

Consumer credit comes in various forms, including those described below.
OVERDRAFT
An overdraft is not normally thought of as a loan, but, nevertheless, it is a form of consumer credit. Specifically,
it is an unsecured credit facility that allows a client to overdraw a chequing account up to a pre-determined limit.
The purpose of an overdraft is to ensure that authorized transactions are not declined because of insufficient funds.
Overdraft protection typically carries a high interest rate (up to 21% + overdraft fee) and charges a fee per use.
Overdraft facilities are intended to be temporary and must be brought into a credit balance for at least one day
during a set period. Depending on the policy of the financial institution, the period may be at least 30 days and up
to 90 days.
CREDIT CARD
A credit card is an open, revolving form of loan typically used by clients to make immediate purchases. Credit cards
offer various options to meet the particular needs of different clients. There are two common types of credit cards
available: those issued by financial institutions (and some finance companies) and those issued by retailers. The
different types are characterized as follows:
Credit cards issued by Financial institutions offer a large selection of card options that provide purchasing
financial Institutions access to a global network of merchants. Options range from basic, no-fee cards to
premium cards offering low rates, travel reward points, travel insurance, and extended
warranties.
The interest rate charged on unpaid balances is often lower than that charged on retail
cards because the financial institution can drive revenue from other related sources. For
example, banks can charge annual membership fees, merchant transaction fees, optional
balance protection, and insurance premiums.
Common cards in this category include Visa, MasterCard, and American Express.

Credit cards issued Retail credit cards are normally issued only by large retail companies.
by retailers
The interest rate charged on unpaid balances is often much higher because there
are no related sources of revenue for the retailer. Cards are mostly limited to paying
immediately for goods and services purchased from the retailer. Cash advances are
restricted, and the cards are generally not honoured by other merchants. Any benefits or
rewards associated with the cards are redeemable only at the retailer.
Cards in this category include those offered by Hudson’s Bay, Shell, and Lowe’s.
CHARGE ACCOUNT
Only a few retailers offer charge accounts, which typically have strict, structured repayment requirements. These
accounts are a type of revolving credit, meaning that the borrower can re-borrow. However, the balance owing must
be repaid in full within a specified time, typically 30 days. Some retailers allow instalment payments, with interest
accruing on unpaid balances. Features and rates vary, including credit limits and minimum use requirements.
Home Depot, for example, may offer a charge account to a paint contractor or tradesperson in the home renovation
business.
PERSONAL LINE OF CREDIT

A personal line of credit (LOC) is an open, revolving loan that allows clients to re-borrow funds (up to an available
limit) without having to re-apply for the loan. An LOC normally requires a minimum monthly repayment (often
interest only) at the end of a 30-day period. The interest rate is applied to the amount drawn from the LOC. The
rate is based on two factors: the bank’s prime rate (which fluctuates regularly) plus a certain number of basis points
to account for borrower risk. (Basis points are a commonly used unit of measurement for interest rates. One basis
point is 1/100 of 1.00% or 0.01%, and 100 basis points equals 1.00%.)
An LOC can be either secured or unsecured. A secured LOC is guaranteed by an underlying asset of unchanging
value that can be liquidated to reimburse the outstanding debt if the borrower defaults on repayment. A secured
LOC receives a preferential interest rate compared to one that is unsecured. For example, an unsecured LOC may
charge an interest rate equal to the prime rate (3.20% at time of update) plus a mark-up of 2.00%. A secured LOC
for the same amount may charge slightly more than the prime rate. Whether secured or unsecured, an LOC charges
interest beginning on the day funds are withdrawn.
EXAMPLE
A client withdraws $5,000 from an unsecured LOC and then repays the same amount five days later. On the
day of repayment, the client must also pay five days’ worth of interest at a rate of 5.2% (assuming a prime rate
of 3.20% plus 2.00%).
PERSONAL LOAN
A personal loan is a type of instalment loan with a fixed term, which is the set time by which the funds borrowed
must be repaid in full. Although the amounts borrowed can be large, the risk associated with this type of loan is
often lower. Traditionally, a lien is taken over the asset purchased with the loan proceeds.
A personal loan is set up with either a fixed or variable interest rate. The fixed rate is set by the bank based on the
overnight lending rate. The variable rate is a revolving interest rate that changes based on market conditions.
Personal loans are granted for a specific purpose, such as the purchase of a vehicle or to consolidate debt. Loans
used for debt consolidation present additional risk to the bank, especially if the debt being consolidated is from
another lender. Frequently, there are no assets attached to such loans. Therefore, the secondary lender takes on risk,
whereas the original lender benefits from having a risky loan repaid. This higher risk is the rationale for the higher
interest rate charged, which usually is not negotiable.

DEMAND LOAN
A demand loan is a short-term loan granted with plenty of collateral. The interest rate is variable, and full
repayment may be demanded by the lender at any time. Likewise, the borrower can repay the loan in full at any
time, without penalty, upon written notice. This type of loan is commonly used in real estate transactions to fund
the down payment on a new property while the buyers wait for the sale of their existing property. When used this
way, the loan is known as bridge financing. Such loans are offered by most banks subject to certain terms and
conditions. They must be supported by a letter of undertaking and a copy of the firm sale agreement of the sold
property.
DID YOU KNOW?
Bridge financing is only provided to clients awaiting the proceeds on a guaranteed sale of the buyer’s
existing property. Normally, if the property has not yet been sold, no bridge financing is provided, unless
a lien is taken on the property.
EXAMPLE
John has purchased a new house and must make the down payment on the closing date of November 1. Funds
for the down payment will come from the sale of his existing house, which will not close until November 30.
He therefore requires financing for 29 days. The contract is made for 45 days, in case the sale of John’s house is
delayed. However, John can repay the full amount at any time.
RESIDENTIAL MORTGAGE
A residential mortgage is a contract between a lender (the mortgagee) and a borrower (the mortgagor), in which
the lender extends credit to help the borrower pay for a property. The loan amount is based on the value of the
property and the borrower’s ability to repay the loan. In return, the borrower grants the lender a claim (called a lien)
on the property as security for the debt.
The decision to become a property owner is often the first major financial decision clients make. Likewise, the
mortgage on a principal residence is often the most significant debt they will incur. As an advisor, you should be
familiar with the general provisions of mortgage loans and the prepayment options available. You should be able
to advise your clients on the benefits and drawbacks of, and alternatives to, property ownership from both a capital
and cash flow perspective. We explore mortgages in detail throughout this chapter.
HOME EQUITY LINE OF CREDIT

A home equity line of credit (HELOC) is a borrowing facility linked to the available equity of an existing property.
A HELOC allows a borrower to borrow funds in the form of an LOC or mortgage, or a combination of both. Some
financial institutions also allow for the inclusion of a credit card and overdraft. We explore this product in more
detail later in this chapter.
LENDING SCENARIO
How do you determine the best credit product to suit a particular client’s needs? Complete the online
ASSESSING A CLIENT’S ABILITY TO REPAY CREDIT

Decisions to grant credit, whether for personal loans, credit cards, or home mortgages, are generally all made on the
basis of two factors: credit history and affordability.

AFFORDABILITY
When determining mortgage affordability, financial institutions consider borrowers’ present and future ability to
handle their financial obligations. They calculate two debt service ratios that determine the amount of debt that
borrowers can afford to carry. In addition, the borrowers must pass a stress test, which calculates their ability to pay
debt if interest rates climb higher than the current average. This information will be covered later in this chapter.
CREDIT HISTORY
Clients’ success in obtaining credit depends on their financial situation and the way they present their situation to
the lending institution. The primary method used for this assessment is the Five Cs of credit approach, which is
based on the following factors:
Character Character refers to the client’s honesty, reliability, repayment history, and intention
to repay the credit. Character is assessed based on the client’s existing level of assets
and debt, employment record, residence stability, and purpose for the loan. Accurate
assessment relies on full disclosure by the client.
Capacity Capacity refers to the client’s ability to repay the loan. Capacity is assessed based on the
client’s current income, job stability, assets, and future considerations.
Credit Credit refers to the client’s past credit history, which the lender considers an indicator of
how debt may be handled in the future.
Credit assessment is determined by the client’s current use and availability of existing
credit, payment history, delinquencies, and any records of outstanding judgments.
Collateral Collateral refers to property that can be used to secure a loan. Lenders may require
collateral as security if the loan is substantial relative to the client’s net worth. If the loan
is in default, the assets pledged as collateral are liquidated to provide for repayment of
the loan.
Capital Capital refers to net worth and is based on the client’s total assets and general financial
situation. Capital is viewed as an extension of the client’s character, an indicator of their
financial management skills, and a source of collateral. A high score in this category
can indicate that the client has a secondary source of funds for repayment in case their
regular income is disrupted.
EXAMPLE
When Vikram Patel approaches Bryan’s financial institution to apply for an LOC to use as an emergency fund,
Bryan assesses Vikram’s creditworthiness using the Five Cs approach. Because Vikram works as a camera operator
in the film industry and sometimes faces employment gaps between jobs, his capacity to repay funds is not
perfect. However, his line of employment pays well, he carries no debt, and he has a spotless credit report. Also,
he has equity in his house that can be used as collateral in the event of default. Based on his Five Cs assessment,
Bryan decides that Vikram presents a low risk, and he approves the LOC.
As an advisor, you should analyze the Five C factors alongside other aspects, including the credit bureau report.
Together, these factors should help you identify areas of weakness and risk in your clients’ credit applications. The
results of your analysis can help you determine whether your clients are likely to receive or be denied their credit
request.

THE IMPORTANCE OF CREDIT HISTORY

Credit history is determined by a credit bureau, an organization that supplies credit information for a fee to credit
bureau members. Members include banks, trust companies, credit unions (Desjardins in Quebec), and other lenders
and issuers of credit. These members routinely conduct credit checks on anyone who applies for a credit card, loan,
mortgage, or any form of credit. Anyone who has applied for or previously used any form of credit will have a credit
file at a credit bureau. Equifax and TransUnion are the two main credit bureaus in Canada.
INFORMATION FOUND ON A CREDIT REPORT

The report generally contains four types of information:
• Personal information
Name, current address, previous address, current employer, employment history, and other personal
information
• Account history
A list of all current and previous creditors and a score related to payment history
• Inquiries
A record of anyone who has requested the credit report in the past few years, either for credit or employment
purposes
• Public record information
Information regarding legal judgments, civil actions, liens, or bankruptcies
THE CREDIT SCORE

Credit-reporting agencies provide a credit score, also known as a beacon score, that is a numerical value based on
a statistical analysis of the borrower’s information. All the information contained in a credit report is translated into
the credit score, which is a three-digit number ranging between 300 and 900 (or zero, if the client has no credit
history). An average credit score is around 650.
The details on a borrower’s credit file can be further used to influence a lender’s decision on whether to
advance credit. An unfavourable credit report can jeopardize a borrower’s ability to obtain credit. A score
between 620 and 680 is generally required to qualify for a mortgage from major financial institutions.
RESIDENTIAL MORTGAGES
3 | Distinguish between the primary and secondary mortgage markets.
The mortgage marketplace has two divisions: the primary market for mortgage funds, and the secondary market
where debt instruments are bought and sold.
The marketplace also includes mortgage brokers, real estate brokers, government agencies such as Canada
Mortgage and Housing Corporation (CMHC), and private mortgage loan insurance providers such as Sagen
(previously known as Genworth Canada) and Canada Guaranty. The National Housing Act (NHA) provides CMHC
with a range of specific powers and tools to address the housing needs of Canadians and related needs, including
housing finance, housing insurance, and assisted housing.
For the purposes of this course, we will focus on only CMHC as an insurance provider for the NHA market.

THE PRIMARY MORTGAGE MARKET

The primary mortgage market refers to the retail source from which borrowers access funds to buy real estate. In
Canada, the main sources of mortgage money are chartered banks, credit unions, and financial cooperatives.
CHARTERED BANKS
Chartered banks concentrate on loans for single-family housing. Because of their vast pool of funds and extensive
branch system, they have a large portion of the market share.
Banks are regulated under the Bank Act and related legislation. Compliance is monitored by the Office of the
Superintendent of Financial Institutions (OSFI). The Bank Act restricts mortgage loans to an 80% loan-to-value
(LTV) ratio, which means that the loan can consist of no more than 80% of the property’s value. A higher LTV may
be permitted if the loan proceeds above 80% are NHA insured.
DID YOU KNOW?
The Bank Act permits a chartered bank to own a majority of the voting shares of a mortgage loan
corporation if the corporation does not own shares of another company. As a result, many chartered
banks have created subsidiaries known as mortgage corporations, such as the Bank of Montreal
Mortgage Corporation. These corporations raise funds by issuing guaranteed investment certificates
(GIC), which are guaranteed by their parent bank. The funds raised are used for mortgages, which are
generally matched to the term and rates of the GICs. Banks charge penalties because they are obligated
to continue paying the interest on the GIC even if the mortgage contract is broken. The matching
process is also known as the cost of funds on the date the mortgage is booked with a lender. This is not
to be confused with the disbursement date.
CREDIT UNIONS AND FINANCIAL COOPERATIVES

Credit unions and other cooperatives share a spot in the market second only to chartered banks. They have
traditionally served small groups such as the employees of a single workplace. They are viewed as competitors to
the chartered banks.
Each member of a credit union is a part owner of the union, which creates a very different institutional climate
from that of chartered banks. As consumers become more educated about financial services and the alternatives
available, credit unions are expanding in number and becoming more high profile.
OTHER LENDERS IN THE PRIMARY MORTGAGE MARKET

The institutions discussed in this section sometimes act outside their primary roles to provide mortgage loans
to clients.
TRUST COMPANIES
Trust companies acting as mortgage lenders, like chartered banks, are restricted to a maximum LTV ratio of 80%
unless the mortgage loan is insured. These institutions are regulated under the Loan and Trust Corporations Act of
each province; however, OSFI is still the regulating body that oversees the financial institutions and ensures that
they are compliant.
As with chartered banks, the liabilities of trust companies are deposits and GICs, most of which are relatively short
term. Regulations therefore require that trust companies maintain an appropriate level of liquidity.

LIFE INSURANCE COMPANIES

Life insurance companies are regulated under the Insurance Companies Act and monitored by OSFI. This Act
regulates many aspects of the companies’ operations, including mortgage investments. As with chartered banks
and trust companies, individual loans are limited to a maximum of 80% of the property’s value unless the loan is
insured.
PENSION FUNDS
Canadian pension funds hold a small percentage of the retail mortgage market. As with other institutions that make
mortgage loans, they are restricted to an 80% LTV ratio without insurance.
Pension funds must ensure the safety of their capital and earn strong returns on their investments. For this reason,
they have typically looked to both bonds and mortgages for security and to certain stocks for higher yields.
Mortgages offer not only security but also relatively low-risk returns that compare favourably with stocks and bonds
in most phases of the market cycle.
Pension funds are also major players in the commercial real estate market. Given their massive pools of capital,
some pension funds have become the owners of large real estate or development companies that invest their
money for the long term. For example, the Ontario Teachers’ Pension Plan owns Cadillac Fairview, one of North
America’s largest owners and managers of commercial real estate. Syndications of various pension funds and life
insurance companies are often created to fund the large debt requirements of commercial real estate transactions.
MORTGAGE INVESTMENT CORPORATION

A mortgage investment corporation (MIC) may be incorporated either provincially or federally. Federally
incorporated MICs are administered under the Trust and Loan Companies Act. As such, they are authorized to accept
deposits that are eligible for deposit insurance from the Canada Deposit Insurance Corporation.
An MIC enables small investors to invest in a diversified pool of mortgages on residential real estate, with the
benefit of using the corporate form of business organization. An MIC is generally treated as a conduit, for income
tax purposes. In other words, its income flows through to its shareholders and is taxed in their hands, rather than at
the corporate level. Examples of MICs are Scotia Mortgage Investment Corporation and TD Mortgage Investment
Corporation.
CANADA MORTGAGE AND HOUSING CORPORATION

CMHC is a Crown corporation wholly owned by the Canadian government. Under the NHA, CMHC is the primary
insurer authorized to provide mortgage loan insurance to lenders against default by borrowers on various types of
loans. CMHC normally provides coverage for borrowers with a down payment of less than 20% of the purchase
price of a property.
CMHC’s primary program is its mortgage loan insurance for borrowers. Since 1954, more than three million
Canadians have insured their mortgage loans with CMHC.
Mortgage insurance is insurance provided to a lender to protect against default by the mortgagor. Loans that
qualify for mortgage insurance include those for detached and semi-detached homes, townhouses, row houses,
condominium housing, and even mobile and modular homes. Loans on newly constructed single and multi-family
residential properties can also be insured.
CMHC’s mortgage loan insurance is available only to approved lenders, such as major banks, credit unions, and life
insurance companies. These institutions must apply to CMHC to become an approved lender and must meet certain
standards of due diligence and service.
CMHC-INSURED MORTGAGES
Borrowers who make down payments of less than 20% of a purchase price are deemed more likely to default;
therefore, they must have some mortgage loan insurance against this risk. If the borrower defaults, the lender has

CHAPTER 5 CONSUMER LENDING AND MORTGAGES 5 • 11
the choice of retaining the property, calling on the borrower’s personal covenant (i.e., the promise to repay), or
making a claim under the mortgage loan insurance.
In the event of a default, mortgage loan insurance covers 100% of eligible lender claims. This includes lost mortgage
principal and foregone interest, as well as “other costs” (e.g., legal fees, costs of property maintenance and disposal)
subject to certain limits.
CMHC also plays a significant role in the multi-unit residential market, insuring mortgage loans made for the
purchase, repair, conversion, or refinancing of existing rental housing projects. CMHC can also insure loans equal
to the property’s value if they are made to a municipality, a public housing authority, a non-profit corporation, or a
cooperative housing association.
CMHC also provides insured loans to individuals and groups under the Residential Rehabilitation Assistance
Program for First Nations on-reserve affordable housing. This program allows for residential renovations to improve
health and safety or provide access for persons with disabilities.
THE SECONDARY MORTGAGE MARKET

The secondary mortgage market is where existing mortgages and blocks of mortgages held by lenders are bought
and sold. The original holders of the mortgages, such as banks or trusts, sell these investments to pension funds,
private investors, or other institutions.
Lenders sell mortgage holdings as part of the process of managing their capital investments and cash flows, as well
as to maintain profitability and corporate liquidity. Mortgage loans allow institutions to earn a profit on the spread
between deposit rates and mortgage rates.
The purchasers of blocks of mortgages seek secure income streams and profitable long-term investments. NHA-
insured mortgages trade near the level of government bond interest rates because the market considers them to
be low-risk obligations of the federal government. In many cases, those who sell the mortgages continue to manage
the loans for a fee, and the mortgagors are unaware that the ownership of the mortgage has passed into other
hands.
Unlike bonds or stocks, mortgages are not a homogenous product. The underlying security on mortgages is real
property, which is inherently illiquid. And, because financial institutions offer negotiable prepayment terms, the
repayment stream is unpredictable. For these reasons, mortgage contracts were once considered unattractive
as an investment vehicle for the secondary market. However, the growth in financial products has resulted in a
corresponding growth in asset and liability matching tools for lenders. One such tool is the mortgage-backed
security (MBS).
Mortgage-backed securities are fixed-rate investments that represent an ownership interest in pools of mortgages
that have been securitized – that is, grouped together and resold to institutional and private investors. One type of
MBS is a pool of residential mortgages secured by CMHC.
CMHC pioneered the development and use of MBS in Canada with the introduction of NHA MBS in 1987. With
this type of MBS, an approved mortgage issuer puts together a pool of eligible insured mortgage loans, and CMHC
applies an unconditional guarantee of timely payment. The securities are then sold to investors, who receive
monthly payments of interest and principal. NHA MBS are high-quality investments, fully guaranteed by CMHC on
behalf of the Government of Canada.
Mortgage funding through securitization has grown significantly in the past several years. Mortgage securitization
in a competitive system of housing finance helps keep mortgage rates down. Unlike most bonds, however, an MBS
carries the risk of prepayment. Most mortgages offer homeowners the option of paying off the entire mortgage
before maturity, subject to a prepayment penalty. Such full prepayments usually occur because of life events, such
as a divorce, death, or job transfer. Also, borrowers often make partial prepayments that reduce the principal by a
lump sum.

Another way in which MBS differ from most bonds is that they tend to pay investors a proportional share of the
interest and principal payments associated with the underlying mortgages each month. CMHC guarantees the
payment of interest and principal to the investor in issues of NHA MBS.
KEY FINANCIAL FACTORS TO CONSIDER WHEN PURCHASING A HOME
4 | Explain the key financial factors required to qualify the client for a residential mortgage.
When your clients decide to buy a home, the next step is to determine how much they can afford to pay. The
maximum house price is usually a combination of the mortgage they can afford to carry plus the down payment
they can make. In that calculation, six key financial factors must be considered:
• LTV ratio
• Debt service ratios
• Mortgage stress test
• Term and amortization
• Interest rate
• Fees incurred in buying the property
LOAN-TO-VALUE RATIO
The LTV ratio represents the relationship between the amount of the mortgage loan made by the financial
institution and the value of the property purchased. It is calculated by dividing the amount of the loan by the value
of the property purchased and is expressed as a percentage (e.g., 80%).
The Bank Act requires that funds borrowed for mortgage purposes be structured as either a conventional mortgage
or a high-ratio mortgage:
With a conventional mortgage, the borrower provides a down payment of 20% or more of the property’s value.
Mortgage loan insurance is not normally required.
With a high-ratio mortgage (or insured mortgage), the borrower usually provides a down payment of less than 20%
of the purchase price. This type of mortgage requires the borrower to obtain mortgage loan insurance to reduce the
risk of the debt to the lending institution. The borrower must pay fees for the mortgage loan insurance. This topic is
covered later in this chapter.
The beneficiary of the mortgage loan insurance policy is the lender, rather than the borrower. CMHC mortgage loan
insurance protects the lender only. Borrowers must obtain mortgage life insurance or personal life insurance if they
want the outstanding balance on the mortgage to be paid off if they die.
Once you know the amount of funds your clients have available to put toward the purchase of a property, you
will be able to calculate the maximum possible mortgage amount. By adding the down payment to the maximum
amount, you can determine the maximum purchase price the client can afford. The federal government has
stipulated minimum mortgage down payment requirements on home purchases, as shown in Table 5.1. The
requirements primarily affect borrowers with less than a 20% down payment who are seeking insured mortgages
for an amount between $500,000 and $999,999.

Table 5.1 | The minimum down payment based on the purchase price
Purchase Price Up to $500,000 Between $500,001 to $999,999 $1,000,000 or more
Minimum Amount 10% for the portion of the

5% of the purchase price 20% of the purchase price
of Down Payment purchase price above $500,000
EXAMPLE
A property’s purchase price is $650,000. The minimum down payment is $40,000, which is calculated as follows:
• The minimum required down payment on the first $500,000 is 5%, or ($500,000 × 0.05) = $25,000
• The minimum required down payment on $150,000, the remaining amount over $500,000, is 10%, or
($150,000 × 0.10) = $15,000
So, in this example, the minimum down payment required is 6.15% ($40,000/$650,000).
It is important to note that the mortgage loan insurance program is only applicable to mortgages under $1 million.
Mortgages over that amount require a 20% down payment, which excuses them from the required insurance. Non-
owner-occupied properties, such as rental properties, also require a 20% down payment.
In all cases, the down payment, or a substantial portion of it, must come from the borrower’s own resources.
The lending institution often requires evidence that the borrower has the necessary funds. Evidence may include a
passbook from a financial institution or investment statements. Borrowed funds cannot be used for down payment
purposes because the purchase would be fully leveraged, and thus too risky for the bank.
Traditionally, mortgage loan insurance providers have required home buyers to come up with the minimum
down payment on their own. However, down payments gifted from immediate relatives are also acceptable.
Gifted funds may need to be accompanied by a letter confirming that no repayment of the funds is required.
Otherwise, the funds would count as a debt on the credit application, which could disqualify the applicant for the
mortgage.
The purchase price of a property is generally the limiting factor in determining its value for lending purposes.
Financial institutions may use an automated valuation management tool (AVM) to conduct appraisals for loans of
up to 95% of the property’s estimated value. However, a full appraisal is usually required for loans that fall outside
of the AVM’s matrix. Banks also reserve the right to order a complete home appraisal (which could include a visual
inspection of the property’s interior and exterior and the age and condition of key components such as the roof or
furnace) should they deem it necessary to fully assess the value of the home.
DIVE DEEPER
For detailed information on insured mortgages, visit the CMHC website.
DEBT SERVICE RATIOS

The maximum mortgage that a lending institution will allow a borrower to carry is based on two ratios: the gross
debt service ratio (GDS ratio or GDSR) and the total debt service ratio (TDS ratio or TDSR). To pass these
affordability tests, the borrower must not exceed either ratio.
GROSS DEBT SERVICE RATIO

The GDS ratio is a standard measure of creditworthiness. It considers only the expenses (including debt payments)
directly associated with the property being purchased. This ratio is calculated on a monthly or annual basis. To

calculate the GDS ratio, the following shelter related costs are added together and divided by the gross family
income:
• Mortgage payments
• Property taxes
• Heating costs
• 50% of any condominium fees
Ideally, the GDS ratio should not be above 32%.
TOTAL DEBT SERVICE RATIO

The TDS ratio is closely linked to the capacity principle from the Five Cs of credit. Whereas the GDS ratio considers
only the expenses and debt directly associated with the property being purchased, the TDS ratio considers all debts.
It is calculated on a monthly or annual basis as a sum of the following elements, where applicable, divided by the
gross family income:
• Mortgage or rent payments

• Property taxes
• Home heating costs
• Condominium fees (50%)
• Minimum required debt payments
NOTE
When calculating the TDS ratio in a quiz or exam question, and no specific debt payment required for credit is
given, the following general rules apply:
• Monthly credit card payment = 3% of credit card limit.

• Monthly LOC payment = 3% of LOC limit.
For example, if the client’s credit card limit is $5,000, the minimum monthly payment is calculated as $5,000 ×
3% = $150, or $1,800 per year. Any balance owing on the credit card is not relevant for TDS ratio purposes.
In brief, the TDS ratio includes shelter costs and the client’s total debt repayment load. The maximum TDS ratio is
generally 40%.
EXAMPLE
Your client Jonathan has a mortgage with monthly payments of $2,100. He also has monthly payments of
$300 for property taxes and $100 for heating. Jonathan earns a gross income of $100,000 per year as a radiology
technician, which comes to $8,300 per month before taxes and deductions. He has no other monthly debt
payments. Jonathan wants to borrow money to finance a new car, on which the payments are expected to be
$400 per month.
Jonathan’s current TDS ratio is calculated as follows:
$2,100 + $300 + $100 + $0
× 100 = 30%
$8,300

EXAMPLE
(cont'd)
Therefore, Jonathan has a TDS ratio of 30%, which means that 30% of his gross income goes to shelter expenses.
Because the ratio is less than 40%, Jonathan can still support an additional debt repayment of up to $830 per
month.
After the car loan is factored into the calculation, Jonathan’s new TDS ratio is calculated as follows:
$2,100 + $300 + $100 + $400
× 100 = 34.94%
$8,300
In the example above, the client had no debts other than his mortgage before financing the car purchase. However,
clients often do have other outstanding debts. When calculating the TDS ratio, you must include the minimum
required payments on all such debt. You must also include the minimum payment on any open revolving credit
facility, such as a an LOC or credit card, even if it has not been used. The calculation is based not on what is owing,
but on the debt payments that would have to be made if the available credit facility was used to its capacity. Many
clients arrange for large LOCs and readily agree to higher credit card limits without realizing that they may hinder
their borrowing capacity by doing so.
EXAMPLE
In addition to the calculations in the previous example, Jonathan has an unused personal LOC with a limit of
$40,000. The monthly payment, based on 3% of the total credit limit, is $1,200, calculated as $40,000 × 3% =
$1,200. Jonathan’s bank uses this payment amount to assess whether he is able to carry the monthly cost of the
car loan, should he fully use the credit facility. With credit cards, a payment of 3% of the credit limit is normally
used based on a calculation similar to the one above.
In this case, Jonathan’s TDS ratio would be calculated as follows:
$2,100 + $300 + $100 + $1,200
× 100 = 44.58% (The client would fail the TDS ratio test.)
$8,300
Therefore, with his current debt load, Jonathan would fail the TDS ratio test.
DID YOU KNOW?
Some financial institutions also take spousal support payments into consideration when assessing a
client’s creditworthiness. Whether such payments exist can be confirmed by reviewing the client’s
separation agreement or tax return.
However, for the purposes of this course, spousal or child support payments are not used in our TDS
ratio calculations.
In the next example, we calculate both ratios (GDS and TDS) to determine a client’s ability to afford a
$120,000 mortgage.
EXAMPLE
Your client Evita has four credit cards, each with a balance of $5,000. The calculations for Evita’s GDS and TDS
ratios are shown in Table 5.2.

Table 5.2 | Gross Debt Service Ratio and Total Debt Service Ratio of a Client with Multiple Credit Cards
Total Annual Gross Income $50,000.00
Consumer Credit Card Debt

(Total credit limit on all four credit cards = $20,000.00 @ 3% × 12 months) $7,200.00
Annual Car Loan Payments $2,400.00
Total Debt Payments $9,600.00
Shelter Costs, recognizing semi-annual compounding and monthly payments
Mortgage Principal and Interest Payments ($120,000.00 @ 4% over 25 years) $7,574.76
Annual Property Taxes $2,500.00
Annual Heating Costs $1,800.00
Total Shelter Costs $11,874.76
GDS ratio: Total Shelter Costs ÷ Total Gross Income = $11,874.76 ÷ $50,000.00 = 23.75%
TDS ratio: Total Shelter Costs and Debt Payments ÷ Total Gross Income =
($11,874.76 + $9,600.00) ÷ $50,000.00 = 42.95%
Based on these calculations, Evita does not meet the TDS ratio test and therefore cannot afford a
$120,000 mortgage.
Clients with a good credit history who meet both the GDS ratio and TDS ratio measures should have no trouble
obtaining credit up to the 40% TDS ratio limit. Financial institutions may use measures other than the GDS and TDS
ratios, such as a credit score, to evaluate a client’s creditworthiness. However, for our purposes, the GDS ratio and
TDS ratio are the most effective guidelines.
CALCULATING THE GDS AND TDS RATIOS
How are affordability tests used to determine whether a borrower qualifies for a mortgage?
Complete the online learning activity to assess your knowledge.
MORTGAGE STRESS TEST

The mortgage stress test is a hurdle brought in by the federal government (Office of the Superintendent of Financial
Institutions)in 2018 to ensure stability in the mortgage marketplace and mitigate mortgage default risk. Given
the very low mortgage interest rates of the past few years, there has been a huge appetite for home ownership.
Potential home buyers are eager to purchase a property before interest rates go up. However, if interest rates
rise sharply, borrowers who could afford a mortgage at a lower rate may suddenly be unable to make the higher
payments. That is why the government has implemented the stress test, which makes it more difficult for the home
buyer to qualify for a mortgage and decreases overall affordability.
Simply put, a borrower must qualify under a 5-year benchmark rate set by the government, which is expected to be
reviewed annually. As of June 1, 2021, the stress test is applied to the higher of two rates:
• 5.25% (the benchmark rate)

• The individual borrower’s mortgage rate + 2.00%

For example, if Eve is offered a mortgage rate of 4.00% by her bank, she would have to qualify for a mortgage rate
of 6.00% under the stress test. And if Adam is offered a mortgage rate of 3.00% by his bank, he would have to
qualify for a mortgage rate of 5.25% under the stress test.
The stress test is not applicable to renewals unless the borrower is changing financial institutions. However, the test
may lead to unfavourable rates for existing borrowers with their current lender if they are unable to qualify under
the new rules.
The stress test has a direct impact on both GDS and TDS ratios. Any increase in these ratios will further lower the
client’s borrowing capacity.
TERM AND AMORTIZATION PERIOD

When applying for a mortgage, your clients must select an appropriate term and amortization period. The term is
the period during which the lender matches the interest rate of the asset (the mortgage) with its deposit liabilities.
The amortization period is the time required to pay the mortgage off completely, which is the period on which the
monthly mortgage payments are based.
The standard repayment term in Canada tends to be five years, and the government-authorized amortization period
is 25 years. At the end of the selected term, the loan is generally renewed for another term at prevailing interest
rates, and so on until the loan is fully repaid.
Lenders may shorten the amortization period for older homes and riskier situations because they want the capital
repaid faster. A shorter amortization period requires a higher monthly payment but reduces the total interest paid
on the debt. A longer amortization period means a lower monthly payment, but a higher amount of interest is paid
over the life of the mortgage. Table 5.3 highlights the payment reduction for a longer mortgage amortization period
and the overall interest savings for a shorter amortization period.
Table 5.3 | Amortization Period for a $120,000 Mortgage at 4%
Monthly Principal Payment Total Interest Interest

Payment* Reductions** Paid*** Savings***
25 years (Longer amortization period) $631.23 $69,366.06 –
15 years (Shorter amortization period) $885.65 ($254.42) $33,184.67 $36,181.39
* The amounts in this table were calculated using the RBC Mortgage Payment Calculator.
** This is the difference between $631.23 and $885.65 = ($254.42) that is being applied directly to the outstanding balance every month.
*** Interest savings are calculated over the entire amortization period, assuming that payments are made monthly at a constant rate of
interest and recognizing semi-annual compounding.
DID YOU KNOW?
As an advisor, you must emphasize to your clients the importance of prepaying a mortgage to the extent
permitted in the mortgage contract. The various repayment options are explained later in this chapter.
INTEREST RATES
Lending institutions offer different rates for different terms. They attempt to match the terms of their assets, such
as mortgages, with those of their liabilities, such as GIC deposits. Their goal is to lock in a spread between the two
rates that is profitable after expenses. For example, if the mortgage rate they collect is 4%, the deposit rate they
pay out might be 2%.

PAYMENT STRUCTURE
In Canada, virtually all residential mortgage loans require blended payments of principal and interest. The Interest
Act, a federal statute, requires that, for such mortgages, the interest rate must be stated with semi-annual
compounding and not in advance. These two concepts are explained below.
Semi-annual When a mortgage features blended payments, the interest and principal portion of
compounding the payments are not readily apparent to the borrower. The Interest Act requires that
the interest portion must be compounded no more frequently than twice a year. The
borrower can have any number of compounding periods within the semi-annual period,
but the effective rate for the half year cannot exceed half of the annual nominal rate.
In other words, the quoted mortgage rate is generally the nominal interest rate. The
effective interest rate is higher—but only slightly—than the quoted annual nominal
rate. For example, a mortgage with a quoted annual nominal rate of 5.00% is really an
effective rate of 5.063%.
Not in advance The second characteristic of most residential mortgages is that interest must be
calculated on a not-in-advance basis. In other words, interest is calculated on the
declining principal, where principal payments are deducted first and interest is calculated
afterward, based on the remaining balance.
QUOTED RATES
Lenders typically quote interest rates for a specific holding period, such as 30 or 90 days. If rates fall during this
period, the client receives the lower rate, but if they rise, the client pays only the quoted rate. Builders that issue
mortgages for new homes usually offer lower-than-market interest rates. In effect, they pay the bank the difference
between the promotional rate and current mortgage rates in a process called “buying down” the rate. There are
usually limits on the time frame or purchase price in pre-arranged financing of this type. When interest rates are
rising, builder loans can be an attractive incentive to purchase a new home.
VARIABLE RATES
Interest rates are normally fixed for the term of the mortgage; however, borrowers may also opt for a fluctuating
rate that is tied to an indicator, such as the prime rate.
Borrowers who choose a variable rate mortgage generally have a higher risk tolerance. Because the mortgage rate
moves with interest rates, the borrower benefits when interest rates fall. The monthly payment amounts are fixed
for the term of the mortgage. However, when rates are lower, a larger part of the payment is applied to the principal
balance, thereby reducing the amount of interest paid. In this way, a small part of the mortgage is prepaid every
time the rate declines.
Of course, the reverse is true when interest rates rise. In that case, the portion of the payment going to the interest
increases, and less of the principal amount is paid. To remedy the situation, the amortization period may increase
automatically to account for the increased interest payment. The financial institution may also force the loan to
be converted to a fixed-term mortgage, or the mortgage may be called, requiring the borrower to pay the loan in
full. Sometimes a pre-arranged interest rate ceiling can be set, at which point the loan is locked in at a fixed rate.
This solution offers some risk management for both sides. Overall, the variable rate mortgage is best suited for an
informed borrower who is prepared to watch interest rate trends.
In recent years, the variable mortgage product has evolved into a five-year term mortgage available in both open
and closed type products. These products are offered by most financial institutions. The five-year variable open
mortgage is payable in full at any time without penalty, but the rate is usually above prime. On the other hand, the
five-year variable closed mortgage provides a rate below or close to prime. The primary difference between the two
products is that a prepayment of the five-year variable closed mortgage results in a penalty.

FEES INCURRED IN BUYING A PROPERTY

Borrowers incur various levies, fees, charges, and taxes in the process of purchasing and financing a property. As
their advisor, you must make sure they understand that they will need cash available for these charges in addition to
the funds set aside for a down payment.
Typically, clients purchasing a home may incur the following fees:
• The CMHC insurance fee

• Appraisal fees
• Inspection fees
• Land transfer tax and other taxes
• Local development charges
• Fees for professional assistance and certifications
• Miscellaneous closing costs
The realtor’s commission on the sale must also be paid, although that money usually comes directly out of the sale
proceeds.
Some of the costs associated with purchasing a property are described in detail below.
MORTGAGE LOAN INSURANCE PREMIUMS

CMHC enables home buyers with at least a 5% down payment to access mortgage financing at interest rates
typically offered to those with a down payment of 20% or more. With a CMHC mortgage loan insurance, the lender
effectively has a Government of Canada guarantee that the loan will be repaid if the borrower defaults. In order to
have a mortgage loan insured by CMHC, the borrower must pay a mortgage loan insurance premium. The premium
fee schedule appears in Table 5.4.
Table 5.4 | Premium Fee Schedule—For Information Only
Mortgage Loan Insurance

LTV Ratio Premium*
Up to and including 95% 4.00%

(Note: this indicates a down (Note: the insurance premium rate
payment of 5%) declines as the percentage of down
payment increases.)
* As a percentage of the mortgage amount.

EXAMPLE
Your clients Raj and Jasmine are buying a home valued at $500,000. They have $25,000 (or 5%) to offer as a
down payment. Their LTV ratio is 95%. Their CMHC mortgage loan insurance premium is calculated as follows:
$500,000 − $25,000 = $475,000 mortgage amount × 4.00% = $19,000
The mortgage loan insurance premium is a one-time fee that can either be paid in full when the loan is first made or
included in the mortgage and amortized over the life of the loan. In the second case, it is repaid over time with each
mortgage payment. The advantage of amortizing the premium over the life of the loan is that it reduces the need
for cash upfront. However, the interest costs for amortizing a fee of up to 4.00% of the loan amount on a property
over 25 years can be significant.
Table 5.4 shows (in the last three rows) that even for loans that qualify as conventional mortgages (which do not
require mortgage loan insurance under the law), the borrower can apply for and obtain that insurance. Lenders may
require an insured mortgage loan for reasons other than insufficient down payment. For example, insurance may be
required if the property is a secondary rental property purchased in an economically depressed region. It may also
be required when the risk of mortgage default is especially high. For example, if the property is in a small city with
only one major employer, the lender may require insurance for the mortgage.
For refinancing and portability purposes, the premium payable to CMHC is the lesser of two amounts:
• A premium on the increase to the loan amount

• A premium on the total loan amount
DIVE DEEPER
The rate schedules for refinance premiums are posted on CMHC’s website.
LAND TRANSFER TAX

A mortgage is usually registered at the same time the property is purchased, and there is usually a provincial tax on
the transfer of the deed to the new owner. In Ontario, for example, the tax is levied on a multi-tiered basis according
to the property’s value.
EXAMPLE
Ontario Land Transfer Tax—For Information Only
0.50% on the first $55,000 of property value

+ 1.00% from $55,000 to $250,000
+ 1.50% from $250,000 to $400,000
+ 2.00% from $400,000
In some cases, depending on the property’s location, the municipality may charge an additional land transfer
tax. For example, residents of Toronto must pay double tax in the form of a municipal land transfer tax plus the
provincial land transfer tax.
DIVE DEEPER
To see the effect of the land transfer tax on the price of a Toronto property, go to your online chapter
and open the following document:
Provincial and Municipal Land Transfer Tax on a Toronto Property

First-time home buyers may be able to take advantage of available rebates on their land transfer fees, subject to the
province or municipality in which the property is located.
MISCELLANEOUS CLOSING COSTS

Borrowers should be prepared to pay any or all of the following costs related to closing a real estate deal:
• A fee for a condominium Status (or Estoppel) Certificate (i.e., a certificate that outlines a condominium
corporation’s financial and legal status)
• A home inspection fee
• Water quality and quantity certificate fees
• A survey fee (for older homes)
• Real estate commissions (payable by the seller)
• Legal fees and disbursements
• Development charges, taxes, and new home warranty fees
• Goods and services tax or harmonized sales tax on new houses
Taxes, charges, and transaction costs for a typical house vary considerably by location. Transaction-related costs
include legal fees, mortgage insurance, land transfer tax, and registry charges. They are usually 2% to 5% of the
purchase price of an average home in most municipalities. Other local charges could increase the total costs
considerably. Overall, fees can add up to a lot of money. Many people are unaware of the extra costs involved in
becoming a homeowner and may not have planned for the additional costs.
DID YOU KNOW?
As an advisor, you should make your clients aware of closing costs in advance of their home search.
Typically, they must have at least 5% down plus an estimated 2% to 5% of the purchase price
(depending on the jurisdiction) for closing costs. These funds must come from a client’s own sources,
especially for high-ratio mortgages.
MORTGAGE BROKER FEE

Some clients use the services of a mortgage broker who is provincially licensed to help people secure mortgage
funds. As with real estate agents, the best way to select a broker is through a reference from a satisfied customer.
Generally, for residential mortgages, the broker is compensated by the lending institution with a finder’s fee for
bringing in the business. The borrower does not generally pay fees to the mortgage broker and does not have to
associate those costs with purchasing a property.
Some financial institutions have created their own teams of mortgage specialists who are not brokers and, unlike
brokers, do not need to be licensed. The mortgage specialists work as employees of the financial institution and
are paid by the institution in the form of a salary or commission or both. The financial institution is responsible for
governing the actions of these specialists and for managing the risks associated with lending the bank’s money.
METHODS OF REDUCING INTEREST COSTS AND PENALTIES
5 | Explain the methods of reducing interest costs and penalties.
In this section, we discuss the methods by which borrowers may take advantage of various options to reduce the
cost of borrowing.

REPAYMENT OPTIONS
Managing their mortgage is an important aspect of financial planning for clients given that it is likely to be the
largest debt they carry. When reviewing how they can do so, the selection of repayment alternatives is an important
consideration. In the long term, by exercising available repayment options, your clients can greatly improve their
financial picture. Mortgage repayment options affect the interest rate, term, amortization period, payment plan,
and payment period, as well as the flexibility offered by prepayment and other options.
DID YOU KNOW?
In discussing mortgages, it is important that you not confuse the concepts of repayment and
prepayment. All mortgages must be repaid on a set schedule; otherwise, the borrower goes into default.
Prepayment involves the voluntary repayment of all or part of the borrowed funds ahead of schedule.
Financial institutions generally offer various options for both repayment and prepayment.
PAYMENT PLANS
The most common payment plan for mortgage loans is one where payments of principal and interest are blended.
However, other methods of payment are possible.
One such option is an interest-only loan with no amortization period, also known as a straight-line mortgage
because the principal portion stays the same. This type of loan is used primarily for bridge financing, rather than
for a conventional home purchase. With bridge financing, funds are advanced to borrowers temporarily so they can
purchase a new home before the sale of their current home is finalized.
Another option is a mortgage with a balloon payment, which is a pre-determined lump sum payable during the
mortgage term or, more commonly, at the end of the term. Longer-term loans, such as a 10-year loan, may have a
contractual requirement for a principal repayment at an earlier date during the term.
PAYMENT PERIODS
Institutions usually offer a choice of weekly, bi-weekly, semi-monthly, or monthly payment periods (i.e., 52, 26, 24,
or 12 annual payments, respectively). Interest costs can be marginally reduced by increasing the payment frequency,
such as from monthly to weekly. Lenders also offer accelerated payments for the same periods. Accelerated
payments can substantially reduce the amortization period, as explained below.
Accelerated bi-weekly Normally, with a bi-weekly payment plan, the regular monthly payment is multiplied
payment by 12 and the result is divided by 26. The accelerated payment, instead, is the monthly
payment amount divided by 2, and 26 payments in that amount are made during
the year. Therefore, the accelerated bi-weekly payment plan has the same number of
payment periods as a bi-weekly payment plan, but the payment amount is higher.
Accelerated weekly Normally, with a weekly payment plan, the regular monthly payment is multiplied
payment by 12 and the result is divided by 52. The accelerated payment instead, is the monthly
payment amount divided by 4, and 52 payments of that amount are made during the
year. Therefore, the accelerated weekly payment plan has the same number of payment
periods as a weekly payment plan, but the payment amount is higher.
Table 5.5 shows the amount of interest a borrower can save over the total amortization under various payment
plans.

Table 5.5 | Payment Plan Comparison for a $120,000 Mortgage at 4%*
Payment Number of Payment Total Period Amortization Total Interest

Frequency Payments per Year Amount Interest Period Saved
Monthly 12 $631.22 $69,367.27 25 years –
Semi-Monthly 24 $315.46 $69,275.90 25 years $91.38
Bi-Weekly 26 $291.18 $69,268.87 25 years $98.41
Weekly 52 $145.56 $69,226.68 25 years $140.59
Accelerated Bi-Weekly 26 $315.61 $59,548.76 21.8 years $9,818.51
Accelerated Weekly 52 $157.81 $59,440.04 21.9 years $9,927.23
* Calculations were done using the Financial Consumer Agency of Canada Mortgage Calculator. https://itools-ioutils.fcac-acfc.gc.ca/MC-CH/
MCCalc-CHCalc-eng.aspx
DID YOU KNOW?
You may encounter situations where clients need to reduce or consolidate their debt. Financial
institutions routinely allow borrowers to skip a payment when they are facing difficult times. However,
this option has a cost: the unpaid interest portion of the skipped payment is usually added to the
principal balance and paid off over time, with added interest.
PREPAYMENT
Mortgage loans are classified as either open or closed. An open mortgage has no restrictions on prepayment (i.e.,
early repayment) of the principal. The money borrowed can be paid back at any time during the term of the loan
without penalty. Generally, interest rates on open mortgages are higher than those for closed mortgages.
A closed mortgage is one where prepayment of the entire principal is not allowed during the term of the loan.
There are, however, statutory regulations concerning prepayment of mortgages.
Most mortgage contracts have a prepayment clause that allows the borrower to repay a percentage of the original
principal amount each year. Most financial institutions allow lump-sum payments that range between 10%
and 20%. Borrowers who pay more than the stated percentage of the principal in a year must pay a penalty.
EXAMPLE
Your client has a $120,000 mortgage at 4% that was originally amortized over 25 years. The monthly payments
are $631.22. Every year for five years, at the end of the year, your client makes a lump-sum payment of
$2,000 on the outstanding balance. The remaining amortization at the end of the five-year term is thereby
reduced by almost three years, and the client pays $1,253.64 less in interest than they would have paid on the
same mortgage with no prepayment.
This ability to prepay the mortgage under certain conditions is an attractive option for borrowers. After a low
interest rate, consumers generally consider the ability to make extra payments without penalties to be one of the
most desirable features of a mortgage. Although the terms of the prepayment option vary among different lenders,
some prepayment rights or penalties are guaranteed by law and cannot be waived by borrowers. These rights are

contained in the Interest Act and apply in all jurisdictions. A prepayment penalty is usually the greater of three
months of interest or the interest rate differential amount1.
As an advisor, you should review the mortgage contract with your client to explain the exact terms of prepayment.
The discussion should cover the conditions under which the mortgage can be paid off in full and the penalties
attached to overpayment.
The NHA, which governs all insured mortgage loans, introduced rules for mortgages on residential properties
purchased after 1999. According to these rules, the only penalty charged on a prepayment or full mortgage payout
is the penalty from the financial institution. Any additional prepayment of the principal benefits the borrower.
The benefit of mortgage prepayment can be compared to that of regular monthly deposits to an RRSP. With
RRSPs, because of compound interest, the earlier a payment is made, the faster the value increases. In the case of
mortgages, lump-sum payments reduce the principal amount, thus reducing the amount of interest owing and
eliminating debt faster.
Some mortgage types allow borrowers to pay extra up to double the payment amount throughout the term of the
mortgage. In other words, a maximum of two mortgage payments can be made in place of a single payment in any
payment period. For example, if the regular monthly mortgage payment is $1,200, the borrower can increase the
payment up to $2,400. The second payment goes directly to reduce the principal balance outstanding. In some
cases, even one double-up payment a year can reduce the amortization period by several years.
HOME EQUITY LINE OF CREDIT

As seen previously, a HELOC is a borrowing facility linked to an existing property’s available equity. It allows a
borrower the ability to borrow funds in the form of an LOC or a mortgage, or combinations of both. Some financial
institutions also allow for the inclusion of a credit card and overdraft. The maximum limit of a HELOC is 80% of the
property’s appraised value.
The setup and allocation of the 80% limit must meet government-approved guidelines. A person may borrow the
full 80% as a mortgage segment or 65% as a LOC limit, with the remaining 15% as a mortgage. Borrowers may
have the allocation of the funds adjusted across the mortgage and loan segments, as long as the limit of the LOC
does not exceed 65% of the home’s purchase price or market value.
DID YOU KNOW?
The 65% limit on a HELOC was imposed to protect lenders and borrowers from the risk that property
values would decline because of a correction in an overheated housing market.
EXAMPLE
Your client Antoine owns a home valued at $500,000 with no mortgage. He would like to apply for a HELOC and
use the funds to purchase a car valued at $80,000. Antoine wants the loan set up as a five-year term loan so that
he is able to pay it off. He would like to keep the remaining equity available for future investment opportunities
that might come up.
Antoine’s bank sets the HELOC up as outlined in Table 5.6.
1
The interest rate differential is the difference between the existing interest rate and the interest rate charged for the remaining term of the
mortgage.

Table 5.6 | HELOC Setup at a Glance
Property value $500,000 × 80% of appraised property value = $400,000 maximum HELOC limit
Allowable Segments Limits per Segment HELOC Setup for Antoine
Line of credit limit Can range between 1% and $320,000 LOC limit (based on 64% of
a maximum of 65% $500,000)
Mortgage segment Can range between 1% and $80,000 car purchase (remaining 16% of
a maximum of 80% $500,000)
Total HELOC = 80%, $400,000 ($320,000 + $80,000)
Clients can use a HELOC for any purpose, including a car purchase or vacation, or to start a small business. Many
use a HELOC for major home renovations. However, they should use caution when using a home’s equity to secure
access to relatively inexpensive credit. The HELOC can provide flexibility, but it also creates risk in that clients may
use their home’s equity to purchase items that do not appreciate in value.
RELATED MORTGAGE TOPICS AND FINANCIAL PLANNING ISSUES
6 | Explain reverse mortgages, self-directed mortgages, real estate investment trusts, the Home Buyers’
Plan, and tax-free First Home Savings Account.
CMHC forecasts continued growth in the demand for housing. However, demographics show that the average age
of household heads is rising, and older people tend to have more assets and more income. For this reason, the role
of residential mortgage credit will change over the next couple of decades. Lenders will likely find that loans are less
risky, and the services advisors provide are likely to be more in demand. Borrowers will seek help in converting their
assets into cash flow and managing their wealth. Annuities and reverse mortgages will become more common, and
new financial products will be developed in response to the changing credit needs of homeowners. In this section,
we discuss the products and services available to address these needs.
REVERSE MORTGAGES
Reverse mortgages, also called home equity conversion mortgages, allow homeowners aged 55 and over to receive
secured loans in tax-free money without having to sell their house. Funds received from a reverse mortgage, derived
from home equity, do not affect any Old-Age Security or Guaranteed Income Supplement benefits that the owners
may be receiving. The amount, which can be anywhere from 10% to 55% of the home’s current appraised value,
can be taken in one lump sum or in regular payments (typically monthly) over a specified period. The total amount
advanced varies with the age of the owner, as well as the location and type of home. Any outstanding loans secured
by the home (such as an existing mortgage or LOC) must be paid off with the proceeds from the loan.
No repayment is required while the owners continue to live in their home–, which is the main advantage of a reverse
mortgage. However, the full amount, including compounded interest on the outstanding balance, becomes due
when the last surviving spouse dies, the home is sold, or the owners move. Reverse mortgage rates tend to be higher
than regular mortgage rates, and total debt carried by the typical senior couple is likely to increase substantially as
the loan builds up. In Canada, the main provider of reverse mortgages is the Canadian Home Income Plan (CHIP)
offered by HomeEquity Bank.

HOME BUYERS’ PLAN

Through the Home Buyers’ Plan (HBP), qualified home buyers can withdraw up to $35,000 from their RRSPs to buy
or build an eligible home in Canada on the condition that they must occupy the property as their primary residence
within one year. Each partner in a couple could withdraw the maximum, for a total limit of $70,000.
The qualified persons are considered first-time home buyers if, in the four-year period, they did not occupy a home
that was their principal place of residence. This rule is waived for disabled persons who have contracted to purchase
or build a qualifying home prior to the withdrawal.
The HBP is also intended to help Canadians maintain home ownership after the breakdown of a marriage or
common-law partnership. To qualify, the client must have been living separate and apart from their spouse or
common-law partner because of a breakdown of their marriage or common-law partnership, for at least 90 days, in
the year of the withdrawal or in the four preceding calendar years. However, where an individual’s principal place of
residence is a home owned and occupied by a new spouse or common-law partner, the individual will not be able to
make an HBP withdrawal under these rules.
A withdrawal under the HBP is not considered income, but rather an interest-free loan from the RRSP. Repayments
to the RRSP are not tax-deductible, and the loan must be completely repaid to the RRSP within 15 years in annual
instalments. The repayment schedule begins in the second calendar year following the year of the withdrawal or by
the first 60 days of the third year. For example, if a withdrawal is made in 2022, the first instalment is due no later
than the first 60 days in 2025. The repayment cannot be made to a spousal plan.
The annual minimum payment is $2,333 for a $35,000 withdrawal. There is no annual maximum repayment
and ideally, the loan should be repaid to the RRSP as quickly as possible. If a repayment is missed, the annual
amount is considered an RRSP withdrawal and taxed as part of the client’s income for that year. Amounts should
be completely repaid by the end of the year in which the plan participant turns age 71. If the loan amounts are not
repaid, the remaining scheduled payments must be included as income in each year as they come due.
DID YOU KNOW?
Contributions made to an RRSP less than 90 days before a withdrawal are not eligible to be used under
the Home Buyers’ Plan.
TAX-FREE FIRST HOME SAVINGS ACCOUNT

The April 7, 2022 federal budget announced a new measure to make first-time home ownership easier by providing
a significant incentive to save money for a down payment.
A tax-free First Home Savings Account (FHSA) will be available for first-time home buyers. This new account
combines some features of a TFSA, an RRSP, and an HBP.
To qualify, a borrower must be a resident of Canada age 18 or over who has not lived in a home they owned in the
year the FHSA is opened or in the previous four calendar years. Qualified borrowers will be eligible to contribute
$8,000 a year up to a maximum limit of $40,000. Like an RRSP, contributions to the FHSA will be deductible from
income taxes. And, like a TFSA, income earned within the account will not be taxed, and withdrawals from the
account, when used to buy a first home, will be tax-free.
The government will be working with major financial institutions to ensure that contributions by potential first-time
home buyers to an FHSA can begin in 2023.
If, for any reason, withdrawals from an FHSA are not made to buy a first home within 15 years, the monies in the
account can be transferred without any tax implications to an RRSP or RRIF. This transfer could be made in addition
to regular RRSP contribution room. Like an HBP, it will also be possible to transfer funds from an RRSP to an FHSA
up to the FHSA’s maximum limits, both annual and lifetime. This offers an advantage over an HBP because funds
transferred to an FHSA will not have to be repaid to the RRSP. A couple of restrictions to note – withdrawals cannot

be made from both an HBP and an FHSA for the same home being purchased. Also, tax-free withdrawals from an
FHSA can only be made for one home during an individual’s lifetime.
SELF-DIRECTED MORTGAGES
Another mortgage option is a non-arm’s length mortgage, where clients can use their existing RRSP as a source of
mortgage funds to buy a home. Clients may arrange with a trust company to advance funds from their self-directed
RRSP for their own mortgage. In effect, the client becomes both lender and borrower.
In such transactions, clients must follow several rules, primarily around the interest rate charged. The client cannot
charge more or less than current market interest rates, so investing in this type of plan must make sense. Monthly
payments must be made to the lender (i.e., the RRSP), just as with a regular mortgage. To be considered a qualified
investment for an RRSP, the mortgage must be insured and administered by a financial institution approved under
the NHA. Terms and conditions must be similar to what would be available to an unrelated borrower, and no special
privileges, such as prepayment, can be granted.
Holding one’s own mortgage within an RRSP is an investment decision that few people take advantage of. Setting
up and administering such a plan can be complicated and expensive. However, you may encounter clients who feel
strongly that a mortgage held in this way will produce returns higher than those available through other forms of
RRSP investment. In such cases, you should consider the possibility and do the necessary analysis.
You can also help clients resolve the pay-down dilemma. With clients who have excess cash available, you can help
determine whether they should pay down their mortgage or invest the funds in an RRSP. Both are excellent savings
mechanisms, but the final decision rests with the client. You could undertake sensitivity analysis—that is, an analysis
of how sensitive each outcome is to changes in the assumptions. Your analysis should take into consideration the
client’s RRSP portfolio, tax implications and long-term debt reduction goals considering the following factors:
• The client’s age and proximity to retirement

• The principal balance of the mortgage and the remaining amortization period
• The mortgage interest rate and current market rates
• The current value of retirement investments
• Prospective cash flows over the period
REAL ESTATE AS AN INVESTMENT

As your baby boomer clients near retirement, you will need to assess the interrelationship between real estate and
other investment assets. Real estate has traditionally been a sound investment, and rental properties are likely to
form part of many clients’ investment portfolios. Investment opportunities also include MBS (discussed previously),
mortgage mutual funds, and real estate investment trusts (REITs).
A REIT is a securitized investment vehicle in which investors own a portion of a portfolio of commercial real estate.
Income generated by REITs is distributed to REIT unit holders retaining its original nature—for example, interest
income or capital gains. These securities offer investors immediate income and the potential for capital appreciation.
They also offer liquidity because the investor can buy or sell listed REIT units through the listing exchange.
Alternatively, investors may buy rental properties, such as a condominium, townhouse, duplex or triplex, or even
a low-rise apartment building. The properties are bought with leverage in mind, which means that the investor
intends to use borrowed funds for maximum growth potential. Ideally, the rental income should cover borrowing
costs, property taxes, and maintenance, as well as providing a modest positive cash flow. Property owners can claim
capital cost allowance for tax purposes, thereby sheltering income that would otherwise be paid out in taxes.
The main reason for owning rental real estate as an investment is to generate capital gains as the property increases
in value. In the past few years, property values in most regions of Canada have shot up, rewarding rental property

owners with substantial capital gains. However, when the residential property market declines, rental property
owners may be left with severe losses, as happened in Canada in the late 1980s and early 1990s. When declining
property values are combined with rising interest rates, it can act as a double blow. For example, during 2007,
nearly 1.3 million U.S. housing properties were subject to foreclosure activity, up 79% from 2006. In 2008, the
mortgage and credit crisis resulted in the greatest number of mortgage foreclosures in history, and had devastating
repercussions on the U.S. economy, with reverberations throughout the world.
Other forms of real estate may form part of a client’s asset base. This chapter focuses on residential mortgages, but
many of the principles and terminology are transferable to other types of real estate. As with any investment, you
and your clients must assess tax, capital, and cash flow implications. You must also apply the principle of caveat
emptor (buyer beware) and take the time to research and understand the investment.
SCENARIO: ERNIE AND BILL
Assess your understanding of mortgage concepts by resolving a client scenario. Complete the online
BUYING A FIRST HOME
At the beginning of this chapter, we presented a scenario in which the Millers’ son Andy was planning to buy his
first house. The Millers were looking for guidance in the context of managing debt and taking on a mortgage.
Now that you have read the chapter, we’ll revisit those questions and provide some answers:
• How can you advise Andy and his parents to ensure that Andy qualifies for a mortgage and can manage his debt
responsibly?
• Advise him to focus borrowing on purchasing assets that will increase in value. For example, it would be
better to buy a house or condo than a luxury car.
• Tell him that if he keeps his TDS and GDS ratios in line, it will be easier for him to qualify for financing.
• Advise him about the benefit of using RRSP savings under an HBP to increase the down payment.
• What direction can you provide to ensure that Andy gets the right type of mortgage and can manage the various
costs associated with the purchase of a home?
• Andy should look for flexible borrowing terms that allow for greater freedom to manage debt. For
example, prepayment and payment acceleration terms will help him pay down the mortgage faster and
save on interest.
• With a substantial down payment, he can avoid having to purchase a high-ratio and paying for a mortgage
loan insurance. Therefore, his costs will be lower because he will not have to pay the mortgage loan
insurance premiums.
• A fixed interest rate can protect him from rising interest rates.
• Accelerated payments can lower his interest costs by directing more of his blended payment to the
principal.
• Andy will need to consider land transfer taxes, legal fees, and furnishing costs when budgeting for a home
purchase.
• Apart from gifting the funds, are there other ways the Millers can help Andy purchase a home? What implications
might there be if they were to use those options?
• They can consider co-signing a mortgage with Andy or making a loan to Andy, rather than gifting the funds.
These options must be closely examined, and, in most cases, it is prudent to consult with a legal advisor.

SUMMARY
In this chapter, we discussed the following key aspects of consumer lending and residential mortgages:
• The various types of credit include overdrafts, credit cards, charge accounts, personal lines of credit, personal
loans, demand loans, mortgage loans, and HELOCs.
• Whether or not clients qualify for credit depends on their financial situation and how they present their
situation to the lending institution. The Five Cs of credit, which help to determine creditworthiness, stand for
character, capacity, credit, collateral, and capital.
• The mortgage marketplace consists of the primary market for mortgage funds and the secondary market, where
debt instruments are bought and sold. The primary market refers to the retail source from which borrowers
access funds to buy real estate. The secondary market is where existing mortgages and blocks of mortgages held
by lenders are bought and sold.
• The maximum house price clients can afford usually consists of two main elements: the monthly mortgage
payment they can afford to make and the down payment they have available. As their advisor, you must
consider six key financial factors: LTV ratio, debt service ratios, mortgage stress test, term and amortization,
interest rate, and fees incurred in buying a property.
• Borrowers may take advantage of various options to reduce the cost of borrowing, such as accelerated
repayment and prepayment.
• The most common payment plan for mortgage loans is one where payments of principal and interest are
blended. Other options include the interest-only loan with no amortization period (also known as a straight-line
mortgage) and the mortgage with a balloon payment.
• As an advisor, you should help your clients evaluate their reasons for borrowing funds and make sure their
cash flow is adequate to repay the loan. You can also help them manage their debt by planning and controlling
expenses with a projected cash flow.
• New financial products are being developed in response to the changing credit needs of homeowners. Current
options available to address such needs include reverse mortgages, the HBP, tax-free First Home Savings
Account, self-directed mortgages, and real estate as an investment.
DISCUSSION BOARD
for Chapter 5.
REVIEW QUESTIONS
Questions.

Legal Aspects of Family
Dynamics 6
CHAPTER OUTLINE
In this chapter, we introduce the various family-related dynamics that may be revealed when you are dealing with
a client’s finances. We also consider the fragility of the family unit and the issues related to marital breakdown. You
will learn about aspects of family law in Canada relating to rights arising from cohabitation, marriage, separation,
and divorce. This chapter will acquaint you with family law rights and obligations arising from relationship
breakdown. We focus on both federally and provincially governed aspects of family law. Federal areas of the law
for married spouses include divorce, child custody and access, spousal support, and child support. The provinces
and territories govern issues around marital property division in their separate jurisdictions. For unmarried spouses,
issues relating to child custody, access, and support also fall under provincial and territorial property legislation.
1 | Describe the topics of conversation relating to Family-Related Issues

family issues that advisors should initiate with
their clients.
2 | Identify family law issues arising from Fundamental Aspects of Family Law
relationship breakdown, including separation,
divorce, custody, and access to children.
3 | Describe common domestic contracts (such as Domestic Contracts

cohabitation agreements, marriage contracts,
and separation agreements) and related
challenges.
4 | Examine the concept of net family property. Property Issues on Relationship Breakdown
5 | Explain the impact that divorce could have on Impact of Divorce on a Client’s Financial Plan
a client’s financial plan.

KEY TERMS
access matrimonial home
cohabitation agreement maximum contact principle
common-law relationship net family property
divorce order parens patriae
duress parenting arrangement
equalization of net family property separation agreement
equalization payment shared parenting
grey divorce sole custody
joint custody spousal support release
marriage contract unconscionable bargain

CHAPTER 6 LEGAL ASPECTS OF FAMILY DYNAMICS 6•3
INTRODUCTION
For most clients, a discussion about family issues evokes the strongest emotional response of any among the
planning issues you might bring up. Whether it involves protecting a spouse, naming future leaders of a family
business, looking after the needs of minor or adult children, or helping aging parents, your clients will likely consider
family to be one of the strongest drivers in their financial decision-making.
Family wealth planning issues often arise in parallel fashion to the various life-stage issues. The life stages of family
formation, home purchase, career change, children’s education, empty nest, retirement, and death are all closely
tied to family wealth planning issues. In fact, your client discovery process will elicit more useful information,
challenges, and concerns if you focus on the issues that families face together.
The most common domestic contracts, including cohabitation agreements, marriage contracts, and separation
agreements, are mainly entered into to protect the family unit from potential conflict and friction. However,
separation or divorce is an unfortunate reality that can have severe repercussions on all members of the family unit.
As such, it is essential that, as a wealth advisor, you understand the basic framework of family law in Canada.
Relationships, including those of unmarried couples, inevitably bring an intertwining of lives and finances. When
cohabitation or marriage is contemplated, legal advice can help prospective spouses understand their potential
future obligations and entitlements, as well as their contractual options.
Upon a relationship breakdown, spouses should seek advice from a lawyer who practices in the area of family law.
As a wealth advisor, you must be mindful of the effects of your clients’ already existing domestic contracts during
financial or estate planning. Family law legislation and case law are complex. Each case revolves around its unique
facts. The purpose of this chapter is to provide a basic introduction to family law.
NOTE
Because provincial and territorial laws vary considerably across Canada, this chapter will focus on Ontario
laws only. However, in dealing with family law matters, you must always consider the laws of the applicable
jurisdiction and urge your clients to obtain the appropriate legal advice from qualified counsel.
For exam purposes, all content in this chapter is examinable, regardless of your province of residence.
Before you begin, read the scenario below, which raises some of the questions you might have about family law.
Think about these questions, but don’t worry if the answers don’t come easily. At the end of the chapter, we will
revisit the scenario and provide answers that summarize what you have learned.
FINANCIAL PLANNING AFTER MARITAL SEPARATION
Linda Lee, who has been your client for several years, calls you with news that she and Tony, her husband of
10 years, are separating. You have met Tony on several occasions, and the couple has a jointly established
registered education savings plan for their two children. Otherwise, however, Tony does not maintain investment
accounts with you. Linda confides that she is unhappy about the separation, which Tony has initiated.
Tony has been successful in his career as a film executive. Linda, on the other hand, gave up a thriving career in
women’s fashion to raise their two children, which freed Tony to pursue his career. She maintained the household
and regularly entertained Tony’s clients and prospects.
With both children now in school, Linda has recently returned to work in her field of expertise. However, she has
had to begin at the bottom to re-establish herself and is earning only a fraction of what she was earning when
she left the industry six years ago.

The couple signed a pre-nuptial agreement prior to their marriage.
• Given the complexity and emotional impact of separation and divorce, what specialists from your team can best
support your client through this difficult and challenging period?
• What does Linda need to know to protect herself and her interests in light of the couple’s separation?
FAMILY-RELATED ISSUES
1 | Describe the topics of conversation relating to family issues that advisors should initiate with their
clients.
A primary challenge facing advisors today (and a huge threat to their book of business) is the intergenerational
transfer of wealth. It is estimated that, within the next ten years, $750 billion will flow from the over-75 cohort to
the next generation of 50- to 75-year-olds1.
In addition, advisors face a threat from inter-spousal wealth transfer. Many advisors have seen a large portfolio
taken away and a strong relationship dissipate when a client dies and the surviving spouse moves the inheritance to
an advisor they feel more comfortable with.
It is generally true in baby boomer households that most younger family members have not had detailed
discussions with their parents about the elders’ financial situation. From a financial planning perspective, this
omission represents a huge void for advisors when it comes to understanding the future obligations and emotional
concerns of their retirement-age clients.
It has always been a good idea for advisors to have intergenerational conversations whenever possible. Today, these
conversations are even more important as aging boomers and their parents discuss their current goals and desires
around estate planning. The aging boomer children may end up being both the beneficiaries and executors of their
parents’ estates. Along with wealth transfer, your clients may be facing these key issues with respect to family
dynamics:
• Gifting money or assets to family

• Funding education for children or grandchildren
• Financial support of minor or adult children
• Future leadership and direction of the family business
• Long-term care of a spouse or aging parents
• Elder abuse
• Leaving estate assets to charity
A big concern with regard to retaining assets is the possibility of divorce. With the number of marriages ending in a
divorce (around 40% is the general consensus), the prospect of an advisor losing a large portion of a client’s assets
increases dramatically.
Life transitions are key tests for both the client and the advisor. For example, through divorce or bereavement, many
clients become sole financial decision-makers. Advisors who have not established a strong trust relationship with
both spouses are at a higher risk of losing clients.
1
CIBC, Angus Reid, 2016, quoted in Financial Post, June 2016

Divorce among aging Canadians, known as grey divorce, has been on the rise for the past two decades. In fact,
in 2013 the average age of divorce for men was 44.5, and for women it was 41.5. The divorce rate for those over the
age of 50 has doubled in the past 25 years2.
New studies suggest that there is a considerable adverse impact on the health and well-being of Canadian retirees
who have gone through divorce later in life.
Retirement often results in a change in the dynamic between spouses or partners. Over the years, the demands of
work and raising a family can cause a couple to go in different directions. Retirement suddenly forces them to spend
more time together and get to know each other again. They may find that the bond created when raising children
together dissolves when the children are gone. Partners who have stayed together until the children leave are now
in a position to decide whether they, too, are ready to start a new life. In this new phase, a re-examination of all
aspects of their lives can sometimes lead to the decision to end a long-term marriage.
THE ROLE OF THE ADVISOR IN DIVORCE

When you are advising a client or couple going through a divorce, there are some obvious ethical considerations. For
example, if you have worked with both spouses in the past, the question arises as to whether you can still work with
each of them separately. A divorce sets up some potential problems regarding privacy, conflicts of interest, and the
requirement to act in the best interests of each client.
When working with a couple who are going through divorce, it is easy to become emotionally involved. After all, you
have developed friendships with long-term clients, and it can be difficult to remain impartial or dispassionate.
When advising clients in the process of separation, you must understand the general dynamics of separation
and its financial and emotional impact on families. You must avoid conflicts of interest and advise your clients to
retain independent legal advice immediately upon separation. You can provide invaluable assistance by working
cooperatively with a separated spouse and their legal advisor to prepare a forward-looking financial plan, taking into
account the financial and tax-related consequences of a relationship breakdown.
FUNDAMENTAL ASPECTS OF FAMILY LAW
2 | Identify family law issues arising from relationship breakdown, including separation, divorce, custody,
and access to children.
Family law in Canada is nuanced, multifaceted, and constantly evolving. Common misconceptions sometimes lead
clients into uninformed and unfair arrangements. Family law orders and agreements may have an impact on the
financial well-being of spouses and children for years to come. In order for clients to properly understand their rights
and obligations as spouses, you must encourage them to obtain legal advice from a lawyer who practices in the area
of family law as soon as possible, even if separation is only contemplated. If clients seem reluctant to seek legal
advice, you should make them aware of the harm that can come from decisions made at separation without the
benefit of such guidance.
Courts are reluctant to set aside contracts; accordingly, it is in a spouse’s best interest to negotiate an agreement
with legal advice and full financial disclosure, rather than to enter into a contract impetuously and then be faced
with the arduous task of attempting to set aside an improvident contract at a later date. On the other hand, if both
spouses retain counsel as soon as possible, exchange disclosure, and then enter into a fair and reasoned agreement,
they are in the best position to make informed decisions about the resolution of their matter.
2
Statistics Canada 2008, Sun Life 2016

Separating spouses typically pass through an emotional cycle of guilt, denial, anger, sadness, and, ultimately,
acceptance. The spouses may be at different stages in the grief cycle. As an advisor, you should be mindful of your
client’s emotional state and the effect it may have on their decision-making, which could lead to a premature
or poorly thought out settlement. A comprehensive and fair resolution will require legal advice and adequate
disclosure.
In this section, we provide a brief explanation of family law issues.
MARRIAGE
The federal Civil Marriage Act received Royal Assent on July 20, 2005. The legal definition of marriage under the Act
is “the lawful union of two persons to the exclusion of all others”. With this revised wording, the Act extends equal
access to civil marriage to same-sex couples. Likewise, the definition of “spouse” under the Divorce Act was changed
to “either of two persons who are married to each other”, thus reflecting gender-neutrality for married couples.
The Civil Marriage Act contains three requirements for marriage:
• Both parties must have “free and enlightened consent” to be the spouse of each other.
• Both must be at least 16 years of age to marry.
• No person may contract a new marriage until every previous marriage has been dissolved, whether by death,
divorce, or nullity.
Under the British North America Act, 1867, the federal government has legislative responsibility for marriage
and divorce. For this reason, the laws regarding marriage and divorce are uniform across Canada. However, each
province and territory is responsible for legislation regulating the marriage ceremony; therefore, some variation
exists from province to province.
UNMARRIED SPOUSES
Although often used, the term common-law relationship is not a legally defined term under the Family Law
Act. This Act defines the term “cohabit” to mean “live together in a conjugal relationship, whether within or
outside marriage”. In this chapter, we use the term unmarried spouses to refer to a couple living together in such
a relationship.
Part III of the Family Law Act deals with child and spousal support obligations. The definition of spouse in this section
includes persons who are not married to each other and have lived together continuously for at least three years or
who had a child together and lived together “in a relationship of some permanence”. Accordingly, rights to spousal
support are available to unmarried spouses under the Family Law Act. However, unmarried spouses in Ontario are
not entitled to seek an equalization of net family property (covered in detail later in the chapter). Part I of the
Family Law Act restricts the definition of spouse to married persons. To date, in Canada, the distinction between
married and unmarried spouses has withstood scrutiny by the Supreme Court of Canada under the Charter of Rights
and Freedoms.
DID YOU KNOW?
In Ontario, only married spouses are entitled to seek an equalization of net family property. However, in
some other Canadian jurisdictions, including British Columbia, Manitoba, and Saskatchewan, property
rights have been extended to unmarried spouses who have cohabited for a defined period. Cohabitation
dates may be difficult to determine, whereas marriage dates are rarely in dispute.

DIVORCE
Divorce is the final, legal ending of a marriage, by court order. In Canada, divorce is legislated under the exclusive
jurisdiction of the federal government under the Divorce Act, 1985. Although corollary issues arising from the
breakdown of a marriage may be in dispute, the issuance of the divorce itself is usually uncontested.
Under the current Act, the sole ground for granting a divorce is breakdown of the marriage. Breakdown is
established if spouses have lived separate and apart for at least one year, or if there is a finding of adultery or mental
or physical cruelty by the court. An application for divorce may be issued immediately upon separation; however,
the court will not grant the divorce until the spouses have been separated for one year; except in rare cases when a
finding of adultery or cruelty has been made.
DID YOU KNOW?
The legal test for living separately is an intention to separate. Many spouses continue to live in the same
home after separation, while still fitting the legal definition of living separate and apart.
Because conduct is no longer a relevant factor in the determination of corollary issues under the Divorce Act,
including custody and support, claims for divorce based on adultery or cruelty are increasingly rare. Most people
prefer to avoid the financial and emotional expense of gathering evidence to prove adultery or cruelty. The fact of
separation exists in all cases where a divorce is sought, and most spouses rely solely on that factor.
Based on section 9(1) of the Divorce Act, every lawyer acting on behalf of a spouse in a divorce proceeding has the
responsibility to discuss the possibility of reconciliation. This responsibility includes two main duties:
• Draw the client’s attention to provisions of the Act, which encourage spousal reconciliation.
• Inform the client of marriage counselling services that are available.
In some cases, however, it may be inappropriate to discuss reconciliation (e.g., where there is a history of abuse).
DID YOU KNOW?
As a matter of public policy, divorce legislation encourages reconciliation; however, the decision of one
spouse to end the marriage is sufficient to effect the separation and commence the divorce process.
Based on section 11 of the Divorce Act, the court must be satisfied that reasonable arrangements have been made
for the support of the children of the marriage before a divorce is granted. The court will not issue the divorce order
until arrangements are made.
A spouse may issue an application for divorce at any time after the breakdown of a marriage, provided that he or
she has resided in the province or territory for at least one year by the time the claim is issued. However, in order
for the application to be issued, one or both spouses must have resided in the appropriate jurisdiction for at least
one year. If there are children of the marriage for whom claims are made, the application must be issued in the
municipality where the children reside.
Many spouses seek to resolve the issues arising from their marriage breakdown by separation agreement.
However, before issuing a claim seeking only a divorce, a spouse may seek other relief in the divorce application,
including, but not limited to, claims for the following issues:
• Custody of and access to children

• Child and spousal support or indexing of spousal support
• Security for support, such as the maintenance of life insurance
• Partition and sale of real property

• Equalization of net family property

• Trust claims
• Restraining orders
• Costs
In Ontario, the final divorce judgment is called the divorce order. The divorce itself takes effect on the 31st day after
the day on which the divorce order is granted. A person may then obtain a divorce certificate, which verifies that no
appeal has been issued. The divorce certificate permits the former spouses to remarry.
If spouses have been separated for a year, and the other issues such as custody, support, and property have not
yet been resolved, a spouse may seek an order to sever the divorce from the corollary issues in order to obtain a
prompt divorce. However, certain rights may be affected by the divorce issuing. For example, properties cease to be
matrimonial homes upon divorce, which may mean that a non-owning spouse could lose the right to possession
of a home or cottage, or the ability to prevent its sale or encumbrance (a mortgage or other charge on property or
assets). Extended health insurance benefits for the insurance holder’s spouse usually end at divorce. Accordingly, it
is important for both spouses to consider the potential consequences if the divorce is granted before all other issues
are resolved.
CUSTODY OF, AND ACCESS TO, CHILDREN

Issues relating to custody of, and access to, children of divorce fall under both federal and provincial jurisdiction.
If the parents are married, the federal Divorce Act governs; if unmarried, provincial legislation applies. In Ontario,
the relevant legislation is the Children’s Law Reform Act.
Custody and access rights are determined based on the best interests of the child. A common misconception exists
that custody and access are the right of a parent. In fact, it is the child’s right to have a relationship with his or
her parent. Grandparents or any other person may also seek custody or access to a child under the Children’s Law
Reform Act.
Parents often develop their own parenting plans and support arrangements and incorporate them into separation
agreements. However, parents cannot contract away the rights of their children. The court reserves the right to
make decisions in the best interests of children, with respect to both parenting and child support. This right, called
the court’s parens patriae jurisdiction, allows the court to intervene to protect the rights of a child.
Custody typically refers to the rights and responsibilities of a parent to make major decisions about a child; it is not
synonymous with parenting time. Policy makers, courts, and parents are increasingly moving away from the term
custody, which implies ownership and control. Many separating parents create parenting plans based on detailed
residency schedules and decision-making protocols without using the terms custody or access.
Parents know their children best, and children tend to do best when their parents are able to negotiate or mediate a
child-focused parenting plan. If parents cannot resolve their parenting issues cooperatively and turn to the court to
impose a parenting schedule, the result may be unsatisfactory for either or both parties.
DID YOU KNOW?
Most experts in childhood psychology agree that it is conflict, not parental separation itself that
harms children. Children suffering from exposure to conflict before separation may be relieved when
their parents separate. On the other hand, when parents engage in combative custody disputes after
separation, that ongoing conflict will likewise harm children. Children should be protected from parental
disputes, rather than burdened with them.

SOLE CUSTODY ORDERS

Sole custody orders are increasingly rare; however, they are still issued in cases where a primary parent has full
care and control of a child, with limited access rights to the non-custodial parent. With sole custody, the legal
responsibility for decision-making regarding a child rests with the custodial parent. However, under section 20(5) of
the Children’s Law Reform Act, the other parent retains the right to make inquiries and to be given information as to
the health, education, and welfare of the child.
A sole custody order is sometimes made if there is a risk of child abduction. The Civil Convention on the International
Aspects of Child Abduction, also known as the Hague Convention, has been adopted in many countries worldwide,
including Canada. This convention provides for the return of children improperly removed. However, not all
countries are signatories to this important international law. Parents who have a legitimate fear of child abduction
should immediately engage family law counsel to seek appropriate safeguards by court order.
In some cases, a child may be found to be at risk in a parent’s care. In those cases, the other parent may seek that
access be supervised. The parent seeking such an order has the burden of proving that supervision is necessary.
JOINT CUSTODY ORDERS

Joint custody usually refers to a parenting arrangement in which the parties share major decision-making
relating to the child after their separation or divorce. The term “joint custody” does not necessarily refer to a shared
residency schedule. Shared parenting is the term generally applied to parenting schedules that meet a certain
threshold under section 9 of the Child Support Guidelines; namely, that each parent has the child in his or her care at
least 40% of the time.
Major parental decisions usually include decisions about a child’s education, upbringing, religious training, medical
care, and general welfare. In joint custody arrangements, a mechanism is often agreed upon to deal with an impasse
in decision-making. For example, parents may agree to retain an experienced childcare professional, such as a social
worker or psychologist, to act as a parenting coordinator. The coordinator assists the parents and mediates or arbitrates
when conflicts arise. Parenting coordinators do not usually deal with material changes or fundamental variations to the
parenting plan. If a material change arises justifying a variation, clients should immediately seek legal advice.
To co-parent effectively after separation, parents must communicate civilly with each other regarding the child’s
needs. Each parent has a legal obligation to facilitate the child’s relationship with the other parent, and parenting
plans should include a regular and enforceable residency schedule. However, all parenting plans require flexibility.
Parents must be willing to adjust their schedules to accommodate unforeseen events and the changing needs of
both children and parents.
BEST INTERESTS OF THE CHILD

The Divorce Act stipulates that a child should have as much contact with each parent as is consistent with the
best interests of the child. This provision is commonly referred to as the maximum contact principle. In making
decisions about custody and access, courts take into consideration the willingness of the person seeking custody to
facilitate the child’s access to the non-custodial parent.
The best interests test is set out in section 16(8) of the Divorce Act and section 24 of the Children’s Law Reform Act
in Ontario. Under the Children’s Law Reform Act, various factors must be considered in determining the child’s best
interests:
• The love, affection, and emotional ties between the child and the person claiming custody or access
• The same consideration regarding other persons, including the other parent, grandparents, other family
members residing with the child, and other persons involved in the child’s care and upbringing
• The child’s views and preferences, if they can be reasonably ascertained
• The length of time the child has lived in a stable home environment

• The ability and willingness of each person to give the child guidance and education, as well as provide for the
necessaries of life and any special needs
• The plan proposed by each person for the child’s care and upbringing
• The permanence and stability of the home situations
• The ability of each person seeking custody to act as a parent
• The nature of the person’s relationship with the child (i.e., whether a familial relationship exists)
Each case is driven by its particular facts and focuses on the child’s needs, rather than the wishes of the parents or
other persons claiming custody or access.
A court may order an assessment of the needs of the child and the ability and willingness of both parties to meet
those needs. In such cases, an expert psychologist, social worker, or psychiatrist will meet with the parents, the
children, and other collateral parties to prepare a report and recommendations on the best interests of the child.
Assessments may be particularly helpful if clinical issues exist, such as a child with special needs or a parent with
mental health issues. In Ontario, the Office of the Children’s Lawyer (OCL) may be appointed by court order to
provide a social work investigation regarding the needs of younger children, or the OCL may act as counsel for older
children. Even when court-ordered, however, the OCL has the right to decline involvement.
Although a court generally shows appropriate deference to the findings of an assessor or the OCL, the reports of
the assessor or OCL are evidence only and remain subject to scrutiny. The court cannot abdicate its decision-making
power to the assessor or OCL and will often make decisions that do not precisely mirror those recommendations.
An assessment or OCL report does not dictate the outcome of parenting issues. At the same time, many matters
settle after parents hear the results of the assessment or OCL involvement, given the expertise of the assessor
or OCL.
VARIATIONS TO ORDERS FOR CUSTODY OR ACCESS

The Divorce Act and the Children’s Law Reform Act both provide for variations of final orders for custody or access.
Under these provisions, a court may order a variation if the court is satisfied that there has been a change in the
condition, means, needs, or other circumstances of the child since the making of the custody order. In making the
variation, the court takes into consideration only the best interests of the child, as determined by reference to that
change.
Children change dramatically as they grow up. Transitions from infant to toddler to school age to teen years create
changes in circumstances justifying a change in parenting arrangements. Although most parties agree to organic
changes as children age, with longer stretches of access and other adjustments, the court is sometimes required
to intervene to recognize appropriate changes. Moreover, as children grow up, their views and preferences become
clearer and therefore more important in the determination of parenting arrangements. The wishes of a three-year-
old child regarding parenting arrangements cannot be reasonably ascertained, whereas those of a mature 13-year-
old may well be considered. Generally, as children grow up, they are increasingly given a voice in determining
parenting arrangements, although voice should not be interpreted as choice. On the contrary, even older children
should not be forced to make a choice.
DOMESTIC CONTRACTS
3 | Describe common domestic contracts (such as cohabitation agreements, marriage contracts, and
separation agreements) and related challenges.
Domestic contracts are addressed in the Family Law Act in Ontario. A domestic contract allows the parties to define
their rights and obligations, opt out of some legislative provisions, and regulate their own financial arrangements.

