This Document Contains Chapters 3 to 4 3 PLANNING YOUR TAX STRATEGY CHAPTER OVERVIEW The basics of taxes and their relationship to financial planning are presented in this chapter by following Stephanie Seymour as she completes her income tax returns (opening case p.73). The material starts with a brief discussion of types of taxes. Next, the fundamental aspects of income taxes are presented including taxable income, deductions, tax rates, and tax credits, tax forms, the basic steps for completing them and filing status. Next, the chapter discusses tax planning strategies related to purchasing decisions, investment alternatives, and retirement. Finally, the chapter concludes with information on tax assistance sources and the audit process. LEARNING OBJECTIVES CHAPTER SUMMARY After studying this chapter, students will be able to: Obj. 1 Describe the importance of taxes for personal financial planning. Tax planning can influence spending, saving, borrowing, and investing decisions. Knowledge of tax laws and maintenance of accurate tax records are necessary to take advantage of appropriate tax benefits. An awareness of income taxes, sales taxes, excise taxes, property taxes, estate taxes, and other taxes is vital for successful financial planning. Obj. 2 Illustrate how federal income taxes are computed by completing a federal income tax return. The major sections of your tax return require you to calculate (1) your filing status, (2) income, (3) deductions, (4) other deductions, (5) tax credits, and (6) your refund or the additional amount you owe. Obj. 3 Select appropriate tax strategies for different financial and personal situations. You may reduce your tax burden through careful planning and making financial decisions related to consumer purchasing, the use of debt, investments, and retirement planning. Obj. 4 Identify tax assistance sources. The main sources of tax assistance are CRA services and publications, other publications, the Internet, computer software, and professional tax preparers such as commercial tax services, accountants, and attorneys. INTRODUCTORY ACTIVITIES • Ask students to comment on the opening case for the chapter (p. 71). • Point out the learning objectives (p. 71) in an effort to highlight the key points in the chapter. • Ask students to provide examples of common concerns associated with preparing a federal income tax return. • Point out methods of financial planning that can save money on taxes. CHAPTER 3 OUTLINE I. Taxes and Financial Planning A. Taxes on Purchases B. Taxes on Property C. Taxes on Wealth D. Taxes on Earnings II. Filing Your Federal and Provincial Income Tax Return A. Who Must File? III. Income Tax Fundamentals A. Step 1: Determining Total Income B. Step 2: Calculating Net Income C. Step 3: Taxable Income D. Step 4: Calculating Taxes Owing E. Step 5: Net Federal Tax F. Making Tax Payments G. Deadlines And Penalties IV. Tax Planning Strategies A. How Should You Receive Income B. Maximizing the Benefit of Deductions and Tax Credits C. Tax Deferral Techniques D. Income Splitting Techniques E. Ensuring That Your Portfolio is Tax Efficient F. Tax Issues Important To Students G. Changing Tax Strategies V. Tax Assistance and the Audit Process A. Tax Information Sources B. Tax Preparation Software and Electronic Filing C. Tax Preparation Services D. What If Your Return Is Audited? CHAPTER 3 LECTURE OUTLINE TAXES AND FINANCIAL PLANNING (p. 72) • • Common goals related to tax planning include: knowing current tax laws maintaining complete records making financial decisions that can reduce your tax liability The principal purpose of taxes is to finance government activities. ∗ ∗ ∗ Instructional Suggestions • Discussion Question: Why do many people avoid the topics of taxes more than other areas of personal financial planning? • Discussion Question: Are progressive taxes the most equitable for all people? Taxes on Purchases (p. 72) • • Federal and provincial sales taxes are added to the purchase price of products. An excise tax is imposed federal and provincial governments on specific goods and services, such as gasoline, cigarettes, alcoholic beverages, tires, air travel, and telephone service. Taxes on Property (p. 72,72) • • The real estate property tax is based on the value of land and buildings. Personal property taxes and taxes on the value of automobiles, boats, furniture, and farm equipment are imposed in some areas by the provincial and municipal governments. Taxes on Wealth (p. 73) • • The federal and provincial governments do not impose estate or inheritance taxes. Federal tax liabilities may arise when incomegenerating investments are transferred to beneficiaries. Taxes on Earnings (p. 73) • • Income taxes are used by the federal government to support social benefit programs such as the Canadian Pension Plan and Employment Insurance. Income tax is a major financial planning factor for most individuals. In addition to federal income tax, most workers are subject to provincial income taxes. • Concept Check 3-1 (p. 74) CHAPTER 3 LECTURE OUTLINE Instructional Suggestions FILING YOUR FEDERAL AND PROVINCIAL INCOME TAX RETURN (p. 74) • The annual submission of your federal income tax requires several decisions and activities. Who Must File? (p. 74) • l All resident and citizens of Canada. If you are a resident of Quebec, you will be able to choose between either the general tax filing system or the simplified system. Quebec is the only province that does not “piggyback” on the federal system of personal taxation, and as a result its residents must file both a federal tax return and a separate Quebec tax return. • Supplementary Resource: Quebec tax forms and guides are available in both English and French from the Provincial government’s Web site at www.gouv.qc.ca. • Discussion Question: Should all types of income be taxed at the same rate? • Text Highlight: Exhibit 31 can be used as a class exercise to discuss items included in taxable income and common deductions. • Assignment: Have students obtain current tax forms and instructions Revenue Canada. • Exercise: Have class members discuss their experiences when preparing their federal tax returns. INCOME TAX FUNDAMENTALS (p. 74) • The process of determining your federal income tax involves computing taxable income, determining the amount of tax owed, and comparing this amount with income tax payments withheld or made during the year. Completing the Federal Income Tax Return The five major sections are: 1. Income 2. Deductions These allow you to calculate net income 3. Other deductions such as capital gains deductions and losses carried over from other years. Subtracting these gives you your taxable income 4. Tax credits These allow you to compute your basic tax 5. Other tax credits such as political donations and labour-sponsored funds. Payable tax is determined here. If it is negative, the government will refund you for this amount that you paid in excess. Step 1: Determining Total Income (p. 74) • Employment income is money received by an individual for personal effort such as wages, salary, commission, fees, tips, or bonuses. CHAPTER 3 LECTURE OUTLINE • • Instructional Suggestions Net business income includes any income from an activity that is carried out for profit. Taxable capital gains (also known as investment income) includes income in the form of interest, dividends, and rental income net of expenses. Step 2: Calculating Net Income (p. 76) • • • • • Net Income is total income reduced by certain adjustments, such as contributions to an RRSP or RPP. Deductions are expenses that can be subtracted from total income. Every taxpayer receives at least the basic personal amount, on which no taxes are paid, but many individuals qualify for more than the basic deduction. Common itemized deductions are expenses that a taxpayer is allowed to deduct from total income; these include: ∗ Contributions ∗ Union and Professional dues ∗ Moving expenses ∗ Child care expenses ∗ Expenses to pay for an attendant for disabled people. • • • Text Highlight: The “Financial Planning Calculations” feature on page 83 demonstrates the difference between a tax credit and a tax deduction. • Discussion Question: Does wise financial planning include getting a large income tax refund each year • Text Highlight: Refer to exhibit 3-3 for 2007 combined income tax rates. Taxable income is the basis for computing the amount of your income tax. The use of tax rates and the benefits of tax credits are the final phase of the tax computation process. Use your taxable income in conjunction