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This document generally follows the procedures a financial planner might observe in pre- senting a comprehensive financial plan. Of course, as noted in the text, planners vary widely in their form of presentation. The plan is now presented as a completed document in contrast to each chapter’s material, which was sometimes provided on a stand-alone basis. Therefore, the integration described in the final chapter, the key to comprehensive financial planning, has already been performed. Aside from the interactive-related changes, the content is similar to that given at the end of each chapter. However, certain material such as review material has been omitted, the order has been shifted, the wording changed somewhat, and some figures in the statements have been revised using our final projections.

OVERVIEW

Personal financial planning is the process of supervising your financial activities so that you can meet the goals you have set out. In order to accomplish those goals, it is helpful to con- struct a financial plan. This document will consider your goals overall, compare them with your current and future resources, and establish a plan for attaining them. In addition to outlining your goals and current assets, the plan consists of the following active areas: cash flow planning, tax planning, investments, risk management, retirement planning, estate planning, educational planning, employee benefits planning, and special circumstances planning, sometimes incorporated in other sections for all else that is financially relevant.

GOALS

Your financial plan will provide the best way for you to achieve your goals. Goals moti- vate you to plan your financial future in an orderly way. As you indicated to me in our first meeting and the one we just had, your goals are as follows:

1. To get out of credit card debt and repay student loans as soon as possible.

2. To be less concerned about the future by planning now.

3. To have two children and maintain the standard of living you have today.

4. To purchase a house in the not-too-distant future.

5. To be financially independent by age 55.

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Web Appendix D Comprehensive Financial Plan—Dan and Laura 141

6. To have your insurance needs examined.

7. To provide money for both children to go to college.

8. To leave $100,000 to each child in your will.

9. To develop an overall asset allocation for your investments.

We will approach these individual goals with an eye toward bridging your individual differences. For instance, while you, Laura, are relaxed and confident about finances in general, Dan is more of a “worrier” about money.

Summary Our analysis indicates that you can achieve most of your financial goals. In a couple of areas, we will recommend adjustments to the goals. Overall, we consider this a very posi- tive result. Specifically, we will outline a plan for ridding yourselves of debt in a timely, structured way. We see no reason why you cannot contribute to your children’s college education, as you would like. We believe that for you to reach financial independence by age 55 would require larger sacrifices between now and then than you would be comfortable with. Therefore, we will recommend that you postpone retirement until age 60. We will recommend that you purchase significant amounts of life insurance so that the needs of your children and the surviving spouse can be met should one of you die prematurely. Regarding your investments, we have set out a detailed asset allocation that will diver- sify you and should provide excellent long-term growth. We will elaborate on each of these and other recommendations in the text.

BALANCE SHEET Introduction As you’ve learned, financial planning is a process that sets goals. But goals cannot be set abstractly. Instead, they must be set in connection with resources. The balance sheet indi- cates the resources that are available. It is a statement of assets, liabilities, and household equity at a point in time. Assets are items that have value to the household going forward. Assets are placed on the left-hand side of the balance sheet. They can be separated into current assets and long-term assets. Current assets are those that are likely to be consumed within the year whereas long-term assets extend beyond a one-year time frame. The balance sheet is separated into current assets, marketable investments, retirement investments, real estate, household assets, and other assets such as household overhead and leisure time. The most prominent business asset for the household is typically the future income stream of its wage earners, called human assets. But because human capital can’t be sold, it isn’t usually placed on balance sheets. Other business assets could be a computer or business car. Marketable assets might include stocks and bonds. Retirement assets are, of course, segregated for use when you’re no longer earning a salary. Real estate is your home. Household assets might include a car, a refrigerator, a television, a VCR, a stereo, a boat, and so on. Liabilities are items the household owes. They are placed on the right-hand side of the balance sheet. Credit card debts, taxes payable, and mortgage debt are all liabilities. They too can be split into current and long term based on whether they are due within one year or beyond that period. Household equity is the difference between assets and liabilities. It is intended to show how much the household is worth at that point in time.

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142 Web Appendix D Comprehensive Financial Plan—Dan and Laura

Household equity can be relatively small or even negative when household members are young and generally increases as their marketable investment portion rises. Net work- ing capital is a figure reached by subtracting current liabilities from current assets. It rep- resents the cash that will become available over the next 12 months to pay liabilities that will fall due over that period. Consequently, a strong balance sheet will have a positive net working capital.

Discussion Your current financial condition as shown in the statement in Table D.1 is fairly positive. Your biggest strength is having $137,000 in marketable assets. On the negative side, you have $27,000 in current liabilities and only $3,000 in current cash. When your long-term liabilities of about $59,000 are added in, your net worth is a positive $88,000. In addition, both you and Dan have strong future income prospects that aren’t included as assets in the current statement. The only negative is a weak net working capital position if we exclude your money market funds under marketable investments as you like us to because you don’t want to dip into them. Excluding those assets, your current liability ex- ceeds your current assets. The important thing to recognize is that your balance sheet is currently fairly strong. However, it doesn’t reflect your human assets, your future earning ability. With the proper care, these human assets will bring about an even stronger future financial position.

CASH FLOW PLANNING Introduction The cash flow statement is sort of an income statement for the household. However, it is broader than a business income statement. It includes not only cash inflows such as job related income and day-to-day expenses, but also capital expenditures—larger outlays for items that last for more than one year—and debt indicating whether borrowings have

Assets Liabilities

Current Assets Current Liabilities Checking accounts $2,800 Credit card debt $20,000 Refund due on returned clothing 200 Educational loan—current 7,000 Total Current Assets $3,000 Total Current Liabilities $27,000

Marketable Investments Long-Term Liabilities

Money market funds1 $34,000 Educational loan—LT portion $39,000 Stocks and stock funds 103,000 Loan from parents 20,000 Total Marketable Investments $137,000 Total Long-Term Liabilities $59,000

Pension Assets

401(k) plans $6,000 Total Liabilities $86,000 IRAs 4,000 Total Pension Assets $10,000

Fixed Household Assets EQUITY

Autos $12,000 Household equity $88,000 Furniture and fixtures 7,000 Total Equity (Net Worth) $88,000 Other 5,000 Total Fixed Household Assets $24,000 Total Assets $174,000 Total Liabilities and Equity $174,000

1 Not considered part of the current assets because the amount won’t be used currently. Instead, it is set aside under marketable investments for long-term use.

TABLE D.1 Balance Sheet

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increased or declined for the year. A functional cash flow statement separates these catego- ries to make it simpler to analyze them. Once cash outflows have been deducted from cash inflows, you have the net cash flow for the year. That is the amount of cash that you’ve received or expended during the year. Under the finance disciplines approach, cash is often the focus and is most easy to identify. All you do is look at your cash at the beginning of the period and compare it with the endof-period figure. The difference should be net cash flow for the year. Cash flow planning is the scheduling of cash outflows to meet near and long-term re- sources. It is often at the heart of a financial plan. Generally, without cash flow, household goals cannot be met. Cash flow planning is particularly important for couples like your- selves. You have to establish the structure to live within your means. That entails saving enough money to fund your goals: these extend from buying a home, to educating your current and anticipated children, to retirement. Where cutbacks are called for, as they are here, it is important to retain those expenditures that each of you believes are particularly important for an enjoyable life.

Discussion Your projected income for the current year is approximately $104,000, and your pro- jected expenses are approximately $117,000, giving you negative cash flow of about $13,000. Your income includes Dan’s salary of $100,000 and investment income of about $4,000. Your expenses before recommended changes include

• Nondiscretionary items (including taxes) totaling about $80,000.

• Discretionary items of about $25,000.

• Capital expenditures of about $6,000 and financing activities of about $6,000.

Observations and Recommendations As noted above, you are projected to run a cash flow deficit this year. That deficit would be projected to increase in the years going forward, with the addition of a second child, the purchase of a home and additional insurance, and other capital expenditures. A rise in some discretionary expenses as a result of the new baby is unavoidable, and I believe that the capital expenditures you are making, including the new home, are wise ones. Nevertheless, growing deficits threaten to put your larger goals at risk. Therefore, I will recommend that you reduce your spending elsewhere. There are a number of areas that appear to be particularly suited being examined and perhaps cut. Among the areas are va- cations, eating out, and clothing. Clothing is treated as an overhead item called nondiscretionary expenses. However, it’s clear that you spend more than is necessary to dress yourself adequately. In fact, the act of shopping and finding interesting items is an enjoyable leisure pursuit. Despite that obser- vation, to simplify things, I’ve included all clothing outlays under the nondiscretionary category. Vacations and eating out are true discretionary expenses. Note that one year ago, all these expenses were considerably lower, which suggests that they could be reduced without dramatically affecting your lifestyle. I believe cutbacks are absolutely necessary for you to realize your goals. In certain cases, the figures even with cutbacks are not that different from those outlays you had last year. I’ve attached a schedule of cutbacks. Notice that they are focused on delivered food, clothing (even though they are placed entirely under the nondiscretionary column for con- venience purposes, both of them have a discretionary component), recreational and per- sonal outlays, and vacations. If there’s an objection to any area of cutbacks, substitute another that provides the same amount of savings.

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The result of these efforts will be to place you on a better financial footing, including an ability to continue making pension payments. I recommend that, as a structuring mecha- nism and to put you in the “savings habit,” you do the following:

1. Establish separate savings accounts for anticipated educational needs and contingen- cies. Placing these in separate “buckets” for each item can better relate savings to a tangible goal. It also can make you more reluctant to withdraw monies for nonessential needs. You are fortunate that Laura’s parents have volunteered to gift you $65,000 provided it is used for the down payment on a home. One bucket down already.

2. You can begin funding these buckets immediately out of your marketable investments, which now total $137,000. With Laura not working, you are projected to run a deficit of close to $90,000 over the next five years. We recommend that you set aside $90,000 in a bucket to cover those deficits. The remaining marketable securities can be used to create an emergency fund, begin a college savings bucket, or fund 401(k)/IRA contribu- tions each year because funds won’t be available from Dan’s salary.