CHAPTER 6 LEGAL ASPECTS OF FAMILY DYNAMICS 6 • 11
The most common domestic contracts under Ontario law are cohabitation agreements, marriage contracts, and
separation agreements. As an advisor, you should always inquire about the existence of any such domestic contracts
that may affect your clients’ financial and estate planning.
FORMALITIES OF A DOMESTIC CONTRACT

Under the Family Law Act, a domestic contract must meet basic requirements to be enforceable. It must be made
in writing, signed by the parties, and witnessed. Both parties must provide full financial disclosure. Although
independent legal advice is not a formal statutory requirement, it is highly advisable to seek legal advice, and the
lack of it will often undermine the enforceability of a contract. With full disclosure and legal advice, both parties
will be in the best position to make informed decisions about the crucial issues that arise upon a relationship
breakdown.
Domestic contracts are regularly challenged. If each party has had independent legal advice during negotiations,
a contract is more likely to be upheld. On the other hand, without the benefit of such advice, the contract may be
found to be invalid, particularly if one party is alleged to have greater bargaining power.
DID YOU KNOW?
Although neither party can be forced to obtain legal advice, it is highly advisable that both do so before
drawing up a domestic contract.
Upon application, a court may set aside a domestic contract, or a provision within the contract, if any of the
following circumstances have occurred:
• One party failed to disclose to the other significant assets or liabilities that existed when the contract was
made. In other words, spouses must continue to disclose their financial circumstances up to the time that the
agreement is finalized, not just the circumstances at the date of separation.
• One party did not understand the consequences of the domestic contract. This threshold may be met if the
spouse did not receive proper legal advice.
• The contract is not enforceable because of duress, fraud, coercion, undue influence, or unconscionability.
In fact, the threshold for these factors may be lower in family law than in other areas of the law.
EXAMPLE
In the 2008 decision on LeVan v. LeVan, the Ontario Court of Appeal set aside a marriage contract based on
the lack of financial disclosure at the time of its negotiation. This case has set a high bar for disclosure in the
negotiation of cohabitation agreements and marriage contracts. The court also found that, even if grounds to
set aside a domestic contract are established, the court retains discretion to honour the contract or set it aside.
Fairness is an important factor in the court’s decision.
Domestic contracts often include releases, including spousal support releases. A spousal support release is a
final and irrevocable waiver of the right to claim support from the other spouse. A release cannot be court-ordered
and can only be contracted between the spouses. The serious consequences of a release must be impressed upon
both spouses. Lump-sum support or other valuable consideration is usually offered in exchange for a spouse’s
relinquishment of support rights.
COHABITATION AGREEMENTS
The Family Law Act in Ontario states that two persons who cohabit or intend to cohabit, and who are not married
to each other, may enter into a cohabitation agreement. In such a contract, the couple usually contracts about their
respective rights and obligations upon a relationship breakdown and death.

A cohabitation agreement often deals with ownership in or division of property and spousal support obligations.
A cohabitation agreement cannot contract about child custody, access, or support. Child-related issues can only be
dealt with based on the best interests of the child and child support laws at the relevant time.
If the parties to a cohabitation agreement marry each other, the agreement becomes a marriage contract. However,
drafters should be vigilant to ensure that the cohabitation agreement contemplates issues that would only arise
upon marriage, such as equalization provisions and matrimonial home rights.
MARRIAGE CONTRACTS
A marriage contract is an agreement between parties who are already married or who are planning to get married.
Under the Family Law Act, two persons who are married to each other or who intend to marry may enter into an
agreement in which they set out their respective rights and obligations on marriage breakdown or death.
A marriage contract usually addresses ownership in, or division of, property and spousal support obligations. As
with cohabitation agreements, a marriage contract cannot address the right to child custody, access, or support.
Furthermore, a provision in a marriage contract that attempts to limit a spouse’s rights regarding possession,
transfer, and encumbrance of the matrimonial home is unenforceable.
Usually, a cohabitation agreement or marriage contract focuses on property rights and spousal support rights on
relationship breakdown. Often, the party who would like to enter into the contract has been through an earlier
separation or has substantial wealth or expectations of future wealth. All parties to a cohabitation agreement or
marriage contract must have legal advice in order to gain a sound understanding of their rights now and in the
future.
In some cases, a person seeking a marriage contract has verifiable date-of-marriage deductions and simply wants
credit for what he or she is bringing into a marriage. In those cases, a contract may not be necessary, provided that
careful records are kept. If an asset being brought into the marriage is a matrimonial home in which the spouses
anticipate remaining, a contract may also be unnecessary. Others have more complicated situations. Some
prospective spouses plan to bring a home with substantial equity into a marriage. Without a contract, they will not
receive a date-of-marriage deduction if they still reside in the home at separation. Only if the home ceases to be a
matrimonial home before separation will the deduction be recaptured.
Some prospective spouses may already be beneficiaries of family trusts, they or may be anticipating substantial
gifts and future inheritances. Given the arduous tracing requirements under the Family Law Act, spouses may seek
a simpler property regime, in which each spouse retains ownership of his or her own property upon a relationship
breakdown. This type of arrangement is sometimes known as a separate regime of property.
SEPARATION AGREEMENTS
A separation agreement usually resolves all issues arising from a relationship breakdown. Such agreements often
include provisions dealing with the following matters:
• Custody and access

• Child support
• Spousal support
• Health benefits
• Security for support
• Equalization of net family property
• Sale, division, or transfer of jointly owned property
• Mutual releases, including property, support, and estate releases
• General contract provisions, including provisions for amendments, severability, and jurisdiction

CHALLENGING A DOMESTIC CONTRACT

The Family Law Act provides that domestic contracts remain subject to the best interests of a child as required by
the Child Support Guidelines. Provisions of domestic contracts that do not comply with these requirements are not
enforceable. Furthermore, a court may set aside all or part of a separation agreement where provisions prevent
remarriage or impose sexual restrictions on a spouse. Finally, a court will set aside a contract when a party has failed
to disclose significant assets or liabilities, or when one party fails to understand the nature or consequences of the
contract.
Parties to a contract should be able to reasonably rely on the arrangements they made within their contracts.
Accordingly, the court is reasonably respectful in enforcing domestic contracts, particularly if the safeguards of
disclosure and legal advice were in place at the time. However, under certain circumstances, courts will agree to set
aside contracts.
DIVE DEEPER
In the Supreme Court of Canada (SCC) case of Hartshorne v. Hartshorne, the court upheld a marriage
contract despite one party’s request for the contract to be set aside. Both parties were lawyers, and the
party seeking to set aside the contract had independent legal advice at the time. The details of the case
can be found on the SCC website.
DURESS
A separation agreement may be voided if one party was induced to sign by violence, threats of violence, or other
undue influence from the other party—in other words, if the first party signed the agreement under duress. The
party who claims to have been under duress must prove it. However, as mentioned earlier, family law generally has
a lower threshold for proving duress. For example, a marriage contract may be set aside if presented shortly before
a wedding, when emotions are high. A spouse who wants to arrange for a marriage contract should consult a lawyer
before becoming engaged, and certainly well before setting a wedding date.
UNCONSCIONABLE TRANSACTIONS
The doctrine of unconscionable bargain, sometimes referred to as unfair advantage, is similar to that of duress.
However, an inequitable transaction should not be equated with an unconscionable one. The term “unconscionable”
refers to something that would “shock the conscience of the court.” It does not mean merely a minor unfairness, but
a situation that cries out to be altered.
EXAMPLE
In Miglin v. Miglin, 2003, the SCC held that unconscionability in family law cases need not be established to the
level required in the common law of contract. The Court stated its position as follows:
There may be persuasive evidence brought before the court that one party took advantage of the vulnerability
of the other party in separation or divorce negotiations that would fall short of evidence of the power
imbalance necessary to demonstrate unconscionability in a commercial context between, say, a consumer
and a large financial institution. Next, the court should not presume an imbalance of power in the relationship
or a vulnerability on the part of one party, nor should it presume that the apparently stronger party took
advantage of any vulnerability on the part of the other. Rather, there must be evidence to warrant the
court’s finding that the agreement should not stand on the basis of a fundamental flaw in the negotiation
process. Recognition of the emotional stress of separation or divorce should not be taken as giving rise to a
presumption that parties in such circumstances are incapable of assenting to a binding agreement.
To avoid allegations of undue influence, duress, or failure to understand the contract, both parties making a
domestic contract should seek legal advice. Some domestic contracts are signed without legal advice, or even in

spite of it. Even though a contract may appear to be final, and the parties rely on it, the circumstances under which
domestic contracts are negotiated may raise questions of validity and fairness. Courts are sometimes more willing
to intervene in domestic contracts than in commercial contracts.
ALTERNATIVE DISPUTE RESOLUTION

Alternative dispute resolution (ADR) is the resolution of family law disputes through means other than traditional
litigation. It may include negotiation, collaborative family law, mediation, or combined mediation and arbitration.
Most ADR mechanisms are meant to help clients achieve resolution in a more cost-effective and cooperative
manner. Court orders are blunt instruments, and the court is an uncomfortable forum to attempt to resolve family
law issues, especially parenting. The ADR process may be less expensive and less confrontational. The process
generally provides flexibility and individualized solutions. However, it remains imperative that clients engage
counsel to assist them in the process of disclosure and, if appropriate, mediation. Counsel-assisted mediation will
ensure that financial disclosure and legal advice are provided before and during the negotiation process. When
separating spouses mediate without the key foundations of disclosure and legal advice, they are often negotiating in
a vacuum. Coming to an agreement “in principle” and then seeking legal advice is a backward approach; disclosure
and legal advice must come before any agreement is negotiated.
KEY CONCEPTS OF FAMILY LAW
How well do you understand the terminology of family law? Complete the online learning activity to assess your
knowledge.
MINI SCENARIOS
Assess your understanding of family law by resolving four mini scenarios.

PROPERTY ISSUES ON RELATIONSHIP BREAKDOWN
4 | Examine the concept of net family property.
In Canada, property rights are governed by provincial legislation. Provinces have legislation that provides for an
equalization of net family property or a sharing of property on marriage breakdown. In some provinces, that right is
extended to unmarried spouses.
Legislation regarding the treatment of property on relationship breakdown varies between provinces in fundamental
respects. In Newfoundland, for example, commercial property is excluded from the sharing regime. Valuation dates
and methods also vary. Spouses must seek legal advice in the appropriate jurisdiction to understand all their rights
arising from relationship breakdown, including property rights. In some cases, the laws of multiple jurisdictions
may be involved. For example, under Ontario’s Family Law Act, if the parties’ last habitual residence was outside of
Ontario, the laws of that jurisdiction must be considered by the parties and by the Ontario court hearing the matter
before property issues can be determined.
Under the Family Law Act, when spouses separate or one dies, either spouse has the right to seek an equalization
of net family property. The party with the greater net family property owes the spouse with the lesser net family
property half of the difference between the two values.

The death of a spouse is considered a breakdown of the marriage and a triggering event under the Family Law
Act. When a spouse dies, if the net family property of the deceased spouse exceeds the net family property of
the surviving spouse, the surviving spouse is entitled to seek an equalization of net family property as if they had
separated the day before death.
When a spouse dies leaving a will, the surviving spouse may elect to either take under the will or to seek an
equalization payment under section 5 of the Family Law Act. Some spouses who believe they are happily married
may be surprised by the terms of their spouse’s will (which can be changed, if the spouse is competent, up to and on
the day of death). In such cases, the spouse may elect to seek an equalization payment that provides them with the
same property rights as a separated spouse.
The net family property of each spouse is not the same as net worth. Under the Family Law Act, net family property
means the value of all property a spouse owns on the valuation date, less certain deductions and exclusions. The
valuation date is the date of separation, which is the date all assets and debts are crystallized for calculating net
family property.
Calculating the net family property of each spouse generally involves the following steps:
1. Add the value of all assets owned by the spouse, including excluded assets.
2. Subtract the spouse’s debts and other liabilities.
3. Subtract the spouse’s date-of-marriage deductions (i.e., the value of all assets owned, less all debts owed, on
the date of marriage).
4. Deduct the value of excluded assets (see below).
5. Deduct the lesser net family property from the higher net family property.
6. Calculate the equalization payment by subtracting the lower value from the higher value and dividing the
difference in half. The spouse with the higher net family property owes the spouse with the lower net family
property half the difference between the two amounts.
NOTE
A spouse’s net family property cannot be less than zero. If deductions, including debts and date-of-marriage
deductions, create a negative number, the spouse’s net family property is zero.
In Ontario, any property owned by a spouse is included in the net family property calculation. Spouses must disclose
all their assets. Full disclosure ensures that a resolution is binding and enforceable. Otherwise, agreements or court
orders may be set aside by reason of non-disclosure.
Net family property is calculated based on ownership. If an asset is jointly owned, half of its value should be
included in the net family property of each spouse. If the property is held in one spouse’s name only, it is included in
that spouse’s net family property, subject to trust claims.
In Ontario and other provinces in which unmarried spouses do not have fixed property rights, unmarried spouses
may make trust claims, claims for unjust enrichment, and claims relating to joint family ventures. Although most
trust claims are made by unmarried spouses, married spouses may also make trust claims against assets held in the
name of one spouse, particularly when values have increased substantially after separation.
The treatment of the matrimonial home is unique. If a spouse comes into the marriage with a home that remains
a matrimonial home at valuation date, the spouse is not entitled to a date-of-marriage deduction for the home’s
value. Likewise, if a gift or inheritance is traceable into the value of a matrimonial home at the date of separation,
the gift or inheritance loses its excluded status. The Family Law Act does not convey ownership to a non-owning
spouse.

Pensions are included in the calculation of net family property. Some legislation, both federal and provincial,
permits the transfer of funds out of one spouse’s pension to assist in making an equalization payment to the other.
Two types of assets are excluded from net family property:
• Property other than a matrimonial home that was acquired by a spouse by gift or inheritance from a third
person after the date of the marriage
• Property that the spouses have agreed by a domestic contract is not to be included in the spouse’s net family
property
The spouse seeking to benefit from a deduction or exclusion bears the onus of proving the deduction or exclusion.
A spouse who owes an equalization payment may make a lump-sum payment that is subject to interest from
the date of separation or the commencement of a court action. Prejudgment interest is awarded at the court’s
discretion. In some cases, the court orders scheduled payments over time, often with interest. A court may order an
equalization payment to be made over ten years; however, this time frame for payment is rarely granted.
Spouses may agree to a variety of mechanisms to effect an equalization payment, including a home transfer,
rollover of registered retirement savings plan (RRSP), pension transfer, share transfer, or corporate rollover. Some of
these mechanisms will defer taxes and reduce the burden of immediate payment. Advisors can assist in structuring
an effective payment plan.
It is important for wealth advisors to keep in mind that the net family property and equalization payment
calculations can be highly complex. They may require input from several parties, including consultation with
accounting, tax, property appraisal, and legal specialists.
IMPACT OF DIVORCE ON A CLIENT’S FINANCIAL PLAN
5 | Explain the impact that divorce could have on a client’s financial plan.
As an advisor, you should not attempt to provide legal counsel. Instead, you should refer divorcing spouses to
lawyers who practice in the area of family law. However, with appropriate qualifications, you may discuss the
potential impact that divorce could have on your client’s financial plan. Your conversation could address the issues
described below:
Tax planning Tax planning issues may include loss of income splitting opportunities and a loss of
income tax deductions and credits. Clients should also understand the non-deductible
and non-taxable nature of child support payments, in contrast to spousal support, which
will be taxable in the hands of the recipient and be deductible by the payor if paid on a
periodic basis pursuant to a valid separation agreement or court order.
Retirement planning Resolution of property issues between married and unmarried spouses, as well as
ongoing support obligations, will affect retirement planning. An equalization payment
may be satisfied, in part, by a lump-sum transfer out of a spouse’s pension, an RRSP
rollover, or the sale or transfer of a home.

Risk management Risk management issues include changing RRSP, pension, and life insurance beneficiary
designations. Often, there are changes in amounts and designations of life insurance
coverage. A spouse who is obligated to pay child or spousal support is usually required
to maintain security for these support payments in the form of life insurance. The other
spouse is usually named as beneficiary, either directly or in trust for the children. These
designations are often irrevocable, which means the other spouse must co-operate in
relinquishing the designation when the support obligation ends.
Estate planning Divorcing clients should update their wills, including their wishes regarding power
of attorney and advance health care directives. It is important to make a new will
after separation; a separation does not revoke an existing will. Divorce will revoke the
provisions of a will respecting that spouse; however, it is advisable to review estate
planning as a whole upon separation. Generally, spousal beneficiary designations
(e.g., for RRSPs, registered retirement income funds, and life insurance policies) should
be changed at source to prevent the former spouse from inadvertently obtaining the
proceeds or benefits.
Cost of divorce These costs could include legal fees, expert fees, the increased cost of maintaining
two households, and the effect of a property resolution, including the possibility of an
equalization of net family property and support obligations.
At the beginning of this chapter, we presented a scenario in which your client Linda Lee asked for your advice on
how to manage her affairs during her marital separation. Now that you have read the chapter, we’ll revisit the
questions we asked and provide some answers.
• Given the complexity and emotional impact of separation and divorce, what specialists from your team can best
support your client through this difficult and challenging period?
• Both clients have several rights and responsibilities in a separation and divorce. As Linda’s advisor, you
should rely on a family law lawyer to provide general guidance and counselling around her entitlement to
child support, spousal support, and property rights.
• You might also recommend counselling to help Linda cope with the emotional impact of separation.
• What does Linda need to know to protect herself and her interests in light of the couple’s separation?
• People going through divorce tend to go through periods of denial, bargaining, anger, depression, and,
finally, acceptance. Your advice and guidance through this difficult life change is a key benefit you can offer
Linda as her advisor.
• It is important to realize that you are not alone in providing this service. You can work with a team of
advisors to help your clients deal with their impending life changes, including the financial impacts and
legal considerations of relationship breakdown.

SUMMARY
In this chapter, we discussed the following key aspects of family law:
• Advisors who are not prepared for their clients’ transfer of wealth from one generation to the next are at risk of
losing a large portion of their business to others who are prepared for this stage.
• Some of the key issues that your clients may be facing with respect to family dynamics include:
• Gifting money or assets to family
• Funding education for children or grandchildren
• Financial support of minor or adult children
• Future leadership and direction of the family business
• Long-term care of a spouse or aging parents
• Divorce
• Elder abuse
• Leaving estate assets to charity
• Divorce is a concern for advisors who have worked with both spouses who have decided to end their
relationship. Problems may arise regarding privacy, conflicts of interest, and the need to act in the best interests
of both parties.
• Divorce is the final, legal ending of a marriage, by court order. In Canada, divorce is legislated under the federal
Divorce Act, 1985. The sole ground for granting a divorce is breakdown of the marriage, which is established
if spouses have lived separate and apart for at least one year. It may be granted sooner if there is a finding of
adultery or cruelty by the court.
• Clients should consider the potential consequences of divorce if it is granted before all other issues are resolved.
For example, properties cease to be matrimonial homes on divorce, which may mean that a non-owning spouse
could lose the right to possession of a home or cottage, or the ability to prevent its sale or encumbrance.
• Custody and access rights are determined based on the best interests of the child. Joint custody usually refers
to a parenting arrangement in which the parents share major decision-making relating to the child; it does not
necessarily refer to a shared residency schedule. Shared parenting is the term generally applied to parenting
schedules when each parent has the child in his or her care at least 40% of the time. A sole custody order is
sometimes made if there is a risk of child abduction. As children grow older, changes to custody and access
arrangements are often made. The court is sometimes required to intervene to recognize appropriate changes.
• A domestic contract allows the parties to define their rights and obligations, opt out of some legislative
provisions, and regulate their own financial arrangements. Although neither party can be forced to obtain legal
advice, it is highly advisable that both do so before drawing up a domestic contract.
• A court may, on application, set aside a domestic contract or a provision within the contract in certain
circumstances. For example, a contract may not be enforceable if one party failed to disclose significant
assets or liabilities when the contract was made. Likewise, duress, fraud, coercion, undue influence, or
unconscionability may render a domestic contract unenforceable.
• A cohabitation agreement often deals with ownership in, or division of, property and spousal support
obligations. Such an agreement cannot contract about child custody, access, or support. Child-related issues can
only be dealt with based on the best interests of the child and child support laws at the relevant time. Likewise,
a marriage contract cannot address the right to child custody, access, or support. Furthermore, it may not
limit a spouse’s rights regarding possession, transfer, and encumbrance of the matrimonial home. A separation
agreement usually resolves all issues arising from a relationship breakdown, including, but not limited to,
custody and access, child support, spousal support, and the sale, division, or transfer of jointly owned property.

• Alternative dispute resolution is the resolution of family law disputes through means other than traditional
litigation. It may include negotiation, collaborative family law, mediation, or mediation/arbitration.
• Full financial disclosure is required in order to resolve issues arising from a relationship breakdown. The
information provided by both spouses is used to determine equalization of net family property, among other
things.
• As an advisor, you should not attempt to provide legal counsel to divorcing spouses, but, with appropriate
qualifications, you can discuss the impact of divorce on a client’s financial plan. Issues to discuss include tax
planning, retirement planning, risk management, estate planning, and the costs of divorce.
DISCUSSION BOARD
for Chapter 6.
REVIEW QUESTIONS
Questions.

Personal Risk Management
Process 7
CHAPTER OUTLINE
In this chapter, we explain the concept of personal risk management as part of a fully integrated wealth
management plan. We describe the different characterizations of risk and what they mean to both advisors and
clients. We also explain the different methods that analysts use to measure risk. Finally, we provide a process for
creating a personal risk management plan that can be used throughout the client’s life cycle.
1 | Explain the benefits of the integrated Strategic Wealth Preservation:

approach to personal risk management for The Big Picture
both advisors and clients.
2 | Identify the risk-related information you need
to create a personal risk management plan for
clients and their families.
3 | Explain the different ways risk is characterized. Risk in the Context of Strategic Wealth
Management
4 | Describe various measures of risk. Measuring Risk
5 | Explain the connected risks underlying family Identifying Risk within a Client’s Net Worth
assets, including those related to human
capital, pension plans, and the family home.
6 | Apply the concept of the family life cycle The Family Life Cycle
to personal risk management and strategic
wealth preservation.
7 | Identify the main steps in the personal risk The Personal Risk Management Process
management process.

KEY TERMS
bell curve pure risk
diversifiable risk serially correlated returns
efficient frontier shortfall risk
human capital speculative risk
lognormal distribution standard deviation
market risk subjective risk
mean systematic risk
Monte Carlo simulation time diversification
non-market risk undiversifiable risk
normal distribution unsystematic risk
objective risk

CHAPTER 7 PERSONAL RISK MANAGEMENT PROCESS 7•3
INTRODUCTION
For your clients to succeed in the financial markets, they must understand the risks inherent in investing. Since the
financial crisis of 2008/09 and the subsequent, pandemic-led economic and market downturn of 2020, volatility
has become a reality investors must deal with and that has influenced their tolerance for risk. It can sometimes
be a challenge for advisors to change clients’ perception of risk and to help them see the potential impact of not
addressing actual risks. In the role of a wealth advisor, you must address risk in the context of strategic wealth
preservation. Integrated wealth management requires that you consider all of the client’s assets and liabilities and
create an integrated plan to mitigate risk.
Risk can be described in terms of two sets of opposing characteristics. The first set deals with the risk of loss only,
as opposed to the possibility of loss or gain. The second deals with actual risk as opposed to perceived risk. Because
clients are usually not fully conversant in financial matters, they often perceive risk unrealistically. It is part of
your role as an advisor to help them understand the amount of risk they need to accept if they want to meet their
financial goals.
An important part of the wealth management process is to create a personal risk management plan. The plan
should address the needs of all members of a client’s household, not just those of the client alone. To create
such a plan, it is important to understand the different stages of the life cycle and the various needs that must be
addressed at each stage. At the same time, you must keep in mind that not every client’s needs fit neatly into a
prescribed pattern. Still, it helps to have a good understanding of life cycle theory when creating a personal risk
management plan for a client. In this chapter, we provide a comprehensive process for creating such a plan. We also
present various strategies you can use to make sure the plans you create for your clients work as intended.
Before you begin, read the scenario below, which raises some of the questions you might have regarding personal
risk management. Think about these questions, but don’t worry if the answers don’t come easily. At the end of the
HELPING THE LEWIS-MAIER HOUSEHOLD PROTECT THEIR ASSETS
Mark Lewis and Karl Maier, your new clients, have decided to take early retirement from their respective
employers. However, Mark would like to work as a consultant for at least another five to 10 years. Both
spouses have been successful savers throughout their working lives, and have amassed substantial investment
portfolios. They are consulting you to discuss how to generate enough retirement income to fund their lifestyle.
Both clients are healthy, so their biggest concern is the risk of outliving their nest egg. They are especially
concerned that something similar to the 2008-09 financial crisis could happen again. They are worried that
their investment portfolios could suffer irrevocable losses that will reduce their retirement income. They want to
know whether it would be better for them to move into a 100% fixed income portfolio.
In light of this scenario, consider the following questions:
• How do Mark and Karl think about risk? Do they understand the potential risks to their investment portfolio?
• Given the many ways to understand and measure risk, how would you determine the perceived and real risks
your clients face?
• How do risks change over time as clients move through the various stages of life?

STRATEGIC WEALTH PRESERVATION: THE BIG PICTURE
1 | Explain the benefits of the integrated approach to personal risk management for both advisors
and clients.
2 | Identify the risk-related information you need to create a personal risk management plan for clients
and their families.
Strategic wealth preservation as a professional wealth management tool has two benefits for advisors and their
clients. First, it broadens the scope of wealth management beyond tangible financial assets to include all assets
and liabilities in an integrated, holistic framework. Second, it incorporates the principles of risk management as an
organizing theory.
Neither of these approaches is totally foreign to wealth advisors. However, in this chapter, we explain how
to integrate them into your practice to a greater extent using a systematic approach. By adopting a broader
perspective on the advisory role, you will be able to build strong, long-term relationships with your clients that are
mutually rewarding.
Wealth management begins with risk management. In fact, your primary role as a wealth advisor is to minimize
the risk that your clients will lose money. This makes sense given that preservation of wealth is the core purpose
of the process. However, strategic wealth preservation goes beyond simply protecting a client’s initial capital from
deterioration. Your broader role is to provide your clients with access to the widest range of opportunities available
given their personal resources. Your focus should be on the client as part of a family and also on the interplay
between personal and business goals and risks.
Scenario | Putting Money to Work
Ivan and Anya consider themselves to be a conservative couple when it comes to money. In fact, Anya says teasingly
that Ivan would feel better burying their money in the backyard to make sure they do not lose it. It is not that they
are short of cash. Last year, they sold their successful dry cleaning business and now, in their late 50s, they are
looking forward to a long, well-funded retirement.
Ivan and Anya started their dry cleaning business 30 years ago with a loan from Ivan’s father and a strong belief that
they could succeed. Over the years, with hard work and good people skills, their business continued to grow. When
they sold it last year, they owned six stores in the city.
Ivan and Anya used the same formula to open each new location. They bought each building in which they located a
new store because they believe that owning is better than renting. They built up a seed fund to make each purchase,
and then arranged the rest of the financing with their bank. They have dealt with the same bank they started out
with. They never worried about the risk of borrowing money to fund growth because they were always confident in
their business formula and know-how.
As their revenues grew, so did the couple’s savings. Initially, they kept all their company profits in a savings account
at the bank. Over time, however, their advisor, Paula, persuaded them to put their money to work. Her strategy was
to convince them that some risks are worth taking. For example, she asked Ivan what it was about stocks that made
him nervous. He said he hated the fact that markets move up and down. He did not want to get caught in a market
downturn and lose the money he and Anya worked so hard for.
“But you aren’t going to sell your investments in a downturn, are you?” responded Paula. “After all, your business
was profitable, but you went through some slow times. Did you automatically sell your stores when you suffered a
setback?”
“Certainly not!” Ivan replied; “In fact, we bought out one competitor in a downturn for considerably less than the
business’s market value.”

Scenario | Putting Money to Work
Paula’s strategy helped to change the couple’s view of risk. They agreed to invest some savings in mutual funds and
bought a number of shares in the bank’s stock. Paula also advised the couple to look for opportunities in market
downturns, rather than view them just in terms of risk.
“If something really has value,” Paula said, “then a short-term drop in the price is a reason to buy, not sell.”
This advice convinced Ivan and Anya because they have always taken the same approach to purchasing real estate.
They believe that land has tangible value that will always increase over the long term, so they do not concern
themselves about short-term losses.
However, when a friend recently tried to talk Ivan and Anya into investing in a fast-food franchise, they refused.
They had no intention of taking such a risk with their savings.
“No thanks!” said Anya to Paula. “We want to take it easy and enjoy what we have accumulated. Pretty soon, we’ll
have grandchildren, and we want to protect their inheritance, not risk it in a new business venture.” On this point,
Paula does not challenge the couple. She realizes that, at this stage of their life cycle, such a venture would not be
a good fit with their goals and their comfort level with risk. She knows that her role is to help the couple make the
best choices in managing their personal assets and preserving them from risks that are unique to their situation.
CREATING A PERSONAL RISK MANAGEMENT PLAN

In this chapter, we provide an analytical framework with which you can begin to set up strategic wealth
management plans for individuals and families. Some techniques you will learn may be new to you, but many will
be familiar. In fact, you may have used some of these methods to select common shares or equity mutual funds
to create balanced portfolios for your clients. However, for most clients at various stages of the life cycle, stocks
and bonds, whether held directly or in registered retirement savings plans (RRSP), are a small part of a much
larger financial picture. What is innovative in a strategic wealth management plan is the application of wealth
management techniques to the client’s situation as a whole. A strategic plan integrates all financial decisions at
once. It takes into consideration the family home, employer and government pension plans, and human capital.
Human capital can be defined as the sum total of a worker’s knowledge, skills, and experience in terms of their
economic value. In financial terms, it is considered to be the present value of the money a person will earn in the
future. For example, a newly qualified dentist’s human capital is much higher than that of a person who does an
unskilled job, such as a dishwasher in a restaurant.
An important part of strategic wealth management is to create a personal risk management plan for clients and
their families. In doing so, you should consider five major concepts:
1. How should we think about risk in the context of strategic wealth management?
How do your clients view risk, and how does it differ from your view as a professional? How do you think their
views will affect their decision-making process?
2. How do we measure risk?
How can you measure risk so that you can tailor your plan to the risk management needs of a specific client’s
situation?
3. What is at risk within the client’s net worth?
Who are the household members whose financial well-being is at stake? What are the assets and liabilities on
the family balance sheet that need managing and protecting?

4. How does the family life cycle affect risk management and wealth management?
What life stage are your clients currently in? How should that affect their decision-making in terms of their
wealth plan?
5. What is the process for managing risk, however it is defined?
Is there a single framework that can be used for all clients? What aspects of the client’s situation should such a
framework address?
THE INTEGRATED APPROACH TO RISK MANAGEMENT
What are the components of an integrated approach to risk management? Complete the online learning
activity to assess your knowledge.
RISK IN THE CONTEXT OF STRATEGIC WEALTH MANAGEMENT
3 | Explain the different ways risk is characterized.
Strategic wealth management demands a deeper appreciation of risk than the typical view taken in financial
planning. Traditionally, risk in this context is thought of as risk that the actual return earned on an investment will
be lower than expected. In the same context, risky assets are assets with an uncertain rate of return.
Therefore, variability in investment returns is generally seen as the defining measure of risk for investors. However,
this view of risk has several limitations. First, it confuses a numerical measurement with a definition Risk is not such
a simple concept that we can understand it simply by understanding how it is measured. Second, it perceives risk
as purely objective and unambiguous; but in reality, risk is also a subjective concept influenced by personal and
social attitudes. And finally, it defines risk in relation to financial investments, which are only one facet of wealth
management.
To define risk in the context of strategic wealth management, we should first consider the objective of wealth
management. We could say that happiness is the ultimate goal; however, happiness is an imprecise concept, and
wealth alone is not enough to guarantee happiness. Nevertheless, we can say that most people try to achieve
happiness by accomplishing their dreams and desires in their present and future lives. And wealth is one means
through which people can achieve what they want from life. But to manage their wealth effectively, people must
have a specific end in mind, rather than a vague hope. As a wealth advisor, you must help your clients manage their
wealth by helping them set clear financial goals.
To be achievable, goals must have the following two attributes:
A set monetary The statement “I want to retire with a good income” is too vague a goal to work with.
amount Instead, clients should specify the amount of income they will need in retirement.
Alternatively, they could specify the nature of their desired lifestyle, so that the required
income for that lifestyle can be calculated.
A specific time frame The statement “I want to retire early” is also too vague a goal. Clients must set a time
frame by stating a specific age or date at which they wish to retire.
For example, a suitable goal might be stated as “retirement at age 64 with an annual after-tax income of $50,000”.
This statement allows you to identify risk as the likelihood of not meeting these clearly defined financial goals. The
underlying risk may be the risk to a client’s sense of well-being, but wealth can only be managed in terms of dated,
quantified goals.

After you and your clients determine what the clients want to achieve with their wealth, you can set financial goals
in terms of dates and dollar amounts. Then, you can apply risk management tools to the financial goals.
In short, wealth management must have goal achievement as its aim, and the risk is that the process will fail clients
in their efforts to meet their goals. This explanation of risk is more complicated than the simple risk of earning
a low return on investments. A client’s goals require management of wealth as a whole; it is not simply a series
of separate investment decisions. The process of setting satisfactory goals and building a comprehensive plan to
achieve them is at the core of strategic wealth management.
EXAMPLE
Helena and Gerry, ages 36 and 32 respectively, are married with two young children. Gerry is a logger, a job that
pays well but is also physically risky and has an uncertain future. Helena is an investment advisor, focusing on the
stock market and working with local clients. She earns a variable income that is entirely commission based. They
live in a rather sparsely populated area that is highly dependent on forestry and mining.
Helena and Gerry want to retire with 60% of their current income when Gerry is 60. To that end, they have
built a large house and bought a cottage. All the money that is not needed for regular expenses goes into the
mortgages on the two properties and some into their RRSPs.
An advisor looking at these items individually would likely focus on how to invest the RRSP contributions and
maintain the properties. An advisor with a more strategic approach, on the other hand, would consider the assets
and liabilities as a package. To carry two mortgages on separate properties at this life stage means that the assets
themselves are facing three different risks:
• First, the properties are both located in a low-population area that is highly dependent on natural resources.
If a large mine or mill closes, or if natural resource prices drop, the value of the properties may drop
considerably.
• Second, the debt itself creates more risk. Having debt, especially large amounts of debt, exposes Helena
and Gerry to risk in terms of not being able to pay the mortgages as scheduled. Worse, they could lose
one or both properties if they are unable to make mortgage payments. Their precarious employment and
unpredictable income increase this risk.
• Third, neither income is secure. If the local economy declines, Gerry may get less work or lose his job
altogether. Helena’s income is also likely to decline under the same circumstances. Her clients, if their own
jobs are unaffected by the decline, will be fearful of that possibility and will become cautious about investing
in the stock market.
In other words, three things are at risk for Helena and Gerry: their human capital, their physical assets, and their
financial debt. Furthermore, the risks are substantially correlated. Any single aspect of their situation on its own
carries a reasonable amount of risk; overall, however, the risk is quite high. As their advisor, you should review the
entire situation and recommend a comprehensive risk management plan that incorporates all their assets and
liabilities.
DID YOU KNOW?
Correlation is a statistical tool used to determine whether pairs of variables are related; if so, correlation
helps to measure the strength of that relationship.

CHARACTERIZATIONS OF RISK
To manage wealth holistically, it is helpful to understand the two characterizations of risk described below.
Pure versus A pure risk is one in which there is a possibility of either loss or no loss. A speculative
speculative risk risk has the possibility of either a loss or a gain. For example, premature death and a
house fire are both pure risks, whereas an equity investment carries speculative risk.
Objective versus An objective risk is one that most people (especially experts) agree is a risk.
subjective risk A subjective risk may be perceived as a risk by one person (especially a non-expert)
but not by another.
Of course, there is no such thing as a completely objective meaning for risk; it is difficult to measure risk in a
way that everyone agrees on. Nonetheless, a panel of experts reviewing a series of financial plans or investment
portfolios could probably come up with a strong consensus ranking of the different risk levels of the plans. However,
if the same choices were presented to a group of people with no special training, they would be unlikely to agree.
Their individual perceptions of risk would likely turn on mistaken beliefs about investing. Some people who consider
themselves risk averse are often not capable of properly identifying and quantifying financial risk.
The perception of risk varies with a person’s age, culture, level of education, and amount of wealth. This subjectivity
can pose a serious dilemma for advisors. Most financial plans have an element of risk, and even when a plan is
appropriate for the client’s circumstances, the client may lose money. If the client perceives that the loss was the
fault of an unreasonably risky plan, the advisor could be in trouble. There is no guarantee that a court of law would
decide instead that the client’s perception of risk was faulty. As an advisor, you may have to educate your clients
and urge them to change their perceptions to be able to implement the best advice. The alternative is to accept the
client’s point of view and implement a less-than-ideal financial plan.
EXAMPLE
William is a 45-year-old client with a modest investment portfolio and modest pension expectations.
Nonetheless, he wants to be able to travel extensively after his retirement at age 65. William is very risk averse
and unwilling to entertain any losses. By losses, he means any reduction in the nominal value of his investment
capital. Furthermore, he does not realize that inflation will reduce the purchasing power of his money over time.
William’s advisor, Ali, works out a savings and investment plan that has a reasonable prospect of succeeding,
provided that William invests primarily in a diversified equity portfolio. William is not pleased because an equity
portfolio is likely to fluctuate in value, which he cannot tolerate. On the other hand, if he invests entirely in
guaranteed investment certificates or short-term bonds, the expected portfolio return will almost certainly leave
him well short of his retirement goal.
Ali’s plan may be sound in terms of helping William achieve his objectives. However, if Ali fails to educate William
and help him overcome his aversion to risk, the client-advisor relationship could be strained.
MEASURING RISK
4 | Describe various measures of risk.
Every risk measure has a fundamental weakness that cannot be escaped: all measures require data, and the only
data available is historical data. Ideally, we would be able to predict future risk, but the best we can do is to look at
the past record and project it forward.

DID YOU KNOW?
Subjective risk is not easily measured. There are some tools available to measure individual risk
tolerance, but their results are not always reliable. For that reason, in our discussions about risk
measurement, we are talking about objective risk.
The most commonly accepted measure of risk1 is standard deviation, or variance, which measures the variability
of outcomes. Other measures are based on shortfall risk, pure risk, and time diversification.
STANDARD DEVIATION
With a risk-free investment, the rate of return of the investment, and therefore its future value, is a certainty.
It follows, then, that uncertainty represents risk, and risk is naturally associated with a range of possible outcomes
in future returns and values. The well-known statistical measure of risk is standard deviation, which has been used
in finance since the pioneering work of Harry Markowitz.2
Standard deviation measures the fluctuation around a central tendency; the greater the fluctuation, the riskier
the asset. A fundamental weakness of standard deviation as a risk measure is that it assigns equal importance to
the probability that a result will be higher than the mean and the probability that a result will be lower than the
mean. However, the chance of getting a better result than expected is not considered a risk; only the downside is
a concern.
DID YOU KNOW?
The mean is the mathematical average of two or more numbers computed by taking the sum of all
values and dividing by the number of values. For example, the mean of 12, 14, 18, and 28 is calculated as
(12 + 14 + 18 + 28) ÷ 4 = 18.
Nonetheless, the standard deviation is a useful tool, and when combined with assumptions about the distribution
of investment returns, it yields useful results. If we assume a reasonably well-behaved distribution, such as normal
distribution or lognormal distribution, we can execute simulations to estimate the probability of reaching a goal.
In many processes, random variation adheres to a certain probability distribution known as normal distribution.
This distribution is commonly referred to as the bell curve because its shape is similar to a bell. In a lognormal
distribution, one cannot lose more than 100%. However, a normal distribution, often found in economics and
nature alike, is unbounded on both sides. Equity returns on well-functioning, modern financial markets, such as the
major stock exchanges, are approximately lognormally distributed historically. Returns on some other common
assets are also lognormal, but not in every case. In some asset classes, there is not enough reliable data for us to
have much confidence in the observed distributions.
Markowitz used the properties of means and standard deviations of investments that are positively—but not
perfectly—correlated to derive an optimal set of portfolios. This concept, as illustrated in Figure 7.1, is known as
the efficient frontier. Each point on the efficient frontier is a portfolio that is not dominated by any other possible
portfolio, and that dominates all less-diversified portfolios. A portfolio that dominates is one that has the lowest
possible risk (standard deviation) for a given rate of return. You could also state that it has the highest possible
return for a given standard deviation. Simply put, investors must diversify widely to reduce risk.
1
This chapter is largely focused on non-investment risks (such as risks to human capital and property). It also covers some specific types of
risks that relate to the chapter’s content. Other risks are presented and defined the chapters to which they are relevant.
2
Harry Markowitz, “Portfolio Selection,” Journal of Finance 7, no. 1 (March 1952): 77–91.

Figure 7.1 | The Efficient Frontier
All portfolios that provide the highest

return for a specified level of risk
Expected Return
Legend:
Efficient Frontier
Individual Assets
Volatility (Risk)
DID YOU KNOW?
Two variables are correlated if the presence of one variable makes the other variable more or less likely
to occur.
For example, economists have found that, during a recession, people buy more chocolates and wine but
book fewer luxury travel tour packages. It is very likely, then, that the shares of chocolate manufacturers
are negatively correlated with those of tour operators. In other words, shares of the former will tend to
rise in value during a recession, whereas those of the latter will tend to fall in value. Including shares of
companies that move in opposite directions within an investment portfolio can bring a much-desired
element of stability to the overall portfolio. Therefore, negative correlation could go a long way toward
reducing investment risk within a portfolio.
In another example, research shows that during periods of economic prosperity, more new cars are
purchased, and more international flights are booked by businesses. A general feeling of well-being in the
population spurs the purchase of cars, and companies are more likely to pursue opportunities for growth
abroad. It is very likely, then, that the shares of automobile manufacturers are positively correlated
with those of major airlines. In other words, shares of both tend to rise in value during an economic
expansion.
Note that too much positive correlation could increase investment risk within a portfolio.
If we measure the risk of a portfolio of investments by standard deviation, we reduce deviation as we add different
investments to the portfolio. Because they are not perfectly correlated, the additional investments reduce deviation
at a declining rate, as the number of investments increases.
To understand this concept, it is important to understand the related concepts of systematic risk and
unsystematic risk (also known as undiversifiable risk and diversifiable risk, or market risk and non-market risk).

CHAPTER 7 PERSONAL RISK MANAGEMENT PROCESS 7 • 11
The global economy contains an irreducible amount of risk, known as systematic risk. No amount of diversification
can reduce the risk in an investment portfolio below this level. The classic demonstration of this property of risk
uses the standard deviation as the measure of risk, but we can intuitively understand that the concept must be true.
For example, there will always be earthquakes, wars, acts of terrorism, floods, and economic recessions. Life itself is
a risky proposition; therefore, some level of risk cannot be escaped in the investment world as well.
Figure 7.2 shows the graphical relationship between total risk, systematic risk, and unsystematic risk.
Figure 7.2 | Portfolio Risk and Number of Stocks
Non-Market Risk
Total Risk of the Portfolio
= Unsystematic Risk
= Standard Deviation
= Diversifiable Risk
Market Risk
= Systematic Risk
= Undiversifiable Risk
Number of Stocks or Investments
As Figure 7.2 shows, total risk and unsystematic risk decline as the number of investments increases. Total risk
approaches a lower limit asymptotically, which means that it approaches, but never reaches, zero. That lower limit
is the systematic risk.
DID YOU KNOW?
In practice, we often think of the x-axis in terms of common shares, only because that is the area
where diversification is most effective. In principle, however, all possible assets should be on the x-axis,
including such things as human capital, private businesses, and the family home.
Because total risk declines asymptotically, there is no limit, in theory, to the number of assets that could be invested
in to reduce risk. In practice, however, we cannot hold an infinite number, or even a very large number, of different
investments. The problem, then, is to determine how much diversification is needed to reduce most of the risk.
For a long time, analysts believed that an equity portfolio with more than eight and fewer than 20 well-chosen
stocks would gain most of the benefit of diversification. However, more recent research suggests that significant risk
reduction still occurs in the U.S. market as portfolios rise above 100 stocks.
Diversification is not simply a matter of picking a wide variety of domestic stocks. Traditionally, a diversified
portfolio has always blended debt and equity. Today, new classes of investments are becoming available to
widen the opportunities for diversification. Portfolios can now include hedge funds, real estate investment trusts,
infrastructure projects (i.e., private investment in infrastructure development and renewal), and international
investments. All these opportunities improve the efficient frontier and allow better risk-return combinations, as
measured by standard deviation.

SHORTFALL RISK
An alternative to standard deviation as a measure of risk is shortfall risk—the risk of not meeting a specified
target. That target could be a rate of return, a lump sum by retirement date, or a periodic payment such as
monthly retirement income. Shortfall risk and standard deviation are related and may give the same information.
Higher standard deviation may lead to higher shortfall risk—but not necessarily. An important difference
between standard deviation and shortfall risk is that shortfall risk incorporates a person’s goals; therefore, it is
much more comprehensive.
Shortfall risk measures the attribute investors really care about—the risk of not meeting their financial goals. It does
not pay attention to the extra upside, but rather focuses on the downside. The typical result is a probability of failure
associated with any given financial plan, usually related to an investment portfolio.
As a measure of risk, shortfall risk fits much more closely than standard deviation with goal-based risk management
typically used in a strategic wealth management plan.
Another development in risk management is the use of a Monte Carlo simulation of investments to estimate
failure probabilities. This tool randomly generates values for uncertain variables repeatedly to simulate a model.
Sophisticated simulations of this sort used to be unreasonably expensive to run, but with advancements in personal
computer technology, they have become affordable and practical.
In the example that follows, variations on a simple scenario illustrate how shortfall differs from standard deviation
as a measure of risk.
EXAMPLE
Lois is retiring soon with no pension and no savings, having squandered everything in an extravagant lifestyle,
which she wishes to continue. She has $100 to her name, and she needs to retire with $2 million to maintain her
lifestyle. How should she invest her money? If she is to have any chance at all of meeting her goal, she has only
one option: she must buy lottery tickets. This investment has a negative expected return and a gigantic variance,
but at least she has a minuscule chance that she will hit the jackpot. Any ordinary investment has a shortfall
probability of 100%, but lottery tickets give an extremely tiny, but positive, probability of success.
Imagine how the scenario might look if Lois could go back 25 years and manage her affairs more sensibly with
an advisor’s help. In that scenario, she has been spending everything she earns to fund her lifestyle, but her
advisor recommends she start saving now and she agrees. Her advisor suggests that if she adopts a balanced
equity and debt portfolio, there will be less variation but only a 65% chance that she will have saved $2 million
by retirement. However, if she were to invest 100% in a broad equity portfolio, including some hedge funds and
international exchange-traded funds, she would have a 75% chance of meeting her goal. This notion of using
shortfall risk has gained some notice in recent years.
As we can see from this example, shortfall risk principles indicate a portfolio structure that would be considered too
risky if measured by standard deviation factors. However, when the client’s goal is factored in, a portfolio with less
variance is actually the riskier one, because it has a lower probability of meeting the desired goal.

DIVE DEEPER
The idea of shortfall risk is easily understood because it is quite intuitive. If you wish to learn more
about it, you may be interested in reading the paper “A Sustainable Spending Rate Without Simulation”.
The article was written by Moshe Milevsky and Chris Robinson (both professors at York University in
Toronto) and published in the Financial Analysts Journal in 2005. This paper contains a formula that can
be programmed into Excel to calculate shortfall probability. In creating an investment plan for a retired
person, it allows both date of death and rate of return as variables.
If you want to further explore the concepts presented in this paper, go to your online chapter and read
the following document:
A Sustainable Spending Rate Without Simulation
PURE RISK
Pure risk is the risk of a loss with no upside possibility, such as a house fire. This concept of risk is used by insurers.
The actual measurement of pure risk is complex, requiring considerable statistical evidence. However, the principles
are well-established and non-controversial. The usual metric is the probability of losing a dollar amount or a
percentage of the value of an asset.
Life insurers use mortality tables developed from large samples of death statistics at every age. The risk
measurement is the probability of death during the next year, starting at any given age. Similar tables exist for
calculating the probability of becoming disabled at a particular age.
Property, casualty, and liability insurers have statistics on occurrences such as theft, fire, car accidents, and burst
pipes. These tables encompass both the probability of the event and the extent of the loss as a percentage of the
total value of the asset.
Such statistics are much more reliable than investment return statistics because many identical events have been
observed over long periods. Therefore, these risks are usually much easier to quantify and manage than speculative
risks.
Pure risks are extremely important in strategic wealth preservation, though they get less media attention than the
daily stock market report. Until quite late in life, most lower-middle-class and middle-class families have far more of
their total worth tied up in their human capital (i.e., employment income or business income) and family home than
in liquid investment assets.
TIME DIVERSIFICATION
Time diversification, a less well-known risk measure, is related to shortfall risk, investments, and serially correlated
returns. If the returns of an asset class are not highly correlated serially, then the risk of achieving the average
return declines the longer you hold the asset.
DID YOU KNOW?
Serially correlated returns are returns that move in patterns over time. For example, bond returns have
a predictable pattern because they are largely related to inflation, which changes more slowly and less
erratically over time than equity returns.
Time diversification works just like diversification among assets, except that instead of assets, the diversified
elements are the years of returns of the same portfolio.

Just as with shortfall risk, time diversification relates to the client’s financial goals. If the goal is short-term, then the
investments held to meet the goal have little chance to benefit from time diversification. For example, if the goal
is to accumulate a down payment to buy a house in three years, long-term investments would be too risky for that
purpose. Therefore, an all-equity portfolio would not be appropriate in that situation. However, if the client’s goal
is long-term—for example, to retire comfortably in 25 years—the time horizon is very far away. Because the money
will be consumed gradually in retirement, the horizon may be closer to 50 years than 25. In this circumstance, the
time diversification effect is very likely to hold. The higher long-term returns from equities are much more likely to
beat the returns from bonds. Bonds are strongly correlated serially and do not reduce in risk much, even over long
periods.
OBJECTIVE MEASURES OF RISK
What are the various methods used to measure objective risk? Complete the online learning activity to
IDENTIFYING RISK WITHIN A CLIENT’S NET WORTH
5 | Explain the connected risks underlying family assets, including those related to human capital,
pension plans, and the family home.
Strategic wealth management embraces all significant assets and liabilities of a client or, in many cases, a family
household. Wherever possible, the wealth of a household should be managed jointly (i.e., with input from both
partners or spouses) to minimize risk and maximize the family’s well-being.
However, what is the universally accepted definition of “family”? In simple terms, all persons who plan their
finances together may constitute a family, but definitions vary depending on the cultural norms of the people
involved.
One cultural norm is for children to live with their parents until they are able to live independently, and the family is
thus the parents and dependent children. In other cultures, the children live with the family, and at least partly share
resources, until they find life partners and leave the family home.
In some cases, grandparents and great-grandparents move in with younger family members, whether or not they
have the financial means to live independently. A household may even include aunts, uncles, and cousins living and
working together. Furthermore, cultural norms shift as second and third generations of immigrants grow up and
adapt to a different norm, or as people with different cultural norms marry.
The law provides little help in this regard. In certain situations, for example, persons who are of adult age can be
legal dependants. Furthermore, under the federal Income Tax Act, a couple need not be married to be considered
two spouses. Under provincial family law legislation, however, only married couples are considered legal spouses.
Unmarried couples who live together are in common-law relationships, which have different legal implications from
marriage. The rules of common-law relationships apply to couples of the same or opposite sex. Same-sex marriages,
on the other hand, are now legally recognized across Canada under federal law.
A further complication arises with second and subsequent marriages with dependent children or spouses from one
or more previous marriages. An ex-spouse may have continuing support obligations for dependent children from
the marriage. Some separation agreements even oblige the spouse providing support to maintain life insurance that
designates the ex-spouse and their children as the beneficiaries.
Despite the many types of family situations, there is one description that fits most situations easily. A family is a
single person or a couple, married or unmarried, plus any dependants. Using this definition, the obligations from
previous spousal relationships may be treated as debts, rather than as obligations to dependants within an extended

family. For example, child or spousal support obligations arising from a previous relationship may be considered
debts. This simplified definition will not work in every instance. However, it can prevent you from making the serious
mistake of managing and preserving wealth with reference only to the individual family member who owns it.
FAMILY ASSETS AND LIABILITIES

Having defined a family, the next step is to identify its assets and liabilities. Table 7.1 shows typical family assets and
liabilities in the form of a balance sheet.
Table 7.1 | Family Assets and Liabilities
Assets Liabilities
• Human capital • Personal unsecured: credit cards, lines of credit,

consumer loans
• Employer pension plans
• Family home • Mortgage on family home
• Registered investment portfolio • Mortgage on vacation home
• Unregistered investment portfolio • Automobile loans
• Government pensions (i.e., Canada Pension Plan, • Business loans with personal liability
Quebec Pension Plan, Old Age Security) • Child and spousal support obligations
• Family vacation home or cottage • Investment loans
• Investment property
• Family business
• Cash surrender value of life insurance
• Personal use assets (e.g., clothing and furnishings)
• Collectibles (e.g., art and antiques)
• Cash
Clients and advisors have a shared goal to strategically manage the clients’ assets and liabilities throughout the
financial life cycle. The clients, in turn, are able to successfully accumulate, preserve, convert, and transfer their
wealth.
In this section, we examine the relationship between family assets and the goal of wealth preservation. We also
examine the purpose of protecting family assets as an aspect of personal risk management. Some of the items we
discuss are not always included on personal balance sheets, or their risky nature is not obvious. Here, we attempt to
clarify the connected risks underlying certain assets, including human capital, pension plans, and the family home,
as described below.
Human capital Human capital is the most important asset of most families for a large part of their
lives. In monetary terms, human capital is the present value of future earnings, net of
taxes and other deductions. The most fundamental objective of wealth preservation is
to protect and enhance this value. A person’s human capital is exposed to several risks,
including those related to unemployment, obsolescence (i.e., skills deteriorating or
becoming outdated), disability, critical illness, and premature death.

Pension plans Pension plans derive from human capital in the form of deferred wages. Therefore,
by protecting human capital, one also protects the client’s growing entitlement to a
pension. A concern arises with defined contribution plans that require the employee to
make the investment decisions and bear all the investing risk. Pension plan entitlements
are also somewhat vulnerable to the risk of employer bankruptcy. The bankruptcy of
Sears Canada in 2017 provides such an example.
The family home The family home fills several roles in purely financial terms:
• It is a source of tax-free income in the form of imputed rent. The family does not
receive the rent in cash, but as a reduction in accommodation costs they would
otherwise pay. The value of this income is stable in that the family automatically
receives it, regardless of the varying market value of the home.
• Because the family automatically receives the imputed rent, the home is an inflation
hedge. If market prices and rents rise, the family does not need to pay more, and if
they fall, the family need not realize the loss.
• It is a tax-free investment in that no tax is payable on any capital gain from the sale
of a principal residence.
The main risk underlying a family home is the amount of debt outstanding against it.
For that reason, advisors recommend that homeowners obtain life insurance at least
matching the amount of the mortgage. Therefore, should premature death occur, the
risk that the surviving spouse and dependent children will lose the home is eliminated.
Likewise, property insurance must be purchased to cover such risks as fire, hurricane, and
flooding.
DID YOU KNOW?
Another way of explaining the family home as a hedge against inflation is with correlation. The prices
of most things we consume are subject to inflation, and housing costs are no exception. Housing prices
are positively correlated with rent, whether imputed or actually paid. An investment whose return is
positively correlated with its cost is less risky because the investment itself is a hedge against that cost.
Advisors are accustomed to dealing with various portfolio investments because that is often where they receive
their income in commissions and trailer fees. An important aspect they often overlook, however, is the correlation
between all the items on the balance sheet, and between those items and family expenses. Positive correlation
increases risk when it is between two assets and decreases risk when it is between an asset and a liability or expense.
The scenario that follows, adapted from Ho and Robinson, illustrates correlation among assets, liabilities, revenues,
and expenses.3
3
Abridged example from Kwok Ho, and Chris Robinson, Personal Financial Planning, 4th ed. (Toronto, ON: Captus Press, 2005), 551–54.

Scenario | Lionel and Karen Levy: High Net Worth Coupled with High Risk
Lionel Levy is a wealthy builder whose net income was $710,000 last year. His entire income was spent, with much
of it going toward support payments related to previous marriages and paying off a line of credit.
Lionel is 55 years old and a smoker. He is married to his third wife, Karen, who is 40, and the couple has two preteen
children. He also has grown children from his two previous marriages, who do not live with him. However, he
provides varying degrees of support, not all of it required under separation agreements.
All of Lionel’s income comes from his company, which builds homes and small apartment buildings. His assets total
$19 million. He owns two apartment buildings, together worth $17 million, that are producing negative cash flow.
He owns a home worth $500,000 and a cottage worth $250,000. He also owns a piece of land that he wants to
sell. All the properties are heavily mortgaged, for a total debt load of $13 million. Furthermore, he plans to buy a
new home worth $2 million. He plans to finance the property using a variable-rate mortgage plus the proceeds from
the sale of the existing home and the piece of land.
Lionel has $50,000 in cash and no other significant assets. He has no RRSP or pension plan, nor does he have life
or disability insurance. The business itself has little tangible value because all the assets are leased. Karen has not
worked outside the home since she married Lionel and has no material assets of her own. Neither of the two has a
will, a living will, or a power of attorney.
Lionel’s situation is dangerously risky. Everything rides on the residential real estate market. His labour income
and the value and income from his apartments are highly correlated. Furthermore, he plans to use variable-rate
financing for a new home. If interest rates rise and house buying declines, the value of his existing buildings is likely
to decline. In that case, he will face a double hit because the income from his company will decline as mortgage
rates rise. In addition, the rest of the family’s non-income-producing assets are also in real estate. The family is
spending all its income and plans to take on more expenses with a much more expensive home. Therefore, there is
little room for error. Practically all their net worth is wrapped up in the real estate sector, which exposes Lionel and
Karen to a very high degree of risk.
Lionel and Karen’s situation may seem bizarre, but it is not unrealistic. Successful business people tend to stick to
what they know without worrying about financial planning. From their point of view, the risks they take made them
rich in the first place. Now, their advisor has to create a plan to help them preserve their wealth.
Lionel needs life and disability insurance in large amounts, which, at his age, will be expensive. He must diversify his
investments away from his business, which he can do by selling the two apartment buildings and the piece of land.
Ideally, Lionel should arrange to pay off all personal debt, including his home and cottage mortgages. If it is suitable
to be leveraged, any further money borrowed should be for investments, because the interest expense will be tax
deductible. (Suitability for leverage is likely, given Lionel’s large cash flow.) One choice of investment that can be
easily eliminated is real estate investment trusts.
DIMENSIONS OF RISK
Identify the various elements of risk within a client’s net worth. Complete the online learning activity to

THE FAMILY LIFE CYCLE
6 | Apply the concept of the family life cycle to personal risk management and strategic wealth
preservation.
The different players in the wealth management field tend to focus on their own specialties. Accountants focus on
taxation issues and internal control systems for businesses. Insurance advisors look at a client’s insurance needs
and determine which policies would best meet those needs. Investment advisors put together portfolios of stocks,
bonds, mutual funds, and other investments. Lawyers draft wills, set up trusts, and transfer property.
Strategic wealth management requires that you analyze and integrate all these elements together. If you focus only
on selling mutual funds to a client whose greatest need is life or disability insurance, you are not doing your job well.
A useful approach when thinking about what families are most likely to need and when, is to think like an
economist—that is, in terms of the life cycle. Economists make forecasts based on the patterns of income and
spending behaviour of groups of people in similar age groups. While economists forecast aggregate economic
behaviour, wealth advisors can drill down to predict individual client behaviour.
THE LIFE CYCLE HYPOTHESIS

The life cycle hypothesis was originally developed in the 1950s by Franco Modigliani (and his student Richard
Brumberg), and worked upon by other economists over the decades. The life cycle could be said to have five
approximate stages:
• Early earning years

• Family commitment years
• Mature earning years
• Nearing retirement
• Retirement
In general, each stage corresponds to an age grouping, although the groupings are somewhat ambiguous, and
different economists may use different names. The considerable amount of overlap accounts for the fact that every
client is unique.
Over the years, the personal life cycle concept was modified and applied to the family life cycle. The demand for
goods and services depends on a family’s stage in the life cycle, not the age of a single person, although the two are
related. For example, young people do not buy diapers until they have children, but a cloth diaper business markets
its service to families with babies, regardless of the age of the parents. Later, this idea moved into financial services
as it applies to retail banking. Finally, it was adapted by Bernier and Robinson and by Ho and Robinson to personal
financial planning. There, it is used as a way of identifying which elements are most likely to be important to a
family, depending on its stage in the life cycle.
Our society has changed significantly since the 1950s. Ho and Robinson, while adapting the life cycle model to
personal financial planning circa 2005, also broadened their characterization of the life cycle stages. For example,
they now allow for the much greater number of singles, particularly singles who have children. However, as Table 7.2
shows, they do not distinguish between married and unmarried couples or between same-sex and opposite-sex
couples.

Table 7.2 | The Family Life Cycle
Stages Description
1 Younger, single
2 Younger couple, no children
3 Couple, dependent children
4 Single, dependent children
5 Older couple, children independent or nearly so
6 Older single
7 Couple, retired
8 Single, retired
Source: Ho and Robinson, 2005, p. 127.
One risk that is not accounted for in Table 7.2 is the impact of provincial family law legislation when a couple
separates. Division of property between unmarried couples is not generally included in this legislation, and hence an
unmarried couple faces an additional problem that could be resolved with a domestic contract.
You can use the family life cycle stages to identify the importance of different issues in risk management and
strategic wealth management. Financial experts differ in how they break down the life cycle, and every family must
plan for its own particular circumstances. However, Table 7.3 provides a good starting point. Note that the stages in
the life cycle in this table correspond to those in Table 7.2.
Table 7.3 | Significance of Risks and Wealth Planning Elements by Stage in the Life Cycle
Stage 1 Stage 2 Stage 3 Stage 4 Stage 5 Stage 6 Stage 7 Stage 8
Budgeting H H H H L L L L
Income tax L M M M H H M M
Human capital M M H H M L M L
Debt management M M H H M L L L
Investments L M L L H H M M
Retirement planning L L L L M H H H
Estate planning L L M M H H H M
Legend: L = low; M = medium; H = high.
Source: Adapted from Ho and Robinson, 2005, p. 128.
Let’s return to the scenario in which we met Lionel and Karen Levy, a wealthy couple living a high-risk lifestyle.

Scenario | Lionel and Karen Levy: Parallel Life Stages
Lionel’s age, 55, might suggest he is in stage 5 of the life cycle. However, Karen is only 40, and the couple has
preteen children, so stage 3 is a closer match. At the same time, Lionel has grown children, so stage 5 is also
relevant.
At stage 3, income taxes are not a critical issue, but they become more important at stage 5. Because Lionel has
his own business, income tax issues are most certainly important. At stage 5, human capital protection is usually of
less importance. However, Karen has no assets or job, and they have dependent children; Lionel’s human capital is
definitely at risk and needs protection from premature death and disability. Being a smoker, Lionel adds to this risk.
As the manager of the household, Karen’s human capital needs protection too, but it is not as serious an issue. By
stage 5, clients have typically reduced their debts so that they are not significant in size. In this case, though, the
family is behaving like a stage 3 family. They have large cash outflow, high debt load (and plans to increase it), and
dependent children.
Despite these stage 3 characteristics, the family’s tax situation aligns more with stage 5 needs because of the
business and the apartment buildings. Likewise, Lionel’s real estate investments are of great significance, given the
value of the apartment buildings. Their portfolio size is closer to stage 5, rather than stage 3. Finally, estate planning
is important precisely because the family is in two stages at once. Support and bequests must be reconciled among
Lionel’s two previous spouses and their children and his current spouse and children. This reconciliation must be
done carefully through a wealth transfer plan.
The information shown earlier in Table 7.3 provides a useful general guideline for the significance of risks and wealth
planning elements by stage in the life cycle. However, Lionel and Karen’s example shows how complicated this
process can be in real life.
THE PERSONAL RISK MANAGEMENT PROCESS
7 | Identify the main steps in the personal risk management process.
In this section, we introduce a process for managing risk. This process was originally conceived for corporate risk
management, but it can equally apply to personal risk management or small-business owners. The process also
applies to the management of pure risk and speculative risk. The process has five steps:
1. Identify risk.
2. Evaluate risk.
3. Control risk.
4. Cover and insure risk.
5. Monitor and revise the risk management plan.
Each step is explained below in detail.
STEP 1: IDENTIFY RISK

The first step in the personal risk management process is a standard procedure that is much the same for every
client. The augmented balance sheet shown earlier in Table 7.1 can be used as the starting point for identifying every
asset that has risk associated with it, including human capital.
Table 7.4 is organized a little differently, but with the same results. Note that the first section of the table (life and
health) refers to the life cycle stages. Property and liability risks are not dependent on the stage in the life cycle;

insurance and liability protection are needed at all stages. However, the extent of liability protection needed may
vary at different stages.
Table 7.4 | Identifying Significant Personal Risks
LIFE AND HEALTH
Stages in the Life Cycle* Risk Possible Losses
All stages Disability Extra expenses, family duties
Stages 1 to 6 Disability Income (for a limited time or permanently)
Stages 2 to 5 Death Income
Stages 2 to 5 and 7 Death Extra expenses, family duties
PROPERTY
Type of Property Risk Possible Losses
Rental residence Damage or destruction Cost of finding other accommodation,

including hotel bills
Owned residence Damage or destruction Repair or replacement, cost of temporary

accommodation
Automobile Theft, damage, destruction Repair or replacement, cost of temporary

replacement rental
Investment assets Loss of value Reduction of income
Other assets Theft, damage, destruction Repair or replacement, additional expenses

while waiting
LIABILITY TO OTHERS
Liable Entity Risk Possible Losses
Family business, whether or Liability to second, third party Amount lost by other parties, legal costs
not incorporated
Property Liability to third party Amount lost by third party, legal costs
* Stages in the Life Cycle: 1 - Younger; single; 2 - Younger couple, no children; 3 - Couple, dependent children; 4 - Single, dependent children;
5 - Older couple, independent children; 6 - Older single; 7 - Couple, retired; 8 - Single, retired.
Source: Adapted from Ho and Robinson, 2005, p. 190.
STEP 2: EVALUATE RISK

After you have identified risks, the next step is to evaluate each risk to determine how consequential it is to the
client’s situation. Table 7.5 categorizes risk based on two aspects: the severity of loss and the probability of its
occurrence. Severity is a matter of personal risk tolerance, which often depends on the client’s level of wealth.
Generally, a risk is considered to be insupportable if its occurrence would have a substantial negative impact on
one’s standard of living.

Table 7.5 | Evaluation of Risks
Probability of Occurrence
Severity of Loss High Low
Large Insupportable Insupportable
Small Supportable Immaterial
Source: Ho and Robinson, 2005, p. 191.
EXAMPLE
For someone with a low income and no savings, an accident causing $1,000 in damage to his car would likely
have a major financial impact. He might therefore choose a low deductible (e.g., $100) when insuring the car.
However, for someone with $500,000 in reasonably liquid investments and no debts, $1,000 in damage would
be insignificant, so this person might choose a higher deductible (e.g., $1,000).
STEP 3: CONTROL RISK

The third step in the personal risk management process is to control risk as much as possible. It may seem like
a logical next step to insure against insupportable risks, but it would be premature to do so. In a personal sense,
for example, you would first control the risk of fire by installing smoke detectors before buying additional home
insurance. Furthermore, some risks are not insurable, but they are controllable. For example, to keep your job and
advance in your career, you can work hard and upgrade your skills. In fact, maintaining one’s human capital by
continuous learning is essential in today’s work environment.
In a business setting, risk control is a much broader topic. To illustrate, fire is a major risk that occurs more
frequently for a lumberyard compared to a home or other type of business. Such a business takes many precautions
against this risk. Security, safety equipment and procedures, and safe working conditions are more important than
insurance for the employees. Money, after all, is cold comfort for a lost life.
Likewise, with financial matters, control must come before insurance. Investment portfolios, for example, need
basic risk control before any kind of complex portfolio insurance is implemented. Segregated funds and principal-
protected notes are types of insurance contracts for portfolios, but they are relatively expensive. The better choice is
much simpler: a properly diversified portfolio.
STEP 4: COVER AND INSURE RISK

Once you have implemented risk controls, the next step in the process is to cover the remaining risk with insurance.
Insurance allows the risk to be shared among a large pool of people or businesses. If the number is large enough,
then the average risk to the group as a whole will be relatively stable and manageable. (This assumes there is no
deliberate selection allowing only high-risk people to join the pool.) An individual loss might be insupportable to
one person or business, but everyone in the pool contributes a premium. Therefore, the total collected is enough to
compensate the unlucky few and also allow the insurance company to make a profit. This is the principle on which
most forms of insurance—life, disability, critical illness, property, and liability—are based and how most risks are
managed. No risk management plan is complete without adequate insurance coverage in place.
Some people, and even some businesses, may decide to cover a risk by self-insuring. For example, retirees who no
longer have access to employer-provided group benefit plans may decide to self-insure their extended health care
and dental care needs. The premiums for coverage through a private extended health care and dental care insurance
policy can be quite high. Instead, they may decide to personally and directly pay the costs of extended health care

and dental treatment as they arise. Likewise, some smaller businesses may choose to not provide a group insurance
benefits plan to their employees. Instead, they may pay for costs that employees incur, up to specified limits.
Generally, self-insurance is not recommended. In some situations, however, it may be the best alternative.
In developing a personal risk management plan, you must consider how different risks interact. Strategic wealth
preservation incorporates all the risks in a plan; it does not seek ways to insure or protect individual items in
isolation. Wealth advisors tend to think of the risks of investments, but the most critical assets on the balance sheet
are usually human capital and the family home. Basic insurance policies for life, health, disability, and property
protect against the obvious risks. However, traditional insurance alone is not wholly effective unless the entire
family balance sheet is considered.
STEP 5: MONITOR AND REVISE THE RISK MANAGEMENT PLAN

The fifth and final step in the personal risk management process is to monitor and revise the plan as needed. For
example, clients tend to forget about insurance once it is established, and that may be a serious mistake. As their
advisor, you must remind the family to review their plan regularly. They need to consider whether the various risk
management measures they have in place are still sufficient, or whether they are in fact still needed.
A useful monitoring method is to align reviews with family milestones. Only a few major milestones, such as
marriage, divorce, the birth of a child, or a significant job promotion, will require adjustments to the plan. However,
clients should understand the importance of making decisions in these circumstances. Clients can also revisit the
plan whenever they move from one stage to another in the family life cycle.
RISK MANAGEMENT PROCESS
What are the steps in the risk management process? Complete the online learning activity to assess your
knowledge.
A COMPREHENSIVE APPROACH TO RISK MANAGEMENT

Clearly, strategic wealth preservation and management is about more than investing money and buying life
insurance. As an advisor, you must take a comprehensive approach to managing a family’s wealth and the risks
involved, as follows:
• Identify the family unit whose wealth is being managed.

• Identify the types of risks to which clients are exposed and the economic loss that could result.
• Determine the frequency and severity of potential risks.
• Determine the risks and their relative importance using the five-step risk management process.
• Identify all assets and liabilities, including human capital.
• Identify the details of existing insurance contracts, such as limits, exclusions, deductibles, and costs. (Many of
these details will be available in the information you collected to create the client’s profile.)
• Identify the risks that income streams and asset values are exposed to.
• Determine how significant the identified risks are in terms of potential economic loss.
• Decide which strategies you will use to manage risk, whether they are control, retention, transfer (insurance or
non-insurance), or a combination of methods.
• Implement plans to manage the important risks.

HELPING THE LEWIS-MAIER HOUSEHOLD PROTECT THEIR ASSETS
At the beginning of this chapter, we presented a scenario in which spouses Mark Lewis and Karl Maier expressed
their concern about protecting their assets. Now that you have read the chapter, we’ll revisit the questions we
asked and provide some answers:
• How do Mark and Karl think about risk? Do they understand the potential risks to their investment portfolio?
• As their advisor, it is critical that you work with Mark and Karl to help them understand the impact of their
perceptions compared to real risks. You should also explain how risk can be mitigated, specifically shortfall
risk.
• From an investment standpoint, the couple has not considered that a 100% fixed income portfolio has
inherent risks, including inflation risk, interest rate risk, credit risk, and risk of lower after-tax cash flow
from an all-interest-income portfolio.
• Giving up the long-term growth potential of equities might have the opposite effect than anticipated by
the couple, creating new risks by reducing their returns and eroding their principal faster as a result of their
income needs.
• As well, as Mark and Karl age, their greatest risk may be a pure risk that they may not have considered:
disability or death.
• Given the many ways to understand and measure risk, how would you determine the perceived and real risks your
clients face?
• You must work to identify all risks they face and evaluate them in terms of the possible losses they could
incur if they were to materialize.
• Human capital, one of the most overlooked assets, provides the income for living costs and for the savings
plans used to fund life goals.
• Few consider what the impact would be if they were physically unable to work or were unable to find
employment.
• If a retiree has enough in pension and retirement savings, their human capital is not a factor. However,
a younger client’s human capital is crucial. Loss of this capital through disability or death could result in
severe financial hardship for the whole family.
• How do risks change over time as clients move through the various stages of life?
• In most circumstances, different risks have greater or lesser significance to clients, depending on what life
stage they are in.
• To a young family, estate planning is not a high priority. Budgeting to maximize cash flow and saving for
their children’s post-secondary education take precedence.
• For Mark and Karl, who are at a later life stage (i.e., stage 7 – couple retired), investment planning,
retirement planning, and estate planning are far more important than debt management or budgeting.
Investment planning includes, for example, holding tax-effective investments that can provide additional
cash flow. Retirement planning includes determining how much income they will need to fund their
lifestyle. They should also consider how much protection they will need from unforeseen health issues.

SUMMARY
In this chapter, we discussed the following key aspects of the personal risk management process:
• Strategic wealth preservation has two benefits for advisors and their clients:
• First, it broadens the scope of wealth management to include all assets and liabilities in an integrated, holistic
framework.
• Second, it incorporates the principles of risk management as an organizing theory.
• Wealth management begins with risk management. Beyond simply protecting a client’s initial capital from
deterioration, your broader role is to provide your clients with access to the widest range of opportunities
available given their personal resources. Your focus should be on the client as part of a family and also on the
interplay between personal and business goals and risks.
• An important part of strategic wealth preservation is to create a personal risk management plan for clients and
their families. In doing so, you should ask the following questions:
• How should we think about risk?
• How do we measure risk?
• What is at risk?
• What is the process for managing risk, however it is defined?
• How does the family life cycle affect risk management and wealth management?
• You should help your clients manage their wealth by setting clear financial goals with two attributes: a set
monetary amount and a specific time frame.
• Risk can be characterized in two ways:
• Pure risk (loss or no loss) versus speculative risk (loss or gain)
• Objective risk (commonly accepted as risk) versus subjective risk (a personal perception of risk)
• The most commonly accepted measure of risk is standard deviation, or variance, which measures the variability
of outcomes. Other measures are based on shortfall risk, pure risk, and time diversification.
• There are connected risks underlying certain assets, including human capital, pension plans, and the family
home.
• The personal risk management process has five steps:
1. Identify risk.
2. Evaluate risk.
3. Control risk.
4. Cover and insure risk.
5. Monitor and revise the risk management plan.
• The life cycle has five approximate stages: early earning years, family commitment years, mature earning
years, nearing retirement, and retirement. You can use the family life cycle stages to identify the importance of
different issues in risk management and strategic wealth management.

DISCUSSION BOARD
for Chapter 7.
REVIEW QUESTIONS
Questions.

Understanding Tax Returns 8
CHAPTER OUTLINE
In this chapter, you will learn about the importance of addressing income tax issues in financial planning. We explain
three tax planning strategies: eliminate, reduce, and defer taxes payable by clients. We also explain how income
taxes are calculated on personal income tax returns, including the deductions and non-refundable tax credits that
can reduce a client’s tax bill. You will also learn about the rules that apply to taxation of investment income. Toward
the end, we explain how some employee benefits are taxable and others are not.
1 | Explain the three strategic categories of Financial Planning and Taxation

effective tax planning.
2 | Illustrate how federal personal income taxes Personal Income Tax Returns
are calculated.
3 | Describe the type of investment returns and Taxation of Investment Income

what taxation rules apply to them.
4 | Differentiate between taxable and non- Taxable and Non-Taxable Employee Benefits
taxable employee benefits.

KEY TERMS
average tax rate net income
deferred compensation non-eligible dividends
eligible dividends standby charge
employee benefits taxable income
employee stock option plan tax credit
marginal tax rate tax deduction
net federal tax total income

CHAPTER 8 UNDERSTANDING TAX RETURNS 8•3
INTRODUCTION
As the old saying goes, there are two certainties in life: death and taxes. An important part of your role as an advisor
is to offer general advice about tax issues. You should therefore have sound knowledge of the federal rules regarding
income tax returns and an understanding of how income taxes are calculated. With this knowledge, you will be
able to understand your clients’ tax concerns and suggest ways to eliminate, reduce, and defer taxes. Note that this
chapter covers only federal tax rules.
Before you begin, read the scenario below, which raises some of the questions you might have about tax planning.
TAXING THE MILLERS
Your clients, Ruth and Peter Miller, have built substantial investment portfolios over many years. They also
have significant real property, including their primary home, a cottage, and a residence in Florida. Other assets
include valuable works of art, jewellery, and a wine collection.
• What can the Millers do to eliminate taxes now and in the future?
• What specific investment products or solution could they use to maximize their after-tax cash flow?
• Peter is unclear about the difference between a tax deduction and a tax credit. How would you explain that to Peter?
NOTE
Some content in this chapter is also covered in Chapters 2, 6, 7, 10, 11, and 12 of the KPMG Tax Planning guide, in
some cases in greater detail. We strongly recommend that you study the content in the KPMG guide in addition
to this text, because they both contain examinable content. For examination purposes, if the content in this
chapter differs from the KPMG guide in any respect, precedence will be given to this content.
FINANCIAL PLANNING AND TAXATION
1 | Explain the three strategic categories of effective tax planning.
The best approach to taxation is to view it as an integral part of financial planning. One’s investment decisions around
most of the products offered by financial institutions will have some impact on the client’s tax situation. Spending,
saving, insurance, investments, and borrowing all involve after-tax cash flows. Furthermore, income taxes constitute an
increasingly important variable in the accumulation and preservation of wealth, especially in retirement and upon death.
Income from different products has different tax treatments, and the marginal tax rates that clients face also differ.
For these reasons, you must carefully assess tax implications when choosing financial products, much as you would
consider maturity, liquidity, and expected yield of investments.
Different taxation rates are imposed on income depending on the income source and tax bracket of the earner. Tax
planning involves shifting income earned or received by taxpayers from highly taxed financial activities and assets to
those taxed at a lower rate. However, tax minimization as the sole objective may lead to poor investment decisions
with adverse, non-tax consequences. For example, an investment that has a positive tax incentive might also carry
higher risk, reduced liquidity, or poor marketability.
Rather than focusing simply on reducing an individual’s tax bill, the goal of sound financial planning should be to
increase after-tax income and household net worth.

ELIMINATING, REDUCING, AND DEFERRING TAXES

The Canadian tax system attempts to provide incentives for certain ventures and income redistribution schemes.
It creates a system of differential tax rates that may vary significantly, depending on several factors:
• When the tax is paid

• Who is paying it
• What the taxable activity is
• What form of business the taxpayer is involved in
• Where the business or activity takes place
In this context, tax planning strategies can be grouped into the three broad categories described below:
Eliminate taxes Taxpayers can structure their affairs so that income earned is not subject to taxation.
An example of an investment vehicle used for this purpose is a tax-free savings account
(TFSA). A TFSA is an account that can be used by clients to save money in a tax-
free manner throughout their lifetime. Contributions to a TFSA are not deductible for
income tax purposes. However, all income earned in the account (such as interest)
is tax-free and all withdrawals from a TFSA are also tax-free. TFSAs will be covered in
greater detail in Chapter 9.
Reduce taxes Taxpayers can adjust their situation so that a lower tax rate is applied to the income
earned. For example, they can split pension income between spouses or use a prescribed
rate loan to split income with family members. By shifting income from a high-income
taxpayer to one with a lower income, clients can decrease the overall tax liability of
the family.
Defer taxes Taxpayers can put off paying taxes to take advantage of potentially lower tax rates in
the future, while having the use of the funds today. A buy-and-hold strategy for equity
investing defers the recognition of taxes for as long as the security is held. Also, time
value of money suggests that a sum of taxes paid 10 years from now is worth less than
the same sum of taxes paid today.
Many financial planning and tax savings strategies combine elements of the three strategic categories.
EXAMPLE
Adam contributes $10,000 to a spousal registered retirement savings plan (RRSP) registered in the name of
Roger, his spouse, who is in a lower tax bracket. If Adam’s marginal tax rate is 35%, he can claim a tax deduction
of $10,000 on his income tax return, which will reduce his immediate tax liability by $3,500. The funds in the
RRSP will grow tax deferred until withdrawal, ideally in retirement. When Roger withdraws the funds, the amount
will be brought into his income and fully taxed at his marginal rate. If that rate remains lower than Adam’s, Roger
will pay less tax on the withdrawn amount than Adam would have.
In this situation, two strategies are in effect:
Tax deferral The returns in the RRSP are tax deferred until withdrawn.
Tax reduction Adam saves tax at his marginal tax rate when he contributes to the RRSP, and Roger
is taxed at a lower rate when he withdraws the contribution. The difference between
these two tax rates represents a pure tax savings.

PERSONAL INCOME TAX RETURNS
2 | Illustrate how federal personal income taxes are calculated.
Almost everyone earning income in Canada must file an annual income tax return. Canadian residents are taxed
on income by both the federal and provincial governments. Furthermore, non-residents may be taxed on income
generated from certain Canadian sources.
The time needed to prepare a personal tax return depends on the complexity of the person’s finances, the
documentation available, and the financial planning strategies used.
The taxation year for individuals is defined as the calendar year (January 1 to December 31). Tax returns must be
filed by April 30 of the following year, unless the individual or spouse is self-employed and unincorporated. In that
case, the deadline for submission is extended to June 15 (but any balance of taxes owing must be paid by April 30 at
the latest).
The Individual Income Tax and Benefit Return is the catch-all tax return for Canadians, in which all types of taxable
income and tax-deductible expenses can be disclosed. The Individual Income Tax and Benefit Return is an eight-
page document, supplemented by various numbered schedules and worksheets for specific types of income and
deductions.
In preparing the Individual Tax and Benefit Return, taxpayers must include details provided on tax information
slips that have been received from employers, payers, and administrators. Most of these slips are mailed out to
individuals by the end of February following the year in which payment was made. Canada Revenue Agency (CRA)
encourages taxpayers to file their tax returns through its NETFILE system.
DID YOU KNOW?
E-file is the system used by professional tax preparers, whereas NETFILE is the method by which most
Canadians file their own tax returns over the Internet.
When using either system to file their tax returns, taxpayers should keep their tax slips rather than
submitting them.
Taxpayers may receive any of several types of tax slips, as follows:
T3 Slip The T3 tax slip lists the amount of income (such as interest, dividends, and capital gains)
distributed to investors holding mutual fund trust units in a non-registered account.
Statement of Trust
This type of slip is also used to report amounts allocated from trusts such as estates and
Income Allocations
family trusts.
and Designations
T4 Slip The T4 tax slip documents total compensation paid to an employee, including any
commissions earned, taxable benefits provided, and amounts withheld for source
Statement of
deductions.
Remuneration Paid
T4A Slip The T4A tax slip provides details of amounts paid from pension plans and many other
sources, including annuities, scholarships, and registered education savings plans.
Statement of Pension,
Retirement, Annuity,
and Other Income

T5 Slip The T5 tax slip is normally issued by financial institutions. It reports interest, dividends,
and capital gains paid to individuals. The capital gains typically result from transactions
Statement of
within corporate class mutual funds, and not from the sale of securities by the taxpayer.
Investment Income
Private corporations, such as investment holding companies, also issue T5 slips to report
dividend amounts paid to shareholders.
T5008 Slip The T5008 tax slip reports amounts received from the disposition of securities for taxable
accounts. Many investment firms do not issue these individual tax slips to account
Statement of Securities
holders for each security disposition; instead, they consolidate all dispositions on a
Transactions
statement that shows the dispositions that have taken place in the investment portfolio.
DIVE DEEPER
Details regarding these and other information slips can be found on the CRA website.
HOW TAXES ARE CALCULATED

The personal tax liability is calculated on a Canadian personal income tax return. The following five-step procedure
is a simplified overview of many of the items regularly seen on a personal tax return.
1. CALCULATE TOTAL INCOME

To arrive at total income, add income from all taxable sources, such as those listed below:
Employment income
+ Pension income (including OAS pension and CPP/QPP benefits)
+ Self-employment income (net business income; net professional income; net farming income; net fishing
income)
+ Taxable amount of dividends (grossed up)
+ Interest income
+ Rental income
+ The taxable portion of capital gains
+ Other income
= Total income
2. CALCULATE NET INCOME

Subtract allowable tax deductions (such as those listed below) from total income to arrive at net income:
• Contributions to an RRSP and registered pension plans

• Union and professional dues
• Child care expenses
• Moving expenses
• Support payments made
• Carrying charges and interest expenses
• Exploration and development expenses

3. CALCULATE TAXABLE INCOME

Subtract any additional deductions from net income (such as those listed below) to arrive at taxable income:
• Security options deductions

• Net capital losses of other years
• Non-capital losses of other years
• Capital gains deduction
4. CALCULATE TAXES OWING

Calculate taxes owing by applying the federal progressive tax rates to taxable income derived above.
From the taxes owing amount, subtract non-refundable personal tax credits, dividend tax credits, and foreign tax
credits to arrive at net federal tax.
DID YOU KNOW?
The amount of federal tax owing is calculated on the Income Tax and Benefit Return based on the
taxable income amount. Progressive tax rates apply so that higher income amounts are taxed at a higher
rate.
5. CALCULATE THE REFUND OR BALANCE OWING

Compare the net taxes owing (both federal and provincial) and the amount of taxes already remitted to the
government. Amounts already remitted to the government include source deductions, such as amounts withheld
from employment income, and instalment payments made.
• If taxes remitted fall short of the net taxes owing, the difference is the balance owing. The taxpayer will have to
remit the shortfall by April 30 (the due date for all amounts owing).
• If taxes remitted throughout the year are in excess of the net taxes owing, the excess amount will be returned to
the taxpayer in the form of a tax refund. CRA sends the refund to the taxpayer after the tax return is assessed.
DIVE DEEPER
For a copy of the Individual Income Tax and Benefit Return Tax Form, go to your online Job Aid and open
the following document:
The Individual Income Tax and Benefit Return Tax Form
TYPES OF TAXABLE INCOME
Can you identify the different types of taxable income? Complete the online learning activity to assess
your knowledge.
FEDERAL TAXES
Federal taxes are assessed on taxable income (i.e., income after deductions) according to a schedule of increasing
tax rates at progressively higher tax brackets, as shown in Table 8.1.

