The Mayfield case: a retirement planning mini case.
Their two children, Nick and Nedra, have both moved away from home and have started their own families. In fact, Nick and his wife have two children n Lisa and Timmy, ages 3 and 2, respectively.
Additional Personal Information
Occupation--Peter City Manager 123 Elm Street Anytown, Anystate 01010 26 Years Occupation--Ann Homemaker 26 Years
Global Assumptions (Valid unless otherwise specified in certain instances)
* Inflation: 3%
* All income and expense figures are given in today's dollars.
* Federal marginal tax bracket: 25%
* State marginal tax bracket: 4.5%
* Any qualified plan or IRA contribution growth rates are assumed to stop at the federally mandated limit unless otherwise restricted.
* All nominal rates of return are pre-tax returns.
* They are currently qualified for Social Security benefits.
Peter currently earns $90,000 per year and expects his salary to increase at 3% per year until retirement. Peter contributes 10% of his salary to his employer-sponsored 403(b) plan. He receives a 33% match from the city. Ann and Peter are covered by an employer-sponsored health care plan which has a premium of only $50 per month and is paid for directly out of Peter's paycheck on a pre-tax basis. The Mayfields currently use interest earned from their municipal bond holdings to supplement their income.
Asset and Liability Information
The Mayfields' marginal state tax rate is 4.5%. The state's income tax is tied to the federal AGI figure. The Mayfields are eligible for two state exemptions in the amount of $1,300 each and a state standard deduction of $10,000. The Mayfields are also eligible for $6,000 in state income tax adjustments. The municipal money market mutual fund is made up of general Anystate state obligations.
Insurance Information and Planning Issues (1)
Life Insurance: Peter purchased a $250,000 10-year term policy when he turned age 50. Peter is the owner and insured. Ann is the beneficiary. In addition, Peter's employer provides him with a group term policy in the amount of one times his salary. When estimating life insurance needs the Mayfields would like to make the following assumptions:
* Life expectancy: Age 95 each
* Final expense needs: $12,000 each
* Estate administration needs: Peter: $36,500; Ann: $9,500
* Other Immediate Needs: $12,000 each
* They would like to pay off all debts at the first death.
* Anticipated expense needs at first death: $85,000 per year before and after retirement (today's dollars).
* They believe they can earn 6% on any proceeds from insurance prior to retirement.
* They believe they can earn 5% on insurance proceeds after retirement.
* They anticipate being in a combined 25% federal and state marginal tax bracket after retirement.
* Projected inflation rate: 3%
* In the event of their spouse's death, Peter and Ann plan to stop working and take early Social Security benefits at age 60. They will receive $16,500 at that time.
* For conservative planning purposes, the Mayfields do not plan on using interest and/or dividends as an income source when planning insurance needs.
* Full retirement benefits, at age 66, are $23,580.
* In addition to Peter's life insurance, they are willing to use all of the retirement, investments, and monetary assets to meet insurance needs.
Retirement Information and Planning Issues
The following information should be used when evaluating the Mayfields' current retirement planning situation: (2)
* Peter does not have a defined benefit plan at this time.
* Retirement age for reduced Social Security benefits is age 62; they plan to retire and take benefits at the earliest possible date.
* Retirement age for full Social Security benefits is age 66.
* Their individual life expectancies are 95 years of age.
* In the event of the death of one spouse, the surviving spouse is eligible to receive $16,500 per year starting at age 60 from Social Security.
* At age 62, Peter's annual Social Security benefit will be $17,950 in today's dollars; Ann is eligible to receive a survivor benefit equal to $8,367.
* At age 66, Peter's annual Social Security benefit will be $24,420 in today's dollars; Ann is eligible to receive one-half of this amount.
* At age 70, Peter's annual Social Security benefit will be $32,900 in today's dollars; Ann is eligible to receive a survivor benefit.
* They would like to replace $90,000 in yearly income, in today's pre-tax dollars, on their first day of retirement (note that this figure is different from the assumption they want to use for insurance planning purposes).
* Ann is the beneficiary for Peter's qualified retirement plan assets.
