Financial Plan

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Capstone Sample Financial Plan Report

Financial Plan

Anthony and Maria Esposito

Client Profile: Anthony Esposito, age 55, is a restaurant owner and Maria Esposito, age 47, is a homemaker. The couple has two children, Anthony Jr., age 12, and Mia, age 6. All family members are in good health.

Scope of the Engagement: Prepare a comprehensive financial plan.

Purpose of the Plan: The purpose of this financial plan is to provide a framework for helping you reach your financial goals and objectives. The plan consists of a section for each of the following subject areas: your financial health, risk management, investment planning, retirement planning, tax planning, and estate planning. The Plan concludes with an action plan which identifies the actions needed to implement the most essential planning recommendations.

Client Goals: A comprehensive review of your financial situation was conducted using information you provided to our firm. The following financial goals were identified and prioritized on the goal-setting worksheet.

1. Ensure that the family is protected adequately in the event of an untimely death

or disability. 2. Ensure that proper legal estate planning and business planning documents are in place

to handle incapacity issues. 3. Have $30,000 available for a European vacation within the next few months. 4. Ensure that Anthony’s investment portfolio and asset allocation strategy

maximizes investment performance, is diversified, and matches his risk tolerance level.

5. Reduce personal income taxes.

Risk Tolerance: Anthony completed a risk tolerance questionnaire and agreed with the results. He is willing to assume a moderately high level of risk to grow his investments and achieve his investment goals.

Economic assumptions at retirement: You both expect to be in a 28% marginal tax bracket when Anthony retires. At that time, you expect inflation will be at 3.1%, that the risk free rate will be 4% and that the market risk premium will be 8.25%. You also assume you will require a return of 8.5% in retirement.

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Summary of Your Financial Health

Documents: The following documents were prepared and are attached to this plan: Statement of Financial Position, Ratio Analysis, and Statement of Cash Flow.

1. Current situation: Your current financial situation reports net worth of $4,275,284 and

net disposable income of $20,947. Together, you have a sizable net worth and adequate disposable income that can be used in reaching your financial goals. In addition, we calculated financial ratios that measure your financial status compared to benchmarks. We discovered that you have a relatively high current ratio of 1.40 (calculated as $77,339/$55,198) which compares your assets to your liabilities and is greater than a benchmark of one. You also clearly pass the monthly housing cost ratio of 11% compared with an upper limit benchmark of 28%. The monthly housing costs and other debt ratios are also clearly passed because a 23% ratio is lower than the 36% benchmark. Based on the homeowner benchmarks of 28% and 36%, these calculations show that your current debt load is manageable and is far less than what your income can support.

However, your current savings and emergency fund is significantly lower than the three to six month amount that is typically needed. For example, without considering investment income or the cash value of the life insurance policy, six months of savings on income of $500,000 is $250,000 yet you have only $21,850 of cash and savings. If you add the cash value of the life insurance policy, then the total amount available for an emergency fund is only $77,339 which represents a shortfall of $172,661. This shortfall needs to be addressed.

The principal residence has a FMV of $950,000 with a remaining mortgage balance of $433,016, with equity of 54.42% of the value of the property. The mortgage is a fixed 4.75% rate with 25 years remaining. Consider refinancing the mortgage at a lower rate and reducing it to a 20 year mortgage.

The vacation home has a FMV of $1,100,000 with a remaining mortgage balance of $372,694, with equity of 66.12% of the value of the property. The mortgage is a fixed 5.25% rate with 9.75 years remaining. Consider refinancing the mortgage at a lower rate for 10 years. Although a refinanced mortgage would be held for 3 months longer, this is immaterial.

2. Additional recommendations: To improve your current financial position and

accomplish one or more of your goals, we reviewed the Statement of Cash Flow to determine if some expenses could be reduced and savings applied to reduce debt or increase the value of the emergency fund. For example, the vacation you wish to take costing $30,000 plus the $24,000 for entertainment, dining out and fun money expenses is 10.20% of income (calculated as $54,000 / $529,372 total income). These expenses are discretionary and we suggest you consider reducing these expenses to improve your financial position.

3. Implementation: To establish an emergency fund, the additional cash should be invested in assets that have a net asset value (NAV) of one. For example, investing in a money market mutual fund, a savings account and/or certificate of deposits with

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maturities six months or less would be appropriate. In the event that an emergency occurred and investment assets were used to cover expenses, it would impact your longer-term goals, and we would need to address this situation.

Summary of Risk Management Documents: A scenario was prepared to identify any weaknesses in your insurance coverage regarding your disability, auto, and health insurance policies. In addition, a life insurance needs analysis was conducted for each spouse. Both documents are attached for your review.

A review of your current risk management position demonstrated the following strengths and weaknesses.

First, the homeowners’ policy needs to be at least 80% of $550,000 or $440,000 to provide you with adequate coverage. The current policy provides only $425,000 of coverage, which represents a shortfall of $4,409 on a $100,000 loss.

