A GENERAL FINANCIAL PLANNING CASE

Onslo Graham is fifty-nine years of age. His wife, Daisy, is age fifty-eight. Onslo and Daisy have been married for nearly thirty years. The Grahams currently live at 3456 Speedway, Anycity, Anystate 01010. They have an adult child, Rose, who recently turned age twenty-eight. Rose also lives in Anycity.

Because of their strong relationship, Onslo and Daisy have titled all property jointly, even though Daisy has been a homemaker and not directly contributed to the purchase price of household assets. Onslo does have one real estate asset that is not jointly owned.

Onslo is the general manager of Tarantula Industries, a closely held corporation, which owns a hockey team in an expanding southwestern minor league. The team is headquartered at 555 West Verity Road, Anycity, Anystate 71010. Onslo has been involved in professional sports management for approximately twenty-five years. He currently earns $137,500 per year in income. Rose is also actively involved with the team. She works in the front office and manages day-to-day operations. Onslo and Daisy hope that Rose will eventually take over management of the team once Onslo retires.

Use the following information to conduct a review of the Grahams' financial situation.

Global Assumptions (Valid unless otherwise specified in certain instances):

Inflation: 4.0 percent.

All income and expense numbers are presented in today's dollars.

Planned retirement age: When Onslo turns age sixty-six.

Combined federal and state marginal tax bracket: 29.72 percent.

All qualified plan or IRA contribution growth rates are assumed to stop at the federally mandated limit unless otherwise restricted.

All nominal rates of return represent pre-tax returns.

As of the date of the case, Onslo and Daisy are not subject to the alternative minimum tax (AMT).

Onslo and Daisy are currently qualified for Social Security benefits.

Income Issues

Onslo currently earns $137,500 per year and expects his salary to increase at 5.0 percent per year until retirement. As a household, Onslo and Daisy also receive $15,403 in non-qualified dividends and interest from miscellaneous other investments, all of which are reinvested. Onslo and Daisy are covered by employer-sponsored health care. The premium, which is paid by Onslo directly, is $2,400 per year. Onslo also contributes $9,600 annually into a 401(k) plan. The plan provides matching at 33 cents on the dollar with no maximum beyond IRC statutory limitations. These expenses are paid for with pre-tax dollars.

Expense Summary

Based on his salary, Onslo had $27,000 withheld for federal, Social Security, and Medicare taxes. He also had $6,565 withheld for state taxes.Table XII.1summarizes other household expenditures.

Table XII.1.Other Household Expenses

Expense

Amount

Frequency

Mortgage payments

$1,829.50

Monthly

Home equity loan payments

$286.67

Monthly

Auto payments

$483.33

Monthly

Credit card payments

$3,500.00

Annually

Auto insurance

$1,300.00

Semi-annually

Homeowners insurance

$450.00

Semi-annually

Life insurance

$3,200.00

Annually

Umbrella liability insurance

$125.00

Annually

Disability insurance

$2,250.00

Annually

IRA contributions (Daisy)

$2,000.00

Annually

IRA contributions (Onslo)

$2,000.00

Annually

Subscriptions

$500.00

Annually

Telephone expense

$91.67

Monthly

Home Internet

$50.00

Monthly

Hobbies (Daisy)

$500.00

Yearly

Tax Issues

Expense

Amount

Frequency

Hobbies (Onslo)

$100.00

Yearly

Recreation/entertainment

$100.00

Monthly

Club dues

$500.00

Yearly

Groceries

$500.00

Monthly

Food away from home

$400.00

Monthly

Real estate taxes

$600.00

Semi-annually

Household maintenance

$200.00

Monthly

Utilities

$300.00

Monthly

Clothing (Daisy)

$300.00

Monthly

Clothing (Onslo)

$600.00

Semi-annually

Laundry services

$100.00

Monthly

Personal care

$100.00

Monthly

Furnishing

$1,000.00

Yearly

Yard maintenance

$100.00

Monthly

Medical copayments (Daisy)

$10.00

Monthly

Medical copayments (Onslo)

$10.00

Monthly

Prescriptions (Daisy)

$300.00

Yearly

Unreimbursed medical expenses

$10.00

Monthly

Gasoline

$100.00

Monthly

Car registrations

$320.00

Yearly

Parking and tolls

$400.00

Yearly

Personal property tax*

$450.00

Yearly

Safe deposit box fee

$100.00

Yearly

Monthly bank fees

$2.00

Monthly

IRA fees

$40.00

Yearly

Accounting fees

$400.00

Yearly

Charitable contributions

$400.00

Monthly

Travel expenses

$2,500.00

Yearly

Vacations

$2,500.00

Se-annually

Alcohol expenses

$350.00

Annually

Gifts to family members (Daisy)

$500.00

Quarterly

Gifts to family members (Onslo)

$500.00

Annually

Other miscellaneous expenses

$500.00

Semi-annually

*Amount includes applicable car registration property tax.

