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Case Study Marius Botha. This case study is based on the six-step financial planning process, which is also recommended by the Financial Planning Institute.

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Presentation on theme: "Case Study Marius Botha. This case study is based on the six-step financial planning process, which is also recommended by the Financial Planning Institute."— Presentation transcript:

1 Case Study Marius Botha

2 This case study is based on the six-step financial planning process, which is also recommended by the Financial Planning Institute of Southern Africa. David and Sarah Lee approach you to assist them with their financial planning. When you make recommendations, please use the assumptions and rates provided in Annexure 1. 2

3 Step 1 Establishing and Defining a Professional Relationship with your Client QUESTION 1 David is concerned about the continuity of your business and the lapsing of your FSB licence. Please advise him with regard to: 1.1 Under what circumstances your licence will/can lapse. (4) 1.2 What will the situation be should your licence lapse with regard to you being able to assist him with his financial planning? (1) 3

4 4 Step 2 Gathering the Client’s Information and Goals Note As all the information in this step is provided, no marks will be allocated for this step.

5 5 Family Structure David is 53 years old (date of birth: 1 January 1958). Sarah, his second wife, is 48 years old (date of birth: 14 January 1963). David and Sarah were married in 1992 (out of community of property, with the inclusion of the accrual system). This is the second marriage for both spouses. David has one child, Andy, (22) from his previous marriage and Sarah has one daughter, Jessica (21) from her previous marriage. They also have one child, Peter (17), born from their current marriage.

6 6 Andy works as an IT consultant. Jessica is a full time student and lives with David and Sarah. Peter is in Grade 12 and is a promising student. When David and Sarah got married in 1992, the CPI was 36,5. It is currently 133,5. In terms of their Ante Nuptial Contract, David’s estate was valued at R300 000 at date of marriage and Sarah’s estate was valued at R20 000.

7 7 Business Interests David and Jerry Roux (his cousin) own a wood furniture manufacturing business. They supply handmade quality furniture mainly to hotels and guest lodges. They bought the business in 1998 for a purchase price of R1 000 000. The business showed rapid growth in the first few years, but the recession has hit them hard and business is currently slow and uncertain.

8 8 The auditor values the business, Classic Creations (Pty) Ltd, at R5 000 000. David holds 60% of the shares and Jerry 40%. David and Jerry have a buy and sell agreement in place. Classic Creations (Pty) Ltd employs 11 staff members and one manager, Simon. The business is suffering because of low staff morale. The employees feel that they are not offered any employee benefits whilst the competitors are offering such benefits to their staff. With a potentially lucrative contract about to be signed, it is imperative that high productivity levels are sustained. They cannot afford to lose staff at this critical stage.

9 9 Assets: David Lee Primary Residence (see Note 1) 2 350 000 Flat (rented out) (see Note 2)600 000 Classic Creations (Pty) Ltd (60%) (see Note 3)3 000 000 Loan account (David Lee Family Trust) (see Note 4)2 300 000 Unit trusts100 000 Furniture and household effects100 000 Car250 000 Cash30 000 Total8 730 000

10 10 Liabilities: David Lee Bond on primary residence1 000 000 Overdraft120 000 Car200 000 Total1 320 000 Notes  The primary residence was bought in 2003 for a purchase price of R 750 000.  The flat was inherited from his father in 2011.  Classic Creations(Pty) Ltd (the entire company), was valued at R 3 000 000 on 1 October 2001.  The David Lee Family Trust holds shares in Funky Fashion (Pty) Ltd (see Question 3.3).

11 11 Policies David has two life policies on his own life:  Policy A: Life cover of R 1 000 000 payable to the estate.  Policy B: Life cover of R 800 000 payable to Sarah. David was previously employed at a large corporate institution and when he resigned (1998) he transferred his total provident fund benefit to a preservation fund. David does not want to sell his interest in Classic Creations (Pty) Ltd when he retires. He will retire at the age of 68. At retirement, David estimates that he will need an income of 70% of his salary. He will need the income for 10 years after retirement.

12 12 Assets: Sarah Lee Property (inherited)1 200 000 Car100 000 Cash Liabilities: Sarah Lee None 50 000

13 13 Inter Vivos Trust The David Lee Family Trust was formed in 1996. David, Sarah and their accountant are the current trustees. The income beneficiaries and capital beneficiaries are David, Sarah and their descendants.

