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Financial Planning
Financial Planning
Financial Planning
Financial Planning
Financial Planning
Financial Planning
Financial Planning
Financial Planning
Financial Planning
Financial Planning
Financial Planning
Financial Planning
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Financial Planning

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  1. Financial Planning Personal finance is comprised of a wide variety of subjects. Though some of the topics and concepts may be unfamiliar, everyone can master the fundamentals. So you can make the most of your money now and be well prepared for the future, this program covers the basic elements of financial planning, including: • Begin Financial Planning • Finance Your Goals – Retirement and Higher Education • Manage Your Taxes • Protect Yourself With Insurance • Plan For Your Estate Chapter 1: Begin Financial Planning Copyright © 2007 BALANCE Financial planning means preparing for your future by making informed money management decisions in the present. There are many tools available that will help you achieve the security you desire – but none are as important as simply taking a steady and committed approach to funding your long-term goals. Understanding Today’s Finances The first step toward planning for your financial future is to understand where you are today. • Net Worth. In order to know how much you need to save to achieve your goals, you need to know how much you already have. A net worth statement will give you that figure. To calculate your net worth, subtract the total of your liabilities from the total of your assets. (Complete the Net Worth worksheet on page 9.) • Cash flow. Knowing the amount of money you have coming in and going out is vital for planning purposes. It will help you reduce budgetary waste (only after you see where you are spending your money can you make powerful changes to your spending and savings habits) and provide you with a figure for savings and investments. (Complete the Cash Flow worksheet on pages 10-12.) Establishing Goals Identifying clear, achievable goals is crucial to a personal finance plan. A financial goal is an exact amount of money needed for a specific purchase or service, at a definite date. By making the goal precise, you’ll be able to track your progress and keep going when you may be tempted to give up. Planning Assistance Part of financial planning is getting the right help. Your financial institution may have professional advisors on staff – and since their services are free to members, they are great place to start. 1
  2. There are many different types of financial advisors, each specializing in various areas of money management: • Certified Financial Planners complete a rigorous two-year course and pass a comprehensive board exam. They can offer tax planning, estate planning, portfolio management and insurance advising. Some planners earn all their income from commissions, while others charge a flat fee. • Chartered Financial Consultants/Chartered Life Underwriters complete a three- year course. They can offer services in tax, estate, insurance, financial and investment management. • Certified Public Accountants often offer financial services. Those with the Personal Financial Specialist designation have at least 250 hours of yearly experience in financial planning and have passed an exam. • Enrolled Agents work exclusively in the field of taxation. In addition to preparing your return, they can help with tax planning, represent you at audits, and negotiate with the IRS on your behalf. • Certified Consumer Credit Counselors are certified by the National Foundation for Copyright © 2007 BALANCE Consumer Credit and offer assistance with budgeting and money management, as well as advice on how to get out of debt and how to use credit wisely. • Brokers are registered representatives that buy and sell securities on behalf of their clients for a commission. Many financial planners are also brokers for one or more investment firms and earn a commission on the sale of investment products. Chapter 2: Finance Your Goals – Retirement and Higher Education There are many long-term financial goals, but two of the most common are funding your retirement and planning for your child’s higher education costs. Retirement While most Americans will be eligible for Social Security distributions, those benefits are only meant to supplement what you have saved. Very few people can live comfortably on Social Security income alone. The amount of money you will need to save depends on many factors – everyone’s situation is different, and you may need more or less depending on your unique needs. Financial planners typically suggest retirees will need between 70 and 80 percent of their current annual income when they stop working. Use online calculators to compute the total amount you would be able to save over time with regular deposits. 2