Second, Anthony has a disability policy that pays out the lessor of $240,000 or 60% of income. Based on his salary of $350,000 and earnings from the K-1 of $150,000, the payout would be $240,000 since this is the lesser amount. The amount Anthony would receive tax-free in 2015 if he became disabled on January 1, 2015 is $180,000 due to the 3 months elimination period.

Third, Maria cannot purchase a disability policy at this time because she does not have any earned income. However, once subcontracting income is earned next year, we will need to determine the amount of disability coverage she needs to protect these earnings.

Fourth, the personal auto policy looks adequate and will pay $13,000 of a $14,000 claim. However, the umbrella policy of $1,000,000 is not sufficient, and an additional amount of coverage should be purchased to increase this amount to $2,000,000 - $3,000,000.

Fifth, the health insurance policy appears to be adequate and $250,000 of medical expenses for Anthony and Maria will cause a $5,000 stop-limit payment. In addition, continued monitoring of this policy is needed whenever changes are made to the new Affordable Care Act.

Finally, a life insurance needs analysis was conducted for each spouse. This indicates a shortfall in coverage of $612,692 for Anthony and $1,388,886 for Maria. The purchase of permanent life insurance policies for both Anthony and Maria is needed.

Summary of Investment Planning Documents: An Investment Policy Statement and an analysis of the investment portfolio was prepared for your review and are attached to this plan.

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1. Current situation: Your current investment situation has some weaknesses that need to be addressed. Although there are $1,050,622 in non-qualified assets and $335,454 in qualified assets, the non-qualified portfolio is not diversified and is under-performing on a total risk basis, as measured by the Sharpe Ratio. However, the SEP IRA portfolio is being managed quite well and no recommended changes need to be made at this time to the “A” share mutual funds in this portfolio.

2. Recommendations: To improve the investment position or accomplish one or more of

your goals, we suggest you implement the following recommendations:

First, diversify the stock portfolio because there are only 5 stocks with a total cost basis of $670,000 and a FMV of $550,300. A tax harvesting strategy can be used to create a $3,000 loss in the current tax year since Stock D has an unrealized gain of $125,000 and the remaining stocks all have unrealized losses.

Second, because you are currently in a high tax bracket, we suggest you sell the bonds and allocate to tax-free municipal bonds if it creates a higher yield than the bonds within the portfolio.

Third, there is substantial default risk on the Corporate Security B that is valued at $196,658. We recommend you sell this stock and purchase a diversified bond mutual fund. When the stock is sold, we recommend building a portfolio of individual stocks that are well diversified. It is also important to determine if a growth strategy to minimize current taxes needs to be implemented. If that is not the case, we suggest building a diversified portfolio using ETFs and mutual funds with low turnover and tax efficiency.

However, if you wish to continue owing the Corporate Security B stock, we can discuss purchasing a put on these securities. If the cost is too high, we would consider selling a call and design a zero cost collar strategy.

Finally, we recommend that you continue purchasing additional securities to save for retirement.

If you accept these investment planning recommendations we will develop an asset allocation strategy for your portfolio that maximizes return in a tax-efficient manner, is more diversified, and matches your moderately-high risk tolerance level.

Summary of Retirement Planning

Documents: A retirement plan analysis was conducted for Maria and is attached.

1. After conducting a retirement needs analysis, it is evident that your current financial position is meeting your retirement goals. The inflation adjusted return that we calculated is 5.2376% (calculated as 1.085 / 1.031 – 1 x 100) which indicates there is an adequate inflation adjusted return to minimize longevity and purchasing power risk. If you wish to be more conservative, then a lower return and a higher inflation rate will

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affect the calculation. For example, if the expected return is 6% and you expect the inflation rate to be 4% at retirement, the inflation adjusted return is 1.9231% (calculated as 1.06 / 1.04 -1 x 100). The lower return and higher inflation rate could create a situation where you have a loss of purchasing power in your retirement years. A change in these factors could also affect the amount of money that is available to you in your retirement years, which is known as longevity risk.

2. Regarding Maria and the self-employment income she expects to receive next year, she will not be able to establish a SIMPLE IRA or a qualified account in 2014 because these accounts must be established in the prior year. However, she can establish and fund a SEP-IRA by the due date of the personal income tax return, including any extension filed. For the prior year net Schedule C income of $10,000, Maria will be able to fund $1,870 as deductible SEP-IRA contribution. In addition, Maria will need to complete Form 5305-SEP. Also, due to Maria’s age and the need for retirement funds to last for a significant period of time, an asset allocated portfolio is recommended to help mitigate longevity and purchasing power risk. Therefore, a positive inflation adjusted return is recommended for her SEP-IRA.

3. We recommend that each spouse should continue funding the maximum retirement

amounts available each year and we can help explore and evaluate the various plans and options that are available to both of you. Anthony’s SEP-IRA should be reviewed periodically and the asset allocation should be adjusted accordingly. We can also provide Maria with an asset allocated portfolio and monitor it on a regular basis.

4. Finally, because the restaurant will be a significant asset that Anthony will sell to fund his

retirement, we recommend a buy-sell agreement funded with disability and life insurance policies which satisfies one of your goals, the goal of protecting this asset in the event of disability or premature death. Also any steps taken to increase the profitability and value of the business will increase the amount available at retirement.