14 14 Last Will and Testament David bequeaths the primary residence and the household effects and furniture to Sarah. The residue is bequeathed to his sons in equal shares. He is very fond of Sarah’s daughter and thinks of her as his own. David believes that she will inherit from her own father, but he still wants to leave her something. In his will, he bequeaths his retirement fund benefit to her. Sarah bequeaths her entire estate to David.

15 15 Salary:David45 000 Rental Income:David Sarah Interest: David Sarah Dividends:David 3 000 7 000 800 150 200 BondDavid10 000 Car David6 000 Life InsuranceDavid4 000 Education costDavid6 000 Household expensesDavid and Sarah18 000 Overdraft interestDavid1 200 Fuel David and Sarah3 000 Entertainment/vacationsDavid and Sarah4 000 56 15052 200 Monthly Income and Expenses: David and Sarah

16 16 Step 3 Analysing and Evaluating the Client’s Financial Status

17 17 Step 4 Develop the Financial Planning Recommendations and present them to the Client

18 18 QUESTION 2 Question 2.1 Accept that David passes away today. David requests that you calculate the following at his death: 2.1.1Accrual claim (8) 2.1.2Capital gains tax (4) 2.1.3Estate duty. (4) Assume that the last expenses and master’s fee amount to R60 000. (16)

19 19 Question 2.2 Analyse the liquidity of his estate and make recommendations, if necessary. Show all your calculations and the cost implications of your recommendations. (4)

20 20 QUESTION 3 Question 3.1 David and Sarah’s son, Peter, is going to University in 2012. He wants to complete BComm, LLB at Stellenbosch (5 years). Assume that university fees for 2012 will amount to R30 000 per annum and are expected to increase by 6% per annum. David wants to utilize the unit trust investment for the university fees. He believes that growth of 7% can be earned. David requests you to calculate the total education cost as a lump sum to establish whether the investment value of the unit trust at this time (today) will be sufficient to cover the fees. (4)

21 21 Question 3.2 David’s Unit Trust portfolio is invested in two Old Mutual Unit Trust funds: Old Mutual Enhanced Income Fund and Old Mutual Financial Services Fund. David is a moderate investor. 3.2.1 He wants you to review the attached fund fact sheets and advise him whether the funds are suitable for him, considering his risk profile, but ignoring the fact that his son will go to university next year. (4) 3.2.2 He also wants to know how the costs of the funds compare, what are included and excluded from the total expense ratio (TER) and whether lower costs are an indication of a superior product. Advise him on these matters.(10)

22 22 Question 3.3 David and his sister, Caroline Steward, operate a business, Funky Fashion (Pty) Ltd. On the advice of their tax specialist, they transferred their shareholding in the business to their respective Inter Vivos Trusts on loan account (non-interest bearing). On the death of Caroline, the shares held by the Caroline Steward Trust must be bought by the David Lee Family Trust and on the death of David, The Caroline Steward Family Trust must purchase the shares held by the David Lee Family Trust. They approach you regarding a buy and sell agreement that will be funded by life insurance policies on the life of David and Caroline.

23 23 They have asked you to explain the following to them: 3.3.1 What requirements have to be met in order to ensure that the policies that are used for buy and sell structures, are exempt from estate duty? (3) 3.3.2 Will the policies that David and Caroline intend to make use of be exempt from estate duty? Please motivate your answer. (4) 3.3.3 How should the policies be structured in order to ensure that they will meet the purpose of the buy and sell agreement? (3) (10)

24 24 Question 3.4 David is revising his will and wants to bequeath the loan account to the trust. This bequest will avoid the trust having to repay the amount when he dies. He seeks your advice regarding the tax implications of the bequest, as well as alternative suggestions that will enable him to make an informed and tax effective decision. (8)

25 25 Question 3.5 Simon, the manager, has resigned with effect of the end of the previous month. A restraint of trade agreement was in place to protect the business against this eventuality. David is unsure of the tax implications for the company and for Simon, and seeks your assistance. Please explain the current tax position for both parties with regard to the restraint of trade position.(6)