  3. Once you know how much you need to save, it is time to start putting money away: • Defined Contribution Plans. These tax-deferred retirement savings plans have taken the place of many pension plans (where an employer contributes and invests money for you). They include a 401(k) – if you work for a for-profit company – and a 403(b) if you work for a school, non-profit organization, church, or charity. With these plans, you make active contributions to a retirement fund. You have control over the investments, and can choose from a diverse menu of mutual funds. • Individual Retirement Accounts (IRAs). There are several varieties of IRAs, but the most common are the Traditional and the Roth. As soon as you open an IRA (at a bank, credit union, or brokerage house) you can begin to invest your savings. Stocks, bonds, and mutual funds are among your investment options. With a Roth IRA, you contribute after-tax dollars, and eligible distributions are tax-free. With a traditional IRA, you contribute pretax dollars and eligible distributions are subject to income taxes. • Plans for the self-employed. If you own your own business, you have a couple retirement plan options open to you. These include the Simplified Employee Pension, which is similar to an IRA, and a Keogh account, which is similar to a 401(k) plan. Making regular contributions to these accounts is a money-smart way to save for your retirement. If Copyright © 2007 BALANCE the account is tax deferred, you don’t have to pay taxes on the investment earnings until you take the money out when you retire (at which time you are likely to be in a lower tax bracket and so will pay less in taxes). If you are able to deduct your contributions from your income taxes, you reduce your taxable income, and pay less in taxes that way. And of course, if the account offers tax-free distributions, you won’t have to pay any taxes on your distributions. Higher Education If you have a child, and you want to pay for his or her higher education costs, you have several good savings options from which to choose: • Coverdell Education Savings Accounts are tax-deferred accounts. While contributions are not tax deductible, they do grow tax-free, and the funds can be withdrawn tax-free as long as they are used to pay eligible schooling costs. Allowable contributions are limited for those making high incomes, and are phased out entirely for very high earners. They may be opened at any financial institution that handles Traditional IRAs, and you can use just about any investment option to build your savings. • 529 Plans allow you to save for your child’s higher education expenses while greatly reducing your tax liability. As long as the investment is used for qualified education expenses, you won’t have to pay income tax on the earnings, and if you use your own state’s plan you may also qualify for a state tax deduction. • Roth IRA. You can use the money you’ve accumulated in your Roth IRA for more than just your retirement. Contributions grow tax-free and can be tapped without penalty to pay for qualified educational expenses. Once your child reaches college age, you can withdraw the initial contribution tax- and penalty-free. The earnings, however, may be subject to taxation. 3
  4. Invest Soon – and Smart Whether you want to accumulate enough money for retirement, higher education, or any other long- term goal, the sooner you save and invest the better. This way compound interest (interest which is calculated not only on the initial principal but also the accumulated interest of prior periods) can work its magic. It is important to develop a wise investment strategy as well. Make sure your portfolio (your collection of investments) is diversified for safety and growth. This means that some of your money should be in cash (low interest, low risk investment vehicles), some in stocks (ownership in a company) and some in bonds (loans to a company or government). A good way to achieve diversification is through mutual funds – investment companies that purchase a wide variety of stocks, bonds, and other securities. The farther away you are from your goal achievement date, the riskier your investments can be since you have time to recover from loss. However, as you near your goal, adjust your portfolio to safer holdings. Chapter 3: Manage Your Taxes Properly managing your taxes can greatly reduce the amount of money you pay both now and in the future. Copyright © 2007 BALANCE Pay the Right Amount You know you are paying the right amount of taxes if you neither get a large tax refund the end of the year, nor owe money to the IRS (or your state). While a refund may seem positive, it is really not making the most of your income during the year. For example, a $2,000 refund translates into $166 that you don’t have in your pocket every month. On the other hand, if you owe and can’t pay the entire sum, you’ll have to pay interest and possibly penalties, thus increasing your tax liability. Max Out Your Retirement Options As previously stated, IRAs, defined contribution plans, and other retirement plans offer tax- advantaged savings. If possible, contribute the maximum allowable amount into your 401(k) or 403(b). Since you make contributions with pre-tax dollars, your taxable income and possibly your marginal tax rate will be lowered. The marginal tax rate is the tax rate