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Assume that Michelle is self-employed. What are her retirement plan options?

2. By using the annuity approach, calculate the capital needed at retirement (age 67) forthe Williamses. Assume a 9% after-tax rate of return. Base the calculation on Michael'ssalary only.

3. By using the capital preservation approach, calculate the capital needed at retirementfor the Williamses.

4. By using the purchasing power preservation approach, calculate the capital needed atretirement for the Williamses.

5. Explain the key differences among the three approaches in Questions 2-4.

6. Use the capital need you computed in Question 2 to determine whether the Williamseswill be able to retire at age 67 with their current annual savings. For current annualsavings, use Michael's Section 401 (k) plan contribution plus the employer's match andassume that Michelle saves all that she currently earns on an annual basis. Assume thatall investment assets (regardless of how they are currently invested) will earn a 9%after-tax rate of return. Consider the checking account, money market account, andcoin collection as nonretirement assets.

7. What changes, if any, would you recommend to the Williamses regarding their retirementplanning?

8. If Michael and Michelle include the receipt of Social Security benefits in their retirementplanning, could they retire at age 67 without increasing their annual savings? Assumethat at age 67 (in today's dollars) Michael's Social Security benefit would be $29,820and Michelle's would be $14,910. Use Michael's salary only.

9. If the Williamses choose to rely on Social Security benefits in their retirement planning,how much earlier than age 67 can they retire? (Assume all other facts as given inQuestion 8).

