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Essentials of Personal Financial Planning



Essentials of Personal Financial Planning was written to challenge the status quo by promoting personal financial planning (PFP) as a profession, not as a sales tool to gather assets under management or facilitate sales of insurance products. The book takes a comprehensive and integrated approach to PFP for accounting students, allowing them to view the profession through the lens of a CPA - with integrity and objectivity. This book systematically introduces the essentials of all the major PFP topics (estate, retirement, investments, insurance, and tax), as well as:

  • The PFP process, concepts and regulatory environment.
  • Professional responsibilities of a CPA personal financial planner and the requirements of the Statement on Standards in PFP Services.
  • Time value of money concepts.
The book then builds on these foundational concepts, showing their interconnectivity and professional opportunities, to provide a deeper understanding of PFP and its application. After reading this book, students will be able to apply the knowledge and skills gained from this course to have an immediate and long-term positive impact for themselves and for the clients they serve.

Susan M. Tillery, CPA/PFS, is President and CEO of Paraklete Financial Inc. Paraklete provides integrated fee-for-service financial planning without asset management or product sales. The firm acts as an Advocate in Financial Services for its clients with a disciplined focus on independence and objectivity. Susan is also a co-founder and president of Financial Planning Advocate LLC, a provider of continuing education for CPAs, financial advisers, universities and colleges.

Ms. Tillery’s experience at Harris myCFO, a multi-family office where she was responsible for the development and delivery of comprehensive family office solutions to affluent families, together with her work at Arthur Andersen, Ronald Blue & Co and other financial firms, provides the framework for Paraklete.

Susan earned both her bachelor’s and master’s degrees in accounting from the University of Georgia. Susan is a member of the American Institute of CPAs (AICPA) and the Georgia Society of CPAs (GSCPA). In addition, she is chair of the AICPA Personal Financial Planning Credential Committee. Susan also serves on the Board for The National Center for Stewardship and Generosity.

Susan has over 30 years of experience in tax, philanthropy and financial planning, as well as in the administrative and compliance areas encountered by affluent individuals and families. Ms. Tillery speaks on the topics of: Financial Planning, CPAs and Financial Planning, Financial Issues Facing Women, Responsibilities of Wealth, Charitable Giving and Stewardship.

Thomas Neal Tillery, CFP, AEP, CLU, ChFC, CRPC, LUTCF is Vice President and Chief Compliance Officer of Paraklete Financial Inc. Tom also is a co-founder and Vice President of Financial Planning Advocate LLC, a provider of continuing education for CPAs, financial advisers, universities and colleges.

Tom earned a M.S. in financial services from The American College and an M.A. in education from The Southern Baptist Theological Seminary. He is an active member of AICPA (Non-CPA Associate), the Atlanta Estate Planning Council and the Society of Financial Service Professionals. He also serves on the Board for The National Center for Stewardship and Generosity.

With more than 30 years of experience in personal financial planning, Tom is a frequent speaker and writer on all topics relating to personal financial planning. He has written personal financial planning curriculum for several universities and online providers. Tom has been a provider of continuing education for attorneys, CPAs and investment and insurance professionals for over 30 years.

Susan, Tom and their family reside in Kennesaw, GA.

Introduction xiii

Chapter 1: Personal Financial Planning 1

Introduction 2

Phases of the Personal Financial Planning Engagement 2

Engage 3

Discover 4

Analyze 5

Recommend 5

Expanded or Additional Engagements 6

Behavioral and Psychological Methods of Building Client Rapport 8

Active Listening 8

Behavioral Biases and Heuristics 9

Socratic Questioning 9

Application of Behavioral Techniques to Client Relationships 10

Gathering Data: Quantitative Versus Qualitative Data 12

Quantitative Data 12

Qualitative Data 13

Risk Tolerance 14

Life Planning and the Personal Financial Planning Process 14

Chapter Review 16

Chapter 2: The Statement on Standards in Personal Financial Planning Services No. 1 19

