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Introduction
The financial planning process enables an individual or a family to plan for his earnings with an aim of converting finances to wealth.
The process comprises of six basic steps these are, establishing and identifying a relationship with the client, gathering client data including goals, analyzing and evaluating the financial status of the client, coming up and presenting financial planning recommendations and alternatives, implementing the financial planning recommendations, and monitoring the implementation of the recommendations (Keown et. al. 10).
This paper aims at carrying financial planning for Alves Family.
Gathering qualitative and quantitative information of the Alves Family
The table below summarizes the current financial situation of the family.
Goals of the family
- George expects to retire at the age of 60 while Marianne will not retire at the same time with George. Both will continue with the internet business.
- The monthly after tax income needed after retirement is 60% of their current net income (60% * $65,000). This amounts to $39,000 at current prices.
- The family requires the 60% income until the last expectancy age of 90.
- To meet the education goals of the family, they need to save $7,000 annually. It is equivalent to $583 monthly. (Explanation: The family intends to save half of the fee per child for university education. It is be payable at the beginning of each academic year. Fee per child $7,000. For two children, the total amount is $14,000. Therefore annual savings is half of $14,000 = $7,000. The monthly savings is $7,000/12 = $583).
Analyzing other qualitative details
- When it comes to asset allocation, the family portrays an aggressive investor. It is shown by the ratio of assets and debt or net worth. Most resources are allocated to assets hence a high net worth.
- The total value of long term care assets at risk amounts to $55,650.
- The net estimated Life Insurance Needs Shortage for George amounts to $93,000.
- The net estimated Life Insurance Needs Shortage for Marianne amounts to $ 2,000.
- George and Marianne do not have wills.
- George and Marianne have Durable Powers of Attorney.
- Both George and Marianne have Health Care Powers of Attorney.
Financial Statements of Alves Family
Statement of income and Expenses
From the previous year’s values, total net income after taxes amounted to $65,000 while total expenses amounted to $64,461. Alves Family made a surplus of $539.
Net worth Statement
The table below shows the net worth statement of Alves Family.
Analyzing information
Ratio analysis
Ratios can be computed to determine the leverage, profitability and liquidity of Alves Family. The table below shows various financial statement ratios.
Four ratios are computed to analyze the financial position of the family. From the calculations, it is evident that the family has very high liquidity amounting to 8.61. It shows that the family is in a position to meet their obligations which fall due within a year. In addition, we can also deduce that the family puts plenty of liquid assets idle. Return on assets is at 8.42%.
This indicates that the family receives dismal returns from their assets. They need to consider venturing into more profitable areas. However, this depends on risk appetite of the family. The net profit margin of the family is high at 30.39%. Finally, the debt of the Family is adequately covered by the total assets at 43.38%.
Tax planning
The aim of tax planning is to organize the financial resources of the company with an intention of reducing tax liability. The net effect is an increase in disposal income of the family. There are three ways the family can reduce taxes these are, reducing income, increasing expenses and making use of the tax credits. Before retirement, the family operates within a tax bracket of 28%.
After retirement, the family will be in a tax bracket of 25%. Further, the family lives in a region where sales tax is 8.5%. As a measure to reduce taxes, the family can increase the length of their investment so that they mature after retirement. This will enable the Family pay the lowest amount of tax.
Cash and debt management
George keeps money in a chequing account which earns no interest but attracts a monthly charge of $15 while Marianne keeps her money in a savings account which earns interest. In case of emergency, George relies on the money in the chequing account which amounts to $14,200 and the investments in GIC and Canada investment bond. The family has a gold card for George and a companion card for Marianne.
The cards attract an annual fee amounting to $185. In addition, the family has a mortgage with a balance of $28,972. Debt comes with costs. Therefore, the family needs to reduce debt so as to eliminate the cost associated with it.
This should be done after prioritizing which should be paid off first, the cost implication and the benefits that will arise from such decision. The family decided to pay off the mortgage first in two years and use a credit card only when necessary.
