Determining the Scope of Engagement
he first step in the financial planning process is determining the scope of engagement. This is a requirement independent of whether you are providing a financial plan or engaging in non-financial planning work when you are a CFP® professional.
The CFP Board provides a compliance checklist at www.cfp.net/for-cfp-
professionals/professional-standards-enforcement/compliance-resources/compliance-checklist to document that you are meeting the Board’s Standards of Professional Conduct. The first element is related to establishing and defining the client-planner relationship.
During your initial meeting with the client, you must have enough of a dialogue to understand what the client is looking for, determine what services and products you may offer, and determine a scope of engagements. You must also
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determine what information you wish to collect. If additional information is needed as the analysis occurs, the client must be notified.
Remember that during the process, your relationship may change from a non-financial planning engagement to a non-financial planning engagement, which requires a change in the type of documentation. For example, the amount and type of information collected could change your engagement into one that, from the client’s and CFP Board’s perspective, is a financial planning engagement.
Clients anticipate that you actually do something with data you collect, so if you collect tax returns, investment returns, and wills, they are assuming you are examining the documents and will be providing advice in those areas. This could lead you into having a financial planning engagement, even if you were just trying to determine a beneficiary designation for their annuity! At this point, you would need to modify your scope of engagement, make additional disclosures in writing, and document the process.
Meet Your Clients
Jim and Anne Dowler
Client Health Age Occupation
Jim Dowler Excellent 42 Manager
Anne Dowler Excellent 42 Administrator Dependent: (no other children planned)
Matt Excellent 5
Jim and Anne Dowler have requested that a CFP® professional evaluate their personal financial situation. In the first meeting you determine that they want to engage you to provide a comprehensive financial plan. A preliminary scope of engagement is defined and signed. All appropriate disclosures for both you and your company were made in that meeting so you have completed the primary requirements of disclosure.
Gather Data
During the first meeting you identified and clarified the financial goals and questions that you will be addressing through your plan. You provided them with a list of documents and information you needed to collect. Notice the
requirement in the CFP Board checklist that you document the following three items:
Goals and objectives
Discussion of any unrealistic goals and unattainable objectives
Data gathered and gaps in data
Documenting these three areas is not only a CFP Board requirement, but is also a good business practice. When clients confirm the basic goals and information, you will find that more clients understand the issues and information with less time spent reviewing basic information in client meetings. Additionally, by having the clients sign off on a summary of questions and goals, you will also prevent wasting time by entering or analyzing incorrect information.
While the CFP Board does not require you to document assumptions in this phase, it is required in a later step. It makes sense, then, to review and confirm this assumption information with the client in this first phase. Documenting your actions and sending this documentation to the client for confirmation eliminates potential time-consuming errors and builds client trust. At this point, the client has already received disclosures and a copy of the signed engagement agreement.
As an example, the following document incorporates
a summary of the questions and goals they would like to have addressed in this plan, with any of your potential concerns about possible unrealistic goals indicated;
a statement of financial position;
a cash flow statement;
assumptions; and
any additional information the client needs to provide.
Client Letter
Dear Jim and Anne,
I enjoyed meeting you yesterday and look forward to working with you on developing a realistic financial plan with practical recommendations that will improve your financial life. The first step is making sure that I clearly understand your issues and we are both on the same page as I develop your plan. I am sending several documents for both of you to review and return with any changes before I build your plan.
After you return these to me, my assistant will schedule an appointment for approximately two weeks out. At that appointment, I will review the results of my analysis and recommendations. Here are the documents that I need you to carefully review, initial, and return with changes or questions.
Summary of Goals and Issues. This is my summary of the goals and issues we discussed. It is important that I capture exactly what you want your money and this analysis to do for you. Please take the time to read it
carefully and provide any changes or additions. This document will drive my work and recommendations, and ensures I address what is important to you.
The only way for me to be sure I am on target is for you to confirm its accuracy. Please respond by the agreed upon deadline.
Statement of Financial Position. If this statement is incorrect, your financial plan will be incorrect. It is easy to miss an asset or liability or simply turn two numbers around, so please review this carefully.
Annual Cash Flow Statement. I will be utilizing this cash flow sheet to determine whether solutions we explore will fit within your cash flow. If I find a way to solve all your financial issues but you won’t be able to pay your mortgage after funding them, I won’t have helped you. This document identifies basic inflows and outflows and identifies funds that are available to direct toward achieving your goals.
Assumptions. Projecting into the future means making assumptions. This document outlines the assumptions we are making and takes your general goals and turns them into very specific, measurable objectives. Please review and get back to me with any questions, concerns, or potential changes. These will change every year based on market conditions, inflation, taxes, and what is happening in your life, so it’s critical we evaluate and agree on these each year.
