Instructor Guide. Chartered Retirement Planning Counselor

Transcription

1 Instructor Guide Chartered Retirement Planning Counselor

2 2013, College for Financial Planning, all rights reserved. This publication may not be duplicated in any way without the express written consent of the publisher. The information contained herein is for the personal use of the reader and may not be incorporated in any commercial programs, other books, databases, or any kind of software or any kind of electronic media including, but not limited to, any type of digital storage mechanism without written consent of the publisher or authors. Making copies of this material or any portion for any purpose other than your own is a violation of United States copyright laws. The College for Financial Planning does not certify individuals to use the CFP, CERTIFIED FINANCIAL PLANNER, and CFP (with flame logo) marks. CFP certification is granted solely by Certified Financial Planner Board of Standards, Inc. to individuals who, in addition to completing an educational requirement such as this CFP Board-Registered Program, have met its ethics, experience, and examination requirements. Certified Financial Planner Board of Standards, Inc. owns the certification marks CFP, CERTIFIED FINANCIAL PLANNER, and federally registered CFP (with flame logo), which it awards to individuals who successfully complete initial and ongoing certification requirements. At the College s discretion, news, updates, and information regarding changes/updates to courses or programs may be posted to the College s website at or you may call the Student Services Center at

3 Table of Contents Introduction... 1 Suggested Class Schedule for the Chartered Retirement Planning Counselor Course... 3 Module Topics... 4 Course Materials... 5 Administrative Overview for Instructors... 6 Lesson The Retirement Planning Process & Meeting Multiple Financial Objectives... 9 Lesson Sources of Retirement Income and Legal Entities Lesson Employer-Sponsored Plans Overview and Outline Lesson Traditional, Roth & SIMPLE IRAs Lesson Individual Deferred Compensation Overview of Materials Lesson Planning for Incapacity, Disability & Long-Term Care Overview of Materials Lesson When to Retire Lesson

4 Retirement Plan Distributions Overview of Materials Lesson Asset Management & Investment Strategy During Retirement Lesson Income Taxes & the Retiree Lesson An Overview of Estate Planning Lesson Retirement Cash Flow Considerations

5 Introduction Although the Chartered Retirement Planning Counselor SM Professional Education Program offered by the College for Financial Planning (College), a subsidiary of the Apollo Group, Inc., is designed for completion by self-study, it also is offered through classes taught by independent class providers. Participating in classes offers students several advantages: it encourages them to be more disciplined in studying; it allows them to reap the benefits of an instructor who is able to offer practical applications based on personal experiences and to explain difficult concepts; and it allows them to interact with other professionals in the financial planning field. This instructor guide provides administrative information as well as practical suggestions and aids for teaching the financial planning program materials. Its structure recognizes the wide variety of effective teaching styles exhibited by instructors, presenting information to facilitate teaching the course rather than supplying lesson plans prescribing how the course should be taught. The College strongly recommends that instructors carefully read the Administrative Overview for Instructors included in this material and communicate pertinent information found there to students. The teaching aids incorporated as a part of this instructor guide include 1. a syllabus for 8, 10, 12, and 15 sessions; 2. true/false questions and answers; and 3. Microsoft PowerPoint slides that can be used as overheads, if desired. If the instructor has access to the appropriate computer and AV equipment, they can be presented electronically in a PowerPoint color presentation. Many of the overhead masters focus on key terminology Introduction 1

6 and the characteristics of product choices and techniques, which are a significant part of this course. Learning objectives are the central focus of study materials developed by the College and are the link that unites reading materials and supplements to review questions and the self-study examination. Review questions and problems for each module are keyed to the learning objectives and are designed to direct and reinforce learning. Emphasize to your students that they will obtain the greatest benefit from the review questions if they take the time to write down answers in their own words prior to reading the given answers. The self-study examinations, on the other hand, are used to test mastery of the general body of knowledge important in financial planning. This instructor guide is furnished to assist independent class providers in delivering high-quality education to students enrolled in the Chartered Retirement Planning Counselor Professional Education Program. Instructor suggestions for additional teaching support materials or services are invited and will be appreciated. Please contact: Michael B. Cates Senior Director of Certification Programs College for Financial Planning 9000 East Nichols Avenue, Suite 200 Centennial, CO Michael.Cates@cffp.edu 2 Chartered Retirement Planning Counselor