Table 8.1 | Federal Tax Rates for 2022—For Information Only
Taxable Income Tax Rate
On the first $50,197 of taxable income 15.0%
On the next $50,195 of taxable income

(on the portion of taxable income over $50,197 up to $100,392) 20.5%


On taxable income over $221,708 33.0%
EXAMPLE
Ralph is a Canadian resident whose employment income in 2022 is expected to be $162,000. He also has interest
income of $5,000. He has contributed $10,000 to his RRSP during that same year and has no other allowable
deductions. Therefore, his taxable income will be $157,000 (calculated as $162,000 + $5,000 − $10,000). His
federal taxes before credits are applied, based on the rates above, are calculated as follows:
On the first $50,197 (at 15.0%) = $7,529.55
On the next $50,195 (at 20.5%) = $10,289.98
On the next $55,233 (at 26.0%) = $14,360.58
On the next $1,375 (at 29.0%) = $398.75
Total tax on $157,000 = $32,578.86
All provinces except Quebec impose taxes using their own tax rates, credits, and surtaxes as part of the Individual
Income Tax and Benefit Return (tax return). Quebec administers its own provincial income tax system and has its
own process for filing provincial income tax returns. Although the tax brackets, tax rates, and tax credits may differ,
the process by which provincial tax is calculated mirrors the calculations shown above.
INCOME TAX PAYABLE
Can you calculate income tax payable on a client’s income? Complete the online learning activity to assess
your knowledge.
DIVE DEEPER
Go to your online chapter to find the following link to a tax calculator:

Tax Calculator
TAX DEDUCTIONS AND TAX CREDITS

What is the difference between a tax deduction and a tax credit?

A tax deduction reduces the taxable income on which federal tax is calculated. Thus, it reduces the amount of tax
the taxpayer owes, based on the combined federal and provincial marginal tax rate for a particular year.
In contrast, a tax credit is a specific reduction of taxes payable. In general, its value is equal to the stated amount
multiplied by the lowest graduated tax rate, regardless of the taxpayer’s tax bracket. A non-refundable tax credit
can be used to lower one’s taxes owing, but it can only lower the taxes owing to nil.
DID YOU KNOW?
A tax credit can be compared to a discount coupon at the cash register in a grocery store. It can be used
to lower the amount owing but can only bring the amount owing to nil. If the value of the tax credit
exceeds the amount of taxes owing, the taxpayer may not be able to use the credit. In some cases,
however, the taxpayer can transfer excess credit amounts to other taxpayers.
Because a tax deduction lowers taxable income, it is often worth more than a tax credit. The only case where there
is no difference between the value of a tax deduction and a tax credit is when the taxpayer’s taxable income is in the
first tax bracket.
A tax deduction can move a taxpayer from one tax bracket to another. For example, if a taxpayer has taxable
income of $50,000, but, then makes an RRSP deduction of $5,000, the person’s taxable income will be reduced to
$45,000. In doing so, the taxpayer has avoided the second tax bracket entirely. In this way, taxpayers are said to
save tax at their marginal tax rate (the tax owing on the next dollar they earn or the next dollar deducted).
MAIN TAX DEDUCTIONS

These are the main deductions available on the Individual Income Tax and Benefit Return:
• Contributions to a registered pension plan (RPP)

• Contributions to an RRSP
• Deduction for elected split-pension amount—that is, the sharing of income from a pension or registered
retirement income fund as an income-splitting strategy
• Annual union and professional dues
• Childcare expenses
• Business investment losses
• Moving expenses (when related to work and not reimbursed by the employer)
• Eligible support payments made
• Carrying charges and interest expenses
• Other employment expenses
EXAMPLE
Simon has a combined federal and provincial marginal tax rate of 44%. He deducts $2,000 in carrying charges
and interest expenses on his investment portfolio, which results in an $880 (calculated as $2,000 × 44%) tax
savings.
Total income, net income, and taxable income must be greater than or equal to zero after deductions. Most
deductions in excess of income are lost. However, if possible, deductions and losses that would otherwise expire can
be used up by accelerating income recognition or by realizing some accrued capital gains.

FEDERAL NON-REFUNDABLE TAX CREDITS

The total non-refundable tax credits consist of a specified percentage of permitted amounts based normally on the
lowest tax bracket. Some (but not all) of the permitted federal tax credits available are listed below:
• Basic personal amount

• Age amount
• Amount for spouse, common-law partner, or eligible dependant
• Disability amount
• Canada or Quebec Pension Plan contributions
• Employment Insurance premiums
• Home buyers' amount
• Medical expenses over a specified percentage of net income
• Caregiver amounts
• Donations and gifts
• Pension income amount
• Tuition and education amounts
As the name suggests, these credits are not refundable; therefore, credits in excess of taxes owing cannot be used.
However, except for taxpayers with very low incomes, most people do not have tax credits exceeding their federal
taxes owing.
EXAMPLE
Previously, we calculated Ralph’s federal taxes owing as $32,578.86. Assume that the only non-refundable
tax credit Ralph receives for 2022 is the Basic Personal Amount (BPA). The BPA for Ralph in 2022 will
be $14,363.07.1 Therefore, using the tax credit rate of 15%, Ralph is entitled to $2,154.46 (calculated as
$14,363.07 × 15%) of non-refundable tax credits. Ralph’s net federal tax is thus reduced to $30,424.40
(calculated as $32,578.86 − $2,154.46).
TAX DEDUCTIONS AND TAX CREDITS
Can you calculate the tax deductions and tax credits that apply to a client’s taxable income?
Complete the two online learning activities to assess your knowledge.
AVERAGE AND MARGINAL TAX RATES

The average tax rate (also called the effective tax rate) is calculated by dividing the total amount of net taxes owing
by taxable income. The result gives taxpayers an idea of their actual income tax burden. In other words, it shows
what was earned and what was paid in income taxes. This information is relevant when you are looking at a client’s
income as a whole. It is often used in payroll calculations and retirement planning where there is interest in knowing
how much tax will be paid in total, based on a given income level.
1
The BPA for 2022 is $14,398. If net income is more than $155,625 (and Ralph’s at $157,000 is more), a partial claim to the BPA must be
calculated using a worksheet. In Ralph’s case, it comes to $14,363.07. This calculation is not examinable.

CHAPTER 8 UNDERSTANDING TAX RETURNS 8 • 11
EXAMPLE
As calculated below, Ralph’s federal and provincial (Ontario) taxes for the year are $47,835.85 and his taxable
income is $157,000. Therefore, his average tax rate is calculated as $47,835.85 ÷ $157,000 = 30.47%.
The calculation of Ralph’s total taxes payable is shown in the following table.
Ontario and Federal Taxes Owing on Taxable Income of $157,000—For Information Only
Net Federal taxes Payable $30,424.40
Provincial tax payable (Ontario)
On the first $46,226 5.05% $2,334.41
On the next $46,228 9.15% $4,229.86
On the next $57,546 11.16% $6,422.13
On the next $7,000 12.16% $851.20
Total $157,000 $13,837.60
Less Ontario basic personal tax credit $11,141 5.05% −$562.62
Ontario taxes $13,274.98
Surtax 1* $13274.98 − $4,991.00 = $8,283.98 20% $1,656.80
Surtax 2* $13,274.98 − $6,387.00 = $6,887.98 36% $2,479.67
Total Ontario taxes $17,411.45
Total Federal taxes $30,424.40
Total taxes payable $47,835.85
* There is 20% surtax for basic taxes above $4,991 and an additional 36% surtax for basic taxes above $6,387. The 36% surtax is in
addition to the 20% surtax, for a total surtax of 56%.
The marginal tax rate is the rate applicable to each additional dollar of income a taxpayer earns. The marginal
rate of tax is relevant in cases where clients want to compare various investment alternatives. Marginal tax rates
measure the amount of tax payable on each dollar if income increases or decreases by that amount.
Marginal tax rates help to measure the increase in taxes owing or the tax savings associated with the events such as
those listed below:
• Making RRSP contributions

• Receiving a bonus
• Receiving various types of investment income

EXAMPLE
Assume that Ralph realized $2,000 in actual capital gains, so his taxable income increased by half that amount to
$158,000. His marginal tax rate for federal purposes is at the 29% tax bracket. He is also subject to provincial tax at
a rate of 18.97% (12.16 × 1.56), including the Ontario surtaxes2, for a total combined marginal tax rate of 47.97%.
Ralph’s average tax rate can be calculated as follows:
• Original tax on $157,000 = $47,835.85

• Plus incremental tax on $1,000 at the marginal rate = $479.70
• Total tax on $158,000 = $48,315.55
• Average tax on $158,000 = $48,315.55 ÷ $158,000 = 30.58%
As taxable income rises, both the marginal tax rate and the average tax rate also increase. In the example, Ralph’s
combined marginal tax rate of 47.97% is much higher than his average tax rate of 30.58%. The same is likely to hold
true for most individual taxpayers.
EXAMPLE
Let’s say that Ralph uses some of his RRSP contribution room to make an additional $6,000 contribution,
thereby lowering his taxable income to $152,000 (calculated as $158,000 − $6,000). His combined federal and
provincial marginal tax rate is 47.97%.
The tax savings that result from the additional RRSP contribution can be calculated as $6,000 × 47.97% =
$2,878.20. Depending on his overall taxes owing and the amounts already remitted, this difference may result in
either a smaller balance owing or an increased refund.
UNDERSTANDING TAX RATES
Can you explain how the different tax rates apply to a client’s income? Complete the online learning
TAXATION OF INVESTMENT INCOME
3 | Describe the type of investment returns and what taxation rules apply to them.
Taxation of investment earnings varies depending on the type of return and the investor’s province of residence.
There are four types of investment return: interest (and foreign-source dividends), Canadian-source dividends,
capital gains, and return of capital (ROC). Each type is subject to different taxation rules.
INTEREST AND FOREIGN-SOURCE DIVIDENDS

Interest income may be earned from deposits held in bank accounts and the money market or from fixed income
instruments. These instruments include corporate bonds, commercial paper, government bonds, mortgage-backed
securities, and mutual funds.
Foreign source dividends are dividends paid from non-Canadian equities. The corporate income from which these
dividends are paid is not subject to Canadian tax; therefore, it does not benefit from the dividend gross-up and
2
The 36% surtax is in addition to the 20% surtax, for a total surtax of 56%. The concept of provincial surtax is not examinable.

dividend tax credit mechanism. Instead, foreign source dividends are taxed at marginal tax rates, in the same way
that interest income is taxed.
Of all types of return, interest and foreign-source dividends are taxed at the highest rate.
CANADIAN-SOURCE DIVIDENDS
Canadian dividends are paid by private and public Canadian corporations to their shareholders holding both
preferred shares and common shares.
Eligible dividend income from Canadian corporations is taxed at a lower rate than simple interest because of the
dividend gross-up tax credit mechanism.
The dividend tax regime for non-eligible dividends uses different factors. Investors are informed on their tax slips
whether their dividends are eligible or not for the tax credit. Non-eligible corporations tend to be private small
businesses, which receive special corporate tax advantages through the small business deduction.
The combined federal and provincial dividend tax credit results in an average tax rate on dividend income that is less
than the rate for interest income. For people paying lower combined tax rates, eligible dividends may attract even
less tax than capital gains.
Lower-income retirees who rely on dividends for income may encounter a problem in that the dividend gross-up
increases net income. As a result, Old Age Security (OAS) and Guaranteed Income Supplement benefits, which are
based on net income, could be subject to a bigger “clawback”, i.e., repayment of pension benefits received (covered
in detail in a later chapter). The age credit and medical benefits could also be reduced. Another effect is that the
gross-up could put the retiree into a higher tax bracket. An increased dividend tax credit may not compensate for
these potential costs.
DID YOU KNOW?
Under the dividend gross-up tax credit mechanism, Canadian-source dividends are grossed up by 38%.
The offsetting federal dividend tax credit is 15.02% of the grossed-up amount (or 20.73% of the actual
amount) The provincial dividend tax credit varies by province. However, these tax credits are available to
mitigate double taxation, which would otherwise occur given that dividends are paid out of a company’s
after-tax earnings.
CAPITAL GAINS
Capital gains and losses arise from the sale or disposition of stocks, bonds, or other financial instruments.
The capital gain or loss is calculated as the difference between two amounts:
• The amount paid for the securities, plus brokerage fees related to the purchase
• The net amount received when the property is sold or disposed of
The capital gains inclusion rate defines the portion of capital gains that must be included in taxable income. That
rate is currently 50%, which means that only half of any capital gains realized in a given year is included as taxable
income. Capital gains are usually considered the most tax-efficient type of income, but not always. Because
dividends receive a refundable tax credit, people in lower income brackets may be better off receiving dividend
income.
Realized capital gains are taxable, whereas unrealized gains are not taxable. A good tax deferral strategy, as long
as the income is not needed, is to hold assets that appreciate over time. The gains accumulate in a compounding
manner, with tax deferred until disposition.

Capital losses can be used to offset capital gains for tax purposes only. They must be applied first in the current year,
and any excess losses can then be applied to net capital gains made in the previous three years. They can also be
carried forward indefinitely. Sales of equities at a loss within 30 days after or before purchasing the equity and still
owned 30 days after the loss sale are considered a superficial loss, and are thus not eligible as a capital loss for tax
purposes.
RETURN OF CAPITAL
Occasionally, and sometimes by design, mutual funds make distributions in excess of their taxable income. The
excess is the ROC. Payouts can exceed reported income because of a large amount of non-cash deductions, such
as depreciation, capital cost allowances, and exploration and development expenses. Sometimes the payout
represents an actual return of an investor’s capital.
An ROC distribution is not taxable in the year the investor receives it. Instead, the original cost of the units is
reduced by the amount of the distribution, and a new average cost per unit is calculated. The new average is the
adjusted cost base, that is, the figure used to calculate the capital gain or loss when the units are eventually sold.
Any ROC results in a larger capital gain or smaller capital loss when the mutual fund is sold.
DIVE DEEPER
Go to your online chapter to find the following link:

Tax Payable on Investment Income
TAXABLE AND NON-TAXABLE EMPLOYEE BENEFITS
4 | Differentiate between taxable and non-taxable employee benefits.
In this section, we explain the characteristics of various types of employee benefits in terms of taxation. Generally,
clients should include the value of any employment benefit received in their employment income. Of course,
employment benefits include salary, wages, commissions, and bonus, but many employees receive additional
benefits. All benefits are normally taxable, but there are some exceptions and special calculations to consider.
PRIVATE HEALTH AND GROUP LIFE INSURANCE PREMIUMS

A private medical insurance plan supplements any government-funded health insurance plans.
Employers obtain a full tax deduction for contributions on their employees’ behalf. Employer contributions to a
private health services plan are not considered taxable employee benefits. Employee-paid premiums to a private
health services plan are considered qualifying medical expenses for purposes of the medical expenses tax credit.
These expenses can be claimed by employees on their tax returns.
Employer-paid premiums for group life insurance are considered a taxable benefit for employees.
CAR ALLOWANCE FOR AN EMPLOYEE-PROVIDED CAR

Employers often give employees additional compensation in lieu of providing them with a company car. This
allowance reimburses the employee for the cost of necessary employment travel.
Allowances in excess of a reasonable amount must be reported as a taxable benefit for the employee. However,
employees can then claim the corresponding proportion of their actual car expenses.

Reasonable allowances do not need to be reported as income, but corresponding car expenses cannot be claimed by
the employee.
The automobile allowance rates for 2022, as listed by CRA, are as follows:
• For the first 5,000 kilometres driven, $0.61 per kilometre

• After 5,000 kilometres, $0.55 per kilometre
BUSINESS MEAL AND ENTERTAINMENT EXPENSES

When employees are reimbursed for expenses, such as the cost of meals incurred in the course of business, the
reimbursements are not considered taxable benefits. To help employees with their personal cash flow and ease
record-keeping requirements, many companies issue corporate credit cards for these types of expenses.
EMPLOYER-PAID COURSES FOR EMPLOYEES

When an employee takes a course at the employer’s initiative that benefits the employer, the cost of the course is
not considered a taxable benefit to the employee. CRA often presumes this to be the case if employees are given
time off with pay to attend a course during regular working hours. For example, there would be no taxable benefit
to an executive attending a $5,000, three-day course on improving negotiation and conflict resolution skills.
Courses provided for the employee’s self-improvement that do not have a broader business purpose are considered
taxable benefits and reported on the employee’s T4 slip.
HOME PURCHASE AND RELOCATION LOANS

Special rules apply to loans from an employer to an employee that the employee uses to acquire a home or to repay
a home loan. The taxable benefit on these loans is determined based on the difference (if any) between the interest
rate payable when the loan was made and CRA’s lowest prescribed rate for the year in question.
INTEREST-FREE LOANS TO EMPLOYEES

An attractive benefit provided to some employees is an interest-free or low-interest loan. A drawback is that
such loans are a taxable benefit for the employee. The deemed interest benefit is equal to the difference between
two amounts:
• The prescribed interest rate for the year (set quarterly by CRA)
• The interest actually paid by the employee in the year, or no later than 30 days after the end of the year
Newly hired executives are sometimes offered such loans to purchase minimum required holdings of company
shares. The interest-free loan used to purchase shares in the employer corporation triggers a taxable benefit.
However, the taxable benefit is offset by a deductible expense because the loan was being used for investment
purposes. The employee’s net income does not increase as a result.
REIMBURSEMENT OF AN EMPLOYEE’S MOVING COSTS

The employer’s reimbursement of an employee’s moving costs is not a taxable benefit to the employee. However,
additional amounts paid as a result of the move, such as a cash incentive to move to a position in a new city, are
taxable.

If the moving costs are not reimbursed, the employee can deduct moving expenses provided that certain conditions
are met, such as the following two requirements:
• The employee’s old residence and new residence must both be in Canada.
• The new residence must be at least 40 kilometres closer to the new work location than the former residence.
Moving expenses are deductible from income earned at the new work location.
PERSONAL USE OF A COMPANY CAR

The personal use by an employee of a company car receives a great deal of attention from CRA. Owners of private
companies that put automobile costs through their businesses fall under similar scrutiny. Detailed record-keeping
is necessary, and special rules are used to compute and separate taxable benefits into two components detailed
below:
Standby charge If an employer makes a company car available for an employee’s personal use, a standby
charge for the car must be included in the employee’s income. The charge applies
whenever an automobile is made available to the employee “by virtue of employment.”
This benefit can be reduced if the employee uses the car primarily (more than 50% of
the time) for employment purposes. When tracking the kilometres driven, employees
should be aware of the tax advantage of keeping non-employment use to less than
half of the total distance travelled. The taxable benefit is reduced by any amounts the
employee pays to the employer for the use of the car, other than payments for operating
expenses.
Payment of personal- Employer-paid operating costs for the personal use of a company car are included in
use costs the employee’s income. The costs must relate to the employee’s personal use of the
car minus any reimbursement of the costs by the employee. Because it is difficult to
track the actual operating costs of every vehicle, CRA allows employers to charge their
employees a flat rate of $0.29 (2022) per personal kilometre driven. Therefore, if an
employee drove 10,000 kilometres for personal use, a taxable benefit of $2,900 would
be added to the employee’s income.
CLUB MEMBERSHIPS
A club membership paid on behalf of an employee is not a taxable benefit to the employee if it is integral to the
business. Recreational or fitness club memberships are more frequently considered taxable benefits than business
club employee memberships. (An employer may find it difficult to prove the business advantage of membership in a
fitness club that provides mostly health-related services.)
EMPLOYEE STOCK OPTION PLANS

Employee stock option plans were very popular for many years, but changes in corporate financial reporting have
reduced the number of employees to whom these options are offered. One exception is the availability of employee
stock options for employees in many start-up technology companies. For many companies, the use of restricted
share units is becoming more common.
An employee stock option plan permits the employee to buy the employer company’s shares at a stated price for
a stated period, usually up to 10 years. The exercise price of the option is normally at or above the stock’s market
value when the option is granted. The employee can exercise the option at any time (unless restricted by vesting
provisions) until the option expires.

If the stock to which the option applies goes up higher than the exercise price, the employee has the benefit of
buying the stock at the original exercise price and benefiting from the spread of the two values. If the market price
of the company’s stock decreases, the employee allows the option to expire and is not forced to buy the stock.
The value of a stock option’s taxable benefit is the difference between the fair market value of the shares at the time
of exercise and the exercise price, plus any fees paid for the option. This amount is included in income in the year
that the options were exercised.
When an employee of a corporation exercises or disposes of an employer stock option, a deduction equal to one-
half of the amount of the taxable benefit can be claimed, provided that the employee deals at arm’s length with the
company and the option’s exercise price was not less than fair market value when the option was granted.
For employees of a Canadian-controlled private corporation (covered in greater detail in Chapter 9), the tax
treatment arising from shares acquired under a stock option plan are more favourable. The shares are taxable only
when the shares are sold, not at the time of exercise.
DID YOU KNOW?
The principal advantage of an employee stock option plan is that the employee incurs no financial outlay
or taxable benefit unless the option is exercised.
SALARY CONTINUANCE PLANS

Salary continuance plans protect employees against loss of income in the event of disability through sickness or
injury. They generally cover both short-term disability (STD) and long-term disability (LTD).
If the employer contributes to such plans, the benefits received by the employee are taxable. However, if the plans
are structured on an “employee pays all premiums” basis, the benefits received by the employee are tax-free. It
is common practice for employers to pay for STD premiums, whereas employees pay for LTD premiums through
ongoing payroll deductions.
DEFERRED COMPENSATION
Some employees attempt to avoid paying tax on employment income by having some of their pay held back and
paid later. This deferral is allowed in only a small number of cases. Deferral of bonuses and sabbatical programs used
by teachers and professors are examples of allowed deferred compensation. Deferred bonuses must be paid within
three years.
RETIRING ALLOWANCE FOR EMPLOYEES

The retiring allowance rules apply only to years of employment up to and including 1995. Individuals with years of
service prior to 1996 can defer tax on the eligible portion of a retiring allowance by transferring it to their RRSP. The
transfer has no impact on the individual’s RRSP contribution room. The eligible portion of the retiring allowance is
the smaller of the following two amounts:
1. Actual amount received as a retirement allowance
2. The sum of:
• $2,000 for each year or part year of service up to and including 1995
• $1,500 for each year or part year of service up to and including 1988, as long as the employee was not
entitled to receive any benefits for those years earned under a pension plan or deferred profit-sharing plan
from contributions an employer made

TAXING THE MILLERS
At the beginning of this chapter, we presented a scenario in which clients Ruth and Peter Miller asked for tax
planning help. Now that you have read the chapter, along with the relevant chapters in KPMG’s Tax Planning
guide, we’ll revisit the questions we asked and provide some answers.
• What can the Millers do to eliminate taxes now and in the future?
• The Millers should make the maximum contribution possible to their individual TFSAs. All income earned
within the TFSA is tax-free and all withdrawals from the TFSA are also tax-free. Between the two of them,
they can have over $163,000 plus investment returns in their TFSAs, all tax-free.
• What specific investment products or solution could they use to maximize their after-tax cash flow?
• One investment solution is to use growth-oriented, Canadian-source, dividend-producing, and capital-
gains-generating investments. Dividends and capital gains are taxed at preferential tax rates compared to
interest income. For instance, the combined federal and provincial top marginal tax rates for individuals
in Ontario is 53.53% for interest and regular income, 26.76% for capital gains, and 39.34% for eligible
dividends. The rates in Quebec and BC are very similar.
• Peter is unclear about the difference between a tax deduction and a tax credit. How would you explain that to
Peter?
• A tax deduction (e.g., the RRSP deduction) reduces the taxable income on which federal tax is calculated.
Thus, it reduces the amount of tax the taxpayer owes, based on the combined federal and provincial
marginal tax rate for a particular year. In contrast, a tax credit (e.g., the BPA) is a specific reduction of
taxes payable. Its value is equal to the stated amount multiplied by the lowest graduated tax rate (15%),
regardless of the taxpayer’s tax bracket.

SUMMARY
In this chapter, we mainly discussed one key aspect of tax planning, namely, understanding your tax return, but we
also covered taxation of investment income and employee benefits:
• Tax planning strategies can be grouped into three broad categories, often used in combination:
• Eliminate taxes
• Reduce taxes
• Defer taxes
• Canadian residents must report their income annually (including income from foreign sources) and pay tax on
the taxable portion to both the federal and provincial governments. Income includes employment, pension,
and business income, income from investments, and the taxable portion of capital gains. Federal taxes are
assessed on taxable income according to a schedule of increasing tax rates at progressively higher tax brackets.
The taxable portion of income is the part left over after all allowable deductions have been subtracted and tax
credits applied.
• The average tax rate is calculated by dividing the total amount of tax paid by taxable income. The marginal tax
rate is the rate applicable to each additional dollar of income that a taxpayer earns.
• Taxation of investment earnings varies depending on the type of return and the investor’s province of residence.
The four types of investment return are interest, Canadian-source dividends, capital gains, and ROC. Each type
is subject to different taxation rules.
• Some employee benefits are taxable; others are not. For example, a car allowance for business purposes would
not be considered a taxable benefit unless it is in excess of a reasonable amount.
NOTE
DISCUSSION BOARD
for Chapter 8.
REVIEW QUESTIONS
Questions.

Tax Reduction Strategies 9
CHAPTER OUTLINE
In this chapter, we discuss various techniques that can be used to minimize taxes. You will learn about the features
and tax advantages of different types of registered accounts used mainly for non-retirement purposes. You will also
learn how the different types of business structures are taxed differently and what the advantages are of certain
types of structures.
1 | Explain the various techniques used to Techniques to Minimize Taxes

minimize taxes.
2 | Describe the features of a tax-free savings Tax-Free Savings Account

account.
3 | Compare the features of registered plans that Registered Plans Used for Non-Retirement
are used for non-retirement goals. Goals
4 | Identify the types of corporate structures and Incorporation

their relationship to taxes.

KEY TERMS
accumulated income payments incorporation
attribution rules labour-sponsored venture capital corporation
Canada Disability Savings Bond lifetime capital gains exemption
Canada Disability Savings Grant listed personal property
Canada Education Savings Grant personal service business
Canada Learning Bond principal residence exemption
Canadian-controlled private corporation registered disability savings plan
carryforward room registered education savings plan
charitable donations specified investment business
cumulative net investment loss superficial loss rules
deferred profit-sharing plan tax-free savings account
educational assistance payments tax-loss selling
income-splitting tax shelter

CHAPTER 9 TAX REDUCTION STRATEGIES 9•3
INTRODUCTION
Most Canadians wish to contribute to society by paying their fair share of taxes. They understand that the public
services we receive are paid for out of the taxes we pay. However, they also want to manage their tax expense
wisely. Taking advantage of legitimate tax breaks that are available to them is a responsible and reasonable practice.
Given that the marginal tax rate in the highest income bracket in most provinces is close to or over 50% (federal
plus provincial), it makes sense to want to reduce one’s taxable income. As an advisor, you do not need to be a tax
expert. In fact, many situations require that you refer clients to such experts, rather than taking on that role yourself.
However, you should be aware of how clients can preserve and grow their investments in a tax-efficient manner and
manage their tax bill to maximize their after-tax income. Note that this chapter covers only federal tax rules.
Several registered plans are available to individual taxpayers that can be used to achieve their non-retirement
goals and lower their overall tax burden. Examples include the tax-free savings account (TFSA) and registered
education savings plan (RESP). For businesses, there are different types of corporate structures with different tax
rules and other rules specific to each type.
Before you begin, read the scenario below, which raises some of the questions you might have about tax planning.
TAXING THE MILLERS
Your clients, Ruth and Peter Miller, have built substantial investment portfolios over many years. They also
have significant real property, including their primary home, a cottage, and a residence in Florida. Other assets
include valuable works of art, jewellery, and a wine collection.
Peter is a corporate lawyer who has recently retired. He has a professional corporation set up for his consulting
work, for which Ruth does the bookkeeping as a paid employee. Her income from the business is much smaller
than Peter’s. Peter is collecting a substantial defined benefit pension while Ruth has a small defined benefit
pension that she accumulated while working with a previous employer many years ago.
The Millers wish to leave their children and grandchildren a sizable estate upon their deaths. They ask you what
you would recommend to reduce their current tax bill, increase their after-tax cash flow, and minimize future
estate taxes.
• What can the Millers do to reduce their tax bills now and in the future?
• Given their professional corporation status, what tax and other advantages can the Millers benefit from?
• What tax strategies could the Millers use to transfer their wealth to their children and grandchildren?
NOTE

TECHNIQUES TO MINIMIZE TAXES
1 | Explain the various techniques used to minimize taxes.
Most people want to protect themselves from high taxes; however, changes to the tax laws have made it
increasingly difficult to reduce taxes. Most techniques for minimizing taxes comprise one or more of the three
strategic categories mentioned earlier: tax elimination, tax reduction, or tax deferral.
It is unlikely that any one person could use all these techniques together. However, you can help all your clients
review their circumstances to assess which techniques they can use.
INCOME ATTRIBUTION RULES AND INCOME-SPLITTING

One way to minimize current and future taxes is to split income among family members. Income-splitting typically
involves the transfer of assets from a person in a high tax bracket to a spouse or child in a lower tax bracket. Income
attribution rules, however, often restrict one’s ability to split income or capital gains among family members to
reduce taxes payable by the family group.
INCOME ATTRIBUTION RULES

The income attribution rules require that certain forms of income arising from the transfer of property be taxed in
the hands of the transferor and not in those of the recipient. The rules apply to income in the form of interest and
dividends received from assets transferred to a spouse or minor children. Capital gains triggered on the sale of an
asset, originally transferred from one’s spouse, are also subject to income attribution. It should be noted that capital
gains received by a minor child on property from a parent are not currently subject to income attribution. However,
this rule is often under scrutiny and may be changed in the future. In the case of marriage breakdown, where a
married couple is living apart and meets specific conditions, the attribution rules do not apply.
The following transfers result in income attribution to the transferor:
• The transfer or loan of funds or property by an individual to a spouse or minor child who uses the funds or
property to earn investment income
• The transfer or loan of funds or property by an individual to a trust in which the person’s spouse or minor
children have a beneficial interest
• The loan or transfer of property by an individual to a corporation, other than a small business corporation (as
defined later in this chapter), in which the spouse or minor children have a direct or indirect interest
However, in all these circumstances, an exemption applies to funds lent. Attribution does not occur if, when the
loan is established, it requires that interest be charged at prevailing prescribed rates or greater. Interest must be paid
within 30 days after the end of the year for each year the loan is outstanding to avoid attribution. This strategy is
called the prescribed-rate loan income-splitting strategy. It is discussed in more depth in the next few pages.
With the exception of transfers between spouses, all other transfers between related parties are deemed to take
place at fair market value. Therefore, capital gains or losses are realized at the time of transfer.
DID YOU KNOW?
An arm’s length transaction is one in which the amount charged by one person or group to another for
a given product is the same as if the parties were not related. An arm’s length transaction must bear a
price that any other transaction would on the open market.

Table 9.1 provides an overview of the key attribution rules.
Table 9.1 | Attribution Rules
Type of To a Child, Sibling, Niece,

Transfer To a Spouse or Nephew under 18 To a Child over 18
Gift Investment income or losses Investment income1 or losses No attribution occurs.
and capital gains or losses are are attributed to the giver;
attributed to the giver. capital gains or losses are not
attributed.
Sale The sale must be made at fair Sale must be made at fair No attribution occurs.
market value, and the spouse market value; otherwise,
must elect out of spousal rollover; investment income or losses
otherwise, investment income or (but not capital gains or losses)
losses and capital gains or losses are attributed to the seller.
are attributed to the seller.
Loan The loan must bear interest at The loan must bear interest at If the loan is made mainly
the prescribed rate; otherwise, the prescribed rate; otherwise, to reduce or avoid tax,
investment income or losses investment income or losses investment income (but not
and capital gains or losses are (but not capital gains or losses) capital gains or losses) is
attributed to the lender. are attributed to the lender. attributed to the lender.
If the loan bears interest
at the prescribed rate, no
attribution occurs.
EXAMPLE
Your clients Juliet, age 46, and François, age 54, have been married for 25 years. They have three children,
ages 21, 16, and 12. Juliet is vice-president of marketing at an international travel company and earns $140,000 a
year. François is a security officer at a condo complex and earns $40,000 a year. Juliet has cash and non-
registered investments worth $500,000. She wants you to explain the tax consequences of her actions in the
following scenarios:
• She gives $100,000 in cash to François to invest.

You explain that there would be no tax benefit to making such a gift because the investment income and capital
gains would be attributed back to her.
• She lends $100,000 in cash to François to invest, on a no-interest basis.
Again, the investment income and capital gains would be attributed back to Juliet. You explain that there
would be no tax benefit to making an interest-free loan. However, if Juliet made a prescribed rate loan to
François, there would be no attribution.
1
Investment income generally includes dividends and interest, whereas capital gains occur when an asset is sold for more than its purchase
price or adjusted cost base.

EXAMPLE
(cont'd)
• She gives $50,000 to her 21-year-old child to invest.

You explain that there would be no attribution of interest income, dividend income, or capital gains to Juliet.
Income tax on income and capital gains would be payable by the adult child at, most likely, a much lower
marginal tax rate. So, there would be a tax benefit to Juliet and her family overall if she gifts funds to an adult
child to invest.
• She gives $50,000 to her 16-year-old child to invest.
You explain that any investment income (including interest and dividends) would be attributed back to Juliet;
however, capital gains would not be attributed back to her. So, there would be some tax benefit for Juliet in
making such a gift. In the year the child turns 18, attribution will no longer apply.
Despite the attribution rules, income can be legitimately split in several ways. Note, however, that some of the
techniques described below are complex. To implement them successfully, you will need to coordinate your wealth
management recommendations with tax advice from a tax professional.
ATTRIBUTION RULES
How do the attribution rules apply in different client scenarios? Complete the online learning activity to
SPLITTING INVESTMENT INCOME WITH CHILDREN

We have seen that, as a result of the income attribution rules, clients cannot legally split their investment income
with their minor children for favourable tax treatment. However, despite the income attribution rules, clients are
generally able to move assets to their minor children, and the subsequent capital gains will be taxed in the hands of
their children, thus avoiding attribution. However, the rules are different for interest, dividends, rents, royalties, and
other income from property. When a parent transfers money to minor children to invest, the parent must pay the
tax on any income from property.
On the other hand, no attribution occurs on any type of income from assets given to a child who is at least 18 at the
end of that year. Even though this may seem to be a good tax strategy, one cannot forget about the legal form of
this transaction. With such a gift, the adult child owns and controls the assets. A client who wishes to retain control
should consider setting up a formal trust instead.
DID YOU KNOW?
If a client transfers money to an adult child as a loan, rather than a gift, and if the Canada Revenue
Agency decides that the primary motive for the transfer is to avoid tax, income attribution rules can
apply. To prevent income attribution, the client should make the loan at the prevailing prescribed rate of
interest or greater.

EXAMPLE
Lucy works as a public relations specialist for a government agency, earning $210,000 a year. Her husband
Chen is a music teacher earning $40,000. The costs incurred by the couple for their children’s sports, camps,
and extracurricular activities are very high. They are considering splitting their income with their minor children
to reduce some of the family tax burden. Their tax advisor recommends that Lucy establish a formal trust with
their minor children as beneficiaries. She can then use a prescribed rate loan to transfer some income to the
children that is used to pay for their extracurricular activities. This strategy has the potential to have any income
generated taxed at the children’s lower marginal tax rate.
Each child can receive a certain amount of interest and grossed-up taxable dividends from Canadian public
companies, free of tax, without seriously affecting the ability of the person in the higher tax bracket to claim certain
credits. This impact should also be considered in any family income-splitting strategy.
GENERATING CAPITAL GAINS IN THE HANDS OF THE CHILDREN

One of the most common ways for clients to split income with their children is to give or lend them cash to invest.
Regardless of the children’s age, there will generally be no attribution of capital gains on the invested money back
to the client. The children will pay the tax on any capital gains generated. Children can earn just over $28,000 in
capital gains (in 2022) without paying much, if any, tax, as long as they have no other source of income. (The basic
personal amount federal tax credit is $14,398 in 2022 and only 50% of capital gains are taxable.)
In addition to cash, clients can transfer existing investments to their children. Note, however, that when assets
are given away, they are deemed to have been disposed of at fair market value. Therefore, if those assets have
appreciated in value since they were originally purchased, the client may have to pay tax on the capital gains in the
year in which the gift was made. This tax cost, however, could still be beneficial in comparison to the taxes saved by
splitting gains with the children.
GIVING FUNDS TO AN ADULT CHILD

When a client gives money to an adult child (in the year the child reaches age 18 at the earliest), no income earned
on the money is attributed back to the giver. The client may also transfer the assets to a trust. This second option
has the same effect but allows the client, as one of the trustees, to retain control over the money. Clients should
seek expert advice to make sure the trust is set up properly.
SETTING UP INTER VIVOS TRUSTS

Changes to the attribution rules have curtailed the usefulness of inter vivos trusts to distribute investment income
among family members (called “sprinkling”) in certain situations. However, it is still possible to fund these trusts with
loans at prescribed interest rates or greater to the advantage of children, spouses, or parents. If the trust documents
permit income and capital gains to be allocated to the beneficiaries, they may be allocated to parents or children.
The primary benefit of an inter vivos trust is that it allows the trustee to transfer assets to the beneficiaries while
maintaining some control of the assets. A second, very important benefit is the ability to call back the amounts
loaned to the trust if desired.
EXAMPLE
With professional help, Jenni set up a family trust to benefit her three minor children a few years ago. The trust
was funded with a prescribed rate loan from Jenni of $500,000 when the prescribed rate was 2%.
Last year, the family trust earned $27,500 in investment income. After paying Jenni the required 2% (i.e.,
$10,000), the trust had $17,500 in income. This income was allocated among her three children and used to pay
for the costs of participating in competitive sports. Thus, $17,500 in income was shifted from Jenni, a high tax
rate taxpayer, to her children, who had no other income and no taxes to pay on their allocated income.

SPLITTING RETIREMENT INCOME

A spousal registered retirement savings plan (RRSP) is a useful tool for splitting retirement income. However, the
plan must be made years in advance; that is, at the time that contributions are made to the spouse’s RRSP. It is
good practice to use a spousal RRSP if the high-income spouse anticipates having more retirement income than the
lower-income spouse. The high-income spouse will get the deduction now, and the RRSP monies will be taxed upon
withdrawal in the hands of the lower-income spouse. To avoid the withdrawal being attributed to the contributor,
the funds must remain in the plan for at least two calendar years after contribution (Jan 1 to Dec 31).
Pension income-splitting is another strategy that is commonly used to reduce the overall tax liability of a retired
couple. Certain types of retirement income can be split between spouses without the need to set up the strategy
years in advance. Canadians receiving “qualifying pension income” are entitled to allocate up to 50% of the sum of
all “qualifying pension income” to their spouse, as follows:
• For Canadians age 65 and over, the major types of qualifying pension income are registered pension plan (RPP)
payments, registered retirement income fund (RRIF) payments, and RRSP annuity payments.
• For Canadians under age 65, qualifying pension income primarily includes RPP payments.
Income that is not considered qualifying pension income includes ad hoc withdrawals from RRSPs, Old Age Security
(OAS), Guaranteed Income Supplement, Canada Pension Plan (CPP), or Quebec Pension Plan (QPP) payments.
For income tax purposes, the amount allocated is deducted from the income of the pension holder and included
in the income of the spouse recipient. In many cases, the allocation increases the recipient’s tax payable. For this
reason, both persons must agree to the allocation in their tax returns for the year in question.
The allocated pension income retains its character and is treated as income of the lower-income spouse for all
purposes under federal income tax rules. Some couples may therefore be eligible for a second pension income tax
credit, where previously only one was available. In addition, splitting pension income could lead to higher OAS
entitlements in some cases where the higher-income spouse was subject to the OAS clawback (which is covered in a
later chapter).
EXAMPLE
Franklin and Tanya are married. Franklin retired at 61 and receives an income from an RPP worth $50,000 per
year. Tanya, 56, still works part-time as a seamstress and earns $20,000 per year.
Their advisor recommends that Franklin allocate $15,000 of his pension income to Tanya so that each person
is taxed on $35,000. In this way, Franklin and Tanya can reduce their combined tax bill by a modest amount.
Furthermore, Franklin will reduce his marginal tax rate, and Tanya will receive an additional personal tax credit on
the pension portion of her income.
SHARING CPP/QPP PENSION INCOME BETWEEN SPOUSES

Spouses are permitted to share their CPP or QPP retirement pensions if both spouses agree. The pension income
that can be shared is based upon the proportion of years that the couple was living together relative to the time
during which contributions were made. Once it is determined how much can be shared, they can each share up
to 50% with the other spouse. If both spouses are eligible for a CPP or QPP pension, both pensions must be shared.
Once approved, the government adjusts the payments to both spouses to reflect the income sharing.
TRANSFERRING MONEY TO COVER INTEREST ON INVESTMENT LOANS

When a client transfers money to a lower-income family member to pay expenses rather than investing, the
attribution rules do not apply. Under this rule, a client could give cash to a family member to pay the interest on an
investment loan. Such a plan makes it much easier for that family member to borrow for investing. Furthermore,

the investment income is taxed at a lower marginal tax rate because it is in the hands of the lower-income family
member. However, clients making such a transfer should be careful not to provide collateral, guarantee the loan, or
make principal repayments. If they do, any income earned on the borrowed funds will be taxed in the hands of the
person guaranteeing or effectively making payments on the loan.
SWAPPING ASSETS WITH A FAMILY MEMBER

Clients can swap assets with a lower-income family member to achieve the same result they would get by passing
an asset over. To do this, a client can “sell” some investments to a spouse or child in exchange for another asset. The
asset taken back should be worth at least as much as the investments being handed over and should not produce an
income of any kind.
Assets that qualify include jewellery, artwork, a collection of coins or other items, or even one spouse’s half of the
family home, provided that the spouse contributed to its purchase. For example, if the house was purchased with
the client’s money alone, the attribution rules will apply. For tax purposes, any swap is to be treated as a sale at fair
market value. Therefore, any accrued gains made from the swap may be taxed.
PAYING SALARY (OR PROFITS) TO FAMILY MEMBERS

A sole proprietor of a business or a partner in a partnership can pay a salary to a spouse in exchange for services. The
salary would be treated as a deductible business expense and included in the calculation of net business income of
the sole proprietor or partner. With this strategy, clients can reduce the net business income of the sole proprietor
or partner and transfer income to the spouse who provided the services. The salary must be reasonable for the
services provided, or the deduction will be disallowed. The spouse is allowed to contribute to CPP or QPP, and
the salary is earned income that generates RRSP contribution room for the spouse. However, even if the business
expense deduction is denied, the recipient spouse will still be taxed on the salary received.
Similarly, an individual can arrange a business partnership with his or her spouse. Profits allocated to the spouse are
taxable in the spouse’s hands, provided that the payments are commensurate with the effort or capital the spouse
contributes.
PAYING AN ALLOWANCE TO A WORKING CHILD

Clients can use the strategy of paying their children an allowance (pocket money) while they are earning their own
income in order to free up the children’s employment earnings for investment purposes. Attribution rules are not
applicable because the children are saving their employment income and spending their allowance. This tactic is
viewed as income-splitting because the children’s tax rate is lower than the tax rate of the parent. Additionally,
a child who has earned income accumulates RRSP contribution room. When the child’s taxable income reaches
the point where it becomes advantageous to make RRSP contributions, the extra room will allow a greater tax
reduction.
EXAMPLE
Sam’s father, who is in the 44% marginal tax bracket, gives Sam (age 15) an annual allowance of $6,000. Sam,
who also earns $6,000 at a landscaping job in the summer, spends 100% of his allowance and saves 100% of
his employment earnings. Sam’s investments yield 10% ($600) and, because his income is below the threshold
where he would be required to pay tax, the interest amount is tax free. If Sam’s father invested the allowance
instead of giving it to Sam, with an assumed yield of 10%, he would pay 44% of the $600, or $264 in additional
taxes. Sam also accumulates RRSP contribution room of $1,080 (18% of $6,000), which he can use at a point in
the future to reduce his taxable income.

TRANSFERRING CAPITAL LOSSES TO A SPOUSE

The concept of transferring capital losses (and capital gains) to the client’s spouse is best described using a scenario.
Scenario | Transferring Capital Losses to a Spouse
Paul paid $20,000 for shares in XYZ Corp in January of last year. Today those same shares are worth just $5,000, so Paul
has an unrealized capital loss of $15,000. Paul does not have any capital gains against which to deduct this loss; however,
his wife, Esther, has about $15,000 of realized capital gains this year. If Paul could transfer his $15,000 unrealized capital
loss to Esther, she could then shelter her capital gains from tax. Three steps are required to achieve this transfer:
1. Paul sells his XYZ shares on the open market and triggers the $15,000 capital loss.
2. Esther then buys the same number and type of XYZ shares on the open market immediately (or within 30 days)
after Paul sells his holding. This step has two results:
• Paul’s $15,000 capital loss is denied because the superficial loss rules impose a 30-day time limit on
repurchases; that is, 30 days before and 30 days after the sale date. (The rules are discussed in detail later in
this chapter.)
• The second result of Paul’s sale is that Esther will pay just $5,000 for her XYZ shares, but the $15,000 loss
denied to Paul is added to her cost. The loss provides her with an adjusted cost base (ACB) of $20,000. Paul’s
loss is handed to Esther in the form of a higher ACB so that she will have a lower capital gain or greater
capital loss when she ultimately sells the shares.
3. Esther waits until the 30-day superficial loss window has closed (to ensure that the loss is denied to Paul),
and then she sells the XYZ shares on the open market. Esther’s ACB is $20,000, but the shares are worth just
$5,000, so she realizes a $15,000 capital loss. Esther can then use this capital loss to offset the capital gains
that she has already realized this year.
It is not critical that Esther have capital gains in the same year that Paul has capital losses. Net capital losses can be
carried back up to three years, or forward indefinitely, to offset gains in other years. So, if Esther reported gains in a prior
year, it may be possible for her to take that $15,000 capital loss and carry it back to recover taxes paid in a prior year.
The critical issue with this strategy is to ensure that the steps are timed correctly. A simple three-step rule should be
followed:
1. Sell on day 1.
2. Buy on day 2.
3. Sell on day 31 (30 days after Step 1).
It is the settlement date—not the trade date—that is critical for tax purposes.
TRANSFERRING PERSONAL TAX CREDITS

A few non-refundable personal tax credits can be transferred from one spouse to the other. The goal is to transfer the
credits to a spouse who can use the credits fully, which could save the family taxes. Note that non-refundable tax
credits generally save the same amount of tax for either spouse. However, if a spouse does not have sufficient tax
owing to be used toward some or all of the tax credits, the credits can be wasted. In such situations, clients should
transfer their entire amount of the credit, or the excess amount that remained unused, to the other spouse’s return.
Four credits in particular can be passed to a client’s spouse:
• Age credit (if the spouse was 65 years or older in the year)
• Disability credit (if the spouse had a severe mental or physical impairment, supported by a signed Form T2201)
• Pension credit (if the spouse had pension income)
• Tuition credit (if the spouse attended a qualifying post-secondary school)

CHAPTER 9 TAX REDUCTION STRATEGIES 9 • 11
All transferred credits are calculated directly on the tax return of the recipient spouse.
INVESTING INHERITANCES IN THE RIGHT NAME

As the advisor, you should recommend to your clients that any inheritance received by the lower-income spouse
should be kept separate from any joint accounts. As long as the inherited money is invested solely in the lower-
income spouse’s name, the investment income will be taxed in their hands alone.
INVESTING GOVERNMENT BENEFITS PAID TO A CHILD IN THE CHILD’S NAME

The 2016 federal budget introduced a new Canada Child Benefit (CCB) program, which replaced the Canada Child
Tax Benefit and the Universal Child Care Benefit.
Payments from the CCB program are made monthly to eligible families. For the period July 2022 to June 2023, it
provides the following maximum annual benefit, which is not taxable:
• $6,997 per child under the age of 6

• $5,903 per child aged 6 to 17
Entitlement to the CCB is based on the adjusted net income of the family. The benefit is reduced or phased out
depending on the adjusted net family income and number of children in the family. Families with net income under
$32,797 are entitled to the maximum benefit.
Benefit payments can be invested in the child’s name without the attribution rules applying. In such cases, the
payments must be deposited directly into an investment account for the child. They cannot be co-mingled with
other funds the client might have given the child. Clients should consider investing the CCB funds for the long term,
perhaps to help with the child’s future education costs.
REPORTING THE SPOUSE’S DIVIDENDS ON THE CLIENT’S TAX RETURN

Clients are permitted to report one spouse’s dividends as the other spouse’s income, which can make sense if the
first spouse’s income is low. In doing so, the higher-earning spouse further reduces the income of the low-earning
spouse. Thus, the high-earning spouse increases the spousal tax credit that he or she is entitled to claim. In fact, a
taxpayer is allowed to make this election only if it increases the spousal tax credit. The higher-earning spouse is also
entitled to claim a dividend tax credit on the dividends reported. A family could potentially save hundreds of dollars
in tax by making this adjustment.
PAYMENT OF EXPENSES BY THE HIGHER-INCOME SPOUSE

An effective tax strategy is to have the higher-income spouse pay all the family’s expenses. The lower-income
spouse can then invest as much of his or her own income as is practical. Because the investment income is earned
on funds invested by the lower-income spouse, it is taxed at a lower rate.
Under this arrangement, the higher-income spouse may pay for the following family expenses:
• All household expenses

• The lower-income spouse’s taxes (other than those withheld from his or her salary)
• The lower-income spouse’s personal debts, such as credit card balances, as long as the amounts were not
incurred to earn income
The lower-income spouse’s income can then be used to generate investment income, rather than going toward
personal debt or expenses. Ideally, the funds invested should go straight from the lower-income paycheque or bank
account, so that it is clear that the money invested belonged to the lower-income spouse.
The attribution rules do not apply to this strategy because it involves no transfer or gift of cash from one spouse to
the other to directly earn investment income. To be consistent with this rationale, the lower-income spouse should

not invest more than his or her income for the year. For example, if the lower-income spouse earns $25,000, and
invests $30,000, it implies that the funds did not come entirely from the lower-income spouse’s own resources.
MAKING INTEREST PAYMENTS TAX DEDUCTIBLE

A valid tax planning strategy is to avoid borrowing to consume; instead, one should borrow to invest in a non-
registered portfolio, thus making interest payments tax deductible. In other words, pay cash out of savings for
items such as houses or cars, and borrow for investments, such as stocks, bonds, or real estate. This strategy helps
generate significant tax savings.
It may be advantageous to liquidate an investment portfolio, pay off a house mortgage, and then use the home as
collateral for a loan to repurchase a securities portfolio. However, this strategy may incur high costs, including the
cost of discharging the mortgage, any mortgage interest penalties, and brokerage commissions. The advantage is
further reduced if the new loan is at a higher interest rate than the existing mortgage.
Clients commonly incur costs they could have saved by planning their personal finances to deduct interest. Many
house buyers can pay hundreds of thousands of dollars in interest on a typical mortgage over a 15-to-25-year
period. They continue to carry such mortgages while investing surplus money in low-interest-earning savings
accounts or guaranteed investment certificates. Instead, they could use surplus funds to pay off the mortgage and
then borrow against the house equity to invest.
DID YOU KNOW?
Unlike interest payments on non-investment loans, such as a loan to purchase a house, interest
payments on investment loans are deductible for tax purposes. However, the interest is only deductible
if the investments are expected to earn taxable income from property. For example, the interest on a
loan to invest in an RRSP, RESP, or TFSA is not tax deductible.
EXAMPLE
Making Interest Payments Tax Deductible
The following table illustrates the result of failing to make interest payments tax deductible. A taxpayer in a 46%
tax bracket (earning approximately $150,000 in annual income) carries an $82,000 mortgage at 3% and has
accumulated $82,000 of surplus savings yielding 5%.
Interest Income Receivable from Surplus Savings* Mortgage Interest Payable
5% of $82,000 $4,100 3% of $82,000 $2,460
Less: Tax—46% of $4,100 $1,886 Less: After-tax interest income $2,214
After-tax interest income $2,214 Shortfall $246
* Savings beyond those needed as an emergency cash reserve.
The recommended course of action in this scenario is to discharge the mortgage using the surplus savings.
The client can borrow against the house equity and repurchase a non-registered investment portfolio with the
borrowed funds. With this strategy and keeping in mind the superficial loss rules discussed below, the interest
payments on the loan become tax deductible.
Usually, one’s affairs cannot be arranged so that all interest payments are tax deductible. However, it is an objective
that clients should consider pursuing. They must select their investment carefully because interest is not deductible
on money borrowed for all investments. For example, commodities such as gold or silver do not qualify. The

investment must be property that can earn taxable income. An investment that can only render a capital gain does
not qualify. Also, care must be taken when setting up the loan to invest. The client must have loan documentation
clearly showing that the borrowed funds have been used to purchase qualifying securities. There should be a direct
link between the loan and the purchase of the qualifying investments. The loan should not be co-mingled with the
client’s personal assets at any point in time. Clients should also understand that no investment should be made
solely for tax purposes. Therefore, considerable planning and effort are needed to establish this structure, so the
client should weigh the tax savings against the possible risks and costs outlined above.
TAX-LOSS SELLING
One planning technique to reduce taxes on already realized capital gains as the year-end approaches is to take
advantage of tax-loss selling. Tax-loss selling requires the planned realization of capital losses before year-end to
offset capital gains that were realized earlier in the year.
The realization of a loss for tax purposes crystallizes a decrease in the value of an investment. However, the tax
benefit may be enough to outweigh the disadvantage of having lost money on a security.
EXAMPLE
An annual review of Yvonne’s non-registered investment portfolio showed that the portfolio allocations were
no longer consistent with her investment objectives. The shift was mostly due to the strong performance of one
asset class. Yvonne’s advisor made several changes to rebalance the portfolio, which resulted in capital gains of
$9,000. As year-end approached, Yvonne worried about the tax she would have to pay on the capital gains that
were realized. She is in a 45% marginal tax bracket.
Yvonne’s advisor suggested selling one particular fund that had underperformed and was currently worth less
than when it was purchased two years earlier. He advised her to sell 1,500 units that had originally cost her
$29 each at the current value of $23 each. In doing so, she could realize a loss of $9,000, which would offset the
net amount of gains already realized during the year to date. The potential tax savings available by completing
this sale at a loss would be equal to the amount of tax on the $9,000 gain. In other words, the savings would be
equal to $9,000 loss × 50% inclusion rate × 45% marginal tax rate, for a $2,025 tax saving.
SUPERFICIAL LOSS RULES

Investors who sell at a loss as part of a year-end tax-loss selling strategy and then reinvest the proceeds in the
same investment may be denied the loss. The superficial loss rules state that an investor cannot take a tax loss if
the security sold at a loss is repurchased by the investor or an affiliated party within a certain time frame. Affiliated
parties include spouses, corporations under the investor’s control, and a trust where the investor and/or their spouse
are majority interest beneficiaries. The restricted period starts 30 days before the loss sale and ends 30 days after
the loss sale. These rules apply not only to the specific security but also to securities that are considered identical.
EXAMPLE
In the previous example, Yvonne’s advisor recommended that Yvonne sell a $9,000 investment at a loss to
offset a $9,000 capital gain. At the beginning of the following year, just after the fund was sold at a loss,
Yvonne learned that it was likely to regain value. She immediately told her advisor that she would like to
repurchase the 1,500 units of the fund. Her advisor explained that she must wait a full 30 days before making
the repurchase. Otherwise, the loss would be denied to her, and her capital gain from the previous year would be
taxable on her tax return. A premature repurchase would have the effect of raising Yvonne’s taxes by $2,025, the
amount she had planned to save through tax-loss selling. Yvonne agreed to wait until 30 days had passed from
the loss sale before making the repurchase.

DEDUCTIBILITY OF FEES
Investors may claim a tax deduction of fees (other than commissions) paid to an investment counsellor for
investment advice, administration, or management of securities. To qualify, the investment counsellor’s principal
business must be advising others on investments or the administration or management of securities.
It is important to make sure that such fees are paid by the person who owns the non-registered investment account.
Fees are not deductible if they are paid in relation to the accounts of other people or for registered accounts,
including a TFSA.
The following types of fees are not tax deductible:
• Fees paid for other types of advice, such as general financial counselling or financial planning
• Subscription fees paid for financial magazines and newspapers
• Trustee fees paid for RRSPs and TFSAs
WHOLE AND UNIVERSAL LIFE INSURANCE

Exempt whole or universal life insurance policies allow investment income to accumulate while sheltered from
tax. An exempt test is used to determine the savings component that can grow tax-sheltered inside a life insurance
policy. When the person whose life is insured dies, the entire proceeds from the policy are paid to the beneficiary
free of tax. The returns from virtually tax-free accumulation, after the deduction of insurance costs, can be
substantial over a long period compared to taxable accumulations.
EXAMPLE
Robin, a 68-year-old entrepreneur, has done very well financially. His business is worth $3 million, he has a
cottage worth $600,000, registered investments worth $1,000,000, and non-registered investments worth
$500,000. Robin’s wife passed away five years ago, and he has three adult children. He is concerned about the
hefty tax bill his heirs will face when he dies. Taxes will be payable on capital gains, and, given his high marginal
tax rate, nearly half of his RRSPs and RRIFs will be consumed by income taxes.
Robin’s advisor recommends that he purchase an exempt whole life insurance policy to provide his heirs with a
lump sum amount at his death. The proceeds will take care of his estate’s tax liabilities. This policy should last for
Robin’s life. Any savings invested in the whole life policy will be sheltered from tax. His heirs will receive the full
value of the policy, including the insurance and investment portions, free of tax. Robin’s advisor must make sure
that the policy remains exempt throughout its existence.
DID YOU KNOW?
Proceeds of a life insurance policy paid to a designated beneficiary bypass the estate and are not subject
to probate fees.
INDIVIDUAL LIFETIME CAPITAL GAINS EXEMPTION

Taxpayers may shelter certain capital gains with their lifetime capital gains exemption (LCGE). The exemption
applies to the disposition of qualified farm or fishing property or of shares of qualified small business corporations
(QSBC) designated as Canadian-controlled private corporations (CCPC). Table 9.2 shows the exemption amounts
for 2021 and 2022.

Table 9.2 | Lifetime Capital Gains Exemption
In 2021 $892,218
In 2022 $913,630
Additional exemption amount for qualified farm or fishing property
In 2021 $107,782
In 2022 $86,370
For tax years after 2015, the LCGE for qualified farm or fishing property adds up to $1 million until the indexing
on the disposition of QSBC shares exceeds $1 million.
A QSBC is defined as either of two entities:
• A CCPC in which 90% or more of its assets, valued at fair market value, are used in an active business carried on
primarily in Canada
• A CCPC whose assets consist of shares or debt of connected CCPCs that meet the definition above
To be eligible as a QSBC, the CCPC’s shares must not have been held by anyone other than the taxpayer or persons
related to the taxpayer throughout the 24 months immediately preceding the disposition.
Throughout the two-year period, more than 50% of the corporation’s assets must have been used either in an
active business in Canada or invested in other small business corporations, or both.
So, if a client sold QSBC shares that originally cost $10,000 for $1,000,000 in 2022 for a capital gain of $990,000,
they would have $913,630 of LCGE available2.
FARMING AND FISHING PROPERTY

Gains on the disposition of qualified farm or fishing property are also eligible for the LCGE. A number of qualifying
rules are in place to ensure that the property was used for farming or fishing in Canada by the taxpayer or specified
members of the taxpayer’s family.
A tax-free rollover is also allowed on qualified farm or fishing property if the property was used for farming/fishing
in Canada immediately before the transfer by the taxpayer, spouse, or child, and then transferred by a sale or gift
to a child resident in Canada. These rules are detailed, and clients in a position to take advantage of the exemption
should seek professional tax advice.
So, if a client sold their qualified farm or fishing property that originally cost $25,000 for $1,050,000 in 2022 for
a capital gain of $1,025,000, they would have $1,000,000 of LCGE available: $913,630 + additional exemption
amount $86,370 = $1,000,0003.
CUMULATIVE NET INVESTMENT LOSSES REDUCE AVAILABLE LIFETIME CAPITAL GAINS

EXEMPTION
If the cumulative amount of investment income minus investment expenses is negative, the balance is called a
cumulative net investment loss (CNIL). The LCGE is reduced by investment losses reported by the taxpayer,
2
Assume that no portion of the LCGE was previously used, and no amount was claimed under the $100,000 capital gains deduction, which
was abolished on February 22, 1994. Anyone who used the entire $100,000 capital gains deduction has $813,630 of LCGE remaining.
3
Assume that no portion of the LCGE was previously used, and no amount was claimed under the $100,000 capital gains deduction, which
was abolished on February 22, 1994. Anyone who used the entire $100,000 capital gains deduction has $900,000 of LCGE remaining.

which can affect how much of a taxable capital gain is ultimately taxed. The adjustment, with respect to investment
losses, is calculated on a cumulative basis.
An individual’s CNIL at the end of a year is the amount by which that person’s investment expenses for the year and
all prior years exceed his or her investment income for those years. This is a value that is tracked cumulatively over
the taxpayer’s lifetime.
EXAMPLE
In Year 1, Andrew’s only investment involved borrowing $10,000 to buy 100 shares of a Canadian-controlled
private corporation. The annual interest expense on the loan was $500. The company paid no dividends;
therefore, at the end of Year 2, Andrew sold the shares.
The sale realized a capital gain of $5,000, so the taxable capital gain was $2,500 (calculated as 50% of $5,000).
The accumulated $1,000 of interest expense reduced the amount of LCGE that could be applied against the
capital gain to shelter it from taxation.
If Andrew had a CNIL balance of zero and an LCGE balance equal to the amount of the taxable capital gain
($2,500), the net effect would be no taxable gain. However, Andrew had a CNIL balance of $1,000, so the
allowed exemption of $2,500 was reduced to $1,500. Therefore, $1,000 of the additional gain must be included
in Andrew’s income in Year 2 and be subject to tax.
CHARITABLE DONATIONS TAX CREDIT

Charitable donations could be cash or gifts in kind, such as paintings, rare books, shares, real estate, or a life
insurance policy. In-kind donations of publicly listed securities to charitable organizations and public and private
foundations are exempt from capital gains tax upon contribution. They are also eligible for the charitable donation
tax credit based on the fair market value of the securities donated. It is a prudent strategy to transfer shares with
unrealized capital gains directly to the charity so that the donor does not pay tax on the capital gains.
DID YOU KNOW?
Donor-advised funds (DAF) are an efficient way for clients to make charitable donations of securities
that benefit their chosen charities and, at the same time, receive tax benefits. A DAF is a separately
identified account set up through a public foundation operating as a Canadian registered charity. After
the donor makes a receiptable contribution, the foundation has ownership of the fund. However, the
donor retains advisory privileges with respect to the granting of funds to other charities of their choice
over time, thereby ensuring a legacy of giving long into the future.
A taxpayer’s charitable donations of up to 75% of net income qualify for a federal tax credit of 15% for the first
$200 of the donation and 29% of the balance. It is a good strategy to combine charitable donations for the entire
family unit on one tax return, thereby limiting the 15% threshold to a single $200 portion of the whole amount.
In 2022, the top federal tax rate on taxable income over $221,708 is 33%. The federal charitable donation tax credit
rate on taxable income in the highest tax bracket is also 33%, rather than 29%. The 29% rate applies on income
below the $221,708 threshold. Therefore, it may be advantageous to claim the combined family donations on the
tax return of the higher earner, if that person makes more than $221,708.

EXAMPLE
Rajesh has taxable income of $230,000 in 2022. If he makes a charitable donation of $35,200 in 2022, his
charitable donations tax credit will be $10,511.68 (calculated as $30.00 + $2,736.36 + $7,745.32). The three
different amounts that add up to Rajesh’s total tax credit are calculated as follows:
$30.00 = 15% of $200
$2,736.36 = 33% of $8,292 (i.e., the amount of his $230,000 income that is above $221,708)
$7,745.32 = 29% of $26,708
$26,708 is the amount of Rajesh’s donations for the year over $200 that is not eligible for the 33% rate above
($35,000 − $8,292).
$8,292 is the lesser of two amounts:
• The amount by which Rajesh’s total donation exceeds $200 ($35,000)

• The amount by which his taxable income exceeds $221,708 ($8,292)
Taxpayers who cannot, or choose not to, claim credit for the full amount in the current year can carry it forward in
any of the next five years. After five years, the credit is lost. In the year of a taxpayer’s death, it may be carried back
one year.
In addition, in the year of the taxpayer’s death and the preceding year, the limit on donations is 100% of a person’s
net income. The federal limit for claiming donations to Canada Revenue Agency is 75% of net income.
LISTED PERSONAL PROPERTY

Listed personal properties are very specific personal assets that tend to increase in value over time. They are
specifically defined in the Income Tax Act and include any of the following personally owned items:
• Prints, etchings, drawings, paintings, sculptures, and other similar works of art
• Jewellery
• Rare folios, manuscripts, and books
• Stamp and coin collections
In addition to providing enjoyment, knowledgeable acquisitions of listed personal property are a means to hedge
against inflation over the long term.
Listed personal property, along with other types of personal-use property, is subject to the so-called “$1,000 rule.”
The rule states that taxpayers are exempt from capital gains on disposals of personal-use property if the amount
received is less than $1,000. Any amount over $1,000 is treated as a capital gain. Listed personal property is
distinguished from other types of personal-use property in one respect. From a tax viewpoint, capital gains realized
on the sale of either type of property should be reported as such (given the $1,000 rule above). However, capital
losses are deductible only against capital gains from listed personal property. A loss from the sale of personal-use
property that is not listed personal property cannot be applied against a capital gain. Personal-use property includes
assets such as a television, computer, or vehicle (if not used in business). When we deplete the value of these assets,
we do not get to claim a capital loss.
However, if a taxpayer sells listed personal property at a capital loss, it can be used to offset a capital gain from
listed personal property only. It cannot be used to offset a capital gain on the sale of securities or other personal
assets.

EXAMPLE
John bought a painting for $200 and sold it later for $1,500. Under the $1,000 rule, his capital gain is calculated
as $1,500 − $1,000 = $500.
Antiques, vintage wines, and other tangible, personal-use items are not considered listed personal property,
although they may also appreciate in value. The fact that the owner can enjoy them, even if they do not appreciate,
makes these types of investments more interesting than stocks or bonds. However, any loss realized on disposal of
such items is considered to be nil for tax purposes and cannot be applied against capital gains.
DID YOU KNOW?
It is a common misconception that antiques are considered listed personal property. However, the list is
very specific, and antiques are not included.
PRINCIPAL RESIDENCE EXEMPTION

Real estate is generally a good hedge against inflation over the long term, although a substantial capital gain on the
sale of a residence is, of course, not guaranteed.
For tax purposes, a taxpayer’s principal residence and secondary residence (if there is one) are treated differently.
PRINCIPAL RESIDENCE
A principal residence may be a house, a cottage, a mobile home, a trailer, a condominium unit, or a share in
a co-operative housing corporation. A seasonal residence such as a cottage could still qualify as a principal
residence if it is regularly occupied for some period each year. A capital gain from the sale of a principal residence
is exempt from tax as long as the property meets the above criteria.
Taxpayers may claim only one principal residence at a time, but they may own more than one principal residence
during their lifetime.
Since January 1, 1982, each “family unit” has been allowed only one principal residence. A family unit includes a
taxpayer and spouse, and any unmarried children under 18 years of age. A spouse who is legally separated and living
apart from the taxpayer is not considered part of the family unit.
If a family owns both a home and a cottage, the capital gain accruing on one of the properties is taxable. It is up to
the family unit to determine which property to designate as their principal residence for each year of ownership.
Given that many types of property may qualify, it is not uncommon for a house to be designated for certain years,
and a cottage to be designated for other years. The property designated is typically the one that had the greatest
increase in value per year of ownership. The gains are allocated to each year on a straight-line basis when the
property is sold. For example, if a person owned a cottage for 10 years, and it increased in value by $200,000, the
taxable capital gain per year of ownership would be $10,000 (50% of $20,000). Most of the appreciation may have
occurred in the last two years, but that fact is not contemplated in the calculation. A family that owns more than
one residence should designate the property that has the highest capital gain per year as the principal residence to
shield as much growth from future taxes as possible.
DID YOU KNOW?
A person who changes principal residences often over several years, for no apparent reason, risks being
classified as being in the business of buying and selling houses. In such cases, the realized gains are
subject to tax as business income.

SECONDARY RESIDENCE
An example of a secondary residence is a cottage or any residence that the taxpayer owns but does not occupy
most of the year. A secondary residence is subject to capital gains tax if a capital gain has accrued on the value
of the property when it is sold or deemed to be disposed of. A deemed disposition means that CRA considers a
property to have been disposed of or sold even if no transaction has taken place.
EXAMPLE
When a person dies, a deemed disposition of all capital property owned right before death is considered to have
occurred. Another example of a deemed disposition is when securities are transferred from a non-registered
investment account to an RRSP.
DID YOU KNOW?
Since 2016, taxpayers are required to report the sale of a principal residence on their income tax return
to claim the principal residence exemption.
TAX SHELTERS
A tax shelter is an investment in certain types of property that has the potential of reducing income taxes in the
year of the investment and the following years after the investment. It may be reasonable to consider that the client
will have losses, deductions, or credits equal to or greater than the original cost of the investment. These deductions
can be used to reduce the clients’ taxable income from other sources.
With most tax shelters, the client can claim a capital cost allowance and other expenses on certain types of
investments to shelter other income and defer income tax.
Tax shelters have been curtailed considerably over the years by changes in tax law and administrative practice.
However, limited opportunities in oil and gas ventures, mining exploration, and certain limited partnership
structures remain available. Presently, relatively few publicly offered tax shelters exist.
Clients should invest in a tax shelter only if, after taking the potential tax benefits into account, there is a
reasonable expectation of profit. The client should be in a high tax bracket and have available capital to invest that
is not already allocated to other important goals. Generally, clients view a tax shelter as a form of tax savings. In
reality, it is simply a form of tax deferral; it is expected that, at some point in the future, the property will generate
income.
Because the risk of a significant loss on a tax shelter investment can be high, clients should have proper accounting
and legal advice before making a commitment. The potential tax benefits alone should not influence their
investment decision.
LABOUR-SPONSORED VENTURE CAPITAL CORPORATION

A substantial amount of the venture capital available for investment in Canadian companies originated in
labour-sponsored venture capital corporations (LSVCCs). The funds from LSVCCs are known labour-sponsored
investment funds. LSVCCs were originally sponsored by organized labour to channel investment into new small
and medium-sized businesses. Traditionally, investments in an LSVCC were eligible for federal and, in some cases,
provincial tax credits.
Shares in LSVCCs are normally qualified investments for RRSPs. An RRSP investment in an LSVCC can be made up
to 60 days after the end of a calendar year and still qualify for the credits for that year.

There are two types of LSVCCs: federally registered and provincially registered. An investment in LSVCCs of up to
$5,000 entitles an investor to a federal tax credit of 15% ($750). Provincial tax credits may also be available, with
limits and tax credits that vary from province to province. The entire $5,000 qualifies for an RRSP tax deduction.
To qualify, the investor must have contribution room, and the shares must be purchased by or transferred to the
investor’s RRSP. The federal LSVCC tax credit is for provincially registered LSVCCs. The federal tax credit for solely
federally registered LSVCCs has been eliminated effective 2017.
There is a minimum holding period of eight years. If the shares are redeemed before the holding period expires, the
tax credits must be repaid to the federal and, if applicable, provincial government. Redemption penalties may be
waived in extenuating circumstances, such as terminal illness or death.
EXAMPLE
Dmitri, a qualified investor in a 40% marginal tax bracket, invests $5,000 in an LSVCC. The fund he invests in
is eligible for both federal and provincial 15% tax credits. His $5,000 RRSP deduction is worth $2,000 in tax
savings. The LSVCC credits are worth another $1,500 (i.e., $750 federal and $750 provincial). Therefore, his
$5,000 initial investment costs only $1,500, calculated as $5,000 − $2,000 − $1,500 = $1,500.
Dmitri may decide to redeem his LSVCC shares after holding the investment for only five years. If so, he will have
to repay the $750 federal tax credit and the $750 provincial credit he received.
Labour-sponsored venture capital corporations are tax shelters. As with other tax shelters, clients should only
invest in an LSVCC if they can reasonably expect to earn a profit. Tax benefits alone should not be the criteria for
an investment decision. Clients should also take applicable provincial regulations and overall tax benefits into
account.
Historically, LSVCCs have had a poor investment record; some have sought creditor protection, and many investors
have lost invested money. As an advisor, you should proceed with caution in recommending an investment in an
LSVCC to your clients.
TAX-FREE SAVINGS ACCOUNT
2 | Describe the features of a tax-free savings account.
TAX-FREE SAVINGS ACCOUNTS

A TFSA is a type of registered account that allows Canadians 18 years old and over to grow invested savings tax-free
throughout their lifetimes. Contributions to a TFSA are not deductible for income tax purposes, but investment
income earned in a TFSA, including capital gains, is not taxed. Savings can be withdrawn with no tax penalty at any
time for any purpose.
When the TFSA was introduced in 2009, it was announced that the annual contribution limit would be indexed
to inflation using $500 increments. Effective 2013, the first $500 increment took effect, which meant more room
for Canadians to put funds aside for their financial goals. The 2015 federal budget increased the annual TFSA
contribution limit to $10,000. However, the 2016 federal budget brought the TFSA contribution limit back down
to $5,500. In 2019, the second $500 increment took effect, bringing the TFSA contribution limit to $6,000 per year.
The total from the beginning and up to 2022 is $81,500. The TFSA contribution limits since inception are shown
in Table 9.3.

Table 9.3 | Tax-Free Savings Account Contribution Limits
TFSA limit 2009 to 2012 $5,000
TFSA limit 2013 to 2014 $5,500
TFSA limit 2015 $10,000
TFSA limit 2016 to 2018 $5,500
TFSA limit 2019 to 2022 $6,000
Unused TFSA contribution room is carried forward and accumulates for future years. Funds available in the TFSA can
be withdrawn tax-free at any time, and the amount withdrawn from the TFSA is added to one’s contribution limit
at the end of the year. Amounts withdrawn can be re-contributed to the TFSA in the same year, if there is unused
TFSA contribution room. Otherwise, the re-contribution must wait until the next calendar year or later to avoid
overcontribution penalties. Re-contribution of withdrawn funds is not mandatory.
A TFSA is an ideal source of emergency funds because the money contributed grows untaxed, and the money
withdrawn is not taxed in any manner. It is also designated as a separate category of deposits insurable by Canada
Deposit Insurance Corporation.
EXAMPLE
Roberta has unused contribution room of $25,000 in her TFSA, and her husband Karl has no contribution room
left. In March 2022, they each withdraw $15,000 from their respective TFSAs to buy a car. In October 2022, they
both want to put $10,000 back into their TFSAs. Roberta has room to re-contribute the full amount because
she had $25,000 in contribution room prior to her withdrawal. However, Karl is not allowed to re-contribute
this year because he had no contribution room left when he withdrew his $15,000. He must wait until next year
when contribution room becomes available. It will then consist of the sum of the yearly maximum 2023 limit
plus any amount withdrawn the year before ($15,000 in Karl’s case).
INCOME-SPLITTING USING A TFSA

A higher-income earner can give money to a lower-income spouse or family member to contribute to their own TFSA
without affecting the contribution room of the giver. Because income is not taxed in the TFSA, no income will be
attributed to the higher-income earner. One of the primary benefits of a TFSA from a tax-saving perspective is that,
unlike RRSPs, there are no restrictions on income-splitting. Furthermore, the money contributed to a TFSA can come
from anywhere, not just from earned income. Therefore, a person can give money to a spouse, children, or grandchildren
for a TFSA contribution, as long as the person receiving the funds is age 18 or over. Interest (or other investment return)
then accrues tax-free in the hands of the holder. Once the money is gifted, however, it belongs to the holder.
EXAMPLE
Tim is 55 years old and has a well-paying job as a tenured university professor. His wife, Beth, who is 45, looks
after their children and does not work outside the home. Tim has a defined benefit pension plan at the university,
and he puts the maximum allowed into an RRSP. Beth cannot contribute to an RRSP because she has no earned
income. Tim has additional savings and wonders what the best way would be to increase the family’s retirement
assets. Tim’s advisor recommends that Beth set up a TFSA. Tim can then give her up to $6,000 per year so that
she can make the maximum annual contribution.
Tim can also give Beth money to use toward her TFSA carryforward contribution room. In this case (in 2022),
Beth has total contribution room of $81,500. When Beth makes withdrawals, they will be treated just like any
other TFSA withdrawal. That is, the money will not be taxed and will be considered hers, regardless of where it
originally came from.

EXAMPLE
(cont'd)
Tim can supplement his RRSP contribution room (which he fully uses each year) by taking full advantage of his
own TFSA contribution room of $6,000. In other words, he can give Beth $6,000 (plus carryforward room) to
contribute to her TFSA, and he can put another $6,000 into his own TFSA.
INVESTMENT ALTERNATIVES FOR TFSA

It is important to consider investment alternatives for TFSAs and choose prudently, based on each client’s situation.
If the TFSA is to be used as an emergency fund in case of unemployment or sickness, the investment must be safe
and liquid. In such a case, the best options are redeemable guaranteed investment certificates, Treasury bills, and
money market mutual funds.
Substantial growth that can be sheltered completely from taxes in a TFSA usually accrues from shares or other
equity investments. But in a tough economic climate, a TFSA consisting of shares is just as likely to fall in value
as it is to rise. Losses in a TFSA could hurt much more than losses in an RRSP because contributions to a TFSA are
made with after-tax dollars. Another point to keep in mind is that capital losses incurred inside a TFSA are not tax
deductible.
Canada Revenue Agency has expressed some concern about a small proportion of TFSA accounts that have quickly
grown to many times the value of the original contributions. These accounts are owned by knowledgeable investors
using aggressive investment strategies. A small number of TFSA accounts that meet certain criteria are either
audited or are at risk of being audited.
PENALTY FOR EXCESS CONTRIBUTIONS

There is a penalty for excess contributions to a TFSA in the form of a 1% per month tax on the highest excess
amount in that month. Excess contributions are not determined separately for each TFSA. They are calculated
cumulatively for all the TFSAs to which the person has contributed.
Canada Revenue Agency receives detailed reports about TFSA activity every year from financial institutions where
these accounts are held. The reports allow CRA to have an up-to-date picture of any over-contributed account
holders. There is no $2,000 excess permitted overcontribution, as there is with an RRSP account. Overcontribution
penalties are assessed from the first dollar of overcontribution.
Most TFSAs under assessment for overcontribution are those where the owner withdrew funds and then re-
contributed in the same year. It is important to let your clients know that they should wait until the next calendar
year after a withdrawal to re-contribute.
EXAMPLE
Brett has a TFSA with no unused contribution room. In April 2021, he contributed the maximum allowed
amount of $6,000. In September 2021, he withdrew $4,000 from the TFSA for a vacation in Costa Rica. In
November 2021, he re-contributed $4,000 to the TFSA.
Early in 2022, Brett received a notice from CRA to pay a penalty tax of $80 (1% per month for November and
December on the excess $4,000).
Brett made a common mistake in re-contributing the $4,000 in the same year in which he made the withdrawal.
Instead, he should have waited until 2022 (the next calendar year) to re-contribute $4,000.

RULES REGARDING IN-KIND TFSA CONTRIBUTIONS

A client who already owns investments such as stocks or bonds may wish to contribute them to a TFSA, thereby
making a contribution in kind. Such a contribution may open the issue of capital gains or losses, in which case the
following rules apply:
• Individuals are deemed to have sold the investments at fair market value when they put them into their TFSA.
• If the ACB was lower than the fair market value, the holder will have made a capital gain, which will be treated
at income tax time like any capital gain.
• If the ACB was greater than the fair market value, the resulting capital loss may not be claimed on the holder’s
income tax return.
DID YOU KNOW?
Clients may not claim a capital loss on a contribution in kind to a TFSA. Therefore, they should not
contribute a security that is in a loss position directly to a TFSA. Instead, they should sell the security,
create a deductible capital loss, and then contribute the proceeds from the sale to the TFSA. If they want
to still own that security inside their TFSA, they should wait at least 31 days before buying the security
back in order to claim the loss; otherwise, the superficial loss rules would apply.
RULES REGARDING TRANSFERS OF TFSA FUNDS

A person who holds two TFSAs and transfers funds from one to the other will not have to pay any tax or penalty.
When a marriage or common-law relationship breaks down, and there is a division of property as a result, a transfer
may be made directly from the TFSA of one spouse (or former spouse) to the TFSA of the other spouse as part of the
settlement. This type of transfer is called a qualifying transfer for a TFSA.
DEEMED DISPOSITION OF A TFSA AT DEATH

There is no tax exposure for a TFSA on deemed disposition at death if the holder names a successor holder. Only the
surviving spouse or a common-law partner can be named as the successor holder. The value of the TFSA on the date
of death and any income earned after that would both continue to be sheltered from tax. The successor holder can
also transfer the account to their existing TFSA without affecting their contribution room.
If a spouse is named as a beneficiary, then the value on the date of death can be transferred tax-free to the surviving
spouse’s TFSA without using up their contribution room. However, any increase from the time of death until the
time of transfer is taxable to the spouse.
If the named beneficiary is an adult person other than a spouse or common-law partner, the account ceases to be
a TFSA when the holder dies. In effect, the TFSA account is treated as if it were deregistered. A beneficiary who has
unused TFSA contribution room can contribute all or part of the amount they receive to their own TFSA.
Any payments from a deceased holder’s TFSA made to beneficiaries, to the extent that they include income earned
after the holder’s death, are taxable to the beneficiaries. Income in this regard includes interest, dividends, and
capital gains.
EXAMPLE
Theodore dies, leaving a TFSA valued at $25,000 to his daughter Anne. The TFSA’s value has increased by
$2,000 between the time of Theodore’s death and the time of transfer, eight months later. Anne will therefore
have to include that $2,000 in her income when she files her tax return.

REGISTERED PLANS USED FOR NON-RETIREMENT GOALS
3 | Compare the features of registered plans that are used for non-retirement goals.
REGISTERED EDUCATION SAVINGS PLANS

An RESP is designed to make saving for post-secondary education attractive for contributors. It is usually established
by parents or grandparents to help finance a child’s (or grandchild’s) education.
An RESP has the following features:
• The maximum lifetime contribution limit is $50,000 per beneficiary; there is no annual maximum.
• The federal government provides a Canada Education Savings Grant (CESG), which is worth 20% of the first
$2,500 of annual RESP contributions.
• Contributions are not tax deductible, but growth within the plan occurs on a tax-deferred basis.
• Amounts in the RESP become taxable only when a child enters a post-secondary institution and starts to receive
payments from the plan.
• A penalty tax of 1% per month is imposed on excess contributions.
The CESG works as follows:
• The annual maximum grant amount per beneficiary, up to and including the year the child turns 17, is $500.
• The lifetime amount per beneficiary is $7,200.
• If the beneficiary has sufficient carryforward room (discussed below), the maximum annual CESG is $1,000 (i.e.,
20% of the first $5,000 contribution).
• If the contribution is less than $2,500 per year, the grant provided by the government is adjusted by the
contribution amount made. The remaining grant can be carried forward to future years.
• Any contribution over $5,000 in any given year will not receive the CESG.
• If no beneficiary pursues post-secondary education, the CESG monies will have to be repaid to the government.
Only the principal amount must be repaid, and not the income earned on the grants.
Investments in RESPs may include mutual funds, segregated funds, stocks, bonds, and cash deposits.
CARRYFORWARD RULES FOR CESGs

For years prior to 2007, the CESG carryforward rules were as follows:
• $400 of CESG payments were available each year for a beneficiary age 17 and under, with specific rules
for 16- and 17-year-olds.
• If the CESG wasn’t paid on behalf of a beneficiary, a maximum of $400 per year was carried forward, creating
a carryforward pool for the beneficiary.
Beginning in 2007, the rules changed as follows:
• The maximum CESG that can be carried forward each year is $500.
• There are specific rules for beneficiaries who are 16 or 17 years old. For those beneficiaries, RESPs are only
eligible for CESGs if at least one of two conditions is met:
• A minimum of $2,000 was contributed to (and not withdrawn from) the child’s RESP before the end of the
calendar year in which they turned 15.
• A minimum annual contribution of $100 was made to (and not withdrawn from) the RESP in at least four of
the years before the end of the calendar year in which the child turned 15.

• For contributions greater than $2,500 that are made for 2007 and subsequent years, a portion of the
carryforward pool gets used up. The ability to use up carryforward room is limited to 20% of the first $5,000 of
RESP contribution made in any given year.
EXAMPLE
It is 2022. Manuel, who was born in 2007, has had no contributions made on his behalf to an RESP. Manuel
has a CESG carryforward pool of $7,200, which represents the lifetime limit for the CESG (i.e., $500 for each
year from 2007 to 2021 equals $7,500, but Manuel cannot receive more than the established CESG cap of
$7,200). If a contribution is made in 2022 for $5,000, the CESG paid will be $1,000, calculated as $500 for
the 2022 contribution of $2,500 and $500 for the next $2,500. The contribution would use up $1,000 of the
carryforward pool, which would now have $6,200 remaining.
MAXIMIZING AN RESP
The major benefit of an RESP is the tax-free compounding of returns. Although the government grant is well
advertised, it may be less valuable. Parents who can afford to do so may do better to accelerate their contributions.
They can then reach the plan limit of $50,000 as soon as possible, rather than delaying contributions in order to
maximize the government’s annual grant. Whether one choice is better than the other depends on several factors:
• The rate of return earned

• The age of the beneficiary when the plan was started
• The CESG carryforward room available
• The number of years until withdrawals begin
WITHDRAWALS FROM AN RESP

Once a beneficiary starts attending an eligible post-secondary program and begins to withdraw funds from the
RESP, the amounts paid from an RESP to an eligible beneficiary to assist with education-related expenses at the
post-secondary level are called the educational assistance payments (EAP). An EAP consists of the CESG, the
Canada Learning Bond (CLB), amounts paid under a provincial education savings program, and the earnings on
the money saved in the RESP. This income portion is taxable as “other income” to the beneficiary. No distinction
is made between Canadian dividends, foreign income, interest income, or capital gains. The original capital portion
is not taxable because it was not tax deductible when it was contributed. However, most post-secondary students
have little or no taxable income, so the tax burden is usually very low. If a full-time student with little other income
withdraws the money, there will likely be no taxes owing. Thus, the funds in the RESP are not only sheltered from
tax during the 18 or so years of accumulation; they are virtually tax-free on withdrawal as well. A beneficiary is
entitled to receive EAPs for up to six months after ceasing enrolment, provided that the payments would have
qualified as EAPs if the payment had been made before the student’s enrolment ceased.
Contributions cannot be made to a plan at any time after the end of the year that includes the 31st anniversary of
the plan, except if the beneficiary is eligible for the disability tax credit. An RESP must be closed by the end of the
year of its 35th anniversary.
DID YOU KNOW?
A specified plan is a single-beneficiary RESP (non-family plan) where the beneficiary is entitled to
receive the disability tax credit. With this type of plan, contributions are allowed until the end of the
year that includes the 35th anniversary, and the plan must be closed by the end of the year that includes
the 40th anniversary.