with the appropriate tax table or tax schedule. Step 4: Calculating Federal Taxes Owing (p. 77) • Text Highlight: On pages 86-89 is a sample federal income tax return for Stephanie Seymour. Under the Income Tax Act, the capital gains exemption is referred to as a capital gains deduction because the realized capital gains are included in determining total income, but are then offset as a deduction to arrive at taxable income. Step 3: Calculating Taxable Income (p. 77) • • The marginal tax rate is the rate you pay on your last dollar earned. The average tax rate is based on the total tax due divided by total income. Step 5: Net Federal Tax (p. 78) • A tax credit is an amount subtracted directly from the amount of taxes owed. There are refundable and non-refundable tax credits. Non-refundable tax credits are more common. They are subtracted from the amount of taxes owed, never reducing federal taxes to below zero • Text Highlight: Refer to exhibit 3-4 for 2007 federal nonrefundable tax credit amounts • Text Highlight: Refer to exhibit 3-5 for a sample of a T-4 form Making Tax Payments (p. 81) • • • • • Source withholding occurs as your employer and others are required to withhold tax at source and remit it to the CRA as well as the Ministère du Revenue if you live in Quebec. The T-4 form reports your annual earnings and the amounts that have been deducted for income tax, social benefits, and other taxes. The CRA form used to request a reduction in source withholdings is the TD-1, the Personal Tax Credit Return. Your tax payments must be made in installments if your payable taxes and the amount you have already had withheld at source is more than $2,000 in both the current year and either of the two preceding years. In Quebec, where the federal government does not collect the provincial tax, the threshold is $1,200 of provincial tax instead of $2,000. Payments must be made quarterly on March, June, September, and December 15th. Deadlines and Penalties (p. 83) • Current Example: In 2005, the average family income was $60,903 and the total tax paid was $28,467. • Text Highlight: Exhibit 37 presents the five general sections of your federal tax return form. • Concept Check 3-2 (p. 83) Most people are required to file their federal income tax return by April 30. If you miss the deadline, you will incur an automatic 5 percent penalty on any balance owing, in addition to 1 percent of the unpaid balance added for each month that your return is late. TAX PLANNING STRATEGIES (p. 91) • • Tax planning is the use of legitimate methods to reduce one’s taxes. Tax evasion is the use of illegal actions to reduce one’s taxes. How Should You Receive Income (p. 91) There exist different ways to arrange your compensation in order to improve your after-tax income. For example, if your job requires you to travel, traveling expenses could be deductible. Maximizing The Benefit of Deductions and Tax Credits (p. 94) • • • • • • The lower income spouse is required to take the child care deduction. Before May 1, 1997, alimony, child support and spousal maintenance were deductible. Interest is tax deductible. Remuneration from stock options plans must be included in taxable income. Capital losses can be subtracted from capital gains. Each individual is eligible for a lifetime $500,000 capital gains exemption on shares of qualifying small businesses. Tax Deferral Techniques (p. 96) Retirement Plans: Registered retirement savings plans (RRSP): If you agree to put away some of your salary, the tax system will tax that income and all proceeds when it is withdrawn form the RRSP. • Owning a home is one of the best tax shelters available to most individuals. • The home buyers’ plan allows first-time buyers to withdraw up to $20,000 as a loan from their RRSP without it counting as a withdrawal. The loan is repaid without interest over the next 15 years. • Students can claim a non-refundable federal tax credit on the interest on their student loans. l Other retirement plans include: Registered Pension Plans (RPPs), Individual Pension Plans (IPPs), and Deferred Profit Sharing Plans (DPSPs). • Current Example: The value of your RRSP contribution in terms of tax savings will depend on your marginal rate of tax. CHAPTER 3 LECTURE OUTLINE Instructional Suggestions Income Splitting Techniques Tax payers may be tempted to invest on the name of their lower income earning spouse or child in order to have investment income taxed at a lower rate. This is not permitted under law. • Ensuring that Your Portfolio is Tax Efficient The taxation of investment income will play a role in the decision of which investment account should hold which type of asset. Tax Issues Important to Students • • • • How to report income from scholarships Common deductions Non-refundable tax credits such as tuition GST/HST credit and CCTB Changing Tax Strategies (p. 99) Each year, the CRA modifies the tax return and filing procedures. In addition the government frequently passes legislation that changes the Income Tax Act. TAX ASSISTANCE AND THE AUDIT PROCESS (p. 101) Tax Information Sources (p. 101) • • Both the Canada Customs and Revenue Agency and the Québec Minstère du Revenue offer comprehensive guides to help you plan and complete your tax return. The Internet is the fastest way to find information about the CRA and the Québec Minstère du Revenue. Web sites such as IE: Money magazine, Canoe Webfin, the Frasier Institute, CANTAX, and the Canadian Taxpayer Federation are also excellent sources of Canadian tax information. Concept Check 3-3(p.101) • • Libraries and bookstores offer books and other publications that help you create a strategy to effectively and legally minimize your total taxes paid. The following are published each year: ∗ Deloitte & Touche’s How to Reduce the Tax You Pay ∗ KPMG’s Tax Planning for You and Your Family ∗ CCH Canadian’s Preparing Your Income Tax Returns ∗ Evelyn Jack’s Jacks on Tax Savings ∗ Prentice Hall Canada’s Canadian Guide to Personal Financial Management Newspapers frequently contain articles related to personal taxes. • Discussion Question: Should individuals do their own taxes or make use of the services of a professional tax preparer? • Text Highlight: An example of a tax-planning system is shown in Exhibit 3-8. • Text Highlight: Exhibit 3-9 helps to minimize your chances of an audit by listing the top ten filing errors. Tax Preparation Software and Electronic Filing (p. 102) l l l A spreadsheet program can be very helpful for maintaining and updating tax data on various income and expense categories. Popular software includes QuickTax and TaxTron. The CRA allows taxpayers to file their returns in electronic format using a system called EFILE. There is however, a transmission fee charged. The Québec Minstère du Revenue has a similar system. Tax Preparation Services (p. 103) • The sources available for professional tax assistance include: ∗ tax services ∗ accountants (CAs, CGAs, CMAs) ∗ tax lawyers What If Your Return Is Audited? (p. 103 • • CRA reviews all returns for completeness and accuracy. Errors are automatically recalculated and you receive a bill or refund. A tax audit is a detailed examination of your tax return by the CRA. • • There are two types of audits. The simplest and most common is the desk audit where you are required to clarify or document minor questions about your tax return. The field audit is more complex and involves and auditing agent who will want to have access to your records. As a taxpayer, you should be aware of your audit rights. This includes your right to appeal an assessment you disagree with. • Concept Check 3-4 (p.106) CONCLUDING ACTIVITIES • Point out the chapter summary (p. 106) and key terms in the text margin. • Discuss selected end-of-chapter Financial Planning Problems, Financial Planning Activities, and Life Situation Case. • Use Chapter Quiz in the Instructor’s Manual. CHAPTER 3 QUIZ ANSWERS True-False 1. T 2. F 3. T 4. F 5. T 6. F 7. F 8. F Multiple Choice 9. A 10. C 11. C 12. A 13. D 14. A 15. D 16. B Name ________________________________________ Date____________________________ CHAPTER 3 QUIZ TRUE-FALSE _____1. An excise tax is imposed on specific goods and services. _____2. Taxable income refers to the amount deducted from a person’s pay. _____3. A tax credit reduces the amount of taxes owed. _____4. Eligible dividends are grossed up by 25 percent and then reported as income. _____5. Auditors from CRA can visit people’s homes to verify deductions. _____6. There is only one type of tax credit that can reduce the amount of tax you