3. Write a check to each account at the beginning of each of Dan’s bimonthly pay periods. We project, however, that you won’t be able to begin doing so until 2020. Not going beyond the remaining amounts in your checking account can be an important structuring tool.

4. Be aware of your spending habits, particularly in the area discussed. However, as long as you don’t do it too often, reward yourself occasionally with a spending “treat” when you have accomplished savings-spending goals for a period of time.

Recognize that your cash flow concerns should ease considerably once Laura goes back to work. Thereafter, the net cash flow will continue to show a deficit, but it will arise from targeted savings with the cash flow before the targeted amounts demonstrating healthy positive figures. In fact, I am building into my longer-term projections an assumption that at least some of the cuts I recommend currently will be restored in 2020, and other expenses (child care, for example) will be added. The cash flow statement is attached (see Table D.2).

Schedule of Cutbacks

2015

Before Plan After Plan

Nondiscretionary Groceries $5,800 $6,800 Delivered food 3,000 0 Total food 8,800 6,800

Dan’s clothing 4,000 3,000 Laura’s clothing 7,000 5,000 Baby’s clothing 2,500 4,000 Total clothing $13,500 $12,000

Total Nondiscretionary $22,300 $18,800

Discretionary

Recreation/entertainment $6,000 $3,000 Personal 6,500 4,000 Vacations 8,000 4,000 Total Discretionary $20,500 $11,000

Total Nondiscretionary and $42,800 $29,800 Discretionary

Total savings $13,000*

* This figure is the sum of the cutbacks as represented by the differences between After Plan and Before Plan columns.

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(continued)

TABLE D.2 Projected Cash Flow Statement

2015 2016 2017 2018 2019 2020 2021

Before After Operating Activities Plan Plan

Income Total compensation $100,000 $100,000 $110,000 $121,000 $133,100 $146,410 $240,882 $259,352 Total investment income 4,000 4,000 4,000 4,000 4,000 4,000 4,000 4,000 Total other income (gift from parents) 0 65,000 0 0 0 0 0 0

Total Income $104,000 $169,000 $114,000 $125,000 $137,100 $150,410 $244,882 $263,352

Expenses

Nondiscretionary Rent $15,000 $15,000 $0 $0 $0 $0 $0 $0 Property tax 0 0 2,500 2,575 2,652 2,732 2,814 2,898 Upkeep and insurance 2,000 2,000 3,000 3,090 3,183 3,278 3,377 3,478 Utilities 3,600 3,700 3,708 3,819 3,934 4,052 4,173 4,299 Furnishings/moving 1,000 1,000 12,530 1,061 1,093 1,126 1,159 1,194 Mortgage interest 0 0 17,219 17,066 16,902 16,727 16,538 16,336 Total housing $21,600 $21,600 $38,957 $27,611 $27,764 $27,914 $28,061 $28,205 Insurance 2,050 5,950 7,090 7,183 7,278 7,377 7,478 7,582 Professional fees 0 4,000 1,030 1,061 1,093 1,126 1,159 1,194 Child care (babysitter) 3,000 3,000 3,090 3,183 3,278 3,377 6,956 7,194 Groceries 5,800 6,800 7,004 7,214 7,431 7,653 7,883 8,120 Delivered food 3,000 0 0 0 0 0 3,478 3,582 Total food 8,800 6,800 7,004 7,214 7,431 7,653 11,361 11,702 Clothing 13,500 12,000 12,360 13,731 13,113 13,506 13,911 14,329 Health care (out of pocket) 1,350 1,350 1,648 1,697 1,748 1,801 1,855 1,910 Transportation 4,500 4,500 5,408 5,570 5,737 5,909 9,564 9,851 Credit card interest 0 0 0 0 0 0 0 0 Income and payroll tax 25,080 25,080 23,917 17,209 30,835 36,956 71,900 78,410 Total Nondiscretionary $79,880 $84,280 $100,503 $93,458 $98,277 $105,617 $152,245 $160,347

Cash Flow before $24,120 $84,720 $13,497 $31,542 $38,823 $44,793 $92,636 $103,005 Discretionary Expenses

Discretionary Recreation/entertainment $6,000 $3,000 $3,090 $3,183 $3,278 $3,377 $6,956 $7,164 Personal 6,500 4,000 4,120 4,244 4,371 4,502 7,535 7,761 Vacations 8,000 4,000 4,120 4,244 4,371 4,502 9,274 9,552 Gifts and charitable 2,000 2,000 2,060 2,122 2,185 2,251 2,319 2,388 contributions Hobbies 2,750 2,750 2,833 2,917 3,005 3,095 3,188 3,284

Total Discretionary $25,250 $15,750 $16,223 $16,709 $17,210 $17,727 $29,272 $30,150

Cash Flow from ($1,130) $68,970 ($2,726) $14,833 $21,613 $27,066 $63,365 $72,855 Operations

Capital Expenditures

Purchase of home $0 $0 $250,000 $0 $0 $0 $0 $0 Total education expenses1 2,666 2,666 24,924 26,046 27,234 28,494 1,458 1,170 Household maintenance2 1,000 31,000 1,030 1,061 1,093 1,126 1,159 1,194

Leisure 2,000 2,000 2,060 2,122 2,185 2,251 2,319 2,388 Total Capital Expenditures $5,666 $35,666 $278,014 $29,229 $30,513 $31,870 $4,936 $4,752

Cash Flow before ($6,796) $33,304 ($280,740) ($14,396) ($8,900) ($4,805) $58,429 $68,103 Financing Activities

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It includes the purchase of a car this year and a home next year. You’ll note that the plan includes a before-planning and after-planning column for the current year, indicating the spending cuts and other changes that I recommend. The material changes will be discussed in the appropriate sections of the plan.

DEBT Introduction Borrowing can be a positive or a negative force in financial planning. Borrowing for capital expenditures that improve income-earning abilities, or for those that reduce ongoing costs, can be highly effective. On the other hand, significant monies borrowed to support normal household expenditures over a period of time should be discouraged. It can lead to a depen- dence on debt and an ever-rising monthly interest and debt repayment schedule that can re- tard your financial planning. In other words, borrowing can make household operations more efficient more quickly, but it also can add to risk and potentially derail your plans.

Discussion Your own situation contains both “good” and “bad” use of debt. The borrowing that Dan made for college enabled him to obtain knowledge and a degree that substantially raised his projected lifetime income. The credit and debt you owe cannot be justified in terms of interest cost or probably even the reason for which the money was spent. Over the next several years until Laura goes back to work, your budget will have to reflect more limited income and higher child rearing and educational costs. Here is my thinking. I understand that debt concerns were the reason you came to see me originally. I also know that the need to move on the recommended purchase of a home has only compounded the problem. The most attractive form of borrowing is home mort- gage debt. Its cost is relatively low, and it is tax deductible.

(concluded )

2015 2016 2017 2018 2019 2020 2021

Before After Operating Activities Plan Plan

Financing Activities

Mortgage principal $0 $0 $2,107 $2,259 $2,423 $2,599 $2,787 $2,989 Student loan principal 3,463 3,463 3,676 3,903 4,144 4,399 4,670 4,958 Credit card payments 3,000 20,000 0 0 0 0 0 0 Total repayments3 6,463 23,463 5,783 6,162 6,567 6,998 7,458 7,948 Mortgage 0 0 (237,500) 0 0 0 0 0 Additional credit card debt 0 0 0 0 0 0 0 0 Total Financing Activities $6,463 $23,463 ($231,717) $6,162 $6,567 $6,998 $7,458 $7,948

CASH FLOW ($13,258) $9,842 ($49,023) ($20,558) ($15,466) ($11,802) $50,972 $60,156

Targeted for retirement4 $0 $0 $0 $0 $0 $0 $50,000 $60,000 Targeted for college 0 0 0 0 0 0 0 0 expenses

NET CASH FLOW ($13,258) $9,842 ($49,023) ($20,558) ($15,466) ($11,802) $972 $156

1 Includes expenses for Laura’s master’s program and student loan interest. 2 Includes $30,000 for Dan’s new car. 3 Includes mortgage, student loan, and credit card principal. 4 The calculation in Chapter 19—Completing the Process indicates $68,000 per year should be targeted for retirement and Web Chapter A—Educational Planning suggests that almost $25,000 per year be set aside annually for the two children starting in 2020. Dan and Laura have agreed to save $50,000 in 2020 and $60,000 in 2021 both years for retirement planning. Given their projected growth in income Dan and Laura will be able to make up for their shortfall in subsequent years for both educational and retirement planning.

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Recommendations I recommend that you

• Finance 90 percent of the cost of the home when you purchase it, if such a loan is available. (Many lenders require 20 percent down, in the wake of the 2008 mortgage meltdown, but some accept smaller amounts. You may temporarily have to pay a higher total interest cost to purchase insurance guaranteeing repayment of the mortgage.) That will result in your temporarily paying a higher interest rate to purchase insurance guaranteeing the lender repayment.

That extra cost will exist until the combination of appreciation on the home and repayment of debt works the debt-to-home-value ratio down to a more reasonable level. Even with the extra cost, the home is still your best form of financing. If you can get your parents to cosign the loan indicating that they will pay the mortgage if you don’t, you may be able to get the home at a regular interest rate.

• Your parents’ role should be able to provide you with the normal 20 percent down payment on the purchase of, say, a $250,000 home. Instead of helping to finance 20 percent of the home, they will finance, say, 5 percent and contribute the remaining amount for Laura’s tuition. Explain to them that you are doing this for tax reasons, as the cost to borrow on the home is lower than the cost to finance a nontax-deductible educational loan.

• Use your existing investments to repay the $20,000 of credit card debt due and $7,000 of student loan debt due. The approximate $65,000 gift from your parents should pay for the 10 percent down payment on the say $250,000 home, moving expenses, and half of Laura’s tuition. It can only enhance the return on Laura going back to graduate school.

• Pay the balance of educational costs in two or three years by liquidating a portion of your investments. In addition, it was nice that Laura’s parents decided to forgive your loan of $20,000 from them.

