FNCE 627 – team assignment no.1 final version

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FNCE 627

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Finance

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Apr 3, 2024

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Team Assignment No. 1: Study case of Alex and Morgan. Team members: Melany Beatriz Torres Perez. (2120311) Silvia Querevalu (2127670) Vedant Abhay Karulkar (2208619) Ramandeep Kaur Dosanj (2224385) Tejesh Sighadia (2219024) Md Rabbi Mrida (2210195) Rachit Hindocha (2227882) University Canada West FNCE 627 – 02: Personal Financial Planning Instructor: William Arambula. February 25 th , 2024

Case Study The following comprehensive analysis will showcase a personal finance strategy for Alex and Morgan, which will be about reflecting on different aspects of their life, including their financial future and how Alex and Morgan can optimize their purchase habits in order to have a balance in entertainment and savings and also how they can execute some strategies that can help them to achieve their financial goals. Assumptions and Key Considerations • The assumptions considered to develop this report are listed below: • Alex and Morgan have government health insurance, and their jobs offer them life, dental, and vision insurance and paid sick leave. • Alex and Morgan's annual mutual income is 140k. • The inflation was considered in the calculations. • Assuming they start a business five years from now with their savings, • Alex and Morgan can roll over their sale proceeds from their business and invest in another similar business’s stocks to earn a regular income in their retirement phase. Key considerations that may impact the financial plan's development: 1. Debt Management: Handling and managing the debts, particularly the existing ones with the giants, like the purchase of a mortgage, is the key point for one to meet the set goals and stay financially stable. 2. Emergency Fund: Making sure the existence of their emergency fund is of an appropriate level to face unexpected expenses or financial problems without breaking their financial plan is the main thing. 3. Tax Implications: Keep in mind that tax issues, such as the relevant income tax, capital gains tax, and appropriate tax deferral options, are very critical for improving their decisions related to finances and reducing their tax burden. 4. Insurance Coverage: Understanding their insurance coverage of health, life, home, and vehicle is what is required for them to manage the risks, take care of their assets, and stay financially secure for their family and themselves. 5. Major Purchases and Investments : Purchasing big orders like a house, business or financial assets need to be reviewed to identify the opportunity costs, the risks taken, and the effects of those decisions on their financial situation. 6. Business Planning: When starting a business, planning for such aspects as raising the capital, managing cash flow, exiting the business, and considering the taxation matters will go a long way towards realizing the entrepreneurial goals. 7. Estate Planning: Establishing or updating estate planning documents such as wills, trusts, asset distribution, and also tax minimization strategies is very critical in managing and transferring assets in the manner they desire and in providing financial security for the heirs. The core recommendations and financial strategies: Based on the case study of Alex and Morgan, the core recommendations and financial strategies are: 1. Budget Optimization and Debt Management: ✓ Evaluate and sanitize existing budget that could enable for balancing lifestyle and savings. ✓ Prioritize basic expenditures and curtail the entertainment spending. ✓ Manage debts to be able to maintain a desirable debt-to-income ratio.

2. Emergency Fund and Insurance Coverage: ✓ Put in your emergency fund three to six months of living. ✓ Review and revise insurance coverage for health, home, life, and car. 3. Investment and Retirement Planning: ✓ Determine long-term goals and establish a diverse asset allocation plan. ✓ The ultimate goal should be a nest egg for retirement of $3.5 million, with RRSPs and CPP as secondary vehicles to increase your savings further. 4. Education Planning: ✓ Estimate education costs and check savings possibilities like RESPs. ✓ Create several hold-back savings for education and think about remittances into it. 5. Major Purchase and Business Planning: ✓ Evaluate key purchases thoughtfully, paying attention to their liquidity and alternative investments. ✓ Develop a plan for starting a business within five years and put the following strategies in place: save something from the income and eliminate unnecessary expenses. 6. Tax Planning Strategies: ✓ Adopt a tax-deferred exchange strategy with different sale structures for business sales. ✓ Find out additional opportunities for smaller businesses classification in order to minimize tax burden. Financial Analysis Financial analysis is assessing an individual's or couple's current cash flows, including income, investments, fixed and variable expenses, commitments, and net worth, to aid in budget planning and the fulfillment of both long- and short-term objectives. Let us consider that Alex and Morgan earn a stable income of $140,000 annually and savings of $240,000. Assuming they reside in British Columbia, their annual revenue in 2024, when the 14.7% tax brackets are accounted for, amounts to $119,420 (BC, 2024). This will generate $9,951.67 per month for them. To better comprehend their present financial situation, we examined their monthly income and fixed and variable expenditures. They contain both immediate and long-term financial objectives. Financial analysis is the process of assessing an individual's or couple's current cash flow. We examined their monthly income and fixed and variable expenditures to better comprehend their present financial situation We examined their monthly income and fixed and variable expenditures to comprehend better their present financial situation, including income, investments, fixed and variable expenses, commitments, and net worth, to aid in budget planning and the fulfillment of both long- and short-term objectives.