owe. _____7. EFILE does not charge a transmission fee for transmitting your tax return if you prepare it yourself. Most people mail the full amount owed in federal income tax each April. _____8. MULTIPLE CHOICE _____9. __________ is fully deductible as an itemized deduction. a. Investment counselling fees. b. Mortgage interest. c. Tax preparation fees. d. Credit card interest. _____10. An example of tax-deferred income is a. RESP. b. child care expenses. c. RRSP. d. commission and bonuses. _____11. An example of an exemption is a. taxable income. b. deductible expenses. c. capital gains. d. amounts not subject to a CRA audit. _____12. Which of the following incomes is subject to income tax? a. investment income. b. GST/HST rebate. c. lottery winnings. d. Canada Child Tax Benefit. _____13. Which of the following is not an example of a tax credit a. CPP/QPP contributions. b. Tuition fees. c. Charitable donations. d. Union and professional dues. _____14. The ____________ is total taxes owed divided by taxable income. a. Average tax rate b. Marginal tax rate c. Normal tax rate d. Abnormal tax rate _____15. The use of illegal actions to reduce one’s taxes is called: a. Tax planning b. Tax break c. Deductions d. Tax evasion _____16. When a CRA agent visits your home or office to verify tax records, this is referred to as a(n) a. office audit. b. field audit. c. correspondence audit. d. desk audit. SUPPLEMENTARY LECTURE Does a Fair Tax Exist? Would you rather pay a tax directly or indirectly? Is a progressive tax better than a proportional tax? These are difficult questions since taxes affect people in different household situations in different ways. Three criteria used in assessing the fairness of taxes are benefits received, ability to pay, and the payment burden. Benefits Received • The fairness criterion states that people should pay taxes in proportion to the benefits they receive from the government. • An example is the use of gasoline taxes and driver’s license fees for road construction and repairs. • Equitable as the benefits-received criterion may seem, it is very difficult to implement. Ability to Pay • A commonly accepted criterion of tax fairness is that individuals with different amounts of wealth or income should pay different amounts of taxes. • Supporters of ability to pay usually argue that high tax bills hurt the rich less than the poor. This argument is the basis for the progressive tax, in which tax rates increase as the level of taxable income increases. The federal income tax is a progressive tax. • In a proportional tax, or flat tax, a constant tax rate is applied to all levels of the tax base. Many state and local income taxes are examples proportional taxes. • Some proportional taxes may seem fair, but in fact they penalize people in low income groups. For example, when all individuals are charged sales tax on food, low income people who use a larger portion of their incomes for necessities, pay a greater percentage of their total income for sales tax than people with higher incomes pay a regressive tax of this kind involves taxes that decrease, as a portion of income, as the tax base increases and tend to place a heavier burden on the poor. For this reason, many states do not tax sales of food and medications. Payment Burden • Many people believe only individuals pay taxes. Although businesses pay property and income taxes, some observers contend that these taxes are passed on to consumers in the form of higher prices. • We pay many indirect taxes of this kind. In addition to those just mentioned, a portion of building owners’ real estate taxes are paid by tenants as part of their rent. • In contrast, direct taxes cannot be passed on to someone else. Property taxes paid by homeowners and income taxes paid by individuals are examples of direct taxes. ANSWERS TO CONCEPT QUESTIONS, FINANCIAL PLANNING PROBLEMS, FINANCIAL PLANNING ACTIVITIES, AND LIFE SITUATION CASE CONCEPT QUESTIONS Concept Check 3-1 (p. 74) 1. How should you consider taxes in your financial planning? Tax planning should include knowing current tax laws, maintaining complete tax records, and making financial decisions that reduce your tax liability. (p. 72) 2. What types of taxes do people frequently overlook when making financial decisions? While most people are aware of the impact of federal income taxes on their financial situation, a wide variety of other taxes also affect financial planning. These include sales, excise, property, estate, inheritance, gift, and state and local income taxes. (pp. 72-73) 3. Who must file a tax return? All resident and citizens of Canada. (p. 73) Concept Check 3-2 (p. 83) 1. What are the five sections of the federal tax return? The five major sections are (1) Income (2) Deductions (3) Other deductions such as capital gains deductions and losses carried over from other years (4) Tax credits (5) Other tax credits such as political donations and labour-sponsored funds 2. What information is needed to compute net income? Net income is the result of subtracting expenses from revenues that is then reduced by certain deductions. 3. What information is needed to compute taxable income? Taxable income is the result of subtracting deductions and exemptions from total income. (See Exhibit 3-1). 4. What is the difference between your marginal tax rate and your average tax rate? The marginal tax rate refers to the rate used to calculate the last (and next) dollar of taxable income. The average tax rate is based on the total tax due divided by taxable income. (pp. 78) 5. How does a tax credit affect the amount owed for federal income tax? A tax credit is a direct (dollar-for-dollar) reduction in the amount owed in taxes. One example of a tax credit is child and dependent care expenses. (p. 78) Concept Check 3-3 (p.101) 1. How does tax avoidance differ from tax evasion? Tax avoidance refers to the use of legitimate methods to reduce one’s taxes. Tax evasion is the use of illegal actions to reduce one’s taxes. (p. 91) 2. What common tax-planning strategies are available to most individuals and households? Common tax planning strategies include owning a home, making purchases that may be deducted as job-related expenses, selecting tax-deferred and tax-exempt investments, owning your own business, and participating in a tax-deferred retirement plan. Concept Check 3-4 (p. 106) 1. What are the main sources available to help people prepare their taxes? The main sources of tax assistance are the CRA and the Québec Ministère du Revenue guides and Web sites. Other Web sites are also available. Additional publications can be found in libraries and bookstores. Articles in newspapers can also be helpful. 2. What actions can reduce the chances of an audit? The following are the top ten filing errors that may lead to an audit: a. Mathematical errors, such as adding or subtracting amounts incorrectly. b. Forgetting to reduce income by identifying workers’ compensation, social assistance payments, and net federal supplements. c. Calculating and claiming provincial tax credits incorrectly. d. Not including pension adjustments, which affect RRSP contribution room for the coming year. e. Claiming GST/HST credits incorrectly by using incorrect spousal income amounts. f. Entering the wrong amount on lines referring to Canada Pension Plan, Quebec Pension Plan, and Employment Insurance contributions and overpayments. g. Claiming incorrect amounts as RRSP contributions. h. Forgetting to claim the basic personal amount. i. Claiming the spousal amount incorrectly. j. Forgetting to claim the age amount, or claiming it incorrectly. 3. What appeal options do taxpayers have if they disagree with an audit decision? If you disagree with the results of the audit, you may file a Notice of Objection through your local Chief of Appeals within 90 days of the disputed assessment or within a year of the original due date for the return. FINANCIAL PLANNING PROBLEMS (p. 107) 1. Franklin Stewart arrived at the following tax information: Gross salary, $47,780 Interest earnings, $225 Dividend income, $80 Basic personal amount, $9600 Deductions, $3,890 Other losses, $1,150 What amount should Franklin report as taxable income? Franklin would have a taxable income of $43,081 resulting from $47,780 + $225 + $80(1.45) – $3,890 – $1,150. 2. What is the average tax rate for a person who paid taxes of $4,864.14 on total taxable income of $39,870? The average tax rate would be 12.2 percent ($4,864.14/ 39,870). 