Planning Personal Finance - Assignment Example

PLANNING PERSONAL FINANCE By of the of the School Liam and Irene are unsure about which offer to accept for their old house. Advise them as to which one would be best for them, giving your reasons. The best option for them is a £193,200, with a moving in date of one month because of the following reasons. It provides the highest return in just a month’s time of £3200. The money can then be used to repay their monthly mortgage payment of £425 hence remaining with £2775. The second reason is the argument of the time value of money which states that an amount paid today is worth more in the future. So the money received now will be invested to generate more in the future. This will also ensure that the house does not remain vacant and idle. The earlier the amount is received, the earlier they will use the proceeds to settle their old mortgage so that they can only remain with one mortgage at a time hence reducing many expenses (Hallman & Rosenbloom, 2003, pg. 94). 2. What advice would you give to Liam regarding his distillery company shares? The rise or fall in stock prices occurs basically because of a variety of reasons. Some of the cause of short term but sharp fall includes negative news about the whole economy, natural disasters, war news, political shifts and gluts of goods. The sharp fall leads to considerable reduction in stock prices in the market hence the sale of the shares will fetch a little amount thus leading to a loss. This therefore implies that Liam should continue holding the shares to speculate against share price increase. With time the share prices will rise as the negative news fades in the market. He should also continue holding the shares in memory of his dad. Further, he is obliged to hold them and hence should not sell them in the near future (Swart, 2002, pg. 34). 3. Explain to Liam’s mother whether and why you think she is right or wrong regarding her feelings about perhaps being better off with a PHI policy rather than the Critical Illness policy. Long term illness causes people to be absent from work for more than 6 months thereby leading to financial hardship to the victims. PHI is therefore the answer to such a condition. Liam’s mother should have therefore taken PHI policy. This is because it is an income replacement insurance, personal disability insurance, long-term disability insurance, income protection insurance or disability income insurance. It therefore pays income that is designed to protect a person’s standard of living on a regular basis in case one suffers a long term sickness like the case of Liam’s mother. It ensures continuous income flow because the payments are made until one dies, return to work or until the policy term expires, whichever occurs first. It would have made Liam’s mother better off than the lump sum payment. This is because the policy is long term in nature hence enabling her to cover for her core monthly financial commitments and obligations such as food, bills, mortgage and rent. Permanent Health Insurance provides regular periodic payments hence are able to take care of future consumption unlike Critical Illness policy which provides a lump sum payment thereby concerned about present consumption only thereby making Permanent Health Insurance the best policy (Llp et al, 2004, pg. 27). 4. Read carefully what Liam and Irene have said regarding their life insurance needs and school and university fees plans. Bearing in mind all they have said, what advice would you give to them? The family has numerous risk exposures in their daily life activities. The risk exposure includes accidents and fire. The family has a car hence most likely to get an accident. They are also members of the golf club and are again most likely to get an accident through injuries. They also go for horse riding and yachting when weather allows. In addition the two have kids to educate. All these factors contribute to their vulnerability to financial hardship should an unlikely event occur in the process. It is therefore advisable that they take an insurance policy so that their future cash flow is taken care of. School fees are paid on regular basis hence after tax income is not the best source of school fees. They should therefore establish a school fee plan that will help them save sufficient money to ensure efficient means to manage their fee payments. School fee plans also offer the most tax efficient means to pay the school fees and in turn offering some form of protection to their money. This will enable their children to get education until university level (Little, 2007, pg. 24). Liam and Irene should also take a permanent Health Insurance because it ensures that their income needs is taken care of. To cover their children lives. They should take a personal life insurance for both of them. This will ensure that their Children’s are covered from any risk such as sickness, accident, and illness. Finally, Liam and Irene should take property insurance for their home to protect it against weather damage, fire and theft (Little, 2007, pg. 39). 5. Basically employers are required to set up an occupational pension scheme for all of their employees. In this case Liam has a public sector occupational pension scheme. In his case the pension is on accrual of 1/80th of his final remuneration for each year he serves at the company for a maximum of 40 years together with a tax free lump sum of three times his pension (Harrison, 2004, pg. 14). The family’s current financial position is still low because only one person has been contributing and should they retire now they will not get sufficient amount to sustain them. Irene should make a pension arrangement so that she can start making pension contributions. Both of them should make an annual pension contribution of £3600 or more so that they can benefit from a tax relief on the contributions made. This tax relief is subject to their annual contribution allowance as well as their level of their earnings. This will therefore increase their tax efficiency in the long run. This is because when one is in drawdown they can basically take their income allowance in full. With money purchase pension savings, they have the opportunity to greatly improve their tax efficiency thus their overall long term wealth.to achieve this they should opt to use all or some of their pension that is available to aid build new untouched pension savings (Harrison, 2004, pg. 31). Those in drawdown and have taken their tax free lump sum have a great opportunity to also improve their tax efficiency of the respective savings with no real cost in case they are not using all the income that is available. This planning will help them reduce their potential tax liability on the available lump sum to their beneficiaries in case they die before 75 years (Harrison, 2004, pg. 12). In addition, the planning will generate a 25% tax free lump sum to their beneficiaries hence helping them to have a greater income or return in the longer term thereby building a more effective strategy for