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Table 1: Monthly Budget In addition to housing expenses (rent), they pay for their monthly grocery bills, entertainment, transportation, and an emergency fund on a monthly basis. Each month, they spend $5,795 and retain $4,156.50. Without long-term liabilities, their current net income amounts to $4,156.50. Net worth is the difference between one's assets and liabilities. This figure evaluates wealth since it indicates what a person possesses after paying off their debts. Considering the information, Alex and Morgan have a positive net worth since their assets exceed their liabilities (MORAH, 2023). As per Santarelli (2024), the average home price in Metro Vancouver is $1.2 million, so if the couple opts for a home loan, their monthly payments will increase from the average mortgage in an urban area, around $6000. Consequently, they allocate $8,795 toward their monthly expenses, leaving them a net surplus of $1,156.50. Figure 1: Mortgage Calculation Source : https://www.ratehub.ca/british-columbia-mortgage-calculator On the contrary, the debt-to-equity ratio in this scenario stands at 60.29% because nearly 60% of their monthly income is allocated towards their mortgage payment. This is significantly exceeding the lenders’ preferred debt-to-income ratio of 35% (MURPHY, 2023). The debt-to-income (DTI) ratio is the percentage of your gross monthly income that goes toward debt payments, and lenders use it to assess your borrowing risk (MURPHY, 2023). Per their financial objectives, Alex

and Morgan must determine which tasks are most critical and how long they must be completed. For the home loan plan, they must carefully assess the impact on their financial stability and cash flows. They must also carefully consider strategies to reduce debt by allocating more funds towards savings, assessing a diversified investment plan to spread the risks, and increasing their income and returns. Additionally, it is essential to ensure that sufficient emergency funds are available to cover three to six months of living expenses just in case something unforeseen occurs. Net Worth Figure 3 Net Worth: In the above scenario, the total value of assets and liabilities is $240,000. As a result, their total net worth is $240,000. Their assets and debts are currently equal, indicating a financial equilibrium. This shows that instead of dropping, their wealth is increasing. Although the couple hasn't made any formal commitments, if they decide to buy a property, they may face liabilities such as a mortgage. This long-term commitment will influence their entire financial situation, including their debt-to-equity ratio. The monthly payments required to add a mortgage will impact their cash flow and discretionary income. The additional costs associated with home ownership include insurance, maintenance, and property taxes, so they will have to be prepared for these. Cash Flow Cash flow refers to the actual inflow and outflow of cash during a period (Kapoor J. R. et al., 2018). The difference between inflows and outflows can result in a surplus or deficit of cash (Kapoor J. R. et al., 2018). As cash inflow, we can assume they have stable jobs and consider both incomes, a sum of 140k per year. In addition, we can consider other investments they might have, or interest earned on investments (Kapoor J. R. et al., 2018). As cash outflows, we can consider fixed expenses such as rent/mortgage, utilities, insurance, loan repayments, and subscription services or recurring payments. Also, variable expenses can include groceries, dining out, entertainment, etc (Kapoor J. R. et al., 2018). After making a record of their cash inflows and outflows, preferably if there is a surplus, this amount should go to savings, investing, or paying debts. In order to analyze cash flow patterns, they should make a personal cash flow statement; this will be helpful for comparison with future cash flow statements and revise deficit or surplus. Also, define a detailed budget to track and control expenses and set realistic timelines for achieving their goals. If they plan to have a family, they should take into consideration approximately 20% of their family budget; this would be approximately 28k (National Bank, 2022). Similarly, they should allocate approximately 10 or 20 percent of their budget to savings and set aside an equivalent of three to six months' worth of expenses rather than income to an emergency fund; this will give a

