stuart financial plan
TRANSCRIPT
A financial plan for
Frank and Madelyn Stuart
Presented by
Nick Johnson
January 31 2014
Table of Contents
Executive Summary 3
Letter of Engagement 4
Contact Information 6
Employment Information 7
Statement of Cash Flows 8
Statement of Financial Position 10
Explanation of Financial Planning Process 12
Assumptions 13
Goals 13
Education Planning 14
Mortgage Indebtedness planning 17
Retirement Planning 20
Insurance Planning 23
Lisa Medical Expenses Planning 25
Frank’s Parents Retirement Planning 26
Emergency Fund Planning 27
Estate Planning 30
Investment Planning 32
Other Foreseeable Issues Planning 35
Executive Summary
The Stuart’s (Frank and Madelyn) is a young couple (both 35 years old) with two children (Blake age
seven and Lisa age five). They are a one income earning family, with Madelyn’s business showing great
strides of growth sense inception. They have many financial goals that will individually be addressed,
and with the proper planning can progress to attaining these goals.
Strengths
Steady income and job security with Frank’s employment.
Great growth seen from Madelyn’s business.
Possible inheritance in excess of $500,000 (per the consideration of this plan, these assets were
not considered).
Retirement plan established.
Weaknesses
Insufficient education funding.
Additional retirement funds required for retirement goals.
Insufficient insurance needs for insurance goals.
Foreseeable medical expenses, insufficient medical expenses funding.
Insufficient emergency funding.
No will established.
Foreseeable budgeting concerns
Disclaimer
The creation of this plan is to provide educational materials in regards to current financial position, and
insights to hypothetical future financial planning. My specialty is in financial planning, but there have
been included aspects of legal, and tax advising. Please consult the appropriate professional for advice in
legal consulting and tax advising. Projected portfolio earnings and returns used in this plan are not
guaranteeing future earnings or returns. Investing does include different types of risk, and no projected
return is guaranteed.
The information in the plan is based off financial information inputted on January 1st 2014. Results may
vary over time.
Letter of engagement
Dear Mr. and Mrs. Stuart,
This engagement letter is intended to disclose the terms of the financial planning engagement between
Nicholas Johnson and Mr. Frank Stuart and Mrs. Madelyn Stuart. All financial information that you have
provided to me will be kept confidential. There may be a future scenario during the financial planning
engagement that I may require to consult with a third-party professional. At that time I would obtain
your written permission to disclose personal information.
As discussed during our initial meeting, this engagement will include all services required to develop an
in-depth financial plan. The services will include, but are not limited to:
Reviewing and prioritizing your goals and objectives of your current financial situation including,
statement of financial position and statement of cash flows.
Developing a financial planning strategy, this will include financial assumptions and projections.
Reviewing exposure to financial risk and developing appropriate risk planning.
Completing a retirement planning review, this will include financial assumptions and will require
assets estimates that will be needed on the retirement date to meet retirement goals.
Addressing estate net worth and developing appropriate estate plan to meet estate planning
objectives.
Analyzing and implementing tax planning strategies to minimize tax consequences.
Reviewing and prioritizing strategies aforementioned into a detailed financial plan.
Presenting a written financial plan that will be reviewing in details with Mr. and Mrs. Stuart.
Referral to other professionals (legal and tax advisors), as needed to assist with implementation
of the financial plan.
Managing the implementation of the financial plan.
Monitoring financial performance of the financial plan.
Ongoing review of assumptions incorporated into the financial plan. These assumptions include
but are not limited to economic factors, political factors, and regulatory factors.
Future determination of possible revisions to the financial plan.
Reviewing investment portfolio and developing asset management strategies.
Recommendations in place to help meet stated financial objectives.
This will be an ongoing professional relationship. It is highly suggested that we continue to meet on an
annual basis (or sooner in regards to significant changes in financial objectives) to ensure the financial
plan is still appropriate for you (Mr. and Mrs. Stuart). If you decide to terminate this engagement, I
require to be notified in writing. Any fees incurred to that termination date will be accrued and payable
in full.
My engagement fee is $995.00 plus applicable taxes for the initial financial plan. The $995.00 also
includes the first year of monitoring of the plan. Payment terms include $699.00 plus applicable taxes
payable upon acceptance of this engagement and with the balance due upon presentation of the
financial plan. After the first year, our meetings will be subject to a fee of $225.00 per hour. I do not
receive a referral fee from any professional(s) that you may be referred to.
I base my financial recommendations off of the information that is provided to me. With that in mind, I
required complete accuracy in regards to the information provided regarding personal and financial
situations which include but are not limited to financial goals, objectives, needs and values, investment
statements, tax returns, copies of wills, power of attorney, insurance policies, employment benefits,
retirement benefits, and appropriate legal arrangements.
It is your responsibility to ensure that any material changes to the above circumstances are disclosed to
me in a timely basis due to the fact that they could impact the financial planning recommendations. If
the terms of the financial planning engagement are subject to change, I will present them to you in a
timely manner in writing. Upon presentation of the new terms, you would have the opportunity to
review and discuss any changes. Both parties would need to agree to these new terms before this
financial planner relationship would be able to continue.
At the present moment I have no conflicts of interest in the acceptance of this engagement. I vow that I
will advise you of any future conflicts of interest that may arise, in writing.
I have read, understood, and agree to the terms stated in this engagement letter.