Risk management and insurance
Work carried out by George involves high risk. Despite the riskiness of the job, the employer does not provide any disability coverage since mishaps are negligible. The company also offers its employees sick leave provision for three months.
George’s employer provides a group life insurance policy up to a three times the gross salary. George took coverage amounting to $185,000. Further, George has liability coverage against accident in his homeowner’s package. The table below shows the insurance summary of the family
There is an insurance cover for George only in the whole family. The insurance is paid by the employer and it benefits only George. Further, the family did not have any insurance included in the estate.
Survivor need analysis
In the event that premature death happen, survivors may not have adequate earnings to enable them keep their lifestyle. Therefore, it is necessary to take insurance coverage that will be adequate to take care of all immediate needs. Comparison of current and future household expense levels with anticipated surviving spouse’s income together with anticipated benefits gives an estimate of appropriate level of life insurance to take.
Others family assets such as pension and retirement accounts are also used in the survivor need analysis. It is of essence to calculate life insurance basic needs estimate for each spouse. This will help reveal additional life insurance coverage that the spouse needs to take (Keown et. al. 15).
Disability income insurance
Apart from death, disability of a spouse may also distort financial planning of a family. Disability have an effect of increasing the annual expenses (increase arising from increase medical cost) accompanied by a decline in income. Therefore, a family may run out of funds easily.
Disability insurance aims at restoring the earnings after tax of the insured earnings earner. This helps in restoring the existing life style of the family (Keown et. al. 27). The table below shows the disability income insurance needs for the family.
The suggested need of disability insurance for George is $35,750 while that of Marianne is $6,500. The total disability income insurance need for the family is $42,250 per annum. Other factors may also affect the disability income insurance needs.
Some of these factors are the amount of pension income, the inflation rate in the country, variation in living expenses, and changes in tax rates among other factors. These factors have the effect of varying the amounts used in computing the disability income insurance amount.
Long term care
Long term care denotes continued custodial or medical care in a health institution of a nursing home or at the residence of the patient. Long term care is provided to people who are unable to carry out one or two activities of their daily life that is, they cannot take care of themselves. Therefore, long term care insurance provides coverage for expenses for care needed beyond a prearranged duration.
The benefits of this insurance policy start after meeting certain conditions. The needs to be insured under long term care insurance are impaired cognitive ability and inability to carry out daily living activities.
From the information gathered from various centers, the cost of long term care in a hospital ranges between $58,000 and $100,000 per annum. This might not be affordable by many families. In addition, the amount required for the long term care increases as an individual ages (Keown et. al. 28). The table below shows estimated long term care requirement for the family.
The amount of financial assets that is exposed to long term care expenses at risk amounts to $55,650. It is not adequate to meet the long term care needs for the family. The family has a shortage of about $79, 400.
Looking at insurance, risk management and insurance, it is clear that the family is not adequately protected. The family only relies on the insurance protection that comes with the homeowner’s package. Other than that, Mr. George has insurance cover that is paid for by the employer. It is evident that the family is not well protected in case of any eventuality.
In the event that one spouse dies or his disabled permanently the family may not be able to maintain their lifestyle since they are not insured. In addition, the family is not adequately covered for the long term care needs. During their old age, they will not be able to provide for their needs thus depleting the family wealth rapidly.
Investment management
Investment management aims at managing the risks associated with investment and maximizing returns. Basically, there are three common risks associated with investments these are, market risk, inflation risk and credit risk. These risks have the effect of reducing the value of investments or losing the whole amount invested.
Inflation risk denotes the risk of the value of investment wearing down as a result of raising living standards in the economy. Market risk arises from fluctuations in prices and performance of investments in the market. Credit risk arises from loss of value of investment for instance bonds of a bankrupt company. Therefore, asset allocation is important to help distribute assets so as to minimize investment risk.
Allocation of assets is based on past market trends and volatility. The past trends help in allocating resources for the future. This is based on the assumption that the past will repeat itself (Keown et. al. 13). The table below summarizes the investments of the Alves Family.
The total investment need to be distributed in such a way that the investment risk is minimized to a great extent while returns are maximized.
