Free CFA Level III: Private Wealth Wealth Planning Practice Questions

B is correct. The funded ratio (or funding ratio) is a key metric in goals-based financial planning that compares the client's current total assets to the present value of all identified financial goals. A funded ratio above 1.0 means the client has more assets than needed to fund all goals (assuming the expected return is achieved), while a ratio below 1.0 indicates a potential shortfall. This metric provides a clear, intuitive measure of overall financial health.

A is incorrect. The ratio of annual income to annual expenses describes a budget surplus/deficit or savings rate, not a funded ratio. The funded ratio is a balance-sheet comparison of total assets to total goal requirements.

C is incorrect. The ratio of tax-deferred to taxable assets describes the tax diversification of the portfolio, not the overall funding status relative to goals.

A is correct. A private foundation provides the donor with maximum control over charitable activities, including full control over grantmaking decisions (which organizations receive funding, how much, and when), investment management of foundation assets (choosing managers, asset allocation), and the ability to employ family members as foundation staff (subject to reasonable compensation rules). This level of control is significantly greater than what a DAF allows.

B is incorrect. Private foundations have substantially higher administrative costs and regulatory burden than DAFs. Foundations must file annual tax returns (Form 990-PF), comply with rules against self-dealing, meet minimum annual distribution requirements (5% of assets), and may need to hire legal and accounting professionals. DAFs are administered by sponsoring organizations that handle most administrative functions.

C is incorrect. DAFs actually offer higher income tax deduction limits than private foundations. Contributions to DAFs (through a public charity sponsor) are deductible up to 60% of AGI for cash and 30% for appreciated property, versus 30% of AGI for cash and 20% for appreciated property contributed to private foundations.

A is correct. The decision requires comparing after-tax figures: if mortgage interest is deductible, the after-tax cost may be approximately 2.5% (at a 28% marginal rate), while the after-tax investment return depends on the tax efficiency of the portfolio. Beyond the mathematical comparison, holistic planning considers: (1) liquidity — paying off the mortgage reduces cash reserves; (2) risk tolerance — the investment return is uncertain while the mortgage cost is fixed; (3) psychological comfort — some clients experience significant stress from carrying debt regardless of the financial mathematics; and (4) other financial priorities that may compete for the funds.

Choice B is incorrect because not all debt is harmful — low-cost, tax-deductible debt secured by an appreciating asset (a home) can be a rational financing tool. Paying off low-rate debt with funds that could earn a higher return may reduce long-term wealth.

Choice C is incorrect because expected returns do not reliably exceed borrowing costs in all environments, and even when they do in expectation, the investment outcome is uncertain. A client who invests instead of paying off the mortgage bears investment risk that may result in losses while the mortgage obligation is fixed and certain.