SAMPLE FINANCIAL PLAN
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John & Joan Smith Sample Financial Plan
This hypothetical financial plan is being presented to illustrate both the process of financial planning and the looks of a plan from Financial Life Advisors. The characters and circumstances are completely fictional and are for illustrative purposes only. You should seek the advice of a qualified professional for your particular situation and should not rely upon any of the information herein to make personal financial decisions.
Hypothetical investment returns presented in this financial plan are based upon historical market index performance and are not indicative of future results. Actual indexes cannot be purchased. Further information about the financial plans investment assumptions are disclosed in the financial plan.
Under the Certified Financial Planner Board of Standards, Inc. “Standards of Professional Conduct”. Financial Life Advisors (FLA) adheres to these Standards of Professional Conduct. The example of the Smiths will walk through what a client can expect when working with FLA and demonstrate how all of those steps are implemented at FLA. This firm is NOT a CPA firm.
FICTIONAL CASE STUDY
- Choosing a Planner and the Initial Consultation
- Background Information and Defining Goals
- Analysis and Financial Plan Construction
- Financial Plan Presentation
- Implementation of the Financial Plan
John and Joan Smith are a normal, middle-aged couple. They were contemplating their retirement and realized that there are many moving parts to their personal finances. They had investments accounts all over the place, were unsure of when they should file for Social Security benefits, thought they had adequate insurance coverage, and were unsure whether they had enough financial resources to last the rest of their lives.
After doing some internet research and talking to friends, the Smiths decide to enlist the help of a financial planner. They decided that they should hire a CERTIFIED FINANCIAL PLANNER™ professional because of the level of training required to be a CFP® professional. Additionally, Financial Life Advisors is Fee-Only firm, which means no products are sold and no commissions or referral fees are accepted. Financial Life Advisors is always a fiduciary in client relationships.
John and Joan filled out a pre-consultation worksheet prior to the initial consultation with FLA. The worksheet helped the Smiths to outline the basics of their situation and helped their FLA advisor figure out what additional questions needed to be asked prior to beginning the financial planning process. After the initial one-hour, free consultation, FLA provided a fixed-fee quote for the cost of the stand-alone financial plan. This way, John and Joan knew what would be involved in the financial planning process, how much the plan would cost, and what they could expect to get from their financial plan.
After signing the Financial Planning Agreement, John and Joan were given separate emotional risk tolerance questionnaires, a budget worksheet, and outline of the documents needed at the “Goals Meeting”. At the goals meeting, John and Joan provided copies of their insurance policies, financial account statements, income tax returns, Social Security statements, tax returns, current budget, and copies of their wills. During this meeting with their CFP® professional, John and Joan then explained, in detail, what they wanted retirement to be like. With the help of their FLA advisor, they outlined each one of their retirement goals.
The following goals were outlined by level of importance ranked from 10 (highest) to 1 (lowest). All costs are in collected in today’s dollars, even though the software has flexible inflation assumptions:
Importance – Goal
10 – Would both like to retire when John is 65, but would be okay with John working until he is 67.
8 – Replace vehicles every 5 years until age 75, then move down to one car. (New car cost $40,000)
6 – Want to be able to take a luxury vacation in retirement every year until they are 80. ($10,000-$8,000)
5 – Purchase a coastal vacation home ($300,000) with annual expenses of $20,000.
John and Joan have the following assets:
- Cash (bank accounts/CDs/Money Market) $80,000
- Brokerage account (stocks/bonds) $350,000 current value, $250,000 basis
- Retirement Annuity ($220,000 current value, $100,000 basis)
- Joan’s IRA ($300,000)
- John’s 401(k) account ($550,000), employer match is 3%
- John is eligible for a pension which will pay 40% of his highest average salary ($120,000) for life without inflation adjustments or a survivor benefit at age 65.
- Home is worth $450,000 with a $100,000 mortgage at a 4.5% interest rate
- John’s BMW is 3 years old and worth $25,000. The loan balance is $10,000.
- Joan’s Lexus is 5 years old and worth $20,000.
