Financial Plan Development

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CFP Certification Professional

Education Program Capstone

Financial Plan

Development

Carol Craigie, MA, ChFC, CFP®

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This publication may not be duplicated in any way without the express written consent of the publisher. The information contained herein is for the personal use of the reader and may not be incorporated in any commercial programs, other books, databases, or any kind of software or any kind of electronic media including, but not limited to, any type of digital storage mechanism without written consent of the publisher or authors. Making copies of this material or any portion for any purpose other than your own is a violation of United States copyright laws.

CFP, CERTIFIED FINANCIAL PLANNERTM, and CFP (with flame logo) are certification marks owned by the Certified Financial Planner Board of Standards, Inc. The College for Financial Planning does not certify individuals to use the CFP, CERTIFIED FINANCIAL PLANNERTM or CFP (with flame logo) certification marks. CFP certification is granted only by the Certified Financial Planner Board of Standards to those persons who, in addition to completing an education requirement such as this CFP Board-Registered Program, have met its ethics, experience, and examination requirements.

At the College’s discretion, news, updates, and information regarding changes/updates to courses or programs may be posted to the College’s website at www.cffp.edu, or you may call the Student Services Center at 1-800-237-9990.

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Preface

elcome to the Financial Plan Development course. This course is very different from the other courses in the CFP Certification Professional Education Program. You will not be studying for an exam, but instead will be building a detailed, comprehensive, financial plan. Our goal for this course is twofold: one is to complete the CFP Board requirements that you demonstrate that you can deliver a comprehensive detailed plan and second that we help you prepare for the CFP®_{Certification Examination by}

reviewing some of the major components covered in the exam.

This course is designed to simulate parts of the financial planning process and reinforce your learning from the prior courses in the CFP Program. In this course you will synthesize and apply the knowledge you have learned in a real-life situation where things can get messy. There are no multiple-choice questions, and in many cases there won’t be just one right answer to the questions you are asked. Many answers to client problems will fall within acceptable planning guidelines and the fiduciary standard.

The ultimate objective of this course is for you to deliver a comprehensive, detailed executive summary and oral presentation that demonstrate your understanding of the financial planning process, client issues, and potential solutions. Our hope is that when you finish this course, you will be confident that you can prepare and deliver a comprehensive plan.

We will not be using financial planning software in this course. There are two reasons for this. The first is that entering information into software is just part of a plan—in some ways, it is the easiest part. The problem is that it doesn’t fully take the client through the process of understanding the issues in their plan and consequences for not addressing these issues. It doesn’t tell them exactly what they need to do to solve the problems nor how to make a decision when comparing alternative solutions. Software doesn’t address issues such as

inadequate liability protection or what to do if you are uninsurable and can’t buy your way out of the problem. Using software isn’t creating a plan; it is just one of the tools a planner uses to do the analysis.

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The second reason is that learning a new software takes considerable time and we would prefer you spend your time learning how to complete the rest of the plan. If you used software you were familiar with, it would be impossible for graders to know whether you are accurate.

For these reasons, we are giving you the results of analysis from software for several components of the plan. You will be expected to interpret the results of the analysis and build your recommendations from there. In other cases, you will need to do calculations that software doesn’t typically do, such as calculating mortgage refinancing or potential tax consequences for shifting a portfolio. Some calculations are included because the Board may test on them and we want you to have the practice.

To support you in your quest as you work your way through the materials, there are mentor classes and recordings, and you may also contact the course instructor to help answer any questions you may have.

You are on your final step to completing the education requirements for CFP®

certification, and we are proud that we can help you achieve your goal. If you have any questions as you’re working your way through this course, you may contact your course instructor or Carol Craigie, the author of these materials, at

[email protected].

Course Overview

Upon completing this course, you will be able to:

 Apply CFP Board’s Financial Planning Practice Standards to the financial planning process.

 Collect all necessary and relevant qualitative and quantitative information required to develop a financial plan.

 Evaluate the impact of economic, political, and regulatory issues with regard to the financial plan.

 Analyze personal financial situations, evaluating client objectives, needs, and values to develop an appropriate strategy within the financial plan.

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 Demonstrate logic and reasoning to identify the strengths and weaknesses of various approaches to a specific problem.

 Demonstrate a comprehensive understanding of the content found within the financial planning curriculum and effectively apply and integrate this information in the formulation of a financial plan.

 Effectively communicate the financial plan, both orally and in writing, including information based on research, peer, colleague or simulated client interaction and/or results emanating from synthesis of material.

The Recommended Learning Process

This course module contains 10 sections through which you will progress, whether you are working in a self-study, online, or classroom setting. The activities in each lesson are organized to support your development of the comprehensive financial plan through specific steps.