• In general, limit your use of credit cards as a form of debt. The cards should generally be paid off each month. In a few instances where you have a bulge payment, say for an unplanned expenditure, you can keep the debt outstanding for a few months. It may still be less costly than other forms of borrowing for short periods of time. However, if you don’t have the demonstrated discipline to pay it off over a few months, then I recommend no credit card debt be taken out at all.

• Keep Dan’s existing college debt for now.

A summary of the transactions over a period of years is as follows:

Cash Inflows

Sale of existing investments $72,000 Parental gift 65,000 Total $137,000

Cash Outflows

Repayment of credit card and student loan debt due $27,000 Payment for graduate school costs 80,000 Down payment on home 25,000 Moving expenses 5,000 Total $137,000

Net cash flow $0

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148 Web Appendix D Comprehensive Financial Plan—Dan and Laura

EDUCATIONAL PLANNING Introduction Proper educational planning for your children is one of the highest priorities you have. We have already gone over many of the relevant factors. Let me discuss in what structure the money should be placed. Holding money in a parent’s name has certain advantages and disadvantages. It allows maximum flexibility so that if you change your mind about funding or want to borrow education funds for a time you can. In addition, keeping it in your name will ensure that it cannot be used for noneducational purposes by your children at 18 as could be done if you gifted monies to them. For financial aid purposes, you are more likely to qualify for aid when the money is in the parent’s name. The tax advantages for holding money in special education accounts have diminished now that tax rates on capital gains and dividends on common stocks have dropped. Those advan- tages have not been eliminated, however. In your circumstance, given your income tax bracket, 529 plans may be best. You can deposit up to $140,000 per child in after-tax dollars over a five-year period. The money will compound tax-free and not be subject to taxes, providing it is used for defined educational purposes. If you don’t use all of the monies on education, the gains will be subject to income taxation and an extra 10 percent penalty on withdrawals. The lack of flexibility can be a plus since it will prevent you from withdrawing sums for less impor- tant purposes. Moreover, in your state, the deposits into the 529 account will allow specific state tax benefits. Importantly, the assets remain in the name of the account holder—you. These 529 accounts have little flexibility as to investment decisions. You must delegate investment responsibility to a state-designated investment firm with little choice on asset allocation. If you were to invest the money yourself, of course, you would have much greater freedom to decide on investments. Think about the options and we will speak fur- ther about them in the implementation stage of the plan. I am recommending that you postpone educational funding for five years. At that point, you will be in a better position to make the required savings. I have calculated that at 6  percent inflation, the $20,000-per-year payout today for each child will be approximately $54,000 for Brian and about $60,000 for your unborn child. At the time of starting the sav- ings, Brian will be six and your yet unborn will be four but will enter school at 18. My calculations are shown in the attached schedule (see Table D.3). Your goals for each offspring are similar. I have illustrated both. The cumulative figures for the second funding

Brian

Age 1 Years to college 17

Child 2

Age 0 Years to college 19

General

Annual cost today $20,000 General inflation 3.0% College inflation 6.0% Investment return 5.7% Tax rate1 10.0% After-tax investment return 5.1% Years to college age, Brian 17 Years to college age, child 2 19

TABLE D.3 Educational Needs Analysis

(continued)

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will be approximately the same with a greater period for accumulating the money. For Brian, you would need a lump sum today of about $89,000; for your new baby, the figure would be about $90,500. However, our projections indicate that you will not be able to start contributing to the college accounts until 2020, when Laura returns to work. At that time, you will need to save $12,990 per year for 12 years to fund Brian’s education. For the new baby, we project that you will need to save $11,836 per year for 14 years.

TAX PLANNING

Tax planning is taking advantage of all established methods of reducing your outlays to the gov- ernment. There are five established ways of doing so plus a separate category for investments, and I will explain them all and indicate whether there is any potential for you to use each method.

1. Increasing deductible expenses. Increasing deductible expenses means finding expenses that you did not know were deductible. In addition, you can develop them by grouping expenses of more than a year into one year or by some other method. You indicated that you and Laura contribute your used clothing to charity. You can deduct your contribu- tion at the market value of those clothes.

2. Deferrals. By deferring taxes, you postpone them, which allows investing the amount deferred in the interim. You are doing this now by investing in a Keogh plan, which accepts pretax dollars that aren’t taxed until you start withdrawals.

3. Conversion. Conversion involves shifting income to reduce the tax rate. It can be done by gifting money directly to your child, who is in a lower tax bracket. I don’t recom- mend this. As you will see in point 4, there is a better solution. The second method is to transform ordinary income into capital gains income. I will discuss this soon.

4. Eliminations. With this method, taxes are eliminated entirely. I have two recommenda- tions. The first is to shift from taxable bonds to municipal bonds in your taxable accounts. Municipals from the state you live in provide tax-free income. The second is to consider saving education money in Section 529 plans. After-tax monies are placed in these plans; they compound tax-free and are not taxable when withdrawn and used for defined educational expenses.

(concluded )

Year

Brian 1 2 3 4 5 Education costs inflated $26,928 $57,087 $60,512 $64,143 $33,996 Lump sum needed at beginning of period2 208,326 Lump sum needed, today’s dollars 89,000 Lump sum needed, year 6 114,294 Annual payment needed, beginning $12,990 in year 6

Child 2 Education costs inflated $30,256 $64,143 $67,991 $72,071 $38,197 Lump sum needed at beginning of period 234,075 Lump sum needed, today’s dollars 90,479 Lump sum needed, year 6 116,194 Annual payment needed, beginning $11,836 in year 6 Lump sum needed, today’s dollars $179,479 Lump sum needed, year 6 $230,488

Total level payment beginning in year 6 $ 24,826

1 This is an estimated average tax rate based on the assumption that many but not all of the college funds would be invested in 529 accounts. 2 This is a net present value calculation, which uses for its discount rate the after-tax return.

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150 Web Appendix D Comprehensive Financial Plan—Dan and Laura

5. Timing of income and expenses. Where appropriate, income and expenses can be timed to take advantage of changes in marginal tax rates. I don’t believe there is any opportu- nity here for you.

6. Tax planning for investments. Tax planning for investments uses short- and long-term gains and losses from investments in strategies designed to reduce taxation. You mentioned to me that you had a significant loss on investment in Hypotronics stock, which you in- tended to sell within the next few months. I noticed you have a gain on Clioxin stock al- ready sold. Unless there is some investment reason not to do so, you should consider selling the Hypotronics before the end of the year to partially offset the gain on Clioxin.

As you are probably aware, flexible spending accounts provide a tax deduction but operate under a “use it (by finding a qualified expense) or lose it” approach. I would take the $2,500 amount. I recognize that you may lose $1,000, but after deduction at your marginal tax rate of 29 percent, it would only come to $710. Your indication of a high likelihood of reaching $2,500 makes that the better opportunity. However, if the possibility of an overpayment is disturbing to you, you can skip the last $1,000. Your tax-planning worksheet with the above recommendations included follows. Notice that after this year, your combined marginal tax rate of 29 percent stays constant throughout the next three years, but your average tax rate declines. This is due to the favor- able tax effects of owning a home. Finally, I am pleased that you are taking over preparation of your tax return. The draft work you have shown me up to now suggests that you are handling it in a competent way. It is likely to make you more knowledgeable in financial matters, which won’t hurt person- ally or in business activities. If your tax work results in further organization of your re- cords and thinking, it is likely to save me time and therefore you money in future follow-up work. Why not take a part of any tax savings and spend it together with Laura on a restau- rant or a weekend away, depending on your success in chipping away the tax bill? Your tax projections are presented in Table D.4.

RETIREMENT PLANNING Introduction Retirement planning is considered by many to be the focal point of financial planning. For those people, being able to enjoy a comfortable retirement is their uppermost concern and goal. To be able to do so with confidence, it is important that long-term planning for retire- ment start at an early date.

Discussion Your insightful comments on what retirement might look like have made it easier for me to calculate the financial steps that should be taken to ensure that you can reach your retire- ment objectives. The process of establishing your current situation includes ascertaining your required savings as compared with your current savings. It reflects your retirement goals and all resources to be established before and after retirement. Here are some of the assumptions I have made going forward:

• Inflation. Unless otherwise noted, we assume inflation of 3 percent, with salaries, Social Security, personal expenses, and the value of your home rising at that rate. To the extent inflation is lower than 3 percent, investment returns and expenses can be e xpected to decline as well.

• Investment return. Unless otherwise noted, we assume an annual return of 5.7 percent, before taxes and after expenses.

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TABLE D.4 Tax Planning Statement