For family plans established after 1998, each beneficiary must be less than 21 years of age at the time they are
named as a beneficiary. The contribution age limit for family-plan beneficiaries is 31.
A family-plan RESP allows for multiple beneficiaries, as well as multiple and joint contributors. The contributors and
beneficiaries must be related by blood or adoption. The beneficiaries can share the funds in any proportion, as long
as each beneficiary receives no more than $7,200 in government grant money.
If none of the beneficiaries pursues post-secondary education, the government grant must be repaid (without
interest). The contributors can transfer up to $50,000 of the RESP income to their RRSPs or spousal RRSPs. They
must have contribution room available, and the RESP must have been in existence for at least 10 years. If no RRSP
contribution room remains, the investment income must be withdrawn at the contributor’s marginal tax rate, and
a 20% tax penalty must be paid. The original capital portion can be withdrawn tax-free, given that it was not tax
deductible when it was contributed.
LOW- AND MIDDLE-INCOME FAMILIES

The following enhancements to the CESG program (also shown in Table 9.4) are available for low- and middle-
income families:
• For families earning in the first bracket of income, the CESG matching rate is 40% on the first $500 and 20% on
the next $2,000 contributed per beneficiary per year. In other words, the maximum government contribution is
$600 per year per child (calculated as $500 × 40% + $2,000 × 20%).
• For families earning in the second bracket of income, the CESG matching rate is 30% on the first $500 and 20%
on the next $2,000 contributed per child per year. In other words, the maximum government contribution
is $550 per year per beneficiary (calculated as $500 × 30% + $2,000 × 20%).
• For families earning in the third bracket of income, the maximum CESG is $500 per year per beneficiary.
Table 9.4 | CESG Enhancements to Low- and Middle-Income Families
Net Family Income*
RESP Contribution First bracket Second bracket Third bracket
$50,197 or less Over $50,197 to $100,392 More than $100,392
First $500 contribution $200 $150 $100
Additional $2,000 contribution $400 $400 $400
Total CESG on First $2,500 $600 $550 $500
* The income levels are adjusted yearly.
A $500 CLB is available to families who are in the lower tax bracket. This assistance usually applies to families
whose net family income is $50,197 or less in 2022 (adjusted yearly).
Additional $100 CLB instalments are deposited each year in which the child’s family is in the lower tax bracket,
up to the year the child turns 15. The initial $500 CLB, plus the $100 annual instalments, provide a child with up to
$2,000. The CLB is deposited into an RESP established by the family.
PLANNING STRATEGIES FOR RESPs

Tax planning for RESPs includes various strategies:
• Maximize RESP contributions in the early years.

• Maximize annual RESP contributions to receive the maximum CESG.

• Use single-beneficiary or multi-beneficiary plans, depending on individual circumstances.

• Make RESP contributions jointly with a spouse for future flexibility.
• Spread withdrawal of accumulated income payments (AIPs) over two years to maximize RRSP contributions.
DID YOU KNOW?
Accumulated income payments are earnings accumulated within an RESP that are withdrawn by the
subscriber if no beneficiary pursues post-secondary education.
The earlier a contribution is made, the greater the effect of long-term, tax-sheltered compounding.
EXAMPLE
When Axel turned nine years old, his parents opened an RESP, to which they contributed $4,000 each year over
nine years. For Axel’s cousin Frankie, an RESP was opened by Frankie’s parents the year he was born, and they
contributed $2,000 each year (over 18 years). Both investments of $36,000 earned a 5% rate of return (not
including CESG). Axel’s family will have an investment worth $44,106 at the end of nine years, whereas Frankie’s
family will accumulate $56,265 after 18 years.
QUALIFYING FOR THE MAXIMUM CESG

Clients who maximize their annual RESP contribution obtain the full CESG on the first $2,500 RESP contribution
(i.e., $500 or 20% of $2,500).
EXAMPLE
Matthew contributed $1,000 last year to an RESP for his newborn daughter Laura, which earned a CESG of
$200 (calculated as 20% of $1,000). The remaining contribution room is $1,500, for which CESG can be carried
forward to a future year. Matthew’s advisor suggests that Matthew contribute $4,000 this year. By doing so,
he can get this year’s full CESG amount on $2,500 and carry forward $1,500 from last year. Therefore, Laura
will receive a total grant of $800, calculated as $500 (20% on this year’s $2,500 contribution) plus $300 (an
additional 20% when using up last year’s carryforward room of $1,500).
PROVINCIAL EDUCATION INCENTIVES

In addition to the CESG offered by the Government of Canada, two provinces offer a supplementary education incentive:
• Quebec offers the Quebec Education Savings Incentive

• British Columbia offers the British Columbia Training and Education Savings Grant
A third provincial program, the Saskatchewan Advantage Grant for Education Savings, has been suspended as of
January 1, 2018.
THE BENEFIT OF A SINGLE-BENEFICIARY RESP COMPARED TO A MULTI-BENEFICIARY RESP

Clients should carefully assess the costs and benefits of an individual plan versus a multi-beneficiary plan (also
called a family plan). Their decision should be guided by their family situation and the likelihood of each child
pursuing post-secondary education.
A multi-beneficiary plan may include as beneficiaries only the subscriber’s children, brothers, sisters, grandchildren,
or great-grandchildren, by blood or adoption. A key advantage is that all the children can be named as beneficiaries.
If one child does not pursue post-secondary education, the other children can use the plan’s accumulated earnings.
There is great flexibility in the allocation of the CESG among beneficiaries.
The benefit of an individual plan is that the beneficiary can be a non-relative, which may suit clients in certain situations.

EXAMPLE
Mila, a single mother who struggles to make ends meet, has very little money to put aside for her daughter
Paula’s post-secondary education. Mila’s long-time friends Jenna and Bruno, who are wealthy, would like to make
it a part of their financial plan to set up an RESP for Paula. Because Paula is not a relative, the couple opts for a
single-beneficiary plan.
THE BENEFIT OF MAKING RESP CONTRIBUTIONS JOINTLY WITH A SPOUSE

Contributions to an RESP should be made jointly for maximum flexibility in the future. If none of the RESP
beneficiaries pursues post-secondary education, the joint subscribers can transfer the AIPs to either or both spouses’
RRSPs.
Accumulated income payments are earnings accumulated within an RESP that are withdrawn by the subscriber if no
beneficiary pursues post-secondary education. They are different from EAPs, which are the amounts paid from an
RESP to an eligible beneficiary to assist with education-related expenses at the post-secondary level.
Their ability to do so is based on the two spouses’ combined RRSP contribution room, assuming three conditions are
met:
• The RESP was in existence for at least 10 years.

• The beneficiary is at least age 21.
• The subscribers are Canadian residents.
The transfers of AIPs to RRSPs do not need to be in equal amounts for each spouse.
THE BEST STRATEGY TO RECEIVE AIPs

If one or both spouses expect to receive AIPs from an RESP, they should not make RRSP contributions in the year or
two prior to receiving the AIPs. This tactic allows them to build up RRSP contribution room to absorb some or all of
the expected AIPs.
An RESP must be terminated before March 1 of the year following the first AIP withdrawal. It is therefore
advantageous to spread withdrawals over a two-year period. If neither spouse holding a joint RESP has RRSP
contribution room, the spouse in the lower tax bracket should take the AIPs as income because that spouse would
pay tax at a lower rate (plus the tax penalty of 20%).
REGISTERED DISABILITY SAVINGS PLAN

The registered disability savings plan (RDSP) is intended to help parents and others save for the long-term
financial security of a person with disabilities. To qualify, the person must be eligible for the disability tax credit.
Contributions to an RDSP are not tax deductible, but earnings are allowed to accrue on a tax-deferred basis.
The federal government provides grants and bonds to encourage contributions to an RDSP. Matching grant and
bond contributions are available in two forms:
Canada Disability The Canada Disability Savings Grant matches contributions on a sliding scale,
Savings Grant depending on family net income and amount contributed. The total potential grant
is $3,500 annually, with a lifetime limit of $70,000.
Canada Disability The Canada Disability Savings Bond is available only to lower-income families,
Savings Bond with eligibility depending on family net income. No contributions are required to be
made to an RDSP to receive the Canada Disability Savings Bond. The potential limit is
$1,000 annually and $20,000 over the beneficiary’s lifetime.

An RDSP can be opened at any time, but contributions are subject to a time limit. Contributions can only be made
until the end of the year in which the beneficiary turns 59. However, matching grant and bond contributions are
only available until the end of the beneficiary’s 49th year. There are no annual contribution limits, but there is a
lifetime limit of $200,000.
Government grants and bonds must stay in the plan for at least 10 years to avoid being clawed back. When
withdrawals are made from an RDSP prematurely, a proportional repayment rule applies. For each $1 withdrawn,
$3 of any grant or bond money paid into the plan within the 10 years preceding the withdrawal may have to be
repaid.
EXAMPLE
Phoebe, age six, has been severely disabled since birth. Her parents are struggling to survive and can barely make
ends meet. Phoebe’s maternal grandparents, Stavros and Irina, want to help out by funding Phoebe’s ongoing and
expensive health care needs over the long term. Their advisor recommends that they contribute to an RDSP set
up with Phoebe as beneficiary.
Stavros and Irina can contribute any amount of their choosing to the RDSP, up to the lifetime limit of $200,000.
They decide to contribute $50,000 per year for four years to the RDSP. They cannot deduct the contributions
from their income; however, the earnings within the RDSP will grow on a tax-sheltered basis until withdrawn.
Withdrawn amounts, made up mostly of investment income (but excluding contributions made) will be taxed in
Phoebe’s hands, likely at a very low tax rate.
DEFERRED PROFIT-SHARING PLAN

A deferred profit-sharing plan (DPSP) is a trust set up by a company with CRA. It can be for all employees or for
one or more classes of employees, such as senior executives or office workers. A DPSP is not regulated by pension
legislation, but it is registered with CRA and must comply with the Income Tax Act.
ESTABLISHING A DPSP
To become a member of a DPSP, a person must be employed by an employer that offers such a plan. All types
of commercial enterprises may establish a DPSP for their employees, including public and private companies,
partnerships, and sole proprietorships. However, DPSPs are not widely used.
An employer that establishes a DPSP makes cash contributions to the plan out of business profits on behalf of
each employee who is a member of the plan. The contributions and earnings accumulate in the plan tax-free until
withdrawn by plan members. Funds can be withdrawn on retirement or earlier, as long as the contributions have
vested with (i.e., belong to) the employee.
A DPSP cannot be registered with CRA in the following circumstances:
• A beneficiary under the plan is related to the employer.

• A beneficiary is a specified shareholder who owns more than 10% of the voting shares of the company, directly
or indirectly, at any time in the year.
• A beneficiary is related to such a shareholder.
To establish a DPSP, the employer must enter into a trust agreement with an independent trustee. Normally, a trust
company acts in this capacity.
ROLE OF THE TRUSTEE

The trustee of a DPSP sets up a trust fund and individual accounts for each DPSP member. At each calendar year-
end, the trustee issues statements showing the value of each account. The trustee also files tax returns and issues
cheques and tax forms, acting upon the employer’s instructions.

QUALIFIED INVESTMENTS FOR A DPSP

Qualified investments for DPSPs are similar to those for RRSPs, with a few major differences designed to prevent a
DPSP from holding the employer’s debt.
The investment in a single year in equity shares of the contributing employer or in a corporation with whom the
employer does not deal at arm’s length is limited by a defined formula.
CONTRIBUTIONS TO A DPSP
Employer contributions to a DPSP are tied to a profit formula (e.g., 5% of profits), which is defined in the plan.
A DPSP must have the following conditions to be accepted for registration:
• It must prohibit contributions to the plan by an employee.

• It must restrict its contributions for each employee to the lesser of two amounts:
• An amount equal to 18% of the employee’s yearly employment compensation (whether salary or wages)
• Half of the money purchase limit for the year (i.e., half of $30,780 in 2022, or $15,390)
• Amounts allocated to an employee by a trustee under the plan must vest irrevocably within two years after the
employee first becomes a beneficiary under the plan.
• It must limit, by a defined formula, annual investment by the plan in equity shares of the contributing employer
or a corporation with whom the employer does not deal at arm’s length.
Employer contributions may be made up to 120 days after the employer’s fiscal year-end. The contributions are
deductible to specified maximum limits, and there are no locking-in or funding requirements.
The pension adjustment is equal to the employer’s contribution only, and the employee’s RRSP contribution room is
reduced by that amount in the following year. A DPSP is often offered in conjunction with a group RRSP.
PAYMENTS AND WITHDRAWALS FROM A DPSP

Employees pay no tax on the amounts their employer contributes to a DPSP on their behalf until payments are
received. Payments from the DPSP are made under the following conditions:
• All payments received by an employee from a DPSP (other than his or her own contributions deposited
before 1991) are taxable as ordinary income.
• Employees pay no tax on employer contributions until they receive payments from the plan.
• Once contributions vest with the employee, payments may be made in full or in part at any time.
• If an employee leaves the company or dies, the employer must pay all vested amounts to the employee or the
employee’s estate within 90 days.
• Mandatory payments must begin within 90 days of the employee’s retirement or 71st birthday, whichever
comes first.
A DPSP payment may be made to the employee in any of several formats:
• A lump sum in cash, stocks, or both

• Periodic payments over 10 years at most
• An acceptable life annuity (i.e., one that meets CRA’s conditions)
TAX STATUS OF FUNDS WITHDRAWN OR TRANSFERRED FROM A DPSP

As long as funds remain in a DPSP, they are not taxed. To retain their tax-free status, the funds cannot be assigned
or used as collateral for a loan. Employee contributions made before 1991 to a DPSP were not tax deductible;

therefore, withdrawals of the portion contributed by an employee are tax-free. However, all other withdrawn funds,
including employer contributions and earnings on all contributions, are taxable as income at the time of withdrawal.
Funds can be transferred directly from a DPSP to either of two account types while retaining tax-free status:
• An RPP or RRSP (without affecting contribution limits)

• Another DPSP (with a minimum of five beneficiaries)
If investments such as stocks are transferred as a single, in-kind payment from a DPSP to an employee, the capital
gain is not taxed as a DPSP benefit. Tax is deferred until the employee subsequently disposes of the stocks.
EXAMPLE
Raphael has a choice of receiving either of two payments:
• A $1,000 amount in cash out of the DPSP as a single payment

• Stocks with a fair market value of $1,000, but an ACB of $800
The better choice for Raphael is the stock payment. In choosing this option, he will have converted $200 from a
DPSP benefit to a capital gain (i.e., $1,000 − $800). He will have to report the $800 as income, but only half the
capital gain will be taxable when he disposes of the stock.
SAVING STRATEGIES
How can clients use savings strategies to reduce their taxes? Complete the online learning activity to
INCORPORATION
4 | Identify the types of corporate structures and their relationship to taxes.
In some circumstances, incorporation can provide tax benefits, given that corporate income earned from active
business activities is generally taxed at a lower rate than personal income. (In contrast, passive investment income
earned by a company is subject to much higher tax rates.) Paying corporate tax rates on active business income
could provide substantial savings.
Another significant advantage of incorporating a CCPC is that, if the value of the company appreciates, there will
be a capital gain upon disposition of the shares. If tax planning is undertaken, those shares could be QSBC shares,
which qualify for the LCGE of $913,630 (as discussed earlier). Family businesses, with both spouses as shareholders,
could realize more than $1.75 million of capital gain that is exempt from income tax.
A CCPC is taxed at the following federal rates:
• 9%, up to $500,000 of active business income (i.e., the small business deduction limit)
• 15%, for $500,000 and over
These rates are significantly lower than the federal personal income tax rates.
In July 2017, the Department of Finance Canada announced measures to limit the benefits that small businesses had
regarding income from passive investments. The 2018 federal budget announced a gradual reduction of access to
the preferential tax rate for those with significant passive investment income. The first $50,000 of passive income is
not affected, nor is income from money invested in active business. However, passive income between $50,000 and

$150,000 will reduce access to the limit by $5 for every $1 of income over the $50,000 threshold. Access to the
lower small business rate disappears completely when passive income in a CCPC reaches $150,000 or greater.
EXAMPLE
If passive income is $120,000, access to the federal preferential tax rate will be reduced by $350,000 (calculated
as $120,000 − $50,000 threshold = $70,000 × 5 = $350,000). This CCPC with business income above the
reduced business limit of $150,000 (calculated as $500,000 − $350,000) will then be taxed on income above
the business limit at the general federal corporate tax rate of 15%.
Each province charges tax on top of the federal rate.
SPLITTING INCOME FROM A CORPORATION

With a corporation, taxpayers can effectively split their income. All income received from an unincorporated
business, net of allowable expenses, is taxed as personal income. If the business is incorporated, however, the
taxpayer can draw a salary from the business and leave other funds in the business. The salary is taxed as personal
income, whereas the amount not withdrawn is taxed at the much lower small business rate. Taxpayers who leave
the money in the business pay only one layer of tax (at low rates) within the corporation.
EXAMPLE
Susan draws a $25,000 salary from her small business and leaves $35,000 in the business. The $25,000 is taxed
as personal income, whereas the $35,000 is taxed as business income within the corporation at a lower rate.
NON-TAX ADVANTAGES OF INCORPORATION

A corporation is a distinct legal identity, legally apart from the people who are its shareholders. It does not cease to
exist when a shareholder dies; therefore, incorporation offers estate planning benefits.
Incorporation also offers limited liability. The shareholders are not legally responsible for any act, obligation, or
liability of the corporation. However, many creditors will not extend credit to a small business corporation without
the controlling shareholders’ personal guarantees. If the shareholders do not guarantee the corporation’s loans,
their liability is limited.
Incorporation has some disadvantages as well.
It can be costly, and it involves a lot of paperwork compared to a sole proprietorship. Two tax returns must be filed
each year: one personal and one for the corporation. Furthermore, the company must keep minutes of its meetings,
and financial statements and other paperwork are required by the government.
PERSONAL SERVICES BUSINESS

One advantage to operating a business as a corporation is the low corporate tax rate. However, certain businesses
such as personal service businesses (PSB) are restricted from benefiting from that rate.
The definition of a PSB is complex. Generally, PSB rules target incorporated entities who would be otherwise
considered individual employees. An example occurs when an employee leaves a company and then incorporates,
and the former employer then hires the newly incorporated company to perform the same work the previous
employee did. Another common example is found when information technology consultants are hired by companies
on contract to perform work that employees would otherwise perform.
A corporation determined to be a PSB does not benefit from the small business deduction (and is therefore not
eligible for the preferential corporate tax rates). The only expenses deductible from PSB income are salaries and

wages paid in the year to the person providing the services, the cost of benefits provided to that person, and certain
other expenses normally deductible by an individual employee.
PROFESSIONAL CORPORATIONS
Certain professionals, including lawyers, doctors, dentists, and accountants, are permitted in most provinces to set
up professional corporations and incorporate their practices. In general, it is beneficial to do so if the revenues they
earn in a year substantially exceed their living expenses. Excess funds may be left inside the corporation.
Professional corporations are eligible for the small business deduction and the preferential tax rate that goes with
it. Also, the disposition of shares may be eligible for the lifetime capital gains exemption. Other benefits associated
with professional corporations include cash basis accounting, creditor proofing, and salary versus dividend options.
However, the advantages must be weighed against one-time and ongoing expenses related to incorporating, along
with the extensive paperwork required.
SPECIFIED INVESTMENT BUSINESS

The Income Tax Act lays out a set of rules governing specified investment businesses (SIB), which are companies
set up to earn passive income from property. The SIB rules are intended to prevent taxpayers from incorporating
such a company to gain the advantage of the small business deduction. The rules apply to investment holding
companies that hold passive investments earning income, such as interest, dividends, royalties, or rent from real
estate. Investment holding companies that employ more than five full-time employees are exempted from the
SIB rules.
CORPORATE TAKEOVERS
Large companies, both public and private, regularly look for opportunities to grow by acquiring smaller companies.
The structures of these acquisitions are often complex, and the tax treatment in each case is unique. Typically, if
only shares of one company are exchanged for shares of another company the transaction may be tax-deferred.
But if a non-share consideration is received, such as cash or debt, there may be more immediate tax considerations.
Clients whose business is subject to a takeover over should seek the expertise of tax professionals to determine how
their shareholders will be affected.
INCOME-SPLITTING WITH FAMILY MEMBERS

The Department of Finance Canada announced several proposed tax changes aimed at private corporations in 2017.
One substantial change was related to income sprinkling among family members under the tax on split income
(TOSI) rules (or the so-called “kiddie tax” rules). After several months of consultations and amendments to the
original proposals, changes were implemented to the TOSI rules for 2018 and subsequent tax years. The TOSI applies
the highest marginal tax rate (currently 33%) to the split income of an individual under the age of 18. In general,
an individual's split income includes certain taxable dividends, taxable capital gains, and income from partnerships
or trusts. The rules were expanded to apply to amounts from a related business received by an adult aged 18 or
over, either directly or indirectly (e.g., from a trust). These amounts, which are usually in the form of dividends,
may be subject to TOSI rules and taxed at the highest marginal tax rate. However, TOSI rules would not apply to
a salary that is paid by the related business. As such, it is the adult spouse or children who are investors only that
are captured by the TOSI rules. If they can demonstrate that they contribute to the business (as is true with many
family businesses), then they may be exempt from the rules. Because the TOSI rules are complex, a tax specialist
should be consulted to ensure the TOSI exemptions are sufficiently met.

DID YOU KNOW?
A related business is one where the taxpayer in question is related to someone who is either actively
involved in the business or who owns a significant portion of its equity.
TAX PLANNING STRATEGIES
What are some tax planning strategies to reduce taxes on investment income? Complete the online
TAXING THE MILLERS
At the beginning of this chapter, we presented a scenario in which clients Ruth and Peter Miller asked for tax
planning help. Now that you have read the chapter, along with the relevant chapters in KPMG’s Tax Planning
guide, we’ll revisit the questions we asked and provide some answers.
• What can the Millers do to reduce their tax bills now and in the future?
• To increase their after-tax cash flow, the Millers should do what they can to minimize taxable income.
• Given the large disparity in their incomes, they could transfer income-producing assets from Peter’s name
to Ruth’s name (keeping the attribution rules in mind). A prescribed interest rate loan from Peter to Ruth
would allow Ruth to generate income that will be taxed at a lower rate.
• Ruth could transfer the charitable donations tax credit and other personal tax credits to Peter.
• The couple could share their CPP benefits, and Peter could split up to 50% of his defined benefit pension
income with Ruth.
• Peter, who is the higher earner, could pay their living costs, which would allow Ruth to invest her income.
• Given their professional corporation status, what tax and other advantages can the Millers benefit from?
• Peter should aim to retain as much of his consulting income in the professional corporation as possible.
That way, he can benefit from the lower small business tax rate.
• Peter may also be able to shelter capital gains on the disposition of the professional corporation’s shares
by using his LCGE.
• Other advantages include creditor proofing and receiving a combination of salary and dividends to create
RRSP contribution room.
• What tax strategies could the Millers use to transfer their wealth to their children and grandchildren?
• The couple could make gifts to their children and grandchildren now to reduce future estate and probate
costs. Keep in mind that gifts to adult children or grandchildren are not subject to attribution rules.
• While they are living, they could pass along their personal-use assets, such as their art and wine collection,
to their designated heirs. They could also donate those assets to a charity to offset possible capital gains
taxes and reduce estate and probate costs at death.
• They could set up an RESP and make contributions to the plan, and use the funds accumulated on a tax-
deferred basis to help pay for their grandchildren’s post-secondary education.

SUMMARY
In this chapter, we discussed the following key aspects of tax planning:
• One way to minimize current and future taxes is to split income among family members by transferring assets
from a person in a high tax bracket to a spouse or child in a lower tax bracket. Attribution rules and TOSI rules
restrict one’s ability to reduce taxes payable with this strategy.
• There are also other effective tax-saving strategies:
• Having the higher-income spouse pay household or living expenses, while the lower-income spouse invests
his or her income
• Making interest payments tax deductible by borrowing to invest
• Realizing capital losses before year-end to offset capital gains that were realized earlier in the year (tax-loss
selling)
• Using the LCGE
• Certain types of tax shelters are also available, but opportunities in this regard have been curtailed over
the years.
• As an advisor, you should understand the rules for different plans (used principally for non-retirement goals that
allow tax-free and tax-deferred growth) including TFSAs, RESPs, RDSPs, and DPSPs. You should help clients use
these plans to their best advantage to reduce taxes as far as possible and avoid overpaying on withdrawals.
• Businesses can sometimes reduce their tax bill by incorporating. Corporate income earned from active business
activities (in contrast to investment income) is generally taxed at a lower rate than personal income. However,
not all types of businesses benefit from the corporate tax rate. The Income Tax Act lays out special rules, such as
rules for PSBs, SIBs, and professional corporations.
NOTE
to this text, because they both contain examinable content. For examination purposes, if this content in this
DISCUSSION BOARD
for Chapter 9.
REVIEW QUESTIONS
Questions.

Registered Retirement
Savings Plans 10
CHAPTER OUTLINE
In this chapter, we discuss all aspects of registered retirement savings plans that are set up as savings vehicles for
retirement. Registered accounts for other purposes, such as saving for post-secondary education or for a disabled
dependant, are covered in Chapter 9.
1 | Explain the value of contributing early and Preparing to Fund Retirement

regularly to a registered retirement savings
plan.
2 | Explain the characteristics of registered An Overview of Registered Retirement

retirement savings plans, including their Savings Plans
advantages and disadvantages.
3 | Explain the registered retirement savings plan Registered Retirement Savings Plan
contribution rules. Contribution Rules
4 | Describe the different types of registered Management of RRSP Accounts

retirement savings plan accounts and identify
the investments that qualify to be held in a
registered retirement savings plan.
5 | Explain clients’ options for their registered What Clients Should Know About their
retirement savings plans before, during, and Registered Retirement Savings Plans
after retirement.

KEY TERMS
carryforward amount Lifelong Learning Plan
contribution limit locked-in retirement account
cumulative excess amount registered retirement savings plan
earned income taxable disposition
Home Buyers’ Plan unused contribution
in-kind contribution withholding tax

CHAPTER 10 REGISTERED RETIREMENT SAVINGS PLANS 10 • 3
INTRODUCTION
The benefits of tax-deferred retirement accounts are essential to effective tax planning and investing. The tax-
sheltering aspects of government-sponsored registered plans allow clients to reduce their tax burden in the year of
contribution. They also provide clients with valuable tax-deferred compounding of investment returns over many
years. As an advisor, you should look for every opportunity to minimize the impact of taxation on your clients’
investments to help them reach their long-term goals.
Before you begin, read the scenario below, which raises some of the questions you might have regarding retirement
savings plans. Think about these questions, but don’t worry if the answers don’t come easily. At the end of the
MAKING THE MOST OF THE MILLERS’ RETIREMENT SAVINGS
Ruth Miller is 65 and her husband Peter is 70. As part of your tax planning with the couple, you examine their
use of tax-deferred retirement savings accounts. The Millers wish to generate the greatest after-tax cash flow
they can to support their retirement needs. However, they also want to minimize taxes on their overall portfolio
by realizing taxable income only when they have to. Furthermore, they want to take advantage of tax deferral
opportunities to grow and preserve their savings. Both Ruth and Peter have RRSPs as well as non-registered
accounts.
• What can the Millers do to shelter income from taxes and maximize their retirement portfolios’ growth?
• Ruth does not know of any disadvantages to investing in an RRSP. What would you tell her?
• Peter and Ruth own valuable works of art, jewellery, and a wine collection. Ruth wants to know if she can hold
any of these items within her RRSP. What would you tell Ruth?
NOTE
Some content in this chapter is also covered in Chapters 3 and 20 of the KPMG Tax Planning guide, in some
cases in greater detail. We strongly recommend that you study the content in the KPMG guide in addition to this
text, because they both contain examinable content. For examination purposes, if the content in this chapter
differs from the KPMG guide in any respect, precedence will be given to this content.
PREPARING TO FUND RETIREMENT
1 | Explain the value of contributing early and regularly to a registered retirement savings plan.
During retirement, people must rely on sources of income other than paid employment. Having enough income
and assets to support their desired lifestyle during retirement requires careful planning. The two key factors needed
to accumulate the required savings are time and money. If they hope to retire in comfort, clients must start
saving early and make regular contributions. They should also understand the tax rules that apply to income from
retirement sources.
Retirees usually receive income from several sources other than a regular paycheque, including employer-provided
pensions, government programs, and savings from both registered and non-registered accounts. Income from most
of these sources is taxable upon receipt. Taxes are not withheld at some of these income sources. Retirees must
arrange either to have them deducted at source or to budget cash flow to pay the required income taxes in quarterly
instalments. It is important that retirees take advantage of the tax breaks to which they are entitled. These may
include non-refundable tax credits for those over age 65, including credits for pension amount, medical expenses,

and disabilities. A significant tax strategy that is available to retirees receiving “eligible retirement income” is the
ability to split pension income between spouses. Low-income pensioners living in Canada may receive assistance
through the Guaranteed Income Supplement, which is available as part of the Old Age Security (OAS) program. On
the other hand, seniors with higher incomes will have some, or all, of their OAS pension “clawed back”. Effective tax
planning can help reduce a retiree’s taxable income below the threshold at which the OAS clawback starts.
As mentioned above, two of the key factors that contribute to the accumulation of required savings on the
retirement date are time and money. Saving in registered retirement plans over many years leverages the power of
tax-deferred compounding to accumulate retirement savings. Unfortunately, given so many conflicting demands on
their income, many clients decide that saving for retirement is not a priority.
The scenario below shows how you can demonstrate to clients the value of contributing early and regularly to a
retirement savings plan.
Scenario | The Power of Compounding
At age 20, one of your clients, Francine, began depositing $2,000 per year into an RRSP, but she stopped
contributing when she turned 30. Her total contributions amount to $20,000 (i.e., $2,000 at the end of each year
for 10 years). Assuming an interest rate of 7%, Francine’s total RRSP value will be about $295,015 at age 65.
Another client, Cathy began contributing to her RRSP when she turned 30 and made deposits of $2,000 per
year every year until age 65. The total contribution she made was $70,000 (i.e., $2,000 at the end of each year
for 35 years). Assuming an interest rate of 7%, Cathy’s total RRSP value will be about $276,473 at age 65 (−$2,000
PMT, 35 n, 7 i/y, 0 PV, COMP FV).
Even though Francine contributed $50,000 less than Cathy into her RRSP, she will retire with about $18,500
(almost 7%) more than Cathy, simply because she began contributing earlier. Her savings compounded at pre-
tax rates of return of 7% for an additional 10 years. Using a financial calculator, Francine’s retirement savings are
calculated as follows:
$−2,000 PMT, 10 n, 7 i/y, COMP FV = $27,632

$−27,632 PV, 35 n, 7 i/y, COMP FV = $295,015
Table 10.1 clearly illustrates the benefit of beginning to save early. It first shows what would have happened if
Francine had contributed at the same rate from age 20 to the end of her career. It then shows how much more
Cathy, who began to save at 30, would have to contribute to retire with the same amount as Francine.
Table 10.1 | The Effect of Compounding over Different Periods
Client Contribution Number of Years Interest Rate Total Deposits RRSP Value at 65
Francine $2,000 10 7% $20,000 $295,015
$2,000 45 7% $90,000 $571,498
Cathy $2,000 35 7% $70,000 $276,473
*$2,134 35 7% $74,695 $295,015
**$4,134 35 7% $144,697 $571,498
* FV = $295,015, I/Y = 7, N = 35, PV = 0, COMP PMT = $2,134.13
** FV = $571,498, I/Y = 7, N = 35, PV = 0, COMP PMT = $4,134.19
Given this scenario, Cathy would have to contribute twice as much as Francine, who started saving 10 years earlier,
to save the same amount of money.

AN OVERVIEW OF REGISTERED RETIREMENT SAVINGS PLANS
2 | Explain the characteristics of registered retirement savings plans, including their advantages and
disadvantages.
Registered retirement savings plans (RRSPs) provide a tax-efficient investment vehicle for clients who are saving
for retirement. Clients benefit from tax-deferred compounded growth of income until the funds are needed (or until
they must be withdrawn under the rules for RRSPs).
An RRSP is an individual retirement savings plan that has been registered with Canada Revenue Agency (CRA).
Canadian taxpayers can contribute a limited portion of their earned income to an RRSP and defer paying income
tax on the contribution until it is withdrawn. Income earned within the plan is also tax-deferred until it is withdrawn
from the plan.
Contributions to an RRSP, within specific limits, are tax-deductible. Contributions can only be made if the taxpayer
has RRSP contribution room.
For tax reporting purposes, RRSP contributions are deducted in the calculation of net income on the taxpayer’s tax
return. Contributions are tracked annually; however, taxpayers can deduct contributions made in the first 60 days of
the next calendar year on the tax return for the current year. However, if the contributions made in the first 60 days
of next year are deducted on the current year’s return, they cannot be claimed again in the next year. Taxpayers who
have used all their RRSP contribution room or who anticipate having a higher marginal tax rate next year may opt
to claim the deduction in the next year. In that case, any contribution made within the first 60 days of the new tax
year must still be reported on the current year’s tax return. However, the contribution may be carried forward and
deducted in the next year (in the calendar year in which it was actually made). This reporting system may cause
some confusion for people who have used all of their available RRSP contribution room.
EXAMPLE
Mina began contributing the maximum amount permitted to her RRSP account as soon as she could and has
continued to contribute every year. In January 20x2, the only RRSP contribution room she has available is the
maximum permitted for the year based on her 20x1 salary. She makes this contribution in the first week of
January 20x2.
Mina must include her January RRSP contribution on her 20x1 personal tax return because it was made in the
first 60 days of 20x2. However, the contribution does not have to be deducted on her 20x1 personal tax return.
Instead, she can designate this as an unused contribution and use it as a tax deduction on her 20x2 tax return.
Unused RRSP contributions are amounts contributed to an RRSP but not deducted in the tax return as an RRSP
deduction (Line 20800).
DID YOU KNOW?
To be tax-deductible in a particular year, RRSP contributions must be made in that taxation year or
within 60 days after the end of the year.
ADVANTAGES AND DISADVANTAGES OF RRSPs

Registered retirement savings plans have many advantages for Canadian taxpayers. As an advisor, you should
be able to explain all advantages to your clients. However, you should also make your clients aware of certain
disadvantages that might make an RRSP unsuitable for certain purposes.

ADVANTAGES OF AN RRSP
Through the compounding of tax-deferred income and capital gains, RRSPs allow people to build a larger retirement
fund than would otherwise be possible. Furthermore, contributions to the plan provide an immediate tax saving, as
long as the amounts are within the person’s contribution limits and deducted on their tax return.
Employer-sponsored pension plans, where they exist, are often not portable. With increased job mobility, taxpayers
can lose the benefits of private pension plans as they change jobs over the years. An advantage of RRSPs is that they
are not affected by a job transfer or loss of employment to the same degree.
Another benefit is that RRSPs issued by financial intermediaries are protected to some degree from seizure by
creditors. To curb the potential for abuse, any RRSP contributions in the 12 months-prior to bankruptcy are not
protected, although this provision may not apply in all provinces.
DID YOU KNOW?
Under the federal Bankruptcy and Insolvency Act, RRSP assets are protected in the event of bankruptcy
initiated on or after July 7, 2008. This provision of the Act also applies to registered retirement income
funds and deferred profit-sharing plans.
Further benefits of RRSPs are as follows:
• They can provide additional funds for early retirement or an extended period of absence from work.
• They allow plan holders to defer paying income tax to later years when they are likely to be in a lower
tax bracket.
• They provide a means for spouses to split their retirement income (using both contributor and spousal RRSPs)
and reduce the effective tax rate on their combined income.
• They allow simple appointment or naming of beneficiaries for estate purposes in most provinces.
• They allow plan holders to access funds for buying a first home or to pay for full-time training or post-secondary
education programs (discussed later in this chapter).
DISADVANTAGES OF AN RRSP
Most of the disadvantages of an RRSP are tax related. Although an RRSP provides tax savings when contributions are
made, tax does eventually come due. When funds are withdrawn from an RRSP, a portion to cover tax is withheld
at source by the financial institution and remitted to CRA (and Revenue Québec for Quebec residents). In addition,
the dollar amount of the withdrawal is reported on the person’s tax return. Plan holders may owe additional taxes,
depending on their marginal tax rate and overall tax situation.
Capital gains earned outside an RRSP are subject to income tax on only 50% of the capital gain, known as
the taxable capital gain. In an RRSP, however, the entire value of a withdrawal is fully taxable as income when
withdrawn. If the RRSP appreciated as a result of realized capital gains, the preferential tax treatment does not
apply–the full dollar value of the withdrawal is included in net income for tax purposes. Furthermore, the plan
holder cannot take advantage of the dividend tax credit on eligible dividend income received within the RRSP.
Additionally, if the plan holder dies, the entire value of the RRSP is included as income on the deceased’s final tax
return. An exception occurs when the RRSP is rolled over to a spouse or, under certain circumstances, left to a
dependent child or grandchild.
Other, non-tax-related, disadvantages of RRSPs are as follows:
• If a whole life insurance policy is registered as an RRSP, the policyholder may not take out policy loans from the
issuing insurance company, and the policy cannot be used as collateral.
• The assets of an RRSP cannot be used as collateral for a loan.

• The plan holder may not borrow from the plan except under federally regulated home buying and education
programs (discussed later in this chapter).
• Funds within an RRSP are most commonly transferred to a registered retirement income fund (RRIF) no later
than December 31 of the plan holder’s 71st birthday. Minimum annual withdrawals must be made from a
RRIF and fully included in the taxpayer’s income. These mandatory withdrawn amounts inflate the taxpayer’s
net income and expose the taxpayer to the OAS clawback, which results in OAS benefits having to be fully or
partially repaid.
REGISTERED RETIREMENT SAVINGS PLAN CONTRIBUTION RULES
3 | Explain the registered retirement savings plan contribution rules.
The annual RRSP contribution amount permitted for tax deduction is generally limited to18% of the contributor’s
earned income. However, the limit may be less or more than 18%, depending on several factors. Mainly, the federal
government sets a maximum annual contribution limit in terms of the dollar amount that can be put into an
RRSP. In 2022, the limit is set at $29,210. As such, taxpayers who have earned income of $200,000 last year cannot
contribute 18% of $200,000 to their RRSP for that year. Contribution room is limited to the dollar amount for that year.
Other factors limiting or expanding the RRSP contribution amount are pension adjustments, as a result of
being a member of a registered pension plan (RPP), and the carryover of available RRSP contribution room from
previous years.
EARNED INCOME
The RRSP contribution limit for a particular year is based on earned income of the taxpayer for the previous year
and any unused RRSP contribution room the taxpayer may have accumulated. To understand RRSPs, therefore, it is
essential that you understand exactly what earned income refers to. Earned income is essentially an individual’s net
income earned from employment or self-employment. The definition is somewhat broad in that it includes taxable
spousal support received, net rental income, and disability payments from the Canada Pension Plan (CPP). However,
most forms of passive income are not included in earned income for RRSP purposes. Excluded from earned income
are investment income (i.e., interest, dividends, and capital gains), pension benefits, withdrawals from registered
accounts, and payments from a deferred profit-sharing plan (DPSP).
The most common types of earned income reported on personal income tax returns include the following items:
• Gross Canadian salaries and wages, including bonuses

• Commissions
• Allocations from employee profit-sharing plans
• Net business or self-employment income
• Net rental income from real property
• Taxable spousal payments received
• Disability payments received under CPP or the Quebec Pension Plan (QPP)
The following items can be deducted from earned income, thereby reducing it for tax purposes:
• Deductible spousal support payments

• Most deductible employment-related expenses, such as professional fees, union dues, or travelling expenses
• Rental losses

CALCULATING THE RRSP CONTRIBUTION AMOUNT

The maximum annual tax-deductible contribution a person is allowed to make to an RRSP is calculated as the lesser
of two amounts:
• 18% of the previous year’s earned income

• The RRSP dollar limit for the year
Minus:
The previous year’s pension adjustment (PA) and the current year’s past service pension adjustment
(PSPA)
Plus: The taxpayer’s unused RRSP contribution room at the end of the immediately preceding taxation year
The RRSP dollar limits for 2022 and 2023 set by the federal government are as follows:
2022: $29,210
2023: $30,780
EXAMPLE
In 2021, Mohsin earned income of $60,000 and had a pension adjustment on his 2021 T4 slip of $4,400. He had
no past service pension adjustment, no unused RRSP contribution room, and no previous RRSP overcontributions.
To calculate Mohsin’s maximum tax-deductible contribution to his RRSP for the 2022 tax year, first compare 18%
of his earned income with the dollar limit:
• 18% of $60,000 = $10,800

• 2022 RRSP dollar limit = $29,210
Next, complete the calculation using the lesser amount:
18% of $60,000: $10,800

Minus: $4,400 (pension adjustment)
RRSP contribution room: $6,400
Mohsin can therefore contribute up to $6,400 by December 31, 2022, or within the first 60 days of 2023. The
maximum amount that can be deducted on his 2022 tax return is $6,400.
IN-KIND RRSP CONTRIBUTIONS

The federal government allows assets in the form of marketable securities to be transferred to an RRSP in lieu of a
cash contribution. The value of these so-called in-kind contributions for tax purposes is the market value on the
date the trustee receives the assets in the plan.
When marketable securities are contributed to an RRSP, the in-kind contribution has the following tax
consequences:
• The transfer of marketable securities is classified as a taxable disposition.

• If the market value of the transferred marketable securities is higher than the original cost price, the plan holder
is deemed to have realized a capital gain. Fifty percent of the capital gain is included in the taxpayer’s net
income as a taxable capital gain.
• There is no tax benefit to a loss created by an in-kind contribution. If the market value of the transferred assets
is lower than the original cost price, the plan holder’s loss for tax purposes is deemed to be zero. The loss is
treated as a superficial loss, and therefore denied, because the taxpayer is considered to have disposed of
securities at a loss and bought them back immediately thereafter.

• If a debt security is contributed between the dates on which interest is paid, the amount of the contribution
includes all interest accrued to the date of transfer. This accrued interest must be included in the contributor’s
taxable income for the year the contribution is made.
In-kind contributions made to an RRSP provide a tax advantage if the contribution is made in either January or
February of a given tax year. Because the contribution is made during the first 60 days of the year, it can be used
as a tax deduction in the previous tax year. However, the capital gain is only recognized in the year the in-kind
contribution is actually made. Therefore, the taxpayer is able to claim a tax deduction one full year before the
corresponding taxable capital gain has to be included in the net income of the taxpayer.
EXAMPLE
It is late February and Leon has not yet made his RRSP contribution. He does not want to forgo the available tax
deduction for the previous year if he makes an RRSP contribution before March 1. However, he has no available
cash. Instead, he contributes $10,000 worth of shares from his non-registered investment portfolio. The shares
have appreciated considerably from when he purchased them for $4,000.
Leon will be able to use the $10,000 in-kind contribution on the tax return his accountant is completing for
the previous tax year. Given his marginal tax rate of 45%, the in-kind contribution will save him about $4,500.
Furthermore, he will not have to realize the $3,000 taxable capital gain (50% of the $6,000 capital gain) on the
transaction this year. Instead, he can claim the taxable capital gain on his tax return for the current year, which is
due over one year from now.
CARRYFORWARD OF UNUSED RRSP CONTRIBUTION LIMITS

In any year where taxpayers do not contribute up to their maximum available RRSP contribution limit, their
contribution room may be carried forward indefinitely. This carryforward amount, along with the calculation of
the new RRSP limit from the previous year, is reported every year to taxpayers on their Notice of Assessment. Total
unused RRSP contribution room in Canada is over the $1 trillion level. Many Canadians are opting to contribute to a
tax-free savings account (TFSA) instead of an RRSP, while a relatively smaller number contribute to both plans.
OVERCONTRIBUTIONS TO AN RRSP
Taxpayers may over-contribute up to $2,000 to an RRSP without penalty. This $2,000 amount is the largest
overcontribution that can be in place at any time without incurring overcontribution penalties. An overcontribution
is also known as an excess contribution.
The overcontribution cannot be deducted for tax purposes, but it can remain in the RRSP and earn tax-deferred
investment income. If it is never deducted for tax purposes in a future year, the excess contribution will be taxable
when it is eventually withdrawn. This results in double taxation of the overcontribution amount. However, an
overcontribution kept in place for many years may generate significant tax-deferred and compounded investment
income over the long term. You should help clients determine whether making an overcontribution fits with their
investment goals before undertaking such a long-range plan.
An overcontribution may become tax-deductible if the taxpayer cannot, or chooses not to, make a full contribution
in the next year or future years. At that point, all or part of the overcontribution may be deemed to be a regular
RRSP contribution, and therefore tax-deductible. The amount is shown on the Notice of Assessment for the tax year
it was made as an unused RRSP contribution previously reported and available to deduct.

EXAMPLE
Last year, John made an overcontribution of $1,800 to his RRSP, which he could not claim as a tax deduction on
his tax return. Because this amount was below the $2,000 maximum overcontribution permitted at any time,
it did not incur an overcontribution penalty.
This year, John decides not to make an RRSP contribution. Instead, he uses the $1,800 overcontribution from last
year as this year’s regular RRSP contribution and claims the tax deduction of $1,800 on this year’s tax return.
Any amount in excess of the allowable overcontribution limit is known as the cumulative excess amount (CEA).
A penalty tax of 1% per month is assessed on the CEA in the plan until the excess is withdrawn. The penalty is
payable by the contributor within 90 days of the end of the year.
DID YOU KNOW?
The CEA penalty must be calculated on CRA form T1-OVP. You can help your clients file this form by
providing a detailed history of all RRSP contributions and withdrawals during the period in question.
The penalty is calculated as follows:
CEA penalty =
Total un-deducted RRSP contributions after 1990 − (Member’s unused RRSP contribution room + $2,000)
MAKING A FINAL RRSP OVERCONTRIBUTION

Plan holders can over-contribute to their RRSPs before the end of the year in which they turn age 71, provided that
they earn income in that year. Based on the plan holder’s income, new RRSP contribution room will be generated for
the following year. Therefore, in that year, overcontribution penalties will cease, and the plan holder can deduct the
contribution. Note that the plan holder must make the overcontribution before transferring the RRSP to a RRIF.
MAKING LUMP-SUM PAYMENTS TO AN RRSP

Lump-sum transfers can be made tax-free to an RRSP from other registered plans, including from RPPs, DPSPs,
and other RRSPs. The transfers do not affect the regular, tax-deductible RRSP contribution limits if they are made
directly from one organization or financial institution to another. When directly transferred, the amount is not
included in income and no deduction arises. In certain cases, especially in transfers from RPPs to RRSPs, rules limit
the amount that can be transferred on a tax-deferred basis. Transfers to an RRSP above this legislated maximum
may result in overcontributions and significant penalties.
LOCKED-IN RETIREMENT ACCOUNT

A lump-sum transfer can be made from one’s RPP to an RRSP. In doing so, the accrued RPP entitlement is
transferred to a locked-in registered plan such as a locked-in retirement account (LIRA), also known as a locked-in
RRSP. A LIRA or locked-in RRSP can accommodate employees who have vested benefits in an employer’s RPP and
who leave the employer before they are eligible to receive retirement or pension income.
Under both federal and provincial pension legislation, employees may not take their pension benefit entitlements
in the form of cash. The funds must be transferred to a locked-in registered plan, which has restrictions similar to
those of a pension plan. The key restriction is that the funds cannot be withdrawn from the plan, as they can from
a regular RRSP. A portion of the funds may be unlocked under certain circumstances in different provinces.

DID YOU KNOW?
Locked-in RRSPs and LIRAs have virtually identical attributes, and the two terms are frequently used
interchangeably. For the purpose of this course, we use the term LIRA when referring to any locked-in
registered plan.
CONTRIBUTIONS TO A SPOUSAL RRSP

Taxpayers may contribute to a spousal RRSP, which is an RRSP registered in the name of a spouse, common-law
partner, or same-sex partner. In doing so, contributors can contribute within their RRSP contribution limit and
claim the corresponding tax deduction on their own tax return. In most situations, the recipient spouse earns less
than the contributor and, therefore, has a lower marginal tax rate. As such, the spouse with the higher income
claims the tax deduction, and the spouse with the lower income pays tax on the RRSP amount upon withdrawal. It
is a tax-effective strategy because the RRSP deduction saves more tax for contributors than if the recipient spouses
had made the contribution out of their own income.
The amount a person can contribute to a spousal RRSP is limited to the contributor’s RRSP contribution room
minus any amount contributed to their own RRSP. The contributor may choose to contribute a part of or the whole
allowable limit to the spousal RRSP. The spouse’s contribution limit is not affected by the contribution to the
spousal RRSP. The allocation between contributions to one’s own RRSP and a spousal RRSP is a personal choice that
should be guided by tax and financial planning considerations.
EXAMPLE
Rekha has an RRSP contribution limit of $15,500 but contributes only $10,000 to a plan in her name. Her
husband Manesh’s RRSP has a contribution limit of only $5,000. Rekha contributes $5,500 to a spousal RRSP
for a total tax deduction of $15,500. Manesh contributes the full $5,000 limit to his own plan and claims a tax
deduction for that amount.
TAX LIABILITY FOR FUNDS WITHDRAWN FROM A SPOUSAL RRSP

Funds withdrawn from a spousal RRSP are generally treated as taxable income of the recipient spouse. However,
withdrawals by the recipient could be taxed in the hands of the contributor if the withdrawal occurs within three
years of the contribution to the spousal RRSP. The three years are not counted from the date of the contribution. The
time restriction includes the year the contribution was made and two full calendar years following the contribution.
If the contribution is withdrawn by the recipient spouse before this deadline, the withdrawal is taxed in the hands
of the contributing spouse in the year of withdrawal. In other words, the withdrawal is attributed back to the
contributor for tax purposes.
The restriction does not apply in the following circumstances:
• At least one of the spouses was a non-resident of Canada at the time of withdrawal
• The contributing spouse died during the year the funds were withdrawn
• The couple were living apart as a result of a marriage breakdown
For purposes of the attribution of withdrawals to the contributing spouse, the most recent contributions are
deemed to be withdrawn first. Therefore, any withdrawals made in the year of a spousal contribution or within the
two years following are attributed as taxable income of the contributor.

EXAMPLE
In each of five consecutive years, Patrick contributes $1,000 to his wife Colleen’s spousal RRSP. He claims each
contribution as a tax deduction in the year it was made. In the fifth year, Colleen decides to withdraw all funds
from her plan. Therefore, for the fifth taxation year, the couple pays tax as follows:
• Patrick includes $3,000 as taxable income on his tax return, made up of contributions from the most recent
year and the two years preceding it.
• Colleen includes the remaining $2,000 as taxable income on her tax return, plus all earnings accumulated on
the total contribution amount of $5,000 in the plan.
DID YOU KNOW?
The restriction on spousal RRSP withdrawals is based on calendar years, not years to date. As mentioned
above, the time restriction includes the year the contribution was made and two full calendar years
following the contribution.
Therefore, a contribution made in February 20x1 cannot be withdrawn without attribution until after
the third December 31 following (in early 20x4), after almost three full years have passed (20x1 +
20x2 and 20x3). However, if the funds are contributed in early December 20x0, the second full calendar
year ends on December 31 20x2, so just over two years later (20x0 + 20x1 and 20x2). To lessen the
impact of the “three-year” rule, you should recommend that clients make spousal contributions as
late in the year as possible and that they make no contributions in the first 60 days of the next year.
This advice is important in situations where the recipient spouse may need to withdraw the spousal
contributions and there is no attribution to the contributor spouse.
SPOUSAL RRSPs
What are the rules regarding contributions to a spousal RRSP? Complete the online learning activity to
INCOME-SPLITTING POTENTIAL OF A SPOUSAL RRSP

The potential for income-splitting and tax savings afforded by spousal RRSPs depends on the following factors:
• The contributing spouse’s tax rate in retirement

• The recipient spouse’s income in retirement
• The non-contributing spouse’s tax rate in retirement
• Annual income generated from a spousal RRSP
• The stability of the couple’s marital situation
A spousal RRSP is legally the property of the recipient spouse. Tax-free transfers between RRSPs are allowed if
ordered by a court under a matrimonial property settlement on the breakdown of a marriage.
Contributions to a spousal RRSP can be made even after the contributing spouse dies. The executor can make a
contribution on behalf of the deceased to a spousal RRSP in the year of death or within 60 days of the year-end, up
to the deceased’s limit. Furthermore, taxpayers older than age 71 who have earned income can make contributions,
up to their limit, to a spousal RRSP. The contributions must end when the recipient spouse reaches age 71. The
example that follows shows two income-splitting scenarios in which couples are advised to use a spousal RRSP to
reduce their taxes.

Scenario | Benefit of Splitting RRSP Income
Gino and Lucia have been married for 20 years and contribute the maximum amount to their RRSPs every year.
Gino has earned more than Lucia over the years and has amassed much larger savings, in both an RRSP and a non-
registered investment account. The couple plans to retire in 10 years and draw on their RRSPs, their non-registered
savings, and their government pensions. Neither Gino nor Lucia has a company pension plan.
Gino will receive more income in retirement than Lucia, and therefore will pay tax at a higher tax rate. To equalize
their retirement income, Gino should start contributing to a spousal RRSP, instead of his own, so that Lucy can draw
from it in retirement. By doing this, the household will pay lower taxes at retirement than if Gino keeps putting
money into his own RRSP.
Another couple, Martin and Denise plan to draw $100,000 out of their combined RRSPs when they retire
in 20 years. Denise’s RRSP is four times the size of Martin’s because she has always had a much higher-paying job
and a higher RRSP contribution limit. Neither spouse is entitled to payments from an employer pension plan at
retirement.
The couple’s advisor recommends that Denise contribute to a spousal RRSP for Martin to somewhat equalize the
value of the couple’s RRSPs at retirement. He demonstrates the advantage of income splitting by showing the
clients two potential scenarios (see Table 10.2).
(Note: The tax rates used in these calculations are approximate and are for illustrative purposes only.)
Table 10.2 | Benefit of Splitting $100,000 of RRSP Income
ALTERNATIVE 1: WITHDRAW $80,000 FROM DENISE’S RRSP AND $20,000 FROM MARTIN’S RRSP
Tax implications (tax rates are approximate)
Withdrawal from Denise’s RRSP $80,000
Less taxes owing: $80,000 × 45% $36,000
After-tax proceeds $44,000
Withdrawal from Martin’s RRSP $20,000
Less taxes owing: $20,000 × 20% $4,000
Total after-tax proceeds = $44,000 + $16,000 = $60,000
ALTERNATIVE 2: WITHDRAW $50,000 FROM DENISE’S RRSP AND $50,000 FROM MARTIN’S RRSP
Tax implications
Withdrawal from each RRSP $50,000
Less taxes owing: $50,000 × 30% $15,000
Total after-tax proceeds = $35,000 × 2 withdrawals = $70,000
Therefore, under Alternative 2, the family has $10,000 more upon retirement, after depleting the total family RRSPs
by the same $100,000.
The popularity of spousal RRSPs has likely diminished since the introduction of the pension income-splitting
measures. Under the pension income-splitting rules, a couple can minimize their tax liability by sharing qualified
pension income (i.e., RRIF payments and RPP income) with one another. One spouse can give the other spouse up

to 50% of his or her qualified pension income, thereby effectively transferring it from the first spouse’s tax return
to that of the second spouse. With the pension income-splitting rules in place, there is less need to use a spousal
RRSP to equalize the RRSP assets held in the name of each spouse. Nevertheless, spousal RRSPs continue to benefit
couples who plan to retire before age 65 and rely on their RRSP holdings for income. Also, pension income-splitting
allows only a maximum of 50% of eligible pension income to be split with the spouse, so to go beyond 50% would
require the use of a spousal RRSP. Consider also that income splitting is a relatively new tax provision that could
be rescinded with the election of new governments. The spousal RRSP, on the other hand, has been in place since
RRSPs were first introduced and is likely to remain a tax-efficient method to equalize retirement income for two
spouses.
MANAGEMENT OF RRSP ACCOUNTS
4 | Describe the different types of registered retirement savings plan accounts and identify the
investments that qualify to be held in a registered retirement savings plan.
Management of an RRSP account relates to the way investments are chosen and decisions around purchases and
sales are communicated, agreed upon, and executed. The different management styles discussed below do not
affect the basic rules that are applicable to all RRSP accounts.
Discretionary Advisors who are qualified as portfolio managers may be authorized by their clients to
managed account manage their RRSP investments on a discretionary basis. With this style, investment
decisions are made by the portfolio manager, rather than the plan holder.
Managed account In a managed RRSP, the plan holder may invest in one or more funds that are held in
trust by a financial institution. For example, the RRSP may hold segregated or mutual
funds managed by a bank, trust company, mutual fund company, or other issuer firm.
The plan holder is not required to make any investment decisions beyond choosing the
fund.
Self-directed account In a self-directed RRSP, the holder of the account assumes responsibility for all
investment decisions. This management style is best suited to knowledgeable investors
who are comfortable making their own investment decisions. These plans are typically
offered by discount brokerages. Self-directed RRSPs are popular with people who have
both time and ability, and who feel that they can outperform a managed RRSP over the
long term.
As an advisor, you should discuss the different management styles with clients interested in opening an RRSP
account. Together, you should investigate the wide variety of plans available to determine which is best suited
to a particular client’s needs. Some clients may choose to have more than one type of RRSP to take advantage of
different benefits that may be valuable to that individual.
QUALIFIED AND NON-QUALIFIED INVESTMENTS FOR RRSPs

Investments that qualify to be held within an RRSP come in many forms; however, not all investment assets are
permitted. In this section, we provide a partial list of the wide variety of assets that do qualify, as well as a shorter
list of non-qualified investments.

QUALIFIED INVESTMENTS FOR RRSPs

The following items represent a partial list of investment assets that are qualified investments for RRSPs:
• Money on deposit in a bank or similar institution

• Bonds, debentures, and similar obligations guaranteed by the Government of Canada, a province, a Canadian
municipality, or a Crown corporation
• Shares and debt obligations of Canadian public companies, exchange-traded funds, real estate investment trusts
(REITs), royalty trusts, and limited partnerships
• Shares of foreign public corporations and American Depository Receipts listed on one of many qualifying stock
exchanges
• Foreign government bonds with investment-grade ratings
• Debt obligations of corporations whose stocks trade on an eligible foreign stock exchange
• Debt obligations of the European Bank for Reconstruction and Development and the International Finance
Corporation, and securities issued under Ontario or New Brunswick community development legislation
• Guaranteed investment certificates issued by a Canadian bank or trust company
• Certain annuities issued by Canadian companies
• Units of a mutual fund trust or an insurance company pooled fund
• Exchange-traded rights, warrants, and options (including call and put options) on securities that qualify for
an RRSP
• The writing of exchange-traded covered calls on securities that qualify for an RRSP (an uncovered call or any put
option would not be considered a qualifying investment)
• Shares, bonds, debentures, or similar obligations issued by certain co-operatives or credit unions and shares of
certain investment corporations
• Certain life insurance policies
• Bankers’ acceptances (i.e., short-term promissory notes issued by corporations and guaranteed by banks,
thereby increasing their negotiability and lowering the cost of borrowing)
• Certain shares in the capital stock of a small business corporation, prescribed venture capital corporations, or
specified cooperative corporations
• Investment-grade gold and silver bullion coins and bars, and certain certificates based on financial institutions’
precious metal holdings
• Debt obligations with an investment-grade rating and that are part of a minimum $25 million issuance, and any
security (other than a futures contract) that is listed on a designated stock exchange (which, for our purposes,
includes any stock exchange currently identified as a prescribed stock exchange)
• A mortgage, or interest in a mortgage or a pool of mortgages, secured by real property located in Canada
The CRA allows certain non-arm’s-length mortgages, including a mortgage on the beneficiary’s own residence,
under prescribed conditions. Also allowed are interests in mortgage-backed securities and shares in most Canadian
mortgage investment companies.
Note that there are no longer any foreign content or foreign property restrictions on RRSPs, as there once were.

DID YOU KNOW?
Mortgage-backed securities are pools of first mortgages on Canadian residential properties. They are
insured by the National Housing Authority and guaranteed by the Canadian Mortgage and Housing
Corporation.
NON-QUALIFIED INVESTMENTS FOR RRSPs

Some investment types, including those listed below, are not qualified for RRSPs:
• Shares and debt obligations of private corporations, unless certain prescribed conditions are met
• Real estate (although REIT units are qualified investments)
• Commodity and financial futures contracts
• Listed personal property, such as works of art, jewellery, rare manuscripts, or stamps
• Uncovered call options and all put options
A plan holder who acquires or retains a non-qualified investment in an RRSP is subject to a tax penalty. In such
cases, a one-time, special tax of 50% of the fair market value (FMV) of the non-qualified investment is levied
against the plan holder. The tax liability is applied either at the time that the RRSP acquired the investment or when
the investment becomes non-qualified.
The income tax is refundable under certain conditions if the plan holder quickly disposes of the unqualified
investment from the RRSP. It must be disposed of by the end of the year following the year in which the tax applied.
However, if the plan holder knew, or should have known, that the investment was non-qualified, the tax is not
refundable. Investment income earned on a non-qualified investment remains taxable to the RRSP.
WHAT CLIENTS SHOULD KNOW ABOUT THEIR REGISTERED

RETIREMENT SAVINGS PLANS
5 | Explain clients’ options for their registered retirement savings plans before, during, and after
retirement.
In this section, we discuss various aspects of RRSPs that clients should understand. We explain some legal
requirements, along with various options that allow clients to use their funds before retirement. We also explain in
detail what happens to an RRSP after the plan holder dies.
ACCESSING RRSP FUNDS BEFORE RETIREMENT

Funds in an RRSP can be withdrawn fully or partially before retirement. Different rules and penalties apply,
depending on the method and purpose of the withdrawal.
PARTIAL WITHDRAWAL OF FUNDS FROM AN RRSP

An RRSP plan holder may make partial withdrawals of funds at any time. The institution holding the RRSP is
required by law to deduct income tax, called withholding tax, at the time the funds are withdrawn from the RRSP.
Withholding tax is a prepayment of income tax incurred by the withdrawal. The rate at which tax is withheld
depends on the amount of the withdrawal from the RRSP. The full amount of the withdrawal is included in the
plan holder’s taxable income in the year of the withdrawal. Tax reporting slips (T4RSP or T4RIF) are issued by
the institution showing both the gross amount withdrawn and any withholding taxes that were remitted to the

government. Holders may have to pay additional taxes, depending on their marginal tax rate. Withholding tax
amounts and rates for Quebec and the rest of Canada are shown in Table 10.3.
Table 10.3 | Withholding Tax Amounts and Rates
All Provinces (Except Quebec) Quebec

Amount Withdrawn Federal Tax Combined (Federal and Quebec Amounts)
Up to $5,000 10% 20%
$5,001 to $15,000 20% 25%
More than $15,000 30% 30%
DID YOU KNOW?
The word deregistration is sometimes used to describe the collapsing or cashing in of an RRSP; however,
this usage is not entirely accurate. From CRA’s viewpoint, the word applies to a situation in which
an RRSP no longer satisfies the rules under which it was registered. Deregistration is not a common
occurrence. When it does occur, the deregistered plan is no longer considered an RRSP. The FMV of its
assets is included in the plan holder’s income for tax purposes in the year the plan is deregistered.
HOME BUYERS’ PLAN

The federal government offers a plan that allows first-time home buyers to withdraw funds from their RRSPs to
help finance the purchase of a qualifying home. The Home Buyers’ Plan (HBP) is restricted to first-time home
buyers and others who meet certain qualifications. Eligible plan holders include those who have not owned and
lived in a home in the four calendar years preceding the year of withdrawal (e.g., beginning January 1, 2018,
for 2022 withdrawals). The four-year qualification period is waived for disabled persons and their relatives who want
to purchase a suitable home for the person with the disability.
Under the HBP, eligible home buyers and their spouses may each withdraw up to $35,000 from their respective
RRSPs for withdrawals after March 19, 2019. The previous amount was $25,000. The home must be in Canada, it
may be new or existing, and the buyers must occupy it as principal residence within one year following its purchase.
In general, the home must be purchased or built before October 1 of the year following the year of the RRSP
withdrawal. Otherwise, the funds must be returned to the RRSP or be taxed as income.
Funds withdrawn from an RRSP for a first-time home purchase are not taxable. However, the funds must, at
minimum, be repaid through equal annual instalments over 15 years. Funds can also be repaid in larger lump-sum
payments over a shorter period. Payments must begin no later than the second year following the withdrawal, or
within the first 60 days of the third year.
EXAMPLE
Igor and Yulia withdraw funds from their RRSPs in March 20x0 to purchase a home. They must buy the home
before October 1, 20x1; otherwise, they must make full repayment to the RRSP by the end of that year. Any
shortfall must be included in taxable income for 20x1. Assuming they do buy the house as planned, the first
repayment to the RRSP is due by 20x2 or within the first 60 days of 20x3 (the year after).

If more than the required minimum amount is repaid in a year, the annual amount to be repaid in subsequent years
is reduced. The minimum repayment is calculated as follows:
Minimum Required Repayment = RRSP Balance Outstanding ÷ Number of Years Remaining for Repayment
If less than the required minimum amount is repaid, the shortfall must be included in net income for tax purposes in
the year it occurs. Any amount included in net income for tax purposes is treated as repaid.
Repayment cannot be made to a spousal RRSP; however, it does not have to be made to the same RRSP from which
the withdrawal was made. Funds withdrawn from one RRSP can be made to another RRSP owned by the same plan
holder.
No further repayments are allowed after the year in which a plan holder reaches age 71. Any amounts unpaid by the
end of that year must be included as income each year, as scheduled payments become due. Special rules apply to
participants who die or leave Canada before they have repaid HBP withdrawals.
In general, HBP participants may not make tax-deductible RRSP contributions for the year in which funds are
withdrawn. Contributions made 90 days or more before the withdrawal date are excepted. The participant’s RRSP
contribution room may be carried forward to future years.
The HBP plan offers home buyers two advantages:
• Access to an interest-free loan

• An opportunity to save on mortgage interest payments by making a larger down payment than otherwise
possible
A disadvantage is that the borrowed funds stop growing on a tax-sheltered basis until they are repaid. As an advisor,
you should help guide any decision to participate in this plan with a careful cost-benefit analysis.
LIFELONG LEARNING PLAN

Another RRSP lending program is the Lifelong Learning Plan (LLP), which allows plan holders and their spouses to
finance their education with RRSP funds. Participants in this program must be enrolled in full-time training or post-
secondary education. They may withdraw up to $10,000 per year from the holder’s RRSP over a four-year period,
and the total amount borrowed cannot exceed $20,000.
Amounts withdrawn must be repaid to the RRSP in equal or greater instalments over 10 years; otherwise, they
will be included in the net income for tax purposes of the person who made the withdrawal. The first repayment is
usually due 60 days after the fifth year following the first withdrawal. It may be due earlier in certain circumstances,
such as when the student fails to complete courses.
Plan holders using an LLP can also participate in the HBP, even if the LLP funds they borrowed have not yet been
fully repaid.
An LLP cannot be used to finance the education or training of a plan holder’s children.
MATURING RRSPs
By law, an RRSP must mature no later than December 31 of the year in which the plan holder turns age 71.
Withdrawals from registered plans must begin by the end of the next year. Many retirees have accumulated several
RRSPs during their working years. As their advisor, you should help such clients consolidate their RRSPs to reduce
administration costs. Consolidated plans also demand less time and provide a simpler picture of their overall
financial situation.

OPTIONS FOR MATURING AN RRSP

Clients holding RRSPs can choose from among three options when their RRSP matures:
• Withdraw all the proceeds as a lump-sum payment, with the entire lump sum included in income in the year it
is received. This option is not recommended unless the amount of funds in the RRSP is small. A large lump-sum
withdrawal could result in a significant tax liability
• Transfer RRSP proceeds to a RRIF on a tax-deferred basis
• Use the RRSP proceeds to purchase an annuity
Clients holding RRIF accounts who are under age 71 can reconvert the RRIF to an RRSP. However, the re-established
RRSP must be converted back to a RRIF before the end of the taxation year in which the client turns age 71.
WHAT HAPPENS TO AN RRSP WHEN THE PLAN HOLDER DIES?

Generally, the FMV of all RRSPs at the date of death is included in the net income of the deceased for tax purposes
for the year of death, unless paid to a qualified beneficiary.
Only the following persons may qualify as a beneficiary:
• The legal spouse or a common-law spouse of the plan holder (called the annuitant in the Income Tax Act)
• A minor child or grandchild financially dependent on the deceased
• A physically or mentally infirm child or grandchild financially dependent on the deceased
A qualified beneficiary may not include a divorced spouse but may include a separated spouse. It is possible to have
two beneficiary spouses: a separated legal spouse and a common-law spouse.
In addition, unless it can be shown otherwise, a person whose income in the preceding year exceeded the basic
personal amount ($14,398 in 2022) is not considered financially dependent.
DID YOU KNOW?
If the value of an RRSP or RRIF decreases between the date of the holder’s death and the date the assets
are distributed to the beneficiary, a deduction of the offsetting amount can be claimed in the deceased’s
final tax return. The offsetting amount is the difference between the FMV at the date of death and the
amount distributed to the beneficiary. The distribution must occur before the end of the year following
the year of death.
REFUND OF PREMIUMS
Canada Revenue Agency defines a refund of premiums as “a payment that is paid or deemed to have been paid from
a deceased annuitant’s RRSP to a qualifying survivor.”
Table 10.4 explains the rules under which qualified beneficiaries receive a refund of premiums from an RRSP on the
death of the plan holder.

Table 10.4 | Rollover of the Refund of Premiums
Spouse or infirm A spouse or a financially dependent child or grandchild who is physically or mentally
financially dependent infirm may transfer all or a portion of a refund of premiums (to the extent that it is
child or grandchild included in their income for the year) to their own RRSP, RRIF, or annuity. The person
can then claim a deduction for the amount transferred within 60 days after the year of
payment from the deceased’s RRSP.
The rules also allow rollover of a deceased person’s RRSP proceeds to the registered
disability savings plan (RDSP) of a financially dependent infirm child or grandchild, up
to the available RDSP contribution room.
Financially dependent A minor child or grandchild, who is not physically or mentally infirm but is a qualified
child or grandchild beneficiary, may only contribute to an annuity and claim a deduction. The annuity must
who is not infirm be a fixed term to age 18. The payments as received are taxable in the hands of the
child or grandchild. A trust under which the child or grandchild is the sole beneficiary of
the annuity payment may also purchase such an annuity.
Financially dependent A corresponding contribution cannot be made to a tax-deferred plan of a non-infirm

adult child or financially dependent adult child or grandchild. Therefore, no tax deferral is possible.
grandchild who is not The only tax advantage available is the ability to shift taxable income from the return
infirm of the deceased to that of the beneficiary. The advantage is that it may be taxed at a
lower marginal tax rate.
EXAMPLE
Maddie, age 10, has been financially dependent on her grandmother, Mary, since Maddie’s parents died in an
accident when she was two years old. Mary recently passed away at age 78. She named Maddie as beneficiary of
her RRIF, worth $400,000. What option does Maddie (or her guardian) have with respect to Mary’s RRIF?
Maddie has been financially dependent on Mary, but she is not physically or mentally infirm. She can therefore
use the RRIF proceeds of $400,000 to purchase a term annuity to age 18. Maddie will most likely receive annuity
payments on a monthly basis, and the income will be taxable in her hands. Therefore, the $400,000 in RRIF
proceeds will not face immediate taxation at a very high (maybe even the highest) marginal tax rate in Mary’s
terminal return. Instead, payments received by Maddie from the annuity will be taxable annually at her much
lower (maybe even the lowest) income tax rate.
OTHER BENEFICIARIES
For beneficiaries other than those discussed in Table 10.4, the FMV of RRSP assets must be included in the
deceased’s tax return as income.
A beneficiary of an RRSP can be named directly (i.e., in the financial institution’s RRSP application and contract) in
all provinces except Quebec. If no beneficiary is named, the proceeds of a plan are paid to the plan holder’s estate.
A plan holder can change the beneficiary at any time.
Designating beneficiaries in Quebec for an RRSP or RRIF is allowed only in a will or marriage contract. However,
if the RRSP or RRIF is held with a life insurance company, a beneficiary can be named directly in the contract.
By naming an RRSP beneficiary in a will, rather than in an RRSP directly, it may be easier to change a beneficiary. The
plan holder does not need to notify every RRSP issuer with the proper legal documentation each time a beneficiary
is changed. If several RRSPs are involved, or if the plan holder repeatedly transfers RRSPs from one issuer to another,
naming beneficiaries in a will makes sense. However, naming a beneficiary directly reduces probate fees because the

funds do not flow through the deceased’s estate; they go directly to the named beneficiary. If there is a beneficiary
designation on both the RRSP plan and the will, it is very important that both designations be the same. Otherwise,
conflict may arise between beneficiaries. The issue of where to name the beneficiary does not matter much in
Quebec, where probate fees are not levied.
DIVE DEEPER
Based on your province of residence estimate the tax savings on your RRSP contribution.
Go to your online chapter to access the RRSP Tax Savings Calculator.
SCENARIO—AMANDA AND GEORGE MITCHELL
Assess your understanding of registered plans by resolving a client scenario. Complete the online learning
At the beginning of this chapter, we presented a scenario in which the Millers were concerned about protecting
their retirement savings and wondered what effect taxes would have on their post-retirement income. Now
that you have read this chapter, along with the relevant chapters in KPMG’s Tax Planning guide, we’ll revisit the
questions we asked and provide some answers:
• What can the Millers do to shelter income from taxes and maximize their retirement portfolios’ growth?
• The Millers can take advantage of all available RRSP contribution room. In this way, they can reduce
taxable income in the year of contribution and shelter the invested funds from tax. Peter should keep in
mind the rule regarding maturity of all RRSPs by the end of the year in which he turns age 71.
• Peter can contribute to a spousal RRSP in Ruth’s name even after he turns age 71 as long as he has earned
income. Thus, he and Ruth can save tax by splitting their income once they start to draw their retirement
savings from a RRIF. They will also be able to split pension income.
• Ruth does not know of any disadvantages to investing in an RRSP. What would you tell her?
• Capital gains earned outside an RRSP are subject to income tax on only 50% of the capital gains, i.e., the
taxable capital gains. In an RRSP, however, the entire value of a withdrawal is fully taxable as income when
withdrawn. So, the beneficial tax treatment of capital gains is not available for investments that accrue
capital gains within an RRSP.
• Mandatory withdrawal from a RRIF (where most RRSP funds are transferred no later than December 31 in
the year of the plan holder’s 71st birthday) raises the net income of the recipient. As a result, their OAS
benefits could be clawed back, meaning they will have to be fully or partially repaid.
• Peter and Ruth own valuable works of art, jewellery, and a wine collection. Ruth wants to know if she can hold
any of these items within her RRSP. What would you tell Ruth?
• These items come under listed personal properties, and listed personal properties are non-qualified
investments for an RRSP. So, Ruth would not be able to hold them within her RRSP.

SUMMARY
In this chapter, we discussed the following key aspects of RRSPs:
• Canadian taxpayers can contribute a limited portion of their earned income to an RRSP and defer paying
income tax on the contribution until it is withdrawn. Income earned within the plan is also tax-deferred until
it is withdrawn from the plan. The annual RRSP contribution amount permitted for tax deduction is generally
limited to 18% of the contributor’s earned income. For high earners, a dollar amount rather than a percentage
may apply, meaning that the contribution limit is less than 18% of their income.
• In any year where taxpayers do not contribute up to their maximum available RRSP contribution limit, their
contribution room may be carried forward indefinitely. Taxpayers may over-contribute up to $2,000 to an RRSP
without penalty. The overcontribution cannot be deducted for tax purposes, but it can remain in the RRSP and
earn tax-deferred investment income.
• Taxpayers may contribute to a spousal RRSP within their RRSP contribution limit and claim the corresponding
tax deduction on their own tax return. Funds withdrawn from a spousal RRSP are generally treated as taxable
income of the recipient spouse. However, withdrawals by the recipient could be taxed in the hands of the
contributor if the withdrawal occurs within three years of the contribution to the spousal RRSP.
• Funds in an RRSP can be withdrawn fully or partially before retirement. Different rules and penalties apply,
depending on the method and purpose of the withdrawal. Under the HBP plan, eligible home buyers and their
spouses may each withdraw up to $35,000 after March 19, 2019, from their respective RRSPs. Funds withdrawn
from an RRSP for a first-time home purchase are not taxable but must be repaid to the RRSP over 15 years at
a minimum. Another RRSP lending program is the LLP, which allows plan holders and their spouses to finance
their education with RRSP funds.
• By law, an RRSP must mature no later than December 31 of the year in which the plan holder turns age 71.
Withdrawals from registered plans must begin by the end of the next year.
NOTE
text, because they both contain examinable content. For examination purposes, if this chapter content differs
from the KPMG guide in any respect, precedence will be given to this textbook content.
DISCUSSION BOARD
for Chapter 10.
REVIEW QUESTIONS
Questions.

Employer-Sponsored Pension
Plans and Funding Retirement 11
CHAPTER OUTLINE
In this chapter, we discuss all aspects of employer-sponsored pension plans, which are a form of savings vehicles for
retirement. We also look at the very important matter of funding retirement using registered retirement income
funds and locked-in accounts.
1 | Explain the types of employer-sponsored Employer-Sponsored Pension Plans

pension plans, along with the rules governing
each type.
2 | Explain how to make the best use of a Registered Plans for Funding Retirement
registered retirement savings plan during
retirement.
3 | Describe the strategies that clients can use
to make the best use of their Registered
Retirement Income Fund accounts.
4 | Distinguish among locked-in retirement plan
options and assess their impact on retirement
planning.

KEY TERMS
best average plan money purchase plan
career average plan Pension Benefits Standards Act
defined benefit pension plan pooled registered pension plan
defined contribution pension plan portability
final average plan retirement compensation arrangement
flat benefit plan salary deferral arrangement
individual pension plan supplemental executive retirement plan
life income fund vesting

CHAPTER 11 EMPLOYER-SPONSORED PENSION PLANS AND FUNDING RETIREMENT 11 • 3
INTRODUCTION
An employer-sponsored pension plan is a type of registered plan that provides a tax-efficient savings and
investment vehicle for clients’ retirement. Clients benefit from employer contributions to the plan as well as tax-
deferred compounded growth of funds until they are needed (or must be withdrawn under the rules for registered
pension plan accounts).
The benefits of tax-deferred retirement accounts are essential to effective tax planning and investing. The tax-
sheltering aspects of employer-sponsored pension plans allow clients to reduce their tax burden in the year of
contribution. They also provide clients with valuable tax-deferred compounding of investment returns over many
years. As an advisor, you should look for every opportunity to minimize the impact of taxation on your clients’
investments to help them reach their long-term goals.
Before you begin, read the scenario below, which raises some of the questions you might have regarding employer-
sponsored pensions and funding retirement. Think about these questions, but don’t worry if the answers don’t come
easily. At the end of the chapter, we will revisit the scenario and provide answers that summarize what you have
learned in this chapter.
Ruth Miller is 65 and her husband Peter is 70. As part of your tax planning with the couple, you examine their
use of tax-deferred retirement savings accounts. The Millers wish to generate the greatest after-tax cash flow
they can to support their retirement needs. However, they also want to minimize taxes on their overall portfolio
by realizing taxable income only when they have to. Furthermore, they want to take advantage of tax deferral
opportunities to grow and preserve their savings. Both Ruth and Peter have registered retirement savings plans
as well as non-registered accounts. Peter is a retired corporate lawyer and is collecting a substantial defined
benefit pension. Ruth has a small defined benefit pension that she accumulated while working with a previous
employer many years ago.
• What can the Millers do to minimize their tax bill in retirement?

• Given key upcoming life events, what specific advice can you give the Millers regarding their respective
registered plans?
• What important actions should they undertake over the next few years regarding their tax-deferred accounts?
NOTE

EMPLOYER-SPONSORED PENSION PLANS
1 | Explain the types of employer-sponsored pension plans, along with the rules governing each type.
When employer-sponsored pension plans were created, the money used to pay pensions did not come from
investments. Instead, when an employee retired, the employer paid a percentage of his or her former salary from
company revenues. Over time, pension expenses became increasingly burdensome to employers. Companies then
began to set aside money to be invested for the benefit of retired employees. Eventually, governments imposed
pension funding requirements on employers to protect workers from an arbitrary cut-off of their pension privileges.
Employer-sponsored pension plans are now an integral part of the financial system. Trust companies, insurance
companies, and pension investment firms are among the largest traders of securities on behalf of pension funds. In
this section, we discuss the various types of employer-sponsored plans in use and the rules that apply to them.
GROUP REGISTERED RETIREMENT SAVINGS PLANS

Group registered retirement savings plans (RRSPs) are similar to individual RRSPs. An employer sponsors and
administers a group RRSP, usually as an alternative to a registered pension plan. Employers often match an
employee’s contributions to the group RRSP as an employee benefit. The employer’s contributions are considered
a taxable benefit and are included in the employment income of the employee. However, both employee and
employer contributions are deductible in the calculation of net income on the employee’s tax return. The onus
is on the employees to ensure that the sum of the employer and employee contributions are within their RRSP
contribution limits.
Group RRSPs are not governed by pension legislation, but by tax legislation. Employer contributions are vested
immediately, and employee and employer contributions can usually be withdrawn at any time. Some plans may
lock in employer contributions until the employee leaves, retires, or fulfills some other condition.
Group RRSPs usually offer employees lower management fees on the investments held. Also, because the RRSP
contribution is made through payroll, the amount of income tax withheld at source by the employer is reduced
based on the amount of contributions made. Another advantage of a group RRSP is that it serves as a form of
disciplined savings for retirement.
EMPLOYER AND EMPLOYEE CONTRIBUTIONS

Combined employer and employee RRSP contributions are subject to the same calculation limits as a regular RRSP.
That is, the sum of the employer and employee contributions must be within the taxpayer’s RRSP contribution limit.
INVESTMENTS
The employer may choose the fund manager and available investment options, which may include the employer’s
own shares. The employee may then choose where his or her money will be invested from among those options.
Small employers sometimes make a contribution but leave all investment decisions up to the employee. The
employee therefore bears the risk or reaps the reward of any particular investment choice.
SETTLEMENT OPTIONS
When employees retire, they may withdraw the funds in a lump sum, use them to purchase an annuity or transfer
them to an RRSP or registered retirement income fund (RRIF). The employer may offer an early retirement subsidy
through a retiring allowance—all, or a part, of which may be eligible to be deposited to the group RRSP.

REGISTERED PENSION PLANS

A registered pension plan (RPP) is a trust registered with Canada Revenue Agency (CRA) and established by an
employer to provide pension benefits for its employees when they retire.
There are two main types of registered pension plans: defined benefit pension plan (DBPP) and defined
contribution pension plan (DCPP), also called a money purchase plan.
Both types can be either contributory or non-contributory. With a contributory plan, both the employer and the
employee contribute to the plan. With a non-contributory plan, the employee is not required to contribute.
Employer and employee contributions to either type of plan are tax-deductible up to specified dollar limits if made
within specified time limits. (This concept is discussed in detail later in the chapter). Employer contributions must
be made within the taxation year or up to 120 days after the end of the taxation year. If made within this period,
the RPP contributions are deductible to the employer in the same way that salary is deductible. Essentially, the
contribution to the RPP is an additional form of remuneration expense for the employer. Employee contributions
must be made by December 31 in the year a deduction is to be claimed. Pension benefits, when paid to the retiree,
are subject to withholding tax.
Many Canadian workers who are members of older RPPs are part of a DBPP. However, many companies looking to
decrease their future pension costs and financing risks are switching to DCPPs.
THE REGULATORY CLIMATE FOR RPPs

As an advisor, you should be aware of government regulations that affect the benefit security and taxation of RPPs.
If the plan covers employees in a province that has passed such legislation, it must be registered under one of the
provincial pension benefits acts. If the business is under federal jurisdiction, it must be registered under the Pension
Benefits Standards Act, 1985 (PBSA).
The PBSA is an Act respecting pension plans organized and administered for the benefit of persons employed
in connection with certain federal works, undertakings, and businesses. Under this Act, the federal government
supervises private pension plans covering federally regulated areas of employment. Areas covered include banks,
airlines, interprovincial and international transportation, and telecommunications.
Provinces have their own pension benefits legislation, and many provisions in the provincial acts are similar to those
in the PBSA. For the most recent details, you should consult a pension specialist.
Both provincial and federal acts regulate benefit security, including funding requirements, benefit entitlement,
investments, disclosure, and audits. Pension plans must also be registered federally with CRA under the Income
Tax Act. This registration allows employer and employee pension contributions to be tax-deductible up to certain
maximums. It also exempts the pension plan’s income from taxation.
Plans for employees in all provinces except Prince Edward Island and for employees under federal jurisdiction must
comply with the provisions of the applicable Acts. Pension legislation has been introduced but has not been enacted
in Prince Edward Island.
Pension plans were once considered a benefit to long-service employees for services rendered. Today they are
generally considered to represent employees’ deferred wages. Changes to legislation have affected, among other
things, pension eligibility, vesting, portability, and mandatory survivor pensions. Vesting is a particularly important
issue for many clients.

DID YOU KNOW?
Vesting is the employees’ right to employer contributions made on their behalf while they are enrolled
in the plan. An employee must belong to a pension plan for a specified number of years before the
employer’s contributions are irrevocably vested. An employee who leaves before the vesting period is up
may withdraw only his or her own contributions, with accrued earnings. Once contributions have vested,
they are guaranteed to belong to the plan member and cannot revert to the employer.
Portability is the ability to transfer years of pension credit and money from one plan to another. The
employee then becomes a member of the second plan and will receive retirement benefits from that
plan alone.
Table 11.1 outlines the salient features of RPP regulation.
Table 11.1 | Key Aspects of the Pension Benefits Standards Act
Eligibility for Members include two groups:

membership
• Full-time employees with 24 months of continuous employment
• Part-time employees with 24 months of continuous employment and earnings equal
to 35% of the year’s maximum pensionable earnings in each of two consecutive
calendar years after December 31, 1984
A pension plan may provide that membership in the plan is compulsory for employees
who are engaged to work on a full-time basis, except employees who, because of their
religious beliefs, object to becoming members of the plan.
Vesting of benefits Full and immediate vesting for all accrued benefits.
Locking-in: Two years of continuous plan membership for benefits accrued from
January 10, 1967.
Minimum pension The pension benefit credit of a DBPP member cannot be less than the aggregate of the
benefit credit member’s required contributions, together with interest, in the following situations:
• When a member retires

• When a member ceases to be a member
• When a member dies
• When the whole or part of the plan is terminated
Marriage or common- A pension benefit payable to an individual cannot terminate when such a person marries
law partnership or enters into a common-law partnership:
• A spouse, former spouse, or former common-law partner of a member or former

member
• A survivor of a deceased member or former member
Mandatory survivor A pension benefit that begins payments on or after January 1, 1987, to a member or
benefits after former member of a pension plan who has a spouse or common-law partner at the time
retirement that payments begin will be in the form of a joint and survivor pension benefit.
A pension benefit may be reduced upon the death of either spouse or common-law
partner. However, it cannot be reduced to less than 60% of the amount that would have
been payable had the death not occurred.