Documents and information needed. The good news is that you were able to give me all the documents I needed, so at this point, there is no additional information I need. I may discover some as I continue your analysis, at which point I will contact you again. Thanks for doing such a great job in getting me what I needed. This will make our process much smoother!
I look forward to hearing back from you on changes, additions, or questions about the information in these documents. I will phone you on Thursday, January 6 at 2:00 p.m. to walk through your comments and changes.
Sincerely, Your adviser
The first document for client review and approval meets the requirement to document goals and raise any issues of unrealistic goals. This letter will also provide you important information that you will need in developing your executive summary. These are the issues that you are committing to address for the client.
Summary of Goals and Issues to be Addressed in Plan Cash Flow
We discussed that you both are comfortable with your current lifestyle and are currently saving $9,900 in after-tax investments, in addition to your 401(k) contributions with employer matches. You are also reinvesting all dividends and interest and paying capital gains taxes from your income so that all your money continues to work for you. Combined savings represents close to 16% of your income. Additionally, once your credit cards are paid off, the $6,000 going toward those are available to accomplish your goals. We agreed that, currently, our plan should not include any reduction in your lifestyle. You are willing to redirect any tax refunds or additional funds uncovered through such items as restructuring your mortgage toward achieving your goals. You also have a
$5,500 distribution coming from Anne’s grandmother’s estate that is being disbursed in February, and are willing to put this toward achieving your goals and would like recommendations on the best way to use this money. My commitment is that the recommendations to improve your financial health and achieve goals will stay within these budget constraints. If it turns out you cannot achieve your goals, you will be presented with the information on your
alternatives such as reducing lifestyle to free up money or postponing or changing a goal.
Consumer Debt
Balances on credit cards are not being added to, and you have been paying them off through a combination of monthly payments and tax refunds. You do not anticipate building credit cards up again after these have been paid off. Once they are paid off, you are willing to redirect these payments to achieve other goals.
You do intend to continue buying cars and assume you will always have car payments. We will not be addressing car financing in this plan. You replace cars about every seven years.
Mortgage
You think you would benefit from refinancing your mortgage and have provided information about alternate rates. You plan on remaining in this house in
Colorado through retirement. You would like a recommendation concerning
which mortgage to choose and whether to pay the closing costs from cash reserves or roll it into the mortgage. You would prefer not to have a mortgage in retirement, but are open to options. Your current mortgage ends in 19.7 years, which is right before retirement. Any savings are to be used for accomplishing other goals. Your current interest rate is 6.87%. Current fixed rates (no ARM) are:
20-year: 5.68%
15-year: 4.25%
Emergency Funds
You would like to have four months of expenses in your reserves. You believe this is adequate given the stability of your jobs, good health, and other financial and family resources. You would like confirmation of how much you should accumulate and recommendations on where to have those funds invested. You currently have $25,000, as some of the cash in your liquid reserves is for paying current bills.
Education
Providing significant support for Matt’s education is an important goal for both of you. You would like to finance $20,000 per year in today’s dollars for four years for his education. You are willing to work longer and retire on less if that is what it takes to accomplish this goal. You are willing to accept 4.5% inflation on college expenses and would like to have this goal achieved by the time he starts college since you may need to contribute additional money from current income during his college years. One of your municipal bond accounts has $22,000 and you consider that to be allocated toward education. In addition, Jim’s parents have just established a 529 plan for Matt and are contributing $100 per month into the account that will go toward the $20,000 target. Jim’s parents have expressed they will continue contributing to the account until he goes to college.
Property and Liability
You would like a second opinion and some advice on your property and liability coverage. You would like to understand more about what the critical components of coverage are before you meet with an agent. You are especially interested in knowing if there are any gaps in your current plans. You accept that we are not
specialists nor licensed in this area, so we will be providing some understanding, guidelines, and estimated quotes received from an outside agency. You are under no obligation to utilize or even talk with the agent who is providing this
information based on our understanding of your current coverage. We do not receive any compensation from this agent. It is simply a service in an area of expertise that we do not have and does not replace meeting with a qualified agent.
Disability
In case of a disability, you don’t really know what would happen or how it would impact your lifestyle or retirement. Anne’s cousin was permanently disabled and you are watching the family struggle with current expenses and worries about the children’s education and their own retirement. You would like to know what steps you should take and what is realistic to expect in case of a disability so you aren’t faced with the same issues as your cousin.