26 26 Question 3.6 After Simon left, staff satisfaction levels dropped to an all-time low. Research made it clear that the staff want the company to implement a preferred compensation scheme. 3.6.1 David wants you to explain how the plan works and whether it will be appropriate for all the employees of the business. (4) 3.6.2 Are there any alternative retirement structures that they should consider, and why would you regard the suggested alternatives as appropriate? (2) (6)

27 27 Question 3.7 Sarah is a home-executive. She occasionally helps out at the business by doing the bookkeeping and rendering general secretarial assistance as and when needed. David wants to transfer the flat, which is currently being rented out, to Sarah as she has a more advantageous income tax rate. This, he believes, will result in a meaningful saving. Advise David on his intended transfer with regard to the donations tax and income tax implications? (4)

28 28 Question 3.8 The business is currently under financial pressure, but they are about to enter into a lucrative contract to manufacture furniture for a new hotel. The business approached the Bank to provide funding. The funding will be approved, but only if David signs an unlimited personal surety. David wants to protect his personal estate. He does not want to leave his wife and children destitute. What measures can be instituted to protect David’s personal estate? (3)

29 29 Question 3.9 David heard that nominating a beneficiary on a life policy will protect the proceeds from attachment in case he dies, leaving an insolvent estate. He wants to know whether this is true. Explain it to him with reference to authority. (5) (56)

30 30 QUESTION 4 Question 4.1 David is classified as a moderate investor. His retirement fund benefit is invested in a Balanced Fund with a spread of 50% equity, 20% bonds, 10% property and 20% cash. The returns (with standard deviation in brackets) on the different asset classes are: Equity:8%(13,5%) Bonds:5%(9,5%) Property:4%(7%) Cash:6%(2%) 4.1.1 Give a brief description of the risk appetite and proposed investment spread for a moderate investor. (2) 4.1.2 Calculate the average return of the balanced fund. (2) (4)

31 31 Question 4.2 David consults you on the bequest of his retirement preservation benefit to Jessica. He wants you to confirm that the benefit will be paid to Jessica. Advise him on the legal position and if Jessica will be entitled to any benefits. (4)

32 32 Question 4.3 David wants to focus on his retirement planning. He requests you to do a calculation to show if he has sufficiently provided for retirement. He asks you to ignore the business for retirement purposes. Assume an inflation rate of 6% and that the net growth of investments amount to 7%.(4)

33 33 Question 4.4 Calculate the maximum amount that David can contribute towards a retirement annuity fund in order to make use of the full allowable income tax deduction. (2) (14)

34 34 Step 5 Implementation of your Recommendations QUESTION 5 David is concerned that he will not be able to afford the recommendations that you made. In light of his current income and expenses please advise him whether he can afford to implement your recommendations, taking into consideration that Peter is going to university next year which will increase his monthly expenditure. lf not, what do you suggest in this regard? (2)

35 35 Step 6 Review and Monitor QUESTION 6 One of your clients wants to terminate the business relationship with you with immediate effect. What are your obligations as a financial services provider, in terms of the Financial Advisory and Intermediary Services Act 37 of 2002, General Code of Conduct, if your client makes this request? (3) TOTAL: 100

36 36 Annexure 1 Should the details prove insufficient, you may make the necessary assumptions, provided that:  You indicate that you have made an assumption;  You give reasons for the assumption;  The assumption/s are in line with the facts, needs and preferences of your clients.  In respect of any investment product that you recommend, use the growth rate of 7%  For any life cover or dread disease cover recommended, use the following premium rates per R 10 000: David R 10,00 pm; Sarah R6,00 pm.  Any lump sum disability cover recommended, use the following premium rates per R 10 000: David R5,00 pm.  For any income protector recommended, use the following premium rates per R10 000: David R500,00 pm.