Embedded throughout the materials are gray shaded “Plan Development” boxes containing exercises that will lead to the completion of your executive summary. YOU SHOULD COMPLETE THE BOXES AS YOU READ THE MATERIAL. If you read the entire course and then go back to work through these exercises, you will find it takes much longer. The numbers and statistics in these boxes are the results of current research and calculations from various sources. It is impossible to put all the calculations and underlying information into the text. MoneyGuidePro software was used to create many of the charts and graphs. You can find a copy of the base plan referred to as the Dowler MoneyGuidePro

report in the student portal. This plan will be helpful in understanding some of

the analysis that has been completed for this course.

The material is designed to lead you through the following steps:

1. Analyze the clients’ data so that you understand their issues and are able to succinctly describe them to the client along with the consequences of not addressing the issues.

2. Evaluate alternatives to solving problems, thus identifying the important characteristics for the solutions that can frame the decision for the clients through the use of advantages, disadvantages, and alternatives.

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3. Select the first and second best alternatives that are in the clients’ best interest, fit within their budget, and work in conjunction with their other goals.

4. Write your recommendations in client-friendly language in a format that provides clients the critical information they need in order to make a decision.

5. Track the impact of your recommendations by using the Cash Flow Changes Tracking Page. One of the largest obstacles to implementing

recommendations is that many clients don’t have a great sense of their own cash flow. Understanding how your recommendations will impact cash flow becomes an impediment. You can remove this impediment to

implementation by showing the clients that you are paying attention to changes to their cash flow and are not going outside of what was agreed upon. By showing your clients the cash flow changes tracking, they can follow the impact of multiple recommendations so costs become less of an issue and the trust in you builds. Advisers who give clients recommendations that they cannot afford breaks the trust clients have in them. Clients lose faith that you understand them and are vested in their well-being. This is why it’s important to estimate the costs of changes and track them so you can build a plan that is within the clients’ resources.

The end result of completing the work in the Plan Development boxes will be the formulation of an issue with recommendations, advantages, and disadvantages that will form your executive summary to the client. You are writing this executive summary to the client, not to an instructor or other financial professional.

The appendices contain material that you may find useful to review prior to beginning the Plan Development boxes.

 Sample Case with Sample Executive Summary & Sample Cash Flow

Changes Tracking. This case and the sample executive summary will give

you a sense of what your final project should be.

 Executive Plan Template. When you write your recommendations, you will

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listed. You can find the basic Word document to use to craft your plan on the student portal with the rest of the course materials.

 Cash Flow Changes Tracking Template. Similar to the executive plan

template, this will be where you track the changes to the client’s cash flow as a result of your recommendations. Note that you are not tracking cash flow, but the CHANGES to their cash flow so the client can see that you are staying within the cash flow constraints given. You may wish to put this into an Excel or Google spreadsheet for your convenience so that it automatically calculates, or download the basic Excel file from the student portal.

 The Dowler MoneyGuidePro Financial Plan report is posted on your

student portal. As mentioned previously, software is good at doing the

long-term projections such as retirement or life insurance needs, but it is not a substitute for a complete plan. We are providing the basic calculations in this report that you will be using to create your executive summary. You may take screenshots of this or reference sections of it in the executive summary. It does not include any recommendations for shifting vehicles or saving more money, but does provide the basis of the analysis.

You are writing your executive summary and the cash flow changes tracking sheet in the same order as the Plan Development boxes. Imagine that your clients will have both the executive summary and the cash flow changes tracking in front of them as you lead them through your analysis and recommendations. By showing them the cash flow, you are building trust that you will stay within the constraints you were given. You are also removing one of the biggest obstacles to implementation for clients: not knowing how costs fit into their budget.

The criteria used to grade your executive summary and oral presentation can be found in Appendix B of this module and on the student learning portal.

Once you have received a passing grade on your executive summary, you will be invited to make an oral presentation to demonstrate your communication skills along with your planning knowledge.

There will be more helpful hints and suggestions in chapters 9 and 10 concerning finalizing your plan. Once you have reviewed the documents mentioned above, it’s time to get started!

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Chapter 1: Financial Planning

Process & Ethics

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

T

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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.

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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

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 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.

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 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.

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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

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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

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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

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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

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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

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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 this money go to Matt but do not want to count on it and aren’t sure if it is a good idea to do so.

You want us to help you prepare for working with an estate planning attorney by understanding what documents you should acquire. The only documents you have are the do-it-yourself wills you put together shortly before leaving on a vacation just after Matt was born. In your current will, everything goes to each other and then to Matt in case of both deaths. We have scheduled a phone conversation to explore secondary estate goals and beneficiaries for next week.