paid on the last dollar of your income. Tax rates are graduated – they are lower for the first income dollars than for later income dollars. Therefore, you may be able to lower your marginal tax rate by contributing to a tax-deferred plan, and pay less in taxes. The investment grows on a tax-deferred basis, so when you retire and take the money out, the earnings will be taxed on your new (and in most cases, lower), tax rate. With a traditional IRA, if you do not have a tax-deferred plan through your employer, in addition to the tax-free compounding you also get an immediate tax deduction, saving you even more money by lowering your tax burden. Contributions to a Roth IRA are made with after-tax dollars. Earnings accumulate tax-deferred and may be withdrawn tax-free if the withdrawal occurs more than five years after you first contributed to it, and you are at least 59 ½. 4
  5. Take Advantage of Employee Benefits If you are an employee, your company may offer some benefits that can reduce your taxable income and therefore your tax liability (the amount you owe): • Flexible Spending Accounts (FSAs). There are two types of FSAs. One is the medical FSA, where you set aside money to pay items such as health insurance co-payments, uninsured treatments, or over-the-counter medications. The other is the dependent care account, where you can set aside work-related child or dependent care expenses. For both, the money usually is taken out through regular, equal payroll deductions on a pretax basis. • Transportation plans. These plans allow you to use pretax dollars (and reduce your taxable income) to pay for public transit, vanpooling, or parking. Use All Your Deductions and Credits A tax deduction is an expense that you can subtract from your gross income, resulting in a lower taxable income. Common examples of tax deductions are: • An exemption amount for you, your spouse, each child, and any other qualified dependents, and certain disabilities • Mortgage interest paid on your primary residence • Equity loan or line of credit interest Copyright © 2007 BALANCE • Charitable contributions to eligible organizations • Certain business expenses • Union and professional dues • Some medical expenses • The cost of tax advice, software, and books • Depreciation of business assets • Some work uniforms and clothing • Moving expenses, in some cases • Some educational expenses • Qualified capital losses A tax credit is a dollar-for-dollar reduction in what you would owe for taxes. For example, if you qualify for a tax credit of $1000, you would be able to subtract that amount from your total tax liability. Common examples of tax credits are: • Earned income credit. This credit reduces the tax burden on lower-income taxpayers. • Education-related credits. The Hope credit can be used for the expenses that you incur in the first two years of college. The lifetime learning credit applies to tuition costs for undergraduates, graduates, and those improving job skills through a training program. • Child-related credits. These include credit for child and dependent care expenses, the child tax credit, and the adoption credit. 5
  6. Chapter 4: Protect Yourself With Insurance The purpose of insurance is to protect you and your family against major financial catastrophes. The key is to have the right amount of coverage – too much and you’ll be spending more than you should on what you don’t need; not enough and you put your assets in jeopardy. Life Insurance The primary purpose of life insurance is income replacement – to protect loved ones who depend on you for financial security. The birth of a child or buying a home where two incomes are needed to make the mortgage payments are common motivations to buy life insurance. Life insurance comes in two basic forms: • Term insurance is bought for a specific period of time – a term of 1, 5, 10, 20, or even 30 years. If you die within that time frame, your beneficiaries will receive a preset amount of money (the death benefit). It never accumulates a cash savings, so if you fail to pay your premiums or die after the term ends, they receive nothing. The major advantage of a term life insurance policy is, if you are young, extremely low premiums for a substantial death benefit. However, each time you renew the policy (and the older you get), the more expensive term insurance becomes. Eventually, with many term policies, the cost of the insurance may not be worth the payoff value once you reach an older age. Copyright © 2007 BALANCE • Cash-value insurance (also called permanent insurance) provides both a death benefit and, since a portion of the money you pay in premiums is invested, cash accumulation. The downside of cash-value insurance policies is that the premiums tend to be considerably more expensive than for term plans. However, as long as you make your premium payments the policy can never be canceled, and money does build up – important features to consider when making your decision. Medical Insurance Health insurance policies cover the cost of most medical expenses. Because of the extremely high costs associated with medical treatment, such insurance is