2015 2016 2017 2018 2019 2020 2021

Before After Plan Plan

Income Wages $100,000 $100,000 $110,000 $121,000 $133,100 $146,410 $239,882 $258,352 Dividend & Interest $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 Capital Gains $1,500 $1,500 $1,500 $1,500 $1,500 $1,500 $1,500 $1,500 Retirement Account Distributions $0 $0 $0 $0 $0 $0 $0 $0 Other Income $0 $0 $0 $0 $0 $0 $0 $0 Total Income $104,000 $104,000 $114,000 $125,000 $137,100 $150,410 $243,882 $262,352 401(k), IRA Contributions $0 $0 $0 $0 $0 $0 $18,000 $18,000 Student Loan Interest $2,500 $2,500 $2,452 $2,226 $1,985 $1,729 $1,458 $1,170 Total $2,500 $2,500 $2,452 $2,226 $1,985 $1,729 $19,458 $19,170 Adjusted Gross Income $101,500 $101,500 $111,548 $122,774 $135,115 $148,681 $224,424 $243,182 Personal Exemptions $11,700 $11,700 $12,051 $12,413 $12,785 $13,168 $13,564 $13,970 Standard Deductions $12,200 $12,200 $12,566 $12,943 $13,331 $13,731 $14,143 $14,567 Medical and dental expenses $1,350 $1,350 $1,648 $1,697 $1,748 $1,801 $1,855 $1,910 AGI times 10% $10,150 $10,150 $11,155 $12,277 $13,512 $14,868 $22,442 $24,318 Deductible medical & dental expenses $0 $0 $0 $0 $0 $0 $0 $0 State and local income taxes $9,385 $9,385 $10,400 $11,534 $12,780 $14,150 $21,798 $23,692 Real estate taxes $0 $0 $2,500 $2,575 $2,652 $2,732 $2,814 $2,898 Personal Property taxes $0 $0 $0 $0 $0 $0 $0 $0 Other taxes $0 $0 $0 $0 $0 $0 $0 $0 Deductible taxes $9,385 $9,385 $12,900 $14,109 $15,432 $16,882 $24,612 $26,590 Home mortgage interest and points $0 $0 $17,219 $17,066 $16,902 $16,727 $16,538 $16,336 Investment Interest $0 $0 $0 $0 $0 $0 $0 $0 Deductible Interest $0 $0 $17,219 $17,066 $16,902 $16,727 $16,538 $16,336 Deductible gifts to charity $500 $500 $500 $500 $500 $500 $500 $500 Unreimbursed employee expenses $0 $500 $515 $546 $597 $672 $779 $930 Tax preparation fees $0 $0 $0 $0 $0 $0 $0 $0 Other Miscellaneous expenses $0 $2,000 $515 $530 $546 $563 $580 $597 Total Miscellaneous expenses $0 $2,500 $1,030 $1,076 $1,143 $1,235 $1,359 $1,527 AGI times 2% $2,030 $2,030 $2,231 $2,455 $2,702 $2,974 $4,488 $4,864 Allowable miscellaneous expenses $0 $470 $0 $0 $0 $0 $0 $0 Total Itemized deductions $9,885 $10,355 $30,619 $31,675 $32,834 $34,109 $41,650 $43,426 Total Deductions $12,400 $12,400 $30,619 $31,675 $32,834 $34,109 $41,650 $43,426 Total Taxable Income $77,250 $77,250 $68,724 $78,528 $89,332 $101,235 $169,036 $185,606 Tax $11,025 $11,025 $9,979 $12,419 $15,231 $17,021 $34,577 $39,217 Total credits $0 $0 $0 $0 $0 $0 $0 $0 Total other taxes $0 $0 $0 $0 $0 $0 $0 $0 Total federal tax $11,025 $11,025 $9,979 $12,419 $15,231 $17,021 $34,577 $39,217 Total state tax $9,385 $9,385 $10,400 $11,534 $12,780 $14,150 $21,798 $23,692 Total federal and state tax $20,410 $20,410 $20,379 $23,953 $28,011 $31,171 $56,375 $62,909 Social security tax (6.20%) $6,200 $6,200 $6,820 $7,347 $7,347 $7,347 $7,347 $7,347 Medicare tax $1,450 $1,450 $1,595 $1,755 $1,930 $2,123 $3,478 $3,746 FICA Tax $7,650 $7,650 $8,415 $9,102 $9,277 $9,470 $10,825 $11,093 Total tax $28,060 $28,060 $28,794 $33,054 $37,288 $40,641 $67,201 $74,002

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152 Web Appendix D Comprehensive Financial Plan—Dan and Laura

• Salaries. We assume that Dan’s salary will increase by 10 percent per year through 2023, then by the rate of inflation. We assume that Laura will return to work in 2020 at a salary of $68,000 per year in today’s dollars. After that, her salary will rise by the rate of inflation.

• Savings. We assume no savings until 2020, when Laura returns to work.

• Expenses. We assume living expenses in retirement of approximately $81,000 per year, in today’s dollars. This assumes that you will (1) pay off your mortgage in the year in which you retire, (2) move to a community where the cost of living is lower by 15 percent, and (3) add $10,000 per year in today’s dollars in travel expenses.

• Retirement age. Unless otherwise noted, we assume that you will retire at 55.

• Taxes. We assume a marginal federal and state tax rate of 28 percent in retirement.

• Life expectancy. We assume that each of you will live until age 95. We would normally as- sume a modestly younger age of death for Dan. However, he has longevity in his family.

Scenario 1 Under scenario 1, we assumed that you would retire at age 55. However, our calculations indicated that this would require a level of savings far in excess of what will be possible. Therefore, this scenario fails.

Scenario 2 Under scenario 2, we assumed that you would retire at age 60. Under this scenario, we project that it will be necessary to save the equivalent of a level $68,000 beginning in 2020. Given Laura’s return to work and the expectation that Dan will receive 10 percent pay increases through 2023, my projections indicate that these savings targets are reach- able. Therefore, the scenario works.

Recommendations I recommend that you plan to work until age 60, and that to attain your goal of financial in- dependence at that age you begin saving the equivalent of a level $68,000 per year beginning in 2020. I say the equivalent because your savings capability will be different in different years. We anticipate that you will save moderately lower amounts in the first few years after Laura returns to work—you may, for example, need to purchase two new cars at that time— and then modestly more than $68,000 for the remainder of your working years. I can revisit this with you when Laura returns to work to help you arrive at a year-by-year plan. Also, Dan asked whether he should continue funding his 401(k) plan in view of spend- ing pressures on the two of you. The 401(k) plan is not an ordinary savings vehicle. It is one that includes special tax benef its. Pretax dollars are placed into it, which means that the deposits are not taxed at that time. For tax purposes, then, it is as if you didn’t earn that money despite the fact that it will be a strong source of investment and retirement dollars. Income and capital gains also are not taxed currently. It is only when you start withdrawals that the money is taxed. By then you should have generated a substantial nest egg. I refer to qualified plans such as the 401(k) as a “government gift” to make my clients aware of the benefit in participating in it and the concurrent loss if they choose not to fund the payments. I believe that thinking applies to you as well. You should make the pay- ments once Laura returns to work and even earlier if possible. Because you are projected to run a cash deficit during the time that Laura is out of work, you will not be able to cover 401(k) contributions out of Dan’s paycheck. However, you have marketable, taxable securities, some but not all of which will be needed to cover those deficits. I recommend, then, that you make the 401(k) contributions and use the mar- ketable assets to cover the additional shortfalls that this creates. Your retirement projections are shown in Table D.5.

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TABLE D.5 Retirement Needs Analysis

Inputs General

Dan’s age 35 Laura’s age 35 Dan’s retirement age 60 Laura’s retirement age 60 Dan’s assumed age of death 95 Laura’s assumed age of death 95 Years until retirement period 1 25 Years until retirement period 2 30 Years in retirement period 1 5 Years in retirement period 2 30

Laura

Pension at age 65, today’s dollars $45,000 After-tax pension 32,400 Current salary 0 Salary in five years, today’s dollars 68,000 Annual increase thereafter 3% Social Security benefits at age 67, today’s dollars $24,196

Dan

Salary $100,000 Annual increase through 2023 10% Annual increase beginning 2024 3% Social Security benefits at age 67, today’s dollars $26,022

Expenses

Living expenses, today’s dollars1 $83,452 15% COL reduction in retirement ($12,518) Additional travel expenses $10,000 Total expenses in retirement $80,935

Economic

Inflation 3.0% Tax rate in retirement2 28.0% Investment return 5.7% After-tax investment return 4.1% Real return 2.6% After-tax real return 1.1%

Step 1. Calculate the Amount Needed in Retirement Retirement Period 1 (60–65)

Living expenses in retirement, today’s dollars $80,935 Laura’s pension in today’s dollars, after taxes 0 Annual shortfall, today’s dollars 80,935 Annual shortfall, age 60 169,459 Lump sum needed to retire mortgage3 110,686

Lump sum needed at age 60 $940,200

Retirement Period 2 (65–95)

Living expenses in retirement, today’s dollars $80,935 Laura’s pension in today’s dollars, after taxes 32,400 Social Security benefits at 65 in today’s dollars, after taxes 33,138 Annual shortfall, today’s dollars 15,396 Annual shortfall, age 65 37,371

Lump sum needed at age 65 964,635

(continued)

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154 Web Appendix D Comprehensive Financial Plan—Dan and Laura

(concluded )

Step 2. Bring the Lump Sum Needed Back to the Present Lump sum currently needed, retirement period 1 $343,981 Lump sum currently needed, retirement period 2 288,629 Lump sum needed in year 6, retirement period 14 420,602 Lump sum needed in year 6, retirement period 2 352,921 Total lump sum needed now 632,610

Total lump sum needed in year 6 $773,523

Step 3. Repeat Steps for Other Needs Lump sum needed for college in year 65 $230,488

Total other needs lump sum, year 6 $230,488

Step 4. Establish the Current Value of Projected Future Saving Accumulated assets as of year 6 $89,479 Projected after-tax savings starting year 66 60,0007

PV of future savings in year 6 807,961

Total existing and projected resources in year 6 $897,441

Step 5. Compare Resources and Needs Total needs in year 6 $1,004,011 Total existing and projected resources in year 6 897,441

Additional resources needed $106,570

Step 6. Establish Additional Annual Savings Needed Additional savings needed beginning year 6 (level payment) $7,9147

Additional annual savings needed beginning year 6 $7,914

1 Sum of discretionary, nondiscretionary, and capital expenses in year 6, discounted to year 1. 2 Estimated marginal federal and state rate. Assumes state tax rate of 5% and blend of ordinary income and capital gains federal rates. 3 Amount owed after 24 years of mortgage payments at normal amortization. Assumes mortgage begins in year 2 of plan. 4 Assumes that savings cannot begin until year 6, when Laura returns to work. 5 From college planning section. 6 Assumes that saving is not possible until Laura returns to work. 7 These figures together equal the $68,000 required savings figure mentioned in the text.

INVESTMENTS Nonfinancial Investments Discussion You have several short-term issues that lend themselves to financial analysis:

• Purchase of a home (real estate assets).

• An outlay on a new car (durable goods assets).

• When Laura goes back to work.

• Whether to enroll in a master’s program (human-related assets).