Table 11.1 | Key Aspects of the Pension Benefits Standards Act
Pre-retirement The survivor of a pension plan member is entitled to that portion of the pension benefit
death benefit credit (also called the Commuted Value) to which the member would have been entitled
on the day of death if the death had not occurred and the member had terminated
employment instead.
A pension plan may provide that a survivor of a member or former member may
waive entitlement to a pension benefit or pension benefit credit and designate a
different beneficiary. The beneficiary must be a dependant of the survivor, member, or
former member, and the survivor must surrender the benefit or credit in writing.
Portability of pension If a member, ceases to be a member of a pension plan or dies before becoming eligible
benefit credits to receive an immediate pension benefit (typically more than 10 years before the
individual’s normal retirement date), the member or the survivor is entitled to any of the
following options:
• Transfer the member’s pension benefit credit or the survivor’s pension benefit credit,
whichever is applicable, to another pension plan, if that other plan permits.
• Transfer the member’s pension benefit credit or the survivor’s pension benefit credit,
whichever is applicable, to a retirement savings plan of the prescribed kind for the
member or survivor.
• Use the member’s pension benefit credit or the survivor’s pension benefit credit,
whichever is applicable, to purchase an immediate or deferred life annuity of the
prescribed kind for the member or survivor.
Pensionable age The pensionable age is the earliest age at which a pension benefit is payable to the
(normal retirement) member under the terms of the pension plan without the consent of the administrator
and without reduction by reason of early retirement. The pensionable age takes into
account the period of employment with the employer or the period of membership in
the pension plan, if applicable.
Early retirement Notwithstanding the pensionable age specified by a pension plan, members of the plan
shall be eligible, beginning 10 years before pensionable age, to receive an immediate
pension benefit based on the period of employment and salary up to the actual
retirement date. A pension plan is not required to provide an immediate pension benefit
beginning earlier than 10 years before pensionable age.
Reference: https://www.canlii.org/en/ca/laws/stat/rsc-1985-c-32-2nd-supp/latest/rsc-1985-c-32-2nd-supp.html
DEFINED BENEFIT PENSION PLANS

A DBPP provides a set level of pension income after retirement. The pension benefit at retirement is known, but
the contributions required to fund the benefit are not known. The benefit may be a flat dollar amount or a certain
percentage of income earned for each year of pensionable service. However, plan members do know what their
benefits will be (in current dollar terms) when they retire. The DBPP can be valued on the net worth statement at
the commuted value (i.e., the plan’s value if it were paid out today in a lump sum).
There are three types of DBPPs:
• Flat benefit plans

• Career average plans
• Final and best average plans

FLAT BENEFIT PLANS

The flat benefit plan is the simplest type of DBPP. The monthly pension is a fixed dollar amount for each year
of service.
For example, a formula of $150 per month, per year of service, after 30 years of service, would produce a pension
of $4,500 per month (calculated as $150 × 30 years).
Flat benefit plans have both advantages and disadvantages for the employee, as described below:
Advantages • The formula is easy to understand.

• The plan is normally funded entirely by the employer.
• The level of benefits usually increases as a result of ongoing employee-employer
negotiations.
• The pension paid is completely separate from and in addition to Old Age Security
(OAS) and Canada Pension Plan or Quebec Pension Plan (CPP/QPP) benefits.
Disadvantages • The plan does not differentiate between the earnings levels of plan participants. In
other words, high-income employees get the same amount as low-income employees.
• The amount paid is established in terms of today’s dollar values. Therefore, if the
pension amount is not regularly increased through negotiation, the pension payable
at retirement is eroded by inflation.
CAREER AVERAGE PLANS

With a career average plan, the pension is calculated as a percentage of an employee’s earnings over the entire
period of service under the plan. Employees may contribute a fixed percentage of their salary (such as 5%) to
this type of plan. Employer contributions required to fund the defined benefit vary according to factors such as
investment yield, mortality, and employee turnover.
EXAMPLE
Henry accumulates a career average pension of 2% of earnings for each year of service while in the plan. When
he reaches 30 years of service, and average monthly earnings of $6,000 over the 30 years, his pension payable at
retirement will be $3,600 per month, calculated as 2% × $6,000 × 30 years.
Career average plans have several advantages and one disadvantage for the employee, as described below:
Advantages • The plan is easily integrated with CPP or QPP benefits.

• It gives equal weight to employees’ earnings throughout their careers.
• Many employers improve career average plan benefits by updating the base year in the
pension formula. For example, if the base year is moved forward to 20x1, all service
before 20x1 will be based on 20x1 earnings, rather than on the actual salary received
when the service was performed.
Disadvantages • The pension payable at retirement may be eroded by inflation if the base year of the
plan formula is not regularly updated.

FINAL AND BEST AVERAGE PLANS

Like a career average plan, a final average plan and a best average plan are based on the employee’s length of service
and average earnings. However, benefits are based on the employee’s average earnings over a much shorter period.
Typically, the plan uses either the final few years of service or the employee’s three to five highest-earning years.
Employees often contribute a percentage of their salary to final average plans. The employer’s costs are variable.
Using the three to five highest-earning years (best average plan) for the calculation is preferable to using the final
few years (final average plan) because an employee’s earnings sometimes drop close to retirement. This flexibility
in the formula allows employees to make changes as they transition into retirement without fear of reducing the
amount of the pension they will receive.
EXAMPLE
Parveen has worked for a company for 29 years and is planning to retire at the end of 20x8. For 27 years, she was
a member of the company’s DBPP. In 20x7, she arranged to reduce her workload to four workdays each week to
care for her ailing spouse. As a result, her total salary for 20x7 and 20x8 dropped accordingly.
The company’s defined benefit pension plan offers a retirement pension based on two factors:
• Years of service in the plan, at a rate of 2% per year

• The average of the three best years of income during the last five years of employment
Parveen’s total salary for the last five years was as follows:
20x4 $51,000
20x5 $48,000
20x6 $38,000
20x7 $31,000
20x8 $30,000
Her pension is based on an average annual salary of $45,667, calculated as ($51,000 + $48,000 + $38,000) ÷ 3 =
$45,667.
Parveen’s annual defined benefit pension amount is therefore $24,660, calculated as $45,667 × 2% × 27 =
$24,660.
Parveen reduced her working hours and earned much less during her last two years of employment, but her
pension amount was not affected because her pension plan included the average of the best three years of
income during the last five years in the calculation.
As with career average plans, final and best average plans have several advantages and one disadvantage for the
employee, as described below:
Advantages • Final and best average plans are easily integrated with CPP or QPP benefits.
• By providing a pension based on earnings near retirement, these plans provide better
protection against inflation, at least up to retirement.
• A formula that considers an employee’s best years allows for flexibility in the
employee’s final years of employment without affecting the amount of their pension.
Disadvantages • Employees whose earnings decline as retirement approaches may receive a lower
pension payment than they would with a career average plan.

COMBINATION OF BENEFIT FORMULAS

In many plans, benefits are determined by reference to two or more benefit formulas. In addition to the regular
benefit formula, most plans contain a limitation that prevents benefits from exceeding the lesser of two amounts:
• 2% of final average earnings × pensionable service (to a maximum of 35 years)

• $2,000 × pensionable service (to a maximum of 35 years)
All formulas must be taken into account for the purpose of calculating the benefit accrual.
MAXIMUM PENSION BENEFIT

The maximum pension benefit (MPB) allowed is 2% of the recipient’s annual earnings, up to a maximum for each
year of service. According to CRA, “the annual benefit accrual rate in a defined benefit plan or provision is the rate
at which the member’s lifetime retirement benefits for the year are accumulated. The effective benefit accrual rate
may not exceed 2% of a member’s remuneration for the year.”
Table 11.2 sets out the most recent maximum benefits available.
Table 11.2 | Maximum Pension Benefits Available for 2021 and 2022
Maximum Earned Income (MPB ÷ 2%) Maximum Pension Benefit

2021 $162,278 $3,245.56
2022 $171,000 $3,420.00
Later 1/9 the money purchase limit
The maximum earned income is the maximum amount that one can earn without being limited by the money
purchase limit when calculating the RRSP limit. For 2022, the MPB is calculated as follows:
$171,000 × 18% = $30,780 ÷ 9 = MPB = $3,420.00
Therefore, the maximum pension benefit for employees who earn more than $171,000 is limited to the MPB (and
not to 2% of their remuneration).
CONTRIBUTION LIMITS
Combined employer/employee contributions are set at a level recommended by a qualified actuary to ensure that
the plan is adequately funded. The actuarial recommendation must be approved by CRA.
Employees’ current service contributions are restricted to the lesser of two amounts (up to a maximum of
$22,126.00 for 2022):
• 9% of the employee’s compensation for the year

• $1,000, plus 70% of the employee’s pension adjustment (see below) for the year
Compensation is generally defined to include salary, wage, and other employment earnings.
Note: There are no restrictions on the employer’s required contributions. They are calculated based on the actuarial
recommendation.
PENSION ADJUSTMENT
The RRSP contribution limit of a member of an employer-sponsored retirement plan is reduced by the amount
of the benefit that the employee accrues from the RPP each year. The pension adjustment is the amount of
contributions made by or the value of benefits accrued to a plan member for a calendar year. The pension
adjustment allows plan members to determine the amount they can contribute to an RRSP without exceeding their
annual contribution limit for all registered plans combined.

The pension adjustment for a DBPP participant is determined by the Factor of 9 formula and it is calculated as
follows:
(Pension Benefit Entitlement × 9) − $600
DID YOU KNOW?
The Factor of 9 formula is used to determine the pension adjustment in a DBPP for any given year. The
federal government created the Factor of 9 formula to equalize the tax-assisted savings and benefits for
those who participate in a defined benefit pension plan.
The Factor of 9 formula states that for every $1 amount of annual defined benefit pension promised to a plan
member, the federal government considers that $9 of funding will be required. This relationship, however, is an
average over a plan member’s entire working career. The government has determined that contributions of 18% of
earnings over a person’s career should be sufficient to provide a pension of 2% of pre-retirement earnings per year
of service. The 2% rate is considered an appropriate limit for tax-assisted retirement savings.
As seen in Table 11.3, the MPB for DBPPs is $3,420.00 in 2022. Using the multiple Factor of 9, the benefit is
equal to the contribution limit for a money purchase plan of $30,780 (calculated as $3,420.00 × 9) or maximum
pensionable earnings of $171,000 × 18% = $30,780. An example of a pension adjustment is shown in Table 11.3.
Table 11.3 | Pension Adjustment
2022 Maximum Maximum Pensionable

Pension Adjustment Maximum Pension Benefit Income or Earnings
2% $3,420.00 $171,000
(2% × $171,000 × 9) − $600 = $30,180
The maximum pension adjustment is $30,180, which is equal to the money purchase plan contribution limit for
2022 of $30,780 minus $600.
The benefit entitlement in the formula is specified in the pension plan document and is the approximate amount of
pension accrued in the year, based on current pensionable earnings. Employee contributions are not included. The
amount calculated using the formula cannot be negative.
CALCULATING THE CLIENT’S DEFINED BENEFIT PENSION
Can you calculate the client’s defined benefit pension? Complete the online learning activity to assess your
knowledge.
DEFINED CONTRIBUTION PENSION PLANS (MONEY PURCHASE PLANS)

In a DCPP, the employee’s contributions to the plan are known, but the final benefit is not predetermined. A DCPP
pays the annual amount that the fair market value (FMV) of the DCPP account will buy at retirement. The FMV
on the retirement date depends on how much the employer and the employee contribute, the annual earnings on
those contributions, and how far the money will go toward a pension fund at retirement. The assets are locked in
and cannot be withdrawn from the pension plan until retirement. The current value of the assets can be recorded on
the net worth statement in the same manner as RRSP assets.
Some people use the funds from a DCPP to purchase an annuity at retirement. Many others choose to transfer
the accumulated amount to a locked-in retirement account (LIRA) to gain more flexibility and control over their
retirement funds. Additional details on this option are discussed later in this chapter.

With a DCPP, the employer does not need to be concerned with the future funding of an employee’s pension.
Employers starting an employee pension plan today usually choose a DCPP, because it is simpler to administer and
poses little risk. The required payment to the pension fund for the employer is known and is not subject to investment
risk. Employees have some choice in how their money is invested, but if they make poor decisions, they suffer the
consequences; the employer is not expected to fund any shortfall. Investment risk rests entirely with the employee.
In this type of plan, the money manager or company administering the pension provides a list of possible
investments in which pension contributions can be invested. Employees choose investments that meet their risk
tolerance and long-term retirement goals. Often, they contribute a percentage of their salary to the plan, and the
employer matches it.
Most of the advantages of a DCPP are in the employer’s favour, whereas the disadvantages fall to the employee, as
described below:
Advantages • They are not as heavily regulated as DBPPs.

• They are easy to understand and administer and have fixed annual costs, so they are
especially popular with small businesses.
• The employer’s responsibility and risk are limited.
• Employees can usually direct the funds to their choice of investment vehicles.
Disadvantages • The final pension amount an employee will receive is unknown until retirement.
• The final pension may be much smaller than expected if the investments chosen have
not performed well.
• Members retiring under practically identical employment circumstances may receive
substantially different pensions.
INVESTMENT OPTIONS PROVIDED BY THE EMPLOYER

In providing a DCPP, employers minimize their future risk by placing the onus of actual investment selection on
the individual plan member. However, employees have varying degrees of investment knowledge and experience,
and may also hesitate to ask for advice. By law, the sponsor of a DCPP is a fiduciary in relation to the plan member.
This means that the employee should be able to look to the employer for investment advice. Therefore, although
employers are not required to provide investment education, it would be prudent to do so. It is in their interest to
demonstrate a desire to help employees reduce their risk exposure.
Before offering a DCPP, employers should consider the investment framework of the plan. They must offer a
sufficient number and variety of investment options, including fixed-income, equity, and balanced portfolios.
Furthermore, the performance of the investments must be compared to appropriate benchmarks.
MAXIMUM PENSION BENEFIT

There is no maximum pension under a DCPP. The value of the pension is based on the amount that can be
purchased by the accumulated contributions plus earnings at the time of retirement. Assets within the plan are
generally locked in until a certain age (e.g., 55), and there may be other conditions to fulfill before funds can be
withdrawn from a DCPP.
CONTRIBUTION LIMITS
The combined employer and employee contributions cannot exceed the lesser of two amounts:
• 18% of the employee’s current yearly compensation

• The money purchase plan contribution limit set by the government for the year

Table 11.4 shows the maximum contributions allowed in 2021 and 2022.
Table 11.4 | Money Purchase Plan Contribution
Money Purchase Plan Contribution Origin of Calculation

Annual Maximum Contribution DBPP Limit Maximum Earned Income
2022 $30,780 $3,420.00 × 9 $171,000 × 18%
2021 $29,210 $3,245.56 × 9 $162,278 × 18%
PENSION ADJUSTMENT
The pension adjustment is the total of the employee’s contributions plus the employer’s contributions to the DCPP
each year. The amount of the new RRSP contribution room available for the following year is reduced by the pension
adjustment amount from the year just passed.
HYBRID PENSION PLANS

Hybrid pension plans involve elements of both DBPPs and DCPPs. One common arrangement is a DBPP that
provides a base-level pension accompanied by a DCPP vehicle for additional voluntary contributions.
Hybrid plans may also provide a pension that takes the greater amount of a defined benefit plan and the pension
that may be purchased by a DCPP. The DBPP has a formula that pays out a percentage of final earnings, and the
employee also contributes to a DCPP. The plan that would pay the employee the largest pension is paid out.
PROVISIONS OF REGISTERED PENSION PLANS
Can you describe the provisions of the different types of registered pension plans? Complete the online
RETIREMENT PENSION PLANS—SUPPLEMENTARY TOPICS

In this section, we discuss various aspects of retirement pension plans, including such aspects as pension
adjustments, reporting requirements, guarantees, and regulatory matters.
PAST SERVICE PENSION ADJUSTMENT

Employers who offer defined benefit plans may upgrade them at times by making additional contributions to an
employee’s plan to provide increased benefits. The difference between the pension adjustment under the old plan
and that under the revised plan is called the past service pension adjustment (PSPA). A PSPA may occur, for example,
when an employee’s union successfully negotiates an increase in the pension benefit for its members in recognition
of past services. In such circumstances, the employer may, for example, credit an employee with additional, post-
1989 pensionable service. Or they may amend the plan to retroactively increase the benefit formula by 0.5% of
earnings for years of pensionable service after 1989. In some cases, there could be a decrease to the benefit formula
(i.e., as a result of bankruptcy protection). In those cases, the PSPA would actually reduce the pension adjustment,
which was overstated in previous years, thereby restoring RRSP contribution room.
Employers making a PSPA must maintain the overall limit on tax-assisted retirement savings of 18% of income.
They do so by reducing the employee’s RRSP contribution room by the amount of the PSPA.

PENSION ADJUSTMENT REVERSAL

A pension adjustment reversal (PAR) is used to restore RRSP contribution room when a plan member terminates
his or her membership in an RPP or deferred profit-sharing plan (DPSP). The key element in determining whether
an employee is eligible for a PAR is membership. A PAR is calculated when membership is terminated, not when
employment is terminated.
EXAMPLE
Two members, Tyrone and Nicola, terminate their employment on November 1. Tyrone transfers his benefits to
a LIRA on December 17, whereas Nicola decides to leave her entitlement in the plan until she retires. Tyrone has
terminated his membership and is therefore entitled to a PAR for the year in question. Nicola, however, who still
has an entitlement to benefits under the plan, is still a member and therefore not eligible for a PAR.
In a DCPP, the PAR is the amount of employer contributions that are unvested at termination of membership.
Unvested contributions are contributions to which employees are not entitled because they have not met the
minimum tenure for membership. Of note, federally legislated RPPs and most provincial legislation (exceptions:
Saskatchewan, New Brunswick, Prince Edward Island, and Newfoundland and Labrador) call for immediate vesting.
Provinces that still maintain an unvested period may require that the member maintain membership for 12 months
or, more commonly, 24 months.
In a DBPP, the PAR is generally the difference between two amounts:
• The total of all pension adjustments and PSPAs listed on an employee’s T4 slips up to termination of
membership
• The commuted value of benefits
Employers and pension plan administrators are required to calculate and report a plan member’s PAR to the
employee. The reversal must be reported within 60 days of the end of the calendar quarter in which membership in
the pension plan ceased.
PENSION ADJUSTMENT REPORTING

The pension adjustment amount is included on the employee’s T4 slip, which is provided to the employee by the
end of February following the tax year just completed.
Using this information, CRA calculates the individual employee’s RRSP contribution room and notifies the employee
on the Notice of Assessment. Because of the timing of this reporting, a taxpayer’s RRSP contribution room for a year
is determined by his or her pension adjustment for the previous year.
The PSPA and PAR amounts are also reported by employers to CRA on specified information slips (PSPA on T215 and
PAR on T10). Plan administrators must also file annual information returns for pension plans by the end of April each
year, as well as actuarial reports for DBPPs.
NORMAL FORM OF PENSION

The normal form of pension is the form of payment defined in the plan. Payments are made in this form unless the
employee chooses another form. In most provinces, if the employee/member has a spouse, the pension payable to
the spouse is reduced to 60% after the employee/member dies. The reduced amount is referred to as a joint-and-
last-survivor pension. It must be paid in most jurisdictions unless both the employee/member and the spouse sign
a waiver. The employee/member may choose a higher percentage of pension to be paid to the surviving spouse (i.e.,
higher than 60%). However, the higher the percentage chosen, the lower the pension amount that will be payable
to the employee/member during their lifetime.

GUARANTEE PERIOD
Pension payments can be guaranteed for the life of the contributor or for a minimum payment period, such as
10 years. Some registered pension plans are insured, and a life insurance company guarantees that stipulated
benefits will be paid in the future. Ontario has set up the Pension Benefits Guarantee Fund to protect the pension
benefits of workers in case a privately sponsored, single-employer pension plan sponsor becomes insolvent.
EARLY RETIREMENT CONSIDERATIONS

Most pension plans pay money on a periodic basis after the contributor retires, but there are exceptions. Where
people are entitled to a small pension payment, pension legislation may allow the commutation of the pension.
In other words, the pension payable is periodically converted into a lump sum and paid out. This option saves the
employer from having to administer the pension for the employee and gives more flexibility to the employee. The
employee may use some or all the cash immediately or place the money with another financial institution. Typically,
the employee would choose a LIRA.
When members of a pension plan leave their employer before retirement, they may have several options:
• Keep their pension entitlement within the pension plan

• Transfer out of the plan to another pension plan
• Transfer funds (up to legislated limits) to a LIRA
One challenge with transferring to a locked-in account is that only a portion of the commuted value of the pension
can be transferred on a tax-deferred basis. The amount that can be transferred is called the maximum transfer value
and is determined by the Income Tax Act. Amounts above the maximum transfer value are taxable to the former
employee upon receipt.
Anyone receiving a payment from their pension plan in excess of the maximum transfer value may contribute any
excess amount to their RRSP if they have the available RRSP contribution room. Situations have occurred when
large overcontributions are inadvertently made to an RRSP, thereby incurring large penalties.
ACCESSING LOCKED-IN FUNDS PRIOR TO RETIREMENT

Pension legislation states that pension plans will provide income for life. Therefore, when a commuted value or lump
sum is moved out of a pension plan, it must move to a locked-in account. Locked-in plans do not allow money to be
withdrawn before retirement unless the money is being transferred to another LIRA or to an employer-sponsored
pension plan or is being used to purchase a life annuity.
Funds may also be accessed prior to retirement in situations such as shortened life expectancy, small plan balances,
non-residency, or financial hardship. The rules for accessing funds vary by province, and not all of these options may
be available in all provinces. Overall, various jurisdictions are becoming more flexible in allowing access to locked-in
funds prior to retirement.
DID YOU KNOW?
Social Security payments received from the United States are eligible for a partial offsetting deduction
under the Canada-U.S. income tax treaty.
LUMP-SUM PAYMENTS OR WITHDRAWALS FROM RRSPS

Lump-sum payments from RRSPs are taxable in the recipient’s hands unless they are transferred into either another
RRSP or an acceptable annuity. In either case, the annuity payments are taxable as received. Lump-sum cash
withdrawals from an RRSP are subject to withholding tax by the financial institution unless the proceeds are directly
transferred to another RRSP.

RETIREMENT PRIOR TO DEATH

The executor of a deceased person who was receiving pension plan benefits must report all pension income received
as income for the final year. The amount should include the pension for the month of death.
The surviving spouse may be entitled to a continuing pension benefit, which would be taxable in the survivor’s
hands. There is no ongoing tax liability to the estate.
If there is no surviving spouse, the deceased may not have specified a person to receive a refund of contributions
or any death benefit payable. In such cases, the commuted value of the pension plan, or the value of the refund of
contributions, is payable to the estate. It is taxable as income of the estate, with the amount reported in the return
for the estate, rather than the final return.
DEATH PRIOR TO RETIREMENT

When a person dies before retirement, there may be benefits payable to the estate, the surviving spouse, or other
named beneficiaries. Pension legislation generally requires that the deceased’s interest in the plan be paid to the
spouse unless the spouse has waived entitlement. Under the pension legislation of some provinces, the funds must
be transferred to a locked-in arrangement for the surviving spouse. There is no tax consequence to the estate, nor
any income reported to the date of death.
In some cases, there is no surviving spouse, and the deceased has designated a beneficiary of his or her interest in
the pension plan. In those cases, the person designated to receive the benefit bears the tax liability. If no beneficiary
is designated, the payment is made to the estate and is taxed as income of the estate.
DID YOU KNOW?
In many provinces, pension plan members who divorce may be required to transfer up to 50% of pension
benefits accumulated during the marriage to the other spouse.
POOLED REGISTERED PENSION PLAN

A pooled registered pension plan (PRPP) is a relatively new kind of DCPP. It is designed for people who are
employed or self-employed and do not have the option of participating in a pension plan at their work. It is
especially geared toward employees of small businesses who are unable to participate in an RPP primarily because
their employer does not offer one. The same type of plan is called a voluntary retirement savings plan in Quebec.
These plans are offered by financial institutions such as banks and insurance companies that administer the plans
and also assume fiduciary duty for them.

Pooled registered pension plans have both advantages and disadvantages, as described below:
Advantages • Because member contributions are pooled, a PRPP is likely to have lower
administration costs.
• The types of investments available are similar to those available for all registered
plans. Again, members could benefit from lower investment management costs due to
economies of scale offered by financial institutions.
• They are available to investors without an employer-to-employee relationship. Self-
employed persons and employees whose employers do not offer a pension plan have
access to a pension plan.
• They are meant to be portable, moving with members from job to job.
• Eligible contributions made by members to their PRPPs are deductible for income tax
purposes.
• Like an RRSP, funds within a PRPP can grow on a tax-deferred basis. Amounts
withdrawn or paid to a member, however, must be included in taxable income.
Disadvantages • To be practical and effective, PRPPs require substantial harmonization of regulations

across federal, provincial, and territorial jurisdictions.
• Employers are not required by law to offer them, at least under federal legislation.
• Employers are also not compelled to contribute to a PRPP. It is therefore valid to
establish a PRPP to which only employees contribute.
ELIGIBILITY
As of January 1, 2013, anyone with a valid Canadian social insurance number can participate in a PRPP if they meet
any one of the following criteria:
• They are employed or self-employed in the Northwest Territories, Nunavut, or Yukon.

• They work in a federally regulated business or industry for an employer who chooses to participate in a PRPP.
• They live in a province that has the required provincial legislation in place.
The PRPP Act applies to PRPPs within the legislative authority of the federal government. Each province must enact
its own legislation and accompanying regulations for PRPPs to be available to individuals not covered in the criteria
above.
These eligibility criteria require provincial co-operation and action. The plans are now available in several provinces,
including British Columbia, Alberta, Saskatchewan, Ontario, Quebec, and Nova Scotia. New Brunswick is expected
to become the latest province to allow workers to save for retirement through PRPPs.
CONTRIBUTIONS TO A POOLED REGISTERED PENSION PLAN

All PRPP contributions made by, and on behalf of, a PRPP member are limited to the member’s RRSP contribution
limit for the year. Generally, the maximum that either a member or employer can contribute in a given tax year is
determined by the member’s RRSP contribution room or deduction limit.
Employer contributions to a PRPP are considered together with the member’s contributions to their PRPP, RRSP,
and spousal RRSP. Any amount above the RRSP deduction limit may be considered excess contribution. As such, it is
subject to a penalty tax of 1% per month for every month the person is a member of the plan.
Any contributions an employer makes to a member’s PRPP are not included in the member’s income and are
deductible by the employer.

EXAMPLE
Josie has $10,000 of RRSP contribution room. She contributes $3,000 to a PRPP and her employer matches her
contribution with another $3,000. Therefore, Josie has used $6,000 of her RRSP contribution room in combined
employer and employee contributions to the PRPP, which leaves her $4,000 of contribution room still available.
DID YOU KNOW?
Each taxpayer’s Notice of Assessment shows two items at the bottom of the statement:
• The RRSP deduction limit for that year, along with the PRPP deduction limit
• The amount of unused contribution room, including any carryforward amount, available for the next
tax year
WITHDRAWALS FROM A POOLED REGISTERED PENSION PLAN

Funds within a PRPP are intended to be available when the plan holder retires, providing a retirement income for
life; as such, federal legislation limits the withdrawals that can be made. Similar to limitations in RPPs, the funds in
a PRPP are generally locked in and cannot be withdrawn until retirement. Provinces are expected to enact their own
rules and regulations regarding locking-in requirements and withdrawals from a PRPP.
Withdrawals from a PRPP may result in a person’s income going above a certain threshold. In such cases, other
income-tested benefits, such as OAS, GIS, and income-tested non-refundable tax credits, could be reduced.
INDIVIDUAL PENSION PLANS

An individual pension plan (IPP) is a registered DBPP usually established by a company for one employee, who is
often the owner-manager. This type of plan is designed to maximize the amount of contributions that are permitted
by the Income Tax Act. These plans provide the greatest benefit allowable under a DBPP.
Individual pension plans, which are sanctioned by CRA, offer a good tax and retirement savings solution. However,
although they may provide greater benefits and higher contribution limits than RRSPs, they are complex and costly
to set up and administer. The set-up fee for an IPP can range from $1,500 to $5,000, depending on the complexity
of the plan, and annual administration fees range from $500 to $2,000. The plan sponsor can deduct these fees. In
comparison, the cost for a self-directed RRSP can range annually from $0 to $250, which cannot be written off.
Owner-managers interested in setting up an IPP should explore its suitability with an advisor who has specialized
knowledge in this area. The plans are generally attractive to people between the ages of 40 and 71, who have a T4
income of more than $171,000, which is the maximum pensionable amount for DBPP (in 2022).
There are two types of IPPs, as described below:
Connected A connected persons plan is designed for owner-managers who own more than 10%
persons plan of any class of shares of the company or who do not deal at arm’s length with the plan
sponsor. This type is most likely to be used by incorporated, self-employed business
owners or professionals.
Non-connected A non-connected person’s plan is designed for persons who are not shareholders or
persons plan who own less than 10% of the company shares. Non-connected plans are often used
to attract or retain senior management personnel. They are most likely to be used by
employers that want to provide enhanced retirement benefits to a key employee.

An IPPs is not available to partners or sole proprietors or to self-employed persons who are not incorporated.
As a DBPP, the pension benefit payable at retirement is based on a known formula, and contributions are made
accordingly to fund the plan. The funds are locked in during the member’s years of employment. The IPP allows a
participant to accumulate an annual pension equal to 2.0% of his average earnings for each year of service following
the implementation of the plan. The total amount is subject to the MPB for DBPPs.
An IPP permits higher tax-deductible contributions than those allowed under an RRSP. Calculations to determine
funding requirements are provided by an actuary and are based on several factors such as the amount of the RRSP
qualifying transfer amounts, the RRSP available contribution room, and the client’s age. As an example, Table 11.5
lists maximum IPP contributions calculated in 2021. These amounts increase annually.
Table 11.5 | Maximum Individual Pension Plan Contributions – For Information only
Age IPP Contribution

45 $33,700
50 $37,000
60 $44,600
65 $46,800
Unlike the RRSP contribution limit, which remains static regardless of the contributor’s age, IPP contribution limits
increase with the plan member’s age. Furthermore, the age of the member at the time the IPP is created affects
the level of contributions required to fund the plan. Plan holders are permitted to fund the plan back to the date
they were hired. Pension actuaries must therefore calculate the money that would have been in the plan if it were
established on that date. The older the person is at the time the IPP is created, the higher the contribution limit is
set, because there are fewer years for the funds to accumulate.
As retirement approaches, the IPP plan holder may transfer the funds to buy a guaranteed retirement benefit
amount. Alternatively, the funds may be transferred to a locked-in RRSP (up to the amount of the commuted value).
Either option further defers tax on a portion of the IPP plan holdings until the plan holder turns 71. At that point, the
locked-in RRSP must be used to purchase an annuity or a life income fund (LIF). Life income funds are discussed
later in this chapter.
Table 11.6 compares the features of an IPP with those of an RRSP.
Table 11.6 | Comparing a Registered Retirement Savings Plan to an Individual Pension Plan
RRSP IPP
Contribution The maximum contribution is 18% of the The maximum contribution is established by
limit previous year’s earned income, up to the an actuary according to CRA rules and both
annual limit. federal and provincial pension acts. Allowable
contributions increase with the plan holder’s
age.
Contributions Contributions are deducted by the Contributions and costs are deducted by the
individual. company and are not subject to payroll taxes.
Creditor Plans are protected in the event of An IPP is a pension plan and thus is protected
protection bankruptcy. from creditors.

Table 11.6 | Comparing a Registered Retirement Savings Plan to an Individual Pension Plan
RRSP IPP
Investment Risk lies with the individual. Risk lies with the employer because if the
risk performance is not up to the formula amount
(the targeted rate of return is 7.5%), the
employer must make additional contributions.
Additional If investments perform poorly, no additional If the investment performance is poor (i.e., less
contributions funds can be added. than 7.5% per annum), the company has to
make additional contributions to fund the plan.
Past service The taxpayer may have unused room that Past service recognition and credit for previous
can be used to make further contributions. years’ income help fund retirement savings.
The plan can be funded back to 1991 for
connected persons.
Current Contributions can be made within 60 days Contributions are allowed up to 120 days after
funding of the end of the calendar year. corporate year-end.
Transfer Assets cannot be transferred to any family Assets can be transferred to members of a
of assets member other than the plan holder’s deceased plan holder’s family other than the
spouse. On the death of an RRSP plan spouse if other family members are included in
holder, assets held within the RRSP can be IPP as plan members. Assets within the IPP can
transferred tax-free to a surviving spouse. be transferred successfully without triggering
On the death of the surviving spouse, all taxes.
RRSP holdings are generally subject to tax
on the surviving spouse’s final tax return.
DID YOU KNOW?
It may be possible to acquire foregone years of service in the IPP for years at the corporation when the
client was not a member of the IPP. The client may wish to transfer assets from an RRSP to the IPP, and
the company may top up the balance to buy back the past service.
PENSION ADJUSTMENTS FOR AN IPP

As with other pension plans, the Factor of 9 is used to calculate IPP members’ pension adjustments in two steps:
1. Multiply the value of the pension benefit the member earns from an IPP in a calendar year by 9.
2. Then, subtract the pension adjustment offset of $600 (i.e., 9 × the benefit − $600).
An IPP plan holder can also make contributions to an RRSP or a spousal RRSP. In most cases, a maximum $600
contribution to an RRSP is allowed each year after the first year of the IPP. This restriction is based on the pension
adjustment triggered by the contribution to the IPP. Given this limited ability to contribute to a spousal plan, there
is little opportunity for income splitting through spousal RRSPs beyond the $600 limit.

DID YOU KNOW?
The rules and regulations affecting IPPs are complex and highly technical, and specialized knowledge
is needed for their set-up, investment, and management. As an advisor, you should consult an IPP
expert when business owner clients wish to set up an IPP, whether for themselves or for a high-earning
employee.
RETIREMENT COMPENSATION ARRANGEMENT

A retirement compensation arrangement (RCA), as set out in the Income Tax Act, allows employers to pre-fund
retirement benefits without using an RPP. An RCA is a savings arrangement occasionally used by private companies
for their employees’ pension funding. It is used to fund the portion of an employee’s pension benefit that exceeds
the benefits permitted under a DBPP or DCPP.
With an RCA, there are no specified contribution limits, as with IPPs and RPPs. An RCA is not registered with CRA as
a registered pension plan; therefore, it does not affect the employee’s ability to contribute to an RPP or RRSP.
Like IPPs, RCAs are often used for the following clients:
• Owners of privately held corporations who want to build up funds for retirement
• Corporate executives with salaries of over $171,000 (in 2022)
The RCA is a taxable trust set up by an employer to hold funds for the employee’s retirement. The employer gives
money to a custodian to hold on behalf of the beneficiary, and the custodian distributes the funds to the beneficiary
when appropriate. Distribution may occur at retirement, before retirement, on loss or leaving of employment, or
when the employee’s job changes substantially.
Investments in an RCA arrangement are governed by the trust agreement, rather than by the Income Tax Act. A wide
range of investments may be included in the RCA trust, including tax-exempt life insurance, stocks, bonds, mutual
funds, and deferred annuity contracts.
Money invested in an RCA is divided equally between two accounts: the RCA investment account and the
refundable tax account held by CRA.
Half of the earnings from the RCA investment account are forwarded to the refundable tax account every year.
Earnings include interest, dividends, and realized capital gains, minus expenses. No preferential tax treatment is
available for either realized capital gains or Canadian-source taxable dividends. Each year, the custodian of the RCA
sends CRA the 50% refundable tax, along with a report summarizing the accounting of that tax. A tax return must
be filed every year for an RCA, even if there has been no activity in that tax year.
For many years, the 50% refundable tax rate was a significant deterrent to the use of RCAs. In 2022, the top
combined federal and provincial marginal tax rates in most provinces are more than 50%. With the refundable tax
being “only” 50%, RCAs are starting to receive some planning consideration for high-income-earning Canadians.
When benefits are paid out of the RCA to a beneficiary, the funds in the refundable tax account are refundable to
the custodian of the RCA. They go back into the RCA in the amount of 50 cents for each dollar paid out of the RCA.
When money is withdrawn from an RCA and paid to the beneficiary, income tax is paid at the marginal tax rate of
the beneficiary.
One situation where RCAs are used is to compensate executives who plan to become non-residents after
completing their employment in Canada. Any payments made to the former executive as a non-resident of
Canada would be subject only to a non-resident withholding tax rate of 25%. Thus, the RCA creates a potential tax
advantage.

Every year, the employer pays tax (which is refundable when the money is eventually paid out) at the following
rates:
50% of all contributions made to the RCA during the year

Plus: 50% of the returns (income and capital gains) earned for the year
Minus: 50% of the benefits paid out during the year
The refundable tax account with CRA is non-interest bearing.

Costs to set up and administer an RCA include the legal cost of setting up the trust, the cost of filing the annual
trust tax return, and the services of the RCA custodian. Generally, experts suggest the use of an IPP before
considering an RCA. The main reason for this recommendation is the 50% refundable tax that must be paid upfront
in the case of an RCA. Another reason is that CRA may characterize an RCA as a salary deferral arrangement, and
thus abusive. Salary deferral arrangements are discussed in detail later in this chapter.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLANS

When employees reach a certain level of income, they have likely maximized their tax-assisted savings under the
RRSP. Moreover, when their income reaches a certain level (e.g., $171,000 in 2022), their benefit under a DBPP and
their contribution limit under a DCPP have reached their limit.
In spite of annual increases in statutory retirement savings limits, the actual dollar amounts have not kept pace with
inflation and wage increases. Some employers have responded to these ceilings by establishing a supplemental
executive retirement plan (SERP) for key employees. This type of plan can be either a defined benefit SERP or a
defined contribution SERP. These plans are popular with employers who have 5,000 or more employees on staff.
Through a SERP, employers can provide members of an RPP with an additional benefit that increases their overall
retirement benefit beyond the maximum RPP limits. A SERP is not registered. Therefore, the employer does not
receive a tax deduction for the contribution until the employee actually receives the benefits. This characteristic is
one reason why many SERPs are unfunded. For the plans that are funded, the methods used include RCAs, letters of
credit, and insurance arrangements.
From an employer’s perspective, the biggest advantage of implementing a SERP is its use in attracting and retaining
top executives and key employees. For employees, the benefit of a SERP is that it can help fund a retirement plan
that more accurately reflects their high salary and accompanying lifestyle.
EXAMPLE
Larry is an executive with a large Canadian company with 35 years of service with his employer. He is now 65 and
ready to retire. Based on his long tenure and membership in the company’s DBPP, he expects to have a pension
income similar to his current $350,000 annual salary. However, Larry is mistaken in this assumption. In reality,
his annual pension will be a fraction of the income he presently receives.
Upon retirement, Larry will qualify for a regular maximum annual pension equal to 35 years × $3,420.00 (the
defined benefit limit for 2022). This totals $119,700, which is significantly less than his current salary and the
pension he was expecting. If the company had provided a SERP, it might have helped to bridge the difference
between his actual pension and his expectations.
The CRA may treat “unreasonable” SERP benefits as a salary deferral arrangement for tax purposes. (Benefits
considered unreasonable are amounts more generous than those provided by the underlying RPP.) In such cases, the
employee is taxed each year on the future benefits promised under the SERP, rather than when they are ultimately
paid out.

SALARY DEFERRAL ARRANGEMENTS

Under tax law, salary deferral is an arrangement under which an employee postpones receiving a salary or wages
to a later year. Any deferred salary or wages must be declared as employment income in the year in which the
employee earns the amount. This requirement removes the incentive for both employers and their employees to
defer the payment of salary and wages. This broad definition of a salary deferral arrangement is intended to capture
any attempt to defer taxation on salary and wages by receiving the payments later.
A number of plans are excluded from the salary deferral arrangement rules under the Income Tax Act. Payments
under the following plans are treated in accordance with their own rules, and not the salary deferral rules:
• RPPs and PRPPs

• Disability or income maintenance insurance plans administered by an insurance company
• Deferred profit-sharing plans and employee profit-sharing plans
• Employee trusts and employee life and health trusts
• Group sickness or accident insurance plans
• Supplementary unemployment benefit plans
• Plans for providing education or training (i.e., sabbaticals)
• Plans established to defer the salary of a professional athlete
• Plans under which a taxpayer has a right to receive a bonus or similar payment for services rendered and to be
paid within three years following the end of that taxation year
REGISTERED PLANS FOR FUNDING RETIREMENT
2 | Explain how to make the best use of a registered retirement savings plan during retirement.
3 | Describe the strategies that clients can use to make the best use of their Registered Retirement
Income Fund accounts.
4 | Distinguish among locked-in retirement plan options and assess their impact on retirement planning.
In this section, we first discuss the methods by which retirees use their RRSP accounts to fund their retirement. We
then continue the discussion with the types of accounts into which various types of pension funds are transferred
after retirement.
METHODS USED TO FUND RETIREMENT FROM AN RRSP

Methods used to fund retirement from an RRSP include a lump-sum payment, a RRIF, or an annuity.
WITHDRAW ALL RRSP PROCEEDS AS A LUMP-SUM PAYMENT

When money is withdrawn from an RRSP as a lump sum, the amount is fully taxable in the year of receipt.
Therefore, it is generally better to spread withdrawals over at least a few years. In that way, the retiree stays in
a lower tax bracket and spreads out the tax liability. However, it may make sense for someone in a very low tax
bracket, with no other funds, to withdraw all RRSP proceeds at once. With the net amount, the holder could pay
off debts and spend the money on such necessities as house repairs. The next year, he or she might be eligible to
receive the GIS, which is designed for retirees with little income beyond the OAS.

DID YOU KNOW?
Clients who have a low income before retirement should consider taking the money out of their RRSP
before age 65, when they will usually begin receiving the OAS and CPP, or QPP. With this strategy, they
can maximize their entitlement to government benefits. These clients may also be eligible for the GIS.
TRANSFER RRSP PROCEEDS TO A RRIF ON A TAX-DEFERRED BASIS

A RRIF has two main advantages over an annuity:
• It allows plan holders control over their investments.

• It allows plan holders to withdraw money as needed (subject to a schedule of minimum withdrawals).
In addition, a RRIF offers the following advantages:
• Clients do not have to turn their investment portfolio into cash when they turn 71.
• They have maximum flexibility in the amount they can withdraw in any one year. (However, if they take out too
much too soon, they could outlive the money.)
• They can set up the RRIF based on the age of the younger spouse, resulting in a lower minimum annual
withdrawal.
• They continue to control the investment choices in the portfolio.
• If interest rates increase and annuity payments become more attractive in the future, clients can use their RRIF
balances to purchase an annuity at a later date.
• Upon the client’s death, the value can be transferred to a beneficiary. If the beneficiary is a spouse or dependent
child, the RRIF proceeds can be rolled over without immediate tax consequences.
• The invested funds within the RRIF continue to accumulate on a tax-deferred basis. (However, mandatory
minimum amounts must be withdrawn each year, according to a schedule.)
For these reasons, transfer to a RRIF is currently the most recommended (and most implemented) maturity option
for an RRSP.
Withdrawals from a RRIF can be based on the age of the younger spouse, although this choice must be made when
the plan is established. This option reduces the minimum withdrawal required and, therefore, the tax liability.
Furthermore, basing withdrawals on the age of the younger spouse allows more funds to remain tax-sheltered
within the RRIF. It is ideal to make withdrawals at the end of the year, if possible, so that funds in the RRIF can
accumulate tax-free during the year. Many retirees withdraw the minimum amount from their RRIF and then invest
it in a tax-free savings account (TFSA). With this strategy, the clients have already paid their tax liability on the
capital, and the tax-free compounding of investment income will continue.
USE THE PROCEEDS TO PURCHASE AN ANNUITY

The proceeds of an RRSP may be used to purchase a life annuity, a life annuity with a guaranteed term, or a joint-
and-last-survivor annuity. These options also permit the deferral of tax because income tax is payable only on
amounts received each year from the annuity. Given the recent low-interest-rate environment, and the fact that the
client effectively locks into the current interest rate as of the date of purchase, annuities have been less popular in
recent years. However, the increased life expectancy of Canadians makes annuities still an attractive option. They
provide income for life, thereby alleviating the fear that one will outlive one’s retirement savings.

RETIREMENT FUNDING CONSIDERATIONS

As an advisor, you should explain the details of the various retirement funding options to your clients.
Clients may transfer RRSP proceeds to any number of RRIFs or annuities (or both) to arrange the flow of retirement
income to meet expected requirements. However, annuity purchases cannot be reversed, therefore, it is important
to make sure the clients do not need extra money or do not wish to keep their money for as long as possible in a
registered plan.
You should make sure that your clients’ RRSP investments can be converted into cash without penalties when
amounts must be paid out from the RRIF. There is no requirement to initially liquidate any qualifying assets from the
RRSP as part of the process of conversion to a RRIF.
Clients may transfer property in an un-matured RRSP to another RRSP in their name or to their RPP (if the RPP rules
permit such a transfer). However, the transfer must take place before the end of the year the client turns 71.
Clients can also use a combination of maturity options. Most clients choose to transfer the funds either to a RRIF or
to an annuity. The income received from a RRIF or annuity generated with RRSP or RRIF dollars is fully taxable in the
year it is received.
DRAWING A RETIREMENT INCOME

When employees retire, they must transfer their RRSP and pension funds into one or more vehicles from which
they can draw a retirement income. Retirees must abide by federal legislation governing withdrawal amounts
from the various income-paying retirement funds. As mentioned earlier, several types of vehicles can be used to
fund retirement. The three most popular vehicles, which we discuss in detail in this section, are RRIFs, LIRAs, and
LIFs. Clients should consider their options at the financial planning stage and select the most appropriate plan or
combination of plans for their projected savings.
REGISTERED RETIREMENT INCOME FUND

A RRIF is an account that is registered with CRA and established by an individual for the purpose of receiving
retirement income. Normally, a plan holder sets up a RRIF by transferring funds from an RRSP. However, a RRIF may
be funded with income from another RRIF, or with pension funds that are not locked in.
A RRIF plan holder is not permitted to make contributions to the plan; however, the funds that remain invested
continue to accumulate tax-free. Therefore, a RRIF provides a way of extending some of the tax-deferral benefits of
an RRSP.
ADVANTAGES OF A RRIF
The main advantage of a RRIF is that it shelters retirement income until funds are withdrawn. Compared to an
annuity, a RRIF gives plan holders more control of their capital and greater flexibility in withdrawing funds. With a
RRIF, ownership of the funds also remains with the plan holder. On death, the balance in the funds may be passed
to the designated beneficiary or the estate of the deceased. However, there is a taxable event upon death. Unless
passed to a spouse or a dependent child or grandchild, the full value of the RRIF is included in the final tax return of
the deceased.
WITHDRAWALS FROM A RRIF

A RRIF requires a minimum annual withdrawal (except in the year it is established), which is taxable as income.
There is no maximum withdrawal. Originally, RRIFs were designed to be depleted by the time the owner reached
age 90. The federal government eliminated that requirement in 1992.
The 2015 federal budget brought in some changes to RRIF minimum withdrawals. The required minimum
withdrawals from age 71 to 94 were lowered. At age 95 and over they remain capped at 20% of the plan balance
each year.

For clients who are 70 and under, the budget announced no changes to the formula. The minimum amount that
must be withdrawn each year is equal to the market value of the RRIF’s assets at the beginning of a calendar year,
divided by the number of years left until the plan holder (or spouse, if younger) reaches 90.
EXAMPLE
Jan, now age 65, currently has $250,000 in assets from a RRIF that was established in 2021. Her minimum
withdrawal amount is $10,000, calculated as $250,000 ÷ (90 − 65).
Another client, Mira, is 74 years old and has the same amount of assets. Her minimum withdrawal amount,
based on minimum RRIF payout percentages, is 5.67% of $250,000, or $14,175.
Except for prescribed minimum payments, RRIFs offer considerable flexibility. Plan holders can vary the income flow
to receive a minimum, level, or indexed amount. They can also vary the schedule of payments to be annual, semi-
annual, quarterly, or monthly. Any amount above the minimum can be withdrawn to allow for varying cash flows.
For example, plan holders can make lump-sum withdrawals for expenses such as vacations and major purchases.
Withdrawals of the required minimum amounts from a RRIF are not subject to withholding taxes. However,
any amounts withdrawn that are in excess of the minimum are subject to the same withholding tax as RRSP
withdrawals. The full amounts withdrawn are subject to taxation on the annual income tax return.
DIVE DEEPER
Go to your online chapter and open the following document:

RRIF Minimum Withdrawal Table
MAKING THE MOST OF AN RRSP OR RRIF

Clients can use various strategies to make the best use of their RRSPs/RRIFs, as described below:
Converting late to Often, there is no reason to convert an RRSP to a RRIF early, and to do so is to force
a RRIF minimum annual withdrawals. Withdrawals can be easily made from an RRSP without
the constraints of minimum annual amounts. The one situation where it could be
advantageous to convert to a RRIF early is if the couple wants to take advantage of
pension income splitting. A RRIF withdrawal is considered qualified pension income
and can be split with a spouse. An ad hoc RRSP withdrawal does not qualify for pension
income splitting.
Making an December 31 of the year one turns 71 years old is the last day on which one can
overcontribution to an contribute to their RRSP. However, income earned in the year a client turns 71 creates
RRSP in December of RRSP contribution room for the following year. In anticipation, clients can make an
the year client turns 71 overcontribution in late December equal to the amount of contribution room before
the year ends. A penalty of 1% is charged for each month a client’s account is in
overcontribution. However, if the client over-contributes in December of the year in
which they turn 71, the penalty will be calculated on only one month’s overcontribution.
The penalty amount is usually modest compared to the tax savings from the RRSP
deduction.
For example, a client in the 50% tax bracket expects to have $10,000 of RRSP contribution
room next year when she turns 72. She contributes $10,000 in December of this year (i.e.,
the year she turns 71), on which she will have to pay a penalty of $80 (1% of $10,000 −
$2,000 unused lifetime overcontribution limit). The amount of the penalty will be more
than offset next year by the $5,000 saved in claiming the $10,000 RRSP deduction.

Making the best use of Clients who have over-contributed to their RRSP should consider deducting the RRSP
an overcontribution contribution amount out of any remaining RRSP contribution room they have prior to
retirement. For example, suppose your client is retiring at age 65 and has $2,000 in
overcontribution inside an RRSP. He does not anticipate having any earned income in the
future. He should therefore include the $2,000 as part of his regular contribution. If the
unused RRSP contribution room for the year is $5,000, he would contribute $3,000 to
his RRSP and claim the $2,000 from the amount that was over-contributed.
Reducing the minimum The RRIF minimum withdrawal can be based on the age of the plan holder or the age
payment of the plan holder’s spouse. When based on the age of a younger spouse, the required
withdrawal minimum is lower; therefore, more funds remain to compound tax deferred.
This strategy prevents immediate taxation of retirement funds not required for current
needs.
Timing the first RRIF An RRSP must mature to a RRIF or an annuity by December 31 of the year the annuitant
withdrawal well turns 71. However, the first withdrawal does not have to be made until the end of
the following year. This feature is a benefit for clients who do not need the funds
immediately. For these clients, the money can stay inside the RRIF and remains tax
deferred for up to 12 more months. Alternatively, they can make withdrawals as required.
Making spousal RRSP Clients earning income after age 71 can still contribute to an RRSP if their spouse is
contributions after younger (under age 72), and therefore still eligible for an RRSP. The older spouse can
age 71 contribute to a spousal RRSP and use the deduction on his or her own tax return.
DID YOU KNOW?
Clients should understand that RRSPs must be converted to a RRIF by the end of the year in which
they turn 71. Any RRSP contribution to be deducted in that tax year must be made, at the latest, on
December 31. Plan holders cannot contribute after age 71 unless they have a younger spouse (in which
case, they can contribute to a spousal RRSP). At age 72, there will be no RRSP to contribute to and
contributions to a RRIF are not allowed.
FREQUENTLY ASKED QUESTIONS ABOUT RRIFs

As an advisor, you should be prepared to answer the following questions, which clients frequently ask about RRIFs:
• How many RRIFs can a person purchase?

There is no limit to the number of RRIFs a person may hold at one time.
• What happens to the RRIF if the owner dies?

Accumulated amounts in a RRIF must be included in the owner’s income in the year of his or her death, with the
following exceptions:
• What if the surviving spouse has been named successor annuitant?
Payments are made to the spouse. Payments are taxable in the spouse’s hands for the years in which they are
received. The RRIF will continue to exist, but with the spouse as the annuitant. Naming a spouse as successor
annuitant is generally recommended for the following reasons:
« Ease of administration
« No requirement to wind up the deceased annuitant’s RRIF and dispose of investments held in the RRIF
« Payments continue as before and remain based on the terms of the deceased annuitant’s RRIF

• What if the surviving spouse has been named beneficiary?

The funds can be transferred to the spouse’s own RRIF or used to buy certain types of annuities. Alternatively,
if the surviving spouse has not reached age 71 at the time of the RRIF holder’s death, the funds can be
transferred to his or her own RRSP or PRPP.
• What if the funds are inherited by a financially dependent child or grandchild who is not physically or mentally
infirm?
They can either be taxed in the hands of the child or grandchild or used to buy a term annuity to age 18. The
term of the annuity is based on a period of 18 years minus the age of the child or grandchild at the date of the
annuity purchase.
• What if the funds are inherited by a financially dependent child or grandchild who is physically or mentally infirm?
The funds may be transferred to the child’s own RRSP, PRPP, RRIF, or registered disability savings plan (RDSP).
Alternatively, the funds may be used to purchase an eligible annuity. However, a person can transfer funds to
an RDSP only up to the available lifetime RDSP contribution room.
• If a person owns several RRSPs, must they all be matured and transferred to a RRIF at once?
No. RRSPs can be matured at different times—over several years, if desired, before age 71. Transfers can be
made to one or more RRIFs each time.
• Can a person mature an RRSP and purchase both a RRIF and an annuity?
Yes. As an advisor, you can suggest a suitable mix, depending on a client’s goals and objectives, retirement
lifestyle, life expectancy, state of health, tax situation, and other such factors.
LOCKED-IN RETIREMENT ACCOUNTS AND LOCKED-IN RRSPs

Employees who have contributed to an employer RPP may leave their employment, lose their job, or take early
retirement (before the age of 55). Depending on the situation, they have the following choices:
• Leave the vested amounts they have accumulated in the plan.

• Transfer pension rights and funds to another RPP of a different employer.
• Transfer amounts due under the plan to a LIF.
• Transfer amounts due under the plan to a LIRA or a locked-in RRSP.
Transferring the funds to a LIRA or locked-in RRSP allows contributors to manage the assets themselves, rather
than entrusting them to the ex-employer’s pension plan manager. As discussed earlier, there is a limit, called the
commuted value, to the amount that can be transferred. Locked-in funds are generally not accessible until the
holder retires, attains a specified age, or meets specific criteria for an early withdrawal.
In general, a LIRA cannot mature more than 10 years before the normal retirement age under the retirement plan
(i.e., usually not before age 55). A LIRA or locked-in RRSP cannot be used to pay an income to the contributor until
it matures; its purpose is to accumulate assets to prepare for retirement. The law states that a LIRA or locked-in
RRSP can be maintained until the end of the calendar year in which the contributor turns 71. It must be converted
into retirement income no later than this date.
At that time, several options are available, depending on the jurisdiction in which the employee lives:
• A LIF
• A locked-in retirement income fund (LRIF)
• A prescribed RRIF (PRIF)
• A life annuity
• Some combination of these options

Each province has its own rules and regulations regarding LIRAs and LIFs and the transfer options available. You
should know these differences and keep them in mind when dealing with individual clients.
LIFE INCOME FUND

A LIF is an alternative to a life annuity for those who have transferred pension funds to a LIRA or locked-in RRSP.
A LIF is similar to a RRIF, but with additional limitations, as illustrated in Table 11.7.
Table 11.7 | Comparing a Life Income Fund to a Registered Retirement Income Fund
LIF RRIF
A LIF is purchased with locked-in retirement savings A RRIF may be purchased with funds from the
from any of the following sources: following sources:
• Another LIF • An RRSP

• A LIRA • Another RRIF
• Locked-in pension funds • A DPSP
• Locked-in RRSPs • Pension funds that are unlocked. Provinces
may allow unlocking of funds in a pension
• Pension funds for a person whose pension plan
plan in certain situations, such as reduced life
has been amended to permit the purchase of a LIF
expectancy of the plan member, low income, or
high medical costs. The rules vary by province.
Some provinces have a minimum age requirement There is no minimum age requirement (although
(e.g., 55); others have no minimum age for RRIFs are rarely set up before age 55 or 60).
establishing a LIF.
A LIF holder must withdraw a minimum amount A RRIF holder must likewise withdraw a minimum
each year. amount each year.
A stipulated maximum amount can be withdrawn There is no maximum amount that can be
each year. Provinces use different formulas to withdrawn each year.
determine the maximum withdrawal amount.
This limit on the maximum withdrawal prevents the A RRIF holder may cash out at any time.
LIF holder from cashing out the LIF. For this reason,
a LIF is sometimes referred to as a locked-in RRIF.
EXAMPLE
It is 2022. Andrei is age 70 and has lived and worked in Ontario since 1968. He has been retired for five years and
has a LIRA with a balance of $300,000. He set up a LIF last year and transferred the funds from the LIRA to the
LIF. This year, the following withdrawal rules apply to Andrei:
• He must withdraw at a minimum of 5% of the LIF balance (i.e., $15,000).

• He is subject to a maximum withdrawal percentage of 8.22% at age 70.
The maximum amount is the greater of two amounts:
• The amount resulting from the withdrawal percentage factor
• The previous year’s returns on his LIF investments
Therefore, if the LIF generated returns of 6% or $18,000, Andrei can withdraw a maximum of $24,660
(calculated as 8.22% of $300,000), which is the greater of the two amounts stated.

DIVE DEEPER
A current list of minimum and maximum LIF withdrawal percentages by province can be found online
with the search term LIF payments.
A LIF offers the same range of investment alternatives as a RRIF and other types of registered plans. Payments
from a LIF must be included in taxable income for the year in which they are received. As with RRIFs, any amount
withdrawn above the minimum is subject to the withholding of income tax by the financial institution administering
the plan. Any withholding taxes can be used on an annual tax return to offset taxes owing for that year.
A LIF can be used as an alternative to a life annuity. It offers the ability to control the investment of the funds,
greater flexibility in withdrawals, and the option to leave a potential estate for heirs.
LOCKED-IN RETIREMENT INCOME FUND AND PRESCRIBED RETIREMENT INCOME FUND

An LRIF is another variation on a RRIF and is subject to the same rules under the Income Tax Act, including minimum
withdrawal rules. An LRIF is available only to members of pension plans in Newfoundland and Labrador. The money
deposited in an LRIF comes from the same sources as a LIF.
Saskatchewan and Manitoba have a PRIF, which is very similar to a LIF; however, there are no maximum withdrawal
limits on a PRIF.
DIVE DEEPER

Comparison of Retirement Plans
CONVERTING TO A LIF OR LRIF

In general, locked-in plans such as LIRAs and locked-in RRSPs may not be cashed in at any time before retirement.
Locked-in funds may only be accessed in a manner that provides income for all of one’s retirement life expectancy.
Each company’s pension plan stipulates how early pension income can be initiated.
Like an RRSP, a LIRA matures at the latest by the end of the year in which the plan holder reaches age 71. At that
time, or earlier if chosen, the plan holder’s options depend on the jurisdiction in which he or she resides:
• In most jurisdictions, they can convert the LIRA or locked-in RRSP to a LIF.
• In Newfoundland and Labrador, they can convert to an LRIF.
• In Saskatchewan and Manitoba, they can convert to a PRIF.
The minimum withdrawals from a LIF or LRIF are the same as from a RRIF. However, according to the pension
jurisdiction of the plan, there are also maximum withdrawals allowed. The LIF maximums are based on a formula
established by provincial pension legislation. The formula produces a LIF maximum income percentage chart each
year, based on the plan holder’s age as of January 1. To calculate the maximum payment, the LIF maximum income
percentage is multiplied by the value of the plan as of January 1. This calculation is determined yearly, based on the
previous year’s November Canadian Socioeconomic Information Management (CANSIM) rate.
The CANSIM rate is set monthly by the Government of Canada, based on the month’s average rate for long-term
Government of Canada bonds. The LRIF maximums are essentially limited to the investment income earned by the
LRIF in the prior year. A LRIF never has to be converted to an annuity. In years when LRIF earnings are lower than the
RRIF minimum, the withdrawal is restricted to the minimum amount. With LIFs in Newfoundland and Labrador, the
holder must convert to an annuity at age 80. The requirement to convert to an annuity has been removed in the
other provinces.

DID YOU KNOW?
When dealing with an individual client, you should be careful in determining the specific rules the client
must follow regarding withdrawals and the unlocking of their pension.
CHARACTERISTICS OF PENSION PLANS
Can you identify the different characteristics of pension plans? Complete the online learning activity to
DIVE DEEPER

Registered Plans
ANNUITIES AND RETIREMENT

To provide Canadians with greater flexibility in managing their retirement savings, Budget 2019 introduced two new
types of annuities under the tax rules for certain registered plans:
• An Advanced Life Deferred Annuity (ALDA) allows a client to move some savings out of their registered
retirement accounts to an annuity deferred until age 85. There is tax deferral on a significant portion of the
client’s retirement funds for another 14 years, from age 71 to age 85 (Annuities purchased with registered funds
generally begin at age 71.) A purchase cap was set at 25% of the source plan to a $160,000 lifetime dollar limit
in 2022. ALDAs are permitted under an RRSP, RRIF, DPSP, PRPP, and defined contribution RPP. An ALDA is also
a qualified investment for a trust governed by an RRSP or a RRIF. The product can be used to manage longevity
risk and clawbacks of government benefits such as OAS and GIS and to help reduce a client’s annual tax bill.
• A Variable Payment Life Annuity (VPLA) provides payments that vary based on the investment performance of
the underlying annuities fund and on the mortality experience of VPLA annuitants. A VPLA is permitted under a
PRPP and defined contribution RPP.
Administrators of a PRPP or defined contribution RPP are allowed to establish a separate annuities fund under
the plan to receive transfers of amounts from members’ accounts to provide VPLAs. However, this type of
annuity will involve employer participation and also require changes to be made to provincial pension benefits
standards legislation.

At the beginning of this chapter, we presented a scenario in which the Millers were concerned about protecting
their retirement savings and wondered what effect taxes would have on their post-retirement income. Now
that you have read this chapter, along with the relevant chapters in KPMG’s Tax Planning guide, we’ll revisit the
questions we asked and provide some answers:
• What can the Millers do to minimize their tax bill in retirement?

• The amount from Ruth’s defined benefit pension should be included in all retirement income calculations.
They should also consider how Ruth’s pension will affect the couple’s spousal income-splitting strategies
in retirement. Since Peter’s income in retirement is likely to be much higher than Ruth’s, Peter can allocate
up to 50% of his defined benefit pension payments and RRIF payments to Ruth. They can also share CPP/
QPP pension benefits if that would help lower their overall tax bill.
• During retirement, the Millers could delay withdrawals from their RRSPs until they are required to convert
to a RRIF or a LIF. By delaying as long as possible, they can defer taxation on their income. They should
only withdraw the minimum amount required from their RRIF to allow for further tax deferral. In addition,
they could contribute any surplus amounts from the minimum RRIF withdrawal to their TFSA. This
strategy would ensure tax-free growth and unrestricted access to funds for the rest of their lives.
• Given key upcoming life events, what specific advice can you give the Millers regarding their respective
registered plans?
• As the Millers go through different life stages, their investment portfolios should be reviewed regularly.
They will have to make sure they have no restrictions that may prevent them from withdrawing the
minimum annual amount from their RRIFs.
• What important actions should they undertake over the next few years regarding their tax-deferred accounts?
• They should request an assessment to determine survivor income needs. They also must decide whether
they should convert some existing investments into annuities with a guaranteed income stream lasting for
both of their lives. The Millers could consider purchasing the recently introduced ALDA because it permits
further tax deferral of a portion (up to an additional 14 years) of their retirement funds, thereby mitigating
their longevity risk.

SUMMARY
In this chapter, we discussed the following key aspects of employer-sponsored pension plans and funding
retirement:
• Group RRSPs are similar to individual RRSPs. An employer sponsors and administers a group RRSP, usually as an
alternative to an RPP. Employers often match an employee’s contributions to the group RRSP as an employee
benefit.
• The two main types of RPPs are DBPP and DCPP. A DBPP provides a set level of pension income after
retirement. In a DCPP, the employee’s contributions to the plan are known, but the final benefit is not
predetermined. Defined benefit plans are falling out of use in favour of DCPPs, which are less costly for
employers. Hybrid pension plans involve elements of both DBPPs and DCPPs.
• A PRPP is designed for self-employed people and employees of small businesses who are unable to participate
in an RPP, primarily because their employer does not offer one.
• An IPP is a registered DBPP usually established by a company for one employee, who is often the owner-
manager. It is designed to maximize the amount of contributions that are permitted by the Income Tax Act.
• An RCA is a savings arrangement occasionally used by private companies for their employees’ pension funding.
There are no specified contribution limits, as with IPPs and RPPs, and they are not registered with CRA as a
registered pension plan; therefore, they do not affect the employees’ ability to contribute to an RPP or RRSP.
• Through a SERP, employers can provide key employees with an additional benefit that increases their overall
retirement benefit beyond the maximum RPP limits. A SERP is not registered; therefore, the employer does not
receive a tax deduction for the contribution until the employee actually receives the benefits.
• The CRA considers a salary deferral arrangement as an arrangement under which an employee postpones
receiving salary or wages to a later year. Any deferred salary or wages must be declared as employment income
in the year in which the employee earns the amount.
• Transfer of RRSP funds to a RRIF is currently the most recommended maturity option for an RRSP. A RRIF
allows plan holders to withdraw money as needed, subject to a schedule of minimum withdrawals. The main
advantage of a RRIF is that it shelters retirement income from taxation until funds are withdrawn.
NOTE
DISCUSSION BOARD
for Chapter 11.
REVIEW QUESTIONS
Questions.

Government Pension Programs 12
CHAPTER OUTLINE
In this chapter we discuss the main government pension programs – Canada Pension Plan/Quebec Pension Plan and
Old Age Security – set up to provide pension income and other benefits to Canadians during their retirement.
1 | Explain the key features, benefits, terms, Canada and Quebec Pension Plans
and conditions of the Canada Pension Plan/
Quebec Pension Plan.
2 | List the factors that should be taken into
consideration when helping clients decide
when to begin collecting CPP/QPP benefits.
3 | Explain the key features, benefits, eligibility Old Age Security program
rules, and tax considerations for the Old Age
Security program.

KEY TERMS
Allowance Old Age Security
Allowance for the Survivor post-retirement benefit
Canada Pension Plan Quebec Pension Plan
children’s benefit survivor benefit
death benefit year’s additional maximum pensionable

earnings
disability benefit
year’s basic exemption
Guaranteed Income Supplement
year’s maximum pensionable earnings
OAS clawback
OAS pension

CHAPTER 12 GOVERNMENT PENSION PROGRAMS 12 • 3
INTRODUCTION
Canada’s huge baby boomer generation is either entering or already in its retirement years. Helping these clients
plan for and enjoy a successful retirement is one of the most important roles you can play in their lives as a
wealth advisor. Most clients want advice on how to develop and implement strategies to meet their goals for the
retirement stage of their life cycle.
Clients planning to retire should take advantage of every source of income available to them. Many clients’
retirement plans are based, to an important extent, on a consistent and reliable source of income from various
government pension programs. Government pensions are one of the three major sources of retirement income.
The other two sources are employer (and private) pensions and accumulated individual savings (in non-registered
accounts and registered plans such as RRSPs).
Before you begin, read the scenario below, which raises some of the questions you might have about government
pensions. Think about these questions, but don’t worry if the answers don’t come easily. At the end of the chapter,
we will revisit the scenario and provide answers that summarize what you have learned.
HELPING THE MILLERS FULFILL THEIR RETIREMENT DREAM
The Millers have decided to retire within the next year. Peter, who is 70, will wind down his consulting business,
and Ruth (age 65), who works at Peter’s company, will help him do so. They would then like to put work behind
them and enjoy their retirement years together. They are debt free and have been enjoying a high family income,
most of which is produced by Peter. They have their principal residence and a vacation home in Florida. They
have engaged you to discuss how they can best maximize their retirement income through their various income
sources. These sources include the government pensions to which they have always contributed and their
investment portfolios.
They would also like to take steps to ensure that they leave behind a sizable estate to their children, Andy,
Gordon, and Mike, and their existing and future grandchildren.
• What retirement income sources should you consider when establishing the Millers’ retirement plan?
• What are some of the aspects of the Millers’ various income sources that they should consider, given their
retirement plan and income needs?
• What two factors should be top of mind when you are considering the CPP/QPP benefits that Peter and Ruth will
be collecting?
NOTE
Some content in this chapter is also covered in Chapter 20 of the KPMG Tax Planning guide, in some cases in
greater detail. We strongly recommend that you study the content in the KPMG guide in addition to this text,
because they both contain examinable content. For examination purposes, if the content in this chapter differs
from the KPMG guide in any respect, precedence will be given to this content.

CANADA AND QUEBEC PENSION PLANS
1 | Explain the key features, benefits, terms, and conditions of the Canada Pension Plan/Quebec Pension
Plan.
2 | List the factors that should be taken into consideration when helping clients decide when to begin
collecting CPP/QPP benefits.
The Canada Pension Plan (CPP) was created by legislation in 1965 as a national social insurance system to provide
retirement, disability, survivor, and death benefits. The legislation allowed individual provinces that provided a
comparable pension plan to opt out of the federal plan.
In the same year, legislation in Quebec established the Quebec Pension Plan (QPP). The two plans, which went
into effect in 1966, are closely coordinated, and contributions to either plan are portable from one province to
another. Since early 2000, same-sex common-law partners have had the same benefits and obligations as opposite-
sex common-law partners.
Initially, CPP and QPP were run on a pay-as-you-go basis, which meant that pension payments made to one
generation of workers were funded from the contributions made by the next generation. Any accumulated surplus
was to be used as a reserve for contingencies.
To prevent a sharp increase in contribution rates and associated intergenerational inequities, a reform plan was
introduced in the late 1990s. Both CPP and QPP moved from the pay-as-you-go basis to a fuller funding model (also
called steady-state funding). Today, the aggregate contributions made throughout the working life of a generation
of workers, along with the return on funds invested, are used to pay all of their benefits.
With these changes came increased contributions and new investment policies. Both CPP and QPP are now
contributory plans, meaning they are financed through contributions from employees, employers, and self-
employed persons, as well as returns on the pension fund. They are not funded through general tax revenues and are
managed independently of governments.
The reform plan also established the Canada Pension Plan Investment Board (CPPIB), which operates at arm’s length
from the federal and provincial governments. The CPPIB’s role is to invest contributions not needed to pay current
benefits. It is directed by legislation to invest the funds for the sole purpose of maximizing investment returns,
without undue risk of loss, having regard to the factors that may affect the funding of the CPP.
Service Canada delivers the CPP program benefits, the Canada Revenue Agency (CRA) collects the contributions,
and the CPPIB manages the investment of funds.
Retraite Québec administers the QPP. The Quebec Department of Revenue collects the contributions and turns
them over to the Retraite Québec, which keeps what it needs to pay current benefits and administration costs. The
remaining funds are deposited with the Caisse de dépôt et placement du Québec for investment.
PARTICIPATION IN THE CPP/QPP PROGRAM

Participation is compulsory for Canadians between 18 and 65 who have earned income in excess of the minimum
income amount, called the year’s basic exemption (YBE). The YBE in 2022 is $3,500. For purposes of CPP or QPP
participation, “earned income” is income from employment or self-employment. Neither employees nor self-
employed persons may contribute in any year in which they have earned income less than the YBE.
Employers whose employees regularly work outside Canada or Quebec may enrol their employees as a group to
continue their coverage during their absence from Canada.
Workers who are not covered by CPP or QPP include casual and migratory employees, exchange teachers, and
members of a religious order under a vow of poverty.

GOVERNMENT PENSION CONTRIBUTIONS

Contributions to CPP and QPP are based on earnings from employment or self-employment only. Earnings on which
contributions must be paid are those above the YBE and up to the year’s maximum pensionable earnings (YMPE).
Table 12.1 shows the YMPE for 2021 and 2022.
Table 12.1 | The Year’s Maximum Pensionable Earnings—For Information Only
2022 $64,900
2021 $61,600
Employees and employers have an equal obligation for the contribution percentage of employee earnings above
the YBE, subject to CPP/QPP maximums. It is the employer’s obligation to deduct the employee’s CPP/QPP
contributions at source. Self-employed people must make the full contribution amount upon filing their income tax
returns.
Table 12.2 shows the CPP/QPP contribution rates for 2022.
Table 12.2 | Contribution Rates for CPP/QPP—2022
Self-Employed Employed
(Responsible for (Both the employee and the employer

full contribution) are responsible for contributions)
All Provinces CPP (except Quebec) 11.40% 5.70% each
Quebec QPP 12.30% 6.15% each
These rates include an additional contribution, as explained later in this chapter.

The maximum employer-employee CPP contribution for 2022 is $3,499.80 each, calculated as 5.70% of
($64,900 − $3,500). Self-employed taxpayers contribute the full 11.40% of earnings, up to the maximum limit of
$6,999.60 calculated as 11.40% of ($64,900 − $3,500).
Taxpayers who earn more than the YMPE may not make additional contributions above the maximum limit. Excess
contributions, which may result when a person works for more than one employer in a tax year, are refunded upon
filing their tax return.
Contributors who have paid into the CPP or QPP have the irrevocable right to a pension based on their years of
contribution. The pension is paid out even if the contributor leaves Canada.
EXAMPLE
Marcia, age 44, who works at a major department store as an appliance salesperson, earned $48,600 in 2022.
Because Marcia is employed, she must contribute $2,570.70, calculated as 5.70% of $45,100 (the amount
between the YBE of $3,500 and her earnings of $48,600). Her employer also contributes $2,570.70 on her behalf
to the CPP.
Marcia’s manager, Juana, earned $72,600 that year. Juana must contribute $3,499.80, calculated as 5.70% of
$61,400 (the amount between YBE of $3,500 and YMPE of $64,900). Juana’s contribution is the maximum
amount that could be paid into the CPP by an employee in 2022.

DID YOU KNOW?
It is important to note that no additional contributions can be made on income above the YMPE. The
benefit amount will be the same for someone who earns the YMPE and someone who earns more than
that amount.
Contributors to the CPP/QPP program are eligible for four main benefits:
• Retirement pension benefits

• Disability benefits
• Survivors’ benefits
• Death benefit
Taxpayers must apply for all benefits they are entitled to. Benefits from both CPP and QPP, except for death
benefits, are recalculated annually to reflect increases in the Consumer Price Index (CPI).
FUNDING INCREASES TO CPP AND QPP

The federal government recently introduced changes to CPP which will increase the amount that Canadians who
have contributed to the plan receive in their retirement years. The goal is to provide a more significant retirement
pension, thus reducing the number of seniors living in poverty. Up until 2019, the CPP retirement benefit replaced
approximately 25% of a person’s income up to the YMPE. The government has put in place mechanisms to gradually
increase this so-called replacement rate to 33.33% of the average work earnings after 2019.
Because the CPP program is self-funding, its proposed expansion will have an impact on the contributions to the
plan. The changes come first in the form of increased contribution rates for employees and employers and an
increased base on which contributions must be made. From 2019 to 2023, the CPP contribution rate for employees
is gradually increasing by one percentage point (from 4.95% to 5.95%) on pensionable earnings between $3,500
and the original earnings limit. Starting in 2019, these pensionable earnings will be known as first additional
pensionable earnings.
In 2024, employees and employers will begin contributing 4% each on an additional range of earnings called year’s
additional maximum pensionable earnings (YAMPE). This second range will start at the original earnings limit
(the current YMPE), which is estimated to be $69,700 in 2025. It will end at the additional earnings limit, which will
be 14% higher by 2025 (estimated to be $79,400).
Under the enhanced CPP program, the CPP contributions up to the “original earnings amount” can be claimed as a
non-refundable tax credit. Any CPP contributions on earnings in the “additional earnings limit” will be eligible for an
income tax deduction.
Quebec is also improving the QPP and harmonizing it with the CPP. From 2019 to 2023, the QPP contribution
rate for employees gradually increases by one percentage point (from 5.40% to 6.40%). Improvements in both
programs are similar overall.
The long-term impact of these changes should be increased income levels for retirees in the future. However, both
employees and employers will have to make additional contributions to the plan and must budget accordingly.
Employers will be required to contribute 1% more on an increased earnings base. Canadians in general will be
contributing more of their current earned income to savings for the future through the enhanced CPP and QPP
programs.
TAXATION
All benefits received by taxpayers under CPP or QPP are taxable income for the recipient.

CALCULATING THE RETIREMENT PENSION BENEFIT

The benefit from the increased contributions will start slowly with a small increase in the pension in 2019, and
phased in over a 45-year period. In 2065, both CPP and QPP retirement benefits will replace 33 ⅓% of a
person’s income up to the YAMPE. Retirees can expect to receive a maximum of $21,000 in today’s dollars,
approximately 40% more than today’s maximum. Prior to the enhanced CPP, the approximate amount of
retirement pension under CPP is calculated as 25% of a contributor’s average monthly pensionable earnings during
the period when he or she was contributing to the plan. Pensions are available to persons who have contributed to
the CPP or QPP in at least one calendar year.
The approximate maximum monthly CPP/QPP retirement benefit payable to a 65-year-old is calculated by taking
the average YMPE over the past five years, dividing by 12, and multiplying by 25%.
EXAMPLE
In 2022, the approximate maximum monthly amount of CPP/QPP retirement pension is calculated as follows:
1. ($55,900 + $57,400 + $58,700 + $61,600 + $64,900) = $298,500
2. $298,500 ÷ 5 = $59,700 ÷ 12 = $4,975.00 × 0.25 = $1,243.75
In general, the CPP and QPP retirement pension replaces approximately 25% of the maximum pensionable earnings
on which people have made contributions.
DID YOU KNOW?
The average CPP monthly payment is approximately $780* as of May 2022, which is lower than the
$1,253.59 maximum payment amount. The fact that many recipients do not qualify for the maximum
benefit or take their CPP before age 65 could explain that difference.
* Reference: https://www.canada.ca/en/services/benefits/publicpensions/cpp/payment-amounts.html
ADJUSTMENTS TO THE CPP/QPP CONTRIBUTORY PERIOD

The provisions of CPP/QPP retirement pension entitlement are based on a contributory period for each individual.
The contributory period begins on January 1, 1966, or the day a contributor turns 18.
It ends the month before the pension begins, the month of the contributor’s 70th birthday, or the month the
contributor dies, whichever comes first.
This period helps determine certain benefit payouts to contributors.
The following adjustments to the contributory period may be made:
• Any month in which a CPP/QPP disability pension was paid may be excluded from the contributory period.
• Seventeen percent of the lowest-earning years in the contributory period before age 65 may be dropped
(thus allowing up to eight years of a contributor’s lowest earnings to be dropped). This provision can
compensate workers for periods when they were not working because of unemployment, illness, or
attendance at school.
• Periods when the contributor stops working or when earnings are lower while raising children under the age of
seven may be excluded.
• Low-earning months after the age of 65 may be excluded.
When these periods are eliminated, the amount of the CPP retirement pension increases.

STATEMENT OF CONTRIBUTIONS
Contributors to the CPP may ask for a Statement of Contributions (or the Statement of Participation in QPP) from
Service Canada. The request can be made online through the Service Canada website or by mail. The CPP statement
gives an estimate of how much that person’s monthly retirement pension could be at age 65 based on average
earnings since age 18 if earnings continue at the same level until age 65.
CPP/QPP contributors should periodically check their statements for accuracy and completeness.
PENSION BENEFITS – EARLY REDUCTION AND DELAYED INCREASE

Contributors to either CPP or QPP may choose to receive their monthly retirement pension for life, starting at the
standard age of 65. Qualified individuals may choose to start collecting benefits as early as age 60 or as late as
age 70. The base amount of the CPP benefit depends on their contributions to the program throughout their life.
There is no requirement to cease working in order to start collecting the retirement benefit. However, the base
amount that one will receive depends upon the chosen start date, as follows:
• Those who choose to begin collecting before they turn 65 will receive a permanently reduced pension, which is
adjusted by 0.6% for every month they retire before age 65.
• Those who choose to begin collecting past age 65, to as late as age 70, will receive a permanently increased
pension. The amount is adjusted by 0.7% for every additional month they wait after age 65.
APPLYING FOR CPP AND QPP BENEFITS

Eligible Canadians who wish to start receiving retirement benefits must apply to CPP or QPP. They should apply no
more than one year before the date on which they wish payments to begin. It can take one to three months for the
application to be processed, so applicants should plan ahead. They will usually be eligible for up to one year of back
payments if they apply late, but payments cannot go back any further than the applicant’s 65th birthday.
CANCELLATION OF CPP AND QPP RETIREMENT PENSION

Recipients of CPP and QPP retirement pension or other benefits can cancel their entitlement no later than 6 months
from the day that they started collecting their retirement pension. They must request the cancellation in writing and
return all monies that were received. When a CPP or QPP beneficiary dies, their pension/benefits must be cancelled
through Service Canada or Retraite Québec as soon as possible.
TAKING CPP AND QPP BENEFITS BEFORE AGE 65

The rules regarding early collection of benefits differ slightly between CPP and QPP, as follows:
CPP program For those who choose to take their CPP retirement pension benefit before age 65, the
monthly amount they are entitled to is reduced by 0.6% for each month they receive
payments before age 65. This reduced amount becomes the CPP retirement pension,
indexed annually for inflation, for the remainder of the pensioner’s life. If they begin
receiving payments at age 60 (the earliest possible date), the monthly payment will
be 36.0% lower than if they had waited until they turned 65.
QPP program For those who choose to take their QPP retirement pension benefit before age 65, the
QPP reduction varies proportionally to the amount of the pension. The benefit is reduced
by 0.5% for a person who receives a very low pension and gradually increases to 0.6%
for a person who receives a maximum pension.

TAKING THE PENSION AFTER AGE 65

Just as contributors to CPP or QPP may start collecting their retirement pension as early as age 60, they may also
postpone collecting up until the age of 70. For contributors who start collecting after age 65, the base amount
of the pension increases by 0.7% for each month in which the recipient is over 65, to a maximum of 42.0%. This
increased amount becomes their CPP retirement pension, indexed annually for inflation, for the rest of their lives.
EXAMPLE
Mariella, age 66, works as a nursing supervisor at a local hospital. She has decided to retire on her 68th birthday
in two years, at which time she wants to start taking her CPP retirement benefit. Mariella was eligible for a CPP
benefit of $875.00 per month at age 65. On her 68th birthday, she will be 36 months over age 65, and her
pension amount will have increased by 0.7% per month.
When Mariella retires, she will receive a monthly CPP benefit of $1,095.50, indexed for inflation, for the rest of
her life. The increased benefit is calculated as follows:
36 × 0.7% = 25.2% of $875.00 = $220.50; therefore, $875.00 + $220.50 = $1,095.50
Mariella’s younger sister, Angela, age 60, is also a nursing supervisor at the same hospital. Angela has decided to
retire from her job this year on her 61st birthday. She will begin taking her CPP retirement benefit at that time.
She would also have been eligible for a CPP benefit of $875 a month at age 65. On her 61st birthday, she will
be 48 months under the age of 65, and her pension amount will be reduced by 0.6% per month.
When Angela retires, she will receive a monthly CPP retirement benefit of $623.00 per month, indexed for
inflation, for the rest of her life. The reduced benefit is calculated as follows:
48 × 0.6% = 28% of $875 = $252.00; therefore $875.00 − $252.00 = $623.00
Note that, in the example, both Mariella and Angela decided to start taking their CPP retirement pension on the
same date that they actually ceased working. However, it is not necessary to do so. A person can begin collecting
CPP benefits at any time after age 60 while continuing to work. Or, conversely, a person can retire at any age and
elect not to receive CPP retirement benefits at that time. They can elect to start their CPP retirement pension
anytime up to the age of 70. It is your role, as the advisor, to help your clients determine the choice that best meets
their life goals. Factors to consider are other sources of income, cash flow, and income taxation.
THE POST-RETIREMENT BENEFIT AND THE RETIREMENT PENSION SUPPLEMENT

In the preceding section, the CPP and QPP retirement pension calculations were based on the date a person chooses
to start collecting it. Once calculated, the pension amount does not change (except to account for inflation).
However, those who start to collect CPP retirement benefits at age 60 must still make contributions to the CPP
program if their earned income exceeds the YBE. In such cases, they earn entitlement to an additional benefit
amount from the CPP program called the post-retirement benefit (PRB) or the retirement pension supplement from
the QPP program. The PRB is the CPP benefit paid to people who continue to work and make CPP contributions
while already receiving a CPP retirement pension.
To be eligible for the PRB, individuals must be between the ages of 60 and 70 and currently receiving their CPP
retirement pension, but earning income in excess of the YBE. It is mandatory for working and self-employed CPP
recipients over age 60 and under age 65 to contribute to the CPP program. Self-employed persons must continue
to contribute both the employee and employer portions. Starting at age, 65 employees and self-employed persons
may choose to stop contributing to the CPP. At age 70, all employees and self-employed persons stop making CPP
contributions.

Table 12.3 outlines the obligation for ongoing CPP contributions after a person has started to collect a CPP
retirement pension and has earned income in excess of the YBE ($3,500).
Table 12.3 | Contribution Obligation for Persons Collecting CPP Benefits
Individual Employer
Contribution Required by Employees Contribution Required
and the Self-Employed (Including the Self-Employed)
Before age 65 Required Required
After age 65 (up to age 70) Optional Only if an individual contribution is made
In all cases, contributions to the CPP program after monthly payments begin will increase the contributor’s PRBs.
The amount of a person’s PRB depends on the level of earned income and the corresponding CPP contributions
made in the previous year. It also depends on the actuarial adjustment based on the person’s age on the effective
date of the PRB. The maximum post-retirement benefit in any year is calculated as 1/40th of the maximum
retirement pension for the year multiplied by the actuarial adjustment factor.
EXAMPLE
Rakesh, age 65, who is already receiving his CPP retirement pension, continues working part-time, earning
$18,000 a year. He and his employer both make the required CPP contributions based on $14,500 of earned
income (calculated as $18,000 minus the basic $3,500 exemption). As a result, Rakesh’s annual overall CPP
benefit amount will increase by an estimated annual PRB that will begin the following year.
Rakesh will receive both the CPP retirement pension and the PRB for the CPP contributions that he made after
he started collecting his pension. For each year that he continues to make CPP contributions, he will earn an
additional PRB amount. The PRB is indexed for inflation and will continue for the rest of his life. However, Rakesh
cannot continue to contribute after he reaches age 70.
In Quebec, individuals who receive a QPP retirement pension and choose to work receive an automatic retirement
pension supplement. The supplement applies to earnings that exceed the $3,500 basic income threshold. The total
supplement for the year is an increase of 0.5% of the earnings above that threshold on which they contributed
during the previous year.
EXAMPLE
Patricia’s retirement pension under the QPP is $750 per month. She has decided to continue to work, earning
an income of $22,700. Beginning next year, Patricia will earn a yearly retirement pension supplement of $96 (or
$8 monthly), calculated as follows:
$22,700 minus the basic $3,500 exemption = $19,200
0.5% of $19,200 = $96
DIVISION OF CPP AND QPP CREDITS AFTER DIVORCE, SEPARATION, OR ANNULMENT

Under the CPP program, pension credits earned during a marriage or common-law relationship are to be split
between two spouses after divorce or separation. To be eligible, the couple must have lived together for at least
12 consecutive months. Division of benefits is mandatory but not automatic. A spouse who wishes to split pension
credits earned during a marriage must submit an application.
To be recognized as de facto spouses in Quebec, the QPP specifies that the spouses must have lived as a couple for
one year if they have a child, or three years if they have no children.

