Menu
Cart 0

Constructed-Response Questions - Part 3 - Post #05 - The CFP Examination - December 2017

Posted by John Gobeil on

The CFP Examination is the second of two exams that must be passed to obtain CFP certification. We have posted this entry to assist you in your preparation for The CFP Examination being held on Friday December 1, 2017.

In our last Post, we reviewed the Refinements to FPSC® Financial Planning Practice Standards.

In this Post, we will review the Sample Examination Item #3, Question 1. We have some suggestions for answering “List five advantages and five disadvantages of Option 4 for Todd including a brief explanation for each.”

Constructed-response questions

A constructed-response question is a question that requires you to produce an answer in your own words, using your laptop computer. These questions will range from short-answer questions to longer, extended-response questions. The questions involve client situations that require you to complete an analysis, prepare a written report, draft a financial plan or write a letter to a client.

Sample Examination Item #3, Question 1

The client situation of this question is about three-quarters of a page long and includes four Registered Pension Plan options.

If you were to first read the situation carefully, underlining what you considered the important points, you would consider all of the information of importance and you would anticipate what you have to do with the information. Given the time pressure on the exam, you do not have the luxury of spending this time.

You need to determine what you have to do with the information before you spend any time analyzing it.

First, you should quickly read the situation, but only for context. Context involves essentially meeting Todd and Nadine. You do not anticipate or solve any problems. You just note who they are and what kind of information the situation provides.

Client Situation

James, a CFP professional, is meeting with Todd and Nadine Paulson, both 58 years of age. Both spouses have worked for ABC Financial, a federally regulated financial institution, for many years. Although Nadine has no plans to retire before age 65, Todd, who suffered a massive heart attack six months ago, is retiring at the end of this year, at age 59. Todd has been presented with the following fully indexed RPP income options:

Option 1 – $1,960 per month with 60% survivor pension

Option 2 – $1,890 per month with 75% survivor pension

Option 3 – $1,820 per month with 100% survivor pension

Option 4 – Commuted value of $395,000 (CRA maximum transfer value of $257,000)

If Todd chooses one of the first three options, he is also eligible to receive a bridge benefit of $798 per month until age 65. With his recent health problems, Todd has thought about estate planning issues and wants to maximize any benefits paid to Nadine should he predecease her. Service Canada has confirmed that Todd will be eligible for a CPP retirement benefit of $880 per month at 65 (Nadine qualifies for the maximum amount) and an OAS benefit of $522 per month.

Todd and Nadine each have basic group life insurance coverage of one times salary, which decreases to $2,000 of coverage on retirement. However, the group health coverage will continue at an unreduced level in retirement provided the monthly pension income option has been chosen. Both Todd and Nadine have concerns about the ongoing viability of ABC Financial.

Todd describes himself as a moderate investor and has $125,000 in his RRSP. He has $38,000 in unused RRSP deduction room. To meet their current cash flow needs, Todd will require monthly after-tax income of $2,500. Taxable income up to $39,000 would carry an effective tax rate of 20%, while taxable income between $39,001 and $65,000 would result in an effective tax rate of 31%.

This item has 3 questions. So, carefully read the response instructions and the response template for question 1.

Response Instructions

List five advantages and five disadvantages of Option 4 for Todd including a brief explanation for each (5 marks)

Response Template Question 1

Advantages

Disadvantages

1.

1.

2.

2.

3.

3.

4.

4.

5.

5.

  

The fact that there are 5 marks indicates that each of the 10 advantages/disadvantages is worth half a mark.

If there are 100 marks for each three-hour, paper, you have 9.0 minutes to answer the question, calculated as ((180 minutes ÷ 100 marks) × 5 marks for this question).

The response instructions say list five advantages and five disadvantages of Option 4.

So, now you want to reread the situation for content, but the relevant content is only everything that would deal with option 4. First read option 4, “Todd has been presented with the following fully indexed RPP income options: Option 4 – Commuted value of $395,000 (CRA maximum transfer value of $257,000)”.  Now read through the entire client situation looking for, and highlighting, anything that would be relevant to option 4.

The relevant facts are:

  1. Todd has a wife;
  2. Todd is in poor health, which is significant in considering the wife’s situation should Todd die first;
  3. Todd has been presented with three fully indexed RPP income options and one option for the commuted value;
  4. while the commuted value is $395,000, the maximum transfer value is only $257,000;
  5. Todd has $38,000 in unused RRSP deduction room;
  6. only, if Todd chooses one of the first three options, is he eligible to receive a bridge benefit of $798 per month until age 65;
  7. the group health coverage will continue at an unreduced level in retirement provided a monthly pension income option has been chosen;
  8. Todd and Nadine have concerns about the ongoing viability of ABC Financial; and
  9. Todd describes himself as a moderate investor.

From this information, you would have the following advantages:

  1. Option 4 removes uncertainty that ABC Financial may not be able to live up to its future obligations to fund the company pension.
  2. Todd can use his unused RRSP deduction room to shelter $38,000 of the commuted value that cannot be transferred to a locked-in retirement account of $138,000, calculated as (commuted value - the maximum transfer value) or ($395,000 - $257,000); and
  3. depending on the investment performance, the commuted value may provide more funds than the other options.