Buying a Home There is no choice as to whether to move when a family situation dictates that one must take place. Given Laura’s pregnancy, it must happen fairly soon. You have asked whether it would be better to buy or rent. Based on the figures supplied to us, $250,000 to buy or $15,000 to rent annually, I have calculated an after-tax rate of return. I have

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assumed that the house would increase in value by the projected rate of inflation, 3  percent a year. We have included the cost of renting an apartment as an offset to higher household costs. It would be a cash payment if you didn’t own a home. I recommend the purchase of a home and not the rental. The tax benef its available through deductibility of interest and real estate taxes, plus the ability to perhaps sell your home without paying any tax (for a married couple, the first $500,000 of gain is tax-free), can make it a highly profitable investment. Our projected return is 19 percent after tax (see Table D.6).

TABLE D.6 Buy versus Rent

Inputs

Rental expense $15,000 Cost of house $250,000 Down payment $12,500 Mortgage $237,500 Interest rate 7.25% Mortgage term (years) 30 Marginal federal tax rate 25.0% Marginal local tax rate1 3.8% Federal/state marginal tax rate 28.8% Inflation rate 3.0% Property taxes $2,500 Upkeep and insurance $3,000 Private mortgage insurance $1,200

2016 2017 2018 2019 2020 2021 2022

Down payment $12,500 Beginning principal 237,500 $235,399 $232,943 $230,303 $227,465 $224,414 $221,134 Mortgage payment 19,442 19,442 19,442 19,442 19,442 19,442 19,442 Interest paid 17,143 16,971 16,786 16,587 16,373 16,143 15,895 Principal paid 2,299 2,471 2,656 2,855 3,069 3,299 3,547 Mortgage Outstanding $235,399 $232,943 $230,303 $227,465 $224,414 $221,134 $217,609

Cash Flow

Outflows Down payment ($12,500) $0 $0 $0 $0 $0 $0 Mortgage payment (19,442) (19,442) (19,442) (19,442) (19,442) (19,442) (19,442) Interest payment (17,143) (16,971) (16,786) (16,587) (16,373) (16,143) (15,895) Principal payment (2,299) (2,471) (2,656) (2,855) (3,069) (3,299) (3,547) Property taxes (2,500) (2,575) (2,652) (2,732) (2,814) (2,898) (2,985) Upkeep and insurance (3,000) (3,090) (3,183) (3,278) (3,377) (3,478) (3,582) PMI 1,200 1,200 1,200 1,200 1,200 1,200 1,200 Balloon payment ($217,609) Total ($36,242) ($23,907) ($24,077) ($24,252) ($24,432) ($24,618) ($242,418)

Inflows Tax deductions $5,669 $5,625 $5,578 $5,528 $5,473 $5,415 $5,353 Proceeds from sale of home $283,587 Total $5,669 $5,625 $5,578 $5,528 $5,473 $5,415 $288,940

Net Cash Flow ($30,573) ($18,282) ($18,499) ($18,724) ($18,959) ($19,203) $46,552 Rent not paid2 $15,000 $15,450 $15,914 $16,391 $16,883 $17,389 $17,911 Effective bottom line ($15,573) ($2,832) ($2,585) ($2,333) (2,077) ($1,814) $64,433

IRR 19%

1 Based on 5 percent state rate deductible on federal return. 2 Not actual cash flow but assumed cost that would have been paid to rent a similar home.

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156 Web Appendix D Comprehensive Financial Plan—Dan and Laura

Buying a New Car The purchase of the car is simple (see Table D.7). You would have a one-time cost of $30,000 net of trade-in plus extra yearly expenses of $1,550 over the assumed seven-year useful life of the car. The benefit of the extra work time made available by driving to work, at the $50-per-hour rate assumed conservatively not to rise each year, would be $50 per day, $250 per week, $12,500 per year before taxes, and $8,906 after taxes. Unfortunately, this automobile expense is not tax-deductible. Your net inflows, therefore, are $7,356 per year. The return on this investment is very high, at 19 percent. You should buy the car and start working extra hours as soon as it is feasible.

Laura’s Plans Laura, you would be making $50,000 a year if you were working today. At an assumed marginal tax bracket of 28.8 percent when you work, plus Social Security payments of 7.65 percent, that would leave you with about $33,000 per year after tax. You mentioned that a full-time housekeeper would cost $25,000 a year and transportation, clothing, and eating out another $2,000 a year. The difference of $6,000 per year is not very meaningful, particularly given your wish to raise your children yourself.

Master’s Program The master’s program provides the potential to earn an $18,000 raise after completion of $80,000 in costs over four years. Assuming that your marginal tax bracket is 28.8  percent, federal and state, when you return to work, your benefit is a raise of about $12,800 per year in today’s after-tax dollars for 16 years to your intended retirement at 55 (see Table D.8). As you can see, on your worksheet the return on the graduate degree is high at 13 percent, even without the additional pension benefits you would receive and the potential to receive an even higher return should you decide to retire later. Because it better fits your personal goals and provides an excellent return on investment, we believe it to be a highly attractive investment. In sum, all of the proposed capital expenditures with the exception of going back to work immediately are considerably higher than those for investments in the marketplace with comparable risk and therefore we recommend that you make them. Personally, I commend you for being so quick to bring up these questions after finding out about the pregnancy. Although it may not seem so now, it will make my job as well as yours easier.

TABLE D.7 New Car

Inputs

Cost of new car $30,000 Additional expenses $1,550 Additional work hours/week 5 Hourly rate $50 Marginal tax rate 28.8% After-tax hourly rate $35.63 Sale price $8,000

2015 2016 2017 2018 2019 2020 2021 2022 Cash Flow

Inflows $8,906 $8,906 $8,906 $8,906 $8,906 $8,906 $16,906 Outflows ($30,000) (1,550) (1,550) (1,550) (1,550) (1,550) (1,550) (1,550) New Cash Flow ($30,000) $7,356 $7,356 $7,356 $7,356 $7,356 $7,356 $15,356 IRR 19%

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TABLE D.8 Master’s Program

Inputs

Cost of program $80,000 Inflation (college) 6.0% Pay raise upon completion $18,000 Marginal tax rate 28.8% After-tax pay raise $12,825 Years of employment 16 General inflation 3.0%

Cash Flow Inflows Outflows Net Cash Flow

2015 $0 $0 $0 2016 0 (22,472) (22,472) 2017 0 (23,820) (23,820) 2018 0 (25,250) (25,250) 2019 0 (26,765) (26,765) 2020 15,314 0 15,314 2021 15,773 0 15,773 2022 16,246 0 16,246 2023 16,734 0 16,734 2024 17,236 0 17,236 2025 17,753 0 17,753 2026 18,285 0 18,285 2027 18,834 0 18,834 2028 19,399 0 19,399 2029 19,981 0 19,981 2030 20,580 0 20,580 2031 21,198 0 21,198 2032 21,834 0 21,834 2033 22,489 0 22,489 2034 23,163 0 23,163 IRR 13%

Financial Investments Introduction We are up to the investments portion of the financial plan. I am going to incorporate in it most of the basics of an investment policy statement for both of you as part of the presenta- tion. The investment policy statement serves as a guide for the management of your port- folio. This statement, which I will present informally, includes many of the steps in my asset allocation process for you. It ensures that we are “on the same page” as to your per- sonal requirements and our investment approach for you going forward. Before we do that, however, I want to review some overall capital market variables. The first is that the outlook for stocks and bonds is strongly influenced by risk and return. In general, the higher the risk, the higher the return. For some it indicates that most securities at any point in time are efficient; their current prices fairly reflect the outlook. For exam- ple, if it looks to you as though a bond had a very attractive yield and therefore high cash return, chances are it is because it has a higher risk attached to it. On the other hand, other people believe in mean reversion. Those people, many of whom have a value-oriented style of investing, buy out-of-favor stocks that are “bargains.” They have the conviction that a disciplined person can take advantage of the temporary mispricing of securities. Mean reversion implies that stocks that are temporarily selling for a lower price than they should will return to their fair value over time. There are, of course, other styles of investing that attempt to take advantage of what are thought to be opportunities in individual securities or even the overall market at certain

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points in time. One, purchasing the fastest-growing companies available, is called the growth style of investing. There is a significant difference between efficient markets and mean reversion and be- tween value and growth investing. Efficient market people believe you cannot consistently outperform the market; they prefer a passive approach to investing. They emphasize keep- ing expenses low and concentrating on proper diversification to reduce risk. Efficient mar- ket people generally use index funds to implement their investment strategy. People who employ mean reversion, one form of value investing, generally believe that strong research and control over emotional reactions can lead to better-than-average returns.

Recommendations This brings us to your asset allocation and my investment policy statement for you. You have several goals that we deal with in other parts of the plan, but you’re overriding one for our purposes today is your desire to retire in 20 years. Thus, your time frame is longer term. Liquidity is as large an issue for you, as we have stated, but not for the retirement monies already accumulated and to be invested in the future. We will be setting aside an emergency fund over time. In the interim, as you have indicated to me earlier, you can bor- row from Laura’s parents for any emergency. You seek above-average returns and your risk tolerance, while somewhat different for each of you, is nonetheless consistent with that objective. In other words, your risk-return objectives are in line. You are in the highest marginal tax bracket. We will be thinking of tax consequences as part of our investment policy. For example, tax-free municipal bonds of your state are likely to be used. Some people have restrictions on types of stocks, such as not allowing tobacco stocks, but you have not indicated any such requirement. For the time being, we will limit purchases to mutual funds. Mutual funds, in my opin- ion, provide the best balance of capable management and relatively low cost. They allow anyone to diversify widely to reduce risk and to take advantage of fund manager expertise in specific sectors of the bond and stock markets. We will employ an active approach to portfolio management. By portfolio management we mean looking at your financial assets overall, making sure that they fit your return and risk requirements as represented by your asset allocation. Our approach of diversifying widely can handle one sometimes-overlooked part of supervision—correlation. Correlation indicates the relationship between assets, the degree to which they react similarly to the same variables. All other things being equal, the lower the correlation, the lower the portfolio risks. For example, investments in Japanese stocks are going to be less correlated with U.S. ones than one large-sized, economically sensitive U.S. industry is with another—say, retail stores and appliance stocks. I employ a diversified style of investing, but with a value tilt. I base the portfolio on a longer-term investment horizon. An asset allocation provides the average weighting of securities by category in the portfolio over time. The average percentage weighting over the longer term is called a strategic asset allocation. I do not try to time the market. I do attempt to take advantage of disparities in valuations at the present time. In other words, I try to moderately overweight those areas that appear to be attractive at the present time. For example, I overweighted international stocks because they seem to be fairly priced and provide attractive returns. On the other hand, I underweighted REITs (that represent your real estate holdings), which, in my opinion, are overvalued at the moment. Unlike timing the market, which implies turnover for short-term profit, this approach ex- pects that, over the intermediate or longer term, our overemphasis of certain areas will lead to higher returns. I call the portfolio breakdown established our tactical asset allocation.

