HS 300 Financial Planning: Process and Environment

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HS 300 Financial PlanningProcess and Environment

• Chapter 8
• Financial Planning Applications

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Learning Objectives
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Learning Objectives

• 1. Identify the two funding requirements
  associated with financing a college education.
• 2. Describe the process for calculating the
  resources required to fund a college education
  including the types of investments typically
  considered for this purpose.
• 3. Describe the various tax deductions, tax
  credits, and penalty waivers that are available
  to encourage saving for a college education.

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Learning Objectives (Continued)

• 4. Explain how a college students financial need
  is determined for purposes of obtaining federal
  student aid, and describe the various types of
  federal student aid available.
• 5. Explain why emergency fund planning is an
  indispensable part of financial planning.
• 6. Explain how an adequate amount of funding for
  emergencies is estimated and what types of
  investments are most appropriate for this purpose.

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Learning Objectives (Continued)

• 7. Identify the key types of household debt.
• 8. Explain the difference between secured and
  unsecured debt.
• 9. Describe the activities involved in credit and
  debt management and explain how they relate to
  the steps in the financial planning process.

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Learning Objectives (Continued)

• 10. Explain the uses of the financial position
  statement and the cash flow statement in
  carrying out credit and debt management
  activities.
• 11. Explain the ways in which leasing an
  automobile differs from purchasing it, and
  identify the key characteristics of people who
  are particularly suited for leasing rather than
  buying an automobile.
• 12. Explain how a leases monthly payment is
  calculated.

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Learning Objectives (Continued)

• 13. Explain the differences between a home
  equity loan and a home equity line of credit,
  and calculate the maximum amount a consumer
  can borrow under each.
• 14. Calculate the amount of home equity debt on
  which interest is deductible for federal income
  tax purposes.
• 15. Describe the key features and principal uses
  of the three types of bankruptcy available to
  consumers in the United States.

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Discussion Break

• Should Sec. 529 plan assets be included as
  student assets, parental assets, or excluded from
  the financial aid calculation?

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Discussion Follow-up Sec. 529 Plan Assets
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Sec. 529 PlansTreatment for Financial Aid

• College savings account in parents name with
  student as beneficiary
• Considered parents assets for Federal Financial
  Aid (FFA)

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Sec. 529 PlansTreatment for Financial Aid

• College savings account in students name, or a
  trust or custodian for the student with student
  as beneficiary
• Not considered students assets for FFA

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Sec. 529 PlansTreatment for Financial Aid

• College savings account in third partys name
  (grandparents) with student as beneficiary
• Has no effect on FFA

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Sec. 529 PlansTreatment for Financial Aid

• College savings account in parents name, with
  students siblings as beneficiaries
• Has no effect on FFA

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Sec. 529 PlansTreatment for Financial Aid

• Prepaid tuition plan
• Legislation enacted in 2006 makes the tax
  treatment consistent with the Section 529 Savings
  Plans

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College Savings
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College Savings

• Education inflation
• Calculating the funding requirement
• Lump sum

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College Savings

• Calculating the funding requirement
• Monthly savings
• Current cost
• Education inflation rate
• Number of years until matriculation
• Investment returns (tax status)

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Selecting a Portfolio

• Taxable account
• Tax advantaged
• Coverdell Education Savings Account
• Sec. 529 Qualified Tuition Plans
• Savings bonds for education
• Roth and traditional IRAs

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Selecting a Portfolio

• CDs
• Savings bonds
• Baccalaureate bonds
• Stocks/bonds/cash
• Mutual funds investing in stocks/bonds/cash
• CollegeSure CDs

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Whose Money?
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Titling Accounts in Childs Name

• Uniform Gift to Minors (UGMA)
• Uniform Transfers to Minors (UTMA)
• Tax code changes in 2007 to kiddie tax make these
  approaches unattractive as a repository for
  college savings

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Trusts

• Sec. 2503(b) trust
• Income paid annually to beneficiaries
• Trust can retain funds past age of majority
• Annual gift tax exclusion for income rights
• Delayed payment of principal until funds are
  needed for college

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Trusts

• Section 2503(c) trust
• Income can accumulate
• Delay payment of principal
• Trust payable at age of majority

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Trusts

• Irrevocable trust with Crummey provision
• Allows income and principal distribution/accumulat
  ion as needed
• Trust can last as long as the income
  beneficiaries live

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Trusts

• Disadvantages
• FAFSA counts trusts as asset of child (35 percent
  expected contribution)
• Trust expenses
• Set-up
• Taxation
• Administration

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Sec. 2503(e)

• Exclusion from taxable gifts if grandparents pay
  college costs directly to the college

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Ownership Issues

• Kiddie tax impact
• Age of majority issues
• FAFSA implications

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Tax Incentives
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Tax Credits

• Hope Scholarship Tax Credit
• 1,500/student/year first 2 years of
  postsecondary education
• Phaseout based on modified adjusted gross income
  (MAGI)
• Must be at least half-time student for at least
  one academic period

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Tax Credits

• Lifetime Learning Tax Credit
• 2,000 calculated as 20 first 10,000 qualified
  expenses
• Available for an unlimited number of years
• Student does not have to be pursuing degree
• Phaseout based on MAGI

