Case Studies with Guided Answers by Beverley Houterman

Transcription

1 Case Studies with Guided Answers by Beverley Houterman 2013 Reed International Books Australia Pty Limited trading as LexisNexis Permission to download and make copies for classroom use is granted. Reproducing or distributing any material from this website for any other purpose requires written permission from the Publisher. Chapter 4: Construction of a Statement of Advice Some terms you may need to know: ABN Appropriate advice Benchmark Cash flow Considered judgement Cost benefit analysis CRM Diligence Financial literacy Housekeeping Informed consent Lifestyle models Longevity analysis Risk tolerance Salary sacrifice Australian Business Number an identifier of a business entity or business component of a larger entity. Advice which is clearly based on the client s needs and goals, is within their ability to achieve without disrupting their lives and which is legal and within all regulatory measures. A standardised outcome against which other outcomes are judged. For example, the benchmark return may be the tax-free rate say 4%. All other investment returns will be judged against that return. A table which shows income from all sources, less any non-taxable income, less any allowable deductions to achieve taxable income, the calculation of an estimated tax liability (including any rebates or allowances) which yields the income a client has after all tax consideration, less all expenses, to achieve a cash flow surplus or deficit. Decisions (or recommendations) made after weighing all the facts and implications of a situation An analysis that looks to identify if the benefits of an action are worth the costs of undertaking that action. Customer relationship management database applications that contain client information in a flexible environment so that users can access with specific client detail or for marketing, such as by post code, by age, by investment value, etc. Diligence is steadfast application, assiduousness and industry in the case of a financial adviser, it would the level of work a reasonable person would expect a professional adviser to undertake when providing advice upon which a client would depend. A measure of a client s understanding of financial matters. The more knowledgeable the client is, the more able they are to give informed consent to more complex strategies. A series of tasks that will clear up a client s financial situation so that they can see their situation better and make decisions regarding future actions. Where a client has been given all the information they need, in a way they can understand, to make a decision based on this knowledge. A way to categorise clients according to common needs, often based on age groupings. A measurement of a number of factors that contribute to longer and healthier lives. Used to set time horizons for retirement income needs and cash flows A person s ability to live through portfolio price volatility a loss aversion measure Having an employer put more of the person s salary in as a super contribution to increase their retirement savings. This money is taxed at the concessional rate of 15% Financial Planning in Australia 5e Case Studies Ch4 Page 1

2 Statement of Advice (SOA) Targeted marketing strategy rather than at their marginal tax rate. Document that sets out the recommendations an adviser is making. Written advice is a requirement for all advice. An attempt to limit the diversity of a client base by selecting one or more client attributes and then marketing to others who have these same attributes, ie, marketing to doctors or teachers or pre-retirees. Case Study 4.1 Eddie and Gail s Retirement Eddie and Gail Summerset, who live in the Blue Mountains (NSW), have three married children and a total of seven grandchildren. Their daughter and one of their sons live within a two-hour drive of Eddie and Gail, while the other son lives in Adelaide. Gail works part-time as a nurse in the local hospital, earning around $35,000 pa, with the superannuation guarantee amount paid by her employer into her super fund. Her current balance is $225,000 which is invested in a balanced fund earning 5.5% pa. She is considering retiring from work when she reaches age 62 (in two years time) as she would like more time at home and in her garden and with her grandchildren. Eddie does repair and maintenance work for local residents and sometimes contract work with a local builder. He averages $30,000 for the contract work and keeps the personal work off the books, but estimates he earns $15,000 a year from this work. When Gail quits her part-time work, Eddie will stop doing the contract work and will only do the repair and maintenance work for long-standing clients. He is now age 63 and is looking forward to travelling around Australia when Gail retires. He believes they will need $35,000 for a camper van and $40,000 for a new, powerful car to pull it. He has some super ($285,000 in a balanced fund earning 5% pa) and the contractor makes contributions into it each year. They keep around $4,000 in their cheque account and $15,000 in an emergency savings account (earning 4%). They sold off their investment property and achieved $235,000 after all costs. This money is now in term deposits earning 6%. Their home is valued at $450,000 and they have indicated that it is in good repair and is where they want to live in retirement. It is insured for $400,000. Their two cars (five and six years old) are fully insured. Gail has life and total and permanent disability insurance within her super equal to her balance, but no other personal insurance. Eddie has no personal insurance. They took out private hospital cover a number of years ago and intend to keep it as long as they can afford it. They pay $213 per month for this cover. Financial Planning in Australia 5e Case Studies Ch4 Page 2

