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HS 300 Financial Planning: Process and Environment

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Title: HS 300 Financial Planning: Process and Environment


1
HS 300 Financial PlanningProcess and Environment
  • Chapter 8
  • Financial Planning Applications

2
Learning Objectives
3
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.

4
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.

5
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.

6
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.

7
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.

8
Discussion Break
  • Should Sec. 529 plan assets be included as
    student assets, parental assets, or excluded from
    the financial aid calculation?

9
Discussion Follow-up Sec. 529 Plan Assets
10
Sec. 529 PlansTreatment for Financial Aid
  • College savings account in parents name with
    student as beneficiary
  • Considered parents assets for Federal Financial
    Aid (FFA)

11
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

12
Sec. 529 PlansTreatment for Financial Aid
  • College savings account in third partys name
    (grandparents) with student as beneficiary
  • Has no effect on FFA

13
Sec. 529 PlansTreatment for Financial Aid
  • College savings account in parents name, with
    students siblings as beneficiaries
  • Has no effect on FFA

14
Sec. 529 PlansTreatment for Financial Aid
  • Prepaid tuition plan
  • Legislation enacted in 2006 makes the tax
    treatment consistent with the Section 529 Savings
    Plans

15
College Savings
16
College Savings
  • Education inflation
  • Calculating the funding requirement
  • Lump sum

17
College Savings
  • Calculating the funding requirement
  • Monthly savings
  • Current cost
  • Education inflation rate
  • Number of years until matriculation
  • Investment returns (tax status)

18
Selecting a Portfolio
  • Taxable account
  • Tax advantaged
  • Coverdell Education Savings Account
  • Sec. 529 Qualified Tuition Plans
  • Savings bonds for education
  • Roth and traditional IRAs

19
Selecting a Portfolio
  • CDs
  • Savings bonds
  • Baccalaureate bonds
  • Stocks/bonds/cash
  • Mutual funds investing in stocks/bonds/cash
  • CollegeSure CDs

20
Whose Money?
21
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

22
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

23
Trusts
  • Section 2503(c) trust
  • Income can accumulate
  • Delay payment of principal
  • Trust payable at age of majority

24
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

25
Trusts
  • Disadvantages
  • FAFSA counts trusts as asset of child (35 percent
    expected contribution)
  • Trust expenses
  • Set-up
  • Taxation
  • Administration

26
Sec. 2503(e)
  • Exclusion from taxable gifts if grandparents pay
    college costs directly to the college

27
Ownership Issues
  • Kiddie tax impact
  • Age of majority issues
  • FAFSA implications

28
Tax Incentives
29
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

30
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

31
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

32
Interest Exclusion
  • Savings bonds for education
  • Phaseout subject to MAGI
  • Bonds cannot be held in childs name

33
Alternative Strategies
34
Alternative Strategies
  • Investing in college housing
  • Family partnerships
  • 401(k) plan loans
  • Cash value life insurance policy loans
  • Roth traditional IRA distributions

35
Applying for Financial Aid
36
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

37
Free Application for Federal Student Aid (FAFSA)
  • Terminology
  • Expected family contribution (EFC)
  • Cost of attendance (COA)
  • Student aid report (SAR)

38
Student Aid
  • Federal Pell Grant
  • Need-based
  • Up to 4,050/year

39
Student Aid
  • Federal Supplemental Education Opportunity Grant
    (FSEOG)
  • Need-based
  • Up to 4,000/year

40
Student Aid
  • Federal Perkins loans
  • Need-based
  • 4,000/year
  • 20,000 cumulative

41
Student Aid
  • Stafford loans
  • Available from Direct Loans or FFEL
  • Subsidized (need based) interest deferred
  • Unsubsidized interest accrues
  • Variable interest rate set annually

42
Student Aid
  • PLUS loans
  • Available from Direct Loans or FFEL
  • Interest accrues from disbursement
  • College resources
  • Scholarships
  • Grants

43
Emergency Fund Planning
44
Emergency Fund
  • Keeps the financial ship afloat in fiscal storms
  • 3 to 6 months worth of living expenses
  • Cash or liquid investments

45
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

46
Credit and Debt Management
47
Credit and Debt Management
  • Mortgage debt (secured)
  • First mortgage
  • Second mortgage
  • Home equity loan
  • Home equity line of credit (HELOC)

48
Credit and Debt Management
  • Consumer debt
  • Personal loans
  • Auto loans (secured)
  • Credit card debt

49
Credit and Debt Management
  • Client financial statements
  • Credit report
  • Credit score

50
Credit and Debt Management
  • Five C(s) of credit
  • Character
  • Capacity
  • Collateral
  • Capital
  • Conditions

51
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

52
Financing Alternatives
53
Leasing Versus Buying a Car
  • Open versus closed-end lease
  • Capitalized cost
  • Money factor interest rate/24

54
Leasing Versus Buying a Car
  • Residual value
  • Monthly depreciation
  • Monthly lease rate
  • Monthly sales tax

55
First Mortgages
  • First mortgage
  • 80 percent LTV is the cutoff for PMI
  • FHA and VA have government guarantees
  • Fixed 30/15

56
First Mortgages
  • First mortgage
  • Adjustable (ARM)
  • Hybrid
  • Interest only

57
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?

58
Financing Alternatives (Continued)
59
Second Mortgages
  • Status as second means LTV is critical to lender
  • Home equity loan
  • Fixed rate
  • Fixed term
  • Fixed payment

60
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

61
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.

62
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

63
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

64
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

65
Chapter Eight Review
66
Chapter Eight Review
  • Three main applications
  • College funding
  • Emergency fund planning
  • Debt management
  • Know your client and make appropriate
    recommendations
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