7 Suggested Class Schedule for the Chartered Retirement Planning Counselor Course Syllabus. Teachers and students alike have found a syllabus to be highly beneficial in organizing and preparing for classes in which they are involved. Enclosed is a syllabus for 8-, 10-, 12-, and 15-week sessions. The College recommends that classes be held for approximately 30 contact hours in preparation for the examinations. Because the modules vary in length and difficulty, some require more class time than others. The two modules that are likely to take the most time to teach are Module 7, When to Retire, and Module 11, Estate Planning. These materials may be used as presented or adapted to specific needs. Many instructors find it useful to provide the syllabus as a handout to each student in the class. Suggested class assignments for 8-, 10-, 12-, or 15-session schedules are outlined in the following table. Session Number 15-Session Schedule 12-Session Schedule 10-Session Schedule 8-Session Schedule 1 Module 1 Module 1 Module 1 Module 1 2 Module 2 Modules 2, 12 Module 2, 12 Modules 2, 12 3 Module 3 Module 3 Module 3 Modules 3, 4 4 Module 4 Module 4 Module 4 Module 5, 6 5 Module 4 Module 5 Module 5 Modules 7, 8 6 Module 5 Module 6 Module 6 Modules 9, 10, 7 Module 6 Module 7 Modules 7, 8 Module 11 8 Module 7 Module 8 Modules 9, 10 Review 9 Module 8 Module 9 Module Module 9 Module 10 Review Introduction 3

8 Session Number 15-Session Schedule 12-Session Schedule 10-Session Schedule 8-Session Schedule 11 Module 9 Module Module 10 Review 13 Module Module Review Module Topics The content of this course is divided into 12 modules, which cover the following topics: The Retirement Planning Process & Meeting Multiple Financial Objectives Sources of Retirement Income and Legal Entities Employer-Sponsored Plans Traditional, Roth, and SIMPLE IRAs Individual Deferred Compensation Planning for Incapacity, Disability & Long-Term Care When to Retire Retirement Plan Distributions Asset Management & Investment Strategy During Retirement Income Taxes & the Retiree An Overview of Estate Planning Retirement Cash Flow Considerations 4 Chartered Retirement Planning Counselor

9 Each module is divided into several sections that cover key topic areas and correspond to the course learning objectives. The learning objectives are listed as a group at the beginning of each module. Then, as a student progresses through a section, each learning objective is repeated as it introduces the relevant discussion. Course Materials Core Materials College for Financial Planning, Chartered Retirement Planning Counselor, Module 1, The Retirement Planning Process & Meeting Multiple Financial Objectives College for Financial Planning, Chartered Retirement Planning Counselor, Module 2, Sources of Retirement Income and Legal Entities College for Financial Planning, Chartered Retirement Planning Counselor, Module 3, Employer-Sponsored Plans College for Financial Planning, Chartered Retirement Planning Counselor, Module 4, Traditional, Roth, and SIMPLE IRAs College for Financial Planning, Chartered Retirement Planning Counselor, Module 5, Individual Deferred Compensation College for Financial Planning, Chartered Retirement Planning Counselor, Module 6, Planning for Incapacity, Disability & Long-Term Care College for Financial Planning, Chartered Retirement Planning Counselor, Module 7, When to Retire College for Financial Planning, Chartered Retirement Planning Counselor, Module 8, Retirement Plan Distributions Introduction 5

10 College for Financial Planning, Chartered Retirement Planning Counselor, Module 9, Asset Management & Investment Strategy During Retirement College for Financial Planning, Chartered Retirement Planning Counselor, Module 10, Income Taxes & the Retiree College for Financial Planning, Chartered Retirement Planning Counselor, Module 11, An Overview of Estate Planning College for Financial Planning, Chartered Retirement Planning Counselor, Module 12, Retirement Cash Flow Considerations Administrative Overview for Instructors Independent class provider application and agreement. All prospective instructors are required to submit to the College for Financial Planning an application for independent class provider status, a signed independent class provider agreement, and a copy of their transcripts (indicating that the minimum of a baccalaureate degree has been earned). After an individual s application has been approved, the new faculty member must submit a request for instructor materials at least four weeks before the proposed class begins. Independent class provider status. The College for Financial Planning has two status categories for independent class providers. Independent class providers are considered active if they have taught at least once during a 12-month period. Independent class providers are considered retired if they have not taught within a 12-month period. To become an active independent class provider again after being retired, an individual must complete a new independent class provider application and agreement, must submit new transcripts, and must teach a class. Independent class provider status is valid for only the program course or courses for which an applicant has been approved, i.e., an instructor who has 6 Chartered Retirement Planning Counselor

11 been approved to instruct this course will not be considered an approved independent class provider for any other course offered by the College. A separate independent class provider application is required for each course. Instructor materials. Each instructor who is approved to teach the Chartered Retirement Planning Counselor Professional Education Program will be provided with the student study materials and the instructor guide. Although the instructor materials are to be used only by the independent class provider, they do contain materials that are appropriate for reproduction and distribution to students. Communications. Instructors are encouraged to communicate with the Academic Affairs department at the College concerning classes, mailings, Live Review classes, and all other non-content issues regarding the independent class provider program. All suggestions or comments regarding instructor materials should be directed to the Academic Affairs department. Location of classes. Instructors should establish a regular location for classroom sessions. An instructor may use his or her office if it contains appropriate facilities. The location and time of the sessions must be indicated on the request for instructor materials. Instructors should select a location that has adequate space, is well lighted, and is equipped with enough table or desk space for each student. Class schedule. The College for Financial Planning recommends that classes be held for at least 30 contact hours in preparation for each course examination. For example, this can be accomplished in 10 three-hour sessions or 12 sessions of two-and-one-half hours. Assignments generally should be taught in numerical sequence. Suggested class assignments for 8-, 10-, 12-, or 15-session schedules are included in the suggested class schedule. The affiliate/independent class provider group will determine the class schedule. Introduction 7

