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Answering a Constructed-Response Question - Post #02 - 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 the last Post, we looked at Gobeil's Collection of 1,000 Questions™, some feedback from previous candidates, changes to the Financial Planning Practice Standards, the knowledge required to pass The CFP Examination, the CFP® Professional Competency Profile and the nature of a constructed-response question.

In this Post, we will review the Sample Examination Item #1 published by the FPSC. We have some suggestions for answering “Provide three recommendations for allocating Jim’s severance payment...”

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.

Templates

Each of these questions includes a response template. A response template is a table with titles and other guidance that directs you in responding to a question. Apparently, every question will have a detailed response template.

A response template makes the answering of these questions much easier because it gives you considerable guidance as to what the examiners are expecting. In fact, it may indicate that you are required to provide information in the solution that was not specifically requested in the response instructions.

Sample Examination Item #1

The client situation of this question is about three quarters of a page long and includes quite a bit of financial information.

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.

We suggest that you 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 Jim and Sarah with the possibility of doing some planning for them. You do not anticipate or solve any problems. You just note who they are and what kind of information the situation provides.

Last year, after 10 years of service, Jim, age 35, was laid off from his job. His salary was $100,000 per year, and he was eligible for an annual bonus of up to 50% of salary. He received a severance payment during the same tax year; the net amount of $50,000 is currently in a short-term deposit earning interest of 1% annually. Sarah, Jim’s spouse, age 33, is not currently employed and will have no income this year. Jim started a new job at the same salary shortly after losing his previous job. His new employer provides a 2% defined benefit pension plan. Jim currently has no TFSA contribution room – he withdrew the full amount in the plan earlier this year to cover expenses while neither partner was working.

Jim and Sarah have been referred to Marie, a CFP professional, to provide recommendations on how to allocate the full amount of the severance. Jim and Sarah do not require any of the funds for current cash flow and would like to implement the strategies as soon as the term deposit comes due next month. Jim and Sarah have moderate risk tolerance and would like to reduce their debt load.

  • They currently have a mortgage of $300,000 at a rate of 4.5%.
  • Credit card balance: $15,000 at a rate of 19%.
  • RRSPs: Jim has $25,000 unused RRSP deduction room; Sarah has no unused RRSP deduction room. Jim currently has $40,000 in RRSP investments as well as a $50,000 LIRA from his previous employer’s pension plan. Sarah’s only retirement asset is an RRSP portfolio of $7,000. Their current registered portfolios are earning a 7% rate of return.
  • Sarah has $10,000 of TFSA contribution room.
  • Marie has advised them that they could expect to receive the same return in a TFSA as they would in their registered savings.
  • Jim’s marginal tax rate is 38%.

Next, you should carefully read the response instructions and the response template.

Response Instructions

Provide three recommendations for allocating Jim’s severance payment that will maximize expected after-tax returns and minimize current-year taxes. Include a rationale for each recommendation.  (3 marks)

Response Template

Allocation

Amount

Rationale

 

 

 

 

 

 

 

 

 

 

The number of marks suggests that there will be ½ marks for each allocation and amount, ½ marks for the rationale of each allocation. If there are 100 marks for each three-hour, paper, you have 5.4 minutes to answer the question, calculated as ((180 minutes ÷ 100 marks) × 3 marks for this question).

The response instructions say allocating Jim’s severance payment that will maximize expected after-tax returns and minimize current-year taxes. The response template asks for amounts.

The three recommendations and the three lines of the template indicate that there must be three assets or liabilities to which you are expected to allocate the funds.

So, before you go to the situation, note that you need to identify the three assets or liabilities to which they should allocate the funds. Of course, you also need to determine the amount of the funds.

Now reread the situation for content.

There are seven assets mentioned: a short-term deposit, a 2% defined benefit pension plan, Jim’s RRSP, Sarah’s RRSP, Jim’s LIRA, Jim’s TFSA and Sarah’s TFSA. Of these, they could only contribute some of the funds to Jim’s RRSP (Jim has $25,000 unused RRSP deduction room), Sarah’s RRSP as a spousal contribution (Jim has $25,000 unused RRSP deduction room) or Sarah’s TFSA (Sarah has $10,000 of TFSA contribution room).  

There are two liabilities mentioned are a mortgage ($300,000 at a rate of 4.5%) and a credit card ($15,000 at a rate of 19%).

Paying the credit card debt of $15,000 at 19% is a no brainer.

Contributing $10,000 to Sarah’s TFSA with a 7% return after-tax has a better return than paying down the mortgage at a rate of 4.5%.

Contributing $25,000 to Sarah’s RRSP also reduces current-year income taxes. However, so does contributing $25,000 to Jim’s RRSP. With pension income splitting, either could be optimal.

The solution says that contributing $25,000 to Sarah’s RRSP is correct. A simplistic answer is probably always best one. However, let us hope that the examiners are open-minded and would consider contributing $25,000 to Jim’s RRSP of merit. It is fortunate that all of the amounts that they can contribute or pay down add up to exactly $50,000, the net amount of the severance.

The sample response for this question includes two rationales for each allocation without any indication in the template that such is the case. Many of these questions will ask for your rationale. If you have any extra time, use it to expand on your rationale.

You should have been able to answer this question based upon your life experience. You certainly do not need advanced training in financial planning.

The key to passing this exam is to answer each question fast and correctly. This process should help.

Our study aid

With access to the Sample Examination Items, we have a much better idea as to the complexity and structure of the questions. The templates make it very easy to determine what you are required to include in your answer. The knowledge required is not very deep. All of the sample questions focus on tactics, not on strategies.

Some of our questions are more difficult than the sample questions.

Next Post

In our next Post, we will review Sample Examination Item #2. We have some suggestions for “In an email, describe in detail the most tax efficient option for the transfer of Lynn’s shares.”                 

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.

 


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