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Personal
Financial Planning--Case Study For Financial Planners
Developing
Plan
Introduction
You have scheduled
a series of appointments with the Greens to go over the different
areas of personal financial planning. For each area you will help
the Greens identify gaps in their current plans, examine alternatives
for closing the gaps and create an action plan that provides them
with solutions. The Greens need financial counseling on:
- Income
Taxes
- Retirement
Planning
- Risk Management
- Investment
Planning
- Stock Options
- Estate Planning
- Education
Funding
Click an area
to begin counseling the Greens.
Income
Taxes
It is near the
end of the tax year and the Greens have come to your office for
a meeting to get some advice on how to handle their taxes. Based
on the information you gathered and your previous discussions with
the Greens, you know their income tax planning goals are the following:
- Shelter some
of Debbie's business income from income taxes.
- Increase
itemized deductions to further reduce taxes and improve cash flow.
- Reduce taxes
on investments.
- Use a $31,000
capital loss carried forward from last year.
- Reduce tax
payments and not pay any penalties (they had a refund of $9,300
last year).
- Pay for
the college educations of Cassidy, David, and Rebecca and shift
assets and/or cash to them so the interest will be taxed at their
rates.
Determining
Alternatives (Note: This is a Flash file.)
What alternatives
can the Greens use to meet their income tax goals? Here are a few
things you may suggest to them. Click an alternative to see how
it can help the Greens.
Debbie
can open a profit sharing Keogh
With
a profit sharing Keogh, Debbie has the flexibility to determine
each year the percentage of net income to contribute. However, the
maximum percentage of compensation that Debbie may contribute is
only 15%.
The
Greens can take out a home equity line of credit to pay off the
credit card debts and use the interest on the loan as a deduction.
By
taking out a home equity line of credit to pay off the credit card
debts, the Greens would reduce their taxes and increase their cash
flow. They can then use the extra cash for other purposes such as
investing for retirement or education planning. Home equity lines
of credit up to $100,000 may be deductible and this makes the effective
interest rate even lower. The interest rate on the home equity line
of credit is probably 50% less than the rate on the credit cards.
The
Greens could gift stock to charity instead of using the $15,000
cash now.
The
Greens could donate some of the ABC shares accumulated through the
exercise Paul’s stock options. These shares have a low basis
and high appreciation and have been held for over one year. This
strategy would satisfy a number of goals:
- Provide diversification
out of ABC stock
- Avoid the
capital gains tax on the sale of the shares
- Provide
an income tax deduction for the full market value of ABC stock
- Free up
cash they would otherwise give to charity. This could be used
to pay down their debt or invest for their children’ education
Paul
could decrease his income tax withholding in order to increase the
couple's monthly cash flow and reduce their refund.
Debbie
and Paul need to have enough withholding and estimated payment to
cover 90% of the current years liability or 108.6% of last years
liability. Decreasing Paul’s withholding would increase their
monthly cash flow. This extra money could then be invested for other
goals
The
Greens could change their investment mix to reduce tax liability
on investments.
Investing
in mutual funds or with money managers emphasize long-term capital
gains will allow their future gains to be taxed at 20% vs. 39.6%
for the Greens ordinary income.
The
Greens could shift their taxable savings account and checking account
to free money market funds.
Since
the Greens are in the 39.6bracket, they should invest in free money
market accounts versus taxable accounts. By shifting these accounts
the interest will be tax free, and they will save approximately
$1,200 in taxes.
The
Greens could use the flexible spending account available at
ABC corporation to fund their medical expenses.
In
reviewing the Green’s income tax return you noticed that they
have medical expenses on Schedule A. If they participate in ABCs
flexible spending plan, they can improve their cash flow. With $1,000
in medical expenses, the Greens could put $1,000 into this plan
on a pretax basis. Since they are in the 39.6% tax bracket, this
would actually decrease their taxes by about $400 per year, which
could be used to fund other goals.
The
Greens could sell some of the winners in their portfolio to
take advantage of the $31,000 loss carried forward from last year.
This
loss carryforward can allow Deborah and Paul to recognize $31,000
of capital gains this year without paying ANY additional taxes.
This is a great opportunity to sell some winners in their account
and recognize some or all of the profit income free.