peace of mind if unexpected situations occur, such as losing a job or having an accident (National Bank, 2022). Along the same lines, they should check with a financial advisor to ensure a more specialized approach. Strategies Where to allocate assets is determined by the level of risk tolerance and the expected rate of return of an investor (Kapoor J. R. et al., 2018). Taking into consideration that they are in their thirties, want to save money for homeownership, education planning for future children, and building a retirement nest egg., and already have other expenses, they should contemplate their financial goals while staying on their budget when making investments. Diversification can be a good strategy if they want to take risks but not so much by including a variety of assets in their portfolio, like stocks, bond mutual funds, or real estate. Moreover, another strategy they can use is tactical asset allocation, which will allow them to create extra value by taking advantage of some situations in the marketplace (THE INVESTOPEDIA TEAM, 2021). Regarding taxes, interest income is fully taxable at their marginal tax rate, and to decrease the tax weight, those financial assets should be held in registered accounts, such as RRSPs, that accept taxes until withdrawals are made (Kapoor J. R. et al., 2018). In this line, in British Columbia, the personal income tax rates apply to specific brackets depending on the income they receive annually. Each year, they will have to fill out their federal T1 Income Tax and Benefit Return to the Canada Revenue Agency (CRA) to know if they owe tax or can claim a refund (Government of British Columbia, 2024). Insurance Coverage As they are planning on having a home and children, they should consider having a home and life insurance. Some jobs offer life insurance, and they should be aware of the level of life insurance coverage. In Canada, government health insurance plans cover most medical bills if they get sick, but sometimes medical prescription prices can be high (Kapoor J. R. et al., 2018). Assuming they have government health insurance, and their jobs offer them life, dental, and vision insurance and paid sick leave, they are covered if they need to go to the hospital for any reason; additionally, they will need to purchase a house and car insurance assuming they have a car. For this, it is necessary that they assess their needs and ask for coverage recommendations according to them, ask for quotes from different entities, and set up payment reviews (TD, n.d.). If they feel their life insurance from their jobs is not enough, they could look for other entities that offer life insurance and determine what their family will need to meet immediate expenses, how much money they want to provide for the future, and how long if something terrible happens. (TD, n.d.) Retirement Considering one of their long-term goals, building a retirement nest egg, Alex and Morgan first need to evaluate their current financial situation and see the total amount of their income to determine the amount of expenses they have, add all their current assets and also, they have to consider any debt. After evaluating their budget, Alex and Morgan need to find areas of improvement in their current budget, and they can optimize to achieve potential savings for their plans. (Kapoor J. R. et al., 2018) They also have to define their desired retirement age and expenses, considering the annual inflation and healthcare costs. If they are currently According to McManamon (2023), a retirement formula mentions a 4% Retirement Plan and the 70%-80% Rule. First, they have to divide their current income by 4%, which should demonstrate

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the total amount needed for their retirement. So, if Alex and Morgan have a mutual income of 140k per year, the 4% Retirement Plan says they will need $3.25 million ($140,000 ÷ .04 = $3.5 million) to ensure a secure and comfortable retirement. So, according to this rule and assuming they have a slightly higher average wage, they should have 3.5 million for their retirement, ensuring their long- term goals. Now that they have an amount to achieve for their retirement, they can identify their sources of retirement income, which can be current retirement savings and their Canada Pension Plan (CPP), which is a monthly pension that replaces part of the income when the person retires. (Employment and Social Development Canada, 2019) Lastly, they need to assess their risk tolerance and investment time horizon by creating a diversified investment portfolio customized to their goals, which could include a mix of stocks, bonds, and other assets that can help them achieve the desired amount to have a peaceful retirement. Education Another important long-term goal is the education plan for their future kids. Alex and Morgan need to estimate the education expense, which can include mainly the tuition fees and consider inflation. Once they have an estimated amount, they can decide on the funding strategy; for example, they can explore the Registered Education Savings Plan (RESP), which is a long-term savings plan to support people saving for their kid's education after high school, and this includes colleges, universities, and apprenticeship programs. An adult can also open a RESP for themselves. (Canada, 2014) Additionally, according to their saving capacity, they can set a saving amount and put that money in an investment account within a long period, considering an expected return from this investment. Also, they can set automated contributions to ensure consistency and make this saving a benefit for them and their future kids. Another suggestion would be to look for scholarships and encourage children to pursue them to save a considerable amount of money. Major Purchase According to Kapoor J. R. et al. (2018), before Alex and Morgan decide how and when to make a major purchase such as a home, firstly, they must ask themselves if they have the cash for the down payment. Also, if they want to use their savings for this purchase. Additionally, it is important that they carefully evaluate the opportunity costs and the psychological costs of making a major purchase. Sometimes, people make a commitment when buying a major product or service, and a period after the purchase, they realize that this is not what they imagined, and now they can not afford it. That is why our recommendation for Alex and Morgan would be to evaluate carefully all their major purchases, the benefit-cost, and their liquidity capability to accept a commitment in the case of a credit or in the case they use all their savings. Finally, they must review and determine their financial options, such as a mortgage that can include a fixed rate or an adjustable rate. Also, look for and analyze loan programs that offer better terms for first-time buyers to get the best deal. Emergency Fund Alex and Morgan, skilled professionals with steady earnings and diverse financial goals, would benefit from having a 3 to 6-month emergency fund. This money should go for housing, utility, groceries, and insurance. The emergency fund should be ready in case of unexpected costs or