3 They have no outstanding debt and usually pay off their credit cards monthly. When discussing other expenses, they estimated that they spend: $160 per week on food; $50 per week on petrol; $500 per quarter on electricity; $213 per month on private hospital cover; $150 per month on telephone; $3,000 per year on rates and water; $4,000 on car registration, insurance and repairs; $200 per month on pay-tv and internet; $10,000 a year on entertainment, vacations, etc. They expect these expenses to remain fairly constant in retirement, increasing with inflation. Thus, they believe they will need around $50,000 pa in retirement. They have a number of questions they would like answered as part of your advice: 1 What should we do with any extra money we have now? 2 Will we be able to afford the new car and caravan? 3 Assuming no big changes, will we be able to get at least a part age pension? 4 Will we be able to earn $50,000 in retirement? Students: For projections of super balances and retirement drawdowns, go to < and link onto MoneySmart or go directly to < For details regarding the age pension, eligibility, rates, and a calculator, go to < (Note that Centerlink has changed its name to Human Services < Employers are required to contribute 9% of an employee s salary into their super. 1 Develop a covering letter that addresses the clients concerns and contains all of the compliance elements. 2 Outline the Scope of Advice for your Statement of advice. 3 List the clients goals. 4 Using the 2012 tax rates (< do a cash flow for the clients and then discuss their cash flow. 5 Construct an Asset and Liabilities table and then discuss their current situation. 6 What lump sums will they require at retirement? 7 Using their current superannuation balances and contributions, calculate what their superannuation balances might be in two years when they intend to retire. 8 At retirement, will Eddie and Gail be able to apply for the age pension? Check the eligibility criteria on the website. Financial Planning in Australia 5e Case Studies Ch4 Page 3

4 9 Use the retirement projection calculator and the super balances you have calculated to determine how long they can expect to receive $50,000 pa from their super. 10 How would their retirement income improve if you recommended they use their term deposit money to buy the caravan and car and then use the rest to increase their super balances at retirement? 11 Looking over your work and the questions they asked have you answered them? Answers: 1 The client letter should mirror the ones in the Statement of Advice provided and include the warnings that the advice is only for these clients; that reviews are important because of changes; and that recommendations must be implemented in a timely manner. 2 Students should use the Scope of Advice provided in the Statement of Advice, and note that the clients want assistance on cash-flow management, affordability of new cars, indicative assessment for age pension upon retirement, retirement income funding, and insurance. They have not mentioned estate planning, but it should be included in the Scope of Advice. 3 Students should note the following goals: a. retire fully over the next 2 3 years; b. travel around Australia in retirement; c. purchase camper van and car to pull it; d. maintain private hospital cover; e. continue current lifestyle; f. achieve $50,000 pa in retirement income; g. potentially achieve a part age pension. 4 Indicative cash flow current year: Cash Flow Statement Eddie Gail Salary and bonus 30,000 35,000 Interest income 7,350 7,350 Assessable income 37,350 42,350 Taxable income 37,350 42,350 Tax 3,685 5,310 Medicare Medicare Levy Surcharge 0 0 Income after tax 33,105 36,405 Total income 69,510 Additional income 15,000 Total income 84,510 General expenses Food and petrol 10,920 Living expenses 23,200 Hospital cover 2,556 Legal and financial planning fees 10,000 Financial Planning in Australia 5e Case Studies Ch4 Page 4

5 Net savings capacity 37,834 Students should note that because of Eddie s extra money and their very frugal lifestyle, they have a significant savings capacity over the next two years. 5 An asset and liability table would look something like this: Asset Owner Value Debt Comment Home Joint $450,000 Nil Fully paid Super Gail $225,000 Nil Balanced, employer contributions 5.5% Super Eddie $285,000 Nil Balanced, employer contributions 5% Cheque Joint $4,000 Nil Nil earnings account Term deposits Joint $235,000 Nil Earning 6% Personal Each Not given 5 and 6 years old. vehicles Net worth $1,199,00 0 Students should note that they have significant wealth, much of it in investment assets, and no debt. 6 Lump sums at retirement would be $35,000 for a caravan and $40,000 for a new car. 7 Using calculators, and the following information, each client s indicative balance would be: Eddie current balance, $285,000, earning 5%, contributions $2,700 pa for 2 years = $315,000 Gail current balance $225,000, earning 5.5%, contributions $3,150 pa for 2 years = $253,380 Total: $568, In two years, Eddie will be age 65 and so can apply for the age pension. Gail will be age 62. Gail cannot qualify for the age pension as she is too young. 9 Using a projection calculator, and their joint super balances, an indicative timeframe before the money runs out is Eddie s age The term deposits have a balance of $235,000. If the cost of the caravan and the car ($75,000) is deducted, there is still $160,000 to put into their super. Taking their expected balance of $568,000 plus the $160,000 = $728,000. My calculator shows their money would last past Eddie s age The clients asked four questions: i What should we do with any extra money we have now? While this question has not been answered fully, the student s work should show that they need to save more if they cannot get the age pension if they want to have a high retirement income. Financial Planning in Australia 5e Case Studies Ch4 Page 5

6 ii iii iv Will we be able to afford the new car and caravan? They can use some of the term deposit money to purchase the caravan and car. Assuming no big changes, will we be able to get at least a part age pension? Initially no, because Gail will not qualify by age. However, if they save enough, they will not need to depend on the age pension. Will we be able to earn $50,000 in retirement? Using the projections, it looks they will be able to afford their retirement income requirements. Financial Planning in Australia 5e Case Studies Ch4 Page 6