Michael and Michelle Williams 62 Personal Financial Planning Cases and Applications Textbook 7th Edition Michael and Michelle Williams believe they have a solid financial future; however, they are concerned about actions they need to take to ensure college educations for two of their children and a secure future for a third child with special needs. They have come to you for assistance in determining how they can achieve these goals. Today is January 1, 2011. Personal Background and Information Michael Williams (Age 35) Michael is a doctor who specializes in internal medicine. He is an employee of Lakeside Hospital. The salary that Michael earns compensates him for patients seen at both the hospital and the Lakeside-owned clinic. Michael is starting his sixth year of practice. He has been discouraged lately with the medical economic environment. Given the proliferation of managed care, he sees only a limited ability to increase his salary in the future and is concerned that his salary increases are not likely to exceed inflation. Michelle Williams (Age 35) Michelle grew up in a middle class family and lost both of her parents to cancer in their early 50s. Michelle is a nurse but has not worked in her profession since her children were born. Michelle is fascinated with all things technological. She is a seller on an online auction site. Michelle has an uncanny sense for shopping for unique items that she buys, adds a markup, and resells. She marks up an item 100%, does not sell the item for less than its marked-up price, and charges the online buyer for all related shipping costs. In 2011, she has changed the dynamic of her business and expects to generate up to $90,000 net income from the business this year. Children Michelle and Michael have three children: Beau (age 7), Lizabeth (age 5), and Madison (age 2). Madison has Down syndrome. Michael's Family Michael is an only child and has been his parents' pride and joy. Michael's parents (Frank and Isabelle) are first-generation immigrants from England. They immigrated before Michael was born and operate a small neighborhood deli. Michael and Michelle met at the deli when Michelle worked there during her college years. The ebb and flow of community life through the deli still fascinates Michelle, and she often visits Michael's parents there. The elder Williamses own the building (fair market value, $150,000) that houses the deli. The neighborhood has seen needed renovations in loyee of nts seen xth year onment. rease his ) exceed cancer ince her s a seller ue items not sell J related cpects to D : 5), and s parents migrated Michelle ebb and en visits et value, ations in Case 5 I Michael and Michelle Wi lliams 63 recent years, and the future outlook for continued renewal is good. The deli enjoys a steady stream of loyal customers and has generated moderate wealth for Michael's parents. They are both 60 years old and are in fair health. Frank and Isabelle have no family in this country except for Michael. As they approach retirement, their primary concerns are the high costs of long-term residential and medical care for the elderly. Michelle's Family Michelle's parents are both deceased. Michelle is close to her only sibling, Joan (age 40). Joan is unmarried and has no children. Joan is particularly close to the Williamses' children. In the past, Joan has mentioned to Michelle that she would consider assisting with the educational and maintenance needs of the children. Joan has given up her job as a business education teacher to be a full-time author of financial self-help books and works out of her home. To date she has enjoyed tremendous success and has raised her annual income from $35,000 a year to $100,000. Personal and Financial Objectives 1. The Williamses want to provide Beau and Lizabeth with up to $25,000 (today's dollars) per year for four years of college education. The children will be on their own for the costs of any graduate work. 2. They want to assist Michael's parents in their retirement years, as needed. 3. They want to be free of mortgage indebtedness by the time Michael is 55 years old. 4. They want to design a retirement plan that will provide an income to replace 70% of Michael's preretirement income. 5. They want to make necessary arrangements for Madison so that she will be cared for throughout her adult life. 6. They want to maintain an adequate emergency fund of six months' living expenses. 7. They want to prepare proper wills and an estate plan. Economic Information They expect inflation to average 3%. They expect an educational consumer price index (CPI) of 5%. They expect Michael's salary to increase 3% annually. 64 Personal Financial Plan ning Cases and Applications Textbook 7th Edition Rates are 7% for a 15-year fixed mortgage and 7.5% for a 30-year fixed mortgage. They are in a 31% federal income tax bracket and a 6% state income tax bracket. Any refinancing will incur 3% of the mortgage as a closing cost which will not be financed. Insurance Information Health Insurance Health insurance is provided for the entire immediate family through Lakeside Hospital. Michael is staunchly opposed to health maintenance organizations (HMOs), as he has seen firsthand how quality of care can suffer under these contracts. Lakeside Hospital's health insurance is through a preferred provider organization (PPO). The contract has a family deductible of $500 per year. If preferred contract physicians are used, the contract is an 80/20 major medical coinsurance plan. The family annual stop-loss limit is $2,000. There is no prescription drug, eye, or dental coverage included in the plan. The plan has unlimited lifetime benefits. Life Insurance Michael has elected $50,000 group term life insurance through the hospital. The hospital pays the premium as a benefit to Michael. Michelle has maintained a $10,000 whole life insurance policy her parents purchased for her as a child. The cash value of the whole life policy is $6,000 and policy is paid up. Disability Insurance The hospital does not provide disability insurance for its employed physicians. Michael has purchased a policy through the American Medical Association. The policy provides own-occupation coverage for disability resulting from either sickness or accident, pays a benefit of 60% of gross pay after an elimination period of 180 days, covers a term of 60 months with residual benefits, and is guaranteed renewable. M alpractice Insurance The hospital provides Michael with malpractice insurance and pays the premium. The policy covers Michael's work at both the hospital and in the clinical practice. Homeowners Insurance The Williamses currently have an HO-3 policy with a replacement value on contents endorsement. The policy covers all risk