financial difficulties. Maintain the capital in a liquid, easily accessible account, such as a high-yield savings or money market account. These accounts provide liquidity and interest. Alex and Morgan should adjust their emergency fund based on income, expenditure, and life events. If their financial situation changes, they may need to raise or reduce their emergency fund. IPP (Individual Pension Plan) Due to their consistent salaries and desire for personalized retirement plans, Alex and Morgan may benefit from an Individual Pension Plan (IPP). IPPs enhance retirement savings growth with larger contribution limits than typical retirement accounts. Tax-deductible contributions and tax-deferred growth boost retirement fund efficiency. Pension-like benefits from IPPs provide a predictable retirement income. Professional management aligns investments with retirement objectives. Creditor protection safeguards savings. IPPs optimize retirement strategies when combined with other plans. A financial adviser or pension expert is needed to customize an IPP and comply with the rules. An IPP gives Alex and Morgan a solid foundation to develop a large retirement nest fund and meet their financial goals. Estate Analysis and Discussion Estate planning includes wills, trusts, and asset distribution plans to manage and transfer Alex and Morgan's assets. Wills name beneficiaries and executors, whereas trusts safeguard assets and simplify transfers. They must decide how to transmit money, property, and businesses to their heirs. For personalized estate planning, tax minimization, and financial security for loved ones in the case of incapacity or death, specialists are essential. Selling the Business Assuming Alex and Morgan will begin their entrepreneurial journey in the next five years to achieve their financial goals and secure their future. They both can use their previous savings and monthly salaries going ahead to manage their goals and maintain stability in the initial period of the business. They can save around $40,000 ($200,000 in 5 years) of their combined annual income annually to create capital. One of the best options for the couple would be to start their business as a side hustle while working full-time as salaried professionals. Like their other savings and investments, they should focus on building a separate savings cushion that will give early income without external financial sources. The couple must cut down on unnecessary expenses, such as certain luxuries, which will help them save money that they can convert for their business funding instead of seeking external financing. Alex and Morgan must focus on creating cash flow from sales and reinvesting it in the business. Developing a clear exit strategy from the start, whether to sell the business or merge with another company, will help them. Small business entrepreneurs can list their enterprises anonymously on business brokerage websites. Alex and Morgan must monitor market circumstances and economic changes to determine the best time to sell the company at a favorable value multiple. Tax Planning Strategies for Selling the Business • Utilizing Capital Gain Tax: Long-term capital gains tax rates are frequently applied on gains generated from the sale of assets held longer than a year. Long-term capital gains tax rates in Canada for 2023 are around 26%, with British Columbia charging approximately 6% (Will, 2023). If they run the business for over a year, their sale proceeds will be subject to lower tax rates.