Frank Stuart 01/01/2014
Client - Mr. Frank Stuart Date
Madelyn Stuart 01/01/2014
Client – Mrs. Madelyn Stuart Date
Nicholas Johnson 01/01/2014
Financial Planner – Nicholas Johnson Date
Contact Information
Contact Name Nicholas Johnson
Title Financial Planner
Address 123 Fake St
City, State, Zip Phoenix, AZ 85203
Office 420-555-5555
Cell 420-555-1111
Fax 420-555-1000
Email [email protected]
Website www.johnsonfinancialplanning.com
Client Names Frank and Madelyn Stuart
Address 750 Elm St
City, State, Zip Phoenix, AZ, 85203
Frank Stuart Cell 555-100-2000
Madelyn Stuart Cell 555-200-1000
Email [email protected]
Family Information
Frank Stuart DOB 1/1/1979 (age 35)
Madelyn Stuart DOB 1/2/1979 (age 35)
Marital Status Married
Children Blake Stuart (age 7)
Lisa Stuart (age 5)
Employment Information
Frank Stuart
Occupation Physician
Annual Income $170,000
Madelyn Stuart
Occupation Self-employed
Annual Income undeterminable (future projections $90,000)
Personal Statement of Cash Flow
Frank and Madelyn Stuart
For the Year Ended December 31, 2013 (assuming to be the same in 2014)
Inflows
Salary – Frank $170,000
Gift from Frank’s parents 20,000
Madelyn’s net self-employment income 4,000*
Interest 900
Total Inflows $194,900
Outflows
Section 401(k) plan contribution $11,900
Mortgage payment (P&I) 20,700
Property taxes (residence) 1,800
FICA and self-employment tax 9,514
Federal income tax withholding 68,000
State income tax withholding 6,734
Utilities 3,980
Disability insurance premium 900
Homeowners insurance premium 2,000
Auto loans 10,789
Auto expense and maintenance 1,200
Auto insurance premium 2,400
Housekeeping service 2,400
Education loan repayment 6,915
Clothing and dry cleaning 5,600
Food 5,750
Entertainment 3,970
Miscellaneous 5,998
Total outflows $170,550
Total cash surplus $24,350
*Madelyn’s projected net self-employment income for 2014 is $90,000.
Statement of Personal Financial Position
Statement of financial position
Frank and Madelyn Stuart
January 1 2014
Assets
Cash/cash equivalents
Checking account JT $2,500
Money Market (1.75% rate) JT 5,000
Total cash/cash equivalent $7,500
Invested Assets
CD JT $15,000
Section 401(k) F 18,000
Cash value of life insurance M 6,000
Coin Collection F 10,000
Total investments $49,000
Personal use assets JT $275,000
Auto (Toyota) JT 22,500
Auto (Audi) JT 47,000
Total personal use assets $344,500
Total Assets $401,000
Liabilities
Credit card balances $550
Auto loan (Audi) 25,000
Auto loan (Toyota) 18,000
Home mortgage $225,000
Student loans 50,500
Total liabilities $319,050
Net worth 81,950
Total liabilities and net worth $401,000
JT= jointly owned
F= Frank’s separate property
M= Madelyn’s separate property
Liabilities are joint liabilities aside from Frank’s student loans, which is Frank’s liability
Home value is $50,000 land and $225,000 home value
Explanation of Financial Planning Process
Define relationship
In this step, I fully explain the services to be provided, my compensation/fee structure. We discuss each
of our expectations of roles that we will have during the financial planning process. Finally, how
decisions will be made will be discuss in full detail during our relationship.
Gather information
In this step, I will gather you financial information and other important date needed to create the
financial plan. Finally, in this step we set and prioritize financial goals and objectives.
Analyze the data
In this step, we will identify your financial strengths and weakness in preparing the financial plan.
Develop the plan
Here the plan is developed in a customizing fashion with my recommendations based on your needs,
goals and objectives. Finally, we will meet to discuss my recommendations and options to meet your
financial goals and objectives.
Implement the plan
In this step, the recommendations are implemented to help meet your financial goals and objectives.
This step may require professionals in other fields (legal and tax advising) that would be needed to be
contacted because the material is out of my field of expertise.
Monitor and manage the plan
After the plan is implemented, there may be situations (family circumstance, economic factors, political
factors, etc.) that may change in the future. It will be important to periodically monitor the financial plan
to ensure that it still works with your financial goals and objectives. The periodical intervals will be
agreed on by both parties.
Assumptions
Expected inflation: 3%
Education inflation: 5%
Health inflation: 6% this number was not originally discussed. Due to one of the objectives concerns
future medical expenses, I felt doubling inflation was an aggressive number to plan for.
After-tax returns on all investments: 9%
Frank’s income will continue to increase annually at: 4%
Current mortgage rates: 7% for a 15-fixed mortgage and 7.5% for a 30-year fixed mortgage. Refinancing
will cost 3% of any mortgage at closing cost. This number will not be included in the new mortgage, and
the Stuart’s would be responsible for this additional expense.
Federal income tax rate: 25%
State income tax rate: 6%
Goals
Save money for children’s first four years of college.
Mortgage free by the time Frank reaches age 55 years old, within 20 years.
Save money for retirement, with a retirement age of 67 and to have 70% of Frank’s
preretirement salary in each year of retirement.
Have sufficient insurance need on Frank’s life.
Pay Lisa’s medical expenses in full for future surgeries and physical therapy sessions.
Assist Frank’s parents in their retirement years as needed.
Have adequate emergency funds available.
Prepare wills and an estate plan to minimize estate tax obligations.
Create an investment portfolio that will generate desired rate of return given stated risk
tolerance and meet stated retirement and educational goals.
Education Planning
Objective 1: The Stuarts want to provide each of their children with up to $25,000 (today’s dollars) per
year for four years of college education. The children will have to pay for the costs of any graduate
school. The Stuarts would like to have accumulated the funds by each child’s first year of college.
