2018 FINANCIAL PLANNING CHALLENGE CARL AND NAOMI BERMAN CASE STUDY

Transcription

1 2018 FINANCIAL PLANNING CHALLENGE CARL AND NAOMI BERMAN CASE STUDY

2 Client Welcome Letter... 3 Executive Summary... 4 Summary of Current Financial Condition... 5 Statement of Net Worth... 5 Statement of Cash Flows... 7 Ratio Analysis... 9 Assumptions SWOT Analysis Strengths, Weaknesses, Opportunities, and Threats Goal Needs Analysis Goal Needs Analysis Summary Life Insurance Needs Analysis Financial Analysis Budget Cash flows and Retirement Income Investment Analysis Recommendations Appendix: Detailed Calculations College Funding - Detailed Calculations and Assumptions Purchase of Harrisburg, VA Home - Detailed Calculations and Assumptions Purchase of Blue Ridge Cabin - Detailed Calculations and Assumptions Social Security - Assumptions... 25

3 CLIENT WELCOME LETTER May 15, 2018 Carl and Naomi Berman Maple Dr Harrisburg, VA Dear Mr. and Mrs. Berman, Thank you for choosing our firm, Sunset Wealth Management, to help you plan your financial journey. We would like to express our appreciation and pleasure in your choice to work with our team full of three experienced advisors on staff. Our team look forwards to the opportunity to build a new relationship as well as provide you with the necessary financial advice that aligns with your goals, needs, and desires in life. We originated in 2011 as a fee-only Registered Investment Advisory (RIA) firm and have helped hundreds of clients in their path towards financial freedom and security. Our approach incorporates providing holistic, high quality, and innovative wealth management services to plan out all the fundamental aspects of our clients financial lives. The philosophy we follow is centered around customization to make sure we create a financial plan and investment portfolio best suited for your goals, risk tolerance, and needs in life. We hold ourselves to a fiduciary standard which entitles us to create a financial plan in your best interest. Our fees are transparent in the sense that we will not charge you hidden costs or push sales to receive commissions. We operate our fee structure as a percentage of your assets we manage and will never charge a hidden fee you are not directly aware of. Thank you again for choosing our firm to guide you through your financial future. We look forward to the opportunity of working with you to help you accomplish all your goals in your financial journey that lies ahead. Sincerely, Sunset Wealth Management

4 EXECUTIVE SUMMARY Carl and Naomi Berman are working professionals in the education field and both earn a healthy income. They have been do it yourselfers in terms of their investment portfolio, saving for retirement, and funding other goals. The Bermans have engaged our firm to perform a complete review and comprehensive financial plan. Thus far, the Bermans have placed focus on saving for the future and now want to know if they are on track to achieve their goals. The Berman s have identified several goals important to them. We have been asked to address college education funding, home purchase practicality, and insurance needs. A major priority is funding the college experience of their two children Matthew (14) and Sarah (11). They have been saving for college for the last 10 years and now want to ensure that fully paying for their children s education is possible. The Berman s currently own a home in Harrisburg, VA; they have revealed major goals of purchasing a home in the historic district of the city one day as well as a small cabin in the Blue Ridge Mountains of Virginia where they could enjoy the outdoors during retirement. The Berman s want to make certain that in the event anything happens to either one of them that the surviving spouse can still fund applicable goals. If Carl were to pass he still would like Naomi to be able to fund all of their goals. If Naomi passes, Carl would want to guarantee coverage for the children s education, but would not purchase the retirement cabin. To that end, our firm is making a thorough recommendation on life and disability insurance. Our firm will also provide counsel on drafting the appropriate estate documents. Upon review of the Berman s financial data, our firm has analyzed the feasibility of the Berman s goals. Our firm has identified strengths and weaknesses associated with the Berman s current financials and life situation as well as opportunities for maximizing their financial health and possible threats to adjust for. Based on our initial analysis and with the implementation of our recommendations the Berman s will be able to achieve all stated goals. Summary of Stated Client Goals & Concerns They hope to use savings to fully fund college expenses for Matthew and Sarah. Is fully funding the kids education an achievable goal? One day owning a home in the historic district of Harrisonburg, VA Keep the original house and rent it for income, or sell it to pay for the new home? Own a small cabin in the Blue Ridge Mountains Insurance review: Life insurance If Carl dies, want Naomi to fund all of their goals If Naomi dies, have kids education funded but do not purchase the cabin Disability insurance Reduction of current lifestyle would be the priority but; They want the income to remain on track with their goals