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Statement of Financial Position

The third document for client review is the Statement of Financial Position. By having clients confirm this is correct, you can eliminate errors and lengthy conversations on resources at the plan presentation.

ASSETS1

LIABILITIES1, 3

Cash/Cash Equivalents

Checking Account $3,623 Credit Cards $6,158

Money Market $25,000 Mortgage $178,392

$28,623 Auto loans $17,447

Invested Assets2 TOTAL

LIABILITIES: $201,997

Jim's whole life cash

value $7,466 Joint after-tax investments $134,898 Total: $142,364 Tax-Advantaged Assets Jim's IRA $32,888

Anne's IRAs $83,924 NET WORTH: $784,384

Anne's Deferred annuity $19,524

Jim's 401(k) $183,412 Anne’s 401(k) $30,146 $349,894 Use Assets Residence $450,000 Personal property $85,000 Autos $30,500 Total: $465,500 TOTAL LIABILITIES

TOTAL ASSETS: $1,086,381 AND NET

WORTH: $1,086,381

1_{All assets and liabilities are owned jointly, unless indicated otherwise.} 2_{Details about investment holdings may be found in the Investment section.} 3_{Details about liabilities may be found in Debt Analysis section.}

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Annual Cash Flow Statement

The fourth document for client review and sign off for acceptance is the annual cash flow statement.

CASH INFLOWS

Jim's gross wages $ 98,595

Anne's gross wages $ 53,601

Investment income $ 5,595

Total $157,791

CASH OUTFLOWS

Savings and

Investments

After-tax savings contributions $9,900

Reinvested investment income $5,595

Qualified plan contributions1 _$10,283

$25,778

Fixed Expenses

Mortgage (P&I) $16,556

Property taxes $2,352

Homeowners insurance $1,223

Insurance (other insurance) $3,308

Credit card payments $6,000

Car payment $5,412

Total Fixed Expenses $34,851

Variable Expenses

Charitable contributions $4,396

Health care out-of-pocket expenses $1,300

Maintenance/ home services/Misc. $7,450

Food and supplies $8,020

Utilities/Internet/cable/phone $9,040

Transportation (gas, oil, repairs) $4,750

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Travel and entertainment $12,500

Total Variable Expenses $52,356

Total Living Expenses $87,207

Employee benefit deductions2, 3 _$4,171

State and local income tax (flat 4.3%) $5,227

Federal income tax4 _$24,032

FICA $11,329

Taxes and Pretax deductions $44,759

Total Expenditures $157,744

Available Cash Flow $47

Net Income (take home pay) $97,353

Gross Wages $152,196

You have given us permission to redirect after-tax investments, tax refunds, and any savings identified in the process toward your goals, including the money paying off credit cards once those are paid off. We are not looking at any changes to lifestyle expenses other than these.

1_{Jim contributes 5% and Anne 10% into 401(k)s}

2_{Employee benefits include Sec. 79 benefit costs plus pre-tax medical and disability payments} 3_{To replace health insurance benefits in case of lost job would require approximately $10,000 per}

year. Emergency fund requirement based on total expenses plus cost of replacing health insurance benefit for total of $99,407 annual expenses. Four months’ reserves are rounded to $33,000 target goal.

4_{Clients are in the 25% federal marginal tax bracket. State taxes are 4.63%.}

Assumptions

The fifth and final document for client review and acceptance is a summary of all the assumptions, including goals. This allows us to reinforce goal ranges,

expectations, and uncover any objections to assumptions prior to creating the plan. We are also meeting the CFP Board requirement to document assumptions.

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Assumptions Used In Your Plan

General

Base inflation 2.5%

Jim’s salary inflation 2.5%

Anne’s salary inflation 2.5%

Emergency reserve goal 4 mo. $33,000

Assumed Rate of Return 5.5%

Retirement Anne Jim

Desired retirement age 62 62

Latest acceptable retirement age 67 67

If spouse retires, how much of other's earned income can be used to meet retirement income goal

90% 90%

Desired retirement income goal $90,000 $90,000

Minimum acceptable retirement income (both

retired) $80,000 $80,000

Amount to reduce income goal for a survivor in

retirement $5,000 $5,000

Plan life expectancy 95 95

Social Security inflation 2.5% 2.5%

Education Matt

Education inflation 4.5%

Child starts college at age 18

Maximum number of years to fund college 4

Minimum amount of expense willing to pay per year for college

(even if you have to extend your retirement age)

$20,000

Maximum amount of expense you are willing to

pay per year for college (Your child knows they will have to pick up any balance – no

exceptions)

$20,000

Outside funding sources included

(assets not owned by you or included in your net worth that will be available)

(scholarships, student loans, student

employment, annual gifts, own current income, etc.)