important to have. Buying a policy before having an accident, a serious illness, or becoming pregnant is vital, since insurance doesn’t cover health care for preexisting medical problems or conditions. Many people have group health insurance plans through their employer or union. If you do, you may be required to pay a portion of the premium, particularly if you work part-time. Still, since the costs and risks associated with health care are spread among many, the cost to you is usually low. Asset (house, car, heirlooms) Homeowners insurance is required if you own your own home. It protects your personal property and personal liability, as well as your lender’s financial interest if you do not pay your mortgage balance. Consider adding a guaranteed replacement cost policy so you could rebuild at today’s prices (plus a little extra to meet current building codes). Flood insurance is also a wise investment, as water damage is common and extremely expensive to repair. If you are a tenant, you may consider purchasing a renter’s insurance policy. Renter’s insurance provides protection for personal property in the event of fire, theft, or wind damage. Most policies come with liability protection, which protects you from the cost of someone having an accident in your home, as well. 6
  7. Whether you rent or own your home, you may want to add even further to your policies if you own expensive jewelry, collectibles, artwork, and furs. Most states require at least a minimum of automobile insurance. However, if want to protect yourself from lawsuits and high repair bills, buying more than what’s required makes sense. Long-term Disability If you can’t work because of an injury or illness, long-term disability policies provide an income stream for a long period of time. This type of insurance is often available through employers, and generally picks up where short-term disability leaves off. Once short-term disability benefits expire, the long- term policy pays 50, 60, or 66 2/3 percent of your salary. Chapter 5: Plan For Your Estate Most people have many reasons to develop some sort of estate plan. To know what they are, consider all the people you love who will be affected when you die. Typically this includes your spouse, children, grandchildren, and friends. Add your passions to the list too – from your school to a charity. An estate plan will enable you to direct the assets you’ve accumulated over the years to those you wish to have it. Copyright © 2007 BALANCE Reasons to Plan for Your Estate If you don’t plan, chances are the bulk of your estate (property) will go to the government. Estate planning also means arranging for guardianship of your children, and making medical and financial arrangements if you become incapacitated – decisions you probably don’t want left to people who do not know (or care about) your desires. Preparing for the distribution of your estate (assets you own at the time of your death) can be a very stressful experience. After all, with so many important decisions to make, no one wants to make the wrong one. Understand Probate Probate is the administrative and court process that takes place after you die. It includes proving the validity of a will (if there is one), identifying, inventorying, and appraising property, paying debts and taxes, and distributing whatever assets remain. Because probate can drag on for months or even years, much of the wealth you’ve accumulated over your lifetime can be eroded. Wills and trusts have the power to reduce probate dramatically – so your heirs can efficiently inherit what you want them to receive. Wills A will is nothing more than a set of instructions that specifies who gets what of your assets. If you have property and loved ones, having a will is vital. If you die without one, state law takes over and makes distribution decisions on your behalf. In most cases everything goes to your spouse and/or children. If you have neither, your closest relatives will be the recipients, and if you have no relatives, your entire estate will be absorbed by the state. While the court may make the same decisions you would have, in many cases it does not. 7
  8. One of the most compelling reasons to draw up a will is if you have children who depend on you for care. A will allows you to stipulate guardianship. Without one, the court will make this very personal choice for you. If your estate is relatively simple, you may choose to create your own will with the help of a quality software program or guidebook. For more complex situations, or if you do not feel comfortable writing your own will, hire an attorney or legal service to do it for you. Because this is such an essential document, you’ll want to be sure its done right. Consider investing in a lawyer to at least look over your finished product. Living Trusts A living trust is a bit more complicated in concept than a will, but in essence it is a separate legal entity that holds title or ownership to your property and assets. While you are alive, and acting as the trustee, you hold full control over all the property held in the trust. The primary reason to create a living trust is to avoid