and replacement value. The deductible is $250 with a premium of $2,000 per year. Case 5 I Michael and Michelle Williams ge. ket. be side Ds) , -ide 65 Automobile Insurance Michael and Michelle have full coverage on both cars, including: $100,000 bodily injury for one person $300,000 bodily injury for all persons $50,000 property damage $100,000 uninsured motorist $10,000 medical payments Deductibles are: $500 comprehensive $1,000 collision I , on~ sed, loss the Investment Information (Assumptions) Expected Return Aggressive stocks Growth stocks S&P 500 ihe 00 he Beta 13.5% 1.7 10% 1.2 9% 1.0 Value stocks 8.5% 0.9 Bonds (corporate) 6.5% 0.6 1.75% 0.2 Money market (bank) The Williamses consider themselves to be moderate risk~taking investors. Retirement Information Michael and Michelle would like to retire on or before age 67. They both expect to live to age 92. They would like to have a standard of living equal to 70% of their preretirement income. They do not want to rely on Social Security benefits in planning for their retirement. Last year Michael began participating in a Section 401 (k) plan available through Lakeside Hospital. Under the plan, the hospital matches $.50 for every dollar contributed, up to 6% of his salary. The plan allows for deferrals up to a maximum of 7% of salary. Gifts, Estates, Trusts, and Will Information is Neither Michael nor Michelle has a will. They realize the importance of having a will; however, Michael's schedule seems to preclude any time for finalizing one. They are most concerned about guardian care for Madison, while at the same time minimizing as much death tax as possible. 66 Personal Financial Planning Cases and Applications Textbook 7th Edition STATEMENT OF CASH FLOWS Michael and Michelle Williams For the Year Ended December 31, 2010 CASH INFLOWS Salary-Michael Gift from Michael's parents Michelle's self-employment income Interest $170,000 20,000 4,000 900 Total inflows $194,900 CASH OUTFLOWS Section 401 (k) plan savings Mortgage payment $ 11,900 20,700 Property taxes (residence) 1,800 FICA and self-employment tax 9,021 Federal income tax withholding 68,000 State income tax withholding 6,734 Utilities 3,980 Disability insurance premium Homeowners insurance Auto notes 900 2,000 10,789 Auto expense and maintenance 1,200 Auto insurance 2,400 Housekeeping service 2,400 Educational loan repayment 6,915 Clothing and dry cleaning 5,600 Food 5,750 Entertainment 3,970 Miscellaneous 5,998 Total outflows Discretionary cash flow $170,057 $24,843 1 Case 5 I Michael and Michelle Williams STATEMENT OF FINANCIAL POSITION Michael and Michelle Williams January 1 r 2011 Assets), Liabilities and Net Worth 2 Cash/cash equivalents Current liabilities Checking account JT $2,500 Money market accounP JT 5,000 (1.75% interest rate) Total cash/cash equivalents $7,500 Invested assets $ 550 Auto loan (Audi) 25,000 Auto loan (Toyota) 18,000 Total current liabilities $43,550 Long-term liabilities CD JT $15,000 Section 401 (k) plan H 10,000 Cash value of life insurance w 6,000 Coin collection H 10,000 Total investments Home mortgage Student loans Total long-term liabilities $225,000 50,500 $275,500 $41,000 Net worth Personal use assets House (appraised 7/01/1 0) Credit card balances 4 JT $275,000 Auto (Toyota) JT 22,500 Auto (Audi) JT 47,000 Total personal use $344,500 Total assets $393,000 Total liabilities and net worth Note to financial statements 'Assets are stated at fair market value. ' Liabilities are stated at principal only and are all joint obligations except the student loans w hich belong to Michael. 'The money market account is currently serving as their emergency fund. ' Land value was determi ned to be $50,000 and the home value $225,000. Replacement value of the home is also $225,000. Title designations JT =Joint tenancy with right of survivorship H =Husband 's separate property W =Wife's separate property The Williamses primarily use cash, check, and debit cards for personal expenditures. $73,950 $393,000 67 68 Personal Financial Planning Cases and Applications Textbook 7th Edition 1. Assume that Michelle is self-employed. What are her retirement plan options? 2. By using the annuity approach, calculate the capital needed at retirement (age 67) for the Williamses. Assume a 9% after-tax rate of return. Base the calculation on Michael's salary only. 3. By using the capital preservation approach, calculate the capital needed at retirement for the Williamses . 4. By using the purchasing power preservation approach, calculate the capital needed at retirement for the Williamses . 5. Explain the key differences among the three approaches in Questions 2-4. 6. Use the capital need you computed in Question 2 to determine whether the Williamses will be able to retire at age 67 with their current annual savings. For current annual savings, use Michael's Section 401 (k) plan contribution plus the employer's match and assume that Michelle saves all that she currently earns on an annual basis. Assume that all investment assets (regardless of how they are currently invested) will earn a 9% after-tax rate of return . Consider the checking account, money market account, and coin collection as nonretirement assets. 7. What changes, if any, would you recommend to the Williamses regarding their retirement planning? 8. If Michael and Michelle include the receipt of Social Security benefits in their retirement planning, could they retire at age 67 without increasing their annual savings? Assume that at age 67 (in today's dollars) Michael's Social Security benefit would be $29,820 and Michelle's would be $14,910. Use Michael's salary only. 9. If the Williamses choose to rely on Social Security benefits in their retirement planning, how much earlier than age 67 can they retire? (Assume all other facts as given in Question 8) . Use the following information for questions 10 through 15. Michelle's online auction business has taken off this year, and she had to hire two employees. She has a Website on which she sells products in a manner similar to other stores. The most unusual and valuable items in her inventory are available through Internet auction only. Her store is linked to the online auction Website and several search engines. She is projecting net income of $90,000 from the business in 2011. Michelle wants to keep her workforce stable by offering them benefits, including a retirement plan . More importantly, she needs to maximize her retirement savings in order to help meet the retirement goals she and Michael have set. She does not want to factor the increase in her business income into their retirement needs calculations. Both Michelle and Michael believe the plan based primarily on his income will be sufficient for their retirement. Michelle wants to make contributions to the employees' retirement accounts as a benefit to them. She has heard a lot about the testing of retirement plans and wants a plan that will minimize the testing and administration burden . Case 5 I Michael and Michelle Williams 69 Her employees make $20,000 and $25,000 each . She is considering a Keogh (HR-1 0) plan, a SEP IRA, a SIMPLE IRA, and a SIMPLE 401 (k). 