12 Class enrollment. Each student enrolled in a class offered by an independent class provider must be officially registered with the College for Financial Planning and must have his or her own study materials. After the second week of classes, the instructor must forward a final class roster to the Academic Affairs department. Course terms. Each student has one year to successfully complete his or her course. If the term of a student s course does not coincide with his or her schedule for classroom instruction, the student should contact the Student Services Center at to rearrange the course term. Examinations. Final examinations for all courses are offered via the Internet and are administered at specific testing sites located throughout the United States. A student may take a final exam 30 days after receiving the materials for a course. Questions regarding how to be set up to take the examination should be addressed to the Student Services Center at , extension Evaluations. Independent class providers are requested to submit their written evaluations of the instructor materials when the class is completed. Forms for students to evaluate independent class providers will be mailed to each instructor. Evaluations should be returned to the Academic Affairs department. The College strongly encourages independent class providers to submit any suggestions they might have for improving the program. Ethics. Instructors should act in accordance with generally accepted educational, professional, and ethical standards. Instructors are requested to cover all material provided in this instructor guide, but an instructor should not attempt to teach the examination. When conducting a class, an instructor is asked to speak in generic terms concerning products. Instructors should also refrain from proselytizing for employment purposes, personal promotion, or sales promotion, and instructors should discourage students and guests from doing the same. 8 Chartered Retirement Planning Counselor

13 Lesson 1 The Retirement Planning Process & Meeting Multiple Financial Objectives To enable you to reach the goal of this module, material is structured around the following learning objectives. 1 1 Describe the six steps of the retirement planning process and what each contributes to the entire process. 1 2 Describe the two key financial statements in which client data are reflected. 1 3 Articulate the pros and cons of retirement income replacement percentages. 1 4 Explain the methods for determining retirement period income and expenses, and preretirement savings needs. 1 5 Calculate the future value of a current sum, the present value of an annuity due (PVAD), and the payment required in a present value of an ordinary annuity (PVOA). 1 6 Describe the problem of multiple financial objectives and a method for meeting each. Lesson 1 9

14 1 1 Describe the six steps of the retirement planning process and what each contributes to the entire process. The most important material in this objective centers on knowing the six steps in the retirement planning process. These six steps include 1. establishing and defining the relationship with the client; 2. gathering client data, including goals; 3. analyzing and evaluating the client s financial status; 4. developing and presenting financial planning recommendations and/or alternatives; 5. implementing the financial planning recommendations; and 6. monitoring the financial planning recommendations. Establish and define the relationship with the client. The relationship between the client and counselor is based upon trust and an understanding of the scope of services to be rendered. Gather client data. Data gathering is generally best accomplished through the use of a survey form or questionnaire. This reduces the chance of overlooking important data. The following categories of data are required for effective retirement planning: family and dependent data names, addresses, and telephone numbers of financial advisors assets, liabilities, and net worth (statement of financial condition) income and expense data (cash flow statement) 10 Chartered Retirement Planning Counselor

15 occupation future employment and compensation expectations information on businesses owned by the client insurance situation employee financial benefits including stock options, pension plan, thrift plan, etc. tax situation existing retirement plans and accounts (including IRAs, tax-deferred annuities, 401(k) plans, etc.) current savings and investments other resources of financial value: patents, licenses, intellectual property rights, expectations of inheritances important time horizons: when children will begin and finish college, anticipated retirement dates, etc. anticipated financial requirements for education, gifting, care of an elderly parent or disabled family member current health of client and family estimate of longevity current estate plans retirement goals investment risk tolerance Lesson 1 11

16 anticipated changes in lifestyle interests and hobbies 1 2 Describe the two key financial statements in which client data are reflected. This objective covers the two major financial statements for an individual the statement of financial position, also known as the balance sheet, and the cash flow statement. Your students should understand that for this course these terms are interchangeable. The statement of financial position provides a list of assets, liabilities, and net worth as of a certain date, which should be stressed to the students. The values are generally presented at fair market value, unlike a corporate balance sheet that generally presents values at the lower of cost or market. The student also needs to know the components within each of these categories. Assets are divided into cash/cash equivalents, invested assets, and use assets; the components of each are important to know. Liabilities are usually classified as short term (those to be paid off within one year) and long term (those to be paid off in one year or more), although they are generally presented together in the liability section of the balance sheet. The net worth is the difference between assets and liabilities and provides a measure of wealth accumulation. The cash flow statement summarizes cash inflows and outflows over a period of time, usually one year. Inflows are sources of income while outflows are sources of expenses. Unlike corporations, individuals are generally on a cash basis rather than an accrual basis for tax purposes, hence the name cash flow statement. Some cash flow statements present a residual surplus or deficit while other cash flow statements equate inflows with outflows. This course uses the latter. The three major categories under outflows are savings and investments, fixed outflows (those that generally do not change significantly from period to period), 12 Chartered Retirement Planning Counselor