- John’s life insurance coverage is through work ($300,000) at $100/month.
- Joan’s life insurance coverage is a whole life policy ($100,000 death benefit, $30,000 cash value, $25,000 basis) at $85/month.
- John has a disability policy through work which replaces 60% of his income if he becomes disabled; Joan has no disability insurance.
- John and Joan have no long term care insurance.
- John and Joan have homeowners and auto property coverage, but no umbrella liability.
- John is maxing out his 401(k) annually. Joan does not have a retirement plan and is self-employed.
- John grosses approx. $120,000 per year; Joan makes approx. $60,000.
- John and Joan drafted wills when their kids were young. The wills have not been updated since.
- After taking a comprehensive risk tolerance questionnaire, it was determined that John was an aggressive investor and Joan, a conservative investor.
- The Smiths spend approximately $5,000 a month on basic living expenses like utilities, entertainment, food, property tax and other expenses not included in separate goals.
- Of all investable assets, the overall fixed income to equity ratio is about 40% fixed income and 60% equities (40/60).
- John’s Social Security statement shows him receiving $2,400 month at age 66; Joan’s shows $1,400 at age 66. Both plan to file for Social Security benefits as soon as eligible to receive them, likely at retirement.
The CFP® professional at FLA who worked with the Smiths then went back and reviewed all of the detailed information provided during the retirement goals and information gathering meeting. Using software from Morningstar OfficeSM, MoneyGuidePro™, SSAnalyzer, and BNA Income Tax™ Planner, the FLA advisor entered all financial assets, property, income, and retirement goals into the financial planning software.
MoneyGuidePro™ – Is like a very powerful and dynamic spreadsheet which tracks how much income and expenses are expected each year of the plan. It adjusts for inflation, life expectancy, taxation and then runs 10,000 simulations of various portfolios to “stress test” the financial plan.
Morningstar OfficeSM – Allows us to provide detailed investment analysis. It can look inside variable annuities, mutual funds, stocks, bonds and ETFs to see what is being held inside of them along with the tax and expenses associated with them.
SSAnalyzer – Social Security claiming strategies are complex and confusing. This software provides us instant side-by-side analysis of various strategies and suggests optimized solutions. One claiming strategy vs. another can vary in lifetime benefits by well over $100,000 dollars.
BNA Income Tax™ Planner – Through Jim Oliver & Associates, our sister full-service CPA firm, we have access to powerful tax software, which allows us to run 20-year detailed tax projections and to optimize tax strategy.
After constructing the financial plan in MoneyGuidePro and testing it, each area of the Smiths’ financial life is evaluated in the context of their personal goals. Since one area of personal finance can influence another, it is important to have the big picture when making specific recommendations in each various part of a financial plan.
Investment Analysis – How has your current portfolio performed? What are you paying and to whom? What is the risk profile of your portfolio and what changes should you make to bring your investment strategy in line with you financial plan?
Income Tax Strategies – By simulating a 20-year projection of taxable income and spending, a clear picture usually emerges. Opportunities to smooth income (or expenses) over time can create a much lower overall tax burden thus adding longevity and strength to an investment portfolio.
Estate Plan Review – Reviewing an estate plan can identify conflicting titling or beneficiary designations. A practical review can identify unnecessary complexity or poor design. It is not just about tax minimization as much as about a smooth transition through diminished capacity and death.
Insurance Report – Insurance is necessary to shift risks which could otherwise be catastrophic, but is inherently expensive and should be minimized to only necessity. This review makes sure all coverage supports the long-term financial goals.
Each report comes with key information about the current situation, explanations on various options, and actionable recommendations.
After running various simulations and trying different scenarios, the financial plan was presented to John and Joan (Step 4 – Recommend a Plan). The financial plan had first been calculated assuming the Smiths continue on their current course of action and pursue all of their stated goals. This calculation showed the feasibility of their current plan. For the Smiths, it was assumed they had paid off their mortgage and cars before retirement.