5. In addition to funding deductible retirement contributions, you can implement additional

savings by contributing the maximum amount to a non-deductible IRA and filing Form 8606. When you are in your retirement years and if your marginal tax bracket has dropped, a Roth conversion strategy can be implemented with the non-deductible IRA account and other retirement accounts.

Summary of Income Tax Planning Documents: Tax calculations for net rental income and Maria’s net subcontracting income were prepared and are attached to this plan.

Current situation: A review of your tax situation shows that changes can be made to reduce your income tax liability.

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1. The investment interest income is currently taxed at the highest marginal rate. We suggest you purchase some municipal bonds for your portfolio because they are more tax efficient. For the non-qualified account, purchase individual grow stock or purchase an ETF/mutual fund that is tax-efficient. Also, due to your high marginal tax bracket, you should fund tax-deductible retirement savings accounts to the maximum limits allowed each year.

2. We recommend that you maximize the value of the restaurant by reducing

expenditures and increasing sales. Although this strategy increases current income, the increase in net operating income (NOI) will increase the value of the business on disposition. If the value of the business is mainly goodwill, the value will be received as a capital gain upon sale. You may want to consider opening another successful restaurant and purchase the building to receive depreciation deductions and possible capital gains treatment on the subsequent sale of the land and building.

3. Although there is a risk to renting the vacation home, any rental income received

from fewer than 15 days will not be taxed. Therefore, based on the 12 day rental income of $12,000, this income is tax-free and the incidental expenses of $400 are non- deductible personal expenses. However, if you do rent the home for the entire year next year, the gross rental income of $78,000 will create rental income of $1,845.

Summary of Estate Planning Documents: A property ownership spreadsheet and estate tax calculations were prepared for each spouse and are attached for your review.

1. Current situation:

• Neither spouse has an estate that is subject to estate taxes if either one of you was to die this year. However, a significant problem is that each estate is subject to excessive probates fees and expenses at this time.

• There are no essential estate planning documents in place, such as powers of attorneys and health care proxies, to manage your affairs if either of you was to become incapacitated. Also, there is no buy/sell agreement in place to transfer the restaurant to Vinnie if Anthony were to become incapacitated.

• Anthony’s life insurance policy is payable to his estate which further increases his probate estate.

2. Recommendations:

• Change the title of your homes and autos from sole ownership to tenancy by the entirety to avoid probate costs. These changes would automatically transfer the properties to the surviving spouse at the first spouse’s death, which is compatible with your objectives.

• Visit with an estate planning attorney to obtain powers of attorneys, health

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care proxies and a buy/sell agreement.

• A recommendation has been made to increase the face value of Anthony’s life insurance policy and for Maria to obtain life insurance coverage. Discuss the options of placing these policies in an irrevocable life insurance trust with your estate planning attorney or naming the other spouse as beneficiary of these policies.

3. Implementation:

• An appointment with an estate planning attorney is needed to accomplish these estate planning objectives and should be made as soon as possible. The costs for implementing these recommendations include changing property titles, and attorney fees. The cost to implement is approximately $10,000 and this expense can be disbursed from cash that is currently in held your joint checking account.

Action Plan:

Several financial strengths were identified during the financial planning analysis however our analysis also indicates that five specific areas need immediate attention. These recommendations are aligned with your goals and will help improve your financial position.

1. Visit with an estate planning attorney as soon as possible to obtain proper estate

planning documents, and possibly trusts, to plan for either spouse’s incapacity. This is the second goal you identified which requires immediate attention. An attorney can assist you with implementing all of the estate planning recommendations made in this plan, including life insurance trusts and a buy-sell agreement. Is it possible to set up an appointment with an attorney this week?

2. Purchase more life insurance for Anthony and purchase a separate life insurance

policy for Maria. At present, the family is not adequately protected in the event that either spouse dies prematurely. This recommendation is compatible with your first goal of protecting the family in the event of an untimely death. We have identified that the rounded life insurance needs are $600,000 for Anthony and $1,400,000 for Maria. Call your insurance agent this week to begin the process of obtaining sufficient insurance coverage.

3. The value of the restaurant is approximately 40% of your invested assets. A buy-sell

agreement funded with disability and life insurance can be used to protect the restaurant’s value. A buy-sell agreement also contributes to fulfilling your first and second goals of protecting your assets in the event of an untimely death or disability. Speak to your insurance agent about funding a buy-sell agreement after you have met with your estate planning attorney.

4. Build an emergency fund that is funded with $250,000. A shortfall of $172,661

was identified therefore cash flows from the restaurant will be deposited into your

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joint savings account each month until the account is fully funded. Begin making deposits at the end of this month.

5. Diversify your stock and bond portfolio. Our firm can develop an investment asset

allocation strategy for you that maximizes investment returns, minimizes taxes, and is aligned with your tolerance for investment risk. We will present our investment planning recommendations for you at our next meeting. Let’s plan to meet again in two weeks.