3. What is a tax credit? Distinguish between the two types of tax credits. (Obj. 2) Tax credit is an amount subtracted directly from the amount of taxes owing. The two types of tax credits are the non-refundable tax credits and the refundable tax credits. Non-refundable tax credits which are more common, are subtracted from the amount of taxes owed but can never reduce net federal tax below zero. Refundable tax credits which are very few at the federal level are sums that are refunded to individuals, if they qualify, even if their tax liability is zero. 4. Based of the following data, will Ann Wilton receive a federal tax refund or owe additional taxes in 2007? (Obj. 2) Net income $48,190 Deductions to determine net income $11,420 Federal income tax withheld $6,784 Total non-refundable tax credit amounts, excluding medical expenses $10,244 Medical expenses $2,300 Deductions of $11,420 have already been taken to arrive at Ann’s net income of $48,190. With no further deductions, Ann’s taxable income would equal her net income. The 2007 federal tax liability on this taxable income would be: $37,178 x 0.15 $5,576.70 ($48,190 - $37,178) x 0.22 $2,422.64 $7,999.34 Ann’s non-refundable tax credits would equal: Medical: [$2,300 – (0.03)($48,190)][0.15] $ 128.15 Other: $10,244 x 0.15 $1,536.60 $1,664.75 Her net federal tax liability in 2007 would be $7,999.34 - $1,664.75 = $6,334.59. If $6,784 of federal tax was deducted at source, then Ann would receive a federal tax refund of $6,784 $6,334.59 = $449.41. 4. Would you prefer a fully taxable investment earning 10.7 percent or a tax free investment earning 8.1 percent? Why? Assume a combined 2007 marginal tax rate of 42% Assuming a marginal tax rate of 42 percent, 10.7 percent times (1 – 0.42) equals an after-tax return of 6.21 percent. Therefore, an 8.1 percent tax-exempt return would be preferred. 5. On December 30, you decide to make a $1,000 charitable donation. If you are in a 22 percent tax bracket, how much will you save in taxes for the current year? If that tax savings was deposited in a savings account for the next five years at 8 percent, what would be the future value of that account? $262 tax savings = ($200 x 15%) + ($800 x 29%) (See Exhibit 3-4c); $262 × 1.469 = $384.88 FINANCIAL PLANNING ACTIVITIES (p. 107) 1. Using the Web sites such as the Canadian Tax Foundation at www.ctf.ca, or Canoe Money at www.money.canoe.ca, or library resources, obtain information about the tax implications of various financial planning decisions. This activity can help students start to understand the extent to which taxes influence financial decisions. In addition, students should obtain some examples of wise tax planning from some various sources. 2. Using library resources or the Web, determine the types of income that are exempt from federal income tax. Student findings should reveal current examples of tax-exempt income and how income sources are taxed for people with different life situations. 3. Survey several people about whether they get a federal tax refund or owe taxes each year. Obtain information about the following: (a) Do they usually get a refund or owe taxes when they file their federal tax return? (b) Is their situation (refund or payment) planned? (c) Why do they want to get a refund each year? (d) Are there situations where getting a refund may not be a wise financial decision? While getting a refund can be viewed as a method of “forced savings” and does prevent a person from having to come up with the money to pay taxes, some people view this action as giving the government an interest-free loan since it has the use of the money until a refund is issued. The opportunity cost is the lost interest that would be earned if it were in savings. 4. Survey friends and relatives about the tax-planning strategies. This exercise can provide students with examples of specific tax planning activities that can benefit them now or in the future. 5. Obtain samples of current tax forms you would use for filing your federal income tax return. These may be ordered by mail, obtained at a local CRA office or post office, or on the Internet at www.craarc.gc.ca. Students should be encouraged to continually update their awareness of changes in the tax laws and tax forms. This will provide them with a foundation for ongoing learning about their taxes. 6. Use CRA publications and other reference materials to answer a specific tax question. Contact a CRA office to obtain an answer for the same question. What differences, if any, exist between the information sources? This activity can help students better understand the federal income tax return preparation process. In addition, they should realize that certain tax matters regarding income and deductions may be open to interpretation. 7. Visit a retailer that sells tax preparation software such as www.quicken.intuit.ca, or visit the Web site of software companies to determine the cost and features of programs that may be used to prepare and file your federal income tax return. Each year, the features offered in tax preparation software makes it easier for a person to do their own taxes. Have students share their experiences related to using tax preparation software. 8. Create a visual presentation (video or slide presentation) that demonstrates actions a person might take to reduce errors when filing a federal tax return. This activity will not only improve student awareness about taxes but can also enhance their communication skills. LIFE SITUATION CASE A Single Father’s Tax Situation (p. 108) 1. What are Eric’s major financial concerns in his current situation? Eric’s major financial concerns include providing for the current and future financial needs of his daughters, weak tax-planning activities, and limited use of investments with tax benefits. 2. In what ways might Eric be able to improve his tax-planning efforts? Eric could take advantage of child care tax benefits and equivalent-to-spouse tax credit, change his withholding amount to avoid owing a large amount in April, and investigate tax-exempt or taxdeferred investments. 3. Is Eric typical of many people in our society with regard to tax planning? Why or why not? While student answers will vary depending on their awareness of tax planning efforts, most individuals tend to avoid this aspect of personal finance. Many believe the topic is too complex, but the content offered in this chapter is designed to provide a basic understanding of this vital area. 4. What additional actions might Eric investigate with regard to taxes and personal financial planning? Other areas Eric might consider include the purchase of a home to take advantage of its tax benefits and expanded use of tax-deferred retirement plans. 5. Calculate the following: a) Eric’s taxable income would equal: Wages Interest ($125 + $65) Total income $47,500 190 $47,690 Less deductions: RRSP deduction Child care deduction Total deductions $ 2,000 6,300 $ 8,300 Net and taxable income $39,390 b) His 2007 federal tax liability would be: $37,178 x 0.15 $5,576.70 ($39,390 - $37,178) x 0.22 486.64 $6,063.34 Less: $13,200 x 0.15 Federal tax liability $1,980 $4,083.34 His average 2007 federal tax rate would be $4,083.34 ÷ $39,390 = 0.1037 or 10.37%. c) Eric will receive a federal tax refund of $4,863 - $4,083.34 = $779.66. COMMENTS ON CONTINUOUS CASE FOR PART 1(p. 109) Getting Started: Planning for the Future 1. What financial decisions should Pamela be thinking about at this point in her life? Pamela should begin by establishing a realistic budget that allows for variations in monthly income. Next, she should work to accumulate an emergency fund. Since a portion of her monthly income is based on commission, she may want to accumulate a larger-than-normal emergency fund. Pam should also begin to pay off her credit card liabilities. Above all, she should quit relying on her credit card to make ends meet. 2. What are some financial goals that Pamela’s might want to accomplish within the next few years? Realistic goals should include the establishment of an emergency fund and an investment program. Another worthwhile goal would include paying off her credit card debt. 3. How should Pamela budget for fluctuations in her income caused by commission earnings? The establishment of a larger-than-normal emergency fund would be one effective way to handle fluctuations in monthly income. She could also maintain a larger balance in her checking account to tide her over during low-income periods. 