The MoneyGuidePro™ software calculates a financial plan’s investment returns and overall strength three different ways. The first method (average return) assumes the long-term average expected return for the selected portfolio and sees if the expected cash flows cover the expected goals. The second method (bad timing) assumes that in the first two years, the portfolio suffers a statistically large decline in value. Then, after that initial decline, the long-term average return is used after that. The final method (Monte Carlo) takes the historical relationships between asset classes and simulates possible returns each year. It then runs 10,000 simulations to see what percentage of the time the plan has sufficient assets to fund ALL retirement goals.
After entering all the stated retirement goals and using their existing asset allocation, the financial plan showed a probability of success of 63% (See a copy of the financial plan). This meant that without changing anything, there was some weakness to the current financial plan. The FLA advisor then simulated the financial plan in the circumstance that John passes away early at the age of 75. Because of the drop in pension and Social Security income which would result from John’s passing, the probability of success for the plan dropped to 47%.
John and Joan were alarmed by the fragility of their retirement plans. John suggested that they would just have to work longer and become more aggressive with their investments. Joan said that she didn’t want to get more aggressive and that they should scrap the vacation home on the coast. The beauty of the financial planning software is that any of the suggested alterations could be tested in real time to see the effect of those goal changes on the plan’s probability of success.
The Smiths’ FLA advisor helped them make some reasonable changes to the financial plan which both John and Joan could agree on. Even though he is a more aggressive investor, John was surprised to find out that lowering the risk of investments actually increased the probability of success. With more risk, the potential for a large loss in the short run can permanently damage the financial plan. When the portfolio risk was decreased, the potential outcomes were much less varied, and the ultimate probability of success increased.
The Smiths wanted to make sure their plan would be successful, so for the financial plan, they wanted to assume the untimely passing of John at age 75 and still assume John’s retirement at age 65 (click here to see the financial plan). With those plan modifications, the probability of success went up to 81% even though both the assumptions of an early passing of John and of a targeted retirement age of 65 reduced the financial resources to fully fund the retirement goals.
In the end the Smiths decided on making some minor goal modifications:
- Reduce portfolio risk profile from 37/63 to 55/45 (fixed/equity).
- Purchase a $250,000 term life policy on John for 15 years to cover the risk presented by an early passing.
- Change from replacing cars every 5 years to every 7 years.
- Modify Social Security claiming strategy (see comparison report) to delay John’s benefit until 70 and for Joan to file a restricted application at 66. This ensures the survivor will have the maximum Social Security benefit possible.
- Reducing the luxury vacation budget from $10,000 to $9,000 per year.
- Buying a slightly less expensive coast vacation home $250,000 instead of $300,000.
- With a lower vacation house value annual costs decrease from $20,000 to $18,000.
- Joan is going to set up a SEP IRA and save an additional $1,000 per month until retirement.
After talking about it, John and Joan did not have a problem working a few extra years. If they keep the above modifications and end up working until John is 67, the probability of success went up to 90%. What’s more, when the CFP® adjusted the software to show that John lives a long, happy life, the probability of success went up to 99%. The Smiths will wait and see how things go as they approach age 65. Their goals may change, or they may feel differently about retirement at that time, but now they do feel better about knowing that no matter what they decide, they have a sense of what type of lifestyle is within their means.
Income Tax Strategies
The income tax projections show the “baseline” or minimum possible taxable income over the next 20 years compared to the cash needed to fund all the goals in the financial plan. The Smiths will likely end up in a 25% bracket when they are 70 and have full Social Security and are being forced to take minimum distributions. This income should cover their cash flow needs at that time. Before 70, their taxable income will drop very low in early retirement, but their spending spikes with the purchase of a vacation home. It will probably make the most sense to mix selling brokerage assets, taking IRA distributions, and financing some of the cost to smooth out the spike in spending without creating a large spike in income tax.
Also, based on itemized deductions, the Smiths can benefit from bunching their itemized deductions and doubling up every other year where available. In “bunching” years, the itemized deductions are much higher, and in “off” years, they will rely on the standard deduction. This simple strategy appears to be able to save an average of $1,000 per year.