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TABLE D.9 Asset Allocation

Current Strategic Tactical Standard Asset Category Allocation Allocation Allocation Deviation 10-Year*

Stocks

Small cap — 10% 14% 19.6 Mid cap — 8% 10% 18.1 Large cap 75% 20% 18% 15.6 International — 17% 20% 19.6 Real Estate Funds** — 5% 3% 23.5 Total stock 75% 60% 65% 18.4

Bonds

Short term — 10% 15% 2.0 Intermediate — 15% 8% 3.5 Long term — 5% 0% 10.0 High yield — 5% 7% 9.5 Total bond 0% 35% 30% 4.2

Money market 25% 5% 5% 0.5

Total 100% 100% 100% 13.3

*10-year data from Morningstar® Office® for the period November 11, 2004, through November 11, 2014. © [2014] Morningstar, Inc. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; (3) does not constitute investment advice offered by Morningstar; and (4) is not warranted to be accurate, complete, or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. Use of information from Morningstar does not necessarily constitute agreement by Morningstar, Inc., of any investment philosophy or strategy presented in this publication. ** Includes traditional real estate funds and REIT funds.

Based on those principles and an overall economic scenario, I have constructed your strategic and tactical asset allocations. They are shown in Table D.9. Notice the wide diversity of asset classes in both stocks and bonds. In bonds they range in risk from short- term bonds, which are the safest, to high-yield bonds, the most risky. Similarly, for stocks they extend from larger capitalization companies, which have the least risk and lowest return, to small capitalization companies, with the greatest risk and highest potential return. Notice also that I have included an allocation in international securities. Part of that allocation includes an investment in a China fund; I believe the securities in this fund to be reasonably priced currently relative to prospects. International securities have the potential to lower your portfolio’s overall volatility, even if they them- selves are more volatile. Based on our discussions, I have provided a breakdown of a diversified portfolio of 60 percent stocks, 40 percent bonds and money market funds. It stands in contrast to your cur- rent portfolio, which has 75 percent concentrated in large cap stocks and the rest in cash. The long-term bond area has not been given an allocation since, historically, intermediate- term bonds over longer periods have provided about the same returns but with lower risk. In view of your concern about inflation, I have placed more money in the short-term area and underweighted intermediate-term bonds in the tactical allocation. This allocation is more oriented to the current outlook. Shorter-term bonds will be affected less than inter- mediate ones in any rise in inflation. In sum, I have provided a diversified portfolio of investment that should assist you in achieving sufficient funds to meet your life cycle needs. We agreed upon a 60-40 stock-bond mix influenced by Dan’s innate conservative na- ture. However, my recommendation is that we raise that to 70-30. The original allocation recommendation was made based on financial assets alone. Here is why I changed my thinking.

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The new asset allocation incorporates the generally lower-risk nature of your nonfinan- cial assets. As you will see, even though the only option you may want to exercise over your life cycle is in the financial area, in making decisions it is important to take into account all your assets. Incidentally, as retirement becomes closer, these low-risk pension assets, which are bondlike, comprise a greater proportion of assets. The same is true of the house, whose risk is also lower than that for stocks. The result can be to have an even greater weighting in equities over time. My final thought on financial investments is that you should consciously avoid a heavy weighting in technology shares, given their correla- tion with Dan’s job. Your final recommended asset allocation is provided in the attached schedule (see Table D.10).

INSURANCE PLANNING Introduction You have asked me to look over all your exposures. To facilitate this process, assets are separated into three principal categories. The first category is human-related assets, which includes human assets. Human assets are derived from your salaries. Your exposures hence involve your personal health, safety practices, and insurance needs. They also include pensions and gifts derived from your work and relationships. Exposures involve inflation and relationship risk, respectively. The second category is financial assets, which involve your investment and financing practices. As you are aware, financial assets have a chance for loss particularly if they are not selected properly. The third category is the real assets comprising your house, furniture, car, and so on. Fire, theft, and depreciation in value are three exposures here. In addition, we will con- sider your intangible assets and liabilities including household goodwill and liability exposure to others. As we discussed, these assets should be thought of as being part of a special portfolio. It is special because it is yours. It comprises not only marketable assets but nonfinancial ones such as your careers. Our goal is to control individual assets and your overall portfo- lio risk to enable you to have confidence that you will reach your goals.

TABLE D.10 Dan and Laura’s Final Asset Allocation

Current Strategic Tactical Standard Asset Category Allocation Allocation Allocation Deviation 10-Year

Stocks

Small cap 10% 13% 20% 21.0 Mid cap 8% 12% 10% 20.7 Large cap 20% 22% 18% 17.8 International 17% 18% 17% 17.8 REIT 5% 5% 5% 14.1 Total stock 60% 70% 70% Bonds

Short term 10% 5% 8% 2.1 Intermediate 15% 8% 5% 4.1 Long term 5% 5% 5% 5.7 High yield 5% 7% 7% 7.9 Total bond 35% 25% 25%

Money market 5% 5% 5% 0.4

Total 100% 100% 100% 14.11

1 Weighted average.

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From a personal perspective, we are pleased to affirm that you have good personal safety practices. You both are practicing good eating habits including balanced meals. Laura is to be commended for her quick loss of the 35 pounds she gained during her preg- nancy with Brian. Both of you exercise regularly. Based on our discussions, you seem safety conscious in your activities. At the present time, each of you is in good health. Your efforts to reduce stress through daily yoga exercises are a plus. However, Laura’s side of the family’s seeming genetic exposure to early mortality due to heart ailments bears watch- ing. It could suggest the advisability of more savings today and perhaps more insurance coverage, since the household would be materially affected financially by any loss of her income and an inability later to qualify for insurance. The only change of practice I could see would be to review Dan’s participation in drag car racing. Dan, I recognize that you have enjoyed racing your 1953 hot rod Chevrolet for many years. I question, however, whether this hobby is appropriate given your responsi- bilities to Laura and Brian. Any personal injury could have a material effect on them. Moreover, it seems inconsistent with your generally conservative nature. Perhaps you could explore an alternative hobby that you might find satisfying. I am pleased that you will have two sources of income once Laura goes back to work. Given her tenure as a schoolteacher, her position balances the higher levels of risk and higher returns that Dan has in his career. You have both indicated that your personal relationship is excellent and that having a child had not resulted in any friction between you. Investments and debt risk have been handled in separate sections. I will begin with life insurance and then discuss other forms of insurance.

Life Insurance Life insurance is a method of protecting family assets so that many goals can be reached in the event of the untimely death of an income earner. Thinking of life insurance is impor- tant to the household since both incomes will be needed long term to meet retirement goals. Your material current debt and your desire to fund a private college education for two children make it particularly relevant. The absence of a replacement source of income could place an inordinately large burden on the surviving spouse. As mentioned before, I do not have enough data yet to recommend a specific amount of insurance. However, I will make a preliminary statement of the adequacy of your current coverage. You have separately indicated that in the event of the loss of one of you, the other should be funded comfortably for life. After careful thought, you have defined that as a 10 percent decline from current living costs now and in retirement; that figure reflects the absence of one household member and a modest reduction in leisure time expenditures. Based on that assumption, it is clear that both of you are currently underinsured. Regarding the appropriate amount of insurance, you have separately indicated that in the event of the loss of one of you, the other should be funded comfortably for life. After careful thought, you have now defined that as a 15 percent decline from living costs cur- rently and in retirement; that figure reflects the absence of one household member and a modest reduction in leisure time expenditures. Based on that assumption, it is clear that both of you are currently underinsured. For Dan, we recommend approximately $1.3 million. For Laura, we recommend approximately $700,000. You asked whether you should have term or whole life insurance. Actually, I am going to recommend a combination of both. Here is a brief description of both types and the rea- sons why I am making that recommendation. Term life represents pure insurance today. Its advantage is low current cost and full freedom to place your savings from the lower cost of your policy in investments that you

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select. Based on our discussions, it is clear that Laura would like as much yearly cash flow as possible to invest herself. Furthermore, it is likely that much more expensive whole life could put a crimp in your current living style if it is used to fund your entire insurance need. Perhaps most important, based on a savings pattern that I will propose, you are likely to be financially independent at some point. At that time, you won’t need any life insurance. Since the need is temporary and the return on alternative investments is likely to exceed life insurance rates, I will be recommending some term insurance. On the other hand, I am recommending some whole life insurance as well. I am con- cerned about your ability to save. Your future goals of saving a material sum are reasonable, but at the present time, judging by your current debt outstanding, you have not yet shown the discipline to save. The excess cash value that you accumulate can be made available to you at the time you cash in your policy. This could be done at the point you reach financial independence. In addition, I believe that Laura’s projection of 20 percent a year growth in investments is too optimistic. This life insurance can be considered a conservative invest- ment in your portfolio to help diversify and balance your aggressive aspirations. As for the comparison between the two term policies (see Appendix I to Chapter 11), it is clear that policy A is cheaper in the early years. On the other hand, policy B becomes less expensive after year 8 and the disparity grows in subsequent years. Both insurance companies are of high quality. The policies are guaranteed renewable and convertible into whole life. If I thought your need was only for eight years, I would recommend A. You could always purchase A and in eight years attempt to go through the process again. I say “attempt” because there is no assurance that you would qualify if some unforeseen decline in health occurred. I believe you will need life insurance for an extended time and I would prefer not running the risk of your becoming uninsurable. Plan B’s 20-year net present value is materially below plan A’s. Consequently, I prefer B. Your life insurance needs calculations are presented in Tables D.11 and D.12.