Pension credits are used to calculate future CPP and QPP benefits. When credits are split between former spouses
or common-law partners, they are equalized for the period the couple lived together. Under this scheme, a former
spouse can be eligible to receive benefits for which he or she would not otherwise qualify. It can result in an
increased pension benefit for a lower-income former spouse or a stay-at-home parent who had an employment
gap. There is no application deadline for splitting pension credits if a marriage ends in divorce or a legal annulment.
If the division of credits involves a common-law relationship, the former partners must apply within four years of
their separation. Both former common-law spouses may agree to waive the time limit for application.
ASSIGNMENT (SHARING) OF CPP/QPP RETIREMENT PENSIONS

Spouses in an ongoing relationship can apply to share their CPP or QPP retirement pension payments, as long as
both are at least 60 and both are receiving their retirement pension. If only one spouse has been a contributor, the
couple can share that one pension.
The assignment of a retirement pension redistributes a couple’s CPP/QPP retirement pension or pensions. The
amount of pension that can be shared depends on the amount of time the couple has lived together and their
respective contributory periods. The overall household pension amount does not change. Instead, it is redistributed
between spouses. The amount of taxable income for each partner may change, thus reducing overall taxes paid. It is
possible for couples to share up to 50% of the CPP or QPP retirement pension earned during their years of marriage
or cohabitation. However, both spouses must agree to the redistribution.
EXAMPLE
Peter and Karen have been married for 20 years and both have been contributing to the CPP program for
30 years. Peter is in a higher tax bracket than Karen. He receives $600 a month in CPP retirement pension, and
Karen receives $300.
Peter and Karen have been married for two-thirds of their contributory period. Therefore, $400 (two-thirds of
Peter’s CPP of $600) is available for sharing, with the remaining $200 unavailable for assignment.
Karen currently gets $300 a month in CPP. Because she and Peter have been married for two-thirds of their
contributory period, $200 of Karen’s CPP (two-thirds of $300) is available for sharing, leaving $100 (the
remaining one-third) of the contribution that she cannot share.
The total amount available for CPP pension sharing is therefore $600 ($400 from Peter and $200 from Karen).
Each would get 50%, or $300, as a result.
After the pension sharing, Peter would get CPP of $500 (i.e., $300 from sharing + $200 of his non-sharable
portion based on the 10-year CPP contributory period prior to marriage).
Karen would get CPP of $400 (i.e., $300 from sharing + $100 of her non-sharable portion based on the 10-year
CPP contributory period prior to marriage).
DISABILITY BENEFIT
The second major component of the CPP and QPP program is the CPP disability benefit. This benefit may apply
when a contributor to the CPP program is disabled during the contributory period before the person is eligible to
collect the CPP retirement pension. Without the disability benefit, disabled contributors may never be able to
participate in the CPP program to which they contributed in past years.
DID YOU KNOW?
A contributor’s disability must be a physical or mental impairment that is both severe and prolonged.
A severe disability is one that prevents the contributor from pursuing regular gainful employment.
A prolonged disability is one that is likely to be of indefinite duration or to result in death.

ELIGIBILITY
To be eligible for a CPP disability pension, contributors must meet all of the following conditions:
• They are considered disabled according to CPP legislation.

• They have earned a specified minimum amount and contributed to the CPP in four of the last six years.
• They are under age 65.
Disabled QPP contributors are eligible for a CPP disability pension if they have contributed during one of the
following periods:
• Half the number of years of their contributory period, but not less than two years
• Five of the last 10 years of their contributory period
• Two of the last three years of their contributory period
• Two years, if the contributory period is only two years
DISABILITY BENEFIT PAYMENTS

Both the CPP and QPP disability pensions consist of a flat-rate component and an earnings-related component. The
latter is equal to 75% of a retirement pension, calculated as if the contributor had reached 65 in the month when
the disability pension became payable.
Disability pensions begin four months after the month in which the person became disabled, and they are payable
every month until the beneficiary recovers from the disability, reaches age 65, or dies (whichever comes first). When
the recipient of a disability pension reaches 65 or takes early retirement between the ages of 60 and 64, the pension
is automatically converted to a retirement pension. The four-month waiting period is waived if the disability occurs
within five years of a previous disability. The first payment begins in the month following the date of disability.
For CPP and QPP, a disabled contributor’s unmarried and dependent children under 18 are eligible for disability
benefits. Additionally, for CPP only, children who are full-time students between the age of 18 and 25 are eligible for
CPP disability benefits.
DEATH BENEFITS, SURVIVOR BENEFITS, AND CHILDREN’S BENEFITS

The remaining components of the CPP and QPP programs provide benefits upon the death of a contributor.
A lump-sum death benefit is provided to the estate. Either or both the survivor benefit and the children’s benefit
are provided to the surviving spouse and dependent children of a CPP or QPP contributor who has died. To qualify,
the deceased must have contributed to the relevant program for at least three years. If the contributory period
was longer than nine years, the contributor must have made contributions in a third of the calendar years in the
contributory period, or 10 calendar years, whichever is less.
The death of a QPP contributor gives entitlement to survivor benefits if the deceased contributed to the QPP for at
least one-third of the period during which he or she could have contributed, and at least three years.
DEATH BENEFITS
Following the death of a qualified CPP or QPP contributor, a lump-sum death benefit is payable to his or her estate.
If there is no estate, the person responsible for the funeral expenses, the surviving spouse or common-law partner,
or other next of kin may be eligible, in that order.
The amount payable under the CPP is equal to six months’ worth of a person’s calculated CPP retirement pension,
or what this amount would have been had the person been age 65 at the time of death. The maximum amount
payable is $2,500.
The QPP death benefit is a lump-sum payment up to a maximum of $2,500, provided that the deceased made
sufficient contributions to the plan during their lifetime. The death benefit payable under the QPP may be paid
to the person responsible for the funeral expenses, up to the amount of such expenses but not exceeding $2,500,

provided that the application is filed within 60 days of the contributor’s death. If no application is filed within
60 days, the benefit is paid to the contributor’s estate.
SURVIVOR BENEFITS
Under the CPP program, following the death of a qualified contributor the spouse or a person who lived with the
contributor and was represented as the contributor’s partner may apply for a surviving spouse’s pension. As of
July 2000, same-sex partners also qualify for CPP survivor benefits upon the death of a contributor who died on or
after January 1, 1998.
Under the QPP program, a pension, called surviving spouse’s pension, is paid to a spouse, whether married or in a
civil union, provided that the spouse and deceased never legally separated. If the couple was separated at the time
of death, or if the relationship was not a marriage or civil union, a pension can be paid in some circumstances. It
may be paid to a person who lived with the contributor in a conjugal relationship for at least three years before the
contributor’s death, or for at least one year if they had a child together, by birth or adoption.
A surviving spouse does not lose entitlement to the deceased spouse’s pension upon remarriage. If a spouse has
been widowed more than once and is therefore eligible for more than one survivor’s pension, the higher of the
survivor benefit amounts (or highest if there were more than two marriages) will be paid.
The amount a surviving spouse or common-law partner may receive depends on the following factors:
• Whether the spouse or common-law partner is also receiving a CPP or QPP disability or retirement pension
• How much, and for how long, the contributor has paid into the plan
• The spouse or common-law partner’s age when the contributor dies
Table 12.4 summarizes the survivor’s pension benefit payment rules.
Table 12.4 | CPP Survivor’s Pension Benefit Payments
If the surviving spouse or common-law partner is: The benefit is:

Age 65 or over 60% of the deceased contributor’s retirement pension,
if the survivor is not receiving other CPP benefits*
Between the ages of 45 and 64 (or is under age 45 Made up of a flat-rate benefit, plus 37.5% of the
and has at least one dependent child or is disabled) deceased contributor’s pension, if the survivor is not
receiving other CPP benefits*
Between the ages of 35 and 45, has no dependent Made up of a flat-rate benefit, plus 37.5% of the
children, and is not disabled deceased contributor’s pension; reduced by 1/120th for
each month the spouse or common-law partner’s age is
less than 45 at the time of the contributor’s death and
applied as a reduction for as long as the pension is paid
Under age 35, not disabled, with no dependent child Not paid until the spouse or common-law partner
reaches age 65 or becomes disabled
* The maximum CPP benefit that can be received by the survivor is the maximum CPP retirement benefit amount. For example, if the
survivor also receives the maximum CPP retirement benefit, they will receive nil as a survivor benefit.
The benefit amount of the surviving spouse’s QPP pension differs depending on when it is paid in relation to the
normal retirement age. Before age 65, it is comprised of a fixed component and a variable one. The fixed portion
is based on the age of the surviving spouse and whether the surviving spouse is disabled or has a dependent or
disabled child. The variable portion consists of 37.5% of the basic retirement pension of the deceased contributor.

From the age of 65, the fixed portion ceases to be paid, and the surviving spouse’s pension is equal to 60% of the
deceased contributor’s basic pension.
CHILDREN’S BENEFIT
If a qualified contributor to the CPP or QPP dies leaving unmarried, dependent children, monthly benefits are
payable to each child. The child must be under 18—or, for CPP, between 18 and 25 and a full-time student attending
a recognized school or university. Post-secondary students must provide proof of enrolment in order for the CPP
children’s benefit to continue.
PORTABILITY OF CPP/QPP BENEFITS

Both the CPP and QPP plans are portable. If a CPP contributor moves to Quebec, his or her record of earnings and
contributions is merged with the QPP. Correspondingly, the earnings and contributions of QPP contributors who
move elsewhere in Canada are merged with CPP.
DIVE DEEPER
Canada has signed reciprocal social security agreements with many countries that allow social security
benefits to be portable upon immigration. Service Canada has posted information sheets about these
agreements on its website; the list now includes 60 countries. A person who has lived in one of these
countries or contributed to its social security system may qualify for a pension from that country, from
Canada, or from both.
PLANNING FOR A CPP/QPP RETIREMENT PENSION

Historically, Canadians would take their CPP/QPP retirement pension whenever they retired. Now, Canadians have
the options to take CPP/QPP as early as age 60 and as late as age 70, with no requirement to cease working. Given
these options, much more planning is required regarding the optimal time to start drawing a CPP/QPP pension. If
the client is likely to live past 75, it makes mathematical sense to start drawing the full amount at age 65, rather
than the reduced amount at age 60. With today’s longer life expectancies, it seems that everyone should wait to
start collecting CPP/QPP until at least age 65. However, more than two-thirds of eligible CPP contributors who
started collecting in 2015 were below age 65.
When helping your clients decide when to begin collecting benefits, you should consider the following factors:
Cash flow needs Does the client need the retirement benefit before age 65?
Health Is the client healthy? What is his or her life expectancy and family health history?
Existence of other If the client needs annual income, could it be drawn from another source while their
income sources CPP/QPP entitlement continues to grow?
Nature of other A CPP/QPP retirement pension is an annuity, indexed for inflation, that clients will
income sources receive for the rest of their lives. If their other sources of retirement income are lump-
sum savings, it may be beneficial to invest a portion of those savings in an income
stream that will pay out as long as the client lives.
Attitude toward the Is the client anxious to begin enjoying the monetary benefits of a program they have
CPP program paid into throughout their working years?
Tax position For clients who are still working, is it worthwhile to take CPP/QPP retirement pension
early, considering that it will likely be taxed at a higher marginal rate?

You should consider all of these factors in the context of the client’s overall situation. Only then can you help the
client make the best decision with respect to the commencement of the CPP/QPP retirement pension.
PROVISIONS OF THE CANADA PENSION PLAN AND QUEBEC PENSION PLAN
What are the provisions of CPP and QPP? Complete the online learning activity to assess your knowledge.
DIVE DEEPER
To see a summary of CPP and QPP benefits, go to your online chapter and open the following document:
Summary of CPP and QPP Benefits
OLD AGE SECURITY PROGRAM
3 | Explain the key features, benefits, eligibility rules, and tax considerations for the Old Age Security
program.
The Old Age Security Act came into force in 1952 and has been amended many times since its inception. Old
Age Security (OAS) is a social assistance program payable to all Canadians or legal residents (including landed
immigrants) of age 65 and older who meet certain residence requirements. The program is financed from general
federal tax revenues, and the benefits are adjusted upward four times a year to reflect increases in the CPI. However,
the payments do not drop if the cost of living falls. The OAS program consists of four benefits:
• OAS pension
• Guaranteed Income Supplement (GIS)
• Allowance
• Allowance for the Survivor
OLD AGE SECURITY PENSION

The OAS pension is the most well-known component of the OAS program. Unlike the CPP program, eligibility for
this pension amount does not depend on contributions to the program; it is based on residency.
ELIGIBILITY CONDITIONS
To qualify for an OAS pension, individuals must be 65 years of age or over and must fulfill one of the following
qualifications:
• They must be Canadian citizens or legal residents at the time their OAS pension application is approved.
• If no longer living in Canada, they must have been Canadian citizens or legal residents on the day before they
left Canada.
To receive a pension in Canada, applicants must have lived in Canada for at least 10 years after reaching age 18. To
receive a pension outside of Canada, applicants must have lived in Canada for at least 20 years after age 18.

FULL OAS PENSION

The amount of a person’s pension is determined by how long the person has lived in Canada. A person who has lived
in Canada after age 18 for periods that total at least 40 years may qualify for a full OAS pension.
PARTIAL OAS PENSION

A person who cannot meet the requirements for the full OAS pension may qualify for a partial pension. A partial
pension is earned at the rate of 1/40th of the full OAS pension for each full year lived in Canada after the applicant’s
18th birthday. The person can delay the first payment for up to five years to get a higher amount. Once a partial
pension has been approved, it may not be increased as a result of added years of residence in Canada.
ABSENCES FROM CANADA

Canadians working outside Canada for a Canadian employer, such as the armed forces or a financial institution,
may have their time working abroad counted as residence in Canada. To qualify, applicants must meet the following
conditions:
• They must have returned to Canada within six months of ending employment or have turned 65 years old while
still employed.
• They must provide both proof of employment from the employer and proof of physically returning to Canada,
if only for one day.
Under certain conditions, this provision may also apply to spouses and dependents and Canadians working abroad
for international organizations.
APPLYING FOR OAS PENSION BENEFITS

The Government of Canada has initiated a proactive enrolment process that will remove the need for many seniors
to complete an OAS application. If a person is going to be automatically enrolled for the OAS pension, they will
be notified by mail the month after turning age 64. Those not selected for automatic enrolment will receive a
letter instructing them to complete an application form and submit it to Service Canada in order to receive the
OAS pension. They should apply as soon as possible after their 64th birthday, but no earlier than one year before
becoming eligible.
Pension benefit payments under the OAS program normally begin a month after the applicant meets the age and
residence requirements. If the applicant makes a late application, payments may be made retroactively for up to
11 months.
Similar to the CPP retirement pension, one can increase one’s OAS entitlement by deferring the start date beyond
age 65. The OAS entitlement increases by 0.6% per month for each month past age 65 during which collection is
deferred.
PAYMENT OF OAS PENSION BENEFITS TO RECIPIENTS OUTSIDE CANADA

Once a full or partial OAS pension has been approved, it may be paid indefinitely to pensioners living outside
Canada who have lived in Canada for at least 20 years since age 18. Otherwise, payment may be made only for the
month of a pensioner’s departure from Canada and for six additional months, after which payment is suspended.
The benefit may be reinstated if the person returns to live in Canada and meets all conditions of eligibility. A person
who lived or worked in a country that has a social security agreement with Canada, and who is considered to meet
the 20-year residence requirement, can receive the payments indefinitely.

EXAMPLE
Lily has worked as a librarian in Canada for 34 years. When she retires next year, she plans to move to Hong Kong
to live close to her nieces and nephews. She is concerned that she may lose her OAS benefits when she moves
and will not have enough income to meet her retirement needs. Her advisor tells Lily that, because she has
lived in Canada for more than 20 years, her OAS benefit will be paid even if she spends her entire retirement in
Hong Kong.
For many non-residents entitled to receive OAS payments, these amounts can be paid in the foreign currency of
the country in which they are living. The OAS amounts paid to non-residents of Canada are subject to Canadian
non-resident withholding taxes. The standard non-resident tax rate is 25%, although this rate may be reduced by
a treaty between Canada and the recipient’s country of residence.
TAXATION OF OAS BENEFITS AND THE PENSION CLAWBACK

Like most other retirement income, the basic OAS pension is taxable income. As mentioned above, the OAS pension
payments are considered a social assistance benefit, funded out of the general funds of the federal government.
Higher-income Canadians are in less need of this benefit. Once their income exceeds a set threshold, they must
repay all or part of the social benefits they receive in any year. This provision is properly known as the OAS Recovery
Tax but is often referred to as the OAS clawback. The amount clawed back can be repaid when the recipient’s
income tax return is filed.
The total amount of OAS pension a person must repay is 15% of the amount by which that person’s net income
(including OAS) exceeds the CRA’s annual stipulated threshold. In other words, for every dollar of income above
the threshold, 15 cents of OAS income must be paid back. The full OAS pension is eliminated when a person’s net
income equals the CRA threshold. This provision is often referred to as the full OAS clawback. Terms of the OAS
clawback are shown in Table 12.5.
Table 12.5 | OAS Pension Threshold and Clawback Amounts
Threshold Clawback Amount
(net income amount at which point OAS (15% of the amount by which net income
benefits are fully clawed back) exceeds the threshold figure)
2022 $133,141 $81,761
2021 $129,260 $79,845
EXAMPLE
In 2022, Eduard collected OAS benefits and had a net income of $88,000. Therefore, Eduard must repay 15% of
$6,239 (calculated as $88,000 − $81,761) of his OAS benefits, or $935.85.
STRATEGIZING TO REDUCE GOVERNMENT CLAWBACKS

When helping clients plan for retirement, it is prudent to keep the OAS clawback threshold in mind. Many
Canadians do not appreciate the rationale that the OAS pension is a social assistance program. They feel that they
should not be penalized for having a high retirement income, so they want to minimize the amount of OAS pension
that they give back to the government.
Although it may not be possible to fully avoid the OAS clawback, clients should project sources of their retirement
income in an effort to reduce the clawback. The CPP pension and OAS pension are included in the client’s net
income for tax purposes, as is income from any registered plans the client may have. Such plans may include

payments from a registered pension plan (RPP) and withdrawals from a registered retirement savings plan (RRSP)
or registered retirement income fund (RRIF). Combined income from these other sources could give rise to the OAS
clawback. However, it may be possible to structure the client’s retirement income in such a way that net income for
tax purposes is minimized.
In considering ways to minimize net income, note that only 50% of capital gains earned in a non-registered account
is taxed as net income. Also note that withdrawals from a tax-free savings account (TFSA) are not included in net
income. Furthermore, income from a TFSA does not affect eligibility for federal income-tested benefits and credits
such as the GIS, which is discussed below.
EXAMPLE
Sam, age 72, is a retired school principal with an annual pension from his school board’s RPP of $66,000. He
also receives a CPP pension of $12,500 and an OAS pension of $7,200, and he must withdraw $5,400 from his
RRIF (assuming a RRIF balance of $100,000 and the mandatory withdrawal rate of 5.4% at age 72). He recently
decided to withdraw $45,000 from his TFSA to buy a new car. Sam’s OAS clawback is calculated as follows:
Taxable Income
Pension from RPP $66,000
CPP benefit $12,500
OAS benefit $7,200
RRIF withdrawal $5,400
Total $91,100
Less 2022 threshold ($81,761)
OAS Clawback
$91,100 − $81,761 = $9,339
15% of $9,339 = $1,400.85
So Sam would have to repay $1,400.85 from the OAS benefit of $7,200 that he received.
Note that the $45,000 withdrawn from Sam’s TFSA for the car purchase did not affect his OAS entitlement
because it is not included in his net income for tax purposes. However, if he had withdrawn that $45,000 from
his RRIF, then his OAS entitlement for 2022 would be clawed back in full. [Note: It is unwise to withdraw money
from a RRIF to purchase consumer goods.]
THE GUARANTEED INCOME SUPPLEMENT

The GIS provides a monthly non-taxable benefit to OAS pension recipients who have a low income and are living in
Canada.
Service Canada implemented a process to automatically enrol seniors who are eligible to receive the OAS pension.
In December 2017, automatic enrolment was expanded to include the GIS.
The amount of the GIS one receives depends on one’s marital status and previous year’s income.
There are two basic categories of rates of payment for the GIS:
• The first category applies to single pensioners, including widowed, divorced, or separated persons, and to
married pensioners whose spouses or common-law partners do not receive either the basic OAS pension or the
Allowance (discussed below).
• The second applies both to legally married couples and couples living in common-law relationships, where both
spouses and common-law partners are pensioners.

The GIS single rate is higher than the GIS married rate. However, each spouse or common-law partner in a couple is
entitled to a benefit, so the combined benefits for a couple are higher than the benefit for a single person. The GIS
benefit amount paid each month is adjusted every quarter by the CPI.
Old age security recipients with low amounts of income that qualifies as “other income” may be eligible for the GIS
if the other income is lower than the maximum annual threshold established by CRA. The GIS amount depends on
the pensioner’s marital status and amount of other income. For purposes of the GIS calculation, other income is
characterized as follows:
• It includes taxable sources of income such as private pension income, employment income, Employment
Insurance benefits, CPP and QPP benefits, interest, dividends, capital gains, rents, foreign pension income,
withdrawals from an RRSP or RRIF, and income from certain other sources, such as Workers’ Compensation
payments or spousal support.
• Employment and self-employment earnings are exempted up to a $5,000 limit, effective July 2020 (previously
$3,500) to encourage labour market participation. This change in exemption ceiling was announced in the 2019
federal budget.
• The 2019 budget also announced a new partial exemption of 50% that will apply on up to $10,000 of
additional employment and self-employment income (beyond the initial $5,000). This applies to both the
recipient, as well as their spouse or common-law partner.
• Withdrawals from a TFSA are not considered other income because they are not taxable.
• The OAS pension is not included in the calculation of other income.
It does not consider the value of assets or personal possessions, savings accounts, investment assets, or a home or
property. If the pensioner is married or living common-law, the partners’ combined income is taken into account to
determine GIS eligibility.
The GIS benefit is reduced by approximately $1 for every $2 of other income. The actual calculation that the
government makes uses a complex set of rate tables.
Unlike the OAS pension, the GIS benefit amount is not subject to income tax. The GIS is not payable outside Canada
beyond a period of six consecutive months, regardless of how long the person has lived in Canada.
EXAMPLE
Ida, who has been single all her life, will be eligible to receive the full OAS pension ($7,707 annually1) when she
turns 65 on January 10, 2022. Because she has little other income, she will most likely also be eligible for the
GIS. If she continues to work part-time after age 65, as she plans to, the GIS will be reduced by approximately
50 cents for each dollar she earns over the two exemptions stated above. Assume, for example, that she earns
$1,000 a month ($12,000 over the year) as a freelance graphic artist. The first $5,000 of her employment
earnings will be fully exempt from the GIS reduction. In addition, the balance of $7,000 will be eligible for a
partial exemption of 50%. Therefore, her GIS entitlement will be reduced by approximately $1,750, as follows:
$12,000 − $5,000 (full exemption) = $7,000 − $3,500 (partial exemption of 50%) = $3,500 ÷ 2 = $1,750
Ida’s earnings of $12,000 will be taxable, along with the amount of her OAS pension ($7,707); the GIS that Ida
receives is not subject to tax. However, she will likely not pay any income taxes because of her non-refundable
tax credits, such as the basic personal amount and the age amount. These tax credits effectively reduce her tax
liability by 15% of $22,296 ($14,398 and $7,898 respectively). As a result, the tax on her first $22,296 of income
is offset by her non-refundable tax credits.
1
OAS pension amounts – January to March 2022

Because the GIS benefit is not taxable income, it is worth more than the same amount of other types of income
that are subject to tax.
The following scenario illustrates the importance of considering the effect of mandatory RRSP withdrawals on OAS
and GIS benefits.
Scenario | Planning for OAS Pension and GIS Entitlement
Joe and Mary are both 60. They have always had modest incomes and are looking forward to receiving the OAS,
and possibly even the GIS. Both spouses are still working, and both have RRSPs. They have heard that they may
lose some of their OAS and GIS benefits due to clawbacks and eligibility tests when they have to begin withdrawing
money from their registered accounts.
It is important that Joe and Mary figure out how much money they will have in their RRSPs when they retire and
how much they will be forced to withdraw at age 71. If they are close to the point where some of their OAS will be
clawed back, they should consider reducing their RRSP contributions and putting their money into TFSAs instead.
Depending on tax implications, it may even be advantageous for Joe and Mary to consider making some withdrawals
from their RRSP before age 71. By doing so, they could reduce the adverse effect of the mandatory withdrawals from
their RRIF on their OAS (and possibly GIS) benefits. Withdrawals from their RRSP can be deposited into TFSAs, so
that future income earned within the TFSAs is tax-free for life.
ALLOWANCE AND ALLOWANCE FOR THE SURVIVOR

The third and fourth components of the OAS program are the Allowance and Allowance for the Survivor.
ALLOWANCE
The Allowance provides money for low-income seniors who meet the following qualifications:
• They have a spouse or common-law partner (same or opposite sex) who receives an OAS pension and is eligible
for the GIS.
• They are between 60 and 64 years old.
• They are Canadian citizens or legal residents at the time the Allowance is approved, or when they last lived here.
• They have an annual combined income less than the maximum allowable annual threshold.
• They lived in Canada since age 18 for at least 10 years.
ALLOWANCE FOR THE SURVIVOR

The Allowance for the Survivor provides money for low-income seniors who have a deceased spouse or common-
law partner and whose sole annual income is less than the maximum annual threshold. Other qualifying criteria are
the same as for the Allowance.
Allowance and Allowance for the Survivor payments are recalculated four times a year to reflect increases in the CPI.
Individuals can apply whenever their income reaches the qualifying range. Recipients must reapply each year. These
OAS benefits are not considered income for income tax purposes.
FLEXIBILITY IN RECEIVING OAS BENEFITS

Eligible OAS pensioners can choose to delay receiving their OAS pension for up to five years. As mentioned
previously, they receive an increase of 0.6% of their OAS pension for every month they delay receipt, up to a
maximum of 36% (60 months) at age 70. This flexibility is applicable only to the OAS.

EXAMPLE
Andrew will be turning 65 in December 20x0. If he decides to delay receiving his OAS pension until he turns
68 years old, his monthly amount will increase by 21.6% at age 68 (0.6% × 36 months).
DID YOU KNOW?
Before deciding to defer OAS pension payments, clients should know that, to be eligible for GIS, they
must be collecting their OAS pension. By deferring their OAS payments, they become ineligible for the
GIS. Furthermore, their spouse or common-law partner will not be eligible for the Allowance benefit
for the period during which they delay the OAS pension. You and your clients should assess this impact
before the clients decide to defer their OAS pension.
PROVISIONS OF GOVERNMENT PENSION PROGRAMS
What are the provisions of government pension programs in Quebec and the rest of Canada?
SCENARIO—JENNY AND CARL BURTON
Assess your understanding of government pension programs by resolving a client scenario. Complete the
DIVE DEEPER
To see a summary of OAS benefits, go to your online chapter and open the following document:
Summary of OAS Benefits

At the beginning of this chapter, we presented a scenario in which Peter and Ruth Miller asked you how they
could maximize their retirement income through their various income sources. They also wanted advice about
leaving behind a sizable estate to their children and grandchildren.
Now that you have read the chapter, along with the relevant chapter in KPMG’s Tax Planning guide, we’ll revisit
the questions we asked and provide some answers.
• What retirement income sources should you consider when establishing the Millers’ retirement plan?
• Consider the amount of monthly benefits that Peter and Ruth will get from the CPP/QPP and OAS
programs.
• Consider other assets such as company pension plans, non-registered investments, TFSAs, RRSPs,
RRIFs, Locked-In Retirement Accounts (LIRAs), and Life Income Funds (LIFs), which are income sources
that clients can and will need to draw on during their retirement years. [Note: These assets/plans are
considered in earlier and later chapters.]
• What are some of the aspects of the Millers’ various income sources that they should consider, given their
retirement plan and income needs?
• It is important to be mindful of the tax consequences of drawing from their various income sources. For
instance, capital gains earned within an RRSP are fully taxed as income upon withdrawal, unlike capital
gains earned in a non-registered investment account where only 50% of the capital gains are taxable upon
disposition. While eligible dividends in a non-registered investment account benefit from a relatively lower
income tax rate due to the gross-up and credit mechanism, that same mechanism artificially inflates a
client’s net income for income tax purposes, thereby exposing them to a potential OAS clawback.
• When managing retirement income, the Millers should take full advantage of the tax-free nature of TFSAs
to the extent possible. For instance, they can deposit mandatory RRIF withdrawals into their TFSAs and
shield the income earned on those funds from taxation.
• What two factors should be top of mind when you are considering the CPP/QPP benefits that Peter and Ruth will
be collecting?
• It is important for you to consider:
« when the Millers should start receiving CPP/QPP benefits; and
« whether they should share CPP/QPP benefits.
Delaying the start of CPP/QPP benefits for Ruth (who is 65) would provide her with higher benefits (up to
42% higher if she delays to age 70). Peter is already 70 years old, so he cannot delay any further.
Sharing CPP/QPP benefits could lower their overall taxes given that Peter’s income in retirement is likely
to be much higher than Ruth’s. It is possible for couples to share up to 50% of the CPP/QPP retirement
pension earned during their years of marriage.

SUMMARY
In this chapter, we discussed the following key aspects of government pensions:
• Participation in the CPP or QPP program is compulsory for Canadians between 18 and 65 who have earned
income in excess of the YBE. Contributions are based on earnings from employment or self-employment only.
Employees and employers have an equal obligation for the contribution amount, which is deducted from the
employee’s income at source.
• Pension credits earned during a marriage or common-law relationship can be split between two spouses after
divorce or separation.
• Disabled contributors to CPP or QPP are eligible for a disability benefit under certain conditions. Other benefits
of the programs are death benefits, survivor’s benefits, and children’s benefits.
• The OAS program is a social assistance program payable to all Canadians or legal residents of age 65 and older
who meet certain residence requirements. Like most other retirement income, the basic OAS pension benefits
are taxable income. Once their income exceeds a set threshold, taxpayers must repay all or part of the OAS
benefits they receive in any year. They can reduce the amount clawed back by structuring their retirement
income in such a way that net income for tax purposes is minimized.
• Lower-income OAS recipients who qualify under an income test are eligible for an additional pension provided
by the GIS. The OAS program also provides the Allowance and Allowance for the Survivor for low-income
seniors who meet certain qualifications.
NOTE
DISCUSSION BOARD
for Chapter 12.
REVIEW QUESTIONS
Questions.

Retirement Planning Process 13
CHAPTER OUTLINE
In this chapter, we discuss a holistic approach to the retirement planning process that factors in all sources of
retirement income. We explain how to determine a client’s retirement income needs and suggest some strategies to
manage an income shortfall. Finally, we provide some general strategies that clients can use to reduce their taxes in
retirement and increase their retirement income.
1 | Describe the holistic approach to the Planning for Financial Security in Retirement
retirement planning process.
2 | Differentiate between the emotional and Retirement Income Needs Analysis

financial concerns associated with each of the
retirement life stages.
3 | Determine the retirement income needs of a
client.
4 | Recommend strategies to minimize taxes Tax-Minimization Strategies

payable in retirement.
5 | List the questions that an advisor should Questions to Consider When Advising Clients
consider when advising clients on their on the Retirement Planning Process
retirement planning process.

KEY TERMS
The Key Terms list targets some significant concepts covered in the textbook. Key terms appear in bold
text in each chapter to help you focus your study efforts on these important topics.
after-tax real rate of return longevity risk
life annuity real rate of return

CHAPTER 13 RETIREMENT PLANNING PROCESS 13 • 3
INTRODUCTION
Canada’s huge baby boomer generation is either entering or already in its retirement years. Helping these clients
plan for a successful retirement is one of the most important roles you can play in their lives as a wealth advisor.
Most clients want advice on how to develop and implement strategies to meet their goals for the retirement stage
of their life cycle. Today, with rising life expectancy, the retirement stage can last for 30 to 35 years.
Clients planning to retire should take advantage of every source of income available to them. But retirement
planning goes beyond concerns about money. It is the process by which one meets one’s desired retirement
lifestyle. It should take into consideration life transitions, family issues, health concerns, and emotional issues that
are part of the changes that accompany the end of employment. Retirement planning is also a means to help clients
move beyond their current situation toward one that is closer to the one they envision for their future.
In the past, retirement planning focused on helping Canadians get to retirement. With many clients now in
retirement, many advisors are specializing in planning for current retirees. Given the sheer number of Canadians
who will be retired in the future, this need will become an even more important focus for advisors.
In addition, consider that a retirement filled with leisure activities and travel is no longer the ultimate goal for most
people. It is important, therefore, that you take a personalized, life-stage approach to retirement planning. Your
approach to discovery and understanding should resonate with your clients from the outset.
Before you begin, read the scenario below, which raises some of the questions you might have about the retirement
planning process. Think about these questions, but don’t worry if the answers don’t come easily. At the end of the
The Millers have decided to retire within the next year. Peter, who is 70, will wind down his consulting business,
and Ruth (age 65), who works at Peter’s company, will help him do so. They would then like to put work behind
them and enjoy their retirement years together. They are debt free and have been enjoying a high family income,
most of which is produced by Peter. They have their principal residence and a vacation home in Florida. They
have engaged you to discuss how they can best maximize their retirement income through their various income
sources. These sources include the government pensions to which they have always contributed and their
investment portfolios.
They would also like to take steps to ensure that they leave behind a sizable estate to their children, Andy,
Gordon, and Mike, and their existing and future grandchildren.
• What key steps should you take to ensure that the Millers have a proper retirement plan?
• If you identify a shortfall in the Millers’ retirement budget, what strategy can you use to address it?
• In addition to the financial considerations, what other issues should you think about as you work with the Millers
to create a retirement plan?
NOTE
because they both contain examinable content. For examination purposes, if the content in this textbook differs

PLANNING FOR FINANCIAL SECURITY IN RETIREMENT
1 | Describe the holistic approach to the retirement planning process.
Planning for retirement is an essential task for people leaving the workforce and starting on their next life stage.
There is an ongoing debate as to how prepared Canadians are for retirement. Headlines in recent years suggest that
many Canadians close to retirement age are not ready to retire.
A pension plan is the most important factor that determines retirement readiness, and half of all Canadians getting
close to retirement do not have such a plan.
Most Canadians have not yet saved enough to support their planned lifestyle in retirement. In fact, only two-thirds of
Canadian tax filers, approximately, actually contribute funds to their registered retirement savings plan (RRSP) each year.
Furthermore, recent data indicates that the average life expectancy of Canadians is increasing. These factors have
contributed to the fear among many Canadians that they have not saved enough for their retirement. Helping
clients, especially baby boomers, plan for their retirement is one of the most important things that you can do for
your clients as an advisor.
At its most basic level, the retirement planning process involves five steps:
1. Determine retirement objectives.
2. Determine the current financial status.
3. Estimate total retirement income sources and needs.
4. Establish an investment plan to meet the client’s retirement needs.
5. Monitor and evaluate the progress to plan.
Each of these steps is described in detail below.
DETERMINE RETIREMENT OBJECTIVES

To determine your clients’ retirement objectives, ask the following questions:
• At what age do you wish to retire?

• How much income do you hope to have in retirement?
• What kind of lifestyle do you want to lead, including any desires for travel or big-ticket expenditures?
• Where do you want to live?
• How will you occupy your free time during retirement? For example, do you plan to work part-time, work at
hobbies, or look after grandchildren?
DETERMINE THE CURRENT FINANCIAL STATUS

To determine your clients’ current financial status, you should first analyze their current situation by reviewing their
cash flow and net worth.
Next, you must identify any constraints that may prevent your clients from meeting their retirement objectives,
which can include the following factors:
• Do they have any personal health problems?

• Do they plan to fund their children’s post-secondary education?
• Are they financially responsible for their elderly parents?
Finally, you must determine how much money your clients currently have available to fund their retirement.

ESTIMATE TOTAL RETIREMENT INCOME SOURCES AND NEEDS

First, determine how much income your clients will receive when retirement commences, including income from
the following sources:
• Government programs, such as the Canada Pension Plan (CPP) or Quebec Pension Plan (QPP), Old Age Security
(OAS), and Guaranteed Income Supplement (GIS)
• Employer programs, such as registered pension plans and deferred profit-sharing plans
• Other sources, such as investment income, rental income, business income, or employment income
Then, determine how much income your clients will need from their personal retirement funds when retirement
commences. The amount will depend on the chosen lifestyle for retirement, retirement age, life expectancy,
expected return on investments, current savings, and inflation. If the clients’ retirement plans are not certain, you
will need to estimate the percentage of pre-retirement income needed.
Next, compare the income your clients will need with the anticipated amount they will receive. Anticipated income
may change during retirement. For example, a person may become eligible to receive different government or
employer-sponsored benefits. Retirement needs may also change, both before and during retirement.
Finally, set a savings objective that considers the projected amount of income needed compared to anticipated
sources of income. If there is a shortfall, clients will need to save more. Alternatively, you can analyze the situation
with your clients to determine which post-retirement expenses are likely to decrease and which may increase, as
shown in Table 13.1.
Table 13.1 | Analysis of Post-Retirement Expenses
Possible Lower Retirement Expenses Possible Higher Retirement Expenses
• Clothing (work wardrobe) • Health, dental, and prescription drug costs*

• Dry cleaning • Travel costs (recreational)
• Travel costs (commuting) • Restaurant meals (dining out more)
• Restaurant meals (fewer work lunches) * This item assumes that benefits from employer group plans
are no longer received or are capped.
This step will be detailed with a case later in this chapter.
ESTABLISH AN INVESTMENT PLAN TO MEET RETIREMENT NEEDS

At this stage, you should establish a savings program with a realistic time frame to assist clients with meeting their
objectives at retirement.
First, you must determine the appropriate asset allocation and corresponding rate of return for the clients’ savings.
Then, you must integrate the investment plan with tax planning to take advantage of possible tax savings.
As part of this process, you should determine the best place to hold the savings. For example, should they be
held in a registered fund such as an RRSP, a tax-free savings account (TFSA), a non-registered account, or some
combination of all three? In some cases, you should also identify the estate planning strategies that will maximize
the assets to be passed to beneficiaries.
MONITOR AND EVALUATE THE PROGRESS TO PLAN

Once a financial plan has been established, you should go through all of the planning steps at least once a year to
determine whether the plan should be modified. You should also revisit the plan whenever significant life changes

occur. Examples include marriage, divorce, remarriage, the birth of a child, the sudden need to care for an elderly
parent, loss of employment, or a substantial change in income. Any of these changes may require a corresponding
change to the financial plan.
Monitoring progress helps to ensure that savings for retirement continue to grow and that the clients are moving
toward their retirement goals. Remember that investments may not generate the returns as expected and that
assumptions may have to be changed.
In the following scenario, an advisor meets with a client to assess his financial situation and help him develop
financial and risk management strategies that will allow him to reach his goals.
Scenario | Planning for Retirement Needs
At age 52, widower Alfred has done an excellent job of accumulating wealth but is far less efficient at managing
it. His net worth is currently in the range of $2,000,000 (excluding his house). However, his assets are spread
among 11 different financial institutions, including banks, trust companies, insurance companies, and mutual funds
brokers. His savings are held in numerous types of investments, including government bonds, individual stocks,
guaranteed investment certificates, and mutual funds.
Alfred spends a lot of time researching the markets and investment options through the financial press and online.
However, he often feels overwhelmed by conflicting information.
He has much the same problem with his advisors from the different institutions that he deals with. He gets lots
of individual advice, but no real overall direction. Nobody seems to be able to help him resolve his two biggest
concerns: retiring in comfort and passing a significant legacy to his two children.
Alfred has recently booked an appointment with Anna, an advisor at a bank where he has some of his investments.
Anna knows a little bit about Alfred’s situation based on some vague notes left by Alfred’s previous advisor at
the same bank (who has since left the industry). Anna plans to speak to Alfred about preparing a comprehensive
retirement plan and consolidating his assets within one financial institution.
Anna doesn’t know enough about Alfred at this point to give specific suggestions, but she can make some valid
generalizations. By dealing with one advisor who will bring experts to the table as needed and one financial group,
Alfred will benefit from a comprehensive and integrated approach. He can look at the value and mix of all his assets,
an important step toward developing an effective financial plan.
The next step will evolve from his meeting with Anna. Alfred will have to clarify what he means by “retiring in
comfort” and passing to his children a “significant legacy”, and then communicate those financial goals to Anna.
Anna needs to know Alfred’s current financial status (e.g., net assets and income) and what his specific goals are for
retirement. Only then can she estimate his retirement needs and calculate his total anticipated retirement income
sources. Next, she will develop financial and risk management strategies to help him reach his goals.
Alfred’s program will involve two components:
• Mitigating investment losses (i.e., controlling the risk of permanent loss of capital), in the form of a balanced
portfolio, hedging strategies, and tax planning
• Specific investment suggestions to maximize the after-tax value of retirement assets while minimizing risk

FOUR KEY ATTRIBUTES OF FINANCIAL SECURITY

Financial security and peace of mind in retirement depend heavily on four key attributes: time, disciplined saving,
strong tax-preferred returns, and minimal taxation in retirement. The substantial erosion of capital by inflation and
taxation is a real danger to your clients’ retirement lifestyle and standard of living. One of the most common fears
of people in retirement transition is outliving their money (a risk known as longevity risk). Clients should fully
understand and appreciate the principles, processes, philosophies, and strategies of holistic planning. When they
do, they have a reasonable chance of accumulating and preserving the assets necessary to provide for a long and
lucrative retirement.
Many clients approaching retirement can expect to live for many more years, and some people will be retired longer
than they were employed. They will have to implement every possible strategy to generate the net real return and
growth required to fund 20 years or more of quality retirement living. With careful planning, they should be free
from the worries and risks of outliving their money, or not being able to afford the consequences of an illness or
disability. By any measure, 20 years is a long-term horizon.
Although it is prudent to adjust one’s risk profile to be more conservative in retirement, it is also prudent to target
returns over the long term to overcome the risks of inflation and taxation. Paradoxically, it can be detrimental
to take too little risk with retirement assets. A fully taxed, low return on assets exposes your clients to the risk of
outliving their money. It is much better to maintain a reasonable investment risk profile to protect the value of
assets that have taken a lifetime to accumulate.
Clients should take full advantage of all government and company retirement benefits to preserve personal assets
as much as possible. Many people regard the mechanics of government programs as too complicated and time-
consuming to warrant what they consider to be measly amounts available. They may also feel they should not take
advantage of programs designed for the benefit of others in worse circumstances. However, it is better to take the
view that every bit helps. And, in some manner or other, seniors have paid for the programs and benefits offered
throughout their working lives. As their advisor, you should design and suggest strategies that give your clients all
benefits they are entitled to.
As bad as inflation may be, taxation can be far more damaging. An overall average tax burden across the various
provinces on an income of $60,000 is about 22%, which is much more damaging than an of 22%. Also, returns
(primarily interest and dividends) generated on assets in a non-registered account are taxed annually. At a
retirement income of $45,000, the tax rates across the country are, approximately, 27.6% on interest and foreign-
source dividends, 13.8% on capital gains, and between 0% and 12.5% on eligible Canadian dividends, depending on
the province of residence.
RETIREMENT INCOME NEEDS ANALYSIS
2 | Differentiate between the emotional and financial concerns associated with each of the retirement
life stages.
3 | Determine the retirement income needs of a client.
After completing the high level of the retirement planning process, a more detailed, step-by-step process is
required. Determining how much income is required during retirement is one of the more challenging components
in the development of a retirement plan. It is a difficult process, not only because of the calculations required but
also because of the impact of personal and emotional changes that occur at retirement. This is what we present
below.

A MORE HOLISTIC APPROACH

A common challenge you may face when helping clients plan for retirement is how to change the conversation
with maturing clients as they move from wealth accumulation to wealth conversion. The planning approach
typically used is to focus on issues such as asset allocation, portfolio maximization, and investment selection.
Wealth conversion, however, is concerned with the discovery process, goal setting, and client education. It requires
a different, more holistic approach. Client discussions should be about how to protect their lifestyle, how to
generate a stable, ongoing income, and how to establish a legacy. Part of the discussion should also deal with health
concerns.
The retirement discovery process is strengthened if you have a sound understanding of the potential issues people
face as they approach the end of work, enter retirement, and age through their retirement years. These issues
include workplace transitions, health challenges and their impact on lifestyle, and psychological turmoil such as
empty nest syndrome, caregiver stress, and bereavement. You must be at ease broaching difficult issues and able
to create a comfortable atmosphere for clients to share their hopes and concerns for the future. The information
you provide will also combine lifestyle issues with financial consequences. At no other time in a client’s financial
planning process does education on life issues play such a key role in their decision-making.
Wealth accumulation was a relatively straightforward process because of the length of investment time horizons
and the absence of current issues that might have changed the strategy. When your clients were young, their issues
were relatively simple, and their investment time horizon was long. Even if mistakes were made, there was plenty of
time to make up for them. In wealth conversion, however, the time horizon is short and the margin for error is small.
Financial planning shifts both to anticipating life changes and reacting to changes that occur in the present. As a
result, the most valuable questions an advisor can ask during the discovery process are open-ended questions that
get clients thinking about themselves, their loved ones, and their goals.
DID YOU KNOW?
As aging baby boomers begin to look at retirement in real terms, rather than as a long-term financial
planning exercise, you will be called upon to provide relevant education, solutions, and services.
HELPING CLIENTS TO CLARIFY THEIR RETIREMENT VISION

One of your important roles as an advisor is to help clients clarify what they would like their retirement to look like.
Both you and your client should be clear about what you are helping the client plan for.
Clients have many choices about how they would like to move into this new life stage. Advisors are familiar with all
of the common attitudes toward retirement:
• Some clients of retirement age are not ready to retire, so they defer their decision to a later date.
• Some want to start a business after they retire.
• Some want to stop all work at once.
• Some want a graduated retirement that initially includes working part-time.
• Some want to switch careers and do something related to their skills and interests.
• Some want to give their time to social or charitable causes they believe in.
• Some want to try traditional retirement for a while, and then decide whether that lifestyle will be a permanent
choice.
It is your role as advisor to help your clients consider these options and define what their retirement will entail.

HELPING CLIENTS MENTALLY PREPARE FOR RETIREMENT

Retirement is as much a psychological concern as it is a financial or workplace issue. This life stage has many
challenges, and you are in a position to help your clients understand the financial consequences of those challenges.
Aspects that are more personal and emotional are best raised by other professionals. There are many seminars and
workshops led by other professionals that may be of interest to clients in their pre-retirement stage. Clients may
want to take advantage of them to explore the following more personal issues:
• Finding life meaning rather than resting

• Aligning their lives more closely with the values and life goals they didn’t have time for when they were working
• Achieving a life balance, rather than focusing on leisure
• Seeking quality leisure, satisfying work, and self-knowledge
• Realizing lifelong dreams over time-filling fun
Goal setting is an exercise that can help clients identify their desires and create strategies to turn them into reality.
You can help your clients prepare mentally for retirement by guiding them through six steps:
1. Help your clients set overall goals and plans to achieve in all areas of their life.
2. Urge your clients to discuss their goals and plans with those who will share their retirement.
3. Ask your clients about the things they have always wanted to do and suggest that they plan to make them
happen.
4. Encourage them to try new activities even if they have to venture outside their comfort zone.
5. Tell your clients to treat all problems or crises as opportunities.
6. Help your clients understand how to create a successful and personalized retirement lifestyle that is right
for them.
UNDERSTANDING THE RETIREMENT LIFE STAGES

Retirement is a time of transition when emotions run high, and introspection is a normal part of the process. As
people come to terms with their relationship to work, their mortality, the death of parents, and the hormonal
changes that occur in mid-life, they often look inward to reframe their world.
Every life change has financial consequences and brings about emotional concerns. The discovery process you use
with retiring clients should focus on uncovering the needs, concerns, opportunities, and goals they have at this point
in their lives. You do not have to be a psychologist, but you should be a good listener.
Table 13.2 shows various emotional and financial concerns that clients have as they approach retirement and in
their retirement years.

Table 13.2 | Client Concerns at Different Life Stages
Approaching retirement (ages 50 to 62) Early retirement (ages 63 to 67)
• Work uncertainty • Health concerns (personal or spouse)

• Contemplating retirement • Adjustment to retirement
• Empty nesting • Change in social network
• Helping children get established • Self-improvement
• Awareness of mortality • Leisure opportunities
• Health challenges • Benevolence
• Care for parents • Income conversion
• Income replacement • Tax minimization
• Retirement readiness • Household budgeting
• Tax efficiency • Pension plan benefits or conversion
• Pension plan options • Real estate purchase or sale
• Real estate purchase or sale • Change in risk profile or asset allocation
• Reassessing life insurance • Long-term care concerns
• Benevolence (desire to do good) • Insurance conversion
• Financing children’s post-secondary education • Financial assistance to children or grandchildren
• Savings maximization • Estate planning and implementation
• Change in risk profile or asset allocation
• Estate planning
Fully retired (68-75) Late-stage retirement (76 on)
• Bereavement (friends and family) • End-of-life issues

• Health limitations • Bereavement
• Decline in social network • Health limitations
• Change in leisure opportunities • Leaving a legacy
• Change in residence • Helping family
• Tax minimization • Change in residence
• RRSP conversion • Long-term or chronic care
• Change in risk profile or asset allocation • Estate considerations
• Estate planning and implementation • Estate settlement (possibly of a spouse)
• Change in spending pattern • Change in spending pattern
• Gifting or planned giving • Gifting or planned giving
• Managing finances on own • Sharing financial management
UNDERSTANDING THE RETIREMENT LIFE STAGES
Can you determine in which retirement life stage the client is? Complete the online learning activity to

HELPING CLIENTS THINK HOLISTICALLY ABOUT LIFESTYLE ISSUES

To be effective, a retirement plan must consider the major lifestyle issues that will make up the client’s post-
retirement life. A retirement plan should address five general areas:
• Family issues
• Health challenges
• Lifestyle goals
• Work options
• Legacy opportunities
You should encourage clients to think holistically about the effect of all these elements on their life and retirement
goals before they retire.
MONEY AS AN ENABLER
With more focus being placed on emotional and personal issues, one major area that many advisors feel is not
receiving enough attention is money. For advisors, money has a place within each of the key life areas. Money is not
a separate issue that exists in a vacuum. It is the means to an end. A sound retirement plan ensures that clients will
have sufficient income to meet their retirement goals. This concept is perhaps the biggest point of departure from
traditional planning, where the focus used to be on asset accumulation, tax planning, and investment strategies.
These issues are important, but they are treated here as tools to enable clients to meet their lifestyle goals.
For many retirees, money has five useful aspects, as described below:
Protection, comfort, A regular income allows retirees to maintain a comfortable lifestyle, frees them from
and safety worry, and contributes to a feeling of security.
Independence Money enables retirees to do what they want when they want and how they want.
Desired lifestyle Spending money on entertainment, home, travel, hobbies, and gifts contributes to
retirement satisfaction.
Assistance for family Older generations often consider themselves stewards of their money for their families.
members Having money allows them to be generous with their children and grandchildren. They
can help family members by paying for education and helping with large purchases such
as a home.
Legacy Living legacies, estate provisions, and charitable giving provide spiritual fulfillment for
many retirees.
You should seek to understand how your clients view money and how they plan to use it in retirement, particularly
in the five areas listed above.
STRATEGIES FOR LIFELONG INCOME

Planning for lifelong income involves some risks. Given that the life expectancy of Canadians is increasing, longevity
risk is an important concern, especially for people with limited savings. To reduce longevity risk, some advisors
suggest investing some of one’s accumulated assets in a life annuity. This approach can help ensure that the
client has a stable source of lifelong income during retirement. Investing in an annuity reduces one’s longevity
risk because the annuity payments will be paid for as long as the annuitant lives. However, a life annuity is not
appropriate for all clients.

The best approach among the following options depends on the client’s accumulated savings and risk profile:
Life annuity only If a client has insufficient savings or a very low tolerance for risk, the most appropriate
option for lifelong income is to purchase a life annuity. A life annuity locks into the
prevailing interest rate at the time of purchase. In its simplest form, the client invests
a lump sum of capital and receives an annual payment for life. The payment amount is
calculated based on the client’s life expectancy and the prevailing interest rates.
Combination of If the client has sufficient savings and a low tolerance for risk, a combination of a life
life annuity and annuity and an investment portfolio may be suitable.
investment portfolio
Investment portfolio If the client has abundant savings and an appropriate risk profile, an investment portfolio
only alone, with an optimal asset mix, can generate lifelong income. No life annuity is required.
RETIREMENT BUDGETING
To determine a client’s retirement income needs, you should help them prepare a realistic retirement budget.
This exercise involves calculating the client’s cash outflows and projecting the estimated income needed to meet
spending needs throughout retirement to the projected date of death. It also involves making assumptions about
the probable state of family or individual finances and lifestyle at retirement.
A starting point for making cash outflow projections is the existing situation. A current budget can serve as a basis
for discussing needs in retirement. You should then prepare a projected retirement budget, adjusting for changes in
income and expenditures. To do so, first estimate the client’s expected retirement income, and then estimate their
expected retirement expenses.
As discussed earlier, retirement income normally comes from three sources:
• Employer and private pension plans, such as registered pension plans (RPPs) or RRSPs
• Government programs, such as OAS, GIS, CPP, or QPP
• Accumulated savings
Many retirees also continue to have employment or business income that supplements the savings they have
accumulated.
As for expected retirement expenses, a generally accepted estimate is 70% of pre-retirement expenses. However,
each client’s situation is unique, and the process you use to determine a particular client’s projected expenses
should be specific to the client.
Expenditures usually change at retirement. To create projections, it helps to divide expenditures into fixed (non-
discretionary) and flexible (discretionary) components. With your assistance, your clients can then determine which
expenses they can reduce after retirement, based on their desired lifestyle.
DETERMINING THE SAVINGS REQUIRED TO GENERATE THE DESIRED LEVEL OF INCOME

AT RETIREMENT
An essential part of the retirement planning process is creating an estimated budget to ensure that income during
retirement is sufficient to meet expenses. The first step in the process is to review the client’s income sources and
expenses to estimate the amount of income available. Next, you must review the client’s retirement objectives and
determine the amount of savings required to generate the income needed to meet those objectives. Throughout
the process, you must also deal with inflation and taxation, two key components that could impact your client’s
retirement lifestyle and standard of living.
In this section, we use a client scenario to illustrate this somewhat complex process. You will have the opportunity
to conduct a retirement income needs analysis and provide advice to the client.

ESTIMATING INCOME AND EXPENSES

Seema, age 50, is a community college professor who currently earns $80,000. She expects to retire at 65 with a
total pension income from all sources of $94,210 (based on a pension projection supplied by the college that takes
inflation into account). She wants to keep both her house and cottage, and she plans to do some travelling. Besides
her pension, she has $50,000 in a non-registered investment portfolio.
Assumptions:
• Investment rate of return is 5%.

• Inflation is 2%.
• All future savings will accumulate in a non-registered account.
• Tax rates:
Working period or accumulation phase Retirement period

Average tax rate 26% 25%
Marginal tax rate 41% 37%
Seema’s estimated current budget is shown in Table 13.3.
Table 13.3 | Current Income and Expenditures
Income
Total income: employment $80,000
Income taxes: federal and provincial @ 26 % tax rate $20,800
After-tax income $59,200
Expenditures
Housing: property taxes, utilities, maintenance, and improvements $12,200
Cottage upkeep, taxes, and utilities $4,000
Clothing $3,000
Food $7,800
Vehicle: car repair and maintenance, instalment payments, and gas $8,000
Charitable contributions $1,500
Insurance: auto, property, and liability $2,500
Medical and dental care $1,800
Entertainment: vacations, movies, plays, concerts, sports events, and entertaining $17,204
Total expenditures $58,004
Surplus or (deficit) $1,196

When creating an estimated budget for retirement, you can estimate your clients’ expected retirement expenses
in today’s dollars by modifying their current expenses to reflect their expected needs. Because expected needs are
based on their retirement goals, you can help your clients estimate expected expenses by considering how their
current lifestyle might change.
For this case, we suppose Seema’s expected retirement expenses are similar to her current expenses of $58,004.
After analyzing her current expenditures, you estimate her total annual inflation-adjusted expenses in retirement to
be $78,066, which leaves a shortfall of $7,409 (as shown in Seema’s estimated projected budget in Table 13.4).
Table 13.4 | Projected Retirement Income and Expenditures
Income
Total income: employer and government pensions $94,210
Income taxes @ 25% average tax rate $23,553

Note: The estimate should be based on the clients’ average tax rate rather than
their marginal tax rate. The average tax rate (i.e., total income tax paid divided by
taxable income) provides an accurate measure of the client’s actual tax burden,
whereas the marginal tax rate only applies to the client’s last dollar of income.
After-tax income from all sources $70,657
Expenditures
Total expenses inflated at 2% to age 65, calculated as PV = 58,004, N = 15, I/Y = 2, $78,066
PMT = 0, COMP FV
Total expenditures adjusted for inflation $78,066
Surplus or (deficit) ($7,409)
MEETING THE SHORTFALL

Seema must develop a plan to meet the income shortfall of $7,409 by first determining her savings required at
retirement. The amount required to meet this shortfall can be calculated based on three values:
1. The amount of additional savings needed given Seema’s expected retirement age of 65 and a life expectancy
of 90
2. The value of personal savings at retirement based on an after-tax rate of return
3. The annual savings made during the 15-year period of accumulation, also based on an after-tax rate of return
In calculating the additional savings needed (item 1), we take a conservative approach using an after-tax real
rate of return instead of the real rate of return. Because the real rate is net of inflation and tax, we can use it to
discount a stream of payments, which will neutralize the impact of inflation and taxes. More information on both
the real rate of return and the after-tax real rate of return is available in the Appendix at the end of this chapter.
The calculation of Seema’s savings required at retirement is shown in Table 13.5. Note that amounts are rounded to
the nearest dollar.

Table 13.5 | Determining Savings Required for Retirement
Annual income needed from investments $7,409
Savings required by retirement date, in current dollars, $160,577

calculated as PMT = 7,409, I/Y = 1.13*, N = 25, FV = 0, COMP PV
* After-tax real rate of return (during the retirement period) =
{(1 + [0.05 × (1 − 0.37)]) / (1 + 0.02)} − 1 = 0.0113 × 100 = 1.13%
• 37% is the marginal tax rate used in the retirement period. The marginal tax rate
applies to each additional dollar of income a taxpayer earns.
Value of personal savings at retirement, calculated as PV = 50,000, I/Y = 2.95*, N = 15, $77,333
PMT = 0, COMP FV
* After-tax rate of return = 5 × (1 − 0.41) = 2.95%
• 41% is the marginal tax rate used in the working period or accumulation phase.
Amount of savings required to cover the deficit, calculated as $160,577 − $77,333 $83,244
Savings required each year, calculated as FV = 83,244, I/Y = 2.95, N = 15, PV = 0, $4,492
COMP PMT
From this calculation, we can see that Seema will need to save $4,492 each year from now until she retires to meet
her retirement goal. However, the government pensions included above (CPP or QPP and OAS) will be indexed for
inflation each year; therefore, this calculation is a conservative analysis of Seema’s required savings.
ASSESSMENT AND REQUIRED ACTION

We can use either of two ways to assess Seema’s situation: one based on assets; the other based on income. Both
methods lead to the same conclusion.
ASSET APPROACH
For the asset approach, an analysis of Seema’s situation (shown in Table 13.5) reveals that she will need savings of
$160,577 at retirement. However, based on present savings, her projected accumulated savings at retirement are
expected to be worth only $77,333. The shortfall is estimated as follows:
• Required savings: $160,577

• Projected savings: $77,333
• Shortfall: −$83,244
Therefore, Seema must begin saving an extra $4,492 every year from now until age 65 to ensure that she will have
the required amount at retirement.
INCOME APPROACH
Using the income approach, we arrive at the same conclusion (shown in Table 13.6 below).
Between her expected annual retirement income of $94,210 and her annual retirement expenditures of $101,619
($78,066 + $23,553), Seema will have an annual shortfall of $7,409. She can withdraw from her personal
savings − expected to be worth $77,333 at retirement − $3,568 a year for 25 years (assuming the remaining savings
grow at a 1.13% after-tax real rate of return). It will make up some of the $7,409 shortfall, but she will still have a
deficit of $3,841 per year. After 25 years, her savings will be fully depleted.

The yearly payment and the deficit are calculated as follows:
Table 13.6 | The yearly payment and the deficit
Annual shortfall $7,409
Annual payment from her personal savings, calculated as PV = $77,333, N = 25, I/Y = 1.13, $3,568
FV = 0, COMP PMT
Deficit, calculated as $7,409 − $3,568 ($3,841)
Seema will need to save $83,244 (calculated as $160,577 − $77,333) to generate the $3,841 (calculated as
PV = $83,244, FV = 0, I/Y = 1.13%, N = 25, COMP PMT). As we saw in our discussion of the asset approach, annual
savings of $4,492 for the next 15 years will fund the deficit of $3,841 for 25 years.
REQUIRED ACTION
Whether the income or asset approach is used, further action involving any or all of five options will be necessary:
Option 1 If Seema manages to save an additional $4,492 per year and puts that amount in an
investment that earns a 2.95% after-tax rate of return, she can retire on time.
Option 2 Assuming Seema has not made any TFSA contribution, an obvious option is to first
transfer her $50,000 personal savings to a TFSA, where the funds will grow tax-free
at 5%. Considering that she will still have unused contribution room of $31,500 in 2022
($81,500 − $50,000) and that the contribution limit increases annually by $6,000, she
should invest annual savings in a TFSA.
Option 3 If she cannot save additional funds, she may still be able to meet her retirement goal. To
succeed, her savings must grow faster than the estimated 2.95% after-tax rate during
her accumulation period, as long as it fits with her risk profile. Transferring her savings to
a TFSA is a first step in the right direction.
Option 4 She can reduce her expected annual expenditures during retirement.
Option 5 She can extend her planned retirement age beyond age 65.
Option 6 She can convert assets to cash at some point in the future. For example, she can sell the
cottage at age 75 and put the proceeds into her investment portfolio.
RETIREMENT INCOME NEEDS ANALYSIS
How do you determine a client’s income needs for retirement? Complete the online learning activity to

TAX-MINIMIZATION STRATEGIES
4 | Recommend strategies to minimize taxes payable in retirement.
Taxation of income continues even after your clients stop working. However, tax planning can help them keep
more of what they earn. Although opportunities to minimize tax seem to become more limited every time tax
rules change, some tax planning strategies remain available for retirees. In this section, we discuss some of those
strategies.
DID YOU KNOW?
Retirement income from the following sources is fully taxable in the recipient’s hands:
• CPP or QPP payments

• OAS payments (but not GIS payments)
• Employer pension plan benefits
• Lump sum withdrawals from an RRSP
• Payments from a registered retirement income fund (RRIF)
• Payments from annuities purchased with an RRSP
• Pension income received from a foreign country
BUILD A TAX-EFFECTIVE PORTFOLIO

During retirement, clients gradually draw down their registered assets and draw on the income generated by non-
registered sources. Tax-free compounding can continue with annual contributions to the TFSA as the limit increases
each year. Your clients should consider the tax treatment of income from the different sources. They can optimize
their after-tax rate of return in retirement through effective use of these investment vehicles. Furthermore, they
should give careful thought to the investment assets held within each vehicle.
By adjusting the target asset allocation, equity investments that offer tax-preferred treatment (i.e., Canadian source
dividends and capital gains) should ideally be held outside registered plans. Short-term, fixed-income investments
intended to generate income for current non-discretionary expenses are typically held inside a RRIF or a TFSA.
TAX LOSS SELLING

Tax loss selling is the realizing of capital losses on investments to offset realized capital gains from other
investments. Although a loss may be disappointing, the ability to use it against a taxable capital gain can help to
reduce the overall tax bill for the year.
PAY QUARTERLY TAX INSTALMENTS

Clients can set up automatic cash deposits that are paid directly into their bank account each quarter. In that way,
their tax instalments can be paid on time, and they can avoid tax penalties and interest charges.
MINIMIZE THE LIFETIME TAX LIABILITY

You can help clients minimize their lifetime tax liability by reviewing their schedule of future income flows, their
income needs, their annual tax bill, and the projected tax liability when they die. You should assess their current
and future tax bracket and plan to recognize income in such a way that can minimize their overall tax bill. Clients

must understand the tax liability that can arise upon their death. At that point, there is a deemed disposition at fair
market value for all assets other than those left to a spouse. The deemed disposition can trigger taxable capital gains
and the inclusion of registered amounts as income in the deceased person’s final tax return.
TRANSFER THE AGE CREDIT TO A SPOUSE

Clients can transfer the unused portion of the age credit, if any, to a spouse with available room. A tax credit may
remain unused when a client does not have sufficient taxes owing to use all of the non-refundable tax credits. The
age credit is provided to those 65 years of age and older and will provide tax savings of 15% on $7,898 in 2022
(federal only). The age amount begins declining when net income reaches $39,826 (for 2022) and is fully eroded
when net income is $92,479 or more. This tax credit depends on each individual’s net income, not that of the
couple. Provinces may offer a separate age amount tax credit.
ESTABLISH RRIF WITHDRAWALS

Withdrawals from a RRIF can be made based on the age of the younger spouse. This tactic results in a lower
minimum withdrawal limit each year, which allows the couple to keep more savings in the RRIF for a longer period.
It enhances the tax-deferral properties of the RRIF and keeps current taxable income lower. Therefore, it reduces the
tax liability and makes it more likely that the couple will qualify for income-tested government benefits.
The starting date when clients must begin making minimum withdrawals from a RRIF is based on the age of the
spouse who is the annuitant of the registered account. This rule does not change if the older spouse holds the RRIF,
but the amount of the minimum withdrawals can be based on the age of the younger spouse. It is a good strategy
to base the minimum withdrawal on the age of the younger spouse because it may provide an opportunity for
continued tax efficiency. A client who needs more money from a RRIF can choose to withdraw an excess amount.
DID YOU KNOW?
All registered accounts must be converted to a retirement option, such as a RRIF, by December 31 of
the year in which the annuitant turns age 71.
GIVE TO CHARITY
Clients can offset some of their taxes payable by using the non-refundable tax credit for charitable donations.
Donations of publicly traded securities provide a significant tax advantage to the contributor. The donor receives
a tax credit based on the fair market value of the shares on the day they were donated. However, if an unrealized
capital gain accrued on these shares, the gain is not subject to tax upon contribution to the charity. It is therefore
advantageous to contribute the shares directly, rather than selling them first and then donating the cash to the
charity. By selling them first, the donor becomes liable for income tax on the realized taxable capital gain.
In addition, taxpayers who are in the top tax bracket – that is, having taxable income of more than
$221,708 in 2022 – could receive an extra tax credit on charitable donations, from 29% to 33%. A client who has
taxable income in the highest tax bracket will be eligible for an enhanced charitable donation tax credit. Normally,
one receives 15% of the first $200 and then 29% on the remainder. As a high-income earner, the upper threshold
is 33% on the remainder (prorated for the proportion of income in excess of $221,708).
TAKE ADVANTAGE OF THE PENSION INCOME TAX CREDIT

Clients who are 65 or older are eligible for a $2,000 pension income tax credit on income from a company pension
plan, a registered annuity, or a RRIF. Even if they do not require the income, clients without a pension plan should
consider converting enough of their RRSP (or spousal RRSP) to a RRIF or an annuity to create $2,000 worth of
eligible pension income. Clients who receive pension income in excess of $2,000 from a spouse through the

provisions of pension income splitting are also eligible for this tax credit. Clients who do not have a pension plan
or RRSP, who have never worked, or who have held most of their assets inside a holding company often miss this
opportunity.
SPLIT SPOUSAL INCOME

Couples can minimize their combined tax liability by splitting their eligible retirement income during retirement.
Before income is shifted to the lower-income spouse, the couple should calculate whether the shift will result in
other benefits being reduced for that spouse. Generally, the equalization of retirement income between spouses
results in substantial tax savings and improved disposable income. Some income-splitting strategies are discussed
below.
SHARE CPP/QPP PENSION BENEFITS

Both CPP and QPP allow spouses to share their benefits. Up to 50% of benefits earned during the couple’s period of
cohabitation can be transferred to the lower-income spouse. Both spouses must agree and must be at least 60 years
old. If either spouse shares their pension benefits, a portion of the other spouse’s CPP or QPP is assigned
automatically back to the first spouse. The amount that can be shared is based on the length of time the couple
lived together as a proportion of their contributory periods, to a maximum of 50%. The greater the difference in the
tax rates of the spouses and their CPP or QPP entitlements, the greater the benefit of sharing.
SPLIT PENSION INCOME BETWEEN SPOUSES

Canadian residents who receive income that qualifies for the pension income tax credit can allocate up to 50% of
that income to a resident spouse or common-law partner. For clients who are 65 years of age or older, qualifying
income includes RPP payments, RRSP annuity payments, and RRIF payments. For clients under age 65, eligible
pension income primarily includes RPP payments and other payments received as a result of the death of their
spouse. By transferring pension income, clients may be able to avoid the OAS clawback and reduce the average tax
rates of both spouses. However, the transfer may also result in the reduction or loss of income-tested tax credits for
the lower-income spouse, such as the age tax credit or medical tax credit.
A higher-taxed spouse can also shift income-producing assets to a lower-taxed spouse. However, if the taxpayer
simply hands a portion of income or property to a spouse, the Canada Revenue Agency’s income attribution rules
will be triggered. Those rules dictate that income from the shifted assets should be taxed in the hands of the original
spouse.
To avoid the income attribution rules, the assets can be transferred to the lower-income spouse for fair market
value. The lower-income spouse can take a loan from the higher-income spouse and invest the proceeds. The loan
must bear interest at the CRA-prescribed rate. As long as interest is paid in the year of the loan or by January 30 of
the following year, the income earned on the invested assets will be taxed in the hands of the recipient (lower-
income spouse). That spouse can deduct the interest paid on the loan as long as the loan proceeds are used to
acquire an asset expected to generate taxable income. The higher-income spouse must claim the interest earned on
the loan as taxable income.
TRANSFER MONEY TO COVER INTEREST ON INVESTMENT LOANS

A client could consider giving cash to pay the interest on any investment loans obtained by the lower-income
spouse. The investment income is then taxed at a lower marginal tax rate.
SWAP ASSETS WITH THE SPOUSE

Clients can sell some investments to a lower-income spouse in exchange for another asset. The asset taken back
should be worth at least as much as the investments being handed over and should not produce an income of any
kind. Assets that qualify include jewellery, artwork, and coin collections (or other collections) owned clearly by the

spouse. For tax purposes, however, any swap is considered to be a sale at fair market value. The asset’s owner may
have to pay on accrued gains when the swap is made.
TRANSFER PERSONAL TAX CREDITS

In some cases, lower-earning spouses can transfer non-refundable, personal tax credits to the higher-income
spouse. Four credits, in particular, can be passed to a client’s spouse: the age credit, the disability credit, the pension
credit, and, if the spouse attends a qualifying post-secondary school, the tuition credit.
PAY HOUSEHOLD EXPENSES THROUGH THE HIGHER-INCOME SPOUSE

Perhaps the simplest technique for splitting income is to have the higher-income spouse pay household expenses,
thus freeing up the other spouse’s income for investment. The lower-income spouse will pay tax on those
investment earnings at a lower marginal tax rate than that of the spouse in the higher tax bracket.
INVEST INHERITANCES IN THE RIGHT NAME

Any inheritance received by a lower-income spouse should be kept separate from any joint accounts or assets
the couple has. As long as the inherited money is invested solely in the name of the lower-income spouse, the
investment income will be taxed in the hands of that spouse alone. Likewise, when money has been left to both
partners, the lower-income spouse should keep his or her portion distinct and separate, allowing it to be taxed at a
lower marginal tax rate.
CONTRIBUTE TO A SPOUSAL RRSP

A higher-income spouse can contribute to a spousal RRSP in the name of the lower-income spouse if the higher-
income spouse has sufficient RRSP contribution room. This strategy can be maintained until December 31st of the
year that the lower-income spouse turns 71. As long as the funds remain in the spouse’s RRSP for the remainder
of the year of contribution, plus two full calendar years after contribution (January 1 to December 31), any monies
subsequently withdrawn are taxable in the lower-income spouse’s name. This strategy can be effective in retirement
to help equalize retirement incomes. This strategy is often overlooked today because income from an RRSP annuity
or RRIF can be split under the provisions of pension income splitting. However, the spousal RRSP has been in
existence for many years, and pension income splitting is a relatively new policy that may be eliminated under
future government platforms.
REPORT THE SPOUSE’S DIVIDEND INCOME ON THE CLIENT’S TAX RETURN

In certain circumstances, it can make sense for the higher-taxed spouse to report all of the other spouse’s dividends
on his or her tax return. By doing so, the client will reduce the lower-taxed spouse’s income and increase the
spousal tax credit entitlement. In fact, the client will be allowed to make this election only if it increases the spousal
tax credit. The higher-taxed spouse will also be entitled to claim a dividend tax credit on the dividends reported.
Therefore, the family could save hundreds of dollars in tax by making this election.
When a couple transfers dividends from one spouse to the other, they will have to transfer all the dividends – they
cannot pick and choose which dividends to transfer. Transferring all the dividends to the higher-income spouse may
increase income enough to cause a clawback of OAS benefits. In such a situation, the client might want to avoid this
type of transfer.
TAX-MINIMIZATION STRATEGIES
What are some tax-minimization strategies to reduce taxes on retirement income? Complete the online

QUESTIONS TO CONSIDER WHEN ADVISING CLIENTS ON THE

RETIREMENT PLANNING PROCESS
5 | List the questions that an advisor should consider when advising clients on their retirement planning
process.
Many clients need help establishing goals for retirement and developing and implementing strategies on how to
meet those goals. As their advisor, you must be a resource who can provide information on the retirement planning
process, government pension programs, RPPs, and annuities. The following questions address some key items to
consider:
• How much monthly and yearly cash flow will be needed in retirement to fund a client’s desired lifestyle?
• What sources of income are available to support the client or household in retirement – government and
employer pension plans, tax-sheltered investments, and non-tax-sheltered investments?
• What are the projected cash inflows and outflows in retirement?
• If there is a gap between cash inflows and outflows (i.e., more outflows than inflows), how will it be covered?
• Can the client adjust their desired lifestyle, delay retirement, adjust the risk level of their investment portfolio to
generate potentially higher returns, or build up more retirement assets through additional savings?
• Has the client considered different scenarios to determine when their retirement savings will run out?
• What are the characteristics of the retirement income stream? Is it an annuity or a lump sum? Is it indexed to
inflation?
• What is the value of personal, employer, and government retirement plans?
• How certain are the benefits from government-sponsored retirement programs, and what is their impact
on cash flows?
• Can the investment portfolio be re-ordered to match the client’s time horizons, income needs, and risk profile?
• How will any shortfall be made up between now and retirement?
• Can the client make additional contributions to their employer’s registered pension plan, and has the client
weighed this opportunity against the alternative of contributing to an RRSP?
• Is the plan being reviewed annually?
• Has the client optimized their RRSP contributions and used up previous contribution room as soon as possible?
• Has the clients used their TFSA to the greatest extent possible?
• Have they split RRSP contributions over multiple tax years to reduce annual tax bills?
• What income-splitting strategies can be used to reduce taxes, both currently and in retirement, to help existing
and planned savings go further?
All these questions should be considered in the context of a financial plan. A complete financial plan will help clients
better understand their financial options. It will also give them peace of mind about their future prospects.

At the beginning of this chapter, we presented a scenario in which Peter and Ruth Miller asked you how they
could maximize their retirement income through their various income sources. They also wanted advice about
leaving behind a sizable estate to their children and grandchildren.
Now that you have read the chapter, along with the relevant chapter in KPMG’s Tax Planning guide, we’ll revisit
the questions we asked and provide some answers.
• What key steps should you take to ensure that the Millers have a proper retirement plan?
• The retirement planning process should include determining the Millers’ retirement objectives, particularly
what lifestyle they are hoping to achieve, key activities they wish to pursue, and, ultimately, what income
they will require.
• An understanding of the Millers’ non-financial concerns and issues is just as important as financial issues.
• After retirement income needs are established, based on your clients’ objectives, an investment plan must
be established to meet those objectives in the most tax-effective manner.
• If you identify a shortfall in the Millers’ retirement budget, what strategy can you use to address it?
• A shortfall between objectives and available cash flow may require that lifestyle aspirations be re-evaluated,
deferred or abandoned to find ways to close the gap. For example, plans to travel extensively in retirement
may have to be shelved, postponed, or curtailed.
• In addition to the financial considerations, what other issues should you think about as you work with the Millers
to create a retirement plan?
• In addition to the financial considerations, you must consider the personal opinions and emotional
biases of the Millers throughout the retirement planning process. For instance, the Millers wish to leave
a substantial legacy to their children and grandchildren. This is, in many respects, an emotional decision
that would have financial implications. It may also indicate that the Millers prefer not to use annuities and
instead rely on RRIFs and non-registered assets for a large portion of their income in retirement.

SUMMARY
In this chapter, we discussed the following key aspects of the retirement planning process:
• At its most basic level, retirement planning requires five steps: (1) set retirement objectives, (2) determine
financial status, (3) estimate total retirement income sources and needs, (4) establish an investment plan, and
(5) evaluate progress.
• A retirement needs analysis should take the following lifestyle issues into consideration: family issues, health
challenges, lifestyle goals, work options, and legacy opportunities.
• Strategies for lifelong income might include a life annuity only, an investment portfolio only, or a combination
of the two. Retirement budgeting should factor in all three sources of expected retirement income: government
programs, employer pensions, and savings. You should help clients create an estimated budget to ensure that
income during retirement is sufficient to meet retirement expenses. Three planning methods to address a
budget shortfall are tax-advantaged investing, adjustments to spending and saving, and asset allocation.
• Tax-minimization strategies include tax loss selling, paying tax in quarterly instalments, minimizing the lifetime
tax liability, transferring the age credit to a spouse, making withdrawals from a RRIF based on the age of a
younger spouse, giving to charity, taking advantage of the pension income tax credit, and pension income
splitting with a spouse.
• As an advisor, you must be a resource for your clients, providing advice and information on the retirement
planning process, government pension programs, RPPs, and annuities.
NOTE
DISCUSSION BOARD
for Chapter 13.
REVIEW QUESTIONS
Questions.

APPENDIX 13 – RETURN MEASURES

All return measures described so far have been nominal return measures, which are returns calculated without
taking into account the effects of taxes and inflation. The dollar amounts in a nominal return include reinvested
income generated from the investment plus the security price at the end of the holding period. However, because
the investor must pay tax on the returns from different sources, which may have lost some purchasing power
because of inflation, the nominal returns do not represent the true return on investment. Therefore, as an advisor,
you must be able to tell your clients what they actually earned. In other words, you must be able to calculate the
after-tax return and real return (i.e., returns after inflation is accounted for).
AFTER-TAX RETURNS
After-tax returns can be difficult to calculate because, in Canada (and in many other countries), different sources of
return are taxed at different levels. The different sources include realized and unrealized net capital gains, dividends,
and interest.
In Canada, unrealized capital gains are usually not taxed, and 50% of realized capital gains (minus any realized
capital losses) is taxed at the client’s marginal rate. Dividends from taxable Canadian corporations are subject to
a complicated “gross-up and credit” system, whereas interest and dividends from non-Canadian corporations are
taxed as ordinary income.
DID YOU KNOW?
In calculating after-tax returns, the portion of each return source that is included in ordinary income is
known as the inclusion rate. The inclusion rates for the different sources are as follows:
• 0% for unrealized capital gains

• 50% for realized capital gains
• 100% for interest income and dividends from non-Canadian corporations
An imprecise method commonly used to approximate a client’s after-tax return is to multiply the nominal return by
(1 minus the investor’s marginal tax rate) on ordinary income, as in Equation A.1.
Equation A.1 – Approximate After-Tax Return
Approximate After-Tax Return = (1 − Marginal Tax Rate on Ordinary Income) × Nominal Return
The marginal tax rate on ordinary income is the tax rate paid on the next dollar of ordinary income earned. For
example, suppose an investor has an 8% nominal return on his non-registered account and a marginal tax rate
of 40%. Using Equation A.1, this investor would have realized an after-tax return of 4.8%, calculated as (1 − 0.4) × 8%.
Keep in mind, however, that different sources of return attract different tax rates. Equation A.1 applies only if all
of an investor’s nominal return is in the form of interest income and dividends from non-Canadian companies.
Otherwise, the equation will likely understate the true after-tax return.
To calculate a more precise after-tax return, use the following four-step process:
1. Break out the nominal return into its different sources.
2. Multiply the investor’s marginal tax rate on ordinary income by the inclusion rate for each return source to
arrive at the marginal tax rate on each source.
3. Multiply the nominal return on each source by 1 minus its marginal tax rate to arrive at the after-tax return on
each source.
4. Add up the after-tax returns on each source to arrive at the investor’s after-tax return.

EXAMPLE
Investor’s After-Tax Return
Your client earns an 8% nominal return based on the following sources:
• 4% return from unrealized capital gains

• 2% return from realized capital gains
• 2% return from interest income
The calculation of this investor’s after-tax return requires three separate calculations, as shown in the following
table:
Marginal Tax on Each After-Tax Return
Nominal Inclusion Source (Based on 40% (Column 1 ×
Source of Return Return Rate marginal tax rate) [1 minus Column 3])
Unrealized capital gains 4% 0% 0% 4.0%
Realized capital gains 2% 50% 20% 1.6%
Interest income 2% 100% 40% 1.2%
Total 8% 6.8%
Note that this calculation is specific to each investor and each possible breakdown of the nominal return.
DID YOU KNOW?
For Canadians, the concept of an after-tax return is relevant only for the returns they earn on their
investments held outside their RRSPs and other registered accounts. Registered accounts are tax-
deferred accounts, which means no tax is paid on investment returns until money is withdrawn from the
plan. When money is withdrawn, the value of the withdrawals is considered ordinary income.
REAL RATE OF RETURN

Inflation manifests as a sustained increase in the price of goods and services over time, thereby reducing the
purchasing power of money. The real rate of return is the return an investor earns after the effect of inflation is
accounted for.
KEEPING UP THE PURCHASING POWER WITH INFLATION

The annual amount of income will have to increase yearly so that its purchasing power will keep up with inflation.
Because the required amount of the payments is not fixed over time, you cannot use the nominal rate (of interest
or return) to determine future value. Instead, you must determine the real rate of return to neutralize the impact of
inflation.
NOMINAL AND REAL RATES OF RETURN

The nominal rate of return is the quoted or stated rate on an investment.
Because inflation reduces the value of a dollar, the return received, that is, the nominal rate, must be reduced by the
inflation rate to arrive at the real rate of return. In other words, the real rate of return is the nominal rate of return
after adjusting for the effects of inflation.
The Fisher equation, below, depicts the relationship between the nominal rate, inflation, and the real rate of return.

Equation A.2 – Real Rate of Return
1 + Nominal Rate
Real Rate of Return = −1
1 + Anticipated Inflation Rate
EXAMPLE
If the nominal rate of return is 5%, and the expected inflation rate is 2%, then the expected real rate of return,
using the Fisher equation is given as follows:
1 + .05
Real rate of return = − 1 = 1.0294 −1 = 0.0294 × 100 = 2.94%
1 + .02
Although the investment grew by 5% in nominal dollar terms, prices increased by 2% over the same period. Thus,
the real rate of return on the investment is 2.94%. The real rate of return accounts for the loss of purchasing
power due to inflation.
ESTIMATED REAL RATE OF RETURN

Practically speaking, we can approximate the real rate of return by simply subtracting the inflation rate from a given
nominal rate. In our previous example, we would obtain an estimated real rate of return of 3% (5% − 2%), which
will tend to slightly overstate the real rate of return. This approximation works for small values, but it is best to use
the Fisher equation to obtain an accurate result.
USING THE REAL RATE OF RETURN

Because the real rate of return is net of inflation, we can use it to discount a stream of payments indexed to
inflation, which will neutralize the impact of inflation. In doing so, we will work with constant dollars, that is, dollars
whose value remains the same throughout the years.
NOTE
When seeking to determine which rates to use, remember that different types of income are taxed at different
rates. For example, employment income, pension income, RRIF income, and interest income are all taxed at
the highest marginal tax rate for the level of income, whereas dividend income is taxed at a much lower rate
(approximately one-third less), and only half of net capital gains is taxable. Therefore, when comparing different
types of investment income, look at the after-tax rates of return to be sure you are comparing rates on a like-
for-like basis.
Also, when estimating values out into the future, consider the effects of inflation on the buying power of those
values, so that, again, you are comparing like for like. After all, what we could buy for a dollar 20 years ago, we
cannot buy for a dollar today. Therefore, when valuing future payments, we must assess them using the real rate
of return (after inflation).
AFTER-TAX REAL RATE OF RETURN

The after-tax real rate of return takes both taxes and inflation into account. For this measure, you need to adjust for
tax before you adjust for inflation because taxes are based on the nominal return, rather than the real rate of return.
Equation A.3 can be used to calculate after-tax real rates of return.

Equation A.3 – After-Tax Real Rate of Return
1 + [Nominal Return × (1 − Marginal Tax Rate on Investment Earnings)]

After-Tax Real Rate of Return =
1 + Inflation Rate
EXAMPLE
Your client has a 37% marginal tax rate on investment earnings. During a period when inflation was 2%, the
client realized a return of 5% on his investments. Therefore, his after-tax real rate of return is 1.13%, calculated as
follows:
After-Tax Real Rate of Return = {(1 + [0.05 × (1 − 0.37)]) / (1 + 0.02)} − 1
= {(1 + 0.0315) / 1.02)} − 1
= 1.0113 − 1
= 0.0113 × 100
= 1.13%

Protecting Retirement Income 14
CHAPTER OUTLINE
In this chapter, we discuss several annuity-based products that are designed to provide an income stream for clients
in their retirement years. We explain how the various types of annuities work, including products that have annuity-
type features and benefits. We also describe some strategies for putting these products to work for suitable clients.
1 | Explain the role that annuities can play in a Understanding Annuities

client’s retirement plan.
2 | Distinguish between straight life, joint life, Types of Annuities

term-certain, and deferred annuities.
3 | Describe the various annuity options available
for specific solutions.
4 | List the issues that an advisor should consider
when recommending annuities.
5 | Identify the features that distinguish Segregated Funds

segregated funds from mutual funds.
6 | Explain the maturity guarantee feature of
a segregated fund.
7 | Explain the role that guaranteed minimum Guaranteed Minimum Withdrawal Benefit
withdrawal benefits can play in a client’s Contracts
retirement plan.
8 | Describe the types of guarantees available
with a guaranteed minimum withdrawal
benefit.
9 | Describe the benefits and costs of guaranteed
minimum withdrawal benefits.