Prioritizing
Alternatives
Here are the
alternatives that Deborah and Paul want to pursue. Based on the
goals described previously in this lesson, prioritize these alternatives.
To prioritize the alternatives, move your cursor over an alternative.
(Note: This is a Flash file.)
Alternative
No. 3
Debbie can open a Keogh account.
Alternative
No. 1
Take out a home
equity line of credit to pay off the credit card debt and use the
interest on the loan as a deduction.
Alternative
No. 5
Gift stock to
charity versus the $15,000 cash being used now.
Alternative
No. 2
To reduce their
refund and increase their monthly cash flow, decrease Paul's withholding.
Alternative
No. 8
Change their
investment mix to reduce tax liability on investments.
Alternative
No. 4
Shift the taxable
savings account and checking account to tax-free money market funds.
Alternative
No. 6
Use the flexible
spending account available at ABC Corporation to fund medical expenses.
Alternative
No. 7
To take advantage
of the $31,000 loss carried forward from last year, the Greens can
sell some of the winners in their portfolio.
Creating
an Action Plan (Note: This is a Flash file.)
Based on the
goals and possible alternatives already identified, here is an action
plan for the Jones. To review the plan with the Greens, think about
the Greens' reactions. Click to learn their actual reactions. The
Jones will tell you which items they want to pursue.
The Greens
can contact a mortgage broker to start the process of setting
up a home equity line of credit with a low interest rate to pay
off the credit card debts and use the interest on the loan as a
deduction. This will be completed within the next week
Paul's
reaction: This will be very helpful. The interest rate
on our credit card is averaging 24%. The equity line of credit will
give us a lower interest rate and the interest will be tax deductible.
Paul can
decrease his income tax withholding. This will increae their
monthly cash flow and reduce their income tax refund. Paul will
submit a new W-4 to his payroll department this week.
Paul's
reaction: This reduction in my withholding will give us
the extra cash we need each month to increase our savings for retirement.
Debbie can
open a Keogh account. You offer to mail a Keogh account application
to Debbie by the end of the week.
Debbie's
reaction: Since we don’t really use this money to
cover our expenses, it would be nice to shelter this money from
tax and save the money for our retirement
The Greens
can shift their taxable savings account and checking account
funds to free money market funds. You offer to send the Jones an
application for a Municipal Bond Money Market Fund by the end of
the week.
Paul'
reaction: I would be nice to shelter the income from these
accounts. This will help to reduce our taxes.
The Greens
can gift stock to charity vs. using the $15,000 cash now. You
can assist the Greens by transferring their existing certificates
into a brokerage account, so when they want to make the donation,
the shares can be electronically wired to the charity.
Debbie's
reaction: I like this because we were going to sell the
ABC stock anyway. This allows us to avoid capital gains tax and
free up $15,000 of cash that we can invest elsewhere.
Question
The Jones would
like to reduce their taxes by increasing their itemized deductions.
One of their goals is to improve their cash flow.
Which of the
following would you suggest to Debbie and Paul to decrease taxes
and increase cash flow?
A. Take out
a home equity line of credit to pay off the credit card debts
B. Pay more
in medical expenses to get the benefit of their deductibility
C. Prepay the
mortgage payments
D. Prepay their
property taxes
Answers:
A. You are correct.
Taking out a HELOC would help Debbie and Paul BOTH reduce their
taxes and increase their cash flow. The interest rate on the home
equity line of credit is probably 50less than the rate on the credit
cards. Additionally, they take out a home equity line of credit
up to $100,000; the interest will be deductible, making the effective
interest rate even lower. This will increase their cash flow and
this extra cash can be used for other purposes such as investing
for retirement or education planning.
B. You are incorrect.
On their cash flow you can see the only have $2,000 of medical expenses.
This is not even close to 7.5of their AGI ($28,565). Therefore,
even if they prepaid some medical expenses, they would probably
not get any benefit. Taking out a HELOC would help Debbie and Paul
BOTH reduce their taxes and increase their cash flow. The interest
rate on the home equity line of credit is probably 50less than the
rate on the credit cards. Additionally, they take out a home equity
line of credit up to $100,000; the interest will be deductible,
making the effective interest rate even lower.