17 and variable outflows (those that generally can change significantly from period to period). The student should be familiar with the components of each of these outflows, as well as the components of the inflows category. At a glance, the income statement will show if the client is spending more than his or her income or not and, therefore, is a point of discussion with the client. If the client has a surplus, this amount is available for some financial purpose, usually investing. A surplus suggests that the client probably can implement this strategy. Understanding financial statements is fundamental to analyzing an individual s financial well-being. This analysis includes general considerations, such as the adequacy of asset diversification. Determining goals and expectations. To be useful in planning, retirement goals should be specific and prioritized. A specific goal indicates an event, an amount, and/or a time. Example: My goal is to retire in April 2025 with a nest egg sufficient to sustain a lifestyle similar to the one I now enjoy. When there are multiple goals, they must be prioritized: Our first goal is to provide a fund to care for our disabled daughter. Our retirement goal will have second priority. Processing & analyzing information. After you identify a client s retirement goals, you must determine the retirement income needs and income sources that are and will be available to fund them. Retirement income need is the dollar amount needed to support a desired lifestyle. Lesson 1 13

18 1 3 Articulate the pros and cons of retirement income replacement percentages. This objective examines the advantages and disadvantages of income replacement percentages, or replacement ratios rough guides used in determining the amount of income needed in retirement, using preretirement income as a base. For example, according to experts, most American retirees need 70% to 80% of preretirement income in order to maintain current living standards. Income replacement percentages are simply rules of thumb. Because retirement lifestyle goals differ greatly, no two clients will need the same percentage of preretirement income to make ends meet in retirement. Typically, a more sophisticated analysis will be needed as clients age. 1 4 Explain the methods for determining retirement period income and expenses, and preretirement savings needs. This objective focuses on methods for determining income, expenses, and savings needs. Estimate a client s retirement expenses. In estimating a client s retirement income needs, you should identify some current expenses that are likely to decrease during retirement, and one or two that will likely increase. During retirement, many items of expense tend to be less or zero. These may include the following: Transportation costs: train, bus, and auto expenses will likely drop when commuting to work ends. One or two cars may be eliminated altogether. 14 Chartered Retirement Planning Counselor

19 Food and housing costs usually are less not as a result of not working, but because most clients have their mortgages paid and children out of the home by the time they retire. Term life insurance and disability premiums can usually be stopped entirely. Dry cleaning bills, professional fees, clothing expenses, and other costs associated with working diminish. On the other hand, some costs usually go up: Medical and dental expenses; Expenditures on hobbies, recreation, and travel. Determine the income available. To determine the income available during retirement given the client s current situation make a list of all assets and income sources that are expected to be available. They should be in the statement of financial position. As a general rule, you should not include emergency fund; funds intended for college education; and the value of the client s personal residence. Two strategies clients can employ in living off their retirement assets: Capital preservation. Followers of this strategy live off the income produced by their assets without touching the principal. This strategy assures that they will not outlive their incomes. A very large asset pool is required to follow this strategy. Capital utilization. In this strategy, both income and principal are tapped for retirement living expenses. These retirees must make a good estimate of their life spans; otherwise they risk outliving their incomes. Lesson 1 15

20 Prudent approach for estimating the length of the retirement period. A prudent approach to estimating the duration of retirement for planning purposes is as follows: Use average life expectancy figures as a starting point. Make conservative adjustments based upon the client s personal health, habits (smoking, drinking, exercise, current fitness, etc.), and family history of longevity. Add 5 to 10 years for good measure. If a couple is involved, base the estimate on the life of the individual expected to live the longest. 1 5 Calculate the future value of a current sum, the present value of an annuity due (PVAD), and the payment required in a present value of an ordinary annuity (PVOA). The amount of a client s preretirement savings need (and withdrawals during retirement) involves time value of money calculations. This requires the use of a financial calculator. The following table summarizes the HP-10B and HP-10BII keystrokes used for the time value of money calculations found in this module. Students should commit these keystrokes to memory. Students who want to use a different calculator may do so as long as it is not programmable and they understand that other calculators will not be supported by the College s faculty. 16 Chartered Retirement Planning Counselor