Introduction 20

The Pathway to Standards in PFP 21

A Timeline of Personal Financial Planning in the United States 21

Statement on Standards in Personal Financial Planning Services 23

Personal Financial Planning Services 24

Applicability 26

Requirements of the Member 27

Steps in a Personal Financial Planning Engagement 27

Planning the PFP Engagement 27

Selecting Other Service Providers 28

Obtaining and Analyzing Information 28

Developing and Communicating PFP Recommendations 29

Other Types of Personal Financial Planning Engagements 29

Implementation Engagement 29

Monitoring Engagement 30

Updating Engagement 30

Chapter Review 30

Chapter 3: Time Value of Money Concepts 35

Introduction 36

Tools for Calculating Time Value of Money 36

Efficiency 37

Establishing Realistic Expectations 37

Fundamental Time Value of Money Functions 38

Present Value 39

Periods (n) 39

Interest (i) 40

Payment (PMT) 41

Future Value (FV) 42

Mode 42

Examples 43

Unequal Cash Flows 46

Present Value 47

Net Present Value 48

Internal Rate of Return 48

Serial Payments 48

Examples 49

Chapter Review 52

Chapter 4: Fundamentals of Personal Financial Planning 57

Introduction 58

Personal Financial Planning Assumptions 58

Personal Statement of Financial Position 60

Spending Plan 62

Financial Ratios 65

Debt-to-Income Ratio 65

PITI Ratio 66

Savings Ratio 66

Emergency Fund 69

Financing Strategies 69

Automobile Purchase or Lease 70

Home: Purchase or Rent 70

Bankruptcy 74

Consumer Protection Issues 74

The Fair Credit Reporting Act and Identity Theft 74

Electronic Fund Transfer Act 75

Fair Credit Reporting Laws 75

Chapter Review 76

Chapter 5: Estate Planning Basics 79

Introduction 80

Fundamentals of Estate Planning 80

The Unified Tax System 81

Generation Skipping Transfer Tax 81

Credits, Deductions, and Other Tax Reductions 81

Step Up In Basis 83

Probate and Intestacy 83

Expatriate Issues 84

Impact of Property Ownership and Beneficiary Designations 84

Community Property and Common Law 84

Basic Estate Planning 85

Data Gathering 86

State Estate Tax 87

Estate Tax Filing Requirements 87

Gross Estate 88

Adjusted Gross Estate 88

Prior Transfer Credit 88

Sources for Estate Liquidity 89

Estate Planning Documents 89

Wills 89

Powers of Attorney 90

Advance Medical Directives 90

Beneficiary Forms 91

Trusts 91

Crummey Power 92

Testamentary Trust 92

Powers of Appointment 92

Chapter Review 93

Chapter 6: Charitable Gift Planning Basics 97

Introduction 98

What is a Charity? 98

Types of Gifts 99

Real Estate 100

Personal Property 100

Charitable Trusts and Planning Tools 101

Charitable Lead Trust 101

Charitable Remainder Trust 102

Wealth Replacement Trust 104

Pooled Income Fund 104

Other Charitable Vehicles 104

Taxation and Income Tax Planning 105

Application of Limitations 105

Carryovers of Excess Charitable Contributions 106

Tax Impacts of Transfers 107

Qualified Charitable Distributions 108

Chapter Review 109

Chapter 7: Principles of Risk and Insurance 113

Introduction 114

Risk Management Concepts 114

Risk 114

Peril and Hazard 115

The Law of Large Numbers and Adverse Selection 115

Self-Insurance 116

Managing Risk 116

Controlling Risk 116

Financing Risk 117

The Risk Management Process 117

Risk Management Matrix 118

Insurance Policy and Company Selection 119

Types of Insurance 120

Life/Health/Disability 121

Property Risk and Insurance 121

Legal Aspects of Insurance 123

Offer and Acceptance 123