4. Assume Pamela’s federal tax refund is $1,100. Given her current situation, what should she do with the refund? Assuming that she doesn’t have an emergency fund, the money from her tax refund could be used to start one. If she has an emergency fund, she may want to use the money to start or add to an investment program. She should avoid the temptation to waste the tax refund on unnecessary purchases. 5. Based on her life situation, what type of tax planning should Pamela consider? Pamela should probably consider a tax-deferred retirement program, tax-exempt or tax-deferred investments, and might consider buying a home to take advantage of the tax benefits associated with that purchase. 4 THE BANKING SERVICES OF FINANCIAL INSTITUTIONS CHAPTER OVERVIEW Using savings plans, chequing accounts, and other financial services is a primary personal financial planning activity. This chapter starts with an overview of these services followed by a discussion of the changing environment of financial services caused by technology and economic conditions. Next, discussion of the different types of financial institutions is offered along with the factors to consider when selecting one. Coverage of choosing and using savings plans includes material on the types of accounts that are available. Finally, selection and use of chequing accounts is presented. LEARNING OBJECTIVES CHAPTER SUMMARY After studying this chapter, students will be able to: Obj. 1 Analyze factors that affect selection and use of financial services. Financial products such as savings plans, chequing accounts, loans, and trust services are used for managing daily financial activities. Technology, opportunity costs, and economic conditions affect the selection and use of financial services. Obj. 2 Compare the types of financial institutions. Chartered banks, trust companies, credit unions and caisses populaires, life insurance companies, investment companies, mortgage and loan companies, pawnshops, and cheque-cashing outlets may be compared on the basis of services offered, rates and fees, safety, convenience, and special programs available to customers. Obj. 3 Compare the costs and benefits of various savings plans Commonly used savings plans include regular savings accounts, term deposits and Guaranteed Investment Certificates, interestearning chequing accounts, and Canada Savings Bonds. Obj. 4 Identify the factors used to evaluate different savings plans. Savings plans may be evaluated on the basis of rate of return, inflation, tax considerations, liquidity, safety, restrictions, and fees. Obj. 5 Compare the costs and benefits of different types of chequing accounts. Regular chequing accounts, activity accounts, and interestearning chequing accounts can be compared with regard to restrictions (such as a minimum balance), fees and charges, interest, and special services. INTRODUCTORY ACTIVITIES • Ask students to comment on the opening case for the chapter (p. 116). • Point out the learning objectives (p. 116) in an effort to highlight the key points in the chapter. • Ask students to provide examples of financial services that could be used to achieve various goals. • Point out the opportunity costs associated with using various financial services (see text page 120). • Obtain sample advertisements, brochures, or Web site printouts from financial institutions with information on their services, rates, and fees. CHAPTER 4 OUTLINE I. II. III. IV. V. VI. A Strategy for Managing Cash A. Meeting Daily Money Needs B. Types Financial Services C. Electronic Banking Services D. Methods of Payment E. Opportunity Costs of Financial Services F. Financial Services and Economic Conditions Types of Financial Institutions A. Deposit-Type Institutions B. Non-Deposit Institutions C. Online Banking D. Comparing Financial Institutions Types of Savings Plans A. Regular Savings Accounts B. Term Deposits and GICs D. Interest-Earning Chequing Accounts E. Canada Savings Bonds Evaluating Savings Plans A. Rate of Return B. Inflation C. Tax Considerations D. Liquidity E. Safety F. Restrictions and Fees Selecting Payment Methods A. Types of Chequing Accounts B. Evaluating Chequing Account Appendix: Using a Chequing Account CHAPTER 4 LECTURE OUTLINE A STRATEGY FOR MANAGING CASH (p. 117) • Daily buying activities require the use of financial services that facilitate business transactions as well as lead to the achievement of financial goals. Meeting Daily Money Needs (p.117) • • Cash, cheque, credit card, or ATM card are the common payment choices. No matter how carefully you manage your money, there may be times when you will need more cash than you have currently available. To cope with that situation, you have two basic choices: liquidate savings or borrow. Types of Financial Services (p. 118) • • Financial services may be viewed in four main categories: 1. Savings involves safe storage of funds for future use. 2. Payment services get you the ability to transfer money to others for conducting business. 3. Borrowing refers to credit alternatives available for short-and long-term needs. 4. Other financial services include insurance protection, investments, real estate purchases, tax assistance, and financial planning A trust is a legal agreement that provides for the management and control of assets by one party for the benefit of another. Electronic Banking Services (p. 118) • • • • • Computerized financial services (see Exhibit 4-2) provide fast, convenient, and efficient systems for recording inflows and outflows of funds. Direct Deposit. Each year, more and more workers are only receiving a pay stub on payday. Their earnings are being automatically deposited into their chequing or savings accounts. Automatic Payments. Many utility companies, loan payments, and other businesses allow customers to use an automatic payment system with bills paid through direct withdrawal from a bank account. An automatic teller machine (ATM), or simply cash machine, is a computer terminal that allows customers to conduct banking transactions. In addition, some ATMs sell bus passes, postage stamps, gift certificates, and mutual funds. ATM convenience can be expensive. Surveys reveal Instructional Suggestions CHAPTER 4 LECTURE OUTLINE • that in casinos, the surcharges often add up to $3 to $5 per transaction. An ATM transaction on a cruise ship can cost $9 or more. To reduce ATM fees, experts suggest that you: (1) compare ATM fees at different financial institutions before opening an account; (2) use your own bank’s ATM whenever possible to avoid surcharge imposed when using the ATM of another financial institution; (3) consider purchasing a monthly service package that includes ATM activity; (4) withdraw larger cash amounts, as needed, to avoid fees on several small transactions; (5) consider using personal cheques, traveler’s cheques, and credit cards when away from home. Methods of Payment (p. 120) • • • • Instructional Suggestions • Current Example: Facerecognition and voicerecognition software are being tested to activate ATM transactions. This same software is being used for border crossings and airport security. • Assignment: Using The Point-of Sale Transactions. ATM cards are accepted at many retail stores and restaurants. An on-line card operates like an ATM card with an instant transfer of funds from your account. On-line transactions require that you enter your PIN to authorize the transaction. Off-line card transactions are processed like credit card charges; your PIN is not required. However, these transactions do not increase the amount owed. Instead, the funds are deducted from your bank account after a day or two. Stored-Value Cards. Prepaid cards for buying telephone service, transit fares, highway tolls, laundry service, library fees, and school lunch debit cards are becoming very common. Smart Cards. “Smart cards,” sometimes called “electronic wallets,” look like ATM cards; however, they also include a microchip. This minicomputer stores prepaid amounts for buying goods and services. In addition, the card stores data about a person’s account balances transaction records, insurance information, and medical history. Electronic Cash. SecurNat, offered by the National Bank of Canada (www.nbc.ca) is a payment solution that allows you to pay for online purchases, from a National Bank approved merchant, using your credit card. Opportunity Costs of Financial Services (p. 120) • As in all decisions, opportunity cost is what you give CHAPTER 4 LECTURE OUTLINE • Instructional Suggestions Financial Post, the Internet, and other current financial data sources, have students update the interest rates on page 108. up when evaluating, selecting, and using financial services. Opportunity