There are different ways to calculate the amount of money needed for educational expenses. Because
the Stuart’s would like to have the money available in the account prior to the first year of the
appropriate child’s first year of college, I individually calculated the amount needed for each child. Steps
in the calculator would not be included in the plan, but for easier purposes of following along, I am
including them below. The uneven cash flow method was considered, but I felt that individualizing each
child would be more efficient to determine how much need to be in each of the child’s accounts.
Assumption
The first year of college will start at age 18.
Blake current age 7
Step 1: Present Value= $25,000 (amount the Stuart’s would like to provide Blake for each of 4 years in
college)
N=11 (age of first of year of education minus current age) (18-7)
Interest= 5% education inflation rate
(Solve for) Future Value (what it will cost each year of college in today’s dollars) = $42,758.48
Step 2: Start in begin mode on the calculator because the money is due at the beginning of the school
year.
Payment (of each year of college expenses in today’s dollars) = $42,758.48
N=4 number of years in college paid for by the Stuart’s
Interested= ((1.09/1.05)-1)*100 education inflation adjusted rate = 3.8095
(Solve for) Present Value = $161,847.43 the amount that will need to be in the account before Blake will
start college
Step 3: Future Value = $161,847.43 (back in end mode on the calculator)
N=11
I=9% after-tax rate of return
(Solve for) Payment= $9,216.67 the amount needed to put into an account for Blake each year until he
starts college
Lisa current age 5
Step 1: Present value: $25,000 (amount the Stuart’s would like to provide Lisa for each of 4 years in
college)
N=13 (age of first of year of education minus current age) (18-5)
Interest=5% education interest rate
(Solve for) Future Value= (what it will cost each year of college in today’s dollars) = $47,141.23
Step 2: Start in begin mode on the calculator because the money is due at the beginning of the school
year.
Payment (of each year of college expenses in today’s dollars) = $47,141.23
N=4 number of years in college paid for by the Stuart’s
Interested= ((1.09/1.05)-1)*100 education inflation adjusted rate = 3.8095
(Solve for) Present Value = $178,436.87 the amount that will need to be in the account before Lisa will
start college
Step 3: Future Value = $178,436.87 (back in end mode on the calculator)
N=13
I=9 after-tax rate of return
Payment = $7,773.88 the amount needed to put into an account for Lisa each year until he starts college
Recommendation
I recommend establishing 529 plans for each of the children. A 529 plan allows for tax-deferred growth,
and as long as the money is used for qualified educational expenses there are no taxes or penalties for
distributions. I would consider establishing a 529 plan in the state of Arizona for state income
deductions. Please consult a tax advisor for further discussion on the state income tax deductions. In the
event of a child does not want to attend college or they will not need 100% of the monies, money in a
529 can be rolled into another beneficiaries 529 account.
You are able to contribute up to $28,000 ($14,000 each from Frank and Madelyn) for each child each
year free of gift tax with gift splitting. Another piece on 529 plans is that you can upfront five years of
gifts in one contribution. Gift taxes may be applicable in the event of a spouse passing within five years.
Additional tax forms may need to be completed in these circumstances, and please consult a tax advisor
about gift-splitting. This would allow to save the appropriate amount each year (Blake $9,216.67 and for
Lisa $7,773.88).
529 accounts will impact the ability to qualify for student aid in a FASFA application. A 529 plan is
minimal impact for student aid because assets owned by the parents are factored into the student aid
calculation on a FASFA application, but are not weighted to the same extent as assets owned by the
child.
Alternative
UTMA Uniform transfers to minors account. This is an account for additional savings for minors. The
monies can be used for educational purposes. One thing about this account is that the money doesn’t
have to be used for educational purposes, and once the child reaches the age of majority they can take
control of the assets. If there are concerns that a child may take the account and use the monies for
purposes other than education, this option may not be the best option. Unearned Income (dividends,
interest, capital gain distributions, or capital gains on sales) are taxable but at a reduced rate. This type
of account is an irrevocable gift to the minor, which means changing of ownership of the assets amongst
children may lead to legal issues. Please consult a legal advisor for further information in the event of
changing ownership if this option is to be considered.
Mortgage Indebtedness Planning
Objective 2: They want to be free of mortgage indebtedness by the time Frank is 55 years old.
The original mortgage details were not included in the original meeting. After discussing over the phone
it was included the following details about the current mortgage.
Current mortgage:
30-year fixed
6 years into the mortgage
Original house value of mortgage: $240,800
Interest Rate: 7.75%
Annual payments (was included in original meeting) $20,700
Interest rates have dropped, with that in mind it is worth considering refinancing at a lower rate.
Current interest rates:
15 year fixed mortgage: 7%
30 year fixed mortgage: 7.5%
Recommendation
I am recommending that we do not refinance. There is 24 years remaining on the mortgage, and with a
goal of being out of mortgage indebtedness in 20 years I am suggesting that to increase payments.
Currently, you are paying a monthly amount of $1,725 (20,700/12). I am suggesting that you increase
your payments to the mortgage by an extra $124.55 a month to be a total of $1,849.55 a month. That
will be an annual amount towards the mortgage of $22,194.60 (1849.55*12). The math would normally
not be included in the plan, but to make it easier to follow the math is below:
Find out how much the investor has paid towards the current mortgage.
Present Value: 240,800 (value of mortgage)
N=30*12 (number of payments 30 year mortgage * 12 payments a year)
I=7.75/12 (monthly interest rate)
Payment=$20,700/12 (annual payment divided by payments per month)
1 (input) 72 (number of payments that have occurred 6 years of payments* 12 payments a
year)(shift)(amort)
Principal Paid= 15,505.52
Interest Paid=108,894.48
Balance remaining on mortgage=$225,294.48
Next, I considered refinancing. So I had to look at what payments would be:
Present Value= $225,294.48 (Principal remaining on house)
N=15*12 (number of payments 15 year mortgage* 12 payments a year)
I=7/12 (15 year fixed mortgage rate/12) monthly interest rate
(solve for) Payment = $2,025.01/month = $24,300.12/annually. This would have the mortgage paid off in
15 years, however this would increase the monthly mortgage payments $300.01 ($2,025.01-1,725).