Adequate Considerations 124

Competent Parties 124

Legal Purpose 124

Legal Form 124

Chapter Review 125

Chapter 8: Insurance Planning Basics, Part I 129

Introduction 130

Life Insurance 130

Life Insurance Types 131

Term Life Insurance 132

Permanent Life Insurance 132

Additional Life Insurance Policy Considerations 134

Contractual Provisions of Life Insurance 134

Riders 135

Nonforfeiture Options 136

Settlement Options 137

Advanced Death Benefits 138

Health Insurance 139

Hospital, Surgical, and Physician’s Expense Insurance Plans 139

Managed Care Plans 140

Medicare (Parts A, B and D) 141

Medicare Supplement Insurance (MEDIGAP) 142

Medicare Advantage Plan (Part C) 142

Medicaid 142

Tricare 143

Health Savings Accounts and Other Tax-Favored Health Plans 143

Health Savings Accounts (HSA) 143

Health Flexible Spending Arrangements (FSA) 144

Health Reimbursement Arrangements (HRA) 144

Chapter Review 144

Chapter 9: Insurance Planning Basics, Part II 149

Introduction 150

Annuities 150

Deferred Fixed, Variable, or Equity-Indexed Annuity 150

Taxation 151

Payment Options 151

Disability Insurance 152

Own Occupation Versus any Occupation 152

Continuance Provisions 153

Additional Provisions 154

Long-term Care Insurance 155

Qualified Care 155

Taxation and Income Tax Planning 156

Medicare Limitations 156

Property and Casualty Insurance 157

Homeowners Insurance 157

Personal Auto Insurance 161

Umbrella Liability Insurance 164

Chapter Review 164

Chapter 10: Investment Basics 169

Introduction 170

Securities Defined 170

The Role of the Personal Financial Planner and Compensation 170

Business Models 172

Broker-Dealer Model 172

Registered Investment Adviser (RIA) Model 172

Dual-License Model 173

CPA Disclosure Requirements 173

The Investment Planning Process 174

The Planning Phase 174

Determine and Prioritize Client’s Specific Financial Goals 175

Client’s Financial Condition 175

Assessing Risk Tolerance 175

Identify Unique Needs 176

Identify Potential Client Investment Constraints 177

Chapter Review 178

Chapter 11: Investment Planning 181

Introduction 182

Capital Markets 182

Types of Investment Vehicles 183

Cash and Cash Equivalents 183

Guaranteed Investment Contract 185

Bond 185

Stock 190

Mutual Fund 190

Exchange Traded Fund 191

Real Estate 192

Alternative Investments 192

Investment Valuation 193

Investment Strategies 194

Market Timing 194

Dollar-Cost Averaging 194

Systematic Withdrawal Plan 195

Bond Ladder 195

Option Strategies 195

Short Selling 195

Margin Account 196

Chapter Review 197

Chapter 12: Planning for Retirement and Financial Independence 199

Introduction 200

PFP Assumptions for Financial Independence 201

Inflation 201

Life Expectancy 202

Financial Independence Spending Plan 203

Modeling Techniques 204

Investment Returns 204

Income Sources 205

Time Value of Money and Inflation-Adjusted Return 208

Mini Case Study 208

Chapter Review 210

Chapter 13: Planning Vehicles for Retirement 215

Introduction 216

Social Security Benefits 216

Eligibility and Benefits 217

Spousal Benefits 218

Working After Retirement 218

Taxation of Benefits 219

Government Pension Offset 219

Railroad Employees 219

Employer-Sponsored Retirement Plans 219

ERISA: Overview of Qualified Plan Rules 221

Vesting 223

Defined Benefit Plans 224

Defined Contribution Plans 226

Other Retirement Plans 232

Additional Employer-Sponsored Retirement Plans 234

Individual Retirement Accounts 234

Spousal IRA 235

