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Many people usually spend the most part of their lives earning money, but the unfortunate part of it is that they rarely take time to plan how efficiently to use their money. That's why a financial plan becomes very important in an individual's life. Shown below is a financial plan for Mr. and Mrs. Bill.
Before anyone reaches his financial goal, he or she needs to first know his or her financial net worth, where one stands at that particular point in time. A person's net worth is the difference between all the valuable things he or she owns and the debts owed. This is simply the difference between assets and liabilities. Mr. Bill will therefore need a statement of net worth to act as a reference point on his financial road map. The following is therefore Mr. Bill's net worth statement or balance sheet.
Mr. and Mrs. Bill's balance sheet as at 31st July 2010
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Net worth $502,000
Available for goals $150,000
Liquid assets are usually short term in nature mostly consisting of cash and its equivalents. They provide a source of money for expenses that are unforeseen. Here I have allocated $19,000 of the cash equivalent investment to this area as an emergency reserve. The remaining investment assets will be listed separately so that they can be available to fund future goals. Retirement plans are assets that are contributed to yearly either through an individual's employer or from own resources. Mr. Bill should strive to have as many investment assets as possible. These will help satisfy future goals like financing the education of his two children, retirement, and other important goals. Business assets constitute the ownership value of any business that Mr. Bill may be interested in, for instance a partnership, a corporation or just a sole proprietorship. In the balance sheet, residence represents the place or places where Mr. Bill's family lives for example, a house, beach house, mountain cabin and so forth. He should also plan to have personal assets. These are primarily for personal, long term enjoyment and use for instance an automobile. Should also consider the liabilities both current and long term so that he can come up with a better way of repaying them so that his net worth is not adversely affected. Currently Mr. Bill has $699,000 in assets and $197,000 in liabilities meaning that his net worth is $502,000. He has besides this, $150,000 available to use in funding his family goals. This includes his liquid assets and those non-retirement benefits. I have not included those taxes that will be due upon conversion of personal assets into cash and in tax benefit accruing from interest expense on liabilities in the net worth summary. The assumption is that Mr. Bill's physical and liquid assets will grow at the inflation rate and that his investment will grow at the rate of return on investment.
Since he is a family man, Mr. Bill has the following goals for his family; to maintain the family's standard of living even during retirement, he is looking forward to paying less tax, to be able to maintain the family's living standards even if eventualities like death or disability occurs, aim at becoming financially stable, he should be able to preserve his estate for his children or heirs, children are still young therefore he should provide for their education, should be able to pay off his mortgage and other pending debts, and should always stay right ahead of inflation. Other goals include earning a higher rate of return, being in a position to buy a home or even a recreational property, to learn how to invest and to manage his money more wisely and finally he should look forward to start a business of his own to remain self dependent.
In order for Mr. Bill to effectively control his financial affairs in line to meeting the above goals, he will need a cash flow statement or a budget. Tracking the flow of expenses or budgeting will give him a strong sense of where his money goes and in doing so; help him reach his financial goals both long term and short term. Below is the cash flow statement for Mr. Bill's family.
The cash flow statement will allow Mr. Bill to exactly know how much money he has. It shows how the funds are allocated, the way they are working for him, what his plans are for them, and also show him how far he is from achieving his goals. Through this statement, Mr. Bill's ability to save and invest is clearly indicated. He is able to analyze his standrd of living, by analyzing whether he is living within or beyond his means besides showing any areas with problems. Each year, this family's spendable income will be sourced from different sources as shown in the table above. When the income needed exceeds the available funds from earnings, social security, then withdrawals can be made from the asset accounts or even from retirement plans if qualified. Mr. Bill's net worth is only $24,600; this is approximately living expenses for five months. He therefore should look for ways of increasing it to about $40,000 because it also covers emergency needs. His lifestyle is bound to change because this is a young family; therefore more money needs to be allocated for entertainment and vocational needs.
Another way of generating income is through investment, but before one formulates his investment plan, he should first evaluate his risk profile and the time span so as to come up with a better investment asset that will meet the required needs. Mr. Bill should aim at maximizing his return and minimizing his portfolio volatility or risk by diversifying in the various classes of asset investment. This will help him protect his portfolio from excessive volatility in a single class. He should purpose to save for the long term possible but not timing and gauging the trends in the market before investing because that is risky. To increase his after-tax returns on investment, Mr. Bill should maximize the retirement plan provided by his employer first; he should consider investing in an insurance product like a variable annuity. He could transfer some amount from a taxable account to an annuity or make periodic contributions to the annuity. If this fits, then Mr. Bill's after tax investment returns will increase.
An individual paying off a debt which charges 10% interest will be the same like one putting his money in a savings account which pays 10% interest. In this case Mr. Bill should consider paying off his consumer credit as fast as possible. Going by his current loan payment, it can be estimated that it will take him more than 50 months to clear his debt. But if he comes up with a debt payment schedule where by he will reduce his expenditure and save enough to offset the debt. If he implements this plan it is possible that he will reduce the payment period significantly. This way he will be able to have some additional amount set aside that he could use in the improvement of his family's standards of living or even make saving for the future goals. Also earlier debt payment will see a reduction in the total sum of the debt from the one that would have been paid over a long period. Should keep saving and retirement as the first priority and vacations second. Constantly update statements and budget, or better still, hire a personal financial planner to assist (Montz 2008).
Mr. Bill's family should come up with ways of managing risks that are inevitable to every person. This can be by taking disability income insurance, life insurance, Long term care, Health insurance, Property and casualty insurance.