$100 per month by grandparents just started and continuing until

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Survivor Planning—what do you want to plan to fund? If Anne is survivor If Jim is survivor

Debts to pay immediately other than residence $23,605 $23,605

Amount of residence debt being paid off $178,392 $178,392

Final expenses & other immediate needs $60,000 $60,000

Other goals funded? Cabin yes yes

College funded? yes yes

Maximum age to which survivor will work 67 67

Changes to spouse's income assumptions prior

to retirement None None

Estimated Income need for survivor prior to

retirement $80,000 $80,000

Estimated Income need for survivor during

retirement $70,000 $70,000

Disability Planning If Anne is _disabled If Jim is _disabled Estimated Income need for family prior to

retirement (pretax) $123,204 $129,719

Contingency plan for reducing expenses in case

of permanent disability not in place not in place

Changes in working partner income prior to

retirement work until 67 work until 67

Long-Term Care Planning

Annual cost in today's dollars of long-term care $82,000 $82,000

Inflation for long-term care expenses 5% 5%

Number of years to assume long-term care

facility or home support utilized 5 5

Year at which we assume long-term care facility

or home support needed 80 80

How much will other expenses be able to be

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Property & Casualty Protection Liability protection minimum will equal or exceed

this net worth $1,000,000 $1,000,000

Liability protection minimum will equal or exceed

annual income times this number 7 7

Legal Documents & Estate Planning Anne Jim

Projected inheritance you may receive 0 $5,000,000–0

Specific bequests

Administration fees— fixed amount 1% 1%

Administration fees—% of probate 2% 2%

Estimated funeral expenses $15,000 $15,000

Prior gifts you have made 0 0

Income Tax Assumptions—Combined Federal & State Marginal Income Tax Rate (25% federal, 4.63%

state) 29.63%

Combined federal and state effective tax rate 16.58%

When the client confirms this information with you, you have completed the first two steps in the planning process plus you have confirmed assumptions, which is also a requirement under the next phase.

Completed

Establish Relationship

 Explain services provided, the process, and required documents.

 Clarify client and planner’s responsibilities—(define the scope of engagement).

Gather Data

 Obtain quantitative and qualitative information through use of interview/questionnaire.

 Determine client’s goals, needs, and priorities.

 Assess client’s values, attitudes, and expectations.

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 Collect all applicable records and documents.

Analyze

You are ready to start analyzing the Dowlers’ financial situation. It may seem that compiling the information above is analysis, but you have just been organizing and understanding the information. Practice Standard 300-1 of the CFP Board compliance checklist requires that you now analyze this data.

Now examine the information in detail and ask these questions:  What are the strengths and weaknesses of their current situation?

 Which life challenges could they face successfully and which challenges would cause financial hardship and disaster?

 What questions were not raised that the clients should ask to be addressed?  Are there any unrealistic goals or assumptions that need to be discussed with

the clients?

 Are there techniques you can suggest that will improve the efficiency of their plan?

 Are there challenges they may face that cannot be addressed by purchasing products but must be addressed by planning or changing lifestyle?

In this phase, you are to accomplish the following tasks: 1. Analyzing and evaluating the client’s financial status

a. Current financial status (e.g., assets, liabilities, cash flow, debt management, risk exposure, capital needs)

b. Special needs (e.g., divorce/remarriage, charitable planning, dependent needs, education needs, terminal illness planning, small business planning)

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c. Risk management adequacy (e.g., life, disability, health care, long-term care, homeowners, auto, other liability insurance, commercial insurance issues, if any.)

d. Investments—current investments, strategies, and policies e. Taxation—current returns, strategies, and tax compliance

f. Retirement—current plan, tax exposures, and Social Security strategies g. Employee benefits utilization

h. Estate planning—documents, strategies, and tax exposures

Once you identify an issue or potential areas for improvement, you need to take the next step of developing and presenting recommendations. In your executive summary you will be following the format of describing the problem, making a recommendation, identifying advantages and disadvantages of your

recommendation and providing an alternative. Additionally, you are tracking the costs of recommendations to make sure they fit within the client’s financial ability. This will be the documentation that you have followed the planning process. Read the requirements below so you can see how this model meets your obligations.