10. ing this type of plan. 57) for lichael's Describe a Keogh (HR-1 0) plan and discuss the advantages and disadvantages in adopt- 11. Describe a SEP IRA and discuss the advantages and disadvantages in adopting this type of plan . ~ ment 12. Describe a SIMPLE IRA and discuss the advantages and disadvantages in adopting this type of plan . j ed at 13. Describe a SIMPLE 401 (k) and discuss the advantages and disadvantages in adopting this type of plan . lliamses JUal :hand n e that 14. Of the four plans discussed, which is the best fit for Michelle's new business? 15. Other than child care costs and unreimbursed medical expenses, what expenses can Michael pay for with pre-tax dollars through his FSA? ~% and etire- 1. List the Williamses' financial strengths and weaknesses. 2. What additional information would you request from the Williamses to complete your data-gathering phase? irement ;sume 3. Comment on the Williamses' use of debt. ,820 4. Assuming a 9% after-tax rate of return, calculate the amount needed today to fund the children's college education . nning, 5. r stores. uction is prowork;he ne and 1 their .rily on to the sting of rden. By using life insurance industry rules of thumb, how much life insurance should Michael carry? 6. In general, what issues must be decided when purchasing a long-term care insurance policy? 7. Frank and Isabelle are thinking of retiring in five years and are considering transferring the deli to Michelle. They believe that such a transfer would be wise, for it would remove the value of the deli from their gross estate . Moreover, they would like to see Michelle receive it, given her love for it. Frank and Isabelle are wondering what the value of the deli might be. Calculate the value of the deli by using the following approaches. a. Capitalized earnings model b. Present value analysis of the earnings and the building (assume the residual value of the earnings is $1,314,570) 70 Personal Financial Planning Cases and Applications Textbook 7th Edition 8. Frank and Isabelle have identified five possible ways that they could effect the transfer of the deli to Michelle. Describe the transfer method and the advantages and disadvantages to the parties. a. Outright gift b. Private annuity c. Self-canceling installment note (SCIN) d. Grantor retained annuity trust e. Family limited partnership 9. The Williamses wish to establish a special needs trust for Madison. What factors and benefits should be contained in such a trust? How should it be funded? 10. Assume that the state in which they live has?- fairly onerous probate system. What can the Williamses do to avoid the probate process? 11. Michael and Michelle wish to refinance their home mortgage. Will they qualify for the 15-year or the 30-year mortgage? What will be the total principal and interest payments for the 15-year and the 30-year mortgage? 12. Are there federal income tax implications regarding the group term life insurance benefit that Michael receives from the hospital if the coverage is increased to two times his salary? If so, what are they? Be sure to include any calculated amounts, and say how and where they would be reported. 13. Lakeside Hospital has just begun offering employees a flexible spending account (FSA) benefit. Michael is considering contributing to the FSA for assistance in covering childcare costs . Recently, however, a CPA friend of Michael's told him about the federal income tax dependent care credit. Assume that Michael approaches you, a financial planner, for advice on which approach would be best to use-FSA or the dependent care credit. Can the Williamses use both the FSA and the dependent care credit? 14. If Michelle only conducts a few online auction transactions will the transactions qualify as a trade or business? Discuss the tax consequences of Michelle's online auction transactions assuming: a) the transactions do not constitute a trade or business, and b) the transactions do constitute a trade or business. For each alternative, specify how transaction gains and losses would be treated for federal income tax purposes, and identify the tax schedule on which the activity would be reported. 15. Assuming a 9% after-tax rate of return, calculate the amount the Williamses need to save annually at year-end to fund the children's college education. Assume payments are made until the second child starts college . 16. What are the Williamses' present insurance portfolio deficiencies? 17. Using a human value approach net of state and federal income taxes and assuming a 9% after-tax rate of return, how much additional life insurance is needed on Michael's life? 18. Michelle's sister wishes to pay for Madison's daycare, schooling, and medical costs. How can she pay these costs so the payment is not considered a taxable gift? -- ---------- - Case 5 I Michael and Michelle Williams 71 19. Assume that Michael's Section 401 (k) plan balance is equally invested in two mutual funds. Mutual Fund A has a standard deviation of 8%, and Mutual Fund B has a standard deviation of 11%. Assume the correlation coefficient of the funds is 75% . Calculate the standard deviation of the two-asset portfolio. 20. What is the residual benefits feature in Michael's disability policy? 21. Should Frank and Isabelle Williams purchase a long-term care insurance policy? Would any premiums paid for the long-term care policy be income tax deductible? 22. In the order of importance, what are the ten primary actions the Williamses should take immediately regarding their financial security? an 23. What issues are involved in the selection of a guardian for Michael and Michelle's children? e 24. Using the financial needs approach and assuming the following expenses, what is the minimum amount of life insurance Michelle should have today? :r n- Final expenses of $20,000 Annual childcare costs of $15,000 per year for 10 years 1- his College funding for Beau ($62,721) and Lizabeth ($58,202) Mortgage of $225,000 A.) Auto loans of $43,000 d- Student loans of $50,500 ify .ns1e sacthe 0 s a el's How Credit card debt of $550 Return on invested money is 9% Expected inflation rate is 3% Emergency fund need of roughly $23,064 ($30,564 need- $7,500 cash) 25. If the Williamses average $2,000 in annual dental and vision care expenses, how much would they save/exclude from taxes by using pre-tax dollars