Disability Income Insurance
This is meant to provide a supplement to an individual's income in the event he is unable to work perhaps due to an accident or illness. Mr. Bill's current disability income insurance needs are all based on his projected expenses, income, and disability income insurance benefits. Since his expenses and income change every year, his insurance needs will definitely also change. He should project his family income in case he dies this year and make adjustments where necessary. Same should be done in case his wife dies, this way any eventuality will be prepared for and therefore it will not come as a shock if at all it happens. Social security disability income has not been included because a person is only considered disabled if he or she can not engage in his own occupation. Since Mr. Bill's employer offers group long-term disability income insurance, he should consider enrolling in this plan (Hallman & Rosenbloom 2003).
Mr. Bill's premature death can impact severely on his survivors. Estate administration and funeral expenses can be a heavy burden to the survivors at a very critical and trying time in their lives. These followed by paying off debts, meeting the educational needs for the children and many other expenses on a reduced income can have adverse effects to the survivors for many years to come. Therefore life insurance can avoid all these risks. Mr. Bill's additional life insurance needs can be determined by subtracting his obligations and support needs from his current resources. Bill's support needs have been based on the estimate that his survivors will have expenses of about $80,000 annually for 45 years. Similarly those of his wife are estimated at $80,000 for 39 years. Bill's resources include $19,000 in liquid assets, life insurance proceeds of $200,000, and $150,000 in investments including retirement plans. Obligations include an emergency fund of $19,000, funeral expenses of up to $6,000, estate administration expenses of $14,000, $5,000 for debts that need immediate payment, children education $160,000, $180,000 for his home mortgage, and other long term debts will cover $50,000. These also include a lump sum of money that will sustain his wife for the remainder of her life and the children until they attain 18 years of age. Nevertheless Bill should consider increasing his life insurance coverage (Montz 2008).
This is the kind of help one needs if he iss unable to care for himself because of a disability or a prolonged illness. This can be in one's home or in a nursing home; therefore it calls for prior planning for it. The longer Bill lives the higher the chances of needing a long term care. When retired, an extended stay at a nursing home can significantly impact on his assets and standards of living. This risk can be avoided by long-term care insurance (Montz 2008).
It is good for one to have an adequate medical coverage because a serious illness can be disastrous to his or her financial well-being. Bill can choose from the many medical covers available although he should consider a number of issues like policy benefits, costs and many others before he opts for one (Montz 2008).
Property and Casualty Insurance
These include auto insurance to protect yourself and your vehicle, and also to cover expenses if you harm or damage another person's auto, Home owner's insurance- this will protect Bill's dwelling, assets and personal property, and Umbrella Liability Insurance- this increases one's auto and home liability coverage especially if sued for damages incurred by someone due to an accident (Hallman & Rosenbloom 2003).
Aim: To be a smart investor whereby you will maintain a variety of investments like bonds, common stock, mutual funds, and real estate. Right now there are various constraints for achieving this, day care, medical bills, auto expenses and many other expenses delay venturing into investment, but with time it will be possible. Besides real estate plans in the future, he should also strive to distribute his money equally among bonds, common stock, and mutual funds, this will ensure a very stable but also increasing savings. After paying major bills such as mortgage, aim at increasing your investments. Allocate some portion of the salary to the emergency fund to be always on th4e safe side during emergencies (Montz 2008).
Lifestyle: Bill may prefer to travel with his wife on a yearly basis, and maintain a living environment that is comfortable. To have excess finances to buy gifts for family and grand children. Strategy: because of many changes that are bound to occur, social security may not be there during his retirement, therefore he should consider this as an option for planning. It is good that he started saving for retirement sometimes back because he knew that this would be a burden when he starts having kids. Retirement income will most likely be based from earned income, social security, income producing assets, and also from pension plans. Having enough finances to enjoy and relax after work is very important in an individual's life. Therefore starting early enough and remembering to save some for retirement despite other financial needs is very vital. Bill should keep this in mind in order to be assured of a better life in retirement which basing on his age will be in 23 years time (Montz 2008).
Individuals do estate planning to minimize federal and state estate taxes and in the process maximize the portion of their estate that goes to their survivors and heirs. It is simply the process of structuring an individual's personal and financial affairs so that when the individual dies, his or her assets are distributed following his or her wishes. In this case it is encouraging because Bill and his wife already have active wills. Their two children are still minors and therefore need guardians to look after them in case their parents die. Incase Bill dies first then the children's guardian will be his wife. And if the wife dies first then she should indicate in her will that Bill will be guardian to the children. In case both of them die, then another guardian has to be chosen possibly Bill's brother. Appoint the power of attorney who will manage your affairs when you are gone. Both Bill and his wife have a health care power of attorney which gives complete discretion to a loved one including decisions to end one's life. This is because it is assumed that one will die before the other (Hallman & Rosenbloom 2003).
Because Bill wants to leave his estate to his children without estate tax, then it will be prudent to set up a qualified personal residence trust, one of the charitable remainder trusts that the tax code allows individuals to set up in order to own their personal property and leave to their heirs without worrying about them paying estate tax. In case they are supposed to pay tax, then a life insurance trust could be used to pay the tax because life insurance proceeds are not taxed by the United States tax code as income. If Bill dies in ten years time, his personal assets and those from the wife, will have grown to $800,000. His expenses will be $160,000 and $600,000 will go to the heirs. Funeral costs will add up to $10,000, administrative expenses will be $40,000 and his debts will be $100,000. All these and other financial records are included in his will that is put in a safe deposit box. Regular updates should be made to the will as changes are bound to occur in an individual's life or in the lives of his or her descendants (Hallman & Rosenbloom 2003).
This plan has shown that apparently Bill needs more funding for education, emergencies, other goals, and retirement. He can avoid this by saving the preretirement earned income that is not needed for expenses, defer the vocational goal and review it at a later date, or reduce the educational needs of the children by a certain percentage.
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