* For retirement planning purposes only, they believe that they can earn a 7.6% rate of return prior to retirement and a 5% rate of return after retirement.
* Inflation before and after retirement is expected to be 3%.
* Peter's salary will increase at the rate of inflation.
* All annual retirement savings will increase by the rate of inflation (3%) prior to retirement.
* The Mayfields are willing to assume that they will remain in the same marginal tax brackets after they retire.
* All non-retirement assets are owned as JTWROS at this time.
Additional Planning Assumptions
The Mayfields would like to maintain their monetary assets as an emergency fund if possible, and use interest earned as a "slush fund" while in retirement.
Goals and Objectives
The Mayfields are very much looking forward to retirement. They hope to spend more time with their growing grandchildren. Given this goal, they plan to retire when Peter turns age 62. They would like to know if they are currently on track to meet this goal.
Their second goal involves establishing an education funding plan to help their grandchildren pay for college expenses. They would like to fund one year of college tuition and room and board for each grandchild. Tuition plus expenses for colleges they have looked at average $18,000 per year. They believe that college costs will continue to rise at a 6% rate, but to off-set some of this increase they are comfortable assuming an 8% rate of return in a tax-advantaged education savings account, which is roughly equivalent to a 5.5% after-tax rate of return.
Use the information provided in this narrative to answer the following case questions.
1. Peter was recently approached by a financial adviser who wanted Peter to consider investing in a variable annuity for retirement. A few days later, the adviser called Peter again and said that a variable universal life (VUL) insurance policy could also be used to fund retirement needs. Which of the following statement(s) is(are) true in relation to annuities and VULs?
I. Given their favorable tax treatment, variable annuities and VUL policies allow earnings to grow tax deferred until withdrawn.
II. Distributions from the annuity, after age will be taxed at the long-term capital gain rate if the annuity has been in existence for at least one year.
III. Distributions from the VUL policy, if made in the form of a loan, will be taxed at the Mayfields' marginal tax rate.
IV. Distributions in the form of a VUL loan need not be reported on IRS Form 1040 for tax purposes.
a. I and II only
b. III and IV only
c. I and IV only
d. II, III, and IV only
2. Reducing a client's life expectancy assumption will have which of the following effects?
a. Increase the amount of life insurance needed.
b. Decrease the amount of retirement assets needed.
c. Increase the amount of retirement assets needed.
d. Both a and c are correct.
3. Peter and Ann have been discussing the possibility of retiring as early as age 60. What do the Mayfields need to consider when planning for this goal?
a. Distributions from their qualified retirement plans at that time will be subject to a 10% early withdrawal penalty.
b. They could extend their current health insurance coverage using both COBRA and HIPPAA benefits until age 65 at which time they could enroll in Medicare.
c. The cost of Medicare will increase dramatically for each year that they postpone enrolling after age 60.
d. None of the above.
4. Suppose that the Mayfields decide to retire at age 60. How much do they need in assets at that time to fund income needs for age 60 and age 61, assuming that they still want $90,000 (in today's dollars) in annual income starting on their first day of retirement? (3)
5. Peter and Ann are concerned about estate planning details. They have heard about income in respect of decedent (IRD). They realize that their retirement plans may be subject to IRD taxation. Which of the following statements is true in relation to IRD property?
I. IRD property will be included in the Mayfields' estates at fair-market-value.
II. IRD property does not receive a step-up in basis.
III. IRD property is subject to income taxation when the heir or estate collects income from the property.
IV. IRD property will be included in the Mayfields' estates at a step-up in basis value.
a. I and III only
c. I, II, and III only
d. II, III, and IV only
6. Assume that the Mayfields want to retire using a capital preservation model approach. They are willing to change some retirement planning assumptions as needed. Which of the following retirement planning assumptions will not help the Mayfields reach their retirement goal?
a. Postpone retirement for two years.
b. Increase the rate of inflation before retirement while keeping the inflation rate stable during retirement.
c. Decrease the income replacement ratio used in the analysis.
d. Reduce their life expectancy.