21 Keystroke(s) P/YR PV FV PMT I/YR N Gold, P/YR Use denotes number of compounding periods per year (accessed through gold keys). The default on the HP-10B and HP-10BII is 12 payments per year. To change the number to 1, enter 1, press the gold key, then press P/Yr. denotes present value (i.e., value before compounding takes place, or after discounting) denotes future value (i.e., value after compounding takes place, or before discounting) denotes periodic payment denotes annual interest rate denotes total number of compounding periods automatically multiplies the number of years by the number of compounding periods per year to arrive at the total number of compounding periods (accessed through gold key) Gold, BEG/END used to program calculator for either an ordinary annuity or an annuity due (accessed through gold key). The calculator shows no display message if it is set for an ordinary annuity calculation (payments at the end of the period); however, the display will show the word BEGIN if it is set correctly for an annuity due. To set the calculator for an ordinary annuity (assuming that the calculator is previously set for an annuity due), the keystroke sequence is as follows: gold, BEG/END. To set the calculator for an annuity due (assuming it is previously set for an ordinary annuity), the keystroke sequence is identical. Gold, DISP, then the number of decimal places The appropriate number of decimal places is programmed on the HP-10BII by pressing gold, =, and then the number of decimal places desired for display. Turning off the calculator or clearing it will not change the number of decimal places. Many answers in the financial services area are calculated to two decimal places. To set two decimal places, the keystrokes are gold, =, 2. There are a myriad of practical problems that can be solved using time value of money concepts. For example, if a client invests $50,000 in a mutual fund that earns 10% per year, how much will he or she have at the end of 15 years? Or, if a client invested $10,000 in a mutual fund eight years ago and it is now worth $24,000, what return did the client earn? If a client contributes $2,000 to a Roth IRA for 30 years and earns 9%, how Lesson 1 17

22 much will he or she have at the end of those 30 years? What is the difference if he or she invests at the beginning of each year or the end of each year? The former are just a sample of the real-world problems that can be solved with a financial function calculator. Problems center on five variables: 1. present value (PV) 2. future value (FV) 3. payment (PMT) 4. interest rate (I) 5. number of periods (N) Most time value of money problems provide three of these variables in the question and ask for a fourth variable as an answer. So the student should determine what is given and what is being asked for. The time value of money problems in the module are divided into the following categories: the future value of a current sum; the present value of an annuity due; and the future value of an ordinary annuity There are certain areas that cause problems for students when they do time value of money problems: 18 Chartered Retirement Planning Counselor

23 Forgetting to clear the calculator before each new problem. If the calculator is not cleared, certain numbers can remain in the calculator s memory and may cause an incorrect answer. Confusing an annuity due with an ordinary annuity. Annuities involve periodic payments. An important question is: When are the payments are made at the beginning of each period (an annuity due) or at the end of each period (an ordinary annuity)? An easy way to remember which is which is to think of bills coming due normally at the beginning of a month and link that to an annuity due (due = beginning). Check for reasonableness. For example, if $2,000 in contributions is made to an IRA for 10 years, assuming a positive return, we know the answer must be more than $20,000. Future Value of a Current Sum When we calculate the future value of a current sum, we are simply compounding that current sum at some rate of return. Here are the inputs for making a future value calculation, along with the ones you would use in solving the following common financial problem: If I invested $10,000 in a money market account that compounded at an annual rate of 5%, what would the account be worth after 10 years? Keystrokes Which Means Example Numbers PV Present (or current) value $10,000 N I/YR The number of periods over which compounding will take place 10 The interest (or inflation) rate at which the PV will compound 5% FV Future value $16, Lesson 1 19

24 Present Value of an Annuity Due The present value of an annuity due (PVAD) is handled as a reverse form of compounding. (An annuity due is a series of periodic payments for which the payment occurs at the beginning of each payment period; it is also known as an annuity in advance. In contrast, an ordinary annuity is a series of periodic payments for which the payment occurs at the end of each payment period. An ordinary annuity is also known as an annuity in arrears.) Every financial calculator can handle it if you know how to structure the problem and key in the right numbers. Set your calculator for payments at the beginning of the period using the keystrokes gold, BEG/END. The word BEGIN should appear in the display of your calculator. Here are the inputs for making a PVAD calculation: Keystrokes PMT N I/YR PV Which Means Payment in this case, the income deficit in year 1 of retirement The number of periods over which compounding will take place here, the anticipated span of retirement (in years) The inflation-adjusted yield on the retirement fund, which is determined by the after-tax rate of return (here 6%) on the fund and the inflation rate (here 4%) Present value of an annuity due what we need to determine Example. Helen has been promised a stream of $15,000 annual payments at the beginning of each year for a period of 10 years. She wants to know the present value of these payments, discounted at a rate of 7%. How would you structure the solution to this problem? Helen s problem can be structured and solved as the present value of an annuity due (PVAD). Note: As we mentioned above, before you try this on your calculator, be aware that the result will depend on whether the PMT is made at the beginning or end of the year. Your device will have a setting for each. Set yours to begin whenever you solve for an annuity due. 20 Chartered Retirement Planning Counselor