5 SUMMARY OF CURRENT FINANCIAL CONDITION STATEMENT OF NET WORTH Net Worth Non-Qualified Assets Carl Naomi Joint Total Bank savings $30,281 $30,281 Trading account $107,338 $107,338 Total Non-Qualified Assets $ - $ - $137,619 $137,619 Qualified Assets 0 Carl's Roth $61,431 $61,431 Naomi's Roth $66,550 $66,550 Carl s IRA $153,577 $153,577 Naomi's 401(k) $204,770 $204,770 Carl s 401k $307,155 $307,155 Total Qualified Assets 522 $522,163 $271,320 $ - $793,483 Lifestyle Assets Residence $453,750 $453,750 Total Lifestyle Assets $ - $ - $453,750 $453,750 Total Assets $522,163 $271,320 $591,369 $1,384,852 Liabilities Mortgage -$314,118 -$314,118 Car Loan -$29,787 -$29,787 Credit Card -$7,515 -$7,515 Total Liabilities $ - $ - -$351,420 -$351,420 Total Net Worth $522,163 $271,320 $239,949 $1,033,432

6 Observations on Net Worth Statement: Carl and Naomi have assets worth $1,384,852 and liabilities of only $351,420. After netting the two figures, their net worth totals a positive $1,033,432 at the start of Their assets are sufficiently larger than their debts which is an indicator of great financial health and discipline by saving for their future retirement.

7 STATEMENT OF CASH FLOWS Cash Flow Details As of 12/31/2017 Cash Inflows Carl Naomi Total Earned Income Salary $140,000 $100,000 $240,000 Subtotal $140,000 $100,000 $240,000 Investment Income Interest $386 $386 $772 Dividends $518 $518 $1,036 Long-Term Capital Gains $1,744 $1,744 $3,488 Subtotal $2,648 $2,648 $5,296 Total Cash Inflows $142,648 $102,648 $245,296 Cash Outflows Lifestyle Expenses Discretionary Expenses Fixed Expenses (excluding liabilities) $25,000 $25,000 $50,000 $20,000 $20,000 $40,000 Mortgage Payment $15,000 $15,000 $30,000 Car Loan $3,900 $3,900 $7,800 Credit Card $1,050 $1,050 $2,100 Subtotal $64,950 $64,950 $129,900 Non-qualified Reinvestments Reinvestments $886 $886 $1,772 Reinvested Accrued Investment Expense $1,521 $1,521 $3,042 Subtotal $2,407 $2,407 $4,814 Qualified Savings 401(k) contributions $7,500 $ - $7,500 Subtotal $7,500 $ - $7,500 Taxes Federal Income Tax $21,449 $16,272 $37,721 State Income Tax $5,883 $4,372 $10,255 Social Security Tax - Employment $7,831 $6,200 $14,031 Medicare Taxes $2,030 $1,450 $3,480 Subtotal $37,193 $28,294 $65,487 Total Cash Outflows $112,050 $95,651 $207,701 Surplus/Deficit $30,598 $6,997 $37,595

8 Observations on Cash Flow Statement: Carl and Naomi have annual cash inflows of $245,296 and annual cash outflows of $207,701. When netting these two figure out, our firm can determine that they have an annual cash surplus of $37,595 given their current financial condition. This is a satisfactory surplus of annual inflows for Carl and Naomi which draws the conclusion that their annual income is sufficient enough to cover all their annual expenses. Areas for improvement lie within reducing discretionary spending to $31,500 and utilizing the larger surplus towards fully funding both Carl and Naomi s 401k accounts.

9 RATIO ANALYSIS

10 Observations on Ratio Analysis: As depicted through the image, Carl and Naomi do not have a sufficient annual cash savings balance to keep up with all their annual expenses. In addition, they can improve on maintaining an adequate emergency fund balance of generally 3-6 months of monetary value that would cover monthly expenses in the case of a threatening situation to health, sudden disability, or job loss. Carl and Naomi have a great liquidity ratio comprised of liquid assets well above satisfactory to cover annual expenses in reference to their trading account balance. Their savings ratio is low when considering they jointly earn $240,000 a year. Carl and Naomi have a great debt to asset ratio with assets comprising 75% to liabilities of 25%. One major recommendation we have for Carl and Naomi is to greatly reduce their discretionary expenses as this represents 24% of their total annual expenses. Finally, considering Carl and Naomi s income and tax liability, they are neutral in their effective tax rate and have a 24% marginal tax rate.