Next, I considered refinancing to a 30 year fixed mortgage but paying the mortgage off in 20 years.
Present Value= $225,294.48 (Principal remaining on house)
N=30*12 (number of payments 30 year mortgage*12 payments a year)
I=7.5/12 (30 year fixed mortgage rate/12) monthly interest rate
(Solve for) Payment= $1,575.29/month = $18,903.48/annually. We need to account for paying off the
mortgage in 20 years instead of 30. To account for this, then I calculated how much an increase in the
mortgage payments to pay off sooner.
Present Value=$225,294.48 (Principal remaining on house)
N=20*12 (number of years to have mortgage paid off*12 payments in a year)
I=7.5/12 (30 year fixed mortgage rate/12) monthly interest rate
(Solve for) Payment = $1,814.96/month = $21,779.52 annually
This would increase monthly mortgage payments $89.96 ($1,814.96-1,725)
Also, there would be an out of pocket expense for the Stuarts of 3% of the value remaining on the
mortgage that they would need to pay out of pocket (.03*$225,294.48)= $6,758.83. If interest rates
continue to go down, this will be reconsidered in the future.
Next, I determined how much the investor will need to increase the mortgage payments to payoff in 20
years instead of the 24 years remaining.
Present Value =$225,294.48 Balance remaining on mortgage
N=20*12 (number of years to have mortgage paid off*12 payments in a year)
I=7.75/12 (30 year fixed mortgage rate at time of mortgage/12) monthly interest rate
(Solve for) Payment = $1,849.55/month = $22,194.60 annually
I am suggesting that we increase monthly mortgage payments by $124.55 ($1,849.55-1,725).
Another piece to consider is having a good housing cost ratio. A good ratio is 28% or less. To get housing
ratio, we have to look at the monthly costs that include the mortgage payments, homeowners
insurance, and property taxes.
Homeowners insurance annual premium $2,000 = $166.67/monthly (2,000/12)
Property taxes $1,800 = $150/monthly (1,800/12)
Annual gross income = $170,000 = $14,166.67/monthly. For a more conservative number I didn’t
consider Madelyn’s project gross income of $90,000. I didn’t consider it because it is a projected
number, and it could lead to a worse situation if I include and the number wasn’t attainable. I didn’t
include the $20,000 gift from Frank’s parents in determining gross income. I didn’t include the gift,
because I assumed the gift is a onetime occurrence and that it will not continue while Frank is still
working. I didn’t include $900 interest income; the reason why I didn’t include the interest income is
because in the event of having to sell that interest bearing security, the interest income would no longer
be available.
Current housing cost ratio
$1,725+$166.67+$150 (monthly mortgage payment+ monthly homeowners insurance premium
payment+ monthly property taxes expense)/ $14,166.67 ($170,000/12 as stated above) = 14.41%. A
ratio under 28% is good.
After recommendation housing cost ratio
$1,849.55+166.67+$150 (monthly mortgage recommended payment + monthly homeowners insurance
premium payment+ monthly property taxes expense)/ $14,166.67 ($170,000/12 as stated above) =
15.29%. A ratio under 28% is good.
Retirement Planning
Objective 3: They plan to retire at the full retirement age (FRA) of 67 and want enough retirement assets
to replace 70% of Frank’s preretirement salary. They want to include Social Security benefits when
planning for retirement.
Assumption
Social Security benefits will still be available when Frank and Madelyn retire.
Social Security will adjust for inflation.
Current Income
Frank’s income: $170,000
Note: Madelyn’s income was not considered in this calculation, because they asked only for Frank’s
preretirement salary figures.
Frank’s income less 70% ($170,000*.7)=$119,000
Social Security benefits
Frank= $29,820
Madelyn= $14,910
Total social security benefits (in today’s dollars)=$44,730
Because the Stuart’s social security benefits part of the calculation, it was next important to Frank’s
salary less 70% minus social security benefits (119,000-44,730)= $74,270
Note: the math would normally would not be included in the certified financial plan, it is included below
so it easier to follow the process.
First Step: Figure out how much will be needed each year in retirement.
Present Value= $74,270
N=32 (Frank’s full retirement age – Frank’s current age) (67-35)
I= 3% (inflation)
(Solve for) Future Value= $191,251.40 (the amount needed every year during retirement)
Step two: (begin mode on the calculator) Payment= $191,251.40 (the amount needed every year during
retirement)
I= ((1.09/1.03)-1)*100= 5.8252 (inflation adjusted return)
N=25 (Frank’s expected live to age – Frank’s full retirement age) (92-67)
(Solve for) Present Value= $2,630,778.16
Step three: Find out how much will need to be put aside each year to have the amount of money in the
account to have enough for all retirement years. (End mode in calculator).
Future Value= $2,630,778.16
Present Value= $18,000 (Current Value of Frank’s Section 401(k))
I=9% (after-tax return rate)
N=32 (Frank’s full retirement age – Frank’s current age) (67-35)
(Solve for) Payment=$14,307.98
Current annual savings into the section 401(k) for Frank is 17,000 (Frank’s contributions 7% of income
and a 3% employer match). Due to my calculations Frank and Madelyn would be able to reach their
retirement goals considering that social security benefits will be available upon retirement age.
