Questions

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. Based on the calculation on Michaels 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 between the three approaches in Questions 2-4.

6. Using the capital 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 Michaels Section 401(k) plan contribution plus the employers 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, market money account, and coin collection as non-retirement 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 todays dollars) Michaels Social Security benefit would be $29,820 and Michelles would be $14,910. Use Michaels salary only.

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

10. Describe a Keogh (HR-10) plan and discuss the advantages and disadvantages in adopting this type of plan.

11. Describe a SEP IRA and discuss the advantages and disadvantages of adopting this type of plan.

12. Describe a SIMPLE IRA and discuss the advantages and disadvantages of adopting this type of plan.

13. Describe a SIMPLE 401(k) and discuss the advantages and disadvantages of adopting this type of plan.

14. Of the four plans discussed, which is the best fit for Michelles 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?

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 interal medicine. He is an employee of Lakeside Hospital. The salary that Michael ears 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 bom 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 Case 5 | Michael and Michelle Williams 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 concems 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 expens- es. 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 Planning 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 bracker. 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 con- tract 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 acci- dent, 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. Malpractice 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 con- tents 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 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 Investment Information (Assumptions) Expected Return Beta Aggressive stocks 13.5% Growth stocks 10% S&P 500 9% Value stocks 8.5% Bonds (corporate) 6.5% Money market (bank) 1.75% 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 contrib- uted, 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 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 finalising one. They are most concerned about guardian care for Madison, while at the same time minimiz- ing 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 Total inflows CASH OUTFLOWS $170,000 20,000 4,000 900 $194,900 Section 401(k) plan savings Mortgage payment Property taxes (residence) FICA and self-employment tax Federal income tax withholding State Income tax withholding Utilities Disability Insurance premium Homeowners Insurance Auto notes Auto expense and maintenance Auto Insurance Housekeeping service Educational loan repayment Clothing and dry cleaning Food Entertainment Miscellaneous $ 11,900 20,700 1,800 9,021 68,000 6,734 3,980 900 2,000 10,789 1,200 2,400 2,400 6,915 5,600 5,750 3,970 5,998 Total outflows Discretionary cash flow $170,057 $ 24,843 Cases Michael and Michelle Williams STATEMENT OF FINANCIAL POSITION Michael and Michelle Williams January 1, 2011 Assets Liabilities and Net Worth $2.500 Cash/cash equivalents Checking account Money market account (1.75% interest rate) Current liabilities Credit card balances Auto loan (Audi Auto loan (Toyota) $ 550 25,000 JT 5,000 18,000 Total cash/cash equivalents $7,500 Total current liabilities $43,550 Invested assets Long-term liabilities Home mortgage Student loans $225,000 50,500 Section 401(k) plan Cash value of life insurance Coin collection Total Investments $15,000 10,000 6,000 10,000 $41,000 Total long-term liabilities $275,500 Net worth $73,950 JT Personal use assets House (appraised 7/01/10 Auto (Toyota) Auto (Audi) Total personal use $275,000 22,500 47,000 $344,500 $393,000 Total assets Total liabilities and net worth $393,000 Note to financial statements Arts are state of market value b e re sted at principal only and real joint obligations at the student loans which belong to Mid "The money market account is currently serving as their emergency fund Land value was determined to be 550,000 and the home value $225.000. Replacement value of the home sho225.000 Title designations JT lintenancy with right of survivorship Her Husband parte property w Wiles para property The Williamses primarily use cash, check, and debit cards for personal expenditures 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 pro- jecting net income of $90,000 from the business in 2011. Michelle wants to keep her work- force 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. 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 interal medicine. He is an employee of Lakeside Hospital. The salary that Michael ears 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 bom 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 Case 5 | Michael and Michelle Williams 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 concems 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 expens- es. 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 Planning 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 bracker. 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 con- tract 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 acci- dent, 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. Malpractice 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 con- tents 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 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 Investment Information (Assumptions) Expected Return Beta Aggressive stocks 13.5% Growth stocks 10% S&P 500 9% Value stocks 8.5% Bonds (corporate) 6.5% Money market (bank) 1.75% 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 contrib- uted, 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 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 finalising one. They are most concerned about guardian care for Madison, while at the same time minimiz- ing 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 Total inflows CASH OUTFLOWS $170,000 20,000 4,000 900 $194,900 Section 401(k) plan savings Mortgage payment Property taxes (residence) FICA and self-employment tax Federal income tax withholding State Income tax withholding Utilities Disability Insurance premium Homeowners Insurance Auto notes Auto expense and maintenance Auto Insurance Housekeeping service Educational loan repayment Clothing and dry cleaning Food Entertainment Miscellaneous $ 11,900 20,700 1,800 9,021 68,000 6,734 3,980 900 2,000 10,789 1,200 2,400 2,400 6,915 5,600 5,750 3,970 5,998 Total outflows Discretionary cash flow $170,057 $ 24,843 Cases Michael and Michelle Williams STATEMENT OF FINANCIAL POSITION Michael and Michelle Williams January 1, 2011 Assets Liabilities and Net Worth $2.500 Cash/cash equivalents Checking account Money market account (1.75% interest rate) Current liabilities Credit card balances Auto loan (Audi Auto loan (Toyota) $ 550 25,000 JT 5,000 18,000 Total cash/cash equivalents $7,500 Total current liabilities $43,550 Invested assets Long-term liabilities Home mortgage Student loans $225,000 50,500 Section 401(k) plan Cash value of life insurance Coin collection Total Investments $15,000 10,000 6,000 10,000 $41,000 Total long-term liabilities $275,500 Net worth $73,950 JT Personal use assets House (appraised 7/01/10 Auto (Toyota) Auto (Audi) Total personal use $275,000 22,500 47,000 $344,500 $393,000 Total assets Total liabilities and net worth $393,000 Note to financial statements Arts are state of market value b e re sted at principal only and real joint obligations at the student loans which belong to Mid "The money market account is currently serving as their emergency fund Land value was determined to be 550,000 and the home value $225.000. Replacement value of the home sho225.000 Title designations JT lintenancy with right of survivorship Her Husband parte property w Wiles para property The Williamses primarily use cash, check, and debit cards for personal expenditures 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 pro- jecting net income of $90,000 from the business in 2011. Michelle wants to keep her work- force 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