KEY TERMS
death benefit guarantee lifetime withdrawal amount
deferred annuity longevity risk
guaranteed minimum withdrawal benefit maturity guarantee
guaranteed withdrawal amount participating annuity
guaranteed withdrawal balance prescribed annuity
impaired life annuity segregated fund
indexed annuity split annuity
individual variable insurance contract straight life annuity
instalment refund annuity structured settlement
integrated annuity term-certain annuity
joint life annuity variable annuity
life annuity with a cash refund

CHAPTER 14 PROTECTING RETIREMENT INCOME 14 • 3
INTRODUCTION
As Canadians live longer, their lives after retirement are also getting longer, and the cost of funding their retirement
is increasing. Many people approaching retirement or already retired live with the valid fear that they will outlive
their savings. With interest rates at historically low levels, many investments are not able to generate enough
income to fund a comfortable lifestyle. Other investments with more earning potential are simply too risky for that
stage of life. Retirees must therefore consider investments that can provide a reliable income during retirement. In
this chapter, we discuss several annuity-based investments designed for this purpose. All of these products have
insurance aspects; in fact, they are regulated as insurance products.
As an advisor, you should keep in mind that the costs of some of these products may neutralize the benefits for
certain clients. Furthermore, some clients are not qualified to buy certain annuity-based products because of
age restrictions. Nevertheless, annuity-based products are a suitable option for many clients and an important
component in many retirement plans. As such, you should be able to explain the products to your clients as a
possible solution to help support their retirement lifestyle and goals.
Before you begin, read the scenario below, which raises some of the questions you may have regarding annuities.
revisit the scenario and provide answers that summarize what you have learned in this chapter.
HELPING THE LEWIS-MAIERS ENJOY THEIR RETIREMENT
Having both stopped working at 60, Mark Lewis and Karl Maier are three years into their retirement. They have
settled into a comfortable lifestyle, splitting time between their home and their cottage, periodic travel, time
with family and friends, and golfing as the seasons permit. As an engineer, Mark still consults with clients on a
project-by-project basis. Despite how life is presently going for the couple, Mark remains concerned about his
family’s history of ill health. He fears he may live a shorter life than Karl, whose family history shows substantial
longevity. Mark has always been the main earner in their household.
Mark and Karl expected interest rates to rise; however, since their retirement, rates have actually come down.
Consequently, they are concerned about their portfolios, both registered and non-registered. They fear that they
are not invested in an appropriate manner to maximize their cash flow on a tax-effective basis. Mark is conflicted
about the need to enhance his after-tax cash flow while minimizing the depletion of the couple’s nest egg. His
growing fear is that their investment portfolios may not support their lifestyle for as long as they originally
thought.
• Given Mark’s concern about dying before Karl, what kinds of investment solutions might you consider to help
address this issue?
• What investment would you recommend and why?
• Considering that Mark is working as a consultant, what risk might arise for him? Are there specific investment
products that might reduce those risks?
UNDERSTANDING ANNUITIES
1 | Explain the role that annuities can play in a client’s retirement plan.
An annuity is a contract between two parties: the issuer and the annuitant (or policyholder). The issuer is usually an
insurance company and the annuitant is the person on whose life the annuity is based. The annuitant is usually, but
not necessarily, the policyholder.

The annuity issuer agrees to make regular payments to the annuitant in exchange for a stipulated premium deposit.
With immediate annuities, the policyholder pays a lump sum in exchange for the regular payouts. With deferred
annuities, premiums may be payable over time.
The payments to the annuitant may be fixed or variable and are guaranteed for a fixed period or life. Annuities can
be purchased with funds that are held in a registered plan, such as a registered retirement savings plan (RRSP), or
with funds from a non-registered account such as a guaranteed investment certificate (GIC) that has matured.
Annuities are available mainly through life insurance companies, although some trust companies and other financial
institutions are licensed to conduct certain types of annuity business in Canada. Annuities are designed to provide
insurance against longevity risk, which is the risk of outliving one’s retirement fund. Future annuity payments
are guaranteed to be made regardless of changes in financial markets and economic conditions. This guarantee,
however, is (largely) as good as the insurer making it. Annuity holders are protected to some degree against loss
under Canadian regulation (as explained below). Nevertheless, as an advisor, you should inquire into the financial
strength of the institution issuing an annuity to a client. The company’s stability is critical, given that annuity
payments may have to be made for several decades.
REGULATION OF ANNUITIES
Assuris is a non-profit organization that provides protection to policyholders in situations where an insurance
company becomes insolvent. Every life insurance company authorized to sell insurance policies in Canada is
required by federal, provincial, and territorial regulators to become a member of Assuris.
If a life insurance company fails, Assuris guarantees that the annuity policyholder will retain up to $2,000 per
month, or 85% of the promised monthly income benefit, whichever is higher.
Furthermore, the Office of the Superintendent of Financial Institutions is responsible for monitoring the solvency
of insurance companies and determining minimum capital surplus requirements. These government-imposed
requirements are designed to ensure that financial institutions, including insurance companies, have set aside
enough reserve capital to cover all future guarantees.
DID YOU KNOW?
Another organization that represents the interests of annuity holders to a certain extent is the Canadian
Life and Health Insurance Association (CLHIA). This organization is a voluntary, non-profit association
with member companies accounting for 99% of Canada’s life and health insurance business. CLHIA’s
purpose is to promote public policy, legislation, and regulation on behalf of its members. However,
it also has a responsibility to represent the best interests of the public.
TYPES OF ANNUITIES
2 | Distinguish between straight life, joint life, term-certain, and deferred annuities.
3 | Describe the various annuity options available for specific solutions.
4 | List the issues that an advisor should consider when recommending annuities.
There are four main types of annuities: straight life, joint life, term-certain, and deferred. Among these types, various
customizable options are available.

STRAIGHT LIFE ANNUITY

A straight life annuity pays the annuitant a guaranteed monthly or annual income until he or she dies, regardless
of how long the annuity was in place. Of all annuities, straight life annuities provide the most guaranteed income
per dollar of premium paid. However, when the annuitant dies, the payments stop, and no residual payment is
made to the annuitant’s estate or beneficiary.
EXAMPLE
Brian is a widower with no heirs. At age 70, he purchases a straight life annuity for $200,000. Brian will get
approximately $14,000 a year, or close to $1,200 a month, for the rest of his life. Payments will cease at
his death.
Straight life annuity payments are a blend of capital and income, which establishes a guaranteed lifetime cash flow
for an annuitant. The main advantage of a straight life annuity is that the annuitant cannot outlive his or her capital.
Only life insurance companies can issue straight life annuities.
A straight life annuity is suitable for the following clients:
• Those with no dependants, who wish to receive the highest available guaranteed payout for life, and are not
concerned with leaving an estate
• Those in similar circumstances, but with dependants who are fully provided for by other means, such as life
insurance policies
LIFE ANNUITY WITH A GUARANTEED PAYOUT PERIOD

The main drawback with straight life annuities is that payments cease at the death of the annuitant. An early
death could therefore result in a significant loss of capital for the annuitant’s estate. As an alternative, insurance
companies offer life annuities that provide payments over a guaranteed number of years. If the annuitant dies
during the guaranteed term, the annuitant’s beneficiary receives payments for the remaining years. If the annuitant
outlives the guarantee period, payments continue for the annuitant until death, but the beneficiary receives
nothing. The guaranteed payout period comes with a cost in that the monthly payment amounts are lower than
those for straight life annuities.
EXAMPLE
At age 65, Etienne purchases a life annuity with a 15-year guaranteed term. At age 72, Etienne dies of a heart
attack. His son Luc, as his beneficiary, continues to receive payments in the same amount for another eight years.
FACTORS AFFECTING A LIFE ANNUITY’S PAYOUT

Along with the type of life annuity selected, annuity issuers consider the following factors in determining the
amount of income they guarantee:
The annuitant’s state Whereas traditional life insurance is more expensive for a person in poor health, the
of health reverse can be true for annuities. Issuers may make higher payments if the annuitant’s
life expectancy is shorter.
The funds available The larger the lump sum invested in an annuity, the more income the annuitant
to buy the annuity receives in payouts.
The annuitant’s age All else being equal (e.g., health), a younger annuitant has a longer number of years to
live, so payments will be lower.

The table of mortality A mortality table shows death rates among members of a population based, on their year
used by the issuer of birth. From this information, insurers can estimate the probability of death at any given
age. There are numerous mortality tables available for use by life insurance companies.
The interest rate used A rate quoted when the annuity is purchased remains valid for the duration of the
to calculate the annuity annuity.
The cost of the The cost of the guarantee is based on a mortality or life expectancy factor.
guarantee
The frequency of the The more often payments are made, the lower they will be. Most commonly, payments
annuity payments are made monthly.
The sex of the Because women are expected to outlive men, payments are lower for a female
annuitant annuitant than for a male of the same age, given the same annuity.
DID YOU KNOW?
Interest rates are one of the most important factors in determining how much income will flow from an
annuity. In the 1980s, when rates were very high, annuities were offering high guaranteed payments. When
interest rates fell, along with guaranteed annuity payment amounts, the popularity of annuities waned.
Interest rates dropped to unprecedented levels in 2020 and 2021 due to the worldwide pandemic. The
reduced rates adversely affected payouts from annuities and returns on fixed income products such as GICs.
Since early 2022, interest rates have risen and with inflation, soaring higher than the Bank of Canada’s
targets, and more interest rate increases are expected. This upward trend in rates is positive for
annuitants and those fixed income investors who can invest when interest rates are higher.
JOINT LIFE ANNUITY

A joint life annuity (also called a joint and last survivor annuity) pays a married or common-law couple as long
as either spouse or partner is alive. When the annuity is first issued, the couple has a choice to make: when the
first spouse dies, the payment amount could remain the same or be reduced, generally to a third or half of the
original payment amount. If the survivor is to receive lower payments, the original payments are set higher than if
the payment amount stays the same after the first death. Whether full or reduced, the survivor receives monthly
payments for life.
EXAMPLE
Seven years ago, Farida and Mehernosh, both aged 75 purchased a joint life annuity with a 10-year guarantee
for $100,000. The annuity was designed to provide fixed payments of approximately $450 per month for both
their lifetimes. After five years, Farida died and Mehernosh continued to receive $450 per month. Two years
after Farida’s death, Mehernosh also died. Their daughter, Doha, who is their named beneficiary, will continue to
receive $450 per month for three more years (i.e., until the 10-year guarantee period is over).
TERM-CERTAIN ANNUITY
A term-certain annuity (also called a fixed-term annuity) provides the annuitant with a specified guaranteed
monthly or annual income for a specified number of years. The most common end date is age 90. If an annuitant
dies before the term ends, their estate or designated beneficiary receives the unpaid balance of the annuity. It may
be paid either as a lump sum or as instalment payments that continue for the duration of the term.

EXAMPLE
Mary, age 70, purchases a term-certain annuity for a 15-year term for $100,000. She will be paid approximately
$630 a month. If Mary dies at age 80, the monthly payment of $630 will continue to be made to her named
beneficiary for another five years. The payments will end after 15 years, whether or not Mary is still alive.
The payment amount on a term-certain annuity is based on interest rates and the length of the term. The longer
the term, the lower each annuity payment will be. Mortality tables are not used to determine the payment amount
because the payment amount is not related to the annuitant’s expected life span.
DID YOU KNOW?
Term-certain annuities can be issued by various financial institutions, not just life insurance companies.
DEFERRED ANNUITY
Whereas an immediate annuity begins payments very soon after the date of purchase, a deferred annuity allows
payments to be put off for several years. For annuities purchased with registered funds, payments can be deferred
no later than the end of the year the annuitant turns 71.
A deferred annuity can be for life or a fixed term, with payments made on a fixed or variable basis. Different types
of deferred annuities can have the payout guaranteed by the issuer. The issuer can also provide a confirmation of
monthly income that will be paid out later, based on the premiums paid into the annuity over the deferral period.
EXAMPLE
Lucy, age 55, purchased a deferred annuity with $200,000 from her savings. The deferral period is 15 years. Lucy
will earn investment income on the $200,000 deposited during the 15-year deferral period. When she turns 70,
the deferral period will end, and the income or payout phase will begin. Lucy will start receiving monthly annuity
payments for life or a fixed term, depending on which option she selects. The payout amounts will be based on
the original $200,000 plus income earned over the deferral period.
The size of the premium paid for a deferred annuity depends on factors such as how soon the annuitant wishes to
receive income payments and how much income is needed. The issuer of a deferred annuity may allow annuitants
to deposit different amounts each year if they prefer. During the deferral period, a competitive rate of interest is
credited, and an appropriate guaranteed payment period can be included for the payout phase.
Deferred annuities have the following tax considerations:
• Contributions to a non-registered deferred annuity are not tax-deductible.

• The opportunity to defer the tax payable on investment income earned within a deferred annuity is limited,
as follows:
• For annuities acquired or materially altered after 1989, accrued investment income must be included in
taxable income annually.
• For annuities in effect before 1990, accrued investment income must be included in taxable income at least
every three years.
• A deferred annuity can be surrendered at any time, and income tax is payable only on accumulated interest that
has not been included in income.
Regarding interest rates, a deferred annuity contract contains a written set of annuity rates for future use. If the
annuity issuer is using a higher set of rates when the annuity payout option is triggered, the annuitant normally
receives the higher rate.

DID YOU KNOW?
Money invested in a deferred annuity is invested with the expectation that it will grow. The annuitant
is given several investment choices with the issuing company. At the end of the deferral period, the
contract must either be cashed in or be converted into an immediate annuity.
Deferred annuities are similar to GICs in several ways:
• In both deferred annuities and GICs, the money invested is expected to earn a return in the form of interest.
• The interest earned is eventually returned to the investor.
• The returns depend on the term of the contract and the level of competition in the marketplace.
However, the two instruments also have important differences:
• With a deferred annuity, the annuitants purchase a contract and the money is invested on their behalf, whereas
a GIC is owned directly by the investor.
• Contributions to a deferred annuity may be reinvested at a guaranteed rate set out in the annuity contract,
whereas a GIC is reinvested at prevailing market rates when it matures.
• A beneficiary can be named in an annuity, whereas a non-registered GIC can only be passed on in a will.
DID YOU KNOW?
By naming a beneficiary, annuitants can pass on the proceeds of the annuity outside a will, thus allowing
probate fees on the proceeds to be avoided. Having a named beneficiary (such as a spouse, child,
grandchild, or parent) also allows the annuity contract to be protected from creditors.
ANNUITY OPTIONS
One annuity option, as mentioned, is a life annuity with a guaranteed payout period. These annuities make
payments for a defined period, even if the annuitant dies within that period. However, the longer the guarantee
period, the lower the payments will be for the same premium amount.
Annuities are offered with a wide range of other options designed to provide specific solutions for differing financial
priorities. Annuity options include the following variations:
• An instalment refund annuity guarantees that, if the annuitant dies before having received the deposit
amount, income payments will continue to the beneficiary until the whole amount is refunded.
• A life annuity with a cash refund is similar to an instalment refund annuity, except that the beneficiary
receives a lump-sum cash refund of the unpaid balance if the annuitant dies early.
• An impaired life annuity is for people with reduced life expectancy because of illness. Medical evidence of the
impairment, such as a physician’s report, must be provided. The annuity payments are higher than those for
people of the same age without any health impairment.
• A participating annuity provides for increased payments to the annuitant if the investment yields are higher
than expected or if the issuing company’s expenses are lower than expected. These annuities have a guaranteed
portion and a dividend portion.
• In an indexed annuity, payments increase each year in line with a formula, usually related to increases in the
cost of living. Payments in the early years may be much less than in later years, especially in annuities that have
a long duration. In comparison, income payments made in each period for most other types of annuities remain
the same.

• Under a variable annuity, the amount of monthly payment to the annuitant varies according to the value of
the investments in a segregated fund into which premiums are placed. Variable annuity contracts have a limit
(called a “floor”) below which benefits may not fall. The floor for benefits is usually equal to 75% of premiums
paid, regardless of what happens to the value of the fund. In fact, segregated funds and similar products are
considered forms of the variable annuity, as will be discussed later in this chapter.
• A split annuity is designed to meet the needs of a person who wants the guaranteed income of an immediate
annuity, but who is reluctant to deplete capital immediately. The funds available for annuity purchase are split
between an immediate, term-certain annuity and a single-premium deferred annuity. The term-certain annuity
provides a guaranteed income over a pre-determined period. When the income from that annuity ceases, the
full amount originally invested is designed to be available as a lump sum from the single-premium deferred
annuity.
• An integrated annuity is designed to allow early retirees to bridge the income gap until they receive benefits
from Old Age Security (OAS) and Canada Pension Plan (CPP) or Quebec Pension Plan (QPP). When early
retirees reach age 65, their annuity payments decrease by the amount of government benefits, applicable at the
time of purchase.
• A prescribed annuity overcomes uneven taxation by spreading the tax load over the life of the annuity. It
is available only if non-registered funds are used to purchase the annuity. Generally, payments from a non-
prescribed annuity (i.e., an annuity subject to accrual taxation) are heavily taxed in the early years because they
are made up of interest. In later years, the tax liability decreases as the capital is used up.
DID YOU KNOW?
When a prescribed annuity is purchased with money on which tax has been paid, the annuitant pays
tax only on the interest generated by the capital; the capital portion is tax free. In contrast, with an
annuity bought with matured RRSP proceeds, the full annuity payment is taxable in the hands of the
annuitant because contributions made to the RRSP were tax-deductible and the income in the RRSP has
accumulated on a tax-deferred basis.
Furthermore, the interest included in the annuitant’s income stays at the same level throughout the
prescribed annuity’s term. In the early years, the taxable amount is lower than that of a non-prescribed
annuity. This provision permits some deferral of taxes. To be considered a prescribed annuity, certain
conditions stipulated in the Income Tax Act must be met.
Given the many variations in the features and types of annuities, purchasers should seek expert advice before
buying an annuity. Furthermore, prices differ among issuers. As an advisor, you should be familiar with the various
types of annuities on the market, and their issuers, so you can make appropriate recommendations to your clients.
(Note that only advisors with a life insurance licence may sell life annuities.)
WITHDRAWAL RIGHTS AND MARKET VALUE ADJUSTMENTS

Deferred annuities generally allow for full or partial withdrawals, although a withdrawal charge may be levied. The
withdrawal may also have tax implications. An annuity issuer can impose a penalty for early withdrawal of invested
funds. The withdrawal charge will be stated in the annuity contract.
Withdrawal charges for deferred annuities are similar to the deferred sales charges levied when an investor redeems
units of a mutual fund. Both are intended to cover the issuer’s administrative, sales, and marketing costs and to
discourage the policyholder or investor from withdrawing the money.

EXAMPLE
Carlos has a deferred annuity worth $50,000 and wants to redeem all of the money three years before maturity.
The insurance company charges 2% of the amount of the withdrawal if made within three years prior to maturity. In
this case, Carlos would receive only $49,000, calculated as $50,000 – (2% × $50,000). If Carlos had redeemed the
annuity with four years left on the contract, the withdrawal charge might have been 3% of the amount withdrawn.
Market value adjustments are often made in addition to withdrawal charges. The amount of money that is returned
to the investor is adjusted to reflect any changes in interest rates from the time of the original investment. The
adjustment can be done in either of two ways:
• If a three-year term deposit is redeemed after one year, for example, the interest paid will be based on the one-
year interest rate at the time of issue (rather than on the three-year rate).
• Alternatively, if interest rates have gone up since issue, the insurance company will have to pay another annuity
purchaser a higher rate of interest for the same size of investment. Therefore, the annuity issuer will charge
a penalty for early withdrawal to adjust for the interest rates now available in the market. This adjustment is
similar to interest penalties charged for paying off a mortgage before the maturity date.
DID YOU KNOW?
Immediate annuities may be commutable or non-commutable. A commutable contract allows the

beneficiary to receive a lump-sum amount instead of a stream of regular payments from the annuity.
A present value calculation is done to determine the amount of the lump-sum payment. A non-
commutable contract does not allow future payments to be made as a lump sum. With some contracts,
commutation is permitted only in cases of severe hardship.
STRUCTURED SETTLEMENT
A structured settlement is the payment of money for a personal injury claim, in which all or part of the settlement
calls for future periodic payments. The payments are usually funded through an annuity purchased from a life
insurance company. Payments for the settlement of a personal injury or death claim are made tax free to the
claimant or, in the case of death, to his or her beneficiaries.
A structured settlement may combine an immediate lump-sum payment and a series of future periodic payments
specifically designated to meet the needs of the claimant. This arrangement recognizes that an injured person has
immediate cash needs and also requires future cash flow.
Instead of making a lump-sum cash settlement with a claimant, a casualty insurance company will often pay the
insurance proceeds directly to the issuer of an annuity. The issuer then becomes responsible for administering the
annuity and making payments to the claimant.
As legal awards continue to escalate, structured settlements based on annuity programs are financially attractive for
resolving expensive claims. Such programs provide benefits to all parties involved: the casualty insurer, the injured
party, and the annuity issuer.
The claimant in these cases derives the following advantages:
• Lifelong financial security regarding the future needs of the claimant or the claimant’s family
• Upfront cash for immediate needs
• Substantial tax savings (in that annuity payments from a personal injury settlement are tax free)
• Relief from the burden of investing and managing a large sum of money
• Protection from creditors and other parties (in that the annuity cannot be commuted, pledged, assigned,
encumbered, or transferred to other parties)

ANNUITIES FOR GENERATING RETIREMENT INCOME
What role do various types of annuities play in generating retirement income? Complete the online
ISSUES TO CONSIDER WHEN RECOMMENDING ANNUITIES

Some clients prefer a guaranteed cash flow during retirement, rather than risk counting on earning a rate of
return from an investment to generate enough cash flow. Annuities have some key features that may suit such
clients when planning for their future cash flow needs. You should ask your clients the following questions before
recommending annuities:
• How much yearly cash flow will the client need in retirement to fund the desired lifestyle?
• What is the value of benefits available from government-sponsored retirement benefits programs, including
OAS and CPP or QPP?
• What is the value of benefits available from employer-sponsored pension plans and private or registered plans,
such as an RRSP or a registered retirement income fund (RRIF)?
• How will any shortfall be made up between now and retirement?
• Can the investment portfolio be reordered to match time horizons, income needs, and risk tolerances?
• When will retirement savings run out under different proposed scenarios?
• Is the proposed asset allocation consistent with the client’s risk tolerance, time horizon, and objectives?
• Should the client increase or decrease exposure to equity investments?
• Has the most appropriate asset mix been chosen to match the client’s investment profile?
SEGREGATED FUNDS
5 | Identify the features that distinguish segregated funds from mutual funds.
6 | Explain the maturity guarantee feature of a segregated fund.
Segregated funds are investment pools similar to mutual funds, but with maturity and death benefit guarantees
provided to contract holders. The contract holder is the person who purchases the contract. The person on whose
life the insurance benefits are based is called the annuitant. As with annuities, the annuitant is usually the contract
holder. When the contract is held within a registered plan, such as an RRSP, the contract holder and annuitant must
be the same person.
A segregated fund is legally known as an individual variable insurance contract. It is essentially an insurance
contract that promises to pay the holder certain specified benefits based on the value of one or more specified
pools of assets. The life insurance company that issues the contract holds these asset pools separate from other
similar pools and from its general assets. A segregated fund gives a purchaser the right to choose among various
segregated pools.
Like mutual funds, segregated funds offer investors professional investment management, diversification, and the
ability to invest in small amounts. Segregated funds, however, also have unique features that enable them to meet
special client needs. Those features include a maturity guarantee, a death benefit guarantee, creditor protection,
and the ability to bypass probate. In this section, we focus on the maturity guarantee, which is often the main
reason for purchasing segregated funds.

Unlike other types of investment funds, segregated funds are regulated as insurance contracts by provincial
insurance regulators. Investors who buy a segregated fund do not actually own the fund’s underlying assets. Their
rights are based solely on the provisions of the insurance contract.
Because of the insurance benefits and guarantees they offer, segregated funds are more expensive for clients than
mutual funds. They tend to have higher management expense ratios (MER) than comparable mutual funds. Before
recommending a segregated fund to a client, you must weigh the benefits of segregated funds against their added
costs. You should also be aware that segregated fund contracts are only available through life insurance companies
and licensed life agents.
As with annuities, investors in segregated funds are protected by Assuris, which guarantees that, if the issuing
company fails, the contract holder will retain up to $60,000 or 85% of the promised guaranteed amounts,
whichever is higher.
STANDARDIZED RISK RATINGS

As of 2017, segregated funds are rated for risk in the same manner as mutual funds, using standard deviation.
The risk rating of the fund is determined by the standard deviation range of the fund, as shown in Table 14.1.
Table 14.1 | Risk Ratings of Segregated Funds
Segregated Fund Risk Rating Standard Deviation Range
Low 0 to less than 6
Low to Medium 6 to less than 11
Medium 11 to less than 16
Medium to High 16 to less than 20
High 20 or greater
The risk tolerance of the investor must match the risk rating of the fund. However, segregated fund contracts
have additional features such as maturity and death benefit guarantees, which could lower the overall risk of the
investment.
MATURITY GUARANTEE
One of the fundamental contractual rights associated with segregated funds is the guarantee that the beneficiary
will receive at least a partial return of the money invested. Provincial insurance legislation requires that the
guaranteed amount be at least 75% of the principal amount over a minimum 10-year holding period. Some
providers of segregated funds top up the maturity guarantee to 100%. This guarantee, whether full or partial,
appeals to people who want specific assurances about the return of the principal amount invested and a limit on
their potential capital loss.
NOTE
The guaranteed amount under the death benefit guarantee must also be at least 75% of the principal amount.
A maturity guarantee, particularly one that offers full protection after 10 years, alters the normal risk-reward
relationship associated with many investments. The guarantee allows investors to participate in rising markets
without a limit on potential returns. At the same time, subject to the 10-year holding period, the client’s invested
capital (i.e., the principal amount) is protected from losses.

The maturity date of a segregated fund contract is a critical component of the contract because the maturity
guarantee comes into effect on that date. The maturity date is normally set 10 years from the contract date and, by
law, the guarantee cannot come into effect any sooner.
EXAMPLE
Suppose an investor decides to redeem a segregated fund contract eight years from the contract date. The
investor would be paid the market value of the segregated fund holdings, whatever that value may be on the date
of redemption. The maturity guarantee would not be triggered until the maturity date.
There are basically three types of maturity guarantees:
• A deposit-based guarantee gives every deposit made by the client its own guarantee amount and maturity date.
• A yearly policy-based guarantee makes recordkeeping simpler by grouping all deposits made within a 12-month
period and giving them the same maturity date.
• A policy-based guarantee (the most generous type) bases all maturity guarantees on the date the policy was
first issued.
With a policy-based guarantee, there may be restrictions on the size of subsequent deposits. The restrictions
are put in place to prevent clients from making minimal deposits at the time of the account opening, and much
larger deposits several years later. Doing so would effectively shorten the holding period required for the maturity
guarantee and increase the potential risk to the insurer.
Depending on the insurance company, a maturity guarantee may be based on either the entire portfolio of funds
held by a client or on each fund. A fund-by-fund guarantee is generally considered better for the client because
it allows the client to hold riskier assets. For example, a fund that invests in a single sector, such as Canadian
resources, is riskier than a balanced portfolio diversified among domestic and foreign equities and fixed income
securities.
To offer greater capital protection, some insurers increase the minimum statutory 75% guarantee to 100%.
The 100%-guaranteed funds levy higher MERs than the 75%-guaranteed funds to reflect the higher risk involved.
Furthermore, some insurers that offer a series of funds with a 100% maturity guarantee may require that clients
hold these select funds for a longer period (e.g., 15 years) to receive the guarantee.
WITHDRAWALS
Withdrawals from a segregated fund contract may be made at any time during the annuitant’s life. Guarantees do
not apply to amounts that are withdrawn or redeemed from a segregated fund contract before the maturity date.
The value of the guarantees is reduced by withdrawals, and the insurance company tracks the ongoing value of
the guarantees. Typically, when deposits are made periodically, withdrawals are made from the oldest units first.
A partial withdrawal of units purchased on a particular date reduces the guaranteed amount for the remaining units
that were purchased at the same time.
AGE RESTRICTIONS
Insurance companies offering 10-year maturity guarantees that exceed the statutory requirement of 75% impose
restrictions on who qualifies for the enhanced guarantee. Normally, the restrictions are based on age; in fact, a client
of a certain age might be excluded outright from buying a company’s segregated funds. Some firms may require
that the person on whose life the death benefits are based must be no older than 80 at the time the policy is issued.
Alternatively, purchasers might receive a reduced level of protection under the policy once they reach a certain age.
Depending on their age and requirements for death benefits, these restrictions can be a crucial consideration in
selecting a provider of segregated funds.
For the industry as a whole, provincial insurance legislation does not specify a maximum age limitation. However,
registered segregated fund contracts are subject to the traditional rule – that is, RRSP deposits must be withdrawn

or converted into an annuity or RRIF by the end of the year in which the contract holder turns 71. In many cases,
clients choose the RRIF option. For non-registered contracts, companies may set the maximum age for contract
ownership, such as 90.
RESET DATES
Segregated fund contracts have at least a 10-year term, and they may be renewable when the term expires,
depending on the annuitant’s age. If renewed, the maturity guarantee is reset for another 10 years.
Many insurers issuing segregated funds have added greater flexibility in the form of more frequent reset dates. In
some cases, holders of segregated fund contracts may lock in the accrued value before the original 10-year period
has expired and, in doing so, extend the maturity date by 10 years.
With some insurance companies or policies, the reset provisions are initiated by the contract holder; with others,
reset is an automatic feature of the policy. For optional resets, there are generally limits on the number of resets
allowed each year. There may be a fee charged for the reset option.
COST OF THE MATURITY GUARANTEE

Segregated funds incur costs similar to those incurred by mutual funds, such as sales commissions, switching
fees, trailer fees, and management expenses. In addition, segregated funds have costs related to their insurance
components, namely the maturity guarantee and death benefit guarantee they offer.
A contract holder’s use of reset provisions also contributes to costs. When the guaranteed amount is reset at a
higher level, the issuer becomes liable for the higher amount.
The MERs for segregated funds are higher than for comparable mutual funds. However, the cost of the insurance
component, and therefore the MER, is lower for a 75% guarantee compared to a 100% guarantee.
TAX TREATMENT OF THE MATURITY GUARANTEE

Payments from a segregated fund contract’s maturity guarantee are taxable. The amount of tax payable depends
on whether the proceeds (net of deductible charges, such as redemption fees) exceed the cost of the contract. The
proceeds of a contract are calculated as the market value of the segregated fund at redemption plus the value of the
guarantee received.
If more than one fund is part of the segregated fund contract, calculations are done for each fund separately.
The cost of the contract is known as the adjusted cost base (ACB). The ACB consists of the original amount
deposited plus any net income or capital gains allocated to the contract. Any capital losses are subtracted.
If the proceeds of the contract are less than the ACB, income tax is payable on the guaranteed amount. However,
the contract holder can use the difference between the market value of the segregated fund and the ACB as a
capital loss.
The tax treatment of maturity and death benefit guarantees can be very complicated. Clients should consult a tax
specialist to determine the way Canada Revenue Agency (CRA) would interpret the Income Tax Act in their particular
circumstances.
ADVISING A CLIENT ON SEGREGATED FUNDS
Can you apply what you learned about segregated funds to a client’s situation? Complete the online

GUARANTEED MINIMUM WITHDRAWAL BENEFIT CONTRACTS
7 | Explain the role that guaranteed minimum withdrawal benefits can play in a client’s retirement plan.
8 | Describe the types of guarantees available with a guaranteed minimum withdrawal benefit.
9 | Describe the benefits and costs of guaranteed minimum withdrawal benefits.
Over the years, the trend for employer-sponsored pension plans has shifted from defined benefit plans toward
defined contribution plans. Consequently, most of the risk associated with funding retirement income for life
has been transferred from the employer to their employees. As a result, investors began to seek other sources
of guaranteed income. This trend contributed to the popularity of guaranteed minimum withdrawal benefit
(GMWB) products. Guaranteed minimum withdrawal benefit products protect investors’ retirement savings from
downside risk while providing participation in the markets and the potential for market gains. These products have
maximum annual withdrawal limits, typically 3% to 5% of the guaranteed withdrawal balance. Restrictions depend
on the annuitant’s age when the lifetime withdrawal payments begin.
A GMWB is a hybrid vehicle composed of investments, insurance, and guaranteed income. It provides maturity and
death benefit guarantees along with an income guarantee. Traditional segregated funds typically attract investors
looking for maturity and death benefit guarantees. The GMWB investor is more likely to seek the guaranteed
income stream and the potential to increase the income amount with resets and bonuses.
A GMWB is similar to an annuity in that they both provide a predictable, steady stream of income for a specified
term or the life of the annuitant. However, with an annuity, the investor gives a lump-sum premium to the
insurance company in exchange for a guaranteed income. That income is calculated based on the premium amount,
age of the annuitant, and interest rates at the time of purchase. With a GMWB, the investor retains control of the
investment and has the option to cash out at the market value at any time, forfeit all guarantees, and terminate the
contract.
When an investor reaches retirement, losses in their portfolio can have serious consequences. During the
accumulation stage, good years and bad years tend to balance out, and investors generally have enough time to
ride out market fluctuations. During retirement, however, they do not have that luxury. Fear of serious losses at this
life stage contributed to the popularity of GMWB products. These products are designed to provide a guaranteed
income, regardless of how the markets perform, thus providing significant protection from market risk.
Guaranteed minimum withdrawal benefit products were introduced in Canada in late 2006, and most insurance
companies developed a competing product. The product’s features and benefits evolved in this competitive
environment, but also created additional costs for the insurer. These costs are reflected in GMWB fees charged to
the investor.
When GMWBs were initially launched in Canada, the guarantee was limited to 20 years. The insurer guaranteed
that investors would be repaid a minimum of 5% (or one 20th) of the principal. However, the investor also had
the opportunity to participate in the markets and potentially increase the income amount through resets, which
typically happened every three years. Resets allowed the investor to reset the guarantees if the market value
was higher than the original guaranteed amounts on the reset date. Some insurers offered income for life for the
annuitant, and some offered a joint and last survivor option.
THREE STRATEGIES
How can clients use annuities, segregated funds, and GMWBs to fund their retirement? Complete the

GUARANTEES ON A GMWB
A GMWB, as traditionally offered, has two phases: the savings phase (or accumulation phase) and the payout phase.
In the savings phase, a bonus of 3% to 5% (which may vary by company) is given to the investor for each year
during which no withdrawal is made. The bonus amount is based on the initial deposit amount. Therefore, as long as
the investor refrains from making withdrawals in the savings phase, the initial deposit could increase.
In the payout phase, the investor begins receiving income payments based on the guaranteed withdrawal amount
(GWA), which is defined below. This stream of income payments will not decline, regardless of market performance.
It lasts for a specified period or the annuitant’s lifetime, depending on which option was selected.
Three types of guarantees are offered with a GMWB:
• Income guarantee
• Maturity guarantee
• Death benefit guarantee
The income guarantee depends on the guaranteed withdrawal balance, which is 100% of the initial deposit
amount and represents the base on which income and bonuses are calculated. This amount does not fluctuate with
the market value. Additional deposits increase the balance dollar-for-dollar, and withdrawals within the allowable
amount for the year likewise reduce the balance.
Every three years, on the contract anniversary date (i.e., the date of the first deposit), the guaranteed withdrawal
balance is compared to the market value on that date. If the market value is greater than the guaranteed withdrawal
balance, the balance is reset to the same amount as the market value. The reset allows an increase in guarantees
based on positive market performance. Income continues until the balance reaches zero (or, for contracts where
income is guaranteed for the life of the annuitant until the annuitant dies).
The income guarantee is represented by the GWA if the annuitant is under age 65. If the annuitant is 65 or older, it
is represented by the lifetime withdrawal amount (LWA). Therefore, the GWA is the guaranteed income amount
paid for a specified period and the LWA is the guaranteed income amount paid for the life of the annuitant. As
mentioned previously, this amount is typically 5% of the guaranteed withdrawal balance, either at the time of
initial investment or after resetting. If a withdrawal is made that is more than the GWA or LWA, the guaranteed
withdrawal balance is reduced proportionately and the GWA or LWA is recalculated based on the new guaranteed
withdrawal balance.
The death benefit guarantee is at least 75% of the initial deposit, but it can be as high as 100%. The death benefit
is the minimum amount that is guaranteed to be paid to the beneficiary. The amount is reduced proportionately for
withdrawals.
The key benefit of GMWBs is the income guarantee, rather than the maturity guarantee, which is often the
main objective for purchasing segregated funds. However, because GMWBs are a type of segregated fund, they
have a maturity guarantee as well, which is at least 75% of the initial deposit amount. The amount is reduced
proportionately for withdrawals.
NOTE
The GMWB plan provides a guaranteed income stream and the potential to increase that income based on the
performance of the underlying portfolio. However, when income is taken immediately, the return on invested
capital is affected by costs related to the GMWB. To benefit from a reset, the return would have to be greater
than the 5% withdrawal plus the MER and additional fees. For example, the investor may require a return of 9%
or 10% annually to realize a benefit.

Scenario | The GMWB as an Investment Alternative
Your client Donald has grown his RRSP portfolio over the years by taking advantage of an equity investing
strategy. However, now he is close to retirement and will need to supplement his pension income with a RRIF.
He plans to invest $200,000 in income-producing products but finds, to his dismay, that fixed income returns are
lower than he expected.
Donald does not want to be exposed to the risk of the stock market because he must depend on his RRIF income
to maintain a comfortable lifestyle. Nor does he want to invest in a portfolio of fixed income investments and be
exposed to inflation risk. Based on these concerns, you decide to explain how a GMWB plan may benefit Donald.
A GMWB guarantees, at a minimum, a flat income for a specified period or for life. Donald can choose the mix of
underlying investments that will fund his plan. The $200,000 he invests could pay him at least 5%, or $10,000,
per year for 20 years. Every three years, if the value of his underlying portfolio has increased, the guaranteed
withdrawal balance will be reset higher, to the same amount as the market value. This will result in potentially
higher income. However, the increase may not be high enough to cover the cost of the MER and additional fees.
You explain that Donald has the choice of a GMWB that offers guaranteed income for 20 years or one that
offers income for life. With either choice, upon his death, Donald’s beneficiaries will receive a death benefit of at
least 75% of the initial deposit, minus any proportional withdrawals. Attracted by the guaranteed payments and
the possibility of increasing his income, he decides to invest in the 20-year plan.
Table 14.2 illustrates how Donald’s GMWB could fare with the initial deposit of $200,000. Assuming he draws
income immediately, the guarantee ensures that he will receive at least 5% of the amount he has deposited
over a minimum of 20 years. The GWA can increase if the market value is greater than the guaranteed
withdrawal balance on the date of the triennial reset. However, the costs of MERs and additional fees must be
considered.
Table 14.2 | $200,000 Guaranteed Minimum Withdrawal Benefit Plan
Year Guaranteed Withdrawal Balance Market Value Guaranteed Withdrawal Amount
0 $200,000 $200,000 $10,000
1 $190,000 $193,800 $10,000
2 $180,000 $201,600 $10,000
3 $170,000 $205,000 $10,000
4 $205,000 $197,000 $10,250
5 $194,750 $186,000 $10,250
6 $184,500 $182,000 $10,250
7 $174,250 $174,000 $10,250
Note that resets are available in year 3 and year 6, as follows:
• Year 3: The market value ($205,000) is greater than the guaranteed withdrawal balance ($170,000).
Therefore, the guaranteed withdrawal balance is reset to $205,000 and the GWA becomes $10,250
(calculated as $205,000 × 5%).
• Year 6: The market value ($182,000) is less than the guaranteed withdrawal balance ($184,500). Therefore,
no reset occurs.

ADDITIONAL BENEFITS OF A GMWB

The benefits of a GMWB include the ability to bypass probate, potential creditor protection, and protection
by Assuris.
ABILITY TO BYPASS PROBATE

Like segregated funds, GMWBs offer an estate planning benefit in that, upon the death of the annuitant, the
proceeds bypass probate and are paid directly to the named beneficiary. Probate fees vary from province to province
and are calculated based on the total assets in the estate. By reducing the total assets in the estate, the amount
paid in probate fees is also reduced.
Furthermore, beneficiaries typically receive GMWB proceeds faster than proceeds that are paid into the estate.
Any investments held in the estate cannot be paid to beneficiaries until the estate has been settled. Similar to life
insurance policies, the named beneficiary of a segregated fund or GMWB contract can remain private and cannot be
contested.
POTENTIAL CREDITOR PROTECTION

Protection from claims by creditors is a major advantage offered by life insurance contracts, and also by segregated
funds and GMWBs. This is especially relevant for small business owners who may have to be personally liable for
debts, despite operating their business as a corporation. Because GMWBs are insurance products, they benefit from
creditor protection. However, it is important to note that if the contract was purchased to avoid actions taken by
creditors, it can be challenged. Certain beneficiary designations by the annuitant, such as spouse, parent, child, and
grandchild or any irrevocable beneficiary designation, solidifies the creditor protection.
Creditor protection is not available in the following instances:
• The segregated fund or GMWB contract has been assigned as collateral for a loan, in which case the lender has
the right to seize the assets in the case of default on the loan.
• Claims exist against the annuitant relating to child or spousal support.
• The annuitant is in arrears with CRA.
Although creditors have no right to the money paid to beneficiaries upon the death of the annuitant, they can make
a claim on any assets that make up the annuitant’s estate.
ASSURIS PROTECTION
The coverage for a GMWB policy by Assuris depends on whether the contract is in the savings phase or payout
phase. Assuris rules are as follows:
Savings phase The savings phase is defined as a contract where there has not been a withdrawal for at
least 12 months. Assuris provides coverage during this phase up to $60,000 or 85% of
the promised guaranteed withdrawal balance, whichever is higher.
Payout phase The payout phase is defined as a contract where a withdrawal has occurred in the
past 12 months. Assuris provides coverage during this phase up to $2,000 per month
or 85% of the promised guaranteed income benefit, whichever is higher.
COSTS OF A GMWB
The additional protection against downside risk provided by GMWBs comes at a high cost. Management fees for
GMWBs can be significantly higher than for other types of investment funds. The regulators require that insurance
companies have some adequate reserves to cover the guarantees, and these reserves are funded (at least in part)

by the fees charged to the contract holders. The fees charged are typically reflective of the percentage of the
guarantees (whether 75% or 100%). When comparing the fees charged by the various insurance providers, all the
benefits offered for the fee must also be considered.
Similar to mutual funds, segregated funds, including GMWBs, charge an MER for the funds held within the contract.
The MER for segregated funds is higher than it is for mutual funds to cover the cost of the guarantees. The premium
for a segregated fund versus a mutual fund can be anywhere from 25 to 100 basis points (0.25% to 1.00%).
In addition to the MER, GMWBs charge an annual fee. This fee ranges from 25 to 85 basis points, depending on the
risk level of the funds held in the contract over the course of the year. Conservative funds charge a fee on the lower
end of the range; growth funds charge a fee closer to the higher end of the range. The fees are charged by redeeming
units of the funds; however, this redemption is not treated as a withdrawal and does not make up part of the 5%
GWA or LWA.
The insurance component of GMWBs, which provides the benefits and guarantees, comes at an additional cost
through increased MERs and additional fees. The full cost of the MER and additional fees could be as high as 4%
or 5%. The fees are an important consideration when determining the value of the benefits and guarantees.
DID YOU KNOW?
Clients should be aware that GMWB costs are steep. In addition to significantly higher management
fees, penalties can decrease the guarantee if the client makes a withdrawal that exceeds the guaranteed
amount.
Furthermore, as an advisor (assuming you are licensed as a life agent), you should ask the GMWB issuer
to confirm whether the terms are fixed for the duration of the contract. Depending on the specific
contract, some aspects may be subject to change. For example, the insurance company may be able to
increase the fees they charge or increase investment restrictions on new money invested. Before clients
buy, they should be aware of any possible changes to the contract so they can decide whether they are
comfortable with those terms.
UNDERLYING INVESTMENTS
The assets within GMWBs are invested in segregated funds. In other words, the segregated pool of assets is
separated from other assets of the insurance provider. These segregated funds are often a fund-on-fund structure,
where the pool of assets in the segregated fund purchases institutional class units of the underlying mutual fund.
The daily net asset value is calculated based on this segregated pool of assets and is different from that of the
mutual fund. However, the performance of the segregated fund will track the same as the mutual fund.
In the past, insurance companies imposed a maximum allocation of 70% or 80% to segregated funds that invested
in equities within GMWBs. Because the insurer assumed risk by providing guarantees, it limited the exposure to
volatile investments. Currently, some companies do not even offer equity funds.
Although GMWBs provide additional protection against downside risk, the portfolio of funds should be consistent
with the risk tolerance of the investor.
TAX CONSIDERATIONS
Several types of transactions that occur in a GMWB contract may need to be reported for tax purposes. For non-
registered policies, these transactions include capital gains and losses resulting from fund switches and withdrawals,
fund closures, and distributions made by the fund. In addition, upon the death of the annuitant, the contract is
deemed to have been disposed of. Any resulting capital gains or losses from the deemed disposition must be
reported, in addition to any top-up added based on the death benefit guarantee. Clients should consult a tax
specialist to determine CRA’s interpretation of the Income Tax Act, as it applies to each circumstance.

SUITABLE INVESTORS AND ACCOUNT TYPES

Depending on their objectives and circumstances, some investors are more suited to a GMWB than others. For
example, a retired government employee with 35 years’ service and a robust defined benefit pension may not need
the guarantees of a GMWB. On the other hand, a retired, self-employed consulting engineer with no employee
pension plan may benefit from those guarantees.
Certain investors cannot invest in GMWBs because their age disqualifies them. The age limit imposed by insurance
companies, typically 75 or 80, applies to the initial sale of the contract. It is intended to mitigate some of the risk
inherent in the benefits and guarantees provided by a GMWB.
A GMWB is an appropriate investment for registered accounts, where the intention is to withdraw no more than
the GWA or LWA, or the minimum prescribed amount (prescribed under the Income Tax Act). Therefore, they are
suitable for an RRSP, a RRIF, a life income fund (LIF), or a locked-in retirement income fund (LRIF).
The minimum prescribed amount that must be withdrawn from a RRIF, LIF, or LRIF is a percentage of the market
value at the beginning of the year based on the owner’s age. This amount could be greater than the GWA or LWA,
depending on market performance and the owner’s age. (The minimum prescribed amount increases with age.)
In these situations, the insurance company is required to pay out at least the minimum prescribed amount from the
registered account, even if it is more than the GWA or LWA. Although a withdrawal over the GWA or LWA would
typically have a negative impact, there is usually no penalty levied in such a scenario.
As discussed earlier, the insurance component of a GMWB contract comes at a cost. Investors must feel that there
is value in the benefits and guarantees offered for the fees charged. Typically, risk-averse investors may be willing to
pay a premium for the additional downside protection. It is also important to note that withdrawals that exceed the
guaranteed amount could trigger penalties that could decrease the contract holder’s guarantee.
Clients should understand that GMWBs are complex products that can vary significantly from one insurer to
another. It is important that they have a thorough understanding of a particular product’s features and fees before
they buy it.
DID YOU KNOW?
A lot has changed since GMWBs were introduced in 2006. The 2008–09 global financial crisis resulted in
a huge decline in equity markets. Investment returns dropped precipitously, starting in the United States
(with its subprime mortgage crisis) and spreading throughout the world. The Toronto Stock Exchange’s
S&P/TSX Composite Index lost 35% of its value in 2008.
During that difficult period and in its aftermath, issuers of GMWBs were faced with the following
concerns:
• Solvency in the banking sector

• Plummeting returns on their investments (and even some sharp losses on the equity side)
• Demands from regulators for higher reserves to support the guarantees
In response, issuers cut back on GMWB offerings, increased fees, and reduced features and benefits.
As a result, GMWBs have become very expensive to offer and maintain. Several providers have even
discontinued this offering.
GMWB PRODUCT
How can clients use GMWB products to fund their retirement? Complete the online learning activity to

HELPING THE LEWIS-MAIERS ENJOY THEIR RETIREMENT
At the beginning of this chapter, we presented a scenario in which Mark Lewis and Karl Maier were looking for
advice about funding for their retirement. We asked you a few questions about what types of income-producing
investments they might consider. Now that you have read the chapter, we’ll revisit those questions and provide
some answers:
• Given Mark’s concern about dying before Karl, what kinds of investment solutions might you consider to help
address this issue?
• Mark and Karl could benefit from an annuity to ensure that their cash flow needs are met throughout their
lives. This product would also address Mark’s concern that Karl could outlive him. Furthermore, they could
opt for certain variations to meet their specific needs:
« As inflation rises, the purchasing power of a typical annuity’s cash flow will diminish. An indexed annuity
could help offset the erosive effects of inflation.
« With a joint and last survivor annuity, Karl would continue to receive annuity payments if Mark were to
die first. The couple could opt for reduced payments that would still meet Karl’s needs.
« With a participating annuity, payments to Mark and Karl would go up if rates and yields were to rise
substantially or if the insurer’s expenses were to decrease.
• What investment would you recommend and why?

• Given their relatively young age, Mark and Karl could also use GMWBs. If Mark were to die before Karl,
the GWA and the death benefit guarantee would suit their needs.
• The longer they chose to delay taking the income, the more their savings would accrue. Meanwhile, their
fears of a market downturn would be addressed. The GMWB would ensure that they always receive a
guaranteed minimum amount paid out promptly.
• If they chose the LWA benefit with a joint and last survivor option, there would be a guaranteed income
stream for both their lifetimes.
Keep in mind, however, that the protection and guarantees offered by GMWBs come with higher management
fees, additional costs, and potential penalties.
• Considering Mark is working as a consultant, what risk might arise for him? Are there specific investment
products that might reduce those risks?
• As an engineering consultant, Mark has a certain amount of liability exposure. He can use a segregated
fund to protect himself against claims. The product would offer other advantages as well, such as a
properly diversified portfolio, protection from losses, and maturity and death benefit guarantees. With
Karl as the named beneficiary, it would also reduce probate fees on the disposition of Mark’s estate if he
were to die first.

SUMMARY
In this chapter, we discussed the following key aspects of annuity-based financial products:
• An annuity is a contract between two parties, the issuer, and the annuitant. The issuer is usually an insurance
company, and the annuitant is the person on whose life the annuity is based. The annuitant is usually, but not
necessarily, the policyholder.
• There are four main types of annuities:
• A straight life annuity pays a guaranteed monthly or annual income until the annuitant dies. At that point, the
payments stop, and no residual payment is made to the annuitant’s estate or beneficiary.
• A joint life annuity pays a married or common-law couple as long as either spouse or partner is alive. When
the annuity is first issued, the couple has a choice to make: when the first spouse dies, the payment amount
to the survivor could remain the same or be reduced.
• A term-certain annuity provides the annuitant with a specified guaranteed monthly or annual income for a
certain number of years. The most common end date is age 90.
• A deferred annuity allows payments to be put off for several years. In the meantime, the deposit amount
earns investment income and keeps growing. For annuities purchased with registered funds, payments can be
deferred no later than the end of the year the annuitant turns 71.
• Among these types, various customizable options are available to provide specific solutions for differing
financial priorities.
• Segregated funds are investment pools similar to mutual funds, but with maturity and death benefit guarantees
provided to contract holders. They are essentially insurance contracts that promise to pay the holder specified
benefits based on the value of one or more pools of assets.
• Segregated funds come with a maturity guarantee and a death benefit guarantee such that the contract holder
or beneficiary will receive at least a partial return of the money invested. Provincial legislation requires that
the guaranteed amount be at least 75% of the principal amount over a minimum 10-year holding period for a
maturity guarantee. The same percentage, at least 75%, applies to the death benefit guarantee. Some providers
of segregated funds top up the guarantees to 100%.
• A maturity guarantee allows investors to participate in rising markets without a limit on potential returns.
At the same time, subject to the 10-year holding period, the client’s invested capital is protected from losses.
Similar protection under the death benefit guarantee is provided in case of death.
• A GMWB is a type of segregated fund composed of investments, insurance, and guaranteed income. Along
with an income guarantee, it provides maturity and death benefit guarantees. A GMWB protects investors’
retirement savings while allowing for participation in the markets. The protection and guarantees come with
sharply higher management fees, additional costs, and potential penalties.
DISCUSSION BOARD
for Chapter 14.
REVIEW QUESTIONS
Questions.

Will and Powers of Attorney 15
CHAPTER OUTLINE
In this chapter, you will learn about estate planning – more specifically, will planning – under Canadian law,
including common law in most of Canada and the Civil Code of Quebec. We explain how the probate process
works and provide some strategies that clients can use to reduce the costs associated with the probate process
and probate fees, if payable. Later in the chapter, you will learn why clients should arrange a power of attorney
for personal care (or a living will) and an enduring power of attorney for property as a substitute decision maker
in the event of incapacity. Finally, you should keep in mind certain compliance considerations when dealing with
vulnerable senior clients who may be exposed to elder abuse.
1 | Explain the importance of having a will when Passing on the Estate

creating an estate plan.
2 | Define the different forms of a will and the
components and clauses in a will.
3 | Explain the factors that one should consider Other Factors to Consider when Making
when making a will. a Will
4 | Describe the process of probating a will. Probate Procedures to Validate a Will
5 | Describe the concepts of power of attorney Powers of Attorney and Living Wills
and living wills within the context of estate (Advance Health Care Directives)
planning.
6 | List the key compliance considerations when Considerations when Dealing with Vulnerable
dealing with vulnerable clients. Clients

15• 2 WEALTH MANAGEMENT ESSENTIALS VOLUME 1
KEY TERMS
advance health care directive financial power of attorney notarial will
beneficiary gift mortis causa patrimony
Certificate of Appointment guardian power of attorney for

of Estate Trustee with a Will personal care
guardian appointment clause
Certificate of Appointment probate
of Estate Trustee without a holograph will
Will probate fee
individual executor
codicil protection mandate
intestate
continuing power of Spousal Election
attorney investment discretion clause
springing power of attorney
conventional or formal will legatee
survivorship clause
corporate executor Letters of Administration
tax election clause
discretionary encroachment Letters Probate
clause testator
life interest in a specific
elder abuse asset clause tutor
estate trustee liquidator vulnerable clients
executor multiple wills

CHAPTER 15 WILL AND POWERS OF ATTORNEY 15 • 3
INTRODUCTION
Each year, thousands of Canadians die without a will, leaving the law to settle their estates without direction from
the deceased regarding their intentions. Without a will, the value of the deceased’s estate may be unnecessarily
decreased due to legal and court costs and other expenses. Costs might arise from the application of the rules of
intestacy or from a lack of tax planning. The estate may not only be heavily taxed but also suffer long delays in
distribution. In other words, the deceased’s family suffers the consequences of poor planning or no plan at all. With
a small investment of time and money, clients can prevent such problems and ensure that their estate goes to those
they wish to leave it to. They can also structure it appropriately to expedite distribution and minimize probate fees
and income tax payable by the estate.
Before you begin, read the scenario below, which raises some of the questions you might have about estate
planning. Think about these questions, but don’t worry if the answers don’t come easily. At the end of the chapter,
ESTATE PLANNING WITH JORGE AND NORA
Your client Jorge and his new wife Nora are meeting with you as a couple for the first time. They want to discuss
Nora’s recent transfer of her investment account. As part of your discovery process, you find out that Nora has
never been married, but was previously in a common-law relationship with the father of her two children. Nora
does not have a will, and Jorge had a will prepared and signed before his divorce from his first wife three years ago.
Jorge, a successful small business owner, has brought substantial assets into the marriage, whereas Nora has
few assets. Just before he and Nora got married, Jorge downloaded a will template from the Internet, which he
personalized, printed, and signed. He believes that this new will supersedes the one he had in place before his
divorce. He also believes it provides appropriately for both Nora and his two teenage children from his previous
marriage. Nora’s children are young adults and are not close to Jorge.
• In the event of either Jorge’s or Nora’s death, what could happen to their estate, given the format of Jorge’s will
and Nora’s lack of a will? What risks would the survivor be exposed to?
• What can you suggest they do to minimize probate fees?
• Nora lives with a debilitating medical condition. What document(s) should she complete with some urgency?
NOTE
The content in this chapter covers both common law and civil code provisions. For study purposes, all content is
examinable regardless of the province of your residence.
Furthermore, some content in this chapter is also covered in Chapters 21 and 22 of the KPMG Tax Planning
guide, in some cases in greater detail. We strongly recommend that you study the content in the KPMG guide in

PASSING ON THE ESTATE
1 | Explain the importance of having a will when creating an estate plan.

2 | Define the different forms of a will and the components and clauses in a will.
All clients who want their estates to pass to their loved ones, friends, relatives, or charities in accordance with their
wishes should draw up a will. The responsibility for passing on an estate at death is solely that of the person who
has assets to pass on. The will is the legal document that implements this process. The person making the will is the
testator, and the person (or persons) receiving the deceased testator’s assets is the beneficiary (or beneficiaries).
The person who settles the estate and distributes the assets according to the terms will is generally known as the
executor. In Ontario, executors are also called estate trustees, and in Quebec, they are known as liquidators.
DYING INTESTATE
Every year, many people die intestate – that is, without having made a will, or having made a will that was revoked
(e.g., by marriage) or otherwise determined to be invalid. Some people avoid making a will because they don’t want
to think about their own death. Others simply procrastinate until it is too late.
In the common law provinces, when a person dies without a valid will, a court application is necessary before any of
the deceased’s assets can be distributed. Assets are then distributed in accordance with provincial intestacy laws. As
a consequence, assets may go to beneficiaries against the deceased person’s wishes.
EXAMPLE
Sylvain dies without a valid will. He is survived by his father Andrew, his brother Gilles, and his de facto spouse
of 20 years, Luisa. Legal devolution of property is made equally between Andrew and Gilles. Luisa, his long-term
companion, receives nothing. It is unlikely that this distribution is in accordance with what Sylvain would have
wished.
Common law provincial intestacy laws and the courts determine who will receive a share of the deceased’s assets
and what portion they will receive. The courts also determine the timing of the transfer and the method by which
the assets are managed during the estate administration processes.
EXAMPLE
In Ontario, if a person dies intestate, an administrator is appointed by the courts to act as estate trustee, upon
application. The Succession Law Reform Act provides for the orderly distribution of the deceased person’s assets.
Under this Act, a surviving (married) spouse takes a preferential share of the deceased spouse’s estate (currently
$200,000), plus a proportional share of the balance. The proportional share is half the balance if the deceased
has one child, and one-third of the balance if there are two or more children.
MAIN PURPOSES OF A WILL

A will is a legal document that can help ensure that the testator’s assets pass according to their wishes after their
death. The will becomes effective, and public, only when it is probated after the testator’s death. The concept of
probation is explained later in this chapter.
A will has two main purposes:
• Appoint an executor.
• Identify the persons whom the testator wants as beneficiaries.

Clients can change the terms or revoke their will as long as they are mentally competent. They should review their
wills whenever a material change or life-changing event takes place in their lives. Even without a major change, wills
should undergo periodic reviews (usually every three to five years). Small changes in a person’s life circumstances
can add up to consequences much larger than the testator realizes. Examples of such changes include the birth of a
child, a change in matrimonial status, or an altered financial situation. In some cases, an outdated will, which does
not reflect the new circumstances in the testator’s life, may have worse consequences than no will at all.
Clients should keep in mind that a will does not always allow for full control in allocating funds to the beneficiaries
they deem fit. Certain life changes, such as marriage or divorce, may result in deemed alterations under provincial
law or even revocation of the will.
EXAMPLE
George, an Ontario resident with two children from his first marriage, had a will at the time of his wife’s death.
He later re-married, but never changed his original will. Under Ontario law (as would be the case in all other
provinces except Quebec, British Columbia, and Alberta), his existing will was revoked by his marriage to his
second wife. Under the same law, George’s new wife will be entitled, on George’s death, to $200,000. Any
amount over that will be shared in thirds between her and George’s two children.
George’s advisor tells George he should make a new will now that he has re-married. By making provisions in this
way for the children from his previous marriage, he ensures that they will benefit to the extent he wishes from
the accumulated assets.
DID YOU KNOW?
A person making a will must be competent and of sound mind at the time, and must act under free will,
without any undue influence or pressure.
FORMS OF A WILL
Wills can be made in three basic forms:
• Conventional or formal will

• Holograph will
• Notarial will in Quebec
Furthermore, a codicil is an amendment to a will and is technically considered to be a will on its own.
Another type of testament is a gift mortis causa, also known as a quasi will.
CONVENTIONAL WILL
A conventional will (also called a formal will, or a will made in presence of witnesses in Quebec) is generally prepared
by a lawyer. Anyone can prepare a formal will, but clients should consult a legal expert to ensure proper wording
(i.e., succession language) and compliance with the province’s formal rules of execution.
In the common law provinces, the testator must sign the will in the presence of two witnesses. Several rules apply
regarding witnesses, which vary by jurisdiction. For example, in some provinces, a witness should not be the spouse
of a beneficiary; if a beneficiary is a witness, the will may remain valid, but the legacy becomes invalid.
In Quebec, in the case of a will made in the presence of witnesses, the will can be written by the testator or a third
party, such as a lawyer, either by hand or by mechanical process. It must be signed by the testator and by two
witnesses of legal age in the presence of the testator.

Preprinted will kits or fill-in-the-blank forms are part of this category of wills, as long as they respect the formal
need to ensure the will’s validity.
DID YOU KNOW?
A preprinted or electronic will is prepared from a printed or computer-generated form. These do-it-
yourself will kits are typically not intended for complex situations. They usually contain standard,
so-called “boilerplate” language that does not necessarily represent the true intentions of the testator.
Like holograph wills, will kits should be used only as a temporary or last resort in circumstances where a
professionally drawn will cannot be obtained in time. To be valid, a will prepared from a kit must adhere
to the formal rules of execution; namely, it must be signed in front of two witnesses.
HOLOGRAPH WILL
A holograph will is a will written and signed entirely in the handwriting of the testator, without assistance from
any mechanical device such as a computer. No writing of any sort can appear on the holograph will other than the
handwriting of the testator. Witnesses are not required because it is expected that a holograph will is executed
by the testator alone, in circumstances that prevent the execution of a conventional will. A letter, in the testator’s
handwriting only, declaring the testator’s intent and containing related matters, may constitute a holographic will.
A holograph will is not valid in Prince Edward Island.
Even where they are valid, holograph wills are not recommended, because the handwriting may be illegible or
the language may be ambiguous or vague. Any of the above issues may render the will open to interpretation and
perhaps a challenge by a disgruntled beneficiary or heir at law.
NOTARIAL WILL IN QUEBEC

In Quebec, a notarial will is a will that is drafted and attested by a notary. It is signed by the notary, the testator,
and a witness (who is not required to know the contents of the will). Such documents are considered notarial deeds
and are not subject to probate upon the testator’s death. The law recognizes notaries’ status as public officers,
which enables them to invest wills with authenticity. Notarial wills are recorded in the central registry of wills of
both the Chambre des notaires and the Barreau du Québec.
GIFTS MORTIS CAUSA

The doctrine of gift mortis causa is often described simply as a deathbed gift made by a dying person. It is made
with the intent that the person receiving the gift shall keep it if death ensues. The classic example is a person with a
terminal illness making a deathbed gift. For such a gift to be valid, three conditions must be met:
• It must have been made in contemplation, though not necessarily in expectation, of death.
• It must be delivered to the recipient without any encumbrance.
• It can only be complete and perfect upon the death of the donor.
A person contemplating his or her imminent death could make a donation mortis causa to a qualified recipient, such
as a charitable organization.
In Quebec, the gift mortis causa is limited to marriage and requires the existence of a legal marriage contract to
be valid. Only spouses and future spouses and their common and respective children may benefit from such a gift.
Charitable organizations are not valid recipients.

DID YOU KNOW?
As an advisor in Quebec, you should always review, with the liquidator of an estate, the marriage
contract of the spouses. Any gift mortis causa in the contract is automatically cancelled by divorce or
a subsequent will. If there is no subsequent will, a gift mortis causa becomes effective on the donor’s
death. As long as the donor is alive, the gift remains revocable.
COMPONENTS OF A WILL
A typical will has the following components:
• Identity of the testator

• A statement revoking all former wills or codicils
• Appointment of the executor or executors and substitute executors
• Instructions to pay all just debts and taxes, as well as funeral and estate-related expenses
• Identity of the beneficiaries (heirs or legatees) to receive specific assets and the residue (anything left over) of
the estate, and the terms on which they are to receive them
A will may include, at the testator’s discretion, his or her wishes for burial or cremation. However, it is better to
instruct close relatives or the executor of one’s wishes in this regard in person. A will is usually opened after the
deceased’s funeral has already taken place.
VARIOUS CLAUSES IN A WILL

Any or all of the following clauses may be included in a will:
Investment discretion Under the relevant law, the executor is restricted to making only conservative, often
clause low-return investments for the estate. An investment discretion clause can be inserted
to allow more flexibility.
Discretionary Beneficiaries who are minors cannot transact, take possession, or make decisions
encroachment clause regarding any assets they are to receive from an estate until they become adults.
A discretionary encroachment clause gives the executor the discretion to use assets
for the benefit of minor beneficiaries until they reach the age of majority. Depending on
the province, a minor is a person under 18 or 19 years of age.
Life interest in a A testator may want to leave to a surviving beneficiary a life interest in the residue of
specific asset clause his or her assets, or in a specific asset, rather than an outright legacy. The testator’s wish
may be for another beneficiary to receive the asset itself when the surviving beneficiary
dies. A life interest in a specific asset allows the surviving beneficiary (called the life-
interest beneficiary) to use, occupy, and enjoy the property during his or her lifetime. An
example of a life interest is a spousal trust, where the spouse receives the income from
a specified property during his or her lifetime. The property is given to the testator’s
children when the life-interest spouse dies.

Guardian appointment A guardian appointment clause appoints a friend or family member as guardian (or
clause tutor, in Quebec) of minor children. In the common law provinces, the guardianship is
with respect to the minor person, not the minor’s property. The property left for a minor
would typically be left in a trust with the appointment of a trustee to manage the trust
assets. Without such an appointment, the Office of the Children’s Lawyer, through the
courts, would be the statutory guardian of the minor’s property. Regulations may vary
from one province to another. Generally, the guardian appointment in the will is limited
to a certain time (e.g., 90 days). Beyond that period, the guardian appointment clause is
not binding on the courts. However, the courts usually follow the wishes of the testator
and approve the continuation of the appointed guardianship beyond the expiry of the
initial period.
Tax election clause A tax election clause allows the executor to make various income tax elections on the
estate’s tax return, where appropriate and advantageous. For example, the executor may
elect to apply the deemed disposition of assets at death to offset capital losses.
Family law Depending on the jurisdiction, several rules concerning family law should be considered
considerations in the will. For example, in Quebec, the testator can provide that the spouse must
renounce partition of the family patrimony to be entitled to inherit under the will.
In Ontario (and in some other provinces), the surviving spouse has the right to file
a Spousal Election within six months. In effect, a Spousal Election states that the
surviving spouse wishes to take division of net family property under the Family Law Act
rather than under the will. It is the executor’s duty to inform a surviving spouse of this
right.
Transfer of registered A special clause regarding the transfer of registered assets may be included to secure a
assets tax benefit. An example is a rollover of a registered retirement savings plan (RRSP) to the
spouse or a financially dependent child or grandchild.
Survivorship clause A survivorship clause is a common clause to avoid going through the probate process
twice within a short time span, thereby avoiding probate tax being paid twice. If drafted
properly, the survivorship clause requires a survivorship period (usually 30 days) before
assets are distributed to a particular beneficiary. If that beneficiary does not survive the
prescribed period, the deceased’s estate is distributed to alternate beneficiaries.
AMENDMENTS TO A WILL BY CODICIL

A will can be amended at any time by a codicil. The codicil is executed and validated like a will and can amend a will
by revoking or amending existing clauses or adding new ones. The signing of a codicil must comply with the same
formal execution rules as the signing of a will.
As with a will, the codicil may be a holograph, made in the presence of two witnesses or notarial. However, the
codicil need not be made in the same form as the will it applies to. For example, a will made before a notary may be
modified through a holograph codicil.
It is essential that a codicil be dated and that it specifies its exact scope. Thus, potential difficulties for those
who will have to interpret and execute the various documents can be prevented. If the changes are numerous or
complicated, it is usually better to execute a new will rather than amend the old one. A codicil is typically used only
to amend or add a provision to the existing will; however, the signing of a codicil legally revokes the existing will in
most provinces. Therefore, the codicil must include a statement by the testator affirming the validity of the existing
will, other than the amendment or addition to the will that the codicil is making.

A holograph codicil must be in the testator’s handwriting. A conventional codicil must include the signatures of two
witnesses to the testator’s signature. In Quebec, the codicil can be handwritten, made in the presence of witnesses,
or made by notarial deed. If the codicil is holograph or made in the presence of witnesses, it must be homologated
(i.e., validated) by the court or notary after the testator dies.
MULTIPLE WILLS
Multiple wills may be effective in certain situations, particularly when assets are held in several jurisdictions, and
where the use of multiple wills is permitted by law in the jurisdiction where the testator resides. For example, a
testator who owns a second residence outside of Canada may benefit from having two wills. People may also use
multiple wills to avoid probate fees (also known as estate administration tax) on certain assets. The drafting of
multiple wills must be done carefully by a trusts and estates lawyer who is experienced in doing so.
PASSING ON THE ESTATE – PARTICULAR ASPECTS IN QUEBEC

Rules of general application in Quebec are codified in the Civil Code of Quebec. In the rest of Canada, they come
from common law or statutes. Common law is composed of rules laid down by the courts in their decisions and is
therefore judge-made law, as opposed to Quebec’s codified system. For this reason, the rules of general application
often differ in Quebec, compared to the rest of Canada.
In addition to the Civil Code of Quebec, two other statutory laws are also in effect:
• Quebec statutes adopted by the National Assembly, which apply only in Quebec
• Federal statutes adopted by the Parliament of Canada, which apply uniformly across the country
For example, the Automobile Insurance Act is a Quebec statute, whereas the Criminal Code of Canada is a federal
statute. Other provinces have their own provincial statutes, which may have similar names.
TRANSMISSION OF PROPERTY ON DEATH

A deceased person’s estate commences upon death at the person’s last place of domicile. Included in the estate
is the deceased’s patrimony, which comprises all assets and liabilities and the whole of the person’s rights and
obligations.
The patrimony of deceased persons devolves (i.e., passes on) to their heirs, or legatees, as stipulated in the
deceased person’s will. If no will exists, the estate devolves according to the prescriptions of law. Without a will, the
heirs must act jointly as liquidators of the estate, a task that may be complicated and which they may not wish to
perform. However, they can appoint one or more executors by majority vote.
The property of a deceased person can be passed on through a will or a marriage contract. Standard provisions
governing the transmission of property upon death found in other provinces may be invalid in Quebec. For example,
the beneficiary provisions for retirement savings plans may differ in Quebec. Some designation of beneficiaries for
an RRSP or a registered retirement income fund (RRIF) is allowed under specific conditions. However, when RRSPs
or RRIFs are held with a life insurance company, a beneficiary can be named directly in the contract.
Basic contents of a will are similar in Quebec to the rest of Canada. However, you should pay particular attention to
the matrimonial regime and family patrimony rules. For example, testators may include a special clause in their will
obliging the spouse to renounce partition of the family patrimony in order to be entitled to the residue of the estate.
A testator may order the transfer of their property to a trust or, in less frequent cases, to a usufruct or a substitution.
Usufruct is the legal right to use and enjoy an asset, such as the right to use the family cottage. As a substitution, for
example, the beneficiary may be bound to keep and transfer the specific property to another beneficiary at a given
time.

Before a beneficiary turns 18, the inheritance is administered in the child’s interest by his or her tutors. The tutors
are, by law, the child’s parents. If the parents have died, another person is designated either in the will or by a
declaration to the Public Curator. Otherwise, the tutor appointment is completed by a legal procedure. If a trust is
created, the trust deed can provide for specific provisions concerning the child’s needs. For example, powers may be
granted to the trustee to pay tuition fees directly to the child’s college.
Another feature is that the liquidation of the estate and the administration of a trust are governed by several
different rules. Therefore, when liquidators have settled the estate, they transfer property to the trust, which is then
administered by the trustee. In many cases, the liquidator and trustee may be the same person.
OTHER FACTORS TO CONSIDER WHEN MAKING A WILL
3 | Explain the factors that one should consider when making a will.
In this section, we discuss various factors you should review with clients who are seeking advice about making a will.
RESTRICTIONS ON THE TESTATOR’S TESTAMENTARY FREEDOM

Testators have considerable latitude in drafting their wills. However, they are restricted under most provincial
legislation in two regards:
• They cannot cut a family member out of their will if that person is a next of kin and financially dependent on
them at the time of their death.
• They must provide for their spouse, according to the minimum required in the province they reside in at the
time of death, subject to a marriage contract.
The law, in this regard, varies somewhat from province to province.

The death of a spouse is considered a breakdown of the marriage and is a triggering event under matrimonial
property legislation. If the testator’s bequest to the surviving spouse is not equal to that provided under legislation
(which is typically one-half of the accumulated assets during marriage), the surviving spouse is entitled to make a
claim or apply for a division of assets under the family law or matrimonial property legislation, rather than taking
under the will. In Ontario, this right is called a Spousal Election, which was discussed earlier.
In some cases, a will may fail to provide adequate, ongoing support and maintenance to a financially dependent
family member. Under common law, that person, or a legal representative, can apply to the courts for a ruling for
continuing support from the estate. Such an application is called a dependant relief claim. The judgment might
include a lump-sum payment to the dependent (either as an equalization payment or compensatory allowance),
or other ongoing support from the estate. Such a judgment could hamper the distribution of the estate to other
beneficiaries.
In Quebec, a court decides only if there is a deadlock between the dependant applying for support and other
beneficiaries of the estate.
DID YOU KNOW?
In Ontario’s Succession Law Reform Act, a dependant eligible for support is defined as a spouse, child,
parent, brother, or sister of the deceased. In Quebec, however, de facto spouses and siblings are not
considered dependants for support claims purposes.

CHOOSING AN EXECUTOR
The executor of an estate (or liquidator in Quebec) is an individual or a corporation such as a trust company
appointed by the testator to manage the testator’s affairs after death according to the terms of the testator’s will.
The executor’s duties are to recover the assets, pay the debts, identify the legatees of specific assets and residuary
beneficiaries, and divide the property of the deceased among them. The executor or liquidator should be selected
with care and consideration for financial stability, good judgment, honesty, and integrity. After all, this person will
represent the testator and the testator’s family in financial affairs during a crucial period.
The choice of executor often depends on the size and complexity of the estate and the range of possible executors.
If the estate is not large, its assets are not complex, and any resulting trust is not expected to endure for many years,
such as with an education trust for minor children, it may be appropriate for the testator to select an individual to
act as executor. Many testators appoint someone such as a spouse, brother, or lawyer to act as executor without
giving serious consideration to the implications of the role. The selection of an individual executor is a decision
your family may have to live with for years to come. The testator can change his or her mind prior to death, but
there is no such opportunity after the fact.
In such cases, the prospective individual should exhibit some or all of the following characteristics:
• They should be of an age and state of health that they would be likely to outlive the duration of the estate.
• They should have general expertise in finance, taxation, and investments.
• They should be reliable and available.
• They should have personal knowledge of the wishes of the testator and the personalities and needs of the
beneficiaries.
If the estate is large or complex, a financially astute close relative can be involved directly, perhaps as the main
executor, with the assistance of experts if necessary. If there is a need for constant assistance, a reputable entity
such as a trust company may be appointed.
A corporate executor such as a trust company is the best choice in many circumstances, particularly if the assets
are of significant value. It is also the appropriate choice when assets are spread out over several jurisdictions
(including international) or when any resulting trust is expected to last for several years.
Corporate executors offer the following advantages:
• Experience in financial and estate planning

They can bring a wealth of experience to the process that would be impossible for most individuals to
accumulate, even in a lifetime of experience.
• Continuity
They cannot be outlived by the beneficiaries of the estate and can be counted on to provide continuous
administration.
• Availability
They are in the business of administering estates and trusts on a full-time basis, so they are always available and
able to act when called upon.
• Impartiality
Because they are not part of the family, they are able to administer the terms of the will the way the testator
intended them to be carried out. As impartial outsiders, they can be relied on to protect the vulnerable and
to do what must be done, according to law and as the will directs, even if some beneficiaries disagree. This
objectivity is one of the most intangible but most valuable services a corporate executor can offer.

• Multi-faceted expertise
The corporate executor comprises a network of employees, all of whom specialize in separate areas of estate
administration. Members of the team usually include lawyers, accountants, and tax and estate planning
specialists.
• Financial security
Corporate executors are generally in a solid-enough financial position to stand behind their actions.
In some circumstances, particularly where the estate is large and the administration is expected to be lengthy and
complicated, it is prudent to appoint two or more executors to act together as co-executors. The will can be drafted
to authorize the executors to act unanimously; in case of a disagreement, the executors can act by majority rule. If
only one executor is appointed, it is prudent to appoint an alternate executor as a replacement in case the first-named
executor predeceases the testator or becomes unable or unwilling to perform the required duties.
In common law provinces, if an alternate executor is not appointed, and the acting executor dies before the
deceased’s estate has been fully administered, the person the executor had appointed as executor of his or her own
estate automatically becomes executor of the deceased’s estate.
In Quebec, if the liquidator dies and no alternate liquidator has been assigned, the testator’s heirs either assume
this function or appoint a substitute. The court will intervene only as a last resort. When there is more than one
liquidator, they must all agree unanimously, unless it is otherwise stated in the will. In the latter case, it is a good
idea to have an odd number of liquidators so that disputes can be settled by a tie-breaking vote.
When a trust is involved, the settlor or beneficiary may be appointed as trustee but must act jointly with another
trustee who is neither settlor nor beneficiary. In contrast to the role of liquidators, trustees act by majority.
COMPENSATION FOR EXECUTORS

Compensation for administering an estate can be negotiated before death; otherwise, it is up to the heirs to agree
on the matter. As a last resort, executors may ask the court to approve their requested compensation.
Compensation may be adjusted up or down based on the following factors, among others:
• The value and complexity of the estate

• The time spent
• The skill and degree of care exercised by the executor
Although there is no statutory rule, the executor is entitled to a fair and reasonable allowance. For example, if an
estate is settled relatively quickly, the executor’s compensation is typically 5% of the estate’s gross value. This
compensation comprises 2.5% of the value of the assets gathered plus 2.5% of the value of the assets distributed.
If the estate’s funds are held and invested in a trust, the trustee who is responsible for the management of the trust
and the distribution of income or capital to the beneficiaries over an extended period is typically entitled to receive
trustee compensation. Typically, compensation is approximately two-fifths of 1% of the average value of the trust.
If no agreement is reached on compensation, the executor of an estate or the trustee of a trust may apply to the
courts to determine what the compensation should be. This method of obtaining approval for compensation is often
included in the proceeding and is known as the formal passing of the accounts. It involves the executor’s or trustee’s
presentation to the courts of all the trust records and accounts for approval.
THE EXECUTOR MUST BE AVAILABLE AND CAPABLE

The executor’s responsibilities are many, and they are time-consuming. A complicated estate can take several years
to settle, and the executor’s role may involve administering a trust over many years. An executor should be fully
aware of what is involved, and both willing and capable of acting in the required capacity. If the role of executor is

likely to last for many years, the person’s age, health, and lifestyle should be taken into account. Longevity is not the
only consideration; so are the physical and mental capabilities to administer the estate.
Executors are responsible for keeping the estate assets safe and can be held accountable by the beneficiary for any
mismanagement of estate funds.
REVOCATION OF A WILL
A will takes effect only upon the death of the testator. It can be revoked at any time up until death unless the person
becomes mentally incapable.
The most common way of revoking a will is by making a subsequent will. The new will normally starts with a
revocation clause, such as “I hereby revoke all my former wills and codicils”.
Even without the revocation clause, the signing of a new, more recent will (whether it is a conventional, holograph,
or notarial will) automatically revokes in some provinces the prior, existing will. As well, in all provinces except
Quebec, Alberta, and British Columbia, marriage revokes a will.
DID YOU KNOW?
The latest will is usually considered to be the only valid will.
Another way of revoking a will is by deliberately destroying it. It can be destroyed either by the testator or in the
presence of, and under written instructions from, the testator. Legislation requires that the testator intends to
revoke the will by destroying it or by having it destroyed (and by witnessing its destruction).
ASSETS COVERED BY A WILL AND ASSETS THAT DO NOT FLOW THROUGH

THE ESTATE
The following types of assets are covered by the will:
• Assets registered in the sole name of the deceased flow through the deceased’s estate.
• Assets registered as tenancy in common, as to the deceased’s fractional interest in the assets, flow through the
deceased’s estate. If one co-tenant dies, that person’s fractional interest in the assets forms part of his or her
estate and is distributed according to the terms of his or her will.
• Assets registered in the name of the deceased’s estate flow through that estate. These assets may include a life
insurance policy or an RRSP naming the estate as beneficiary.
The following assets are not subject to the terms of the will and are not included in the estate:
• Assets for which there is already a named beneficiary on a stand-alone document, such a Beneficiary
Designation Form. (These assets may include a life insurance policy, pension plan, TFSA, RRSP, or RRIF.)
• Assets that have been gifted before death.
• Assets for which the owners are registered as joint tenants with rights of survivorship (in common law
provinces).
• Assets held in an inter vivos trust.
• Business interests covered by a buy-sell agreement.
• Assets covered by a pre-nuptial, cohabitation agreement, or matrimonial regime.

These assets are not distributed according to the instructions in the will. However, the estate is the taxpayer, and
the tax liability is to be paid as a result of the deemed disposition at death. The assets listed above that pass through
the estate must be declared on the application for probate and are subject to provincial probate tax.
In planning the distribution of the estate, clients should consider all their assets, not just those covered by the will.
Otherwise, the estate plan may not produce the desired goals.
LIFE EVENTS THAT AFFECT A WILL

Clients should understand that certain life events, including marriage and divorce, may automatically alter the
terms of a will or even revoke an existing will. It is important, therefore, that clients review their wills whenever
there is a change in marital status.
THE EFFECT OF MARRIAGE ON A WILL

As mentioned earlier, marriage results in a revocation of an existing will in some common law provinces. The public
policy behind this law is an attempt to make provision for the new spouse. However, the law is changing in this
regard, and changes are reflected in the new legislation of some provinces.
If a will is made in contemplation of a marriage to a specific person, the will should state so. However, it should also
specify how assets should be distributed if the marriage does not take place. Thus, if a will is made without providing
for an anticipated marriage, a new will should be made upon marriage to avoid dying intestate under common law.
In Quebec, as mentioned earlier, a valid will drafted before marriage remains valid. However, the estate must still go
through family patrimony and matrimonial regime rules before assets are distributed.
THE EFFECT OF DIVORCE ON A WILL

A divorce does not revoke a will; however, the appointments, bequests, legacies, and any other benefits in favour
of the former spouse are cancelled. Because the Divorce Act is a federal statute, this Act applies to all provinces in
Canada. Among other things, it provides the grounds for divorce. The terms of division of property otherwise fall
under provincial statutes.
By contrast, legal separation does not affect wills in most provinces. Therefore, if a new will is not made and the
testator dies, the estranged spouse inherits under the will.
Generally, your clients should always revisit their wills when there is a change in marital status, regardless of the
relevant provincial legislation. They may wish to update their will by revisions through codicils or prepare a new
will. A significant change in a person’s situation, such as marriage or divorce always merits at least a review of the
existing will. In most provinces, divorce does not affect beneficiary designations made in a contract (such as a life
insurance policy) outside the will. Designations made by a former spouse remain in effect unless the former spouse
designates a new beneficiary in the contract.
PROBATE PROCEDURES TO VALIDATE A WILL
4 | Describe the process of probating a will.
Probate is the legal process by which the courts confirm a person’s will to be his or her valid last will and testament.
Probating a will also validates the authority of the executor. In this section, we describe probate procedures in the
common law provinces and Quebec.

PROBATE IN COMMON LAW PROVINCES

In common law provinces, a will is valid without a court order under the following conditions:
• The will has been prepared by a mentally competent person and properly signed and witnessed.
• It has not been revoked by a later will, by marriage, or by destruction of the original document.
APPLICATION TO THE COURT

The executor is responsible for administering the estate and transferring its assets to the beneficiaries.
In Ontario, the executor’s first duty is to apply to the Ontario Court (General Division) for a Certificate of
Appointment of Estate Trustee with a Will. The certificate is a court order identifying the executor and declaring
that the will is valid. It also gives the executor control over the estate’s assets and liabilities and the authority to
administer the estate. Provinces other than Ontario follow similar procedures; however, in some provinces, the
court order may be referred to as Letters Probate.
DID YOU KNOW?
Probate is an old legal word meaning “proof”. Letters Probate are simply proof, from a court, that a will
is the deceased’s last will.
The executor must also serve on all the residuary beneficiaries a copy of the application to the court for a Certificate
of Estate Trustee with a Will (also known as the application for probate). The executor has the responsibility to
ensure that the application package is actually delivered into the hands of the intended recipients. The package
must include the following documents:
• The original will, including originals of any codicils, plus a photocopy of the will and each codicil
• An application for probate in the prescribed form, according to the Rules of Civil Procedure, stating the following
details:
• The residence of the deceased
• Marital status
• Date of the will
• The fact that the applicant is the estate trustee
• The value of the estate
• An affidavit of the execution of the will and any codicil, usually signed by one of the witnesses when the will or
codicil is signed
• An affidavit of service of notice stating that the persons named in the notice are the persons entitled to share in
the distribution of the estate
• Court fees payable (with a cheque in favour of the Court Accountant, acting for the provincial government)
• Death certificate
• An inventory of the estate assets
ISSUANCE OF A CERTIFICATE OF APPOINTMENT OF ESTATE TRUSTEE WITH A WILL

Assuming the will is not being challenged, the court issues a Certificate of Appointment of Estate Trustee with a
Will. Before issuing the certificate, the court ascertains that the proper documents have been filed and found to be
in order and that the court fees have been paid.