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The detailed steps under developing and presenting financial planning recommendations and/or alternatives include:

Prepare and present a financial plan (with client input), tailored to the client— that includes analysis of the client’s:

1. Financial position (current and projected statements) 2. Cash flow (projections and recommendations) 3. Estate tax (projections and recommendations)

4. Capital needs at retirement (projections and recommendations) 5. Capital needs projection for death (projections and recommendations) 6. Capital needs—disability (projections and recommendations)

7. Capital needs for special needs (projections and recommendations) a. Income tax (projections, recommendations, and strategies) b. Employee benefits

c. Asset allocation (statement, recommendations, and strategy) 8. Investments (recommendations, policy statement, and policy

recommendations)

9. Risks and potential liabilities (assessment and recommendations) 10. Priority list of action items

a. List the priority of each area of planning interest.

b. Work with the client to ensure that the plan meets the identified goals and objectives.

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Implement and Monitor Plan

The final steps are ones that you will not be addressing in this module, but it is a good idea to review them now as they will be tested on the CFP®_{Certification}

Examination. It is also suggested that you examine the Code of Ethics and Practice Standards on the CFP Board’s website at www.cfp.net/about-cfp-board/ethics-enforcement/standards-of-professional-conduct.

Responsibilities under implementing the financial planning recommendations include:

a. Assist the client with implementation of the plan. b. Coordinate with other professionals as necessary.

Responsibilities under monitoring the financial planning recommendations include:

a. Regularly monitor and evaluate the progress of the plan. b. Review changes in laws that affect the plan.

(1) Update client information regularly.

(2) Recommend changes to the plan as required.

This completes the review of the Financial Planning Process. You are now ready to analyze and evaluate the client data.

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Chapter 2: Client Cash Flow, Debt

& Risk Management

ne of the first steps in analyzing a client’s situation is to become

familiar with their cash flow and gain an understanding of savings, debt patterns, and available cash flow that will impact their ability to

accomplish their goals. Take a few minutes to explore the Dowlers’ basic information presented in Chapter 1, and then look for opportunities that could create efficiencies that free up money to help them accomplish their goals. The Plan Development boxes below are designed to focus your analysis in areas where you may find opportunities or that should be addressed in your final financial plan.

Cash Flow

The Dowlers have given you permission to redirect the following cash flow resources to accomplish their goals. You may uncover additional options as you work through this case:

 Annual current available after-tax savings: $9,900

 Annual tax refund/or changed withholding available to reallocate to meet goals: $5,600 refund for this this year and going forward, we are assuming $5,000. (By increasing withholding, this will result in $11,600 available in the first year and $5,000 going forward.)

 Inheritance lump sum first year only: $5,500

 Funds going toward credit cards once those are paid off

Emergency Funds

Whether you look at emergency funds as cash flow or risk management,

everyone agrees this is one of the first goals that needs to be established and one of the most difficult for clients and advisers to accomplish. Research regarding how people make decisions gives us some of the reasons for this difficulty. Optimism bias, immediacy bias, and a whole host of other “biases” make us

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believe that emergencies won’t happen to us in the near future—that is, unless we have experienced one recently. Advisers are also reluctant to have money “just doing nothing!” Planners may have the same biases as clients in believing that nothing bad will happen soon.

Jim and Anne have already accumulated a significant portion of their emergency funds with their $25,000. The target for reserves was set and confirmed in the summary of goals and issues. The target included the cost of purchasing

unsubsidized health insurance if Jim lost his job. The target is $33,000. You will have to balance meeting other goals from their cash flow with their need for emergency funds. At a minimum, they need to have $30,000 in reserves by the end of this year and the full $33,000 by end of year two. You may fully fund it in year one or shift $3,000 to the second year. Plan Development #1 is a sample recommendation to get you started and provide a model recommendation. Feel free to customize this recommendation for your executive plan.

Plan Development #1

This is a sample recommendation to get you started. Please feel free to change it or leave as is.

Issue. While you have a good start on accumulating sufficient emergency

reserves, your current amount would last 3.4 months without covering any additional out-of-pocket expenses for medical insurance in case of a job loss or medical expenses in case of an illness.

Recommendation. Increase emergency reserves this year to at least four

months of reserves, including coverage for medical insurance, which requires an additional $8,000 deposited this year.

Move the funds from the taxable money market to the Colorado municipal money market, which has a better after-tax return.

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Advantages

 Increases your ability to handle any emergencies that come along.  Using the municipal money market is more efficient with a better

after-tax return than your current money market.

 As long as one of you is working, this amount would cover six months of

the unemployment.

Disadvantage

 Funds invested in safe liquid assets earn less than those that have higher

risk.

Alternative. Use Roth IRA to begin accumulating more emergency reserves

beyond the current $25,000 because you can withdraw your principal at any time without penalty and the funds are protected from creditors. If you use this strategy, you would not count earnings toward your emergency reserves but principal only.

