Personal Finance SIXTH EDITION Chapter 21 Estate Planning Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Chapter Objectives 21.1 Review the components of a financial plan 21.2 Illustrate how a financial plan’s components are integrated 21.3 Provide an example of a financial plan Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Review of Components Within a Financial Plan (1 of 8) • Budgeting – Allows you to forecast how much money you will have at the end of the month so you can anticipate cash shortages or surpluses – Budgeting trade-off A trade-off between spending today and allocating funds for the future Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Review of Components Within a Financial Plan (2 of 8) Biggest problem is excessive spending Financial planning involves decisions about how much money to allocate for liquidity, insurance, investments, and retirement planning Overspending on cars is common error Many spend now and think about saving later Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Review of Components Within a Financial Plan (3 of 8) • Managing Liquidity – Ensuring that you have enough liquid assets to cover any budget deficits – Checking account, savings account, money market, or short-term financing Liquidity trade-off A trade-off between liquid assets which earn low interest rates and non-liquid assets which earn higher interest rates Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Review of Components Within a Financial Plan (4 of 8) Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Review of Components Within a Financial Plan (5 of 8) • Personal financing – Allows you to make purchases without having the full amount of cash – Useful for large purchases like a car or a home Personal financing tradeoff Trade-off between tax advantages of mortgage loans with potential budgeting problems Trade-off between longer maturities with lower payments and more interest and shorter maturities with higher payments and less interest Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Review of Components Within a Financial Plan (6 of 8) • Protecting your assets and income – Insurance protects against events that could reduce your income or your wealth – Insurance trade-off • Insurance needs come before investing Managing investments – Making investment choices that meet your financial needs and your risk tolerance Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Review of Components Within a Financial Plan (7 of 8) – Investment trade-off Trade-off between low risk, low interest investments and high risk, high interest investments Trade-off between high risk, single investments and lower risk, diversified investments Trade-off between using money now and investing it for the future Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Review of Components Within a Financial Plan (8 of 8) • Retirement planning – Ensures sufficient funds at the time you retire – Retirement account trade-off • Saving for retirement limits current spending Maintaining your financial documents – You should store all financial documents in one place, either a safe at home or a safety deposit box at a bank Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Financial Planning Online (1 of 2) • Go to http://www.kiplinger.com • This Web site provides useful information about financial planning that can help you complete and refine your financial plan Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Integrating the Components • As time passes, your financial position will change • Your financial goals may also change • You will need to revise your financial plan to meet your financial goals Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Exhibit 21.2 Documents Used for Financial Planning (1 of 2) EXHIBIT 21.2 Documents Used for Financial Planning Liquidity • Certificates of deposit • Bank account balances • Any other money market securities owned Financing • Credit card account numbers • Credit card balances • Personal loan (such as car loan) agreements • Mortgage loan agreement Insurance • Insurance policies • Home inventory of items covered by homeowner’s insurance Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Exhibit 21.2 Documents Used for Financial Planning (2 of 2) EXHIBIT 21.2 Documents Used for Financial Planning Investments • Stock certificates • Bonds • Account balance showing the market value of stocks • Account balance showing the market value of bonds • Account balance showing the market value of mutual funds Retirement and Estate Plans • Retirement plan contracts • Retirement account balances Will Trust agreements Copyright â 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Exhibit 21.3 Update on Stephanie Spratt’s Personal Balance Sheet (1 of 2) EXHIBIT 21.3 Update on Stephanie Spratt’s Personal Balance Sheet Initial Personal Balance Sheet (from Chapter 2) As of Today Assets Liquid Assets Cash $500 $200 Checking account 3,500 200 2,600 $4,000 $3,000 Money market fund (MMF) Total liquid assets Household Assets Home $0 $108,000 Car 1,000 15,000 Furniture 1,000 1,000 $2,000 $124,000 Total household assets Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Exhibit 21.3 Update on Stephanie Spratt’s Personal Balance Sheet (2 of 2) EXHIBIT 21.3 Update on Stephanie Spratt’s Personal Balance Sheet Investment Assets Stocks $3,000 $3,200 Mutual funds 2,000 Investment in retirement account 800 Total investment assets $3,000 $6,000 TOTAL ASSETS $9,000 $130,000 Liabilities and Net Worth Current Liabilities Credit card balance $2,000 $0 Total current liabilities $2,000 $0 Car loan $0 $17,000 Mortgage 100,000 $0 $117,000 TOTAL LIABILITIES $2,000 $117,000 Net Worth $7,000 $13,000 Long-Term Liabilities Total long-term liabilities Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Exhibit 21.4 Update on Stephanie Spratt’s Monthly Cash Flow Statement of 2) EXHIBIT 21.4 Update on Stephanie Spratt’s Monthly Cash Flow Statement Initial Cash Flow Most Recent Change in the Statement Cash Flow Statement Cash Flow Statement Cash Inflows Disposable (after-tax) income $2,500 $3,000 +$500 Interest on deposits 0 No change Dividend payments 