From the table above, the total investment asset of the Family is $71,150. It is necessary to point out that the family keeps a lot of ($14,200) in accounts which do not earn interest. The family needs to invest the money in profitable investments. The current and suggested asset allocation is shown in the table below.
The pie chart below shows the current situation of asset allocation
The pie chart below shows the suggested asset allocation that would maximize returns for the family
Retirement planning
Planning for retirement entails understanding the current financial situation,
This section aims at coming up with alternatives, choosing an alternative from the lists available and taking an action at present. The table below shows the current retirement goals of the family.
Other expenses
Assumptions made when coming up with the values
The mortgage balance will be paid at an interest rate of 6.5%. The amount is adjusted for annual appreciation of the building and inflation rate.
Resources for retirement
This section looks at the resources available for retirement such as retirement plans, social security, pension benefits and other income. The table below shows the state of the current situation of Alves Family.
From the above table, the total investing asset available for the family is $32,450. It is because George considers that only the money in his pension plan and RRSP will be used for retirement purposes. Therefore, all other investments will not be available for retirement. The cost after retirement for the family amounts to $39,000 while the available investment assets are $32,450. This shows a shortfall amounting to $6,550.
Estate planning issues
Estate planning is a vital element of financial planning for a family. It needs to be integrated with other components of financial planning such as retirement and insurance planning. This section shows the estate planning concepts. It also demonstrates the benefits that arise from the use of available estate planning techniques.
The ultimate goal of most clients is to decrease tax exposure of their estates. Other goals include estate liquidity, managing probate, administrative expenses, caring for the beneficiaries, having control over assets, ensuring equitable distribution of assets and general lifetime planning.
Estate planning needs to be monitored frequently to ensure that all that were planned for are under control (Keown et. al. 32). The table below shows the current situation of Alves Family.
Assumptions
- Assume that the administrative and probate expenses are 3% of the total estate assets.
- Also, assume that the estimated final expenses are $10,000.
The table below shows the existing estate planning of the family.
The table below shows the estate net worth statement for the family.
From the table above, George’s gross estate amount to $101, 600 while Marianne’s gross estate amounts to $188,500. Estate taxes are at 0%, therefore both of them will not pay taxes. The administration and probate expenses are at 3% of the value of the estate. This amounts to $3,048 for George and $937.5 for Mary. The final expenses totals to 10,000 for both of them.
Alignment of financial resources and goals
This section will give the financial forecasts for the family for five years starting with 2012. The forecasts will take into considerations the goals of the family.
From the above table, if Alves family pursues all the goals then expenses will exceed net revenue in 2012 and 2013. It is because the family will incur about an additional $21,369 with no increase in income. This deficit should not arise during financial planning.
There are no adjustments required for the value of the net worth. However, it is inevitable to point out that the amount of net worth will increase by $100,000 once the family completes paying the mortgage.
Recommendations to achieve the goals
Based on the forecasts and the discussion above, Alves Family may not be in a financial position to achieve all their goals. This applies paying off the mortgage balance of $28,972 within the next two years, renovating the kitchen and vacation. It is important for the Family to weigh various options that will ensure that the expenses do not exceed income.
The annual payment of the mortgage is $16,369 (taking into account the new interest rate of 6.5%). Renovating the kitchen costs $5,000 per year while vacation costs $6,500. The affordable option for the family is to repay the mortgage in two years (2012 and 2013) as planned.
Vacation and renovation of the kitchen to start after the two years that is, 2014. This arrangement will yield the family a positive surplus for all the years as shown in the table below.
Apart from rescheduling their goals, the family should also take adequate insurance coverage. This will ensure that they are able to maintain their existing lifestyle in the event of any eventuality. In addition, it will guarantee both George and Marianne a peaceful life in their old age.
Assumptions made in the analysis
Other than the information provided in the case study, there are some other assumptions that are made in the analysis. The assumptions are summarized in the table below.
Works Cited
Keown, Arthur, Eldon Gardner, Khalil Torbzadeh and Gordon Dixon. Personal Finance: Turning Money into Wealth. Asia: Pearson Education Inc., 2004. Print.
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