37 37 Answer to Question 2.1.1 David=300 000÷36.5  133.5=R1 097 260 Sarah=20 000÷36.5  133.5=R73 151  The inflation adjusted values of the estates at date of marriage are as follows:

38 38  The current values of their respective estates and the accruals are: Answer to Question 2.1.1 David Sarah Assets8 730 000 1 350 000 Plus: Policy payable to estate1 000 000 0 9 730 000 1 350 000 Less: Inheritance during the marriage600 000 1 200 000 9 130 000 150 000 Less: Liabilities1 320 000 0 7 810 000 150 000 Less: Values at marriage (inflation adjusted)1 097 260 73 151 Accruals6 712 740 76 849

39 39 Note. The paper does not state whether the property inherited by Sarah was inherited during the marriage or before the marriage was concluded. It is assumed for the purpose of this exercise that it was inherited during the marriage. It is consequently excluded from the accrual. Capital gains tax payable on the death of David has not been taken into account for the purposes of the accrual calculation. There seems to be different points of view in this regard. As David’s estate shows a bigger accrual than that of Sarah she will have the following claim against his estate: Answer to Question 2.1.1 (6 712 740 – 76 849)÷ 2=R3 317 946

40 40 Base cost of Classic Creations i. MV on 1 October 2001 was R1 800 000 ii. 20% of (proceeds minus post VDV expenses) is R600 000 (20% of R3 000 000), or iii. TABC = R600 000 + [3 ÷ 14 (R3 000 000 – R600 000)] = R1 114 286 R1 800 000 is the biggest and thus selected as VDV. Answer to Question 2.1.2

41 41 Answer to Question 2.1.2 AssetProceedsBase costExclusion/ roll-over Gain/Loss Primary residence Roll-over0 Flat600 000 00 Classic Creations (Pty) Ltd 3 000 0001 800 000 1 200 000 Loan Account Trust2 300 000 00 Unit trusts100 000 00 Car Personal use0 Capital gain 1 200 000 Less: Annual exclusion 300 000 Aggregate capital gain 900 000 Taxable capital gain 300 000 Capital gains tax (one-third) R120 000

42 42 No estate duty is payable. Note on section 4(q) deduction. It is the total of the primary residence, household effects and furniture and policy of R800 000). Property (given) 8 730 000 Deemed Property – Policy A – payable to his estate1 000 000 – Policy B – payable to his spouse800 000 1 800 000 Total value of estate 10 530 000 Less Deductions Master’s fee and last expenses (given)60 000 Liabilities1 320 000 Capital gains tax120 000 Executor’s remuneration (0.0399  R9 730 000) 388 227 Accrual claim [section 4(lA)}3 317 946 Accrual to spouse [section 4(q)] – (see note)3 250 000 8 456 173 Net Estate 2 073 827 Less: Section 4A 3 500 000 Dutiable estate zero

43 43 There will be no cash shortfall so no recommendation needs to be made. There is a big surplus. The question is to calculate whether there will be sufficient cash in David’s estate to pay all liabilities and expenses. Cash available in the estate should David die. Proceeds of shares sold (buy-and-sell agreement)3 000 000 Policy proceeds to estate1 000 000 Cash30 000 Total cash on death4 030 000 The following cash is needed on David’s death Master’s fee and last expenses (given)60 000 Liabilities1 320 000 Executor’s remuneration (0.0399  R9 730 000) 388 227 Capital gains tax120 000 Total cash needed1 888 227

44 44 One must calculate the lump sum that he must invest at the beginning of 2012 that will allow him to make annual withdrawals starting with R30 000 in beginning of 2012 and that increases by 6% per annum whilst the fund in which it is invested will grow by 7% per annum. This amount must be compared to the current value of his unit trust investment (R100 000). Resultant rate (% change) = (7 – 6) ÷ 1.06 = 0.9434% Answer to Question 3.1 Begin mode and 1 P/YR 30 000PMT 5N 0.9434I/Yr PV147 222 As the amount calculated above is greater than the current value of his unit trust funds, the unit trust funds will not be sufficient to pay the university fees for the 5 year course.

45 45  Company products involved so not discussed Answer to Questions 3.2.1 and 3.2.2

46 46 Answer to Question 3.3.1 1.To qualify for the exclusion, the policy must have been taken out or acquired by a person who was the partner (co- shareholder/co-member) of the deceased as at date of his death 2.On the date of death of the deceased the person who acquired the policy must have been a partner of the deceased, or have held any share or like interest in a company in which the deceased on that date held any share or like interest. 3.The purpose of the policy must be to enable that person to acquire the whole or part of the deceased’s interest in the partnership or the deceased’s share or like interest in that company and any claim by the deceased against that company. 4.No premiums on the policy were paid or borne by the deceased.