11 ASSUMPTIONS Item Assumption David - Age of Death 90 Naomi - Age of Death 90 Inflation - CPI 3% College Assumptions College inflation Years in college (per child) University of Virginia Tuition + Room & Board / Cost Per Year Today Investment rates of return : Pre-retirement (aggressive) Post-retirement (conservative) 529 Plan Mortgage Assumptions: Insurance/prop taxes built into monthly payment Home appreciation per year Mortgage paid off in 2031 Downtown Harrisburg Home Purchase Cost - Today s Dollars Property appreciation (per year) Blue Ridge Cabin: Purchase Cost - Today s Dollars Property appreciation (per year) Living Expenses: Annual increase in line with CPI Inflation assumption above Salaries: Annual increase in line with CPI Inflation assumption above 4% 4 32,700 8% 6% 8% 4% 400,000 3% 200,000 3%

12 Strengths SWOT ANALYSIS STRENGTHS, WEAKNESSES, OPPORTUNITIES, AND THREATS Saving for their future has been a priority since marriage. Good financial mindset, good behavior Employed, annual income is satisfactory ($140,000 & $100,000) Good health Saving for retirement (401k, Roth, Traditional IRA,) Well diversified, Have a home as an asset. Weaknesses Discretionary spending seems high No 529 Education Savings Plan Bank Savings (Emergency Fund) not sufficient (not 3-6 months of current spending) Lack of Insurance (Life Insurance, Disability, L/T Care Insurance) Lack of Estate Documents, (Trust, Will, Beneficiaries) Has Credit Card debt (not necessary) Cash flow of trading account, low profit Car Loan Debt Opportunities Existing funding within trading account to roll into 529 accounts Sufficient years to accumulate interest and appreciation on 529 accounts Sufficient years to accumulate interest and appreciation on qualified retirement and investment accounts Selling Home (Equity in Home currently, opportunity for Capital Gain once sold) Can adjust discretionary spending to allocate to qualified retirement accounts Conversion to a Roth IRA from a Traditional IRA Threats Death Disability Job loss Market crash Economic recession Discretionary spending Social Security could not be around in the future

13 GOAL NEEDS ANALYSIS Goal PV of $ Needed $ Needed to meet Goal In xx Years Assumed Discount /Growth Rate Pay for full college expenses - Matthew $ (107,849) 146, % Pay for full college expenses - Sarah $ (94,988) 162, % Own a home in Historic District Harrisburg, VA $ (400,000) 553, % Own a small cabin in Blue Ridge Mountains $ (200,000) 350, % Fully fund Retirement spending goal $ (512,821) $2,213, % PV of Financial Goals $ (1,315,659) PV of Current Savings & Investments Trading Account (529 Accounts) $ 107,335 Roth Accounts $ 127, (k) accounts (less: estimated 30% tax burden) $ 465,851 PV of Current Savings & Investments $ 701,067 Surplus/(Shortfall) of Current Funding ASSUMING NO ANNUITIES $ (614,591) Calculations Assuming Annuities PV of Carl s Social Security Benefit Assume $36,000 per year benefit starting at Age 70. Calculate PV of 70, then discount back to today s PV PV of Naomi s Social Security Benefit Assume $30,000 per year benefit starting at Age 70. Calculate PV of 70, then discount back to today s PV Surplus/(Shortfall) of Current Funding ASSUMING Social Security $ 445,391 $989, , % $ 371,159 $824, , % $ 201,959

14 GOAL NEEDS ANALYSIS SUMMARY Observations on Goals Needs Analysis: Carl and Naomi Berman stated several important goals upon meeting with our firm. A main concern was the question of whether fully funding both their children s college experience was possible. Another stated goal was to purchase a home in the Historic District of Harrisburg, VA at some point as well as to purchase a cabin in the Blue Ridge Mountains of Virginia to enjoy during retirement. First, our firm analyzed the amount needed to fully fund their goals at the applicable and recommended years. From that point, assumptions on the either the discount rate or inflation rate were made and used to find the present value needed to fund the Berman s goals. The present value of $1,315,659 was determined as the amount in today s dollars needed to fund the Berman s financial goals. The present value of the Berman s current savings and investments is $701,067. Accounting for the annuity of Social Security paid out, the surplus of the Berman s financial goals is $201,959.

