Alves Family Financial Planning Case Study

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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.

ItemAmount ($)
1Total assets: Marianne234,650
Marianne1,300
George69850
Combined assets163500
2Total liabilities101, 800
Current liabilities – line of credit for Marianne1,800
Long term liabilities – mortgage100,000
3Net worth of the family (Total assets – total liabilities)132,850
4Total working assets (assets which continuously flow in and out of the family)15,500

Goals of the family

  1. 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.
  2. 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.
  3. The family requires the 60% income until the last expectancy age of 90.
  4. 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

  1. 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.
  2. The total value of long term care assets at risk amounts to $55,650.
  3. The net estimated Life Insurance Needs Shortage for George amounts to $93,000.
  4. The net estimated Life Insurance Needs Shortage for Marianne amounts to $ 2,000.
  5. George and Marianne do not have wills.
  6. George and Marianne have Durable Powers of Attorney.
  7. Both George and Marianne have Health Care Powers of Attorney.

Financial Statements of Alves Family

Statement of income and Expenses

ItemAmount ($)
Net income
George55,000
Marianne10,000
Total65,000
Annual expenses
Housing:
Mortgage payment10,716
Property tax1,200
Property insurance700
Maintenance2,000
Utilities, heat, phone and others5,600
Automobile:
Payments8,500
Gas, insurance, repairs4,445
Parental care6,000
Health and hygiene4,100
Groceries3,200
Clothing3,500
Miscellaneous (Charitable donations, gifts, etc.)8,500
RRSP contribution2,000
Leisure and travel4,000
Total expenses64,461
Surplus539

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.

Assets($)($)
Liquid assets:
Chequing Account14,200
Savings Account1,30015,500
Investment:
Registered (RRSPs):
BlueBell Canadian equity fund24,000
Non – registered:
Government of Saskatchewan bond10,000
Canada savings bond5,200
GIC8,000
BlueBell Canadian Equity Fund8,45055,650
Personal:
Residence120,000
Household furnishings35,000
Car8500163, 500
Total assets234,650
Liabilities
Current liabilities:
Line of credit – Marianne business1,8001,800
Long term liabilities:
Mortgage100,000100,000
Total liabilities101,800
Net worth (Assets – liabilities)132,850

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.

RatiosValue
Liquidity
1Current ratio = current assets/current liabilities8.61
Profitability ratios
2Return on assets = net income/total assets8.42%
3Net profit margin = Net profit/revenue30.39%
Leverage ratio
4Debt to asset ratio = total debt/total assets43.38%

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

Company name
InsuredGeorge
OwnerGeorge
BeneficiaryGeorge
TypeTerm
Death benefit$185, 000
Annual premium
Total premiums paid
Current cash values

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.

GeorgeMarianne
Current income$55,000Current income$10,000
Replacement ratio *65%Replacement ratio *65%
Suggested insurance need$35,750Suggested insurance need$6,500

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.

GeorgeMarianne
Probable daily care cost$185$185
Probable annual care cost$67,525$67,525
Probable years of care77
Inflation rate2.5%2.5%

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.

Investments
Liquid assets:
Chequing Account14,200
Savings Account1,30015,500
Investment:
Registered (RRSPs):
BlueBell Canadian equity fund24,000
Non – registered:
Government of Saskatchewan bond10,000
Canada savings bond5,200
GIC8,000
BlueBell Canadian Equity Fund8,45055,650
Total investment71,150

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.

Asset allocation
CurrentSuggestedChange
Cash & reserves924913%35575%-5692
Income1707624%00%-17076
Income & growth44825.63%10673.15%-34152
Growth00%2846040%28460
Aggressive growth00%2846040%28460
Others00%0%0
Total71,150100%71,150100%0

The pie chart below shows the current situation of asset allocation

The current situation of asset allocation

The pie chart below shows the suggested asset allocation that would maximize returns for the family

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.