Nondeductible IRA 235

Roth IRA 235

Roth IRA Conversions 236

Chapter Review 236

Chapter 14: Elder Planning Basics 239

Introduction 240

Nonfinancial Factors 240

Types of Care 241

Communicating with Cognitively Impaired Clients 242

Incapacity and Incompetency 242

Financial Decisions 243

Financial Fraud 243

Housing Decisions 244

Health Care Options 245

Government Programs 245

Veterans Benefits 247

Funding Sources for Elder Care 248

Taxation and Income Tax Planning 250

Filing a Tax Return 250

Medical Expenses 250

Home Care 251

Long-Term Care 251

Integration and Application of Elder Planning with Personal Financial Planning 251

Estate Planning 251

Advance Directives 252

Health Care Proxy 252

Power of Attorney and Durable Power of Attorney 252

Chapter Review 254

Chapter 15: Education Planning Basics 257

Introduction 258

Funding Methods 258

Qualified Tuition Programs (529 Plans) 258

Coverdell Education Savings Accounts 260

Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) 261

Education Savings Bond Program 261

Financial Aid 262

Federal Student Aid 262

Scholarships 264

Loans 264

Taxation and Income Tax Planning 265

Taxation of Scholarships and Grants 265

Credits 265

Deductions 266

Educational Assistance Program 267

Integratuion and Application of Education Planning with PFP 267

Risk Management and Insurance Planning 267

Retirement Planning 267

Estate Planning 268

Investment Planning 268

Education Needs Analysis Case Study 268

Step One--Calculate the Future Value of One-Third of the Cost of College 269

Step Two--Calculate the Present Value of the Serial Payments Need to Fund College 269

Step Three--Calculate the Total Amount Needed 270

Chapter Review 270

Chapter 16: Applications in Estate Planning 273

Introduction 274

Trusts Revisited 274

Credit Shelter Trust 274

Marital Trust 275

Qualified Terminable Interest Property Trust 275

Disclaimer Trust 275

Additional Trust Types 276

Gifting Strategies 277

Interest-Free Loans 277

Installment Sales to Family Members 277

Self-Cancelling Installment Note 278

Additional Tax Issues 278

Generation-Skipping Transfer (GST) Tax 278

Income in Respect of the Decedent 279

Closely Held Business Issues 280

Special Valuation Under Section 2032(A) Farm and Real Estate 280

Section 6166 Deferrals of Estate Tax 280

Buy-Sell Agreement 281

Section 303 Redemption 282

Other Estate Planning Considerations 283

Qualified Domestic Trust 283

Planning for Blended Family Relationships 283

Cohabitation 284

Integration and Application of Estate Planning with PFP 284

Life Insurance 284

Retirement Planning 285

Private Foundation 285

Chapter Review 285

Chapter 17: Applications in Risk Management 289

Introduction 290

Life Insurance Applications 290

Life Insurance Illustrations 290

Settlements 291

Modified Endowment Contracts 293

Transfer for Value Rules, Section 101(A)(2) 293

Section 1035 Exchanges 294

Impact on Other Aspects of Personal Financial Planning 294

Annuities 296

Medical Insurance 296

Taxation and Income Tax Planning 296

Affordable Care Act 297

Healthcare Marketplace--Individual and Small Employer 298

Premium Tax Credits 298

Individual Shared Responsibility Provision 298

Employer Shared Responsibility Provision 298

Disability Insurance 299

Long-term Care Insurance 299

Taxation and Income Tax Planning 299

Retaining the Risk--The Self-Insurance Option 300

Integration and Application of Long-Term Care Insurance with Personal Financial Planning 301