25 Here are the inputs for making a PVAD calculation, using Helen s numbers: Keystrokes PMT N Which Means Payment in this case, the income deficit in year 1 of retirement The number of periods over which compounding will take place here, the anticipated span of retirement (in years) Helen s Numbers $15,000 I/YR The interest rate 7% PVAD Present value of an annuity due $112, Inflation-adjusted interest rate. A common application for time value calculations over longer periods of time involves calculating an inflation-adjusted interest rate. This interest rate is a rate of return earned after overcoming the effects of inflation. Recently, inflation has been mild, causing many people to disregard the effect it can have on an individual achieving his or her goals. Yet, there is no guarantee that inflation will always be low; it must be a force to keep in mind. An approximate way of thinking about the inflation-adjusted interest rate would be to simply subtract the rate of inflation from the interest rate. For example, a 10% rate of return minus a 3% inflation rate would equal a 7% inflation-adjusted interest rate. However, we can be more precise with a simple formula that factors in the compounding effect over time: 1 + total return Inflation -adjusted interest rate = inflation rate Example. Cindy wants to have an annual retirement income of $50,000 protected against 3% inflation. Assuming an 8% after-tax rate of return and a retirement period of 25 years, how much money does Cindy need in order to provide the $50,000 at the beginning of each retirement year? Lesson 1 21

26 To solve this, we will need the inflation-adjusted rate of return: (( ) 1) 100 = To solve this with the Hewlett-Packard 10B or Hewlett-Packard 10BII financial calculator, the following keystrokes should be entered. Step Keystrokes 1. Clear the calculator. gold, Clear All 2. Ensure the number of compounding periods per year is accurate. In this case, 1 period is appropriate. Since we are calculating payments to Cindy, calculator should be set on begin. 3. Enter the known values in any order. 50,000, +/, PMT 4. Request the unknown value solve for PVAD. PV , I/YR 25, N The display will show the correct answer, in this case $749,813. Future Value of an Ordinary Annuity Suppose a client needs to save $500,000 for retirement over 31 years. The best way to address the problem is through a series of bite-sized, periodic investments. If these investments (PMTs) are of equal size, we can determine their future value in 31 years through a time value of money calculation called the future value of an ordinary annuity (FVOA). 22 Chartered Retirement Planning Counselor

27 Keystrokes Which Means Numbers PMT N Payment in this case, the dollar amount of each year s investment? The number of periods over which annual contributions will take place 31 I/YR The after-tax rate of return 8% FV Future value of an annuity due what these payments and their compounding will eventually total $500,000 Note: Unlike an annuity due which presumes that PMTs are made at the beginning of each period, the ordinary annuity presumes that PMTs are made at the end of each period. So be sure to set the switch on your calculator accordingly. Input FV, i, and n as described above, then press the PMT button. You should get $4,054. This is the amount that your client needs to invest at 8% after tax in each of the next 31 years if they hope to accumulate $500, Describe the problem of multiple financial objectives and a method for meeting each. Problem of meeting multiple financial objectives. Clients may have the following financial goals that conflict with their retirement goals: housing; education funds for their children; emergency funds; funds needed to care for elderly parents or a disabled child. A method for achieving several competing financial goals. One way to deal with this problem is to work with a client to prioritize the goals, and sequence them. Lesson 1 23

28 For example, a client who wants to buy a house, accumulate funds for education, and save for retirement could set up three investment accounts (one for each goal) and fund each with a pre-determined percentage of available investment resources, as shown below. Account Through Housing 70% College 20% 80% Retirement 10% 20% 100% As each top priority goal is fully funded, resources may be reallocated to the remaining goals in order of priority. Implement the financial plan. Implementation involves the actual investment of a retirement fund, a major subject in its own right. The following principles should be observed in implementing a retirement plan: Risk and return go hand in hand. Small differences in rates of return create big differences in outcomes over time. Diversification helps to manage risk. Some asset classes produce much higher returns than others. Tax-advantaged retirement vehicles should have priority over most other investment options. 24 Chartered Retirement Planning Counselor

29 Monitor the financial plan recommendations. The last step in the asset management process is monitoring performance. Monitoring performance, however, entails more than simply seeing how the investments are doing. It also incorporates monitoring outside factors such as tax, regulatory, and economic changes that might impact client progress toward accomplishing their goals, as well as changes in client situations that might require modifications or adjustments to their investments. The monitoring step is formalized by setting periodic meetings with clients to discuss the changes mentioned above. This is normally done at least annually, but can be more often if necessary. During these meetings, there should be a two-way exchange of information between the client and the investment professional. Monitoring the plan is an ongoing process and should continue for an indefinite period of time. Lesson 1 25