47 47  For the exclusion to apply, it is a requirement in terms of section 3(3)(a)(iA) of the Estate Duty Act that the person who took out the policy (the trustee of the Caroline Steward Family Trust), as well as the deceased (the person whose life has been insured – David the trustee of the David Lee Family Trust) hold a share in the company as at date of death of the deceased.  In this case, David (the deceased and trustee of the David Lee Family Trust), does not hold a share in Funky Fashion (Pty) Ltd as his shares has been transferred to his family trust. Answer to Question 3.3.2

48 48 Answer to Question 3.3.3  The two trusts should enter into a buy-and-sell agreement in terms of which the David Lee Family Trust agrees to sell the shares that it owns in Funky Fashions (Pty) Ltd to the Caroline Steward Family Trust on David’s death and in terms of which the Caroline Steward Family Trust agrees to buy such shares from the David Lee Family Trust. Also vice versa.  The David Lee Family Trust should take out a policy on the life of Caroline and the Caroline Steward Family Trust should take out a policy on the life of David  As both policies will be dutiable the amount insured for must include the estate duty. The amount needed must be divided by 0.80.

49 49 Answer to Question 3.4  In ITC 1793 there was a bequest of loan to trust. Court ruled that paragraph 12(5) of Eighth Schedule applies.  In ITC 1835 loan was part of residue that was a bequeathed to trust. Court ruled that paragraph 12(5) of Eighth Schedule did not apply as it was not the intention of the testator to discharge the debt.

50 50 Answer to Question 3.4 From SARS Comprehensive Guide to CGT.  Were it not for paragraph 12(5), the discharge of a debt by a creditor would have no CGT implications for the debtor. After all, the debt owed is a liability, not an asset, and without an asset CGT cannot be imposed. In order to subject the debtor to CGT, paragraph 12(5)(b) creates the following four things in the hands of the debtor: Asset: The debtor is deemed to have acquired a claim to the debt reduced or discharged. Base cost: The base cost of the asset is deemed to be nil. Proceeds: The proceeds are determined as follows:

51 51 o If the debtor paid nothing – the amount discharged or reduced. o If the debtor paid something – the difference between the amount paid and the amount discharged or reduced. Disposal: The claim acquired by the debtor is deemed to be disposed of.  In other words, the debtor will have a capital gain equal to the amount of the debt that has been discharged or reduced less any amount paid to the creditor.

52 52 Answer to Question 3.4 From SARS Comprehensive Guide to CGT. It has been suggested that the problem encountered in ITC 1793 can be circumvented by the deceased to leaving cash or other assets to the heir, which can be used by the heir to repay the debt due. Whether such a strategy would succeed will depend on the facts of each case. No doubt the intention of the parties concerning repayment of the debt during the deceased’s lifetime will be a relevant factor. A loan made without any expectation of repayment may be regarded as a donation in disguise.  CGT inclusion rate for trust is 50%.  CGT would be R2 300 000  0.66667  0.4 = R613 333.  He can bequeath the loan account to somebody else.  The trust can insure his life to redeem loan in the event of his death.

53 53 Answer to Question 3.5 The recipient (Simon the manager)  The payment is included in his gross income [paragraph (cA) of the definition in gross income]. For the payer (the company)  The restraint payment is deductible by the company as Simon is a natural person and the amount is included in Simon’s income.  The amount to be deducted may not exceed in any year of assessment the lesser of  so much of the amount incurred as is equal to the amount divided by the number of years or part thereof during which the restraint of trade will apply; or  one-third of the amount incurred.  Section 23(l) prohibits a restraint of trade payment as a deduction but not if it qualifies under section 11(cA).

54 54 Answer to Question 3.6.1  Preferred compensation is not a retirement vehicle but a vehicle used for the retention of the services of key employees. It is not a requirement that all participants must be key employees. Employer and employee to enter into agreement. Employee to take out endowment policy on his life and cede it as security to employer. Employer increases salary of employee for an amount equal to policy premium plus tax attracted (e.g. 10 000 ÷ 0,6 = R16 667. Employer to cancel security cession if employee still in his employ after a stated period (maturity). Increased salary amount tax deductible by employer [section 11(a)]. Policy pay-out to employee tax-free. Answer to Question 3.6

55 55  A pension or provident fund would be more appropriate.  In the case of a pension fund it will provide the employee with a tax deduction in respect of the contributions. Answer to Question 3.6.2

56 56 Answer to Question 3.7  There is no indication that the transfer of the flat is remuneration for the services that she renders at the company. In fact it cannot be, as if it were to be the case, such remuneration would be paid by the company and not from the private assets of her husband. The fact that she does work for the company is ignored. The donation between spouses is exempt from donations tax. The rental income will be included in the income of the donor spouse, David [section 7(2)]. Only if the sole or main purpose of donation is the reduction, postponement or avoidance of the donor’s liability for any tax etc. under the Income Tax Act or any Act administered by SARS.