Recommendation
If we consider that in retirement social security benefits will be available, I suggest continuing the same
annual savings in the 401(k). In the event that money needs to be used for other scenarios, we could
even reduce Frank’s contributions from 7% to 6%. That would be an annual savings into the section
401(k) of $15,300 (6% of Frank’s income and 3% employer match). That would still be enough to meet
the Stuart’s financial goals.
Alternative
I did similar calculations stating that social security benefits would not be there upon retirement.
Present Value= $119,000
N=32 (Frank’s full retirement age – Frank’s current age) (67-35)
I= 3% (inflation)
(Solve for) Future Value= $306,434.85 (the amount needed every year during retirement)
(begin mode) Payment= $306,434.85
I= ((1.09/1.03)-1)*100= 5.8252 (inflation adjusted return)
N=25 (Frank’s expected live to age – Frank’s full retirement age) (92-67)
(Solve for) Present Value= $4,215,211.43
(end mode)
Future Value= $4,215,211.43
Present Value= $18,000 (Current Value of Frank’s Section 401(k))
I=9% (after-tax return rate)
N=32 (Frank’s full retirement age – Frank’s current age) (67-35)
(Solve for) Payment= 23,966.98
Frank’s current 401(k) savings is $17,000 (7% of salary that Frank is saving + 3% of salary the employer is
matching). Next step, was to find out how much additional the Stuart’s would need to save in this
scenario (23,966.98-17,000)= $6,966.98
Recommendations
I am suggesting that Frank increases his contributions into his section 401(k) by 1% to 8%. That would be
a total annual savings of 11% (8% Frank contributions +3% employer match)=$18,700. That would mean
that an additional $5,266.98. Your wife is eligible to make a full contribution into a traditional IRA of
$5,500 because of net self-employment income is less than the MAGI phase-out for a nonactive
participant ($181,000-191,000). Another option I was going to suggest is that Madelyn establishes a SEP-
IRA.
Madelyn’s small business would allow her to put aside at most 20% of self-employment income (2014).
It is easy to establish (5305-SEP tax form filing with the IRS), and in the event of years were you are not
able to make contributions, you are not required to make contributions. There are other alternatives to
small business employment plans, but the reason this was considered due to the ease of establishing,
and contributions do not need to occur in regularly (something to consider in years where projected net
self-employment income are not feasible).
Insurance Planning
Objective 4: The Stuarts want to review their insurance coverage and make changes as needed. For
purposes of determining any additional life insurance need on Frank’s life, the Stuarts want to use the
human life value method, and they assume that Frank’s personal consumption is 15% of his after-tax
earnings.
Life Insurance
First Step was to look at the human life value method and determine the insurance needs.
Gross Salary: $170,000
Taxes= $170,000*31% (25% federal income tax rate+ 6% state income tax rate)=$52,700
Consumption= (170,000-52,700)*.15= $17,595
Family Share Earnings FSE= $170,000-(52,700+17,595) (70,295) (taxes + consumption) = $99,705
Second step: Calculate work life expectancy
Work life expectancy= 32 (full retirement age – current age for Frank) (67-35)
Third step: Determine the future of the family share of earnings over Frank’s work.
Payment=$99,705 (Family share earnings)
I=4 (annual increase in Frank’s salary)
N=32 (Work life expectancy)
(Solve for) Future value= $6,251,649.93
Final Step: Determine the human life value.
Future Value= $6,251,649.93
I= 3% (inflation rate)
N=32 (Work life expectancy)
(Solve for) Present Value= $2,427,747.19
Recommendation
I am suggesting a 30 year level term life insurance policy for the amount of $2.4 million. I rounded the
present value of the coverage above to $2,450,000. Frank already has coverage of $50,000 with his
employer. I subtracted $50,000 from the amount of coverage needed to get $2.4 million. The level term
would be a fixed premium for the 30 years. The premium would be more expensive than an annual
renewable term in the beginning years, but in the later years of the life insurance would be cheaper
than an annual renewable term in the latter years of the level term. This would provide insurance
coverage until age 65. At that time we can reevaluate insurance needs at age 65 with only 2 more years
until full retirement age. I would also recommend a disability waiver of premium policy rider. This would
prevent lapsing coverage as a result of nonpayment of premiums during insured’s disability. This would
increase the cost of the premium, but it is something to consider in the event for disability planning.
After researching different options available online, I was able to get estimates on monthly premiums:
Frank Stuart life age 35, very good health, 30 year level term insurance on $2.4 million estimated
monthly premium $250/month.
Homeowners Insurance
The homeowners insurance coverage was not discussed, I would suggest to have 80% of the value of the
house covered by the insurance ($225,000*.8) $180,000. If the homeowner’s insurance coverage is less
than 80%, the insurance payment in the event of damage would be less. The 80% coverage on the value
of the house is an insurance requirement.
Auto Insurance
The automobiles currently have full coverage because they are currently being paid off. When the cars
get paid off, something to consider is reducing the coverage on the vehicles (especially when they are
older in age). The reason to consider reducing the coverage after the cars are paid off is to reduce
premium payments for a car that is reducing in value. Another piece to consider is the need for
comprehensive insurance after the car is paid off. Comprehensive insurance protects for non-collision
scenarios like: theft, breakage of glass, falling objects, flood, earthquake, hail, vandalism, and contact
with bird or animal. Some of these perils are less likely to incur in Arizona (falling objects, earthquake,
hail, and contact with bird or animal). If you lived in an area with a higher likelihood of one of the listed
perils above occurring, I would suggest keeping comprehensive coverage.
Disability Insurance
Frank has disability insurance coverage that pays 60% benefit of gross pay after elimination period of
180 days, covers a term of 60 months, offers a residual disability benefit and is guaranteed renewable. I
feel that is good coverage to cover in incident of disability. The one concern that I have the disability
coverage is the elimination period of 180 days. That would be six months without income, it will be
crucial in that scenario to have sufficient emergency funding to fund for six months of no income.