(Note: The cost of completing the emergency fund has also been put into the cash flow changes tracking sheet. Each time you write a recommendation, be sure to enter the change to the costs!)

Debt Analysis

Consumer Debt

One of the areas to examine for potential efficiencies or improvement is debt. Table 1 provides details concerning the Dowlers’ current debt situation.

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Table 1: Debt Payment Information Description Balance Annual Payments Annual Minimum Payments Req’d Rate Home first mortgage* $178,392 $ 16,556 $ 16,556 6.87% Visa Card $ 3,816 $ 3,000 $ 602 15.25% MasterCard $ 2,342 $ 3,000 $ 370 13.75% Car Loan $ 17,447 $ 5,412 $ 5,412 5.90% $201,997 $27,968 $ 22,940

*Original 30-year mortgage, remaining term 236 months—19.7 years remaining

Analysis questions. It helps to complete an analysis of debt ratios so you can

evaluate the appropriateness of use of debt for the client. It also lets you know what types of rates the client would qualify for when they refinance their mortgage. Table 2 shows popular ratios:

Table 2: Debt Management Rules of Thumb Debt Management Rule of Thumb

Nonmortgage debt-to-income ratio 20% or less of net income

Front-end ratio 28% or less of gross income

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Plan Development #2

Use the following information to complete these calculations for the Dowlers:

Net Income (take-home pay) $97,353

Gross Wages $152,196

Calculate the Nonmortgage Debt-to-Income Ratio. The nonmortgage

debt-to-income ratio compares the annual MINIMUM REQUIRED payments in Table 1 to service debt. This is because the client could reduce their payments to this when taking on more debt. This measure excludes the mortgage and uses a person’s annual take-home pay (or net income). A ratio of 15% or lower is healthy, and a ratio of 20% or higher is considered a warning sign that nonmortgage debt is excessive. The nonmortgage debt-to-income ratio is calculated as follows:

Annual nonmortgage debt repayment Nonmortage debt-to-income ratio

Annual net income =

Gross Income versus Net Income

For mortgage lending purposes, the debt-to-income calculation is always based on gross income. Gross income is a before-tax calculation. The reason for the use of gross income in both the front-end and back-end ratios is the tax-favored status afforded mortgage interest payments. Because consumer debt is afforded no such tax-favored status, this calculation is done on a net income (take-home pay), or after-tax basis. Again, because this is being used to calculate the borrower’s ability to consistently make payments, only the minimum required payments are considered, NOT the payments currently being made.

Calculate the front-end ratio (a.k.a. “debt-to-income ratio”).

PITI Front-end ratio =

Gross income

This ratio is similar to the nonmortgage debt-to-income ratio, but it indicates the percentage of income that goes toward housing costs. This includes PITI

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(principal, interest, taxes, and insurance premiums) and also homeowners’ association dues, when applicable.

Use the following information to calculate the front-end ratio:

Mortgage (P&I) $16,556

Property taxes $2,552

Homeowners insurance $1,223

Calculate the back-end ratio. This ratio identifies the percentage of income that

goes toward paying all recurring debt payments, including those covered by the front-end ratio, and other debts such as credit card payments, car loan payments, student loan payments, child support payments, alimony payments, and legal judgments. Use the income information provided in Table 1 plus Jim and Anne’s PITI expenses from the prior question to calculate their back-end ratio:

All debt + PITI Back-end ratio =

Gross income

Now that you have calculated these important ratios, compare them to the “rules of thumb” provided to determine whether they would fall within an acceptable range, which would indicate favorable refinancing opportunities. This may impact your recommendations to the clients.

Use the information you have calculated about the client’s debt ratios in your summary of debt uses and strategies so they understand how these ratios impact their ability to acquire favorable debt terms.

Debt Strategies

Efficient structuring of debt can free up money to accomplish other goals. Evaluate and make recommendations on the Dowlers’ debt restructuring. Plan Development #3 is designed to help you write your recommendation. This would also impact the debt ratios you just calculated. Sometimes restructuring debt to more efficient strategies can be beneficial in qualifying for even more beneficial strategies! Borrowing short term from a parent can sometimes allow an adult

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child to restructure their debt to qualify for lower rates in a home equity line and then the debt can be repaid with the lower-costing credit. Learn to look at debt restructuring as an opportunity.

Remember that you can immediately redirect the prior debt payments to

accomplish Jim and Anne’s other financial goals once their debt is paid off. You know you have some money that can be redirected to goals now, and you may uncover more in future analysis. There is enough money that they could pay off their debts immediately. How much cash flow can you add to available cash flow resources if they pay their credit card debts off immediately?