30 Lesson 2 Sources of Retirement Income and Legal Entities To enable you to reach the goal of this module, material is structured around the following learning objectives: 2 1 Describe the characteristics and uses of variable annuities and life insurance as retirement savings vehicles. 2 2 Describe the mutual fund and its use in retirement planning. 2 3 Describe characteristics of the Old-Age, Survivors, and Disability Insurance (OASDI) program. 2 4 Describe characteristics of employer-sponsored qualified retirement plans. 2 5 Describe characteristics of employer-sponsored nonqualified retirement plans. 2 6 Analyze a situation to determine the present value of income earned during retirement. 2-7 Explain the characteristics of the eight legal forms of business. 26 Chartered Retirement Planning Counselor

31 2 1 Describe the characteristics and uses of variable annuities and life insurance as retirement savings vehicles. Tax deferral. This objective focuses on the characteristics and uses of variable annuities and life insurance as retirement savings vehicles. One important characteristic of these vehicles is tax deferral. Tax deferral means that taxation of a contribution or investment outcome may be postponed. All things being equal, investment earnings grow more rapidly when they are tax deferred, because the amounts that would normally be siphoned off to pay current taxes are left in the account where they produce a return. Annuities In purest terms, an annuity is simply a series of payments, which may be received at either the beginning (annuity due) or the end (ordinary annuity) of a period. A commercial annuity, or what is commonly called an annuity, is a tax-deferred investment vehicle that can provide regular payments to the investor. Payments may be made for a specific amount, for a specific number of years, or for life. A fixed annuity guarantees the dollar amount of these payments. The variable annuity is simply one member of a large family of annuity products. In addition to being a tool to make a series of payments, today s commercial annuities also provide a vehicle to accumulate funds. All commercial annuities are issued by insurance companies because each annuity contains an element of insurance. Be sure the class learns the difference between an annuity and a life insurance policy. The similarities don t go much further than the fact that both can provide a stream of income, and that annuity payouts are determined by mortality tables. Annuities come in many forms, and the diversity can be confusing. Mention that you want to talk about a variable, joint and survivor, Lesson 2 27

32 flexible premium, deferred, refund annuity, and watch the students eyes glaze over. To help keep things straight, point out that there are some options that automatically negate others. An annuity will be either fixed-dollar or variable (not both), single-life or joint and survivor, immediate or deferred, single premium or flexible premium, or straight life or refund. Part of the confusion when dealing with annuities is not understanding that there are two phases to an annuity: the accumulation phase, where the annuity is built; and the payout phase, where the funds are disbursed. Of course, an immediate annuity has a very short accumulation phase. Variable annuities present a slightly different situation than fixed annuities. Fixed annuities deal with dollars and the insurer s general account. Variable annuities deal with accumulation units, separate accounts (subaccounts), and annuity units. Variable annuities are variable during both the accumulation and annuity (payout) phases. Although fixed options can be chosen, they generally don t make sense because of the higher fees associated with variable accounts. Be sure your students know the difference between the company s general account and a variable annuity s separate accounts. For example, variable annuities based on stock portfolios shift the burden of investment risk onto investors shoulders but offer investors the possibility of earning a higher rate of return. 28 Chartered Retirement Planning Counselor

33 Life Insurance There s much more to life insurance than term. This section explores the various types of permanent insurance in addition to the different forms of term. It s a good idea to ask students to check their biases at the door when discussing the different types of life insurance. Each type has its uses, and may or may not be an effective tool in a given circumstance. Term insurance. Term insurance offers pure life insurance protection. Term rates are determined using mortality rates and insurer administrative costs, which may include sales charges. The upside to term is its low initial premium. However, as the chances of a person dying increase with age, so do the premiums. Historically, term insurance has paid relatively few death claims. Why? Most people don t die young, and term rates get prohibitive as a person ages. In fact, so many people were dropping their life insurance as they aged because of sky-high premiums that insurance companies felt the need to respond. The insurer s response was permanent insurance. They added a premium to the basic term rates in order to keep payments level. They did this by investing the extra premium, so as real term rates increased, money could be drawn from the cash value to make those higher payments. Level premiums meant fewer dropped policies, and more insurance paying death claims. Be sure to stress that life insurance is not inherently an investment vehicle. The fact that cash values can be used as an investment may serve to obscure the real reason they exist. Having said that, several creative and valuable uses have been developed for life insurance cash values. Cash value life insurance. Cash value life insurance provides a death benefit and an element of tax-deferred savings. In contrast, term life insurance provides a death benefit equal to the face value of the policy if death occurs while the policy is in force. Though more expensive than term Lesson 2 29