Notarized copies of the certificate may be required to transfer property from the deceased to the estate or to a
beneficiary. As previously mentioned, property held in joint tenancy, however, is not part of the estate and passes
automatically to the surviving joint tenant or tenants. If the deceased owned real estate in joint tenancy, the
transfer of title is done by submission of a survivorship application.
ISSUANCE OF A CERTIFICATE OF APPOINTMENT OF ESTATE TRUSTEE WITHOUT A WILL

In Ontario, if a person dies intestate, the deceased’s nearest relative is entitled to apply to court to have an estate
trustee appointed by the courts. If no one applies, a creditor may do so. The documents required, Certificate of
Appointment of Estate Trustee without a Will, are similar to those for a Certificate of Appointment of Estate
Trustee with a Will. The appointed estate administrator distributes the estate’s assets in accordance with the
applicable intestate succession rules. Any amounts to which a minor is entitled are paid into the courts. The Office
of the Children’s Lawyer manages the property on behalf of the minor until age of majority is attained. Other
provinces follow similar procedures. However, in some provinces, the court orders are referred to as Letters of
Administration.
PROBATE FEES AND METHODS OF AVOIDING OR REDUCING THE IMPACT OF PROBATE

Probate fees are charged on the total value of the deceased’s estate, regardless of whether there is a will, upon the
granting of a Certificate of Estate Trustee with a Will or a Certificate of Estate Trustee without a Will. The total value
of the estate is the market value of all assets owned by the deceased at the time of death. No deductions are made
for debts, other than for mortgages on personal real property, such as a house.
EXAMPLE
Marguerite died owning a $200,000 house with a $50,000 mortgage and $20,000 in guaranteed investment
certificates. She also owed $10,000 on her credit accounts. Therefore, the value of her probatable assets is
$170,000, calculated as $200,000, minus the $50,000 mortgage, plus $20,000 in guaranteed investment
certificates. Her $10,000 credit card debt is not taken into account. The probate fee payable is the provincial rate
charged on the $170,000 amount.
Probate fees vary from province to province. In most provinces, they are based on a percentage of the value of
the estate and are paid out of the assets of the estate. In Quebec, the estate assumes pre-established court costs
related to the process, but no probate fees are payable based on the value of estate assets. In Manitoba, as of
November 6, 2020, probate fees have been eliminated.
In Ontario, as of January 1, 2020, the estate administration tax (i.e., the probate fee) has been eliminated for the
first $50,000 of the estate’s value. Probate fees in Ontario are 1.5% (or $15 per $1,000) of the estate value in
excess of $50,000. The only other provinces where the rate is as high are Nova Scotia and British Columbia. British
Columbia’s rate is approximately 1.4%, and Nova Scotia’s rate is approximately 1.7%.
EXAMPLE
An estate in Ontario worth $1,000,000 would be subject to probate fees of $14,250, calculated as follows:
$1,000,000 – $50,000 = $950,000 at 1.5% (or $15 per $1,000) = $14,250
Certain assets owned by a deceased person are excluded from the estate for probate fee purposes. Excluded assets
include assets held in joint tenancy with right of survivorship, life insurance proceeds, and registered accounts with
named beneficiaries designated outside the will.

Probate fees are calculated on the basis of the gross value of an estate. By reducing the value of an estate’s assets,
one can reduce the probate fee payable after death, when the will is probated. Clients can reduce the size of their
estate for this purpose through the following means:
• Transferring ownership of property to someone else during their lifetime

• Transferring assets to an inter vivos trust during their lifetime
• Establishing a spousal trust under the testator’s will (although this strategy will only avoid probate fee on the
death of the survivor spouse, not on the death of the first spouse to die)
• Holding properties jointly with right of survivorship (so that when one of the joint owners dies, the other
automatically gets title)
• Gifting money or assets to family members or a charity during the person’s lifetime
• Converting personal debt into a mortgage on personally held real estate or corporate debt
• Using multiple wills where permitted. Probate usually entails a delay of several months before certain funds
are distributed, including estate funds in bank accounts and assets such as securities or real estate. In some
provinces, probated wills are considered public information; therefore, details of an estate’s inventory and
bequests may be accessed by the general public
DID YOU KNOW?
It is important to note that probate and income taxes are not the same thing. The deceased’s estate may
have to pay tax on income or on gains from assets that are excluded for probate purposes.
In the following scenario, an advisor explains the probate process to a client who wishes to revise her will.
Scenario | Probating a Will
Maureen is a recently divorced Ontario resident who is concerned about the need to revise her will. Her estate is
currently worth about $1,000,000 and consists mostly of real estate and securities.
Maureen tells her advisor that her aunt’s will was voided because she was not mentally competent at the time it
was written. She wonders how her bank, issuers of her RRSPs, and others will know that her own will is valid when
the time comes.
Maureen also wants to know what type of estate taxes or fees will have to be paid when she dies. She has been told
that the bill could come to thousands of dollars and wants to know what she can do to reduce that amount. She
wonders, for example, if her property should be registered jointly with her minor son.
Maureen’s advisor explains to Maureen that, in the normal course of events, her will would be validated through
the probate process and verified by the courts. Once the will has been probated, her executor will receive Letters
Probate, a certified true copy of which could be provided to issuers of Maureen’s assets. This document further
verifies that her executor has legal authority to deal with the assets.
The amount of probate fees that Maureen’s estate will incur will depend on the value of the assets passing through
her will and the province in which her will is probated. A will is most often probated in the province in which the
testator lived at the time of his or her death.

Scenario | Probating a Will
It is true that registering assets with heirs jointly with rights of survivorship will cause the assets to bypass the
estate (and therefore, probate fees). However, avoiding probate fees should not be the only goal in making an estate
plan. In this case, Maureen would be ill-advised to make any of her assets joint with her minor child. Among other
problems, she would lose sole control of the assets, and her minor child would not be able to deal with them. The
transfer of assets to her son would trigger capital gains tax, and attribution of income would apply on any future
income generated by the transferred property, all to be paid by Maureen. Therefore, she would trigger immediate
capital gains (or losses) on the disposition of a half-interest in her property. Instead, Maureen should consider using
an inter vivos family trust to protect her interests and those of her minor child, now and in the future.
INTESTACY AND PROBATE
What is the probate process when a person dies intestate? Complete the online learning activity to assess
your knowledge.
DIVE DEEPER
For a helpful set of guidelines to provincial probate tax rates, go to your online chapter and open the
following document:
Probate Tax Rates by Province
PROBATE IN QUEBEC
In Quebec, the liquidator of an estate has the following responsibilities:
• Identify the successors and the property to be partitioned and distributed to each successor
• Recover the succession’s claims and pay its debts
• Distribute assets to the successors
• Prepare a rendering of account
PROBATE OF THE WILL

Probate is necessary only for holograph wills and for those made in the presence of witnesses. Therefore, if the
deceased has made this type of will, the liquidator may have to get the will probated and take all the necessary
steps for its execution. Probate confirms whether the will meets the requirements to be legally valid. However, the
probate procedure does not confer a conclusive validity to the will or prevent others from contesting the will in the
future. The liquidator must make sure that the will in question is the latest version.
WILL SEARCH IN QUEBEC

The search for a will is an important task following a death. In all cases, whether or not a will can be found through
the deceased’s papers, the liquidator must submit a request for a will search of the registry of wills of both the
Chambre des notaires and the Barreau du Québec.
The search will reveal whether the deceased left a will, or whether the will in hand is the most recent one that was
made. If the deceased made more than one will, the liquidator must use the most recent will to settle the estate.
The liquidator must also check whether the deceased had a marriage contract or a contract of civil union. If there
is one, the liquidator must check whether the contract contained a gift to take effect when the deceased dies
(e.g., a surviving spouse clause).

The person requesting a will search must provide the original copy of the act of death or the death certificate issued
by the Directeur de l’état civil. In due course, the Chambre des notaires and Barreau du Québec issue a certificate of
search that must be presented to financial institutions and other interested parties.
If the liquidator doesn’t find a will or a clause of this kind in the marriage contract, the law decides who inherits the
deceased’s property, as discussed earlier in this chapter.
EXAMPLE
Xavier is the liquidator of Henry’s estate. Henry left a last will in notarial form. For this document to be accepted
as valid by the financial institutions handling Henry’s accounts, it must be accompanied by a will search. There is
no need to go through the judicial process provided for probate, as would be the case with a holograph will or a
will made in the presence of witnesses.
In Quebec, probate proceeds as follows:
• The existence of the will is publicized, and the will is deposited in the record of the Superior Court of Quebec.
• It is established that the will appears to be valid.
• Interested parties are then able to obtain certified copies of the original will.
• The applicant (generally, the liquidator of the estate), a notary, or a lawyer completes the probate of the will.
Information on whether a will has been probated can be obtained from the courthouse in the judicial district where
the deceased resided.
The estate must assume the cost of filing an application to the court for the probate of a non-notarial will. It must
also assume legal fees charged for consulting a notary or a lawyer.
INVENTORY PUBLISHING
Among other duties, the liquidator must prepare an inventory of the estate and have a notice of inventory published
in the Register of Personal and Movable Real Rights. The notice identifies the deceased and indicates the place
where interested persons may consult the inventory. The liquidator can be exempted from making an inventory only
with the consent of all the heirs. In such cases, the heirs become liable for the debts of the succession, even beyond
the value of the property they inherit.
EXAMPLE
The following passage shows the typical wording on a notice of inventory:
Be advised that Richard Goodman, in his lifetime residing at 12345 17th avenue, Montreal, Quebec, 101 101,
died on April 15, 2016. The inventory of his estate has been completed by John Goodman, the liquidator of his
estate, on August 10th, 2016 in conformity with the law. The inventory can be consulted at the office of Me.
Albert Smith, notary, 1234 One street, Montreal, Quebec, 101 101.
RENDERING OF ACCOUNT
If the liquidation of an estate lasts more than a year, the liquidator must prepare an account of his or her
management to the heirs and creditors at least once per year.
After all, the estate’s creditors have been paid and the assets have been distributed under the terms of the will,
the liquidator must prepare an account showing the succession’s residual assets. The liquidator may be required to
attach a proposal for the partition of these assets between the heirs. When the heirs accept this final account, the
liquidator is usually discharged.
PROVISIONS OF A WILL
What are the provisions of a typical will? Complete the online learning activity to assess your knowledge.

POWERS OF ATTORNEY AND LIVING WILLS (ADVANCE HEALTH CARE

DIRECTIVES)
5 | Describe the concepts of power of attorney and living wills within the context of estate planning.
As clients approach retirement, their chances of experiencing serious disability, incapacity, or health problems
increase. As an advisor, you should be able to help your clients prepare by appointing someone to make financial
and health care decisions on their behalf when they are not able to do so. You should be aware of the available
options so that you can advise your clients on what action to take.
The form and requirements for powers of attorney vary from province to province. Your clients may have to consult
a professional in the appropriate jurisdiction to prepare these documents.
POWER OF ATTORNEY
A will gives an executor authority to administer and distribute the assets in the estate of a deceased after death.
In contrast, a power of attorney authorizes someone to make decisions on another person’s behalf while the
person is still alive. The authorized person (i.e., the attorney) is a substitute decision maker. These decisions may be
financial or personal.
A power of attorney is a document that gives written authority to one or more persons or a corporation to act on
behalf of the person granting authority. The person granting authority is the donor, and the person or corporation
given authority is the donee, more commonly referred to as the attorney. With a power of attorney, the donee has
the legal authority to make decisions and to perform certain actions, on behalf of the donor.
In Quebec, a power of attorney is also called a mandate, the donor is called the mandator, and the donee is the
mandatary.
FINANCIAL POWER OF ATTORNEY OR POWER OF ATTORNEY FOR PROPERTY

In financial matters, a financial power of attorney may give a limited or general authority to act. If the power of
attorney is limited, the donee is restricted to the power specified in the document. For example, the donor may give
the donee the power to sell certain securities or to accept a business takeover bid while the donor is on vacation.
Your role as advisor is to explain to the client the advantages and the risks associated with the different types of
power of attorney contracts.
For a power of attorney to be valid, donors must have the capacity to grant a power of attorney when they sign
the document. To avoid litigation, persons experiencing failing mental health should choose a donee to act on their
behalf while they are still mentally competent. In certain circumstances, it may be advisable for the execution of a
power of attorney to be witnessed by a doctor, who can testify about the donor’s mental capacity.
Power of attorney may be executed for financial or personal reasons. It may provide full power or only limited
power during the donor’s absence. In all situations, the donee is accountable in law for all actions and must act
solely for the benefit of the donor. The donor is presumed to have capacity to grant a power of attorney. With
respect to the power of attorney for property, this means that the donor understands the nature of his or her assets
and the nature of the authority he or she is granting. The donor also understands that, as a result, the appointed
donee is able to take all sorts of actions with respect to the donor’s property. A dishonest donee could defraud the
donor.
FORMALITIES
Granting power of attorney involves the following formalities:
• Naming the donor and appointing the donee

• Specifying the authority being granted

• Signing of the document by the donor in the presence of two witnesses
Many people appoint their spouse, adult child, or another trusted person close to them as the donee.
In Quebec, two powers of attorney may be required:
• A mandate that is effective while the mandator is capable

• A second mandate, called a protection mandate, that becomes effective if the mandator becomes
incapacitated
MENTAL INCOMPETENCE
In common law provinces, a continuing power of attorney (or enduring power of attorney) is a document that
authorizes the appointed donee to manage the donor’s financial affairs, even if the donor becomes mentally
incapable. (The donee’s powers do not extend to making a will.)
If no restrictions or conditions are stated, the donee can do anything with the donor’s property that the donor could
have done if mentally capable. Therefore, both the limits of the authority and the choice of donee should be made
with great care.
In Quebec, continuing power of attorney is called a protection mandate. However, this document must be approved
through a legal process before becoming effective.
PERSONAL CARE POWER OF ATTORNEY

A personal care power of attorney (generally included in a protection mandate in Quebec) allows the donor to
appoint someone to make personal care decisions if the donor becomes mentally incapable. Such decisions could
include choosing the donor’s place of residence, food, or medical treatment.
As with a financial power of attorney, limits can be placed on the authority of the donee, and special instructions
can be given. The donee should be someone the donor knows well and can trust with important personal decisions.
A living will or an advance health care directive may form part of this power of attorney, or may it be a separate
document.
LEGAL CONSEQUENCES OF NOT HAVING A POWER OF ATTORNEY

If an individual becomes incapable of making decisions about one’s property, the Public Guardian and Trustee takes
over decision-making duties as the statutory guardian of that person’s property. In such cases, family members or
associates can apply to the court to replace the Public Guardian and Trustee and become the incapacitated family
member’s court-appointed guardian of property. The procedure is time-consuming and costly, and the legal process
can create a great deal of anxiety for a family already in a traumatic situation. Furthermore, the court-appointed
guardian of property has limited decision-making authority, unlike an attorney appointed by a donor. For example,
court-appointed guardians are limited in the types of investments they may make on behalf of the incapable
individual. In contrast, attorneys for property are not restricted in the same way, as long as they are acting in the
best interests of the incapacitated donor.
EXAMPLE
Hubert, a Quebec resident, was seriously injured in an accident, to the point where he was unable to care for
himself and his family. Because he did not have a protection mandate, a curator and a family council were
appointed. The appointees must follow strict rules from the Civil Code of Quebec governing the administration of
Hubert’s affairs, such as reporting to the Public Curator, on an annual basis.

PROVINCIAL LEGAL REQUIREMENTS

Legal requirements for powers of attorney documents vary among the provinces. In Ontario, there are three types of
powers of attorney:
Continuing power of A continuing power of attorney for property covers the donor’s financial affairs and
attorney for property allows the donee to act for the donor even if the donor becomes incapacitated.
Non-continuing power of A non-continuing power of attorney for property covers the donor’s financial affairs
attorney for property but cannot be used if the donor becomes mentally incapable. Donors might give this
power of attorney to someone to look after their financial transactions while they are
away from home for an extended period.
Power of attorney for A power of attorney for personal care covers the donor’s personal decisions, such as
personal care housing and health care.
There is also the concept of a springing power of attorney, which “springs”, or is activated, at some point in the
future, when the donor is deemed incapable of managing their own financial affairs. The donor of a springing power
of attorney can be confident that the appointed attorney is not going to interfere in their financial affairs until
incapacity is determined. However, such a power of attorney can cause conflict in situations where the donor insists
that she or he is still capable while it is obvious to family members and the appointed attorney that the donor is
clearly no longer capable. It could even lead to unnecessary and expensive court action during a difficult time.
In Quebec, a mandate may be classified either as special (i.e., for a particular business) or general (i.e., for all
the businesses of the mandator). A mandate expressed in general terms confers the power to perform acts of
simple administration. These acts generally include only income collection, bank account administration, and bill
payments. The power to perform other acts is conferred only by express mandate, except in the case of a protection
mandate.
A protection mandate must be given by the mandator while the person is still mentally capable. The mandate may
not be executed by the mandatary until after its homologation (i.e., court approval). The homologation procedure
ends with a court judgment making the mandate executory. Mandataries are then entitled to use the powers
entrusted to them.
The Civil Code of Quebec provides for two forms of protection mandate in case of incapacity: by notarial deed and
given in the presence of witnesses. As noted earlier, the mandate becomes effective only after its homologation.
A protection mandate usually covers financial decisions, personal care, living will, and advance care decisions. It can
also be coupled with a power of attorney for financial purposes before the incapacity of the donor.
LIVING WILLS AND ADVANCE HEALTH CARE DIRECTIVES

A living will, which is very similar to an advance health care directive, provides instructions on the treatment a
person wishes or does not wish to receive in the event of a terminal illness or incurable injury. It may be part of the
power of attorney or a separate document. A protection mandate serves the same purpose in Quebec.
Both living wills and advance health care directives specify the medical treatment that a donor would like to receive
in case of a terminal medical condition, incurable injury, or severe mental or physical incapacity.
However, an advance health care directive often contains more detailed directions than a living will about the types
of medical treatment that may or not be desired, depending on the specific medical condition involved. A living will
is usually more general in nature. For example, many people write a living will stating that they do not want to be
kept alive on artificial life support if they have no hope of recovery.

Other than the level of detail, the two documents differ very little and are often referred to interchangeably. In
some provinces, the living will or advance health care directive provisions can be incorporated in a personal care
power of attorney document.
Several provinces are preparing legislation to clarify questions surrounding living wills. In the meantime, a living will
may help influence the medical treatment a dying or comatose person receives. A living will is of value to people for
whom prolonged medical treatment is a concern. A copy of the document may be left with the person’s physician,
as well as a family member or friend who is familiar with the person’s wishes.
CONSIDERATIONS WHEN DEALING WITH VULNERABLE CLIENTS
6 | List the key compliance considerations when dealing with vulnerable clients.
Elder abuse has more than doubled among Canadian seniors over the past two decades. A major contributing factor
to that increase has been a rise in financial abuse by family members1. Today, financial abuse as an elder abuse
issue is second only to the psychological abuse of seniors. In fact, it is estimated that adult children, spouses, and
grandchildren are responsible for close to 40% of reported financial abuse cases2.
The most common examples of financial abuse include theft, fraud, and misrepresentation in gaining access
to financial resources. In addition, there can be coercion or deception involved in the will-making process or in
appointing a power of attorney. Even worse is the use of emotional coercion of elders who may have mobility or
dependence issues.
Advisors, as part of the Know Your Client process, must gather information that specifically pertains to their clients’
personal and financial circumstances. They must also make sufficient enquiries to determine the existence of
testamentary related documents, in particular, the existence of a valid and current power of attorney and a properly
executed will. Furthermore, they must be in frequent communication with clients, especially with vulnerable
clients, and understand the importance of product due diligence and suitability. As a financial advisor, you have a
grave responsibility to be alert to signs of abuse of elderly clients by family or non-family members.
A power of attorney is an important tool to support both the client and the advisor in instances of diminished
capacity or incapacity and wherever there are concerns related to financial exploitation. Generally, registered
firms will accept a power of attorney that meets applicable provincial requirements and will allow the attorney to
conduct financial transactions on behalf of the client. Registered firms in this regard include financial institutions
and related organizations registered with the Ontario Securities Commission or other provincial regulatory agency.
When there is any doubt or concern about the legitimacy of a power of attorney or specific instructions arising
from it, advisors should escalate the matter for review. They must inform the attorney of such action and provide
a general timeframe for resolution. If an organization or institution decides that it cannot act on the attorney’s
instructions, it should state the reason and, if appropriate, what must be done to move forward. Possible actions
that clients and their attorneys could take to resolve the impasse include providing a revised power of attorney,
obtaining legal confirmation that provides clarification of a legal issue, or, in some cases, providing a doctor’s letter
confirming mental capability on the date the power of attorney was signed and witnessed.
Registrants should have policies and procedures regarding powers of attorney that include the following measures:
• Confirm the existence, validity, and currency of a power of attorney at the time of account opening. A power
of attorney must be witnessed by two individuals, neither of whom can be the named attorney, the attorney’s
1
Journal of Elder Abuse & Neglect, 2016
2
Ibid.

spouse or partner, your client’s spouse or partner, your client’s child or a person they treat as a child, a person
whose property is under guardianship, or anyone under the age of 18.
• Obtain a copy of the power of attorney and ensure that any further supporting documentation is on file. Such
documentation will help to confirm whether the power of attorney the dealer member has is the most current
version available.
• Verify that the Know Your Client information is consistent with the power of attorney provided.
• A crucial step is to make certain that a power of attorney survives the client’s mental infirmity. In addition, if
the power of attorney activates only upon the infirmity of the client (i.e., if it is a springing power of attorney),
be mindful of accepting any instructions on that power of attorney until all requirements for its activation have
been met.
• Another common issue arising with respect to the use of a power of attorney is whether the attorney is able to
make a gift on behalf of the donor. This issue usually arises shortly before or at diminished capacity of the client,
where the power of attorney (typically a family member) seeks to accomplish certain tax savings for estate
planning purposes. In these circumstances, reference to provincial legislation governing powers of attorney is
critical in order to ensure that such planning is possible. Typically, gifts or testamentary type-dispositions are
not within the scope of a power of attorney and therefore are not permitted.
• When receiving an attorney’s trading or other instructions, first verify that the power of attorney has been
confirmed to be active and in use on the account. Then, before accepting the instructions, verify that the
client’s investment needs and objectives, financial circumstances, risk tolerance, and other relevant information
has been considered and that the proposed transactions are deemed suitable for the client (and not for the
attorney).
Apart from appointing a power of attorney, registered firms are also encouraging elderly clients to provide
information about a trusted contact person (TCP), similar to an emergency contact person for children at school.
The TCP should be an individual other than the client’s already designated contact person, such as a spouse or child.
As the name suggests, the TCP is an individual whom the client trusts. Ideally, he or she is neither the client’s power
of attorney nor a designated person on the account. They should have no interest in the account or the client’s
affairs, other than acting solely in the client’s best interests.
RED FLAGS
Advisors are in an excellent position to notice red flags such as a change in the behaviour of vulnerable clients.
Advisors who truly know their clients will be able to spot such signals. Given the well-established and close
relationships they enjoy with their clients (which typically commence at the time of initial client onboarding), these
advisors will be able to serve their clients’ needs when they are at their most vulnerable.
Generally, clients are more at risk when they are isolated, when they have recently lost a spouse, or when they are
unfamiliar with financial matters. Clients with relatives who are in debt or who have substance abuse or gambling
problems are at particular risk.
The following red flags are some of the most common signs of abuse to look for when dealing with elderly clients:
• It is difficult to contact the client’s power of attorney.

• Frequent changes occur with respect to persons who can access the client, such as caregivers and other service
providers being hired and fired too often (whether by the client, the client’s power of attorney, or the client’s
loved ones).
• The client has signed a legal document such as a power of attorney without appearing to understand it.
• Unusual activity occurs in the client’s bank or investment accounts, including large, unexplained withdrawals,
frequent transfers between accounts, or ATM withdrawals.

• A caregiver expresses excessive interest in the amount of money being spent by the client.
• Changes to the client’s power of attorney documentation are of a dubious nature.
• Signatures on documents appear suspicious.
• Documentation about financial arrangements is missing.
• Implausible explanations are given about the client’s finances, either by the client or the client’s caregiver or
power of attorney.
• The client is unaware of or does not understand financial arrangements that have been made on his or her
behalf.
At the beginning of this chapter, we presented a scenario in which newly married Nora and Jorge were looking
for estate planning advice. Now that you have read the chapter, along with the relevant chapters in KPMG’s Tax
Planning guide, we’ll revisit the questions we asked and provide some answers.
• In the event of either Jorge’s or Nora’s death, what could happen to their estate, given the format of Jorge’s will
and Nora’s lack of a will? What risks would the survivor be exposed to?
• Jorge’s self-drafted will is unlikely to properly capture his wishes for his estate; therefore, it could be
successfully challenged by his heirs, including his two children from his previous marriage. Nora does not
have a will; if she were to pass away, she would do so intestate. If Nora dies without a valid will, a court
application will be necessary before any of her assets can be distributed; assets will then be distributed
in accordance with provincial intestacy laws. As a consequence, assets may go to beneficiaries against
Nora’s wishes.
• What can you suggest they do to minimize probate fees?

• These are some of the steps they could take:
« Appoint named beneficiaries where possible, such as for life insurance policies, RRSPs, RRIFs, TFSAs, and
pension plans.
« Set up joint ownership of certain accounts and assets (specifically, joint tenancy with right of
survivorship).
« Gift money or assets to family members or a charity during their lifetime.
• Nora lives with a debilitating medical condition. What document(s) should she complete with some urgency?
Nora should complete both a continuing power of attorney for property and an advance health care
directive/power of attorney for personal care. Given her debilitating medical condition, it is more than likely
that Nora could be incapacitated physically and/or mentally in which case having a power of attorney for
property and a living will would be of much help to her and to her loved ones.

SUMMARY
In this chapter, we discussed the following key aspects of estate planning:
• Wills can be made in three basic forms: a conventional will, a holograph will, and, in Quebec, a notarial will. A
codicil is an amendment to a will and is technically considered to be a will on its own. If no will exists, a person’s
estate devolves according to the prescriptions of law. The property of a deceased person can also be passed on
through a marriage contract.
• Testators are restricted under most provincial legislation in two regards: they cannot cut a financially dependent
family member out of their will, and they must provide for their spouse.
• The executor of an estate (or liquidator in Quebec) is an individual or a corporation such as a trust company
appointed by the testator to manage the testator’s affairs after death according to the terms of the testator’s
will. Executors are responsible for keeping the estate assets safe and can be held accountable by the beneficiary
or beneficiaries for any mismanagement of estate funds.
• In all provinces except Quebec, Alberta, and British Columbia, marriage revokes an existing will. A divorce
does not revoke a will; however, any benefits in favour of the former spouse are cancelled. By contrast, legal
separation does not affect wills in most provinces.
• Certain assets, such as those for which there is already a named beneficiary on a form outside the will, are not
subject to the terms of the will.
• Probate is the legal process by which the courts confirm a person’s will to be his or her valid last will and
testament. Probating a will also validates the authority of the executor. Probate fees are charged on the total
value of the deceased’s estate, regardless of whether there is a will. Certain assets owned by a deceased person
are excluded from the estate for probate fees purposes. By reducing the value of an estate’s assets, the client can
reduce the probate fees payable after death, when the will is probated.
• A power of attorney is a document that gives written authority to one or more persons or a corporation to
act on behalf of the person granting authority. A power of attorney may be executed for financial or personal
reasons. It may provide full power or only limited power during the donor’s absence. It may also grant power
only when the donor becomes physically or mentally incapacitated.
• A living will provides instructions on the treatment a person wishes or does not wish to receive in the event
of a terminal illness or incurable injury. It may be part of the power of attorney or a separate document. A
protection mandate serves the same purpose in Quebec.
• Advisors should keep in mind certain compliance considerations when dealing with vulnerable senior clients
who may be exposed to elder abuse.
NOTE
Some content in this chapter is also covered in Chapters 21 and 22 of the KPMG guide, in some cases in greater
detail. We strongly recommend that you study the content in the KPMG guide in addition to this text, because
they both contain examinable content. For examination purposes, if the content in this chapter differs from the
KPMG guide in any respect, precedence will be given to this content.

DISCUSSION BOARD
for Chapter 15.
REVIEW QUESTIONS
Questions.

Estate Planning Strategies 16
CHAPTER OUTLINE
In this chapter, you will learn about the different types of trusts and their specific roles in estate planning. We also
explain how to reduce an estate’s income tax burden, both before and after death. Later in the chapter, we end by
providing a checklist of issues you and your clients should consider when preparing an estate plan.
1 | Describe the different types of trusts Trusts

and explain their application in wealth
management.
2 | Describe strategies that minimize or defer Taxation

clients’ income tax before and after death to
reduce their estate’s tax burden.
3 | Recognize general issues to consider for estate General Issues to Consider for
planning. Estate Planning

KEY TERMS
21-year rule irrevocable trust rights or things
beneficiary life insurance trust settlor
charitable remainder trust personal trust social trust
constructive trust preferred beneficiary spousal trust
estate freeze private trust testamentary trust
express trust qualified disability trust trustee
graduated rate estate resulting trust
inter vivos trust revocable trust

CHAPTER 16 ESTATE PLANNING STRATEGIES 16 • 3
INTRODUCTION
Trusts are a complex area of the law. The discussion about trusts in this chapter provides a basic and relatively
simplified overview of the mechanism of trusts and its application in wealth management. A trust specialist should
be consulted in situations where a client could benefit from setting up a trust.
One of the largest tax bills clients (or, more accurately, their estates) invariably face is at death. As such, a lot of
effort is expended to reduce the potential burden of taxes at death by planning to minimize taxes before and after
death. For example, one major strategy of reducing taxes at death is to provide gifts to heirs before death. It should
be kept in mind though that different techniques and strategies have different repercussions, often unexpected, and
a tax specialist may need to be consulted to set up everything accurately.
Before you begin, read the scenario below, which raises some of the questions you might have about estate
planning. Think about these questions, but don’t worry if the answers don’t come easily. At the end of the chapter,
Your client Jorge and his new wife Nora are meeting with you as a couple for the first time. They want to discuss
Nora’s recent transfer of her investment account. As part of your discovery process, you find out that Nora
has never been married, but was previously in a common-law relationship with the father of her two children.
Nora does not have a will, and Jorge had a will prepared and signed before his divorce from his first wife three
years ago.
Jorge, a successful small business owner, has brought substantial assets into the marriage, whereas Nora has
few assets. Just before he and Nora got married, Jorge downloaded a will template from the Internet, which he
personalized, printed, and signed. He believes that this new will supersedes the one he had in place before his
divorce. He also believes it provides appropriately for both Nora and his two teenage children from his previous
marriage. Nora’s children are young adults and are not close to Jorge.
• Nora lives with a debilitating medical condition. What type of trust would be of benefit in her situation?
• What can you suggest they do to reduce potential taxes at death?
• What can Jorge and Nora do to ensure that their children’s needs are met in the event of the parents’ death?
What can Jorge do to ensure that Nora would be financially secure if he were to die before her? At the same time,
how can he protect the rights of his children to his estate?
NOTE
The content in this chapter covers both common law and civil code provisions. For study purposes, all content is
examinable regardless of the province of your residence.
Furthermore, some content in this chapter is also covered in Chapters 21 and 22 of the KPMG Tax Planning
guide, in some cases in greater detail. We strongly recommend that you study the content in the KPMG guide in
addition to this text, because they both contain examinable content. For examination purposes, if content in this

TRUSTS
1 | Describe the different types of trusts and explain their application in wealth management.
A trust is a relationship that is created when one party (the settlor) transfers assets to another party (the trustee)
who holds legal title to the transferred property for the benefit of another party (the beneficiary), who has the
beneficial interest. The trust document provides instructions on how the assets are to be managed, and when
and how they can be used by the beneficiaries. The beneficiaries may be identified by name or as a class (e.g.,
“my children”). The settlor, the person who settles the trust, must be of the age of majority and must be legally
competent to enter into a contract. Legal restrictions apply to persons with limited capacity to contract, such as a
bankrupt or a mentally incompetent person).
EXAMPLE
Mrs. Carson who lives on the East Coast of Canada, creates a trust for which she is the settlor, her son Mathew is
the trustee, and her granddaughter Nadine is the beneficiary.
• As the settlor, Mrs. Carson is transferring the $100,000 in the trust, which is now part of the trust property.
She will no longer own those funds legally or beneficially and cannot make any transactions.
• As the trustee, Mathew will have legal title to the trust property and will be able to carry out transactions
and invest the funds. However, he will be responsible for managing the trust property according to the terms
and conditions of the trust expressed by Mrs. Carson for the benefit of Nadine.
• As the beneficiary, Nadine will have a beneficial interest in the trust.
In setting up an inter vivos trust, it is possible for the same person to be both settlor and trustee, except in Quebec.
In such cases, it is important to ensure that negative tax implications, such as attribution of income, are avoided. In
certain circumstances, for example, in creating an alter ego trust, the settlor is the same person as the trustee and
the beneficiary. However, other than in the case of an alter ego trust, the settlor is typically neither the trustee nor
the beneficiary.
In Quebec, the settlor or the beneficiary must act jointly with a trustee who is neither the settlor nor a beneficiary.
For example, consider a case where a testator leaves the income to her spouse for his lifetime and the residue to
her child upon the spouse’s death. In such a case, the spouse and child cannot act alone; a third trustee must be
appointed.
When a settlor transfers legal title of an asset to a trustee, by will or inter vivos deed, the deemed disposition rule
may apply. A capital gain or loss may result for the settlor or the settlor’s estate. However, it is possible to transfer
assets to a spousal trust (testamentary or inter vivos) on a rollover basis.
Unlike a corporation, a trust is not a legal entity. It is a relationship that exists among a trustee, the property, and
the beneficiary or beneficiaries, whenever a trustee accepts holding legal ownership of property for the benefit of
beneficiaries. This concept is somewhat different than the one applicable in Quebec, which is discussed later in the
chapter. The procedural and administrative aspects of trusts and the responsibilities and powers of trustees are
outlined in the provincial Trustee Acts and the Civil Code in Quebec.
Generally, the beneficiary is the person who has any contingent or absolute right to the assets held in the trust. The
trustee has control over the assets of a trust but does not beneficially own the assets held in the trust.
Typically, in an inter vivos trust, the trustee is appointed by the settlor, whereas the estate trustee or trustee of a
testamentary trust is appointed in a will by the testator. In some circumstances, the court must appoint a trustee.

At common law, and according to statutory law, trustees are fiduciaries, and are therefore held to a high standard of
care. The applicable law places onerous fiduciary obligations on trustees. Additionally, the trust instrument dictates
the terms of trust and outlines the duties and obligations of the trustee who is appointed. The terms of the trust,
which specify the trustee’s duties, may override those duties at law.
DUTIES OF THE TRUSTEE

There are four primary duties imposed on trustees by common law, which are also applicable in the province of
Quebec. They relate to conflicts of interest, standard of care, delegation of duties, and impartiality.
CONFLICT OF INTEREST
A trustee cannot be seen to be in a conflict of interest between his or her own interest and that of the beneficiaries.
In this respect, the following rules apply:
• A trustee cannot profit from actions taken as a trustee.

• A trustee cannot acquire trust property or enter into contracts with the trust personally.
If a breach of trust occurs, the trustee can be compelled to return the profit and pay financial damages to the
beneficiaries.
STANDARD OF CARE IN MANAGEMENT OF TRUST FUNDS

A trustee is bound by a duty to act honestly and in good faith and to take reasonable and proper care of the trust
property. The standard of care that must be met is that of a prudent investor (or “prudent and diligent person”, in
Quebec) managing his or her own investments or business.
DELEGATION BY TRUSTEE
Generally, trustees are not permitted to delegate their power and duties to another person. This law is similar to
the law that pertains to directors of companies, which prohibits delegation of director duties. However, in certain
circumstances, and depending on the nature of the responsibilities, tasks involving the administration of the trust
property may be delegated.
The trustee may employ an agent, such as a trust company, or a professional, such as an investment advisor, to
carry out certain activities, where appropriate.
A trustee is not responsible for any loss caused by the agent’s acts, as long as the trustee did not delegate exercise
of discretion. However, because the trustee’s decisions are held to a prudent investor standard, the trustee’s choice
of a particular agent must be justified and held to the same standard. Furthermore, the trustee must continue to
monitor and supervise the agent’s work.
In Quebec, the trustee may not delegate the administration of the trust or the trustee’s discretionary powers, except
to co-administrators. For example, a trustee may delegate the investment policy decision to a co-trustee.
MAINTAINING AN EVEN HAND

Trustees must act impartially in dealing with the trust assets for the benefit of the beneficiaries. In Quebec, this
obligation is known as the impartiality rule. It may arise, for example, when investments are made that favour the
interests of income beneficiaries to the detriment of capital beneficiaries, or vice versa.
EXAMPLE
A trust is set up that affects both Rashida and Noura. Rashida is entitled to the income of the trust for her
lifetime. Noura will receive the capital upon Rashida’s death. To respect the even hand rule, the trustee will
probably decide to consider a balanced portfolio deed.

The duty of maintaining an even hand does not apply to discretionary distributions of property to the beneficiaries
through a discretionary trust.
Discretionary trusts generally provide that trustees may use their discretion to benefit any beneficiary, as they see
fit. However, they must be impartial in evaluating the needs of each beneficiary and take steps to be informed of
each beneficiary’s situation. They must also clearly address the issue of whether to exercise discretionary power, and
they must exercise discretion honestly, prudently, and in good faith. The duty to maintain an even hand does not
require that the trustee split up trust property equally between beneficiaries of a discretionary trust.
TYPES OF TRUSTS
A trust is constituted when three “certainties” exist:
Certainty of intention There is a clear intention to create a trust.
Certainty of subject The trust property is delivered to the trustee.
Certainty of objects The beneficiaries of the trust (i.e., named individuals, persons, or closed classes) are
clearly described and are identifiable.
Clients often mistakenly assume that a trust is created simply by the intention to create a trust, much like a
contract. However, a trust is generally not created until the property is actually settled on the trustee by the settlor.
A mere promise by the settlor to transfer property to the trust is not enforceable and does not establish a trust.
The Income Tax Act treats a trust as if it were a separate person, and the nature of a trust is that of a relationship.
As noted earlier, a trust is not a legal entity; however, for purposes of the Income Tax Act and taxation, it is treated
as a separate taxpayer. A separate tax return must be filed each year for the trust.
DID YOU KNOW?
A trust can be established expressly, by statute, through a will, or by operation of law (as a result of
conduct or the occurrence of an event) in common-law provinces.
TESTAMENTARY AND INTER VIVOS TRUSTS

A testamentary trust is created by the testator’s will and arises at the testator’s death. An inter vivos trust is set up
during the settlor’s lifetime. The settlor creates the trust in three ways:
• By demonstrating an intention to create a trust

• By transferring legal ownership of certain clearly identified property to the trustee
• By clearly identifying the beneficiaries for whom the property is being held in trust
In common-law provinces, inter vivos trusts may be revocable or irrevocable. A revocable trust can be undone by
the settlor at any time. However, revoking the trust will bring about negative tax consequences, depending on the
nature of the property held in the trust. If the settlor reclaims the assets or changes the beneficiaries, all income and
capital gains will be attributed back to the settlor. With an irrevocable trust, the settlor cannot revoke the terms of
the trust and has no legal right to take back any of the trust’s assets. If it is not clearly stated in the trust documents
that the trust is revocable, it is assumed to be irrevocable under common law.
There are several reasons for setting up an inter vivos trust. A recurring concern is to protect assets from being
lost through spendthrift behaviour by a beneficiary. Assets may also be protected from creditors’ claims if certain
conditions are met. Often, the settlor wishes to gift significant assets to his or her children or other family members,
but the gifting is done through a trust rather than directly, so that the assets can be managed and safeguarded for a
lengthy period.

Inter vivos trusts have the following drawbacks:
• The procedures involved in setting them up are complicated.

• Legal and accounting fees must be paid.
• Tax must be reported annually.
• Settlors may be reluctant to give up control, wishing instead to use or benefit from the assets or investment
income.
EXPRESS TRUSTS
Express trusts expressly state the terms of the trust. Most express trusts are written, outlining the intentions of the
settlor or testator. Wills, codicils, discretionary family trusts, and other inter vivos trusts are examples of express
trusts.
RESULTING AND CONSTRUCTIVE TRUSTS IN COMMON LAW

In common law, trusts such as resulting trusts and constructive trusts can be declared to exist by the operation
of law.
A resulting trust presumes that a person has a share in a property based on that person’s contribution of finance or
labour to acquiring or maintaining the property.
EXAMPLE
Two friends, Alejandro and Elsa, purchase a house. Each contributes $100,000 toward the purchase. Even if title
to the house is only in Alejandro’s name, a court could find that Elsa has an interest by means of a resulting trust.
Constructive trusts may be formed when one party is unjustly enriched at the expense of another person. The court
imposes an obligation on the unjustly enriched party to compensate, or transfer property to, the deprived party.
EXAMPLE
Sheila looked after her bedridden brother-in-law, Sheldon, for several years before his death. Sheldon had assured
Sheila that she would be looked after upon his death. However, Sheldon’s will provided only a small gift of
$5,000 for Sheila and left the balance of the $500,000 estate to his son. Sheila could claim a constructive trust
on Sheldon’s property and seek fair compensation.
OTHER TYPES OF TRUSTS

Three other types of trusts to consider when working with your clients are described below:
Life insurance trust A life insurance trust consists of the proceeds of one or more insurance policies.
Charitable remainder A charitable remainder trust is set up with the purpose of benefiting the community
trust or the public. This type of trust can also be used to donate funds to a charitable
organization. Settlors can receive all the income generated by the trust for their
remaining lifetime. When the settlor dies, all remaining capital goes to the charity.
Spousal trust A spousal trust is essentially any testamentary or inter vivos trust created by a testator
or a settlor for the benefit of a spouse. Such trusts must meet certain conditions. The
trust must provide that the spouse is entitled to receive all the income of the trust
before the spouse’s death. Furthermore, only the spouse may obtain or use any of the
income or capital of the trust before his or her death.

THE 21-YEAR RULE

Clients often want to establish trusts that will last forever. However, such trusts are generally considered invalid
because they are contrary to the common-law rule against perpetuities. The 21-year rule is designed to prevent
people from tying up assets beyond a certain period (which is ordinarily 120 years).
The common-law rule has been modified in some provinces. For example, British Columbia’s Perpetuity Act has a
“wait-and-see” rule that will only invalidate a trust if vesting has not occurred within 80 years. (Vesting is the right
of the beneficiary to absolute ownership of property.) The wait-and-see rule does not apply in Quebec, but the
province has other provisions that limit the duration of a trust. Not all provinces have a perpetuity act in place.
Under the Income Tax Act, a trust is taxed every 21 years, as if it had disposed of and re-acquired all capital property
at fair market value. (In other words, a deemed disposition occurs.)
TYPES OF TRUSTS
What are the features of the different types of trusts? Complete the online learning activity to assess your
knowledge.
REASONS FOR CREATING INTER VIVOS TRUSTS

Inter vivos trusts are created for several non-tax-related reasons, including asset management and protection and
to avoid deemed disposition and probate fees.
ASSET MANAGEMENT
The flexibility that results from trusts becomes most apparent in the context of an estate freeze when the
shareholder uses a discretionary trust rather than issuing shares directly to family members. When a trust is
used, benefits arising from the shares are not fixed and can be adjusted from time to time, as circumstances
change. Examples might include health problems, drug dependencies, mental breakdowns, marital breakdowns,
or tax changes. When direct ownership by family members is employed, relative shareholdings are fixed, and the
reallocation of shares, and the resulting benefits, become far more problematic.
ASSET PROTECTION
Holding assets in an irrevocable discretionary trust can protect the assets both from the beneficiaries’ creditors
and from the beneficiaries themselves. A settlement of property in a trust by a settlor who is insolvent or close to
insolvency may be subject to attack under fraudulent conveyance legislation. A trust must not be made to delay,
hinder, or defraud creditors of their just and lawful remedies. A disposition of property under circumstances of
collusion, guile, malice, or fraud is void and has no effect against the wronged party.
AVOIDING DEEMED DISPOSITION AT DEATH AND PROBATE FEES

Assets placed by a person in an inter vivos trust before death will not be subject to the deemed disposition rule at
the time of that person’s death. The assets do not form part of the deceased’s estate and are not subject to probate;
they are held by the trustee for the beneficiary. Thus, the deceased avoids a significant tax bill at death. However,
tax may be payable when the trust is settled (i.e., when assets are transferred to the trust).
PROVISIONS IN TRUST AGREEMENTS

In creating a trust agreement, the settlor must be identified, along with the trustee or trustees. The deed must
also identify the trust property given to, and accepted by, the trustee. It must also clearly identify the income
beneficiaries and the capital beneficiaries. Other provisions in trust agreements are discussed below.

DETERMINATION OF THE BENEFICIARIES

The beneficiaries must be identified carefully. They are often defined as a closed class, such as the children or
grandchildren of the settlor or testator.
PURPOSE OF THE TRUST

The purpose for which a trust is established (called appropriation in the Civil Code of Quebec) should be clearly
described. The purpose can vary.
In a purely discretionary trust, the trustee has absolute and unfettered discretion to distribute the trust income and
capital to any beneficiary (e.g., either spouse, children, or grandchildren).
In a non-discretionary trust, the distribution of income and capital occurs according to the fixed terms prescribed by
the settlor or testator.
EXAMPLE
The settlor of a trust set up for a charity might direct that only the income from a certain asset should go to that
particular charity. Furthermore, the settlor might direct that income should only be used only for cancer research.
INDEMNIFICATION OF THE TRUSTEE

In theory, the fiduciary duties associated with being a trustee are so onerous that it would be difficult to recruit
trustees. For this reason, trust deeds typically contain provisions to lower the high standards that trustees must
otherwise meet. The effect is that trustees are liable only in the event of wilful default of their duties.
In addition, trustees are often indemnified for any actions they take within the scope of the duties specified in the
trust deed. However, limits on the trustee’s liability in the trust indenture alone may not limit the trustee’s liability
to a third party. Accordingly, trustees should make sure that this limitation on liability is included in the documents
relating to any transaction they undertake as a trustee.
TRUSTEE’S INVESTMENT POWERS

Unless a trust deed states otherwise, the trustee’s investment powers are those allowed under the applicable
provincial statute. Because statutory powers are usually restrictive, the trust deed may enlarge investment powers
beyond what is allowed under the provincial statute.
In Quebec, unless otherwise provided for in the trust instrument, trustees have full authority. Their power to invest
is not limited to a restricted investments list. However, they are still bound by the duty to act with prudence and
diligence and in the best interest of the beneficiaries.
AVOIDING THE 21-YEAR RULE

Many personal trusts contain a provision under which all trust property is distributed to the beneficiaries on a tax-
deferred basis before the 21-year deemed disposition rule applies. This distribution of capital can be made only to
the capital beneficiaries of a trust, not to the income beneficiaries.
In many cases, but not always, the income beneficiary and the capital beneficiary are the same person. For
example, a trust that holds an investment portfolio may distribute the income generated by the capital, the funds
of which are invested, to certain named beneficiaries during their lifetime. Upon the death of the last of the income
beneficiaries, other named individuals, the capital beneficiaries, will receive the capital, the trust funds, as capital
distributions. Until the death of the income beneficiaries, the capital beneficiaries are not entitled to receive any
distributions.
Canadian resident capital beneficiaries of a Canadian resident trust can receive the capital distribution on a tax
deferral basis, as long as the distribution occurs prior to the expiry of 21 years from the trust’s date of creation.
In such a case, the recipient capital beneficiary assumes the trust capital property at its adjusted cost base (ACB).

EXAMPLE
A stock was acquired by a trust at an ACB of $100. The trust’s assets are now being distributed to the capital
beneficiary of the trust. A rollover occurs on a tax-deferred basis at the ACB of $100. When the capital beneficiary
sells the stock (or dies) the capital gain will be taxed in his hands (or in the hands of his estate).
This provision may serve to wind up the trust on a tax-deferred basis. However, such a clause does not prevent
trustees of a discretionary trust from distributing the property, as they choose, before the end of the 21-year
time limit.
DID YOU KNOW?
The 21-year deemed disposition rule does not apply to a spousal trust; the deemed disposition is
deferred until the death of the surviving spouse. After that spouse dies, the 21-year rule is applied in
accordance with the Income Tax Act.
FAILURE OF THE TRUST—LACK OF BENEFICIARIES

If a trust fails because there are no beneficiaries, the trust property ordinarily reverts to the settlor by operation
of law (or the settlor’s estate, if the settlor is deceased). A trust should provide for an alternative method of
distribution that prevents trust property from reverting to the settlor. This provision ensures that the trust has no
reversionary element that would subject the settlor to attribution during his or her lifetime.
POWER OF APPOINTMENT
Trustees often exercise powers of appointment (i.e., powers to determine, distribute, or hold property for a
particular beneficiary). In Quebec, power of appointment may be exercised by the trustee or a third person
designated by the settlor only if a class of persons is clearly determined in the trust deed.
LETTER OF WISHES
A non-binding declaration of the settlor’s wishes is often annexed to the will. This provision is a way of suggesting
how the trustee should administer the trust and exercise discretionary powers in the case of a discretionary trust.
LEGAL ASPECTS OF TRUSTS IN QUEBEC

Several legal aspects related to trusts differ in Quebec from those that apply elsewhere in Canada.
Under the Civil Code of Quebec, a trust results from an act whereby the settlor transfers property from his or her
patrimony to that of another person for a particular purpose. The trust takes effect as soon as the trustee agrees to
hold and administer the trust patrimony for the beneficiaries.
The trust patrimony consists only of the property transferred in trust. Unlike the common-law trust, where the
trustee owns the legal title of the trust property, the trust patrimony is distinct from other property belonging to
the settlor, trustee, or beneficiary, and none of them has any real right to the property held in trust. The settlor’s
creditors cannot take legal action against the property held in trust unless the trust was specifically created to
defraud them.
A trust is established by contract, whether for payment or for free (e.g., by will or gift); in certain cases, it is
established by operation of law. A trust must be created in a written document.

TYPES OF TRUSTS IN QUEBEC

In addition to express trusts, inter vivos trusts, and testamentary trusts, three other types of trusts exist under
Quebec’s Civil Code, which are described below:
Social trust A social trust is a trust constituted for cultural, educational, philanthropic, religious, or
scientific purposes. A social trust is set up for the general benefit of the community, not
to generate a profit.
Personal trust A personal trust is a trust constituted for free to secure a benefit for a particular person
(i.e., a trust established by a will or a gift).
For example, a trust set up for the benefit of a spouse is considered to be a personal
trust.
Private trust A private trust is a trust created for specific purposes, such as maintaining or preserving
property for a specific use (e.g., maintenance of a grave or memorial). It can also be a
trust constituted by onerous title, as one created for the purpose of making of profit
(e.g., mutual funds or RRSPs).
DID YOU KNOW?
Resulting and constructive trusts do not exist in Quebec.
TAXES AND TRUSTS

When income earned in a trust is distributed to the beneficiaries, it is taxed in their hands. The income retains
its character for tax purposes. For example, in a trust, as for an individual, Canadian dividends are eligible for the
dividend tax credit, and only 50% of capital gains are taxable, whereas interest income is fully taxable.
The general rule for the taxation of personal trusts is that the income of the trust is not taxed in the trust’s hands
to the extent that it is paid or payable to a beneficiary in the year. A personal trust is effectively treated as if its
property were owned by an individual. That person is deemed to be subject to tax and to be a completely separate
tax-paying entity. If the trust is deemed to be a resident of Canada but earns income from foreign sources, its
worldwide income is subject to Canadian tax. It is important to note that a personal trust is not eligible for personal
tax credits.
A trust generally calculates its income in much the same way any other individual would. The distinction between
testamentary and inter vivos trusts has little bearing on the way the trust’s income is determined. In either case,
that income includes income from business, property, and other income. It also includes any taxable capital gains,
minus allowable capital losses.
As previously mentioned, trusts are deemed to dispose of all trust property every 21 years, including capital
properties, land inventories, and resource properties.
The residence of a trust determines the income tax jurisdiction in which the trust will be taxed. Residence is
established based on the trustees’ place of residence, the location of the assets, and the location from which the
assets are administered.

DEDUCTING VERSUS DESIGNATING TRUST INCOME

Trusts differ from living persons in that a trust may deduct amounts that are paid or are payable to its beneficiaries
in a particular year. This deduction is claimed when computing the income of the trust for the year in which the
payment is made or the liability to pay is incurred. This deduction becomes the beneficiaries’ trust income; it is
included in their income and taxed in their hands. However, any income not paid or payable to beneficiaries is taxed
in the trust.
A trust may retain income earned in one taxation year and pay it out to a beneficiary in the following taxation year.
In such cases, the beneficiary does not pay additional tax if the funds have already been taxed. In other words, the
income is taxed either in the hands of the trust or in those of the beneficiary, but not both. Thus, double taxation is
avoided. The election to tax income in the trust (referred to as designating the income as being taxed) can be made
under three conditions:
• The trust is a resident in Canada throughout the year.

• It is not exempt from tax.
• It is not a specified trust.
These rules apply to income paid or payable to beneficiaries. The designation is usually made when there are non-
capital losses that can be deducted against capital gains. It is also important to note that, when there are multiple
beneficiaries, the designation applies to all beneficiaries. Once the designation is made on the trust’s tax return, this
amount cannot be deducted off the trust’s tax return.
ADDITIONAL PROVISIONS APPLICABLE TO PERSONAL TRUSTS

Since 2015, a personal trust must file its income tax return within 90 days of December 31. (In contrast, individuals
must file their income tax returns no later than April 30 of the year following the taxation year.) Trusts (both
testamentary and inter vivos) must have a taxation year ending December 31 and must make quarterly instalments.
TAXING OF MULTIPLE TRUSTS

Some people may wish to create more than one trust, such as one trust for each child, for example. In such cases,
incomes of the trusts may be added together and taxed as if they were the income of a single trust. This outcome
arises when both of two conditions apply:
• Substantially all of the property of the various trusts is received from one person.
• The income accrues, or will ultimately accrue, to the same beneficiaries or group of beneficiaries.
Drafting of the trust deed must be precise, so that the separate trusts are clearly established to split income
between several trusts.
TRUSTS FOR MINOR CHILDREN

Typically, the terms of the trust stipulate that the trust capital, and perhaps all or some of the income, will be
retained within the trust until the minor beneficiary reaches a certain age.
In this case, even though the trust income is not actually paid out in a particular year, it is deemed to be payable to
the minor. In other words, the amount is deducted from the trust’s income and added to the minor’s income.
In such cases, to be in accord with the Income Tax Act, the following conditions must be met:
• The income must not become payable in the year.

• The beneficiary must be under 21 years of age at the end of the year.

• The beneficiary’s right to the income must be vested by the end of the year without the exercise or the non-
exercise of a discretionary power.
• The beneficiary’s right must not be subject to any future conditions (other than a condition that the age of
survival cannot exceed 40 years).
CAPITAL GAIN DISTRIBUTIONS

The terms of a trust should specify whether a taxable capital gain realized by the trust is to be included in the
income of one or more beneficiaries for tax purposes.
If a trustee is bound to pay only income to a beneficiary, the amount paid to the beneficiary does not include a
capital gain. (Capital gains are not income, under trust law, unless contrary directions are specified in the trust
deed.)
However, all or part of the payment may involve a distribution of capital to a capital beneficiary (e.g., at the
termination of the trust). In that case, all or part of the taxable capital gain realized by the trust can be included as
part of the distribution. Thus, the beneficiary can offset any allowable capital losses realized in the year or carried
over from another taxation year against the capital gain.
FOREIGN INCOME
A trust resident in Canada that has income from foreign sources may allocate all or part of this income to its
beneficiaries. The amount allocated in this way is deemed to be the beneficiaries’ income from foreign sources;
therefore, the beneficiaries can claim a foreign tax credit. The applicable portion of the foreign tax will be deemed to
have been paid by the beneficiary. If the trust income comes from more than one foreign country, these allocations
must be made on a country-by-country basis.
QUALIFIED DISABILITY TRUST

A qualified disability trust (QDT) is a type of trust designed to benefit disabled individuals by permitting the lower
tax rates to apply to the trust. A QDT remains subject to graduated tax rates as long as the named beneficiary with
a disability is eligible for the tax credit. In order to qualify, a QDT must meet the following conditions:
• It must be a testamentary trust.

• It must be resident in Canada.
• It must make a joint election in its T3 tax return with one or more of its electing trust beneficiaries to be a QDT
for the year.
• It must have income for the taxation year (not including income from a preferred beneficiary election) which
does not exceed the dependant tax credit.
In addition, each electing beneficiary must be named as a beneficiary by the particular individual (i.e., the testator)
in a will. The beneficiary must also be eligible for the disability tax credit for the beneficiary’s tax year in which the
trust’s year ends. An electing beneficiary cannot jointly elect with any other trust to be a QDT for the other trust’s
taxation year that ends in the beneficiary’s taxation year.
THE PREFERRED BENEFICIARY ELECTION

In certain cases, a trust document will not permit a distribution of income or capital until the beneficiaries reach
a certain age. In other cases, the distribution of income or capital may be at the trustee’s discretion. In the second
situation, the trustee may decide that it would be inappropriate to distribute income or capital in a particular year.
In either case, the trust’s effective income would probably be considerably higher than it would have been if the
income and capital gain had been allocated to the beneficiaries. This is because trusts that do not pay a portion of

their income to the beneficiaries during the year may not claim the beneficiaries’ income deduction in the trust’s tax
return. Since 2016, any taxes on the accumulating income (including realized capital gain) are payable by the trust
at the trust’s maximum tax rate.
A preferred beneficiary can be one of two types:
• A Canadian resident who is a beneficiary of a trust at the end of the trust’s taxation year and who qualifies for
the disability tax credit under the Income Tax Act.
• A Canadian who is an adult, dependent on others by reason of a mental or physical infirmity, and who is also
one of the following:
• The settlor of the trust
• The current or former spouse or common-law partner of the settlor of the trust
« A child, grandchild, or great-grandchild of the settlor of the trust, or the spouse or common-law partner of
any such person.
The preferred beneficiary election is available to testamentary trusts. However, for tax reasons, it was used mostly
by inter vivos trusts in the past. Any accumulating income in an inter vivos trust would otherwise be taxed at the
maximum personal income tax rate, rather than at graduated tax rates. Since 2016, graduated tax rates have been
eliminated in testamentary trusts, so this election is now used more frequently.
TAXATION
2 | Describe strategies that minimize or defer clients’ income tax before and after death to reduce their
estate’s tax burden.
In this section, we explain how clients can minimize or defer income tax before death to reduce their estate’s
tax burden.
DISPOSITION OF CAPITAL PROPERTY BEFORE DEATH

A disposition of capital property includes both depreciable and non-depreciable property. It generally occurs at fair
market value, with a resulting capital gain or loss and possible recapture of capital cost allowance or terminal loss.
Exceptions to this general rule include the following types of transfers:
• Transfer of capital property to a spouse or a spousal trust

• Transfer of qualified fishing property to a child
• Transfer of qualified farm property to a child
• Transfer of personally owned property from an individual to a corporation (subject to several conditions)
If a client transfers assets with an accrued loss (i.e., assets that have dropped in value) to an affiliated person, the
capital loss could be denied under certain stop-loss tax rules. The transfer might also lead to double taxation.
(A spouse is considered to be an affiliated person, but children are not. Certain corporations or partnerships can also
be affiliated.)
However, a client may transfer property at fair market value to offset non-capital (business or property) losses or
capital losses. In other words, the client can deliberately create capital gains or recapture the capital cost allowance
for this purpose.

TRANSFER OF CAPITAL PROPERTY TO A SPOUSE OR SPOUSAL TRUST

DURING THE SETTLOR’S LIFETIME
One way your clients can remove property from their estate for the purposes of reducing probate fees at death
is to transfer the asset to another person or a trust. The transferred assets, therefore, are not part of the probate
procedure. Clients can transfer their capital property, tax-free and at the ACB, to the following recipients:
• The taxpayer’s spouse (including a common-law spouse, or a de facto spouse in Quebec)

• A spousal trust
• A former spouse in settlement of a divorce
Both the transferor and the spouse or spousal trust must reside in Canada at the time of the transfer. This rule,
which creates the deferral of tax, is known as a spousal rollover.
EXAMPLE
Jerome, a small business owner, wishes to shield certain personal assets (including an investment portfolio and
real estate property) from business creditors. He transfers them to his wife without immediate tax consequences.
In other words, the transfer does not result in an immediate capital gain or loss to Jerome.
ATTRIBUTION RULES
If assets are put into a spousal trust, all the income and capital of the spousal trust must be exclusively for the use
of the spouse during the spouse’s lifetime. The transferor’s proceeds of disposition in a spousal rollover are known as
the tax basis, or ACB, of the assets. For example, the proceeds of disposition for depreciable property are deemed to
be the undepreciated capital cost of the depreciable property.
A spousal rollover occurs on a tax-free basis. However, if the spouse disposes of the property during his lifetime, any
capital gain or loss is attributed back to the transferor, unless the transferor is no longer married to the recipient
spouse.
In addition, any income earned from the transferred property after the transfer is attributed back to the transferor.
Therefore, it is not possible to split income or capital gains between spouses simply by transferring property.
However, the payment of tax on a capital gain is deferred until the recipient spouse disposes of the property.
Furthermore, there is no income attribution after the spouses have separated and, if both spouses jointly elect,
there is no attribution of capital gains to the transferor spouse.
ELECTION TO AVOID ROLLOVER

The transferor may elect to have the proceeds of disposition and the cost of acquisition to the transferee be equal
to the fair market value of the property. This option is important if a person transfers property to a spouse and
subsequently divorces or separates from the spouse. If no election is made, the recipient spouse will, upon disposing
of the property, pay tax on the capital gains based on the transferor’s ACB as mentioned above. In effect, the
recipient pays tax not only on his or her own capital gain but also on that of the former spouse.
SHARES OF A SMALL BUSINESS CORPORATION

Small business corporations are exempt from the income attribution rules, which apply to loans and transfers
made to corporations, the shares of which are held by a spouse or minor children (subject to certain limitations).
Also, capital gains on the disposition of shares of a qualified small business corporation may qualify for the lifetime
capital gains exemption.

TRANSFERRING CAPITAL PROPERTY TO A CORPORATION

A client can transfer certain property to a corporation and elect to defer the full accrued gain or realize a portion of
the gain. To do so, the client can use estate freeze techniques under Sections 85 and 86 of the Income Tax Act.
ESTATE FREEZE
The main reason to freeze an estate is to limit the shareholder’s tax liability for potential asset growth. To do so,
shareholders must freeze the value of their specified growth assets, so that future growth occurs normally in the
hands of their children or spouse. Growth assets generally consist of capital property likely to increase in value, such
as stocks, bonds, real estate, business interests, and shares of a private corporation.
In an estate freeze, the accrued value in the assets, before the freeze starts, belongs to the owner of the shares—the
shareholder or transferor. Subsequent growth in the value usually accrues to the owner’s children or spouse. When
the transferor dies, the increase in value up to the freeze date is taxed in the hands of the estate. (Or, it is taxed
in the owner’s hands if the owner disposes of the assets before death.) Any subsequent growth in value will be
ultimately taxed in the hands of the children or spouse.
An estate freeze may be structured so that the owner of growth assets transfers them directly to his or her children
or spouse.
THE USE OF HOLDING COMPANIES AND INTER VIVOS TRUSTS

The traditional method of freezing an estate is to use a holding company (often referred to as a “holdco”). A
holding company is generally a company that has control over another company through ownership of a sufficient
proportion of that company’s shares. It is also possible to use an inter vivos trust or family trust in conjunction with
a holding company when conducting an estate freeze.
Clients making an estate freeze may have the following requirements:
• Maintain control over the assets, even though any growth passes to the next generation.
• Secure a source of income after the estate freeze.
• Get assurance that no immediate tax liability arises on the estate freeze.
A typical estate freeze is accomplished through a holding company. A person who owns all the common shares
of a thriving company can transfer them into a newly incorporated holding company. The person can then take
back, as consideration, the holding company’s preferred shares of the same value as the common shares that were
exchanged for the preferred shares (under Section 85 of the Income Tax Act). The transfer is effected at cost, and no
taxable capital gain arises. Figure 16.1 shows the estate freeze process.

Figure 16.1 | Holding Company Freeze
Before the Freeze After the Freeze
Parents Parents Children
B
100% Preferred Common
Ownership Shared Shares
Common A Holding
Shares Rollover Company
Operating Operating
Company Company
In Figure 16.1, the following rules apply:
• The cost base of the common shares flows through to the preferred shares, along with any gain in the common
shares. (A)
• The preferred shares are voting, non-participating, non-cumulative, redeemable shares, with a fixed dividend
rate. (B)
• The preferred shares are redeemable at the fair market value of the common shares transferred into the holding
company.
The holding company’s newly issued, nil-value common shares (the new growth shares) are issued to the children in
such a way that the preferred shares have more votes than the common shares. Because the preferred shares have
a fixed redemption amount, any future growth in the common shares belongs to the children. In this kind of estate
freeze, the shareholder or transferor maintains voting control in the holding company through the voting preferred
shares. The shareholder also receives preferred share dividend income, but the future growth of the assets accrues to
the children. The fixed preferred dividend can be set to meet the shareholder’s income needs.
Alternatively, a person can achieve a partial estate freeze by transferring only a portion of the growth assets to the
next generation.
If a client requests an estate freeze, you should seek expert assistance from a lawyer and an accountant.
RISKS OF ESTATE FREEZING

Freezing an estate carries the following risks:
• Once an estate freeze is in place, any growth in the new common shares accrues to the children.
• Non-growth assets taken back by the shareholder or transferor, such as promissory notes or preferred shares,
may not provide adequate income.
Regarding the second point, inflation or other changes after the estate has been frozen, for example, may reduce the
value of the assets. After the freeze, clients may change their minds and feel that those benefiting from the freeze
no longer deserve to do so. However, once established, an estate freeze is difficult to reverse, and doing so may
involve considerable cost.

SALE OR GIFT TO ACHIEVE AN ESTATE FREEZE

In some cases, a simple sale or gift can result in an estate freeze. For example, it may be simpler and less expensive
for parents to sell or give securities to their children rather than incorporating a holding company or setting up an
inter vivos trust. Future growth in the value of the shares will not accrue to the parents. However, control of the
securities is lost after the sale or gift is made.
TAXES AT DEATH
The following taxes arise on the death of an individual in Canada:
• Tax on income from the deemed disposition of capital property on death, as reflected in the deceased’s final
personal income tax return
• Income tax on deemed proceeds of RRSPs and RRIFs
• Foreign estate taxes and succession duties (if any of the deceased’s property is outside Canada or if the
deceased was a citizen or resident of a foreign country)
Neither the federal government nor the provinces levy a gift or estate tax. Instead, they collect final taxes through
the deceased’s last income tax return. Income tax paid when the deceased’s final tax return is filed includes tax on
capital gains from the deemed disposition of capital property at death.
The amount of tax payable depends on the extent to which the estate can use the qualifying small business
corporation exemption for capital gains. It also depends on whether the capital cost allowance needs to be
recaptured. (The capital cost allowance claimed on depreciable property in earlier years may have to be brought into
income at death and taxed). Previous years’ capital gains reserves can be transferred to a spouse or spousal trust
through a rollover, but they do not qualify for the capital gains exemption.
MINIMIZING OR DEFERRING TAXES ON DEATH

When drawing up a will, clients should consider certain techniques to minimize or defer tax at death. The procedure
may require the executor or liquidator to file up to four separate income tax returns for the deceased, as follows:
• The deceased’s final personal tax return

• A second tax return for rights or things belonging to the deceased
• A third tax return if the deceased was a partner or owner in a business enterprise
• A fourth tax return if the deceased had an interest in the income of a testamentary trust (defined later
in this chapter)
RIGHTS OR THINGS
According to Canada Revenue Agency’s tax guide T4011, “rights or things are amounts that were not paid at the time
of death and had the person not died, would have been included in his or her income when received”. They could also be
considered items that are earned but not received at the date of death.
The following items are examples of rights and things:
• Accrued (i.e., owed to deceased), but unpaid, salaries and wages

• Accrued (i.e., owed to deceased), but unpaid vacation pay
• Uncashed matured bond or debenture interest coupons
• Bond interest earned to a payment date before death, but not paid and not reported in previous years
• Unpaid dividends declared before the date of death

• Supplies on hand, inventory, and accounts receivable if the deceased was a farmer or fisherman and used the
cash method
• Work in progress, if the deceased was a sole proprietor and a professional (e.g., a medical doctor, veterinarian,
chiropractor, accountant, dentist, or lawyer, or, in Quebec, an advocate or notary) who had elected to exclude
work in progress when calculating his or her total income
• Old Age Security benefits that were due and payable before the date of death
The following items are not rights or things:
• Amounts that accumulate periodically, such as interest from a bank account

• Bond interest accumulated between the last interest payment date before the person died and the date
of death
• Income from an RRSP
• Eligible capital property
• Canadian or foreign resource properties
DID YOU KNOW?
Eligible capital property can be broadly described as intangible property, such as goodwill. The cost of
such property neither qualifies for capital cost allowance nor is deductible in the year of its acquisition as
a current expense.
TAXATION OF RIGHTS OR THINGS

Two elective provisions are available to an executor:
• File a separate return on the rights or things, as though the deceased were another person entitled to personal
tax credits. Advantages of this provision are the double use of certain personal tax credits and the application
of a relatively lower marginal tax rate. Personal tax credits include the basic personal amount, spouse amount,
eligible dependant amount, and age amount.
• Include the right or thing in the beneficiary’s income for that year rather instead of the right or thing being taxed
in the deceased’s estate. This provision is useful for beneficiaries in a low tax bracket.
The executor should calculate income tax on the rights or things under each provision and select the one that
results in lower tax.
TAXATION AT DEATH
How are a person’s assets taxed upon the person’s death? Complete the online learning activity to assess
your knowledge.
THE DISPOSITION OF CAPITAL PROPERTY AT DEATH

Two rules apply when disposing of capital property at death:
• Unrealized capital gains on capital property (including depreciable property) are taxed in the deceased’s final
income tax return. Exempting provisions may be used, which are discussed below.
• A taxpayer is deemed to have disposed of all capital property, including depreciable property, immediately
before death. The person is also deemed to have received proceeds equal to the fair market value of the
property. Any resulting taxable capital gain (50% of the capital gain) is considered income of the deceased.

THE TRANSFER OF PROPERTY TO A SURVIVING SPOUSE

As discussed earlier, tax rules provide for a rollover of capital property from a deceased to a surviving spouse or a
testamentary spousal trust. Non-depreciable property is transferred at its ACB. Depreciable property is transferred
at its undepreciated capital cost.
The deceased must have been resident in Canada immediately before death. The capital property must be passed to
either a resident spouse who resided in Canada at the time of death or a testamentary spousal trust. (The residency
of the trust is determined by the residency of the trustees as this is where the central management and control of
trust assets takes place.)
The testamentary trust must provide that the spouse is the only beneficiary entitled to the income after death and
that no person other than the spouse may receive any capital from the trust before the spouse’s death. In other
words, the capital property must vest in the spouse or spousal trust without restrictions within 36 months after the
death of the taxpayer. A statement that remarriage or cohabitation of the survivor spouse will bring about a capital
distribution to someone other than the spouse taints the spousal trust. In such a case, the tax deferral would be
denied upon death.
The Income Tax Act permits an executor to make an election for any property subject to a spousal rollover. By doing
so, the executor intentionally triggers a deemed disposition at fair market value. In this way, capital gains can be
created to absorb unused capital losses or bring an accrued capital gain into the income of the deceased (where the
tax rate warrants it).
NON-DEDUCTIBLE RESERVES ON THE DECEASED’S FINAL TAX RETURN

Taxpayers are allowed to deduct certain reserves when computing taxable income so that income is deferred to a
future year. (Normally, income is deferred until the year in which the proceeds are actually received.) In the year of
death, however, a final tax return is filed on the deceased’s behalf; therefore, reserves cannot be deducted to defer
income.
The following reserves are not deductible:
• Amounts receivable from property sold in the course of a business

• Unearned commissions
• Amounts receivable on the disposition of capital property
• Amounts receivable on the disposition of a resource property
A tax-free rollover is allowed if an election is filed and the reserves pass to the deceased’s spouse or spousal trust.
The spouse or spousal trust can claim these reserves, although they had originally belonged to the deceased. The
amount of the reserve claimed is then included in the income of the spouse or spousal trust in the first taxation year
ending after the death of the taxpayer. The spouse or spousal trust may, in turn, claim a reserve to the extent the
deceased person could have claimed it, had he or she survived. Therefore, it is possible to shift some income to a
spouse in a lower tax bracket. That spouse can pay the tax as payments are received over a number of years.
An executor can file a separate tax return when a proprietor or a partner dies after the business’s fiscal year-end, but
before the calendar year-end. This applies from the close of the fiscal period to the date of death. The deceased’s
personal exemptions may be claimed on this separate tax return, despite having been previously claimed on the
deceased’s final tax return.

EXAMPLE
Lynn’s consulting practice has a year-end of January 31. If Lynn died on April 30, 20x7, her executor could choose
between the following filing options:
• One final return reporting 15 months of income from February 1, 20x6 to April 30, 20x7
• Two tax returns:
• A final return reporting 12 months of income for the period ending January 31, 20x7
• An optional return reporting the business income for three months from February 1, 20x7 to April 30, 20x7
ALLOWANCES FOR CAPITAL LOSSES

A taxpayer’s allowable capital losses in the year of death may exceed the taxable capital gains in the same year. In
such cases, the excess can be applied against other income in the year of death and the immediately preceding tax
year.
Subject to certain limitations, the executor may treat losses from the estate’s disposition of capital property as if
they had been incurred by the deceased, rather than the estate. The executor must file an amended personal tax
return for the deceased to take advantage of this election.
GRADUATED RATE ESTATES

Recent amendments were introduced affecting taxation at death, introducing the rules affecting graduated rate
estates (GRE). Subject to a few conditions, a GRE is an estate that arose on, and as a consequence of, the death of a
person. Such an estate remains qualified as a GRE for no more than 36 months after the date of death. (This period
is considered by Canada Revenue Agency to be a reasonable requested time to settle an estate.)
Among other advantages, a GRE benefits from being subject to graduated tax rates. Income realized during the
36 months after the death and not paid to the beneficiaries is taxable at the graduated rates.
HIGHEST MARGINAL RATE TAXATION

Testamentary trusts have been taxed as individuals, benefiting from graduated tax rates, until December 31, 2015.
Beginning in 2016, testamentary trusts are taxed at a flat top rate. However, graduated rates will continue to apply
when the trust is for the benefit of a disabled person eligible for the disability tax credit.
Both testamentary and inter vivos trusts are now subject to the highest marginal rate of tax on all their income.
CHARITABLE DONATION AT DEATH

As an advisor, you should discuss the issue of charitable donations at death with your clients. As of January 1, 2016,
taxation rules permit greater flexibility in using the donation tax credit for donations made by will and for gifts by
direct designation. The rules now allow a donation to be allocated between the deceased and his or her estate when
the donation is made by a GRE. In such cases, the deceased may use the donation credit in the year of death or the
year immediately preceding death. Alternatively, the GRE may use the donation in the year of the donation, carry it
back to any of its prior taxation years, or carry it forward for up to five years.
It is also important to consider that there is no tax on capital gains for gifts of publicly traded securities, as long as
the gift is made by a GRE.
A GRE is in existence as long as at least a part of the estate remains undistributed. Therefore, that undistributed part
of the estate is still legally in the hands of the executor, to be managed for the benefit of the residuary beneficiaries.
Only that part of the estate that is the GRE is subject to the lower tax rates (and only for 36 months from the date
of death). Any assets already distributed no longer comprise part of the estate and are not part of the GRE.

POST-MORTEM PLANNING FOR PRIVATE CORPORATIONS AT DEATH

When a testator dies owning shares of a private corporation, a capital gain may be realized under the deemed
disposition at death rule. If there is no rollover to a spouse or a spousal trust, the person who acquires the shares is
deemed to have acquired them at a cost equal to their fair market value immediately before the deceased’s death.
With respect to a private corporation, this deemed disposition does not alter the ACB of the underlying assets
owned by the corporation. When the assets are extracted from the company, corporate taxes are triggered and paid
on any accrued value or recapture from the disposition of the assets. A taxable dividend results from the distribution
of the assets or substituted property to the shareholders.
As a result, double taxation occurs. The fair market value of the corporation is taxed first as a capital gain in the
terminal return of the deceased. It is then taxed a second time in the estate as a dividend on distribution from the
company. Post-mortem planning becomes essential at this point.
In such cases, three techniques may be used in planning for the estate’s first taxation year: loss carry-back, pipeline,
and bump. The implementation of these three approaches requires in-depth planning with a tax specialist, which is
beyond the scope of this course. However, a brief overview of the three approaches is provided below.
LOSS CARRY-BACK TECHNIQUE

The loss carry-back technique involves the creation of a capital loss in the estate’s first taxation year, which is
carried back to offset capital gains at death. This planning typically involves the winding up or redemption of
the corporation by the estate. It may also involve redemption of all or some portion of the estate’s shares in the
deceased’s terminal return. Loss carry-back requires that the loss be sustained in the estate’s first taxation year, and
is subject to numerous stop-loss rules.
PIPELINE TECHNIQUE
The pipeline technique is attractive for private corporations that were formerly carrying on business, and have
significant retained earnings that have not given rise to capital dividends or to refundable tax. This technique
essentially involves depleting the surplus to the extent allowed by the Income Tax Act as a means of avoiding double
taxation upon death. According to tax specialists, the benefit of the pipeline transaction is that it reduces the tax on
the removal of corporate surplus to the capital gains rate applicable on the death of the shareholder.
EXAMPLE
A company shareholder dies, leaving his shares of a private corporation named A Co with a fair market value of
$1,000 and an ACB of zero. The shareholder is deemed to have disposed of the shares for $1,000 and the estate is
deemed to have acquired the shares at an ACB of $1,000.
The estate then incorporates a holding company named B Co and sells the shares of A Co to B Co, taking back as
consideration a $1,000 promissory note (payable to the estate).
A Co and B Co are then merged by winding up or amalgamating. Alternatively, the shares of A Co-owned by B
Co may be redeemed and the assets of A Co paid to B Co as the proceeds of the redemption. The assets of A Co
then become available to repay the promissory note to the estate. There is no tax payable by the estate on the
repayment of the promissory note, and the estate may then distribute the acquired assets to the beneficiaries as
tax-free capital distributions.
Again, planning and execution of the pipeline technique should be done with the assistance of a tax specialist. It is
important to verify Canada Revenue Agency’s position on this topic on a regular basis.
BUMP TECHNIQUE
The bump technique is similar to the pipeline strategy. The initial steps are the same, up to the issuance of the
promissory note.

Upon winding up or amalgamation, the newly combined company can bump up the ACB of capital property to the
fair market value of the property held at the time the acquirer last acquired control of the company from an arm’s
length person. Generally, this would be the date of death. This strategy is useful when the holding company will be
retained and there are significant inherent gains in the underlying capital property of the corporation, such as a large
investment portfolio. In this case, the promissory note can be repaid over time.
GENERAL ISSUES TO CONSIDER FOR ESTATE PLANNING
3 | Recognize general issues to consider for estate planning.
Estate planning exists for clients who want to pass on their assets to their heirs in a relatively trouble-free and tax-
efficient manner. When those clients die, their will should reflect their desires, and they should have taken steps to
minimize taxes where possible. To ensure that their remaining assets are distributed effectively, you and your clients
should consider the following questions:
• Does the client need to write a new will or modify an existing one?
• Has the client selected one or more executors or liquidators, trustees, or guardians and their substitutes?
• Has the client chosen an independent trustee to act with the settlor or beneficiary, in Quebec?
• Has the client evaluated the effect of any existing marital agreements or family law considerations, such as
partition of family patrimony, in Quebec?
• Has the client evaluated opportunities to make an estate freeze or other strategies to minimize taxes when
transferring assets? (This item is a consideration in business succession planning, for example, where it may
include a partial or full estate freeze or a buy-sell agreement.)
• Does the client need to revise beneficiary designations for RRSPs, tax-free savings accounts, pension plans, or
insurance contracts?
• Does the client need to revise insurance coverage and name appropriate beneficiaries?
• Have you reviewed the suitability of joint ownership of assets (in common-law provinces)?
• Has the client made certain that funeral instructions are left with the executor or close family members?
• Does the client need a pre-paid funeral plan?
• Have you identified any associated special needs? (Consider special protection for physical or mental incapacity,
minors, dependants, and the potential for bankruptcy or family breakdown.)
• Has the client determined the amounts to leave to beneficiaries and charities?
• Have you explained the trust types designed for special needs, such as a QDT, a family trust, or a discretionary
trust?
• Have you assessed the suitability of inter vivos trusts for transferring wealth in the present?
• Have you explained the tax benefits of planned giving (i.e., giving gifts to charitable organizations now or upon
death)?
• Has the client appointed a power of attorney (enduring or not) or a protection mandate, in Quebec?
• Has the client prepared a living will to convey instructions to relatives and medical personnel at the time of a
critical illness?

SCENARIO—THE MUSIC SHOP
In this activity, you will be asked to resolve a client scenario involving trusts. Complete the online learning
At the beginning of this chapter, we presented a scenario in which newly married Nora and Jorge were looking
for estate planning advice. Now that you have read the chapter, along with the relevant chapters in KPMG’s Tax
Planning guide, we’ll revisit the questions we asked and provide some answers.
• Nora lives with a debilitating medical condition. What type of trust would be of benefit in her situation?
A QDT (set up as a testamentary trust) would help in her situation because it is designed to benefit disabled
individuals by permitting lower tax rates to apply (i.e., graduated tax rates instead of the top marginal tax
rate). To be eligible, Nora would have to qualify for the federal disability tax credit.
• What can you suggest they do to reduce potential taxes at death?
• You should suggest they take the following steps:
« Look for ways to avoid capital gains taxes upon death.
(For example, they can transfer or gift assets prior to death, or they can establish qualifying trusts into
which they can transfer assets at their ACB. Both strategies can help to reduce estate taxes (and probate
fees.)
« Take advantage of the lifetime capital gains exemption regarding Jorge’s small business. Implement an
estate freeze on some of Jorge’s assets to reduce taxes (and probate fees) upon his death.
• What can Jorge and Nora do to ensure that their children’s needs are met in the event of the parents’ death?
What can Jorge do to ensure that Nora would be financially secure if he were to die before her? At the same time,
how can he protect the rights of his children to his estate?
• Jorge could set up a testamentary trust to establish Nora’s life interest (or a usufruct in Quebec) in his
estate’s assets, with those assets passing to his children after Nora’s death.
• He could also establish an inter vivos trust to ensure that his children are provided for and that they use
the assets and income they receive from the trust responsibly.
• Jorge would appoint a trustee, whose role is properly defined, to fulfill his wishes.

SUMMARY
In this chapter, we discussed the following key aspects of estate planning:
• A trust is an effective vehicle for transferring assets to heirs. A trust may be testamentary (arising as a
consequence of death) or inter vivos (arising from a transfer of property by a person who is living). There are
different types of trust for different needs.
• The four primary duties imposed on trustees relate to conflicts of interest, standard of care, delegation of duties,
and impartiality.
• Taxes arising on the death of an individual in Canada include tax on income from the deemed disposition of
capital property, income tax on deemed proceeds of RRSPs and RRIFs, and foreign estate taxes and succession
duties.
• To minimize or defer taxes on death, the executor or liquidator may file separate income tax returns for the
deceased, taking advantage of tax provisions for different types of income.
• In an estate freeze, the accrued value in the assets, before the freeze starts, belongs to the shareholder.
Subsequent growth in the value usually accrues to the owner’s children or spouse. When the owner dies, the
increase in value up to the freeze date is taxed in the hands of the estate. The traditional method of freezing an
estate is to use a holding company or a combination of holding company and an inter vivos or family trust.
NOTE
Some content in this chapter is also covered in Chapters 21 and 22 of the KPMG guide, in some cases in greater
detail. We strongly recommend that you study the content in the KPMG guide in addition to this text, because
they both contain examinable content. For examination purposes, if the content in this chapter differs from the
KPMG guide in any respect, precedence will be given to this content.
DISCUSSION BOARD
for Chapter 16.
REVIEW QUESTIONS
Questions.

200 Wellington Street West, 15th Floor • Toronto, Ontario M5V 3C7
625 René-Lévesque Blvd West, 4th Floor • Montréal, Québec H3B 1R2
Telephone 1+866•866•2601 Fax 1+866•866•2660 Website www.csi.ca

Wme Txt-Vol01-2022 12 en V01 Wcag

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Wme Txt-Vol01-2022 12 en V01 Wcag

Uploaded by

Copyright:

Available Formats

VOLUME 1

Credentials that matter. ®

TELL US HOW WE’RE DOING

© CANADIAN SECURITIES INSTITUTE

Telephone 416 • 364 • 9130 Fax 416 • 359 • 0486

Toll-Free 1 + 866 • 866 • 2601 Toll-Free Fax 1 + 866 • 866 • 2660

Credentials that matter.®

First printing: 2006

Copyright © 2022 by Canadian Securities Institute

WHAT IS THE BIG PICTURE?

© CANADIAN SECURITIES INSTITUTE

WHAT WILL YOU LEARN?

KEY CHAPTER FEATURES

Icons Features Description

© CANADIAN SECURITIES INSTITUTE

Icons Features Description

YOUR JOURNEY THROUGH THE COURSE

DID YOU KNOW?

• Build good study habits.

© CANADIAN SECURITIES INSTITUTE

TWO EXAM TYPES

© CANADIAN SECURITIES INSTITUTE

© CANADIAN SECURITIES INSTITUTE

Table of Contents | Volume 1

1 Wealth Management Today

1•3 WEALTH MANAGEMENT IN CANADA

© CANADIAN SECURITIES INSTITUTE

1 • 26 Working with Outside Professionals

2 Ethics and Wealth Management

2•3 ETHICS IN THE FINANCIAL SERVICES INDUSTRY

© CANADIAN SECURITIES INSTITUTE

3 Getting to Know the Client

3•3 INFORMATION REQUIRED BY REGULATION AND LAW

4 Assessing the Client’s Financial Situation

4•3 ANALYZING PERSONAL FINANCIAL STATEMENTS AND SAVINGS PLAN

4 • 19 APPENDIX 4 – FINANCIAL MATH

© CANADIAN SECURITIES INSTITUTE

5 Consumer Lending and Mortgages

5•3 CREDIT PLANNING

6 Legal Aspects of Family Dynamics

6•4 FAMILY-RELATED ISSUES

© CANADIAN SECURITIES INSTITUTE

6•5 The Role of the Advisor In Divorce

6 • 16 IMPACT OF DIVORCE ON A CLIENT’S FINANCIAL PLAN

7 Personal Risk Management Process

7•4 STRATEGIC WEALTH PRESERVATION: THE BIG PICTURE

© CANADIAN SECURITIES INSTITUTE

7 • 22 Step 4: Cover and Insure Risk

8 Understanding Tax Returns

8•3 FINANCIAL PLANNING AND TAXATION

© CANADIAN SECURITIES INSTITUTE

9 Tax Reduction Strategies

9•4 TECHNIQUES TO MINIMIZE TAXES

© CANADIAN SECURITIES INSTITUTE

10 Registered Retirement Savings Plans

10 • 3 PREPARING TO FUND RETIREMENT

10 • 5 AN OVERVIEW OF REGISTERED RETIREMENT SAVINGS PLANS

11 Employer-Sponsored Pension Plans and Funding Retirement

11 • 4 EMPLOYER-SPONSORED PENSION PLANS

© CANADIAN SECURITIES INSTITUTE

11 • 7 Defined Benefit Pension Plans

12 Government Pension Programs

12 • 4 CANADA AND QUEBEC PENSION PLANS