Property and Casualty Insurance 301

Additional Insured Endorsement 301

Taxation and Income Tax Planning 302

Business Owners Insurance 302

Chapter Review 303

Chapter 18: Applications in Investment Planning 307

Introduction 308

Perform Financial Analysis 308

Investment Risk 308

Taxation and Income Tax Planning 309

Assess Impact of Constraints 309

Asset Class Allocation Strategy 310

The Investment Policy Statement 310

The Monitoring and Updating Phase 315

Measuring Performance and Goal Achievement 316

Reevaluation of the IPS 317

Integration and Application of Investment Planning with PFP 317

Risk Management and Insurance Planning 317

Planning for Financial Independence 318

Estate Planning 318

Charitable Planning 318

Chapter Review 319

Chapter 19: Applications in Planning for Retirement 323

Introduction 324

Employer Considerations 324

Contribution Limits 325

Defined Benefit Plans 325

Defined Contribution Plans 327

Retirement Distribution Optimization Planning (Income Management) 328

Avoiding Early Withdrawal Penalties 329

Employer Stock and Net Unrealized Appreciation (NUA) 330

Required Beginning Dates and Minimum Distributions 332

Annuity Options 333

Lump-Sum Distributions 334

Qualified Domestic Relations Order 335

Income Tax Issues 336

Incorporating Tax Rate Diversification in the Choice of Retirement Savings Vehicles 336

Impact of Tax-Loss Harvesting in the Retirement Planning Process 336

Investment Management During Retirement 338

Withdrawal Rates 339

Asset Allocation 339

Integration and Application of Retirement Planning in the PFP Process 340

Life Expectancy 340

Asset Protection 340

Chapter Review 341

Chapter 20: Applications in Employee Benefits Planning 345

Introduction 346

Group Insurance Benefits 346

Group Disability Insurance 346

Group Life Insurance 347

Group Medical Insurance 348

Section 125 Cafeteria Plans 350

Group Long-Term Care Insurance 351

Group Dental Insurance 351

Group Vision Insurance 351

Other Employee Benefits 352

Fringe Benefits 352

Adoption Assistance Program 353

De Minimis Benefits 353

Employee Achievement Awards 353

Educational Assistance Program 354

Prepaid Legal Services 354

Retirement Planning Services 354

Job Placement or Outplacement Services 354

Meals 354

On-Premise Athletic Facilities 355

Qualified Moving Expenses 355

Chapter Review 355

Chapter 21: Applications in Executive Compensation Planning 359

Introduction 360

Executive Compensation Agreements 360

Employment Agreement 360

Severance Agreement 360

Noncompete Agreement 360

Other Arrangements 361

Nonqualified Deferred Compensation 363

Funded and Unfunded Plans 364

Types of Nonqualified Deferred Compensation Plans 364

Equity Compensation Plans 365

Restricted Stock Plan 366

Phantom Stock Plan 366

Qualified Employee Stock Purchase Plan 367

Incentive Stock Option and Nonqualified Stock Option 367

Stock Appreciation Right 368

Section 83(B) Election 368

Top-Hat Plan 369

Chapter Review 369

Chapter 22: Applications in Personal Financial Planning in Special Circumstances 373

Introduction 374

Housing 374

Sale of Principal Residence 374

Vacation Home 376

Household Employees 376

Closely Held Business Basics 378

Entity Selection Process 378

Application of Trusts 382

Employing Spouse or Children and FICA Taxes 382

Business Applications of Insurance 382

Divorce 383

Income Tax Considerations 384

Statement on Standards in Personal Financial Planning and Conflicts of Interest 385

Chapter Review 385

Chapter 23: Delivery Models and Regulatory Issues 389

Introduction 390

Regulatory Landscape 390

Regulatory Bodies 390

Significant Federal Legislation 391

Significant State Legislation 392

Financial Services Industry Regulations and Requirements 393

Securities Licensing 393

Insurance Licensing 394

Regulatory Investment Reporting 395

Delivery Platforms (Business Models) 395

Investment Advisers 395

Registered Investment Adviser 397

Broker-Dealer 398

Insurance Company 398

Trust Company 398

Chapter Review 399