Plan Development #3

Write a recommendation concerning paying off their credit cards now. Be

specific about the impact to cash flow. Be specific about the advantages and disadvantages. Use the same format that was used for emergency reserves:

Issue: (Incorporate facts from your debt ratio analysis from Plan Development

#2 and general knowledge to clearly define the issue specific to the client and potential consequences of NOT addressing the issue.)

Recommendation: (Recommendations should be short, clear, and actionable

statements telling the client what you want them to do.)

Advantages: (Your advantages and disadvantages should be the critical

components that clients should consider when making a decision about each specific recommendation. Use short bullet points for clarity.)

Disadvantages: (No one trusts a person who only shares the advantages.

Additionally, the client needs to be able to understand the disadvantages so they can make an informed decision about whether the disadvantages outweigh the advantages or another strategy needs to be considered.)

Alternative: (This demonstrates that you have considered other alternatives and

are providing them what you believe is the next best alternative. Behavioral research shows that people hesitate to make decisions if they don’t know what an alternative is.)

When you complete a recommendation, make sure you transfer it to your final executive summary and track the cash flow in the cash flow summary document.

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Both of these formats are in Appendix C of this module. As you work your way through this course, you will be building your executive summary. While you may end up tweaking some of the recommendations in the final stage, you will have all the important information in one place.

Mortgage Options

Mortgage debt provides many opportunities and pitfalls for clients. Learning to evaluate whether it is better to pay closing costs out of pocket versus cash, or to shift to a different mortgage is an important calculation. Deciding on a fixed or variable interest rate, the best term for the clients, whether to pay points, whether refinancing is worth the closing costs, and whether to pay closing costs from other resources or fold them into the mortgage are all important components. For your case, you are making a relatively simple decision. You have already

determined that the loan term must be completed by retirement. The Dowlers are not planning on moving, even in retirement. They want to lock in a fixed rate. Their income is stable and they have other resources so you aren’t too worried about needing to lower their payment to protect them from being unable to meet the mortgage. You have narrowed down the options to the ones in Plan

Development #4. You need to complete the chart below by calculating the new payments, the difference between their current mortgage payment and the various options, and finally, the break-even period to recover from the closing costs.

Plan Development #4

Complete the chart below showing potential mortgage options.

 Set your calculator to 12 compounding periods per year  Make sure it is in end mode

 PV = the new loan amount after adding in closing costs  FV = 0

 N = number of years times compounding periods (use shift key)  I = the mortgage rate

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Solve for each payment. Subtract the new monthly payment from the old payment to identify the difference.

Recovery period is determined by dividing closing costs by the monthly savings. Obviously if the new monthly payment is greater than the old monthly payment, the answer will be N.A. for the recovery period. A more complex calculation can be done to determine when the amortization schedule will reflect the savings, but that is beyond the scope of this course.

Current _Mortgage 20 yr. fixed closing costs out of pocket 15 yr. fixed closing costs in mortgage 15 yr. fixed closing costs out of pocket Current balance $178,392 $178,392 $178,392 $178,392 Term (years) 19.67 20 15 15 Rate 6.87% 5.68% 4.25% 4.25% Closing costs 2% $3,568 $3,568 $3,568 Amount of new loan $178,392 $181,960 $178,392 Payment $1,380 ? ? ? Monthly savings 0 ? ? ? Recovery period in months 0 ? ? ?

Interest paid over

life of loan $147,549 $120,490 $65,064 $63,169

Mortgage Tax Deduction Impact estimate

-$382 -$848 -$822

If you wish to add mortgage rider which pays off mortgage in case of death or total disability after six months for either Jim or Anne, the cost would be $400 per year.

Write your recommendation for restructuring their mortgage in your executive summary. Be specific about why you chose the option for the clients and

remember to incorporate the impact of your recommendation in the cash flow changes tracking page.

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At this point, you should have a few entries into your three-year cash flow chart showing the results of paying off their credit cards and refinancing their

mortgage. By showing the utilization of available resources combined with your changes, you can see what funds you will have available to address their goals in the future. You are using three years because you may need to spend money in the first year or two to accomplish goals that will free up funds in later years. You can see some of these numbers entered already in the cash flow changes tracking form. Make sure you continue to transfer these numbers to the cash flow changes tracking form.