costs associated with financial services may include higher return with low liquidity, higher costs for convenience of 24-hour electronic banking, or lost interest when a “free” chequing account requires that you maintain a minimum balance. Financial Services and Economic Conditions (p. 120) • Changing interest rates, fluctuating consumer prices, and other economic factors influence the availability and use of financial services. • Concept Check 4-1 (p. 121) • Assignment: Have students survey three to five people to determine the main factors that influenced their selection of a financial institution with which they do business. TYPES OF FINANCIAL INSTITUTIONS (p. 121) • Financial institutions may be viewed in two major categories. Deposit-Type Institutions (p. 122) • • • Traditionally, chartered banks have offered the widest range of financial services. A Trust company offers a broad range of financial services similar to those provided by banks. In addition, they are the only ones allowed to act as a trustee in charge of corporate or individual property, stocks, and bonds. Credit unions are user-owner, nonprofit, cooperative financial institutions that offer a wide range of services. A Caisse Populaire is the Quebec equivalent of a credit union. Non-deposit Financial Institutions (p. 123) • • Many life insurance companies offer policies that contain savings and investment features. Investment companies, referred to as mutual funds, have become involved in banking-type activities. A common service of these organizations is the money market fund, a combination savings-investment plan in which the investment company uses your money to purchase a variety of financial instruments. CHAPTER 4 LECTURE OUTLINE • • • Instructional Suggestions Making loans to consumers and small businesses is the main function of mortgage and loan companies. Pawnshops make loans based on the value of some tangible possession, such as jewelry or other valuable items. Many low- and moderate-income families use these organizations to quickly obtain cash loans. Pawnshops charge higher fees than other financial institutions. Most banks will not cash a cheque unless the person has an account. Cheque-cashing outlets (CCO) charge anywhere from 1% to 20% of the face value of a cheque; the average cost is between 2% and 3%. Online banking (p. 124) • Cyberbanking, banking through the telephone, personal computer, and online services, continues to expand. Hundreds of banks now have “cyber” branches so customers can cheque balances, pay bills, transfer funds, compare savings plans, and apply for loans on the Internet. Comparing Financial Institutions (p. 125) • Some major factors to consider when selecting a financial institution are: ∗ services offered ∗ convenience/location ∗ safety/deposit insurance ∗ interest rates ∗ fees and charges TYPES OF SAVINGS PLANS (p. 128) • The basis for your attainment of financial goals is the accumulation of funds that results from an effective savings and investment program. Regular Savings Plans (p. 128) • Regular savings accounts, traditionally referred to as passbook accounts, involve a low or no minimum balance and allow savers to withdraw money as needed. Term Deposits and Guaranteed Investment Certificates (p. 129) • Term deposits guarantee a rate of interest for a specified term. The trade-off is that your money becomes less accessible for a time. • GICs are essentially term deposits with a longer term, • Concept Check 4-2 (p. 127) CHAPTER 4 LECTURE OUTLINE • Instructional Suggestions ranging from 1 to 5 years. Managing your term deposits and GICs. When they reach maturity, it is important to assess all earnings and costs. Do not allow your financial institution to automatically roll your money over into another deposit for the same term. Interest-Earning Chequing Accounts (p. 129) • A variety of interest-earning chequing accounts can be used as savings vehicles. Canada Savings Bonds (p. 129) • • • There are two types of Canada Savings Bonds. The regular interest bond pays annual interest on November 1st of each year. Only cash is permitted to buy this bond. The compound interest reinvests payable interest automatically until redemption or maturity. This bond can be purchased by cash, a monthly payment plan through a financial institution, or through a payroll savings plan. CSBs can be cashed in by the owner at any bank in Canada, at any time. EVALUATING SAVINGS PLANS (p. 130) Rate of Return (p. 130) • Rate of return, or yield, is the percentage of increase in the value of your savings due to earned interest. • Compounding refers to interest that is earned on previously earned interest. The more frequent the compounding, the higher your rate of return will be. • The effective annual rate (EAR) formula is used to incorporate the effect of compounding. The formula is: EAR = (1 + km)m – 1; where m is the number of compounding periods in a year and km the rate of return for one period. • The nominal interest rate is the periodic rate multiplied by the number of compounding periods in a year. Inflation (p. 131) • The rate of return you earn on your savings should be compared with the inflation rate. • In general, as the inflation rate increases, the interest rates offered to savers also increase. This gives you an • Concept Check 4-3 (p. 130) CHAPTER 4 LECTURE OUTLINE Instructional Suggestions opportunity to select a savings option that will minimize the erosion of your dollars on deposit. Tax Considerations (p. 131) • Taxes reduce your earnings on savings. For example, a 10 percent return for a saver in a 26 percent tax bracket means a real return of only 7.4 percent. (See “Financial Planning Calculations” feature on page 131.) Liquidity (p. 131) • Liquidity allows you to withdraw your money on short notice. Safety (p. 131) • • Most savings plans at banks, trust companies, and credit unions or caisses populaires are insured by agencies affiliated with the federal government. The Canadian Deposit Insurance Corporation (CDIC) will protect eligible deposits up to a maximum of $100,000 per person, including principal and interest. Eligible deposits include savings and chequing accounts, term deposits, GICs, debentures, and other obligations issued by institutions that are members of the CDIC. To find out more, access the CDIC site at www.cdic.ca. Restrictions and Fees (p. 132) • Restrictions and costs may include a delay between the time interest is earned and the time it is added to your account. Also, some institutions charge a transaction fee for each deposit or withdrawal. SELECTING PAYMENT METHODS (p. 132) • With about 90 percent of business transactions conducted by cheque, a chequing account is a necessity for most people. Types of Chequing Accounts (p. 132) • The main types of chequing accounts are: ∗ regular chequing accounts are likely to have a monthly service charge or a minimum balance to avoid the fee ∗ activity accounts charge for each cheque written and sometimes for each deposit made ∗ interest-earning chequing accounts Evaluating Chequing Accounts (p. 133) • The most common limitation on chequing accounts is • Concept Check 4-4 (p. 132) CHAPTER 4 LECTURE OUTLINE • • • • the amount that must be kept on deposit to earn interest or avoid a service charge. Nearly all financial institutions require a minimum balance or impose service charges for chequing accounts. The interest rate, frequency of compounding, and interest computation method will affect the earnings on your chequing account. Financial institutions may offer chequing account customers such extra services as 24-hour teller machines and home banking services. Overdraft protection is an automatic loan made to chequing customers to cover the amount of cheques written in excess of the available balance. Other Payment Methods (p. 134) • • • Instructional Suggestions A certified cheque is a personal cheque with guaranteed payment. A money order is a payment device purchased from financial institutions, post offices, or stores. Traveler’s cheques allow you to make payments when away from home. • Discussion Question: When would a payment form other than a personal cheque be used? • Discussion Question: Why do traveler’s cheque companies encourage people to save their unused cheques after vacation rather than spending them? • Concept Check 4-5 (p. 135) CONCLUDING ACTIVITIES • Point out the chapter summary (p. 137) and key terms in the text margin. • Discuss selected end-of-chapter Financial Planning Problems, Financial Planning Activities, and Life Situation Case. • Use the