probate. Property held in a trust won’t have to go through probate before your loved ones receive their inheritance. More, where wills are public, trusts are private, and usually harder to dispute. As with a will, you can create your own living trust by using software and guidebooks developed for “do-it-yourselfers.” However, living trusts by nature are often more involved than wills, so having a Copyright © 2007 BALANCE lawyer draw it up for you in the first place may be the better way to go. Not everyone needs a living trust though. Before spending the money to create one, be aware that they can be costly to arrange, are time-consuming to put together, and require considerable ongoing maintenance (adding to the cost). Changes to a trust can take a long time, and moving certain assets such as real estate, savings, and brokerage accounts into the trust requires re-titling, which can be cumbersome. A Will Plus a Trust Wills and living trusts are not mutually exclusive estate planning devices. In fact, if you have a trust, you should probably have a will to make sure all of your assets will be distributed according to your wishes. Most trusts do not provide instructions for everything in your estate. A will acts as a back up for what is not included in the trust, as it would have a clause naming a person who you want to receive all leftover property. Without a will, anything you didn’t transfer into the trust will go through that long and expensive probate process. Once again, those assets will be distributed according to state law – and most likely not the way you would choose to have your property dispersed. 8
  9. Net Worth Worksheet In order to evaluate your progress as you work toward your goals, you must determine what your overall financial picture looks like today. Your net worth is simply the difference between what you own and what you owe. To make sure you are staying on track, it’s a good idea to calculate your assets and liabilities annually. If you conscientiously follow your plan you should see a gradual, steady increase in your net worth. What You Own Amount What You Owe Amount Checking/Saving Accounts Mortgage Investment Accounts Credit Cards Stocks & Bonds Student Loan(s) IRA/401(k) Auto Loan(s) Home/Real Estate Othe Loan(s) Automobile(s) Income Tax Due Other Assets Other Debt(s) Copyright © 2007 BALANCE Total Owned (A) Total Owed (B) Total Owned (A) Total Owed (B) Net Worth – = 9
  10. Cash Flow Worksheet Monthly Income Enter your gross and net (after taxes) income from all sources. For income received infrequently, such as bonuses or tax returns, calculate the annual income, then divide by 12 to find the monthly amount. Source Gross Net Job Spouse’s job Part-time job Rental/room & board received Commissions/bonuses Tax refunds Investment income Government benefits Copyright © 2007 BALANCE Unemployment insurance Child support/alimony Support from family/friends Other Total 10
  11. Monthly Expenses Since many expenses are variable, such as utilities and groceries, it is important to average these expenses. Other expenses are periodic (such as insurance or vehicle registration). Again, calculate the annual amount and divide by 12. Category Expense Average Per Month Goal Per Month Rent/Mortgage 2nd Mortgage/Equity Line Homeowner’s/Renter’s Insurance Condo Fees/HOA Dues Housing Home Maintenance Gas/Electric Water/Sewer/Garbage Telephone Groceries/Household Items Food At Work/School Insurance Health/Dental/Vision (Exclude Payroll Deducted Amounts) Life/Disability Copyright © 2007 BALANCE Doctor/Chiropractor Medical Care Optometrist/Lenses (Exclude Payroll Deducted Amounts) Dentist/Orthodontist Prescriptions Car Payment #1 Car Payment #2 Auto Insurance Transportation Registration (Exclude Payroll Deducted Amounts) Gasoline/Oil Maintenance/Repairs Public Transportation/Tolls/Parking Child Care Daycare (Exclude Payroll Deducted Amounts) Child Support/Alimony Emergency Savings Goals Prior Year Income Taxes Estimated Tax Payments (Self-Employed) Loan payment Credit Card #1 Unsecured Debt Credit Card #2 Credit Card #3 Credit Card #4 11
  12. Category Expense Average Per Month Goal Per Month Beauty/Barber Personal Clothing/Jewelry Cosmetics/Manicure Cable/Satellite Movies/Concerts/Theater Books/Magazines Entertainment CD/Tapes/Videos/DVD Dining Out Sports/Hobbies Vacation/Travel Banking Fees Laundry Union Dues Internet Service Pet Care Gifts for Holidays/Birthdays Copyright © 2007 BALANCE Cell Phone/Pager Postage Miscellaneous Cigarettes/Alcohol Contributions to Church/Charity Other Other Other Other Other Other TOTALS (include totals from page 10) Bottom Line Once you have determined the total of your take-home pay and expenses you are ready to determine your bottom line. Subtract the total of all expenses including debt payments from your net income. If the result is a positive number, you can add the extra money to your savings to reach your goals sooner. If your expenses exceed your income, you’ll need to make some adjustments to bring your finances back into balance. Total Monthly Income Total Expenses Balance – = 12

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