7. Calculating the future value of regular savings using a geometrically varying annuity assumption, will tend to
a. Reduce the future value of the asset.
b. Reduce the tax liability of the asset.
c. Increase the future value of the asset.
e. Increase the interest rate used to calculate the future value.
Describe how the Mayfields' asset allocation approach may need to change as they get closer to their retirement goal.
Mayfield Case Endnotes
(1.) Some of the assumptions in this section are different than assumptions used in other planning areas. Use these assumptions for insurance planning purposes.
(2.) Some of the assumptions in this section are different than assumptions used in other planning areas. Use these assumptions for retirement planning purposes.
(3.) When answering this question use the rate of return, inflation, and life expectancy assumptions provided in the case.
Dedicated and Discretionary Expenses Source of Expense Amount Frequency Pre-Tax Medical Premiums $600 Annually 401(k) Contributions $750 Monthly Social Security Withholdings $6,839 Annually Federal Tax Withholdings $10,000 Annually State Tax Withholdings $3,400 Annually Mortgage Payment (P + I) $511.63 Monthly Credit Card Payments $450 Annually Auto Insurance $550 Semi-Annually Homeowner's Insurance $50 Monthly Life Insurance (Private Policy) $780 Annually Other Insurance Not Calculated Umbrella Policy $150 Annually Peter Traditional IRA Contribution $2,000 Annually Ann Traditional IRA Contribution $2,000 Annually Unallocated Savings $1,000 Quarterly Subscriptions $50 Monthly Telephone Charges $1,560 Annually Alarm System $40 Monthly Internet and Cable $90 Monthly Hobbies $100 Monthly Recreation $400 Monthly Health Club Dues $90 Monthly Groceries $3,900 Annually Eating Out Expenses $4,900 Annually Real Estate Taxes $1,600 Annually Household Maintenance $90 Monthly Utilities $2,160 Annually Clothing $1,700 Annually Dry Cleaning $60 Monthly Personal Care $100 Monthly Stereo Equipment $800 Annually Yard Maintenance Service $900 Annually Eye Glasses $725 Annually Health Insurance Co-Pays $500 Annually Prescriptions $400 Annually Other Medical Expenses $350 Annually Gas and Car Maintenance $800 Semi-Annually Car Licenses (Not Tax Deductible) $250 Annually Parking in City $100 Annually Trains and Taxis in City $300 Annually Personal Property Tax $750 Annually Safe Deposit Fees $40 Monthly Bank Fees $4 Monthly IRA Fees $45 Annually Tax Preparation Fees $450 Annually Charitable Contributions $300 Monthly Business Travel * $1,500 Annually Vacations $1,000 Quarterly Business Expenses * $250 Annually Alcohol Expenses $250 Semi-Annually Postage Stamps $125 Annually Gifts to Children/Grandchildren $1,300 Semi-Annually Other Misc. Expenses $500 Annually * Peter's employer does not reimburse these expenses. Asset and Liability Information Asset/Liability Value Notes Checking Account $13,000 No Interest Earned on Asset Municipal Money Market $240,000 2.50% Federal Annual Fund (General Obligation) Tax-Free Yield I-Bonds $42,000 Market Value Peter's 401(k) $975,000 Invested in Equities Peter's Traditional IRA $52,000 Invested in Equities Ann's Traditional IRA $35,000 Invested in Equities Primary Residence $375,000 Mazda Automobile $6,700 5 Years Old Honda Automobile $5,200 6 Years Old Household Furnishings $30,000 Yard Equipment $7,500 Other Misc. Assets $14,000 Visa Credit Card $2,500 14.90% Interest Rate MasterCard $4,000 9.90% Interest Rate Discover Card $1,000 18.90% Interest Rate Macy's Credit Card $500 21.00% Interest Rate First Mortgage $25,685 Home Purchased 25 Years Ago; $75,000 Financed at 7.25% for 30 Years; 300 Payments Made-to-Date Note: All non-retirement assets are jointly owned
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|Title Annotation:||Chapter 15: Other Case Studies|
|Publication:||The Case Approach to Financial Planning|
|Date:||Jan 1, 2008|
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