Inputs General

Dan’s age 35 Laura’s age 35 Laura’s retirement age 60 Dan’s assumed age of death 35 Laura’s assumed age of death 95 Years in preretirement period 1 5 Years in preretirement period 2 13 Years in preretirement period 3 7 Years in retirement period 1 5 Years in retirement period 2 30

Laura

Pension $45,000 After-tax pension 33,750 Current salary 0 Salary in year 6 68,000 Salary after tax 51,000 Annual increase 3% Social Security benefits Laura’s Social Security in retirement 24,196 Social Security after taxes 18,147 Survivor benefits until children grown, before tax1 26,250 Survivor spousal benefits at age 60, before tax 10,725

TABLE D.11 Insurance Needs Analysis—Dan

(continued)

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Expenses

Current expenses2 $103,032 Reduction at Dan’s death 15% Expenses after Dan’s death 87,578 Expenses after children grown3 68,794

Available Assets

Investment assets $150,000 Liabilities 86,000 Available assets 64,000

Economic

Inflation 3.0% Investment return 5.7% After-tax return 4.1% Real return 2.6% After-tax real return 1.1% Average tax rate preretirement period 14 0% Average tax rate preretirement period 2 25% Average tax rate preretirement period 3 25% Average tax rate retirement period 1 10% Average tax rate in retirement 25%

Step 1. Determine the Amount Needed to Fund the Preretirement Period Preretirement peri.od 1, years 1–5 Annual expenses, today’s dollars $87,578 Social Security survivor benefits, after taxes 26,250 Laura’s salary, after taxes 0 Total income, after taxes 26,250 Annual shortfall 61,328

Lump-sum shortfall, today’s dollars $300,203

Preretirement period 2, years 6–18

Annual expenses, today’s dollars $87,578 Social Security survivor benefits, after taxes 20,672 Laura’s salary, after taxes 51,000 Total income, after taxes 71,672 Annual shortfall, today’s dollars 15,906 Annual shortfall, year 6 18,439 Lump-sum shortfall, year 6 225,034

Lump-sum shortfall, today’s dollars $184,039

Preretirement period 3, years 19–25

Annual expenses, today’s dollars $68,794 Laura’s salary, after taxes 51,000 Total income, after taxes 51,000 Annual shortfall, today’s dollars 17,794 Annual shortfall, year 19 30,294 Lump-sum shortfall, year 19 205,428

Lump-sum shortfall, today’s dollars $99,597

Step 2. Determine the Amount Needed to Fund the Retirement Period Retirement Period 1 (60–65) Living expenses, today’s dollars $68,794 Social Security spousal survivor benefits, after tax5 9,813

(continued)

(concluded)

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164 Web Appendix D Comprehensive Financial Plan—Dan and Laura

Annual shortall, today’s dollars 58,981 Annual shortfall, age 60 123,493 Lump-sum shortfall, age 60 604,508

Lump-sum shortfall, today’s dollars $221,165

Retirement Period 2 (65–95)

Living expenses, today’s dollars $68,794 Laura’s annual pension, after taxes 33,750 Social Security benefits, after taxes 16,501 Total income 50,251 Annual shortfall, today’s dollars 18,544 Annual shortfall, age 65 45,010 Lump-sum shortfall, age 65 1,161,829

Lump-sum shortfall, today’s dollars $347,632

Step 3. Determine the Total Lump Sum Needed Today Lump sum currently needed, preretirement period 1 $300,203 Lump sum currently needed, preretirement period 2 184,039 Lump sum currently needed, preretirement period 3 99,597 Lump sum currently needed, retirement period 1 221,165 Lump sum currently needed, retirement period 2 347,632

Total lump sum needed, today’s dollars $1,152,636

Step 4. Repeat Steps for Other Needs Lump sum needed currently for college $179,479 Burial expenses 20,000

Total lump sum for other needs, today’s dollars $199,479

Step 5. Establish Insurance Need Total lump sump needed for all needs, today’s dollars $1,352,116

Available assets $64,000

Total insurance needed, today’s dollars $1,288,116

1 Estimate based on 175 percent of Dan’s primary insurance amount at the time of his death. Actual numbers will be modestly different because different benefits end in different years. 2 Average of living expenses over next seven years. 3 85 percent of what they would spend as a couple in retirement. 4 All tax rates are estimates based on income projections. 5 Estimate based on Dan’s primary insurance amount.

(concluded)

Long-Term Care Insurance Long-term care insurance is, in my opinion, a worthwhile product to consider. It can provide funds for extraordinarily high-cost nursing home care that might otherwise impoverish the still-healthy spouse and provide more assurance of leaving funds for your children. Its home health payments to aides also can actually allow people who might otherwise have to move to a facility to remain in their own home. However, I be- lieve it is too early to consider this type of policy. The costs would be relatively inex- pensive, but they are not locked in and can be increased based on insurance company experience. Interim investing may provide a better rate of return. At a later date, say, in your 50s when you hope to retire, your financial circumstances may be better known. Of course, you would have to assume the risk of an illness in the meantime that rendered you uninsurable.

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TABLE D.12 Insurance Needs Analysis—Laura

Inputs General

Dan’s age 35 Laura’s age 35 Dan’s retirement age 60 Laura’s assumed age of death 35 Dan’s assumed age of death 95 Years in preretirement period 1 18 Years in preretirement period 2 7 Years in retirement period 1 5 Years in retirement period 2 30

Dan

Salary $100,000 Annual increase through 2022 10% Annual increase beginning 2023 3% Social Security benefits Dan’s Social Security at age 67, before tax 26,022 Social Security at age 67, after tax 19,829 Survivor benefits until children grown, before tax1 24,150 Survivor spousal benefits at age 60, before tax 9,867

Expenses

Current expenses2 $103,032 Expense reduction at Laura’s death 15% Expenses after Laura’s death 87,578 Expenses after children grown3 68,794

Available Assets

Investment assets $150,000 Liabilities 86,000 Available assets 64,000

Economic

Inflation 3.0% Investment return 5.7% After-tax investment return 4.1% Real return 2.6% After-tax real return 1.1% Average tax rate, preretirement period4 30% Average tax rate, retirement period 1 10% Average tax rate, retirement period 2 28%

Step 1. Determine the Amount Needed to Fund the Preretirement Period Preretirement period 1, years 1–18

Annual expenses, today’s dollars $87,578 Social Security survivor benefits, after taxes 17,992 Annual shortfall, today’s dollars 69,586 Lump-sum shortfall, today’s dollars 1,145,779 NPV Dan’s salary, after taxes5 1,612,183

Lump-sum surplus, today’s dollars $466,404

Preretirement period 2, years 19–25

Annual expenses, today’s dollars $87,578 Dan’s income6 118,452 Annual surplus, today’s dollars 30,874

(continued)

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166 Web Appendix D Comprehensive Financial Plan—Dan and Laura

Annual surplus, year 19 52,561 Lump-sum surplus, year 19 356,428

Lump-sum surplus, today’s dollars $172,806

Step 2. Determine the Amount Needed to Fund the Retirement Period Retirement Period 1 (60–65)

Living expenses, today’s dollars $68,794 Social Security survivor benefits at age 60, after taxes7 9,028 Annual shortfall, today’s dollars 59,766 Annual shortfall, age 60 125,137 Lump-sum shortfall, age 60 612,554

Lump-sum shortfall, today’s dollars $224,109

Retirement Period 2 (65–95)

Living expenses, today’s dollars $68,794 Social Security benefits at age 65, after taxes 16,225 Annual shortfall, today’s dollars 52,569 Annual shortfall, age 65 127,599 Lump-sum shortfall, age 65 3,293,652

Lump-sum shortfall, today’s dollars $985,497

Step 3. Determine the Total Lump Sum Needed Today

Lump-sum surplus, preretirement period 1 $466,404 Lump-sum surplus, preretirement period 2 172,806 Lump sum currently needed, retirement period 1 224,109 Lump sum currently needed, retirement period 2 985,497

Total lump sum needed, today’s dollars $570,396

Step 4. Repeat Steps for Other Needs Lump sum needed currently for college $179,479 Burial expenses 20,000

Total lump sum for other needs, today’s dollars $199,479

Step 5. Establish Insurance Need Total lump sum needed for all needs, today’s dollars $769,875

Available assets $64,000

Total insurance needed, today’s dollars $705,875

1 Estimate based on 175 percent of Laura’s primary insurance amount at the time of her death. Actual numbers will be modestly different because different benefits end in different years. 2 Average of living expenses over next seven years. 3 85 percent of what they would spend as a couple in retirement. 4 All tax rates are estimates based on income projections. 5 Net present value calculation assumes 10 percent annual increases first eight years, 3 percent increases thereafter, and discount rate equal to rate of inflation. 6 Calculated future salary based on assumptions in Footnote 5, then found present value based on inflation rate. 7 Estimate based on Laura’s primary insurance amount.