C. You are incorrect.
This would reduce their taxes but not help their . Taking out a
HELOC would help Debbie and Paul BOTH reduce their taxes and increase
their cash flow. The interest rate on the home equity line of credit
is probably 50less than the rate on the credit cards. Additionally,
they take out a home equity line of credit up to $100,000, the interest
will be deductible, making the effective interest rate even lower.
D. You are incorrect.
This would reduce their taxes but not help their cash flow. Taking
out a HELOC would help Debbie and Paul BOTH reduce their taxes and
increase their cash flow. The interest rate on the home equity line
of credit is probably 50less than the rate on the credit cards.
Additionally, they take out a home equity line of credit up to $100,000,
the interest will be deductible, making the effective interest rate
even lower.
Developing
a Plan
The Greens have
come to your office for a meeting. They would like to begin the
process of developing a retirement plan.
After reviewing
the Greens' financial information, identifying their financial goals,
and analyzing their available resources, you made some calculations
and determined the Greens do not have enough resources to meet their
retirement goals.
The resources
that the Greens can use for retirement income are their 401(k) plans,
IRAs, Social Security, Paul's pension, and the GHI brokerage account.
They will use their ABC stock options and ABC Corporation stock
for retirement income and education funding.
Click here
to
see the Greens' Retirement Planning Calculations. (Note: Link to
calculations.
Click the links
below to go through the process of developing a plan.
Determine
alternatives
Prioritize
alternatives
Create an
action plan
Retirement
Planning Calculations
What will the
Greens sources of income be worth at retirement? Assuming Paul's
investments earn 9.9 percent per year, Paul continues contributing
to his current 401(k), and Social Security benefits are not adjusted
for inflation, each of these will be worth:
According to
the calculations, the present value of their shortfall, expressed
as a lump sum, is roughly $3.1 million.
Determining
Alternatives
The Greens would
like your assistance in developing a plan to close the $3.1 million
gap. You point out to the Greens that they can look at a number
of factors. Click an alternative to see what how it could benefit
the family.
Alternative
1: Invest more in the GHI account
Alternative
2: Invest more in the Keogh plan and earn more
Alternative
3: Retire at a later age
Alternative
4: Spend less money in retirement
Alternative
5: Increase the monthly mortgage principal payments to pay off the
mortgage earlier
Alternative
6: Work part time during retirement
Alternative
7: Reduce current expenses so they can save more for retirement
Alternative
1
Here is what
will happen to the GHI account if Paul and Debbie add the following
amounts each month until age 55:
$2,000: By
adding $2,000 per month, the account will increase to $1,260,000.
$3,000: By
adding $3,000 per month, the account will increase to $1,500,000.
$4,000: By
adding $4,000 per month, the account will increase to $1,760,000.
This will close the gap from $3.1 million to $2.1 million.
Alternative
2
If Debbie puts
$10,000 per year into a Keogh plan until Paul retires at 55, it
could be worth roughly $200,000 at retirement.
However, Debbie
and Paul will need to earn 9.9 percent on these investments (and
their other retirement assets) to reach this goal.
This will close
the gap to roughly $1.9 million.
Prioritizing
Alternatives (Note: Flash File)
The Greens have
decided to pursue four out of the six alternatives. Based on the
goals described previously in this lesson, prioritize these alternatives.
Move your cursor
over an alternative to see the Greens' priority:
#1 Save more
money in their brokerage account and Keogh.
#2 Earn higher
investment returns on the brokerage account and Keogh.
#3 Reduce expenses
during retirement.
#4 Retire later.
Creating
an Action Plan
The Greens have
agreed on the changes they will make in their retirement assumptions
and goals. They need to develop an action plan to help close the
gap in their retirement plan.
(Note: Graphic
- boxes for each set. User moves mouse over each item to learn the
family's reactions.)
A. What? Save
more money in the brokerage account and Keogh.
B. When? Within
the next three to six months
C. Who? Paul
and Debbie, with the assistance of their financial advisor
D. Debbie: "It
looks like we should start an automatic investment plan to save
$4,000 per month into our brokerage account. I will also start putting
$10,000 into a Keogh each year."
- What? Review
current investments and determine what changes should be made
to earn a higher rate of return.