0 No change $2,500 $3,000 +$500 $600 $0 – $600 Internet 50 50 No change Electricity and water 60 80 +20 Cellular 60 60 No change 300 300 No change 130 140 +10 Total cash inflows Cash Outflows Rent Groceries Health and disability insurance and expenses Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved (1 Exhibit 21.4 Update on Stephanie Spratt’s Monthly Cash Flow Statement of 2) EXHIBIT 21.4 Update on Stephanie Spratt’s Monthly Cash Flow Statement Initial Cash Flow Most Recent Change in the Statement Cash Flow Statement Cash Flow Statement Cash Outflows Clothing 100 100 No change Car insurance and maintenance 200 100 –100 Recreation 600 400 –200 412 +412 insurance) 966 +966 Life insurance payment 10 +10 Contribution to retirement plan 300 +300 $2,100 $2,918 +$818 $400 $82 –$318 Car loan payment Mortgage payment (includes property taxes and Total cash outflows Net cash flows Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved (2 Exhibit 21.5 Stephanie Spratt’s Financial Plan (1 of 5) EXHIBIT 21.5 Stephanie Spratt’s Financial Plan BUDGET PLAN My monthly salary of $3,000 after taxes is direct deposited to my checking account I will use this account to cover all bills and other expenses My total expenses (including recreation) should be about $2,918 per month This leaves me with net cash flows of $82 I will also receive an annual tax refund of about $3,000 The taxes I pay during the year will exceed my tax liability, as the interest payments on my mortgage will reduce my taxable income I will use the net cash flows each month to cover any unanticipated expenses that occurred during the month My second priority is to use the net cash flows to keep about $2,600 in my money market fund (MMF) to ensure liquidity If this fund is already at that level, I will use the net cash flows each month to invest in a mutual fund Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Exhibit 21.5 Stephanie Spratt’s Financial Plan (2 of 5) EXHIBIT 21.5 Stephanie Spratt’s Financial Plan PLAN FOR MANAGING LIQUIDITY Since my salary is direct deposited to my checking account, I have a convenient means of covering my expenses My backup source of liquidity is my MMF, which currently contains $2,600; I will maintain the account balance at about that level to ensure liquidity If I ever need more money than is in this account, I could rely on my net cash flows In addition, I could sell some shares of my mutual fund, or I could cover some expenses with a credit card, and would hope to use part of my next paycheck to pay off the credit card bill Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Exhibit 21.5 Stephanie Spratt’s Financial Plan (3 of 5) EXHIBIT 21.5 Stephanie Spratt’s Financial Plan PLAN FOR FINANCING I have two finance payments: a monthly car loan payment of $412, and a monthly mortgage payment of $966 (including property taxes and homeowner’s insurance) I would like to pay off the car loan early if possible The interest rate on that loan is 7.60%, and the interest is not tax-deductible The principal remaining on the car loan will decrease over time as I pay down the debt with my monthly payments I may consider selling my shares of the mutual fund and using the proceeds to pay off part of the car loan My decision will depend on whether I believe the mutual fund can provide a higher return to me than the cost of the car loan When I pay off the car loan, my cash outflows will be reduced by $412 per month Thus, I should have more net cash flows that I can use to make investments and increase contributions to my retirement account Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Exhibit 21.5 Stephanie Spratt’s Financial Plan (4 of 5) EXHIBIT 21.5 Stephanie Spratt’s Financial Plan INSURANCE PLAN I have car insurance that covers the car and limits my liability I have homeowner’s insurance that covers the full market value of my home I have health insurance through my employer I have disability insurance that will provide financial support if I become disabled I have life insurance, with my two nieces named as the beneficiaries If I decide to have children in the future, I will purchase additional life insurance in which they would be named as the beneficiaries PLAN FOR INVESTING I have an individual stock that I plan to sell, and I will use the proceeds to invest in a stock mutual fund This creates more diversification and reduces my exposure to risk Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Exhibit 21.5 Stephanie Spratt’s Financial Plan (5 of 5) EXHIBIT 21.5 Stephanie Spratt’s Financial Plan RETIREMENT AND ESTATE PLAN I would like to allocate an additional $100 per month toward an individual retirement account (IRA) as I expect that it would increase my retirement fund by an estimated $185,710 at the time of my expected retirement However, I am not likely to have an extra $100 each month that I could contribute to an IRA at this time I will contribute even more income to my retirement (up to the maximum limit allowed) as my income increases over time I will also create a will to ensure that any wealth that I have accumulated is allocated in the manner that I desire Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Financial Planning Online (2 of 2) • Go to the personal finance section of http://www.cnn.com • This Web site provides a variety of financial planning calculators that can help you conduct an integrated financial plan, including tax planning, mortgage financing, retirement planning, and investing Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved ... Update on Stephanie Spratt’s Personal Balance Sheet (1 of 2) EXHIBIT 21. 3 Update on Stephanie Spratt’s Personal Balance Sheet Initial Personal Balance Sheet (from Chapter 2) As of Today Assets... Pearson Education, Inc All Rights Reserved Exhibit 21. 2 Documents Used for Financial Planning (1 of 2) EXHIBIT 21. 2 Documents Used for Financial Planning Liquidity • Certificates of deposit • Bank... Pearson Education, Inc All Rights Reserved Exhibit 21. 2 Documents Used for Financial Planning (2 of 2) EXHIBIT 21. 2 Documents Used for Financial Planning Investments • Stock certificates • Bonds