Chapter Quiz in the Instructor’s Manual. CHAPTER 4 QUIZ ANSWERS True False 1. T 2. F 3. T 4. F 5. F 6. F 7. T 8. F Multiple Choice 9. D 10. A 11. B 12. A 13. C 14. C 15. C 16. C Name ________________________________________ Date____________________________ CHAPTER 4 QUIZ TRUE-FALSE _____1. _____2. A pre-arranged personal line of credit is the most efficient source of quick cash. Term deposits cannot be redeemed before maturity. _____3. A credit union usually offers a wider range of financial services than a chartered bank. _____4. A savings account with daily compounding will have lower earnings than an account with quarterly compounding. _____5. A GIC is a chequing account that earns interest. _____6. _____7. Your selection of a savings plan is not influenced by the rate or return on the plan. Interest-earning chequing accounts usually require a minimum balance _____8. Like most investments, CSBs are sold throughout the year. MULTIPLE CHOICE _____9. The fewest financial services would probably be offered by a(n) a. credit union. b. trust company. c. chartered bank. d. investment company. _____10. The rate of return on a savings account may also be referred to as a. yield. b. compounding. c. liquidity. d. equity. _____11. The savings plan that is likely to have a set rate of return is a a. money market account. b. guaranteed investment certificate. c. debit card account. d. money market fund. _____12. A personal cheque with guaranteed payment is a a. certified cheque. b. bank draft. c. cashier’s cheque. d. money order. _____13. The effective annual rate (EAR) formula is used to a. take inflation into account b. calculate the nominal rate of return c. incorporate compounding d. determine your real rate of return _____14. Which of the following is a drawback of a money market fund? a. Low rate of return b. Penalty for early withdrawals c. Not insured d. High minimum balance _____15. A(n) ____________ is a computer terminal where you can withdraw cash, make deposits, check your balance and conduct other financial services. a. Direct Deposit b. Automatic Payments c. Automated Teller Machines d. Smart Card _____16. A __________ endorsement is most useful when depositing checks by mail. a. special b. blank c. restrictive d. multiple SUPPLEMENTARY LECTURE Are You an Informed User of Financial Services? For each of the following statements indicate a “Yes” or “No” answer. Yes No _____ _____ 1. Do you know a financial institution in your community that has safety deposit boxes? _____ _____ 2. Do you know the current rate of return on your savings account? _____ _____ 3. Do you know the frequency of compounding for your savings account? _____ _____ 4. Do you know where you can buy Canada Savings Bonds in your community? _____ _____ 5. Do you know if there is a credit union/caisse populaire in your community? _____ _____ 6. Do you know the location of your financial institution’s 24-hour automatic teller machines? _____ _____ 7. Do you know the monthly service charge on your chequing account and the fees on your ATM withdrawals? _____ _____ 8. Do you know the minimum balance on your chequing account to avoid a service charge? _____ _____ 9. Do you know the charge for an overdraft on your chequing account? _____ _____ 10. Do you know the annual percentage rate charged on your credit cards and charge accounts? _____ _____ 11. Do you know the annual fee for your bank credit card? _____ _____ 12. Do you know what the interest rate is for automobile loans at your financial institution? ANSWERS TO CONCEPT QUESTIONS, OPENING CASE QUESTIONS, FINANCIAL PLANNING PROBLEMS, FINANCIAL PLANNING ACTIVITIES, LIFE SITUATION CASE, AND INTERNET CASE CONCEPT QUESTIONS Concept Check 4-1 (p. 121) 1. What is the relationship between financial services and overall financial planning? Financial services are used to manage financial activities and to achieve financial goals. See Exhibit 4-1 (p. 117) for an overview of this relationship. 2. What are the major categories of financial services? The major financial services are savings plans, payment services, borrowing, and other services such as insurance protection, investments, tax assistance, financial planning, and trusts. 3. What financial services are available through electronic banking systems? Common electronic banking transactions include obtaining cash, point of purchase payment, direct deposit, preauthorized payments, and transfer of funds between chequing, savings, and loans. 4. Why shouldn’t you select financial services on the basis of only monetary factors? Certain factors such as convenience and personal service may not be easily measured in terms of money. 5. How do changing economic conditions affect the use of financial services? As interest rates rise, you are more likely to save and borrow less. When interest rates decline, spending and borrowing increase. See Exhibit 4-3 (p. 121) for additional information on the effect of interest rates on financial services use. Concept Check 4-2 (p. 127) 1. What are the examples of deposit-type financial institutions? Deposit-type financial institutions include chartered banks, trust companies, mutual savings banks, and credit unions and caisses populaires. 2. What factors do consumers usually consider when selecting a financial institution to meet their saving and chequing needs? When selecting a financial institution, a person should consider the services available, convenience (location, hours, branch offices, banking by mail, automatic teller machines), safety, personal service, rates charged, and interest paid to savers. Concept Check 4-3 (p. 130) 1. What are the main types of savings plans offered by financial institutions? The main types of savings plans are regular savings accounts, term deposits and GICs, interest-earning chequing accounts, and Canada Savings Bonds. 2. What are the benefits of Canada Savings Bonds? Canada Savings Bonds are extremely secure as they are guaranteed by the federal government. Concept Check 4-4 (p. 132) 1. When would prefer a savings plan with high liquidity over one with a high rate of return? If a person will need to have access to savings funds in the near future, liquidity would be preferred over a high rate of return since a penalty for early withdrawal may be involved to get the higher yield. 2. What is the relationship between compounding and calculating the future value of an amount? Future value calculations can also be referred to as compounding since the process involves determining interest on the initial deposit plus any previously earned interest. 3. How do inflation and taxes affect earnings on savings? Inflation and taxes reduce the real rate of return earned on savings. Concept Check 4-5 (p. 135) 1. What factors are commonly considered when selecting a chequing account? When selecting a chequing account consider restrictions (such as minimum balance and holding period for deposited cheques), fees and charges, special features, and interest earned. 2. Are chequing accounts that earn interest preferable to regular chequing accounts? Why or why not? This depends on the minimum balance required to earn interest and the fees charged. OPENING CASE QUESTIONS (p. 116) 1. What benefits and costs are associated with automatic teller machines? Electronic banking provides convenience, speed, and accuracy. In contrast, fees may be charged for the services and a financial institution is likely to have detailed information related to your financial activities. 2. How does the use of financial services like ATMs affect a person’s overall financial plan? An ATM can be a benefit for personal financial activities through serving the need for cash, by providing convenience, and offering detailed financial records. However, excessive use of ATMs can result in overspending and reduced saving for long-term financial security. 3. What could Chris do to reduce his banking fees and manage his money more wisely? Chris could do two major things to reduce his banking fees. First, he could compare services and charges at different financial institutions. Second, he could reduce his use of the most costly financial services he uses. 4. Locate a Web site that provides information suggesting methods for reducing banking fees. Students’ answers will vary. Many Web sites of government agencies, personal finance periodicals, and consumer protection organizations will be of value. FINANCIAL PLANNING PROBLEMS (p. 138) 1. What would be common savings goals of a person who buys a five-year GIC paying 8.75 percent instead of an 18-month savings certificate paying 7.5 percent? A person saving for a longer-term goal such as children’s education, retirement, or purchase of a vacation home may make use of a five-year GIC. A person who will need the funds in less than two years would use an 18-month savings certificate. Also, if you believe interest rates will be dropping, use of a long-term certificate will guarantee a higher savings rate over this period. 