- When? Within
the next month
- Who? Paul
and Debbie, with assistance from their financial advisor
Debbie: "We
would like your assistance in reviewing our investments in the Oldco
401(k) plan and the GHI brokerage account. We would like to being
a program to reallocate these investments according to our plan.
- What? Review
current cash flow and determine which expenses can be reduced
in retirement.
- When? Within
the next three months
- Who? Paul
and Debbie
Paul: "I
would rather cut back on our expenses during retirement than limit
our lifestyle today. For example, I do not want to give up our weekly
lawn service today, but in retirement, I would be willing to do
the yard work myself.
- What? Consider
the possible need to work beyond desired retirement age.
- When? Over
the next several years
- Who? Paul
and Debbie
Paul: "It
looks like I might have to work one or two years after age 55. I
will want to continue to monitor this as I get closer to retirement,
and as we update our plan."
Question
In developing
their retirement plan, Paul indicates he would like to do something
with his old 401(k) plan to make sure it is more diversified. Which
of the following statements is true regarding what Paul can do with
the Oldco 401(k)?
A. IRS rules
do not allow a person to roll over a 401(k) plan to another 401(k)
plan.
B. He can roll
the 401(k) to his current IRA or to a rollover IRA.
C. Paul could
start withdrawing money from the Oldco 401(k) today without penalty,
because he has separated from service from the prior company.
Correct Answer:
B. He can roll
the 401(k) to his current IRA or to a rollover IRA. After an employee
has separated from service, he has the option to roll over this
money to an established IRA or to a new IRA.
Risk
Management
Paul and Deborah
have just started to review their insurance needs, and they have
come to your office to get some advice on risk management. You have
gone through the four steps of the risk management process:
- Step 1: Quantify
the risk.
- Step 2: Analyze
the resources available to cover those risks.
- Step 3: Determine
the need for insurance.
- Step 4: Select
an appropriate insurance product.
You have already
gone through the process of quantifying the risks to the Greens.
Based on your analysis and your previous discussions with the Greens,
you know their risk management goals:
- In case of
Paul's death, Debbie should be able to maintain her current standard
of living for the rest of her life.
- In the case
of Paul's death, enough funds should be available to cover the
children's expenses and pay for the children's college.
- In the case
of Debbie's death, enough money should be available to provide
child care until the children turn 18.
- Provide long-term
disability insurance in case of long-term illness (Paul's family
has a history of multiple sclerosis).
- Review their
long-term disability coverage in case Paul becomes permanently
disabled.
- Review property
and casualty insurance in the case of a total loss or lawsuit.
Before making
some recommendations to Debbie and Paul, please answer some questions
related to their situation.
Question:
More Life Insurance for Wife
One of Debbie
and Paul's life insurance goals is, in case of Paul's death, Debbie
should be able to maintain her current standard of living, and the
children's college should be paid for.
What type of
insurance product would be most appropriate to recommend to Debbie
and Paul to cover the cost of raising the children in case Paul
passes away?
A. Whole life
policy
B. Variable
universal policy
C. 15-year level
term insurance
D. Universal
policy
Answers:
A. You are incorrect.
The 15-year level term insurance would be more appropriate because
this is a temporary need, and since the risk will no longer exist
when the children become adults, term insurance would be the most
appropriate insurance policy. Whole life policies would be more
appropriate if the need were permanent.
B. You are incorrect.
The 15-year level term insurance would be more appropriate because
this is a temporary need, and since the risk will no longer exist
when the children become adults, term insurance would be the most
appropriate insurance policy. A variable universal policy would
be more appropriate if the need were permanent.
C. You are correct.
The 15-year level term insurance would be appropriate because this
is a temporary need, and since the risk will no longer exist when
the children become adults, term insurance would be the most appropriate
insurance policy.
D. You are incorrect.
The 15-year level term insurance would be more appropriate because
this is a temporary need, and since the risk will no longer exist
when the children become adults, term insurance would be the most
appropriate insurance policy. A universal policy would be more appropriate
if the need were permanent.
Question:
More Insurance for Husband
Another of Paul
and Debbie's goals is, in case of Paul's death, Debbie should be
able to maintain her current standard of living for the rest of
her life. Paul is considering more insurance to provide Debbie with
a stream of income for a longer period of time.