The investment analysis shows the Smiths’ portfolio has slightly outperformed its relative benchmark. The only dark spot is the performance and fees of the variable annuity, which is more than double the cost of other investments and underperformed by over 2% annually. This should be swapped for a lower cost and better performing annuity contract in a 1035 exchange to avoid tax consequences.
From the financial plan projections, a much more conservative investment mix is called for. Using asset allocation and a 45% equity portfolio will keep risk in line with overall goals and should still produce a long-term return sufficient to cover the Smiths’ goals. In order to lower the tax consequences of the investment returns and increase the longevity of the portfolio, asset location should be employed. By segmenting asset classes by tax treatment across qualified and non-qualified accounts, 85% of the taxable income can be kept in the tax deferred accounts (causing no reportable current income); the 15% that remains will produce mostly qualified dividends, which are taxed at the lower long-term capital gains rates.
As detailed in the insurance report, the Smiths’ FLA advisor discovered that they do not have an umbrella liability policy. This gap in coverage left a huge liability uncovered. For several hundred dollars a year, they added 1 million dollars of blanket liability coverage. They were also underinsured on the contents coverage of their homeowners, so they raised their deductibles on their home and auto policies. The additional coverage was almost completely offset by the decrease in premium from increasing deductibles. These changes to property and casualty insurance increased the out-of-pocket costs moderately, but those same changes increased the catastrophic loss coverage tremendously.
It was also recommended that Joan cash in her universal whole life policy. The insurance coverage was no longer needed for John’s protection, was underfunded and would either require more funding to keep it in force for Joan’s whole life or it would quickly start to lose cash value and then lapse. Luckily, the tax cost to terminate the contract was minimal. It was also suggested that the Smiths take a look at long term care insurance and carefully consider a 15 year term life policy to protect Joan if the John were to pass before 80, where financial projections showed a negative effect on Joan.
Estate Plan Review
The Smiths did not have any estate planning documents. They felt that everything automatically went to each other and most of their accounts had beneficiary designations, anyway. They had not thought about incapacity or end of life concerns. When presented with potential contingencies for minor grandchildren as heirs, the Smiths thought further review was necessary.
After going through the estate plan review, the Smiths asked for a professional referral to an attorney who helped them draw up a will, as well as execute a statutory durable power of attorney, medical power of attorney, and medical directives.
Implementation & Monitoring
After completing the financial plan, John and Joan received printed copies of all of their reports and copies of the retirement plan. All of the specific recommendations were also condensed into an action plan checklist so John and Joan could simply, in order, implement all of the necessary actions.
John and Joan decided to retain Financial Life Advisors to manage their investments, to coordinate tax preparation, and to be available to update the financial plan and provide ongoing advice. They recognized that they wanted to focus on other things and have a trusted advisor who, moving forward, would continue to help them manage all of the plan’s aspects.
FLA handled all of the paperwork to move the IRA, brokerage, and annuity to be managed at a discount broker and custodian. FLA also set up the SEP IRA account for Joan to start saving additional retirement funds in. Coordinating with the Smiths’ CPA, their FLA advisor worked through the tax implications of reallocating their portfolio in line with the new lower risk asset allocation.
John and Joan’s FLA advisor worked with their existing insurance agent to modify their property coverage and helped coordinate with their attorney when their wills and other estate planning documents were being updated. To explore long term care and disability insurance, their FLA advisor then solicited multiple bids on long term care from an independent agent who specializes solely in LTC.
After the financial plan was first put in place, the Smiths had their portfolio monitored continually by their FLA advisor. As questions have come up, the Smiths contact FLA for financial advice without additional fees. All of their services are included in one asset management fee. The financial plan is updated annually and as changes in tax, investment, and insurance change, FLA will reach out to the Smiths, giving information about financial opportunities and threats to their retirement plan. As tax laws and their situation may change, FLA is available to be involved in the estate planning process as needed. The Smiths have found that the long-term relationship and team approach of Financial Life Advisors have put their minds at ease, as they now feel they have a true financial advocate in their corner.
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