Other Insurance I reviewed all of your insurance excluding life insurance, which has already been dis- cussed. My impression is that you generally have done a good job of protecting yourself. My specific recommendations follow. In your auto insurance policy, you currently have $100,000 for bodily injury and prop- erty damage and $300,000 per accident, which is the state minimum. I recommend that

(concluded)

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you increase that coverage to $250,000 and $500,000, respectively. Coverage in today’s litigious society, in which costs for claims have climbed steeply, suggests that this is a more appropriate figure. The cost increase isn’t that great. You should save money on my next recommendation, which is to eliminate collision coverage on Laura’s car. The car is 10 years old and the current cost you are paying for collision is too high relative to the benefit. You should self-insure for that risk. Your rental coverage on your apartment is adequate for now. As you accumulate more expensive furniture, appliances, and other items, you will need higher amounts. I believe we will be revisiting this question once you purchase your home. Although we can discuss homeowners insurance in more detail at the appropriate time, I believe a broad form HO-5 policy is best and prefer one that has guaranteed replacement cost so that you are fully protected as the market value of your home increases. You should review your apartment or homeowners coverage every two years or so to make sure that the coverage reflects the then-current value of your possessions. The entire family is currently covered under a comprehensive medical plan. In recent years, you have not had any medical expenditures other than for delivery and follow-up for your son. You mentioned that your experience with the HMO doctor was only fair. I recommend that you consider a point-of-service policy that your company offers and that you would have to contribute to. This policy is partially subsidized by the em- ployer and will allow you to select a physician of your choice. Be prepared to pay coin- surance for many medical occurrences. I believe the cost-to-benef it ratio is worth it, if only for your ability to select a doctor of your choice in the unlikely event of a major illness. Dan has a disability policy at work that is paid for by his employer and pays 60 percent of his total compensation in the event of a disability. Unfortunately, the coverage is limited to one year for any type of disability. Thereafter, the policy will pay only if he is unable to perform a position he is suitable for. I would prefer an own occupation definition that would pay if he could no longer perform in the career he has now. Moreover, the policy isn’t portable. If Dan were to have some mishap that rendered him uninsurable and then for any reason he left his job, he would be vulnerable. Since there is a viable policy in force, the question is whether you want to fund a more desirable policy. If you do, please let me know within the next week so that I can include its cost in our projection (they subse- quently declined). Finally, I recommend a $1 million umbrella insurance policy. As the term indicates, an umbrella covers you for a variety of losses. It will support you against a very large auto- mobile suit (the cost to obtain it is reduced by the extra auto coverage I am recommending on your existing policy). It also will provide coverage for miscellaneous losses such as slander and defamation of character.

ESTATE PLANNING

Estate planning is the method of providing for your heirs according to your wishes in a tax-efficient manner. You are at a relatively young age in your marital lives with limited assets now. Estate planning is relatively simple. I have assumed that there will be two chil- dren, as is your wish, as you are well on the way to fulfilling that intention. My principal objective here is to get you to obtain a will. There are many people who say they should have a will but, for whatever reason, never actually do it. If you die intes- tate (without a will), the state will determine the division of your assets. For example, if Dan were to pass away in this state, the children would receive half of the assets. I know, Dan, that you want Laura to receive all of your assets. And you are correct, Dan, that the

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likelihood is you will both live long lives, but the will provides important protection in the event of a premature outcome. The issue of who should be guardian is a contentious one and beyond the scope of the financial plan. I am confident that you will select the person who is best suited to raising your children. Even including potential insurance proceeds, should either of you pass away while being covered by life insurance, you are both well under the federal estate and gift tax minimums. Therefore, I am not going to focus on the tax savings and disadvantages inher- ent in relying upon exemption portability or setting up bypass trusts. I believe that you should both establish durable and medical powers of attorney and liv- ing wills. The durable powers will allow each of you to act on behalf of the other at times of incapacity, in general situations for the durable powers and in times of serious illness for the medical powers. The living will can indicate your desires in connection with terminal illness. You also should have a document that details your personal wishes and where as- sets and personal papers are as well as the name, address, and telephone number of your advisors. Keep in mind that estate planning should be reviewed periodically as your assets grow and the needs for your children change. Finally, I want to underline my desire for you to obtain a will as soon as possible. If you like, I will supply some recommendations of attorneys to consider.

SPECIAL CIRCUMSTANCES PLANNING

You have asked me to comment on a variety of family problems. They fall under what I call special requirements. Special requirements planning consists of segments of the finan- cial plan that are not shared by all households. For example, elder care planning may only be relevant for those couples who reach an age and a point when they or their parents will fairly soon be unable to operate a household independently. You have indicated that there seems to be a great deal of problems in your respective families. My response is that it is not at all uncommon for many families to have one or more special circumstances. The problems only seem uncommon because you are asking that I comment on so many different family members’ problems in one financial plan. It is not usual that two people are willing to pay for financial advice for so many parents and siblings. As you requested, I will provide some broad views on a variety of topics that you have presented to me. You are aware that hard recommendations would require that I know more about the financial circumstances and values of each family member, which requires that, at a minimum, I meet or speak with them. Laura’s uncle is terminally ill but to date has retained his mental faculties. He should check his will to make sure that it reflects his current wishes. Also, he should make sure that he has a living will that indicates his wishes about life support and has a health care proxy assigned to one family member. He should prepare an informal letter of instruction expressing nonlegal matters such as where all money is and the names and addresses of key advisors. Because you mentioned that he is affluent, a gifting program to the children may be considered to reduce estate taxation. Although your uncle may wish to continue to invest actively, any sales of stock with large capital gains may be postponed until death to take advantage of the favorable tax treatment at that time (called a step-up in  basis). Laura’s sister Bonnie is in a vulnerable financial position. She isn’t working full-time and has no assets in her name. Should her relationship end, she would be close to

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destitute. Moreover, if her partner was to pass away, she would not get any Social Security and, because there is no will, probably no assets. They would go to his nearest blood relative. Both should get wills as soon as possible. Bonnie should try to get money gifted to her or placed in an irrevocable trust for her benefit. A domestic partnership agreement, which is recognized in her state and municipality, should be established. It should outline such things as the duties of both parties and the division of assets in the event of a split-up. Dan’s parents are still mobile but need some assistance. In reading their long-term care insurance policies that you supplied to me, both cover care assistance in their home. In order to qualify, however, they must be unable to perform two of the following basic func- tions: bathing, eating, dressing, continence, going to the bathroom, and moving from place to place, or, alternatively, are mentally incapacitated, most commonly with Alzheimer’s disease. If they meet the criteria, the policies will cover low-cost aid. If not, they or you will have to pay for the service. Dan’s brother, Matt, has a modest income and the principal contributor to household cash flow is his wife. He supported the family while she went to graduate school for archi- tecture. He may be entitled to half the assets including those in her pension plan. He also may be entitled to alimony becausee her income was developed with his support. This pos- sibility arises because his income is very low. On the other hand, I might consider a large lump sum instead of alimony. His wife should have responsibility for the majority or all of the child care expenses. The negotiation strategy will depend in part on the personalities of the two people. In addition, the financial plan should accommodate Philip’s two children, who have special needs. I have inquired and, in their county, the school system is required to educate adequately all students with special needs even if that means sending them to a private school. He should look into that possibility. As far as his other requirements, they would be covered under Social Security as their income is too high for Supplementary Security Income payments. I recommend that they look into a special needs trust that could supplement but not re- place the aid being given by the government. When they are older, the sons will be able to qualify for aid themselves. Thereafter when Philip is unable to, his older sister may admin- ister the special needs trust. The financial planner could provide a program for financial literacy.

SUMMARY OF RECOMMENDATIONS Cash Flow 1. Reduce your spending in areas including vacations, dining out, and clothing, per our

recommendations in the cash flow planning section of the report.

2. Establish separate savings accounts for anticipated educational needs and contingen- cies. Fund these buckets out of your marketable investments.

3. Beginning in 2020, write a check to each account at the beginning of each of Dan’s bimonthly pay periods.

4. Be aware of your spending habits. As you meet your goals, reward yourself occasion- ally for meeting your goals.

Debt 1. Finance 90 percent of the cost of your home.

2. Make the down payment out of the gift from Laura’s parents.

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170 Web Appendix D Comprehensive Financial Plan—Dan and Laura

3. Use existing investments to repay the $27,000 in credit card debt and student loan debt due.

4. In general, limit your use of credit cards as a form of debt.

Education Planning 1. Postpone contributions for children’s education until 2020.

2. Begin saving $12,990 per year for 12 years to fund Brian’s education and $11,836 per year for 14 years for your unborn child until college starts.

3. Utilize 529 plans for educational savings.

Tax Planning 1. Take maximum advantage of tax deductions, including by grouping expenses of

more than one year into one year. Deduct your clothing contributions at market value.

2. Contribute to tax-advantaged retirement accounts to the extent possible.

3. Shift investment money from taxable bonds to tax-free municipal bonds.

4. When you begin making college contributions, do so through 529 plans, as mentioned above.

5. Assuming you continue to feel capable and interested in doing so, go ahead and prepare your own taxes.

Retirement Planning 1. Plan to work until age 60.

2. Begin saving the equivalent of a level $68,000 per year, beginning in 2020. The amount may be moderately lower in the first few years.

3. Make maximum contributions to 401(k) and retirement plans.

Investments Nonfinancial Investments 1. Purchase a home instead of renting.

2. Buy a car and start working extra hours as soon as it is feasible.

3. Laura should enroll in the master’s program.

Investment Planning As your investment managers, we will be doing the following:

1. For the time being, limit your purchases to mutual funds.

2. Diversify widely, with a value tilt.

3. Take advantage of valuation disparities with moderate asset allocation adjustments.

4. Invest in a portfolio of 70 percent stocks and 30 percent bonds and cash.

Insurance Planning 1. Purchase $1.3 million of life insurance coverage for Dan and $700,000 for Laura.

2. Buy a combination of term and whole life coverage.

3. Purchase the plan B term insurance coverage.

4. Consider purchasing long-term care insurance in the future.

5. Increase your auto coverage to $250,000 for bodily injury and $500,000 per accident.

6. Consider a point-of-service medical insurance policy.

7. Purchase $1 million in umbrella coverage.

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Estate Planning 1. Have a will drawn up as soon as possible.

2. Select a guardian for the children.

3. Establish durable and medical powers of attorney and living wills.

Specialized Planning 1. Have Laura’s uncle check his will to ensure that it reflects his current wishes; he also

should create (or review if he already has created) a living will and health care proxy (medical power of attorney) and prepare a letter addressing important nonlegal issues.

2. Laura’s uncle should consider any gifting programs in the context of his ill health.

3. Bonnie and her partner should create wills and a domestic partnership agreement as soon as possible.

4. Philip should look into whether his children are entitled to a private school education under policies of the county school system.

5. Philip should also look into special needs trusts.

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