Taking into
account all of the financial planning goals of the Greens, what
type of long-term insurance would you recommend for Paul?
A. Annually
renewable term insurance
B. Whole life
C. 15-year level
term policy
D. Variable
universal life
Answers:
A. You are incorrect.
To provide a stream of income for the rest of Debbie's life is a
permanent need. Term insurance is more appropriate for a temporary
need. A variable universal life policy might be most appropriate
for Paul. It would provide the extra death benefit in case he should
pass away. Additionally, the variable universal life would be another
way Debbie and Paul could save for retirement. The cash value in
this policy could be invested in a mix of stocks, bonds, or mutual
funds. If it were invested in stocks, the extra cash value could
be used as an additional source of income during retirement.
B. You are incorrect.
A whole life policy may be an appropriate choice because it is a
permanent policy. However, a variable universal life policy might
be most appropriate for Paul. It would provide the extra death benefit
in case he should pass away. Additionally, the variable universal
life would be another way Debbie and Paul could save for retirement.
The cash value in this policy could be invested in a mix of stocks,
bonds, or mutual funds. If it were invested in stocks, the extra
cash value could be used as an additional source of income during
retirement.
C. You are incorrect.
To provide a stream of income for the rest of Debbie's life is a
permanent need. Term insurance is more appropriate for a temporary
need. A variable universal life policy might be most appropriate
for Paul. It would provide the extra death benefit in case he should
pass away. Additionally, the variable universal life policy would
be another way Debbie and Paul could save for retirement. The cash
value in this policy could be invested in a mix of stocks, bonds,
or mutual funds. If it were invested in stocks, the extra cash value
could be used as an additional source of income during retirement.
D. You are correct.
A variable universal life policy might be most appropriate for Paul.
It would provide the extra death benefit in case he should pass
away. Additionally, the variable universal life policy would be
another way Debbie and Paul could save for retirement. The cash
value in this policy could be invested in a mix of stocks, bonds,
or mutual funds. If it were invested in stocks, the extra cash value
could be used as an additional source of income during retirement.
Question:
Long-Term Care Insurance
Debbie has been
reading a lot about long-term care insurance policies. She is especially
interested since she knows that multiple sclerosis (MS) runs in
Paul's family. Paul is healthy today, but what could happen to him
down the road?
When reviewing
a long-term care policy with the Greens, what should the Greens
be most concerned about?
A. The benefit
waiting period
B. The daily
benefit amount
C. Exclusions
for muscular disorders
D. Type of care
covered
Answers:
A. You are incorrect.
Although this is an important feature of a long-term care policy,
because MS is what Debbie is primarily concerned about, any long-term
care policy that is recommended should provide a benefit in the
event a person requires care for MS.
B. You are incorrect.
Although this is an important feature of a long-term care policy,
because MS is what Debbie is primarily concerned about, any long-term
care policy that is recommended should provide a benefit in the
event a person requires care for MS.
C. You are correct.
Because MS is what Debbie is primarily concerned about, any long-term
care policy that is recommended should provide a benefit in the
event a person requires care for MS.
D. You are incorrect.
Although this is an important feature of a long-term care policy,
because MS is what Debbie is primarily concerned about, any long-term
care policy that is recommended should provide a benefit in the
event a person requires care for MS.
Investment
Planning
Paul and Debbie
have been investing for a long time. Today they have come to your
office to get some advice on investment planning. You explain to
Paul and Debbie that you would like to take a moment to develop
an investment policy statement. The first step in developing an
investment policy statement is to set goals. These goals help determine
what investments a person should make.
To establish
their financial goals, Paul and Debbie must answer the following
questions. Click a question to see the Greens' answer. (note italics
are pop-ups)
What goal are
they trying to reach?
- They want
to retire at age 55.
- They also
want to pay for college for the three children.
What is their
investment time horizon (short, medium, or long)
- ·For
retirement, the time horizon is medium to long.
- ·For
Rebecca's college education the time horizon is short.
- ·For
Cassidy and David's college educations, the time horizon is long.
How much do
Paul and Debbie need to fund their goals? ($144,000 per year for
retirement)
- The Greens
will need $5.1 million for retirement.