34 life insurance per $1,000 of death benefit coverage, cash value life insurance relieves the client s family of the financial risk of an untimely death, while also representing a pool of financial value that increases tax deferred with time and with each premium payment. Whole life insurance. Whole life is a form of permanent cash value life insurance. A whole life policy has a stated face value, a lifetime term (generally to age 100), and often a level premium payment. Part of each payment pays for pure insurance and the expenses of the policy; the rest adds to a policy reserve, thus contributing to the policy s cash value. The policy is normally structured so that the guaranteed cash value will equal the policy s face amount by age 100. The build-up in value makes cash value life insurance useful in retirement planning. Whole life (sometimes called ordinary life or straight life ) is, in effect, a decreasing term life policy with a savings account. Universal life insurance. The life insurance policies described thus far have all been predictable as to premiums, death benefits, and the guaranteed cash value of fully paid-up policies. Only dividends add an element that is not set in stone. With universal life, however, policy face values, cash values, and even premiums are flexible. Universal life combines the characteristics of term insurance and a side fund that is responsive to changing interest rates. Premium dollars are used to pay for insurance protection and the expenses of the policy. The maximum cost of insurance is spelled out in the policy itself, although most companies actually charge a much lower rate. The remainder of the premium is used to increase the cash value of the policy. This cash value is credited, with interest, at the company s currently specified interest rate for such policies; the rate fluctuates over time. (There is a guaranteed rate in the contract, but the current rate, which is announced for a specified period, is often higher.) 30 Chartered Retirement Planning Counselor

35 Variable life insurance. Owners of whole life policies face the same inflationary problem as owners of fixed annuity contracts: If the cost of living rises faster than the rate at which the company guarantees to compound accumulated savings, purchasing power will erode. To deal with this, many companies offer variable life policies in which the growth of cash value varies with investment return. Variable life, like whole life, provides a face amount of insurance, payable at death, and a savings element. That savings element may be invested in stocks, bonds, or money market instruments. This fact, as with the variable annuity, makes growth of cash value a function of premium payments and investment performance. The death benefit may also vary, but insurers are required to guarantee that the face amount of the variable life policy will never be less than the originally issued face amount, no matter what investment returns are experienced. 68). The following are important features of variable life to remember: Premiums are fixed, but face amounts and cash values vary with investment performance. Cash value grows on a tax-deferred basis. The policyholder selects the investment account from among those offered for the policy, and usually enjoys flexibility in shifting cash value among a number of investment funds, each having a different investment objective. Similar to variable annuities, the burden of investment risk is shifted onto investors shoulders. However, the variable contracts provide investors an opportunity to possibly earn much higher rates of return. Variable universal life insurance. Variable universal life contracts combine features of a variable contract and a universal contract. As with a variable life contract, separate accounts are provided for investments in money market, stock, or bond funds. The cash value account varies based Lesson 2 31

36 upon the performance of the investments within the account. As with a universal life contract, a variable universal life insurance contract allows for premium flexibility the policyholder can vary the amount of premium paid each month. A variable universal life insurance contract also allows for some flexibility in the face amount of the contract. The following are important features of variable universal life to remember: Premiums are flexible and the policyholder can make adjustments with the premium paid. Death benefits can be increased or decreased (within limits) at the option of the policyholder without starting a new policy. (Certain increases may require supplemental application and, perhaps, medical underwriting.) Cash value grows on a tax-deferred basis. The policyholder selects the investment account from among those offered for the policy, and usually enjoys flexibility in shifting cash value among a number of investment funds, each having a different investment objective. The policyholder can make withdrawals or borrow from the policy. Income Tax Implications for Life Insurance Policies that Have Cash Value The basic principles of income taxation that apply to any life insurance policy in which there is a cash value are: Increases in cash value generally accumulate on a tax-free or taxdeferred basis. 32 Chartered Retirement Planning Counselor

37 If a cash value policy is surrendered, the amount of the cash surrender value that exceeds the total net premiums paid is subject to taxation as ordinary income. Some policies pay dividends; these are not taxable because they are a credit to living policyholders for excess premiums collected by the company. However, if dividends accumulate at interest, the interest element is currently taxable income. Loans taken against cash value are not taxed as income. One exception is when a policy is classified as a modified endowment contract (i.e., it has failed the seven-pay test). In that case, withdrawals are taxed on a LIFO (earnings first) basis. Death benefits generally pass to beneficiaries tax free. However, any subsequent earnings on death benefits are subject to tax. This applies equally to lump-sum payouts and to funds left with the insurance company for payment via any of the settlement options. Borrowing Against Cash Value Policies One special and useful feature of cash value life insurance is the provision that makes it possible for a policyholder to borrow an amount equal to some or all of the policy s accumulated cash value. Policyholders can borrow an amount equal to some or all of their accumulated cash value. Typically, loans can be made up to the current surrender amount of the policy (less one year s interest). Interest charges are not tax deductible for individuals. Insurance vs. Investment Buy term and invest the difference has been the rallying cry of many investment professionals through the years. Like Rodney Dangerfield, permanent life insurance policies often get no respect. Valid reasons to Lesson 2 33