Onslo and Daisy complete their own tax returns using a nationally known tax preparation software package. Onslo pays his company's accountant to double-check his calculations. Onslo and Daisy file married filing jointly. Onslo and Daisy are eligible for a $1,250 state standard deduction and a $275 state exemption per person. Onslo is considered an employee of his firm and does not pay self-employment income taxes. Household held assets are summarized inTable XII.2. Household debts and liabilities are shown inTable XII.3.

Table XII.2.Asset Summary

Asset

Amount

Ownership

Financial Assets

Checking account

$6,500

Joint

Savings account

$10,000

Joint

Taxable money market mutual fund

$230,000

Joint

I-bonds

$15,000

Joint

Government bond funds

$41,000

Joint

Corporate bond funds

$45,000

Joint

High-yield bond funds

$15,000

Joint

Large-cap funds

$151,600

Joint

Mid-cap funds

$70,600

Joint

Small-cap funds

$37,000

Joint

Rental real estate portfolio*

$2,100,000

Onslo

Retirement Assets

Large-cap funds (401k)

$40,000

Onslo

Mid-cap funds (401k)

$35,000

Onslo

Small-cap funds (401k)

$15,000

Onslo

Corporate bond funds (401k)

$27,000

Onslo

International funds (IRA)

$19,000

Onslo

High-yield bond funds (IRA)

$17,500

Daisy

Other Assets

Primary residence

$375,000

Joint

Mazda MPV

$25,000

Joint

Ford Taurus

$7,800

Joint

Artwork

$2,500

Joint

Hockey collectibles

$1,500

Joint

Sporting/hobbies supplies

$3,500

Joint

14-foot aluminum boat

$7,000

Joint

Furniture

$28,000

Joint

Other assets

$6,500

Joint

*The rental real estate is income and tax neutral; the property does not generate income or losses for cash flow or tax purposes.

Table XII.3.Debt and Liability Summary

Liability

Amount

Ownership

Visa credit card

$12,000

Joint

MasterCard

$8,000

Joint

Discover card

$7,500

Joint

Garts sporting goods card

$5,000

Joint

Loan due in 45 days

$2,500

Onslo

Mortgage

$235,984

Joint

Home equity loan

$29,471

Joint

Mazda loan

$9,177

Joint

Life Insurance Information and Planning Issues

Onslo and Daisy would like you to analyze their life insurance situation using the following assumptions and facts:

In the event of a death, household expenses will drop to $105,000 per year.

Final expenses (funeral and burial costs) will be $25,000 for each person.

Estate and legal costs will be $69,930 for Onslo and $16,135 for Daisy.

All outstanding liabilities will be paid at the first death.

Other immediate needs should be funded with $10,000 each.

Onslo and Daisy would like to plan conservatively in the event of a death by assuming a 6.0 percent before-tax rate of return on any insurance proceeds both pre- and post-retirement.

For planning purposes, assume Onslo and Daisy will be in a combined state and federal tax bracket of 30.0 percent before retirement.

Full retirement age is sixty-six for both Onslo and Daisy.

Onslo and Daisy would like to replace $90,000, before taxes, while in retirement for the surviving spouse.

Daisy is eligible to receive $1,958 per month (in today's dollars) as a Social Security survivor benefit at age sixty-six (assumes that Onslo dies today).

Onslo will receive $2,024 Social Security benefits per month (in today's dollars) in retirement at age sixty-six.

Onslo and Daisy are eligible to receive survivor benefits equal to a 71.5 percent reduction in full benefits from age sixty to sixty-six.

In the event of either spouse's death, the other spouse plans to stop working at age sixty and begin taking early retirement survivor benefits.

For conservative planning purposes, the Grahams do not plan on using interest and/or dividends as an income source when determining insurance needs.

Onslo and Daisy are willing to use all their retirement savings and $350,000 in other assets to offset life insurance needs.

Onslo expects his salary to remain the same following Daisy's death.

Daisy does not expect to work after Onslo's death.

Table XII.4summarizes life insurance policy information for Onslo and Daisy.

Table XII.4.Life Insurance Policies Owned by Onslo and Daisy

Disability Insurance Information and Planning Issues

Onslo and Daisy have not focused too heavily on disability planning issues. Onslo and Daisy do know that they do not want to account for Social Security benefits in the event of a disability. A few years ago, Onslo purchased a long-term disability insurance policy in the private market (not through a cafeteria plan at work). Information about the policy is summarized below:

The policy is defined as own-occupation and is issued by an A.M. Best A- rated company.