GeorgeMary
Age3838
Retirement age6060
Years until retirement2222
Years of retirement2732
Annual after tax retirement spending$39,000 (expressed in dollar prices at present)

Other expenses

ExpenseAmountStarting yearIncrease rateDuration the expense will last
Remodel Kitchen$5,00020120%2
Mortgage$16,36920130%2 years
College: Estelle$3,50020152.5%4
College: Jonathan$3,50020182.5%4
Vacation$6,50020122.5%3 years

Assumptions made when coming up with the values

Rate before retirementRate after retirement
1Inflation rate2.5%2.5%
2Average income tax rate26.0%19.0%
3Average return on investments7.5%7.5%

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.

ItemAmount
Retirement plans
BlueBell Canadian Equity Fund24,000
BlueBell Canadian Equity Fund8,450
Total investment assets32,450

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.

Basic dataGeorgeMarianne
Current age3838
Age at death (Assume that the age at death is similar to their current age)3838

Assumptions

  1. Assume that the administrative and probate expenses are 3% of the total estate assets.
  2. Also, assume that the estimated final expenses are $10,000.

The table below shows the existing estate planning of the family.

Existing estate planning
ItemGeorgeMarianne
WillNoNo
Revocable living trustNoNo
Marital trust provisionsNoNo
Credit shelter trust provisionsNoNo
QTIP trust provisionNoNo
General skip trust provisionsNoNo
Irrevocable life insurance trustNoNo
Durable general power of attorneyYesYes
Durable health care power of attorneyYesYes
Living Will
Existing percentage of the estate in the living trust0%0%

The table below shows the estate net worth statement for the family.

GeorgeMarianneCombinedTotal
Assets
Savings and investment:
Chequing account14,20014,200
Savings account1,3001,300
Government of Saskatchewan bond10,00010,000
Canada Savings bonds5,2005,200
GIC8,0008,000
Retirement account:
BlueBell Canadian Equity fund24,00024,000
BlueBell Canadian Equity fund8,4508,450
Personal:
Residence120,000120,000
Household furnishings35,00035,000
Car8,5008,500
Total assets69,8501,300163,500234,650
Liabilities
Line of credit – Marianne’s business1,8001,800
Mortgage100,000100,000
Total liabilities01,800100,000101,800
Net worth69,850(500)63,500132,850
Adjustments:
Estate share of joint property31,75031,750
Life insurance in estate00
Estate net worth101,60031,250

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.

Item2011
($)
2012
($)
2013
($)
2014
($)
2015
($)
2016
($)
Net income
George55,00055,00055,00055,00055,00055,000
Marianne10,00010,00010,00010,00010,00010,000
Total65,00065,00065,00065,00065,00065,000
Annual expenses
Housing:
Remodel kitchen05,0005,000000
Mortgage repayment10,71616,36916,369000
Mortgage payment – property tax1,2001,2001,2001,2001,2001,200
Property insurance700700700700700700
Maintenance2,0002,0002,0002,0002,0002,000
Utilities, heat, phone and others5,6005,6005,6005,6005,6005,600
College Estelle00003,5003,500
College Jonathan000000
Automobile:000000
Payments8,50000000
Payments – gas, insurance, repairs4,4454,4454,4454,4454,4454,445
Parental care6,0006,0006,0006,0006,0006,000
Health and hygiene4,1004,1004,1004,1004,1004,100
Groceries3,2003,2003,2003,2003,2003,200
Clothing3,5003,5003,5003,5003,5003,500
Miscellaneous (Charitable donations, gifts, etc.)8,5008,5008,5008,5008,5008,500
RRSP contribution2,0002,0002,0002,0002,0002,000
Leisure and travel4,0004,0004,0004,0004,0004,000
Vacation06,5006,5006,50000
Total expenses64,46173,11473,11451,74548,74548,745
Surplus539-8,114-8,11413,25516,25516,255

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.

Item201120122013201420152016
Surplus5393,3863,3868,2554,7559,755

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.

Asset Allocation
CurrentSuggested
1Cash & reserves13%5%
2Income24%0%
3Income & growth63%15%
4Growth0%40%
5Aggressive growth0%40%
6Others0%0%
Total100%100%
Rate assumptions (before & after retirement)
Before retirementAfter retirement
Effective tax rates28%25%
Life expectancy for George and Marianne is 90 years.
Administrative and probate expenses are 3% of the total estate assets

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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