Savings Habits

Much more important than any improvement in rate of return is how much the client is saving. Rules of thumb (save between 15%–20% of income) are helpful because they provide a framework for clients to evaluate their own behavior. For some people it seems an impossible goal. Remind clients that their employer contributions to qualified plans count too! It is helpful to consistently track and tell a client what their savings ratio is. Clients who are exceeding the ratio can be complimented and shown how that habit relates to financial security. When you are preparing your executive summary, you may want to work in Jim and Anne’s savings ratio and how it compares to the 15%–20% savings target.

Plan Development #5

What is the Clients’ Savings Ratio?

The Dowlers are saving $9,900 after tax each year and contributing $10,290 to their qualified plans. Jim is contributing 5% of his salary of $98,536. (Taxable income for both clients will be higher because of the inclusion of Section 79 income from the group life insurance, but this income is not matched for 401(k) contributions.) His company matches 100% of the first 3% of his salary. Anne is contributing 10% of her salary of $53,559, and her company match is also 3% of her salary.

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Retirement Plan Contributions Salary

401(k)

Contribution Company Match Total

Jim $98,536 $4,927 $2,956 $7,883

Anne $53,559 $5,356 $1,607 $6,963

Total $10,283 $4,563 $14,846

Consider using this information about their saving rates in your executive summary to help the client understand how their habits compare to the standards and how this relates to accomplishing their goals.

Risk Management

The next category of analysis is examining the risks that could destroy a client’s financial security. One in 10 family units will experience a financial crisis in a 10-year period—you don’t know whether it will be loss of job, serious medical problems, disability, auto accident, lawsuit, home fire, death, etc. Optimism bias makes people believe that they won’t be the one and it won’t be this year. Part of your job is helping clients see the potential risks and potential consequences. If you hold yourself out as a comprehensive financial planner, you must disclose if you are not going to address certain types of risks such as property and liability. It is perfectly fine to disclose that you are not an expert in these areas and that you are recommending the client work with a qualified specialist. But just like with estate planning, you are frequently the only one who knows the big picture and the small details that are only exposed when a thorough fact find is done. For example, knowing that a client is a snowbird impacts both their estate planning and their property and liability insurance issues. Knowing that a client has a business impacts life insurance, disability, estate planning, and property and liability coverage needs. You don’t need to become an expert in solving issues in all these areas, but becoming good at identifying risks and helping motivate the client to address the risks will help make you a great planner. Creating a strong relationship with a P&C specialist will benefit you and your clients.

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Property and Liability Issues

Every year homes and businesses are destroyed by fire, floods, and other natural disasters. Lawsuits, car accidents, boating deaths, and bicycle injuries keep happening. Ignoring property and liability issues is like pretending a $100,000 loan outstanding doesn’t exist on a balance sheet. Use this section to identify potential risks and solutions. Jim and Anne have purchased insurance policies from various providers and do not typically review their coverage with agents routinely.

Homeowners Insurance

The Dowlers live in a nice middle-class neighborhood with good schools. The estimated replacement costs for a residence similar to theirs from a reputable online valuation site is $320,000, and the land is valued at $130,000 for a total value of $450,000. Building costs in the area are high and increasing at around 4.5% this year.

Land is never considered when determining the amount of property protection because land doesn’t go away. (The exception to this is coast or lake property, which requires special coverage.) This is one of the reasons that market value is ignored when it comes to insurance. The replacement costs can be higher or lower than market price, with the value of the land being a piece of the equation. For protection purposes, look at the replacement costs. Getting the replacement costs means working with more than one insurance company and asking them to estimate the costs.

To replace their personal property would cost approximately $125,000, but they don’t have an inventory. (Hint: Maybe you should suggest one?)

In addition to their usual property, Jim and Anne own two snowmobiles and a fishing boat. Since their boat or the snowmobiles are not worth much, they did not mention them to the insurance company or cover them in their policies. Their umbrella policy does not provide ANY coverage unless there is an underlying policy covering the motorized conveyance.

Financial Plan Development

CFP Certification Professional

Education Program Capstone

Financial Plan

Development

Table of Contents

Preface

Course Overview

The Recommended Learning Process

Chapter 1: Financial Planning

Process & Ethics

Determining the Scope of Engagement

T

Meet Your Clients

Jim and Anne Dowler

Gather Data

Client Letter

Statement of Financial Position

Annual Cash Flow Statement

Assumptions

Completed

Establish Relationship

Gather Data

Analyze

Implement and Monitor Plan

Chapter 2: Client Cash Flow, Debt

& Risk Management

Cash Flow

Emergency Funds

Plan Development #1

Debt Analysis

Consumer Debt

Plan Development #2

Debt Strategies

Plan Development #3

Mortgage Options

Plan Development #4

Savings Habits

Plan Development #5

Risk Management

Property and Liability Issues

Homeowners Insurance