The policy has a six-month elimination period.

The policy pays 50 percent of Onslo's current salary until age sixty-five.

All premiums are paid with after-tax dollars.

If disabled, Onslo and Daisy would like to continue to save for other financial objectives.

Other Insurance Information and Planning Issues

The Grahams do not currently have a long-term care insurance policy. In the case of a long-term care need, Onslo and Daisy are comfortable assuming nursing home costs of $65,000 per year in today's dollars, with a four year funding need. Both are healthy with both sets of parents still alive and well. In fact, Onslo and Daisy skate twice a week at the team's local indoor practice arena.

Onslo and Daisy have worked with the same property and casualty insurance agent for twenty-five years. Their agent encouraged them to purchase a $1 million umbrella policy four years ago. This required that the Grahams increase the split-limit coverage on their personal automobile policies to $100/$300/$100. Their current HO-3 homeowner's policy provides 100 percent inflation protection coverage.

Current yield information for use when solving case questions is provided inTable XII.5.

Table XII.5. Current Yield Information

Investment Class

Yield

Checking account

0.00%

Savings account

2.00%

Taxable money market fund

3.00%

Anystate municipal money market fund

2.40%

EE savings bonds

3.50%

I bonds

4.50%

Government bonds

4.50%

Corporate bonds

5.00%

High-yield bonds

6.50%

Real estate

3.75%

Gold

0.00%

Large-cap stocks

2.00%

Mid-cap stocks

1.00%

Small-cap stocks

0.00%

Loan Rates

30-year mortgage*

5.95%

15-year mortgage*

5.75%

Home equity line of credit*

5.85%

Home equity loan*

7.35%

5-year auto loan

6.10%

Personal loan

8.25%

*APR includes closing costs

Retirement Information and Planning Issues

The following information should be used when evaluating the Grahams' current retirement planning situation:

Onslo and Daisy would like to retire when Onslo reaches age sixty-six.

Although the actual tax rate will likely be less, Onslo and Daisy would like to assume that they will be in a 25 percent combined federal and state marginal tax bracket while in retirement.

Prior to retirement, Onslo and Daisy are comfortable assuming that future rates of return will be 10.72 percent, before taxes, on retirement assets and savings.

If retired today, they would like to replace 90 percent of Onslo's salary.

At retirement, Onslo will be eligible to receive $2,024 (in today's dollars) in Social Security benefits per month.

Daisy has not yet earned forty quarters for Social Security benefits, but she does qualify for spousal benefits.

Onslo and Daisy are comfortable assuming a life expectancy of ninety-five years.

Contributions to Onslo's 401(k) will increase by 3 percent each year.

Daisy is the primary beneficiary of Onslo's retirement assets.

All qualified assets held outside of the 401(k) are in traditional IRAs.

After retirement, Onslo and Daisy plan to allocate retirement assets to generate a before-tax return of 8.70 percent.

Estate Information and Planning Issues

Onslo and Daisy have separate wills. Onslo's will leaves all his assets to Daisy. Daisy's will leaves all her assets to Onslo. Each person's will names their attorney as the estate executor, and in the event of a simultaneous death, it is assumed that Onslo predeceases Daisy. Other estate planning assumptions include:

Funeral and burial expenses will be $25,000 each.

Estate and legal costs will be $5,000 each.

Executor fees will be approximately 2.0 percent of the gross estate before the marital transfer.

The net growth rate of the survivor's estate is estimated to be, on average, 4.0 percent annually.

Daisy is the sole beneficiary of Onslo's IRA and retirement plan assets.

Onslo is the sole beneficiary of Daisy's IRA assets.

Daisy has a strong allegiance to the University of Anystate. She would like to leave a legacy gift to the university, if possible.

No other estate planning documents are known to exist.

Goals and Objectives

Onslo and Daisy have two primary goals. First, they would like to know whether they are on or off track to meet an age sixty-six retirement goal. Second, they feel that a thorough review of their current estate situation is in order. Specifically, Onslo and Daisy would like to minimize any estate and/or gift taxes paid in the event of death. Other planning objectives include reviewing the discretionary cash flow, net worth, and life insurance situation. Onslo and Daisy are looking for guidance on ways to improve their general financial well-being.

Given what Onslo and Daisy currently have saved, which of the following statements is(are) true in relation to Onslo's and Daisy's current retirement planning situation?

a.Onslo and Daisy currently have adequate cash flow to fund their retirement goal.

b.If Onslo can convert his rental real estate holdings to cash prior to age sixty-six, the Grahams can meet their retirement goal.

c.Postponing retirement by one year will allow them to reach their retirement goal without using any additional assets.

d.None of these statement is correct.

e.Only statements b and c are correct.