2. Compute the earnings for the year, for a $15,000 savings account that earns 12% compounded a) Annually b) Quarterly c) Monthly d) daily. a) $15,000 × 1.12 = $16,800 b) $15,000 × 1.1255 = $16,882.5 c) $15,000 × 1.1268 = $16,902 d) $15,000 × 1.1275 = 16,912.5 3. What would be the value of a savings account started with $500 earning 3 percent (compounded annually) after 10 years? $500 x 1.34 = $670 4. Brenda Young desires to have $10,000 eight years from now for her daughter’s college fund. If she will earn 7 percent (compounded annually) on her money, what amount should she deposit now? Use the present value of a single amount calculation. $10,000 x .582 = $5,820 5. What amount would you have if you deposit $1,500 a year for 30 years at 8 percent (compounded annually)? $1,500 × 113.28 = $169,920 6. With a 26 percent marginal tax rate, which would give you a better return on your savings, a tax-free yield of 7 percent or a taxable yield of 9.5 percent? Why? The 9.5 percent taxable yield is better since after taxes it comes to7.03 percent (9.5% × (1 − .26) 7. What is the annual opportunity cost of a chequing account that requires a $350 minimum balance to avoid service charges? Assume an interest rate of 6.5 percent. $350 × .065 = $22.75 8. What would be the net annual cost of the following chequing accounts? a. Monthly fee, $3.75; processing fee, 25 cents per cheque; cheques written, an average of 22 a month. (22 cheques × 12 months) ξ $0.25 + $3.75 × 12 months = $111 cost b. Interest earnings of 6 percent with a $500 minimum balance; average monthly balance, $600; monthly service charge of $15 for falling below the minimum balance, which occurs three times a year (no interest earned in these months). $600 × .06 = 36 × 9/12 = $27 less $45 services charge = $18 net cost 9. Based on the following information; determine the true balance of your chequing account. Balance in your chequebook, $356 Balance on bank statement, $472 Service charge and other fees, $15 Interest earned on the account, $4 Total of outstanding cheques, $187 Deposits in transit, $60 $472 - $187 + $60 or $356 + $4 - $15 $345 is the reconciled balance. FINANCIAL PLANNING ACTIVITIES (p. 138) 1. Using the World Wide Web or library resources, obtain information about recent information about new developments in financial services. How have technology, changing economic conditions, and new legislation affected the types and availability of various saving and chequing financial services? This activity can provide insight into the changing nature and use of financial services in our society. 2. Research current economic conditions (interest rates, inflation) using The Financial Post, other library resources or the World Wide Web. Based on current economic conditions, what actions would you recommend to people who are saving and borrowing money? Have students obtain current interest rate information on commonly reported items (see text p. 117). Also, each month changes in the Consumer Price Index are reported in the news. Changes in interest rates and consumer prices will benefit savers when they are low, but higher interest rates will increase costs of borrowing. 3. Collect advertisements and promotional information from several financial institutions, or locate the Web sites of financial institutions such as The Bank of Montreal (www.bmo.com) and the TD Canada Trust (www.tdcanadatrust.com). Create a list of factors that a person might consider when comparing costs and benefits of various savings plans and chequing accounts. Advertising for financial services has expanded significantly over the past few years. Have students analyze these ads and Web sites in relation to the factors discussed in the chapter. 4. Survey several people to determine awareness and use of various financial services such as online banking, “smart cards”, and cheque-writing software. While faster and more efficient service is available with “smart cards”, major concerns relate to potential computer crime and invasion of privacy as organizations have expanded access to personal and financial data about consumers. 5. Using the Web site for the Credit Union Central of Canada (www.cucentral.ca) or other sources, obtain information about joining a credit union and the services offered by this type of financial institution. Credit unions can provide a valuable source for financial services. Encourage students to become aware of these organizations. 6. Collect advertisements from several financial institutions with information about the savings plans they offer. (You may do this using the Web sites of various financial institutions). Compare the features and potential earnings of two or three savings plan. Have students report on the information presented in advertisements and Web sites for savings plans. 7. Using library sources (such as The Financial Post and other current business periodicals) or Web sites (such as www.money.canoe.ca), prepare a summary of current rates of return for various savings accounts, term deposits and GICs, and Canada Savings Bonds. Student awareness of current interest rates can result in wiser financial decisions both in the shortterm and long-term. 8. Visit software retailers to obtain information of the features in various personal computer programs used for maintaining a chequing account. Information about programs such as Managing Your Money, Microsoft Money, and Quicken may be obtained on the Internet. More and more consumers are making use of cheque-writing software. Have students report on their experiences with these computer programs. LIFE SITUATION CASE (1) Chequing Out Financial Services (p. 139) 1. Which financial services are most important to Carla and Ed Johnson? Having separate chequing accounts and the convenience of 24-hour banking are most important to the Johnsons. By coordinating and comparing financial services, the Johnsons could probably save money on service fees while also increasing the level of their savings. 2. What efforts are the Johnsons currently making to assess their use of financial services in relation to their own financial activities? While the Johnsons have some information on the use, costs, and benefits of financial services, this effort has not been made in a systematic manner. They need to consider the need for financial services in relation to their overall financial goals. 3. How should the Johnsons assess their needs for financial services? On what basis should they compare financial services? They should investigate the services of their current financial institutions along with others. The comparison should include costs, fees, interest earnings, convenience (hours, location, electronic banking), minimum balance. The Johnsons could probably find a financial institution that would allow them to have separate chequing accounts while reducing their service charges and increasing the amount in savings. 4. What should the Johnsons do to improve their use of financial services? Student answers will vary, but they should be expressed in relation to costs, benefits, and financial goals. LIFE SITUATION CASE (2) Selecting Online Financial Services (p. 139) 1. What factors should Margo consider when comparing a “Web-only” bank and online banking with her current financial institution? Margo should consider the services available, fees and other charges, interest earned, Web site security, government regulations of the banks, and protection of privacy of her financial information. 2. Locate Web sites that Margo might use when considering the use of online banking? In addition to the Web sites of traditional banks and online-only banks, Margo should also search for information and assistance from sources such as personal finance magazines, government agencies, and consumer protection organizations. 3. What actions would you recommend for Margo? Answers will vary. Students should point out costs, convenience, privacy, and other factors related to the wise use of financial services. Solution Manual for Personal Finance Jack Kapoor, Les Dlabay, Robert J. Hughes, Arshad Ahmad 9780071320597, 9781259453144
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