Long-Term Care
You want to know if you should be concerned about purchasing long-term care insurance now. You have also heard that long-term care insurance is not worth it and don’t know what to think. We agreed that inflation for those expenses and premiums should be assumed at 5%. You would like the spouse to be able to remain in your own home and not experience a reduction in lifestyle. You would like advice on the optimal age to address this issue, if now is not the time.
Survivor Needs
You think that in case of the death of either one of you, $80,000 per year reducing to $70,000 in retirement would be adequate. You would like the mortgage paid off, college funded, and the same lifestyle provided for the survivor now and in retirement. You would like for us to determine how much life insurance and what type of coverage would provide for this goal.
Additionally, you would like an initial lump sum available for final expenses and miscellaneous expenses in the first year, and think $60,000 should be adequate.
You would rather err on the side of a little too much insurance rather than risk problems for the survivor. You both have clearly stated that you want the
surviving spouse and Matt to maintain the same lifestyle that they have today and pre-fund retirement and education objectives. You both would like to see the family cabin purchased even if the other is no longer around. You also both want the surviving spouse to be able to retire at age 62 if you can financially afford this along with your other goals. You are willing to accept the Social Security projections provided and 2.5% inflation. You have agreed that 5.5% long-term return is an acceptable rate to use.
Investments
You are willing to reallocate contributions or funds if it will help achieve your goals, including the $200 per month going into the annuity. You would like our analysis of the annuity and whether you should keep and continue funding it or utilize the funds elsewhere. Jim is more aggressive than Anne, but neither of you really feel that you understand risk. The last downturn has made you nervous, but you are not sure what actions you should be taking. You are willing to take average risk before retirement, which was confirmed by multiple risk tolerance assessments.
You would like us to make recommendations on both asset allocation and investment selection. We discussed that this will be a multi-step process. This initial step will be the selection of a model portfolio and calculation of the taxable gains. After agreement upon this stage, we will create an investment policy statement and finally evaluate the individual investments. You are willing to accept the proxies for returns and average risk return assumptions embedded in our software from our portfolio management team, and understand that these are only representative of an asset class, not the individual investments.
Tax Planning Advice
Your accountant has provided you with a projection showing you are on target to get another refund this year of around $5,600, and the projection for next year is showing another $5,542 refund. This has been consistent for the last several years. You have been using the refunds to pay down debt or invest. Going forward, you are willing to redirect all of those funds to help accomplish your goals. Your intention this year was to again put this refund toward debt, but you are open to other suggestions. Because we are not sure of tax law changes or how
other strategies may impact your goals, we are only going to utilize around 90%
of the projected refund your accountant has calculated in our analysis, which we rounded down to $5,000 in order to make sure you do not end up owing taxes.
You are also interested in hearing recommendations that would reduce your taxes now and in the future, but accomplishing your goals comes before tax benefits. If we can find strategies that create a tax advantage, we have permission to use any freed-up funds to help accomplish your goals as well.
Retirement
You would ideally be prepared to retire on $90,000 annual income at age 62 and assume life expectancy of 95. A survivor could live on $80,000 if alone in retirement. However, as we discussed, you may need to readjust your goals. You have identified a willingness to work until age 67 if that is what it takes to create a secure retirement with a minimum income of $80,000. When it comes to prioritizing retirement solutions, you would prefer to drop the income
requirement to $85,000 first, and then drop age down to age 62 if your first goal cannot be achieved within your budget constraints. We will adjust your
retirement goal so that you continue working until you have the security of reaching the minimum income goal of $80,000.
You would also like to buy out Anne’s cousin from his half of the family cabin in the mountains at age 62, if possible. It is estimated that the costs would be
$100,000 in today’s dollars. You can either purchase it outright or carry a 10-year note at 6.5%.
We will not know whether these goals are realistic until I complete your analysis.
In addition to the retirement parameters identified above, you would also be willing to defer or carry a longer note on the cabin if it can fit within your retirement budget.
Estate Planning
You want to leave an estate for the benefit of Matt. Anne’s inheritance from her parents was what helped you to accumulate your current resources. Jim is an only child and will inherit everything from his parents. They are in their late sixties and in good health, so he does not anticipate receiving an inheritance soon.
Jim is also the executor and has power of attorney for his parents. Help in having
a general understanding of an executor or power of attorney would be
appreciated. He is concerned about handling that role and not sure what it entails.
Jim’s parents currently have investments worth around $3.5 million and their estate is continuing to grow slightly, but they are concerned about inflation and potential long-term care and/or medical costs. You both think you would rather
Jim’s parents currently have investments worth around $3.5 million and their estate is continuing to grow slightly, but they are concerned about inflation and potential long-term care and/or medical costs. You both think you would rather