So, we are short two advantages that you will have to pull out of your knowledge of transfers of commuted values. There are three more:

  1. the annuitant of a federally-regulated LIF who is 55 years of age or older is entitled to a one-time conversion of up to 50% of the holdings into a non-locked-in registered plan, either a Registered Retirement Savings Plan (RRSP) or a Registered Retirement Income Fund (RRIF);
  2. Todd and Nadine would have greater flexibility in the timing of accessing the funds with no limits on the amounts that they could withdraw from the unlocked RRSP/RRIF and minimum withdrawals only once the annuitant, who could then be Todd or Nadine, attains 71 years of age; and
  3. upon Todd’s death, any amounts left in Todd’s RRSPs, RRIFS, Restricted Locked-in Savings Plan (RLSP) and Restricted Life Income Funds (RLIFs) could be left to Nadine although any locked-in funds would have to remain locked-in.

From this information, you would have the following disadvantages:

  1. Todd would not be eligible for a fully indexed income;
  2. Todd can only transfer the maximum transfer value of $257,000 to a locked-in retirement account;
  3. Even contributing the amount of his unused RRSP deduction room $38,000 to an RRSP, Todd would have to report taxable income of $100,000, calculated as (commuted value - the maximum transfer value - unused RRSP deduction room) or ($395,000 -  $257,000 - $38,000);
  4. Todd is a moderate investor who would be assuming the full investment risk of his retirement capital;
  5. Todd would not be eligible to receive a bridge benefit of $798 per month until age 65;
  6. Todd would not be eligible to receive the group health coverage; and
  7. Depending on the investment performance, the commuted value may provide less funds than the other options; and
  8. Because his employer is a federally-regulated financial institution, Todd’s locked-in account would be governed by the federal Pension Benefits Standards Act, which requires that any funds left to a surviving spouse remain locked-in upon the death of the annuitant.

 Scoring Table

In the Scoring Table, the FPSC identifies 5 advantages and 7 disadvantages.

Advantages

Disadvantages

1. It removes uncertainty that ABC Financial may not be able to live up to its future obligations to fund the company pension.

1. Only a portion of the cash value will be paid into a LIRA on a tax-deferred basis ($257,000), so a portion of the balance will be subject to tax at Todd’s marginal tax rate.

2. The remaining balance would pass to Nadine on a tax-deferred basis on Todd’s death.

2. Todd is assuming the full investment risk of his retirement capital.

3. It offers greater flexibility of income stream and the ability to unlock up to 50% of the pension.

3. Todd would be giving up full indexation of his pension benefit.

4. The unused RRSP deduction room can be funded with the lump sum cash value payment.

4. Todd would lose his ongoing health benefits.

5. Depending on its investment performance, the cash value amount may be able to provide an increased income benefit.

5. Todd would lose the bridge benefit payment.

6. Todd will pay tax at a higher MTR with this lump sum cash value payment.

7. Depending on its investment performance, the cash value amount may provide a reduced income benefit.

 

In the Scoring Table, the FPSC identifies 5 advantages and 7 disadvantages. However, advantage 3 says “It offers greater flexibility of income stream and the ability to unlock up to 50% of the pension”, which looks like two advantages.

So, how to get your 5 marks?

Find the relevant facts in the client situation and type them in the response template allocating them between advantages and disadvantages as you can determine.

The Response Instructions sayInclude a brief explanation for each”. However, as you can see, the sample response is very light on explanations.

For example, “Disadvantage 2. Todd is assuming the full investment risk of his retirement capital.”

“Disadvantage 4. Todd would lose his ongoing health benefits.”

We do not see much of an explanation, brief or otherwise. A brief explanation would probably say “The group health coverage will continue at an unreduced level in retirement provided a monthly pension income option has been chosen; so Todd would lose his ongoing health benefits.”

Use your judgement about the extent to which you comply with a requirement to “include a brief explanation for each”, but make sure that you have at least clearly described the advantages/disadvantages.

When we attended the FPSC Educator’s Conference, we learned that the examiners will not take off marks for wrong answers unless they indicate a violation of the Code of Ethics?

Marking practice

The FPSC has a marking practice for constructed response questions as described in the Guide to Examinations for CFP® Certification.

“When completing constructed response questions that require a specified number of responses (e.g., list three, provide four) candidates are required to provide up to the indicated amount.

If more than the required number of responses is given, only the first answers corresponding with the required amount will be scored with the remainder not considered.

For example, if the question requires the candidate to list three issues with a given situation and the candidate lists 5, only the first 3 will be considered for scoring of the exam.”

Next Post

In our next Post, we will review Sample Examination Item #3, Questions 2 and 3.

Effectiveness of our study aids

We always appreciate feedback on the effectiveness of our study aids. Together, we can continue to have the best study aids available.

John Gobeil, BSc, CFP®
David Gobeil, CPA, CA, CFP® 

Certified Financial Planner® and CFP® are certification marks owned outside the U.S. by the Financial Planning Standards Board Ltd. The Financial Planners Standards Council is the marks licensing authority for the CFP marks in Canada, through agreement with FPSB.


Share this post



← Older Post Newer Post →

Sale

Unavailable

Sold Out