- The Greens
will need the following amounts for the children's educations:
- Cassidy
$289,000
- David
$243,000
- Rebecca
$65,000
What is their
investment profile? (conservative, moderate, aggressive investor)
- Both Debbie
and Paul are comfortable taking investment risk right now, since
they believe the long-term trend for stocks is generally positive.
Determining
Alternatives
Given the size
of the Greens' investment portfolio, you would recommend that they
begin a program of investing in individual stocks. Here are a few
things you may wish to suggest to them. Click an alternative to
see how it would help the Greens. (Note the suggestions are underlined.
The answer is a popup.)
Buy individual
stocks instead of mutual funds.
One of the advantages
of buying individual stocks is being able to control when the stock
is purchased and sold. This gives the Greens the ability to control
the timing of capital gains and losses.
Given their
tax bracket, this control is important. In the past, the Greens'
mutual funds have often surprised them with the amount of short-term
capital gains distributed to shareholders at the end of the year.
One of the typical
disadvantages of individual stocks is the need to research companies.
However, you would be able to provide the research on these companies
and make recommendations on when the stock should be bought or sold.
Shift the
funds in their IRAs from CDs to equities.
Paul and Debbie's
IRAs are invested in CDs; however, they should view the IRAs as
a very long-term investment. In fact, they could leave this money
there until they reach age 70 ½. With this type of time horizon,
it would be wise to invest in equities, possible large- or small-company
stocks that have a higher rate of return over the long run.
Sell some
stocks in the GHI account to use the $31,000 capital loss carryforward
they have.
In reviewing
the Greens' GHI brokerage account, you see they are holding the
HBG Large Cap mutual fund with a $20,000 long-term gain, and ABC
Technologies, which has an $80,000 short-term gain on the date of
your meeting. You could sell all of the HBG mutual fund and enough
of the ABC stock to generate a $31,000 gain. This would use up the
capital loss carryforward, and the proceeds from these stocks could
be invested elsewhere.
Given their
tax situation, the Greens should not be investing in taxable bonds
and high-dividend-paying stocks.
Given that they
are in the highest tax bracket, the Greens should try to invest
in low-dividend-paying stocks and/or tax-free municipal bonds in
their taxable accounts. If they focus on growth stocks, they may
be able to have these profits taxed at the lower long-term capital
gains rate of 20 percent.
However, they
should not avoid mutual funds with high portfolio turnovers and
high-dividend-yielding stocks altogether, since these can be an
important part of their overall investment allocation. But if they
are to invest in these tax-"inefficient" investments,
they might want to put them in tax-deferred accounts such as their
401(k)s, IRAs, and Keoghs. This way the investments will continue
to grow tax-deferred, and they will not pay the income tax for many
more years.
Developing
a Plan
The Greens have
come to your office for advice concerning their stock options. Now
that you are informed of their financial situation, help them develop
a plan that meets their stock option goals:
- Develop a
stock option strategy that minimizes taxes and maximizes the value
of the stock.
- Develop a
strategy for when to exercise Incentive Stock Options (ISOs) and
Nonqualified Stock Options (NQSOs) based on which type of option
exercise is best for achieving their goals.
- Balance stock
investments to minimize risk and maximize profit.
- Exercise
and sell stocks when most profitable.
Click here
to see Paul's stock option statement.
Please answer
the following questions before helping the Greens put together a
stock option plan.
Developing
a Plan
The Greens have
come to your office for a meeting to discuss their education funding
plan. You have looked at the Greens' financial information, identified
their financial goals, analyzed the Greens' available resources
and any potential gaps in their financial plans, and are ready to
help them develop a plan.
The Greens'
educational goals are as follows:
- Four years
of private college for Cassidy (2) and David (5)
- Four years
of public college for Rebecca, a child from a former marriage
- Start a monthly
savings plan for college
- Shift money
to children's name
- Borrow money
for Rebecca
Click the steps
below to review the education planning process with the Greens:
Step 1: Gather
information
Step 2: Set
goals
Step 3: Examine
resources
Step 4: Develop
plan
Step 5: Monitor
plan
Before you walk
through the plan with Paul and Debbie, please answer a few questions
related to education planning.
The process
of developing a plan includes:
- Determining
alternatives
- Prioritizing
alternatives
- Creating
an action plan
The remainder
of the course was deleted.
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