Lisa Medical Expenses Planning
Objective 5: They want to make arrangements for Lisa’s medical care to be paid in full, which includes
any deductibles or other out-of-pocket expenses.
Assumptions
Due to the fact that health interest was not given, I used a number of 6%. The reason for using this
number is that is double inflation (3%), which is an aggressive number to consider that health interest
rate will consistently double inflation.
In my calculation, I estimated that surgery and/or physical therapy would be needed each year until Lisa
is in high school. I also assumed that the costs each year would exceed $7,000. That includes the amount
of the $2,000 deductible and $5,000 stop-loss limit. That would mean $3,000 out of pocket expenses
every year (2,000+(.2*5,000)).
Another assumption that was made is that the health insurance coverage will not change while Frank is
employed. Another assumption is Lisa will graduate high school at age 18 she would be a freshman in
high school at age 15.
Note: The math would not normally be included in the financial plan, but for purposes of making it
simpler to follow along it was included below.
Calculations
Payment= $3,000
I= 6%
N=10 (age at first year of high school – current age) (15-5)
(Solve for) Future Value= $39,542.38
Recommendation
I would have an additional Lisa medical expenses fund set aside. This would be similar to an emergency
fund, investing mainly in liquid securities (money market mutual funds, CD’s, etc.). This recommendation
may not get the after-tax return of 9% due to the securities that we would be investing in.
Frank’s Parents Retirement Planning
Objective 6: They want to assist Frank’s parents in their retirement years, as needed.
I know that you have asked for information on your (Frank’s) parents financial situation to get a better
understanding of how much assistance you need to provide them in their retirement years. I disclosed
to you in our letter of engagement, your information is completely confident. I have a similar
relationship with your (Frank’s) parents. I cannot disclose how much they have for retirement or what
recommendations I have provided to them. This is a conflict of interest, and I am bound to keep the
financial information of the individuals that I work with confidential. I still recognize that you would like
to assist them as needed in their retirement. I see this as a less of a priority for an objective.
Emergency Fund Planning
Objective 7: They want to maintain an adequate emergency fund of six months’ living expenses.
In situations where both spouses are working, I only recommend to have three months’ living expenses
set aside in an emergency fund. To be more conservative, even though I recognize that both of you
(Frank and Madelyn) are working, I still suggest having six months’ living expenses set aside for an
emergency fund. The reason I recommend this is because Madelyn’s net self-employment income has
seen amazing projected growth but with consumer spending habits along with other economic factors, I
am not sure if this growth can be considered a consistent source of income.
Calculations:
I added all of your outflows together that was given to me, except for the following: Section 401(k) plan
contributions, FICA and self-employment tax, federal income tax withholding, and state withholding.
The reason these were removed from the calculation is because if you are no longer working, you will no
longer be contributing to a 401(k). You would also not be paying into social security (FICA). Lastly, taxes
were removed because if you have no income from salary, your total income is $900 in interest which
would be below the lowest tax bracket barrier of $17,850 (2014). The taxes owed in that situation would
be 10% of $900.
The following expenses were added together to get a total living expenses.
Mortgage payment (P & I) $20,700
Property taxes (residence) 1,800
Utilities 3,980
Disability insurance premium 900
Homeowners insurance premium 2,000
Auto loans 10,789
Auto expense and maintenance 1,200
Auto insurance premium 2,400
Housekeeping service 2,400
Education loan repayment 6,915
Clothing and dry cleaning 5,600
Food 5,750
Entertainment 3,970
Miscellaneous 5,998
Total living expenses annually $74,402
I took that number and divided it by two to represent how much to have saved in an emergency fund
($74,402/2) which is $37,201. If Madelyn’s income is consistent in the future, I would only suggest
having three months’ living expenses set aside in an emergency fund. That would be the annual
expenses above divided by four ($74,402/4) which is $18,600.50.
Recommendation
I suggest that the money market and CD that you already have be part of your emergency fund
($15,000+5,000) is $20,000. I am recommending that we save and additional $17,201. I suggest that an
additional $5,201 is put into the money market that you currently have, so that balance would be
$10,201 in the money market. The other $12,000 I would suggest to establish a CD ladder. We would
purchase 12 CDs for $1,000 each. Each CD would mature in a year at the end of each month in the
calendar. Example below:
CD 1 for $1,000 established January 2014 matures January 2015
CD2 for $1,000 established February 2014 matures February 2015
CD3 for $1,000 established March 2014 matures March 2015
CD4 for $1,000 established April 2014 matures April 2015
CD5 for $1,000 established May 2014 matures May 2015
CD6 for $1,000 established June 2014 matures June 2015
CD7 for $1,000 established July 2014 matures July 2015
CD8 for $1,000 established August 2014 matures August 2015
CD9 for $1,000 established September 2014 matures September 2015
CD10 for $1,000 established October 2014 matures October 2015
CD11 for $1,000 established November 2014 matures November 2015
CD12 for $1,000 established December 2014 matures December 2015
In the future, you would continue to have this money buy another CD maturing in one year. What this
would do is at the end of each month you would have a CD mature this way in the event of
unemployment or an emergency situation you can take the money from the CD without paying penalties
for cashing before the CD matures. With the balance in your current CD, upon maturity you would put
$15,000 balance into the money market.
Alternative
If you wish not to have such a high amount in liquid securities, and you feel that Madelyn’s income will
be consistent in the future you only would need to set aside three months’ living expenses in an
emergency fund. The reason for this is that it is very unlikely that both spouses become unemployed at
the same time. In this case, as earlier discussed, you would only need to have $18,600.50. We would use
what you currently have your CD ($15,000) and $3,600.50 in the money market. You would use the
other money that you have in the money market ($5,000-3,600.50) which is $1,399.50 to invest with.