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Tax Deduction

• Deductibility of higher education expenses
• 4,000 maximum deduction
• Started in 2004
• Phaseout based on MAGI
• Use of tax credits and other tax- advantaged
  programs limits deduction

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Interest Exclusion

• Savings bonds for education
• Phaseout subject to MAGI
• Bonds cannot be held in childs name

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Alternative Strategies
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Alternative Strategies

• Investing in college housing
• Family partnerships
• 401(k) plan loans
• Cash value life insurance policy loans
• Roth traditional IRA distributions

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Applying for Financial Aid
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Free Application for Federal Student Aid (FAFSA)

• Expected student contribution 35 percent
• Spend kids money first
• Expected parent contribution 5.6 percent
• Exemptions and exclusions drive down asset base
  and expected contributions

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Free Application for Federal Student Aid (FAFSA)

• Terminology
• Expected family contribution (EFC)
• Cost of attendance (COA)
• Student aid report (SAR)

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Student Aid

• Federal Pell Grant
• Need-based
• Up to 4,050/year

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Student Aid

• Federal Supplemental Education Opportunity Grant
  (FSEOG)
• Need-based
• Up to 4,000/year

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Student Aid

• Federal Perkins loans
• Need-based
• 4,000/year
• 20,000 cumulative

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Student Aid

• Stafford loans
• Available from Direct Loans or FFEL
• Subsidized (need based) interest deferred
• Unsubsidized interest accrues
• Variable interest rate set annually

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Student Aid

• PLUS loans
• Available from Direct Loans or FFEL
• Interest accrues from disbursement
• College resources
• Scholarships
• Grants

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Emergency Fund Planning
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Emergency Fund

• Keeps the financial ship afloat in fiscal storms
• 3 to 6 months worth of living expenses
• Cash or liquid investments

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Emergency Fund

• Keeps the financial ship afloat in fiscal storms
• Amount influenced by
• Job security
• Wages/salary/commission/bonus
• Characteristics of investment portfolio
• Other available sources of cash

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Credit and Debt Management
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Credit and Debt Management

• Mortgage debt (secured)
• First mortgage
• Second mortgage
• Home equity loan
• Home equity line of credit (HELOC)

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Credit and Debt Management

• Consumer debt
• Personal loans
• Auto loans (secured)
• Credit card debt

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Credit and Debt Management

• Client financial statements
• Credit report
• Credit score

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Credit and Debt Management

• Five C(s) of credit
• Character
• Capacity
• Collateral
• Capital
• Conditions

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Ratio Analysis

• Debt service ratio
• Total loan payments/gross income
• Front ratio (28)
• Housing costs (PITI)/gross income
• Back ratio (36)
• Total debt/gross income

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Financing Alternatives
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Leasing Versus Buying a Car

• Open versus closed-end lease
• Capitalized cost
• Money factor interest rate/24

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Leasing Versus Buying a Car

• Residual value
• Monthly depreciation
• Monthly lease rate
• Monthly sales tax

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First Mortgages

• First mortgage
• 80 percent LTV is the cutoff for PMI
• FHA and VA have government guarantees
• Fixed 30/15

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First Mortgages

• First mortgage
• Adjustable (ARM)
• Hybrid
• Interest only

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Discussion Break

• When should a client prepay his or her mortgage
  either from the perspective of paying it off or
  making additional principal payments each month?
  
• Would your answer change if you had an
  assets-under-management agreement with the client?

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Financing Alternatives (Continued)
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Second Mortgages

• Status as second means LTV is critical to lender
• Home equity loan
• Fixed rate
• Fixed term
• Fixed payment

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Second Mortgages

• Home equity line of credit (HELOC)
• Variable rate
• Pricing index plus spread
• Caps/floors/collars
• Interest only payments in early years
• Hybrids available

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Bankruptcy After the 2005 Bankruptcy Reform Act

• There is now a means-based test to determine who
  can qualify for a Chapter 7 filing. Mandatory
  credit counseling and financial education became
  part of the bankruptcy process. You cannot file
  a Chapter 7 bankruptcy if you obtained a
  discharge of your debts in a Chapter 7 case
  within the last 8 years, or a Chapter 13 case
  within the last 6 years.

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Chapter 7 Bankruptcy

• Chapter 7 liquidation
• Formation of bankruptcy estate from petitioners
  eligible assets used to pay creditors
• Court discharges all eligible debts
• Stays on credit report for 10 years

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Chapter 13 Bankruptcy

• Petitioner must have income that exceeds
  reasonable living expenses
• Three-year repayment plan
• Eligible debts remaining after completion of
  repayment plan are discharged by the bankruptcy
  court
• Debtor retains property whether exempt or
  non-exempt
• Filing remains on credit report for 7 years

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Chapter 11 Reorganization

• Less common for individuals
• Plan must be approved by a majority of creditors
  in each class and by enough creditors in each
  class to equal 2/3 of the indebtedness in that
  class
• Debtor retains possession of assets and continues
  to operate business

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Chapter Eight Review
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Chapter Eight Review

• Three main applications
• College funding
• Emergency fund planning
• Debt management
• Know your client and make appropriate
  recommendations