57 57  The company can take out a policy for the life of David.  David and the company to enter into an agreement that in the event of David’s death the company will use the proceeds of the policy for no other purpose than to redeem the bank loan.  This means that the bank will not have to recover such loan from David’s estate.  The policy proceeds (less premiums plus 6% interest) will be dutiable. The sum insured must cover the value of the outstanding loan plus the estate duty thereon.  The premium not tax deductible and proceeds not subject to income tax. Answer to Question 3.8

58 58 Answer to Question 3.9  In Pieterse v Shrosbree N O and Others; Shrosbree N O v Love and Others 2005(1) SA 309 SCA held that A beneficiary nomination is a stipulatio alteri and on acceptance of the benefit by the nominee it is payable to the nominee and not part of the insolvent estate. Section 63 of the Long-term Insurance Act contains no provision that purports to divert the policy proceeds to the insolvent estate. If David should be declared insolvent before his death the trustees of his insolvent estate will be entitled to cancel the beneficiary nomination so that the policy will be included in his insolvent estate. Certain dispositions by a person prior to sequestration can be set aside by court. Not discussed in Shrosbree.

59 59 From Handbook page 725. The moderate investor is looking for both income and growth. The equity content dominates the bonds and cash content. The portfolio, however, would tend to be less volatile than the market as a whole. Equities55% Gilts 35% Cash 10% Answer to Question 4.1.1

60 60 Answer to Question 4.1.2  The average return on the balanced fund is calculated as follows (easiest method): 50at8%=4 20at5%=1 10at4%=0,4 20at6%=1,2 6,6%

61 61 Answer to Question 4.2  Retirement benefits do not form part of the estate of the member on death (section 37C). Cannot bequeath.  As he will be survived by dependants the trustees will have the discretion to make an equitable distribution between such dependants.  In terms of the definition of dependant a person that the deceased member did in fact maintain is also a dependant. If he maintains her she is a dependant.  Once he retires he can nominate her as beneficiary to the living annuity. Section 37C will not apply and she will then receive the benefit.

62 62 Answer to Question 4.3 R45 000  12 =R540 000 70% of R540 000=R378 000 378 000PV 15N 6I/YR FV905 899 Then 7 – 6=1 1 ÷ 1,06=0,9434%

63 63 Answer to Question 4.3 905 899PMT 10N 0,9434I/YR PVR8 687 344 The capital needed is R8 687 344 One cannot calculate whether it is sufficient as retirement fund value is not given.

64 64 15% of (taxable salary plus rental income). (R540 000 + R36 000)  0.15=R86 400 p. a R7 200 per month. Answer to Question 4.4

65 65 Answer to Question 5  No life insurance was recommended as there was no shortfall.  The only recommendation is a contribution to an RA fund. His disposable monthly income is R3 950 (R56 150 – R52 200). He should therefore restrict his contribution to what he can afford. David currently pays education costs of R6 000 per month for Peter. This (R72 000 per year) is less than the university fees for 2012. David will probably not even have to use the unit trust funds for education purposes. David has nothing to be concerned about.

66 66 Answer to Question 6  Paragraph 20 General Code of Conduct  An FSP, subject to contractual obligations, must give immediate effect to a request of a client who wishes to terminate any agreement with the provider relating to a financial product or advice (page 111; The FAIS ACT Explained; Hattingh and Millard).

67 67 Dismantling Deferred Compensation  Employer’s tax position  Employee’s tax position  Value forfeited by employee  Future premiums  Surrender  Paid-up  Agreement

68 68  Future tax position of employer  Future Tax position of employee  Is the employee receiving the same value?

69 69 The END Thank you

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