15 LIFE INSURANCE NEEDS ANALYSIS If Carl Dies Immediate Needs Funeral Expenses $ 20,000 Pay Off Car Loan Debt $ 29,787 Pay Off Credit Card $ 7,515 Pay off Mortgage $ 314,118 Subtotal - Immediate Needs $ 371,420 Loss of Income $1,291,516 $ 1,230, years Assume 60% of Carl s Salary discounted Naomi Buy Cabin $ 350,701 College - Son $ 107, ,728 4 years out 8% discount rate College - Daughter $ 94, ,792 7 years out PV of Future Needs $ 1,845,054 Total Insurance Needs In Event of Carl Death $ 2,216,474 If Naomi Dies Immediate Needs Funeral Expenses $ 20,000 Pay Off Car Loan Debt $ 29,787 Pay Off Credit Card $ 7,515 Pay Off Mortgage $ 314,118 Subtotal - Immediate Needs $ 371,420 Loss of Income $ 1,230, years Assume 60% of Naomi s Salary discounted College - Son $ 107, ,728 4 yrs out 8% discount rate College - Daughter $ 94, ,791 7 years out PV of Future Needs $ 1,432,850 Total Insurance Needs In Event of Carl Death $ 1,804,270

16 Observations and Recommendations - Life Insurance Needs Analysis: Buy term life insurance policy in the amount of $2.25 million for a term of 20 years for Carl Berman. Buy term life insurance policy in the amount of $1.8 million for a term of 20 years for Naomi Berman. A term of 20 years will allow the Berman family to fully fund all goals and future needs in case of death of either or both spouses. Once the Bermans reach retirement age and near collecting Social Security, Life insurance will not be necessary as they will have ample qualified retirement accounts and a large trading account to fund any unexpected need.

17 FINANCIAL ANALYSIS BUDGET CASH FLOWS AND RETIREMENT INCOME Spreadsheet 1

18 Spreadsheet 2

19 Spreadsheet 3

20 Observations on Financial Analysis of Budget Cash Flows and Retirement Income: This spreadsheet which was cut vertically, originally made horizontally, illustrates the complete picture of the financial life of Carl and Naomi Berman. Reaching from today in 2018 to 2065 when Naomi reaches 90 years old, it is an all encompassing view of the Berman s cash inflows, cash outflows, major expenditures, goal achievement, and qualified retirement portfolio. Spreadsheet 1, column 7 features the amount Carl and Naomi will pay into their Qualified Retirement accounts (401k and IRAs) combined, along with what the portfolios will grow to at an established 8% compounding return pre-retirement in column 8. When the Bermans retire they will have a projected $5,354,583 in their qualified retirement accounts. From there, column 9 shows the Qualified Retirement balance as they move through retirement. Post-retirement, these assets will be invested less aggressively and show growth at a 6% rate of return. Column 10, labeled as Qualified Retirement Cashed Out Amount largely shows the amount needed to withdraw to cover basic living expenses. The Bermans will have discretion to withdraw additional funds for travel, leisure, or any other use. Due to the Berman s ample income and surplus once fully funding 529 plans and qualified retirement accounts, Spreadsheet 2 displays the reopening of a trading account in 2022 to accumulate funds for real estate goals and other spending. The trading account is fully funded in 2037 when Carl and Naomi retire and assumes a return of 8% compounding. The trading account grows to a value of $43,746,451 by In column 6 of spreadsheet 2 the total 529 annual contributions for both Matthew and Sarah are shown. The estimated total annual cost of Life, Disability, and Long-term care insurance needed for the Berman family is listed in column 7 of spreadsheet 2 at $15,000 per year. Annual outflow costs are calculated in comuns 8 and 9 of spreadsheet 2. The segment that is spreadsheet 3 focuses on the running total of the surplus/deficit per year. In column 3 of spreadsheet 3, the mortgage is shown running down until it is paid off. As can be seen from this total financial picture of the Berman family, they will have the financials needed to achieve all of their goals. Carl and Naomi Berman will also have amassed a wealth of assets and will be able to spend amply in retirement and transfer wealth to their children through their estate if they so choose. See graphics on next page to (1) Represent the growth (contributions and 8% compounding return) of the Berman s qualified retirement accounts in pre-retirement. (2) The account value and growth (6% compounding return) of the Berman s qualified retirement accounts post-retirement. (3) The value of the trading account that was created from surplus funds in 2022 as it grows over time at a 8% compounding return.