• Structuring Business Sale into Asset Sale: The purchase price is divided among the company's many assets, and each asset's value is determined at fair market value at the time of sale (Stienburg, 2024). Alex and Morgan may profit from lower depreciation recapture rates than ordinary income tax rates on stock transactions. The revenues of a traditional business sale are usually taxed at both the corporate and individual levels. • Tax Deferral Strategies: Alex and Morgan must use tax-deferred exchange tactics, such as reinvesting sale proceeds to buy stocks in another business to receive profits annually (Chow, 2021). This strategy mainly benefits investors who want to continue increasing their assets. Instead of accounting for the entire gain in the year of sale, a company may postpone taxes on a portion of its revenue until later, when payments are received. • Qualifying as a Small Business: If the company is classified as a small corporation. In that case, Alex and Morgan may be eligible for a partial or whole exemption from capital gains taxes on selling qualified small business shares (Amos, 2023).

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References Amos, S. (2023, April 3). Small business tax deductions in Canada. Wealth Management Canada. https://wealthmanagementcanada.com/blog/small-business-tax-deductions-canada/ BC, G. o. (15 de January de 2024). Personal income tax rates. Obtenido de Government of BC: https://www2.gov.bc.ca/gov/content/taxes/income-taxes/personal/tax-rates Canada, S. (2014, March 31). Education savings. Www.canada.ca. https://www.canada.ca/en/services/benefits/education/education-savings.html Chow, T. (2021, January 1). What are the ‘replacement property’ rules? Why do they exist? What are the tax implications? Pressbooks. https://kpu.pressbooks.pub/intercdntax/chapter/what-are-the-replacement-property- rules-why-do-they-exist-what-are-the-tax- implications/#:~:text=The%20purpose%20of%20the%20replacement,to%20purchas e%20a%20replacement%20property . Employment and Social Development Canada. (2019). Canada Pension Plan - Overview - Canada.ca. Canada.ca. https://www.canada.ca/en/services/benefits/publicpensions/cpp.html Government of British Columbia. (2024, January 25). Reporting and paying personal income tax. https://www2.gov.bc.ca/gov/content/taxes/income-taxes/personal/report-pay Kapoor J. R., Dlabay L. R., Hughes R. J., Stevenson L. and Kerst E. J. (2018). Personal Finance. 8th Edition. McGraw Hill. 1260326950 · 9781260326956 McManamon, P. (2023, December 12). How Much to Save For Retirement & How to Calculate It. InCharge Debt Solutions . https://www.incharge.org/financial-literacy/budgeting- saving/how-much-will-i-need-to-save-for-retirement/

MORAH, C. (16 de December de 2023). Evaluating Your Personal Financial Statement. Obtenido de Investopedia : https://www.investopedia.com/articles/pf/08/evaluate-personal- financial-statement.asp MURPHY, C. B. (21 de August de 2023). Debt-to-Income (DTI) Ratio: What's Good and How To Calculate It. Obtenido de Investopedia: https://www.investopedia.com/terms/d/dti.asp#:~:text=to%2DIncome%20Ratio%3F- ,As%20a%20general%20guideline%2C%2043%25%20is%20the%20highest%20DTI %20ratio,varies%20from%20lender%20to%20lender National Bank. (2022, August 23). How to make a personal budget. National Bank. https://www.nbc.ca/personal/advice/budget/creating-a-personal-budget.html Ratehub. (2022, April 7). BC Mortgage Payment Calculator. Ratehub.ca. https://www.ratehub.ca/british-columbia-mortgage-calculator Santarelli, M. (23 de January de 2024). Vancouver Housing Market Trends And Forecast for 2024. Obtenido de Norada Real Estate Investments: https://www.noradarealestate.com/blog/vancouver-housing- market/#:~:text=Average%20Home%20Prices%20in%20Vancouver,increase%2C%20%2D 5%25%20MoM) Stienburg, C. (2024, February 16). Key Considerations Before Selling Your Business: Navigating Asset Sale vs. Share Sale. CanadianSME Small Business Magazine. https://canadiansme.ca/key-considerations-before-selling-your-business-navigating- asset-sale-vs-share-sale/ TD. (n.d.). How much life insurance do I need? TD Insurance. https://www.tdinsurance.com/products-services/life-insurance/life-guide/life- insurance-needs

Will. (2023, March 4). 2023 Corporate tax rates and small business tax rates in Canada. WTC Chartered Professional Accountant. https://wtcca.com/corporate-tax-rates-and-small- business-tax-rates-in-canada/

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