When the CD expires I would suggest using $12,000 to do a CD ladder that I suggested earlier with one
year maturities ending every month of a calendar year, and with the other $3,000 going into your
money market. I suggest waiting until the CD matures so that you do not face penalties of selling it
before the CD matures.
Estate Planning
Objective 8: They want to prepare proper wills and an estate plan.
At the time being, you both have not created any wills. I would suggest to create wills. There are
multiple reasons for drafting a will, one of the main reasons being that you will name the executor of
the estate. I would recommend that you name Madelyn the executor for Frank’s estate, and Frank the
executor for Madelyn’s estate. I would suggest that you name a secondary executor in the event of a
spouse predeceasing. In the will you can also name who would be legal guardian and trustees of the
estate. The guardian would be responsible for taking care of Blake and Lisa in the event of both of you
passing away. You should name someone who you trust, and who would be willing to take in Blake and
Lisa and make them part of your family. The trustee of the estate would have fiduciary responsibility.
You would want to appoint someone who you trust with the handling of the estate as well as monetarily
savvy.
Other documents that I recommend you create are a letter of personal instructions, a living will, and a
power of an attorney for health care. The letter of personal instructions would be created to establish
the funeral arrangements at the time of the death. These details are not included in the will. The living
will would be created in the instance to give directions directly to the physician. Some of the instructions
would include but are not limited to: choices about resuscitations, and live support. The power of
attorney for health care would give the elected individual the ability to act on your behalf in the ability
for electing health and medical related decisions.
I looked at your current assets, anything that his held jointly will go to the surviving spouse and will
avoid probate. Any retirement accounts avoid probate as long as beneficiaries are designated that are
not the estate. I would highly suggest designating each other as the primary beneficiary on any current
or future retirement accounts with the secondary being split amongst your children. The current asset
that would be subject to probate is Frank’s coin collection.
The above assets would still be subject to estate taxes. All assets that are jointly owned, 50% of those
assets would be included in one of the individuals passing away. Assets owned individually by Frank
(retirement accounts and coin collection) would be subject estate taxes if Frank is in possession of the
assets at the time of death. Any assets that are going to the surviving spouse qualify for the estate tax
marital deduction. As long as the estate value is not greater than $5,340,000 (2014) estate taxes would
not be due. In the event, any portion of the $5,340,000 is unused it is portable to the living spouse. This
could be up to a $10,680,000 (2014) that could be a possible exemption for the living spouse.
Recommendation
I am suggesting the creation of two trusts an appointment trust (A trust) and a QTIP (C trust). Any assets
that you would like the surviving spouse to own and have access to will be in the A trust. This is a marital
trust that qualifies for the estate marital tax deduction. The surviving spouse has power of appointment,
and all income must be payable to the surviving spouse. Any assets that you would like to give to the
children would be included in the QTIP (C trust). This trust still qualifies for the marital tax estate
deduction. The surviving spouse receives income from the trust and can only use the principal in
emergency situations. The remaining interest in the trust will go the children upon death of the surviving
spouse. This type of trust should highly be considered in the event of a premature death (death prior to
age 92) and the realization that the surviving spouse could remarry into a household with children. This
would mean that the children from the first marriage would receive assets on death from the surviving
spouse. For QTIP or C trusts, it is common to not give power of appointment to the surviving spouse.
Investment Planning
Objective 9: They want to create an investment portfolio that will generate their desired rate of return
given their risk tolerance to meet their education and retirement planning goals.
The Stuart’s required rate of return is 9%. The Stuart’s have mentioned that they consider themselves
moderate-to-high risk investors. They have are creating a portfolio comprised of 80% S&P 500 index
fund, 10% value fund, 5% bonds (corporate), and 5% money market (bank) to achieve both their risk
tolerance and desired rate of return.
That portfolio would be 90% invested in large-cap stocks, 5% invested in bonds (corporate), and 5%
invest in money markets. I consider that to be a more aggressive portfolio. I feel that I would consider
being more diversified in bond exposure and more diversified in small-cap stocks.
Assumptions:
The different investment options are the only ones available for in the appropriate retirement and
education savings accounts. Other investments that I would consider would be international exposure
(both stock and bonds) as well as a portion in commodities (gold less than 5% portfolio). These would
further diversify the portfolio.
Recommendation
I have created two options for retirement savings and education savings that I feel is a diversified
portfolio, it is more terms with their risk tolerance, and still help meets their required rate of return. The
investment portfolio was created by using a weighted return approach. For retirement investment
planning, I looked into the fact that the Stuart’s plan on retiring in 32 years, at a full retirement age of
67. I proposed two options that would eliminate money market exposure in a retirement account,
reduce stock exposure, and increase bond exposure. I was more aggressive with the retirement account
because there are more years until the Stuart’s are considering retirement in comparison to the number
of years the children will be starting college. For education investment planning, I looked into the fact
the children will be starting college in 11 years (Blake) and 13 years (Lisa).
1st Option for the retirement account 75% stock exposure and 25% bond exposure
Investment Portfolio break-down
35% - S&P 500 Index fund
15% - Value tocks fund
15% - Growth stock fund
10% - Small-cap stock fund
25% - Corporate bonds fund
Calculation
(.35*9)+(.1*13.5)+(.15*10)+.15*8.5)+(25*+6.5)
(3.15)+(1.35)+(1.5)+(1.275)+(3.25)= Weight average expected return 10.53%
2nd Option for the retirement account 70% stock exposure and 30% bond exposure.