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22 INVESTMENT ANALYSIS

23 RECOMMENDATIONS Pay off all the Credit Card Debt in Year 0. Utilize existing bank savings of $30,281 as emergency savings and add to fund in Years 1-5 in increments of $13, per year to total $100,000 in Year 6 to meet a goal of 6 months in expenses. Reduce discretionary expenses from $50,000 to $31,500. Use excess to fully fund 401k accounts. Reallocate entire trading account between two 529 plans for Matthew and Sarah. Superfund Matthew s with $70,000. Superfund Sarah s with $37,338. Max out 401k contributions for both Carl and Naomi at $18,500 each. 401k and 529 contributions will generate approximately $8,000 in tax savings annually. Acquire Life, Disability, Long Term Care Insurance for both Carl and Naomi. Premiums estimated to be $15,000 annually combined. Provide referral to Insurance Broker. Arrange meeting with an Estate Planning Attorney that can provide counsel on Wills, Powers of Attorney, and all the necessary estate items to create a Revocable Living Trust. Consult with CPA to ensure all tax benefits are fully taken advantage of. Pay off the car loan in Year 4. Maintain $7,800 annually to allow for new car purchases and car maintenance. Current mortgage is paid off in Sell current home in 2029 and use equity to purchase new downtown Harrisburg, VA home outright. When Carl begins drawing on retirement accounts, buy Blue Ridge Cabin in Carl retires at age 65 in year 2037, Naomi retires at age 62. Each will begin collecting Social Security when they are 70 years old. In 2037, the year they retire they will cash out 1.25 million in order to purchase Blue Ridge Mountains cabin and provide income cushion until Social Security begins. Consider a Roth IRA conversion for current Traditional IRA accounts. Ask Carl and Naomi to bring information regarding if they are enrolled in a Pension plan at work to the next meeting. Ask Carl and Naomi to bring salary history and most recent annual Social Security Statement to next meeting.

24 APPENDIX: DETAILED CALCULATIONS COLLEGE FUNDING - DETAILED CALCULATIONS AND ASSUMPTIONS College inflation calculations: Assumption is College inflation 4% per year. Expectation is living on campus all 4 years. University of Virginia In state Tuition Today s dollars: $16,800 University of Virginia Room & Board Today s Dollars: $15,900 Total= $32,700 Son (Matthew) Calculation: N=4 i/y=4 PV=32,700 PMT=0 FV=38,254 (first year of son s college) BGN Mode: N=4 i/y= PV=? PMT=-38,784 FV=0, PV=146, <-needed at 18 will continue to grow (1.08/ *100)= Superfund Son with 70,000. What are the monthly contributions needed to have total amount for four years at son s age of 18 if investments are returning 8%? N=48 i/y=8 PV=-70,000 PMT=? FV=146,728.07, PMT= per month Daughter (Sarah) Calculation: N=7 i/4=4 PV=32,700 PMT=0 FV=43,030 (first year of daughter s college) BGN Mode: N=4 i/y= PV=? PMT=-43,030 FV=0, PV=162, <- needed at 18 will continue to grow (1.08/ *100)=3.8462

25 Superfund Daughter with 37,338. What are the monthly contributions needed to have total amount for four years at Daughter s age of 18 if investments are returning 8%? N=84 i/y=8 PV=-37,338 PMT=? FV=158,542.63, PMT= per month PURCHASE OF HARRISBURG, VA HOME - DETAILED CALCULATIONS AND ASSUMPTIONS Assumption is that Historic District Harrisburg Home Costs $400,000 in Today s Dollars. Home prices inflate at 3%. The Historic District Harrisburg Home will be purchased in 2031 when mortgage of current home is paid off and full equity of current home is realized. The estimated price is $553,693.55, but the Berman s have discretion up to $660, which was the equity in their previous home once they sold it also in N=11 i/y=3 PV=400,000 PMT=0 FV=?, FV=$553, <- Purchase Price of Downtown Harrisburg, VA Home in PURCHASE OF BLUE RIDGE CABIN - DETAILED CALCULATIONS AND ASSUMPTIONS Assumption is that Blue Ridge Log Cabin costs $200,000 in today s dollars. Home prices inflate at 3%. The Blue Ridge Log Cabin will be purchased the year the Berman s enter retirement. N=19 i/y=3 PV=200,000 PMT=0 FV=?, FV=$350, <- Purchase price of Log Cabin in SOCIAL SECURITY - ASSUMPTIONS Estimate provided based on current income. Next meeting please provide salary history and most recent annual Social Security statement.