35% - S&P 500 Index fund
15% - Small-cap stock fund
10% - Growth stock fund
10% - Value stock fund
30% - Corporate bond fund
Calculation
(.35*9)+(.15*13.5)+(.1*10)+(.1*8.5)+(.3*6.5)
(3.15)+(2.025)+(1)+(.85)+(1.95)= Weighted average expected return 10.18%
1st Option for the education account 70% stock exposure and 30% bond exposure.
35% - S&P 500 Index fund
15% - Small-cap stock fund
10% - Growth stock fund
10% - Value stock fund
30% - Corporate bond fund
Calculation
(.35*9)+(.15*13.5)+(.1*10)+(.1*8.5)+(.3*6.5)
(3.15)+(2.025)+(1)+(.85)+(1.95)= Weighted average expected return 10.18%
2nd Option for the education account 65% stock exposure and 35% bond exposure.
25% - S&P 500 Index fund
20% - Small-cap stock fund
10% - Growth stock fund
10% - Value stock fund
35% - Corporate bond fund
Calculation
(.25*9)+(.2*13.5)+(.1*1)+(.1*8.5)+(.35*6.5)
(2.25)+(2.7)+(1)+(.85)+(2.275)= Weighted average expected return of 9.075%
Other Foreseeable Issues Planning
Budgeting
In 2013, the Stuart’s received $20,000 gift from Frank’s parents and Madelyn’s self-employment income
was $4,000. From our discussion, this seems to be a one-time gift, and that it should not be expected to
be an annual gift. In 2013, there was a cash surplus of $24,350. This is a bit concerning, because without
the gift and the self-employment income there is only a surplus of $350. I understand that Madelyn’s
self-employment net income is projected in $90,000. In the event where that projection is unreachable,
you may have issues with reaching financial goals with the current cash outflows.
Assumption
The $90,000 net self-employment income is unattainable for 2014.
Madelyn’s self-employment income will stay the same ($4,000) for 2014.
Recommendation
I recommend considering reducing some of the cash outflows. Some expenses to consider reducing is
entertainment and miscellaneous. The amount spent on entertainment and miscellaneous in 2013 was
$9,968. I did not consider the $500,000 inheritance in this recommendation. Other cash outflows can be
considered to be reduced for 2014. I highly suggest reviewing outflows and considering reducing
unnecessary cash outflows.
Inheritance
There are two parts that will be discussed in this portion, the inheritance of $500,000 that will be
received, and Joanne’s thoughts to do with her inheritance.
In regards to the $500,000 inheritance I would suggest reducing some liabilities with this money. I would
suggest paying off the credit card bills and the automobiles. The total liabilities for the credit card and
automobiles are ($550+25,000+$18,000) $43,550. This would reduce monthly outflows for the
automobiles, and reducing automobile insurance coverage could be considered (this was discussed in
the insurance portion). The remaining $456,450 I would suggest to set money aside for the education
accounts and Lisa medical expense planning. 529 plans will allow for $280,000 to be set aside now
($140,000 for 5 years of gifts from Frank and Madelyn for Blake and Lisa). I am recommending setting
aside $70,000 in Blake’s 529 plan and $70,000 in Lisa 529 plan. The amount to set aside in liquid
securities for Lisa medical expenses 39,543. This will have $276,907 remaining from the inheritance. I
would suggest creating a revocable living trust, and setting aside $151,907 in the account. This will allow
for Frank and Madelyn to be trustee’s that can use the money as deemed appropriate. The remaining
amount ($125,000) I would suggest to split amongst the A and C trusts (discussed earlier), this would be
$62,500 in the A trust that the surviving spouse will receive upon death of the first spouse. The other
$62,500 would go into the QTIP (C trust). The surviving spouse would receive this trust upon the death
of the surviving spouse. The surviving spouse would be able to use the income from the C trust, and
have access to the principal only in emergency situations. The remaining balance would go to the
children upon the death of the surviving spouse.
This recommendation pays off liabilities, and reduces cash outflows. This sets aside money for the
children for their education, would set aside money in a revocable trust that can be used by Frank and
Madelyn for future unforeseen expenses. The remaining amount would go into trust to be received in
the event of Frank or Madelyn passing away.
Joanne’s inheritance
Joanne will be receiving a portion of the estate, and I assuming that will be the same amount that
Madelyn is receiving ($500,000). Joanne wants to disclaim her portion and have the money go directly
to Blake and Lisa. This is very humble request, but if she directs her portion to go the Blake and Lisa she
would be subject to gift taxes.
Assumption
Joanne has used her gift tax exemption of $5,340,000 (2014) already.
Recommendation
The first option that I am suggesting is that Joanne does not disclaim her portion of the inheritance. She
keeps her inheritance in account owned by Joanne. When Blake and Lisa reach education age, she pays
the money that she wanted to disclaim directly to the institution where Blake and Lisa choose to go. If
money is going directly to the college to pay for the tuition, this is an exemption from gift tax.
The second option is that she does not disclaim the inheritance. In this scenario, she gifts Blake and Lisa
the gift amount each year ($14,000 for 2014). This money could be put into the 529 plan, (as long as the
maximum contribution limit is not reached this is dependent of the state and the value can range from
$100,000 to $250,000). This way Joanne would not be subject to undue gift taxes.
The third option is that she disclaims the inheritance. In this choice Joanne would not have a choice
where the money goes. The money goes back to the estate where the estate would direct the money
appropriately per the will. Of the three, this is my least favorite option. The reason being is that Joanne
is adamant of sending her portion to Blake and Lisa. This option does not allow her to direct the assets.
One of the first two options is the options that I would recommend to further consider. This is because
Joanne will have the option to direct the proceeds without paying undue gift tax. She may have to sit on
the money for some time (depending on which option is selected), but she will have the option to direct
her portion of the inheritance without paying undue gift tax.