their retirement income. Amount to be received in retirement Liam Contribution is 8% of his salary Contribution =8%*6200= £4960 In ten years he has contributed a total of £ (4960*10) = £49600 Tax free lump sum is thrice his contribution. Therefore tax free lump sum is 49600*3= £148800 Total contributions for Liam is therefore 49600+1488000= £ 198,400. Irene Suppose she also takes the same policy. She will contribute (60-360/80)*26000= £7800 yearly. So in 245 years she will have contributed £ 187200 Their combined contribution will be (£198400+187200) = £ 385600 6. In order to arrive at tax liability for an individual, we need to determine the adjusted gross income (AGI). AGI is defined as a measure of income that is particularly used to determine the amount of money or someone’s income that is to be taxed. It is calculated as ones gross income arising from taxable sources minus all the necessary allowable deductions. These deductions include items like alimony, unreimbursed business expenses, deductible retirement plan contributions and medical expenses. These adjustments to income are also known as above-the-line deductions. We are therefore going to determine all sources of income for the family then deduct all the basic deductions in order to arrive at the tax liability (Hodgetts, 2003, pg. 126). Sources of income, cash inflows Liam Salary £62000 Cash receipts from the sale of the old house £ 193200 Interest income £ 20 Dividend income £ 440 Sale of the shares £ 6250 Total cash inflow 62000+ 193200+ 20+440+6250= £261910 Cash out flows Payment towards charity £ 800 School fees £ 3600 Mortgage repayment £1000*12= £ 12000 House insurance payment 130*12= £1560 Pension contribution= £ 4960 Total cash out flow= 800+3600+12000+1560+4960= £22920 per year Taxable income £ 261910-22920= £238990 Taxation: Salary: first £31865 (0.2*31865) = £6373 Second £31135(0.4*31135) = £12454 Dividend income (0.1*440) =£ 44 Savings income: (0.1*6250=£ 625 Sales tax= 0.2*238990= £47798 Total tax liability 47798+625+44+12454+6373= £67294 Irene Cash inflow Salary £ 26000 Interest on treasury stock 4.75%*8000= £380 Total cash inflow 26000+380= £26380 Cash out flow Purchase of treasury stock £8000 Net cash inflow = 26380-8000= £18380 Tax liability: since it falls between 0-31865 we use 20% Tax liability for Irene is therefore 0%*18380= £3676 Total tax liability for both of them 67294+3676= £70970 7. In view of her tax status, advise Irene whether it is better to sell the 4.75% Treasury stock 2022 or keep it until redemption date. Provide evidence to support your reasoning. What are the gross interest yield on the stock and the net redemption yield on the stock? From Irene’s tax status it is better to keep the treasury stock until redemption date because she is going to earn more return due to the high gross interest yield as outlined below. Current price (8000/100)*114= £9120 Redemption cost 1.0475^8*8000= £11596.37 Gross interest yield (449.55/8000)*100= 5.62% Net redemption yield= 11596.37-8000= £3596.37 8. Differences between low-cost endowment mortgage and capital and interest repayment one. Low cost endowment mortgage is one that the mortgage loans are basically arranged on an interest only basis. This is where the capital amount is usually intended to be repaid using one or more endowment policies. Low cost endowment enables a customer to pay only interest on the borrowed capital thereby helping them save money that would go to the ordinary loan repayment hence making payments to the endowment policy instead. This therefore implies that the investment that is made through this endowment policy is going to be sufficient to repay the loan at the expiry of the term and even create a surplus in cash. Because the premiums are invested in low risk, this policy has a moderate risk. In addition, it also provides a bonus to the investor which adds back to the policy. At the maturity of the contract, an insurance company gives a final bonus on the policy which may be greater than or equal to the mortgage (Garrett, 2012, pg. 83). Repayment mortgage on the other hand, has a repayment amount consisting of both interest and capital hence ensuring that there is a slight decrease in the capital amount each time a repayment is made. Each repayment therefore reduces the outstanding debt. Early years of repayment shows that a bigger chunk of the amount repaid goes towards interest repayment. 9. Differences between lump sum payment and regular savings scheme. Regular savings scheme, monthly savings scheme implies that one invests a specified amount each month on a regular basis into the foreseeable future. This amount can be as low as £20 per month however most of the funds have a monthly minimum contribution of £50. Lump sum payments on the other hand have a minimum lump sum investment requirement of £500. From the above requirements it is evident that monthly savings scheme is better that the lumps sum payment because it has a low minimum contribution requirement (Garman & Forgue, 2011, pg. 4). Further, regular investments in small amounts benefit an investor from the standpoint of ‘pound/cost averaging.’ This is so because when the market fall, the small amounts of regular contribution will definitely purchase or fetch more units due to the low unit price. In contrast, when there is increase in value over time, the subsequent units in possession or your holding will automatically be worth more than in the case of lump sum payments (Garrett, 2012, pg. 49). Regular savings plan, monthly contribution scheme, eliminates the worry of market timing for instance the worry that one is investing at the ‘wrong’ time because the contribution is spread over a long period of time unlike lump sum payment which is a one period event. Regular savings plan eliminates wrong timing worry by giving the investor a hope that pound/cost averaging will over time out the troughs and peaks. 10. APR calculation To determine the amount to be paid as interest on the credit we divide the rate by two, and then multiply it by the number of periods. The rate got is then multiplied by the amount borrowed to get the total interest on the credit (French, 2006, pg. 76). (7.9/2)* 5=19.75% Interest on the credit= 19.75%*14500= £2863.75. The total interest to be paid on the credit is therefore £2863.75 To get the APR, divide the interest on credit by the number of the periods which in this case is 5. (2863.75/5)= £572.75 They will therefore pay £572.75 towards the interest repayment each year. The APR is therefore the yearly interest repayment divided by the total credit: (572.75/14500)100%= 3.95% per annum. 11. compound interest calculation a. £7,000 deposited at 2.95% over 5 years. A=P (1+r) ^n A= 7000(1+0.0295) ^5 A= £8095.24 Compound interest= 8095.24-7000 =£1095.24 b. On a balance of £13,826.81 inclusive of compound interest at 2.35% over 4 years. How much, therefore, is the original capital sum deposited in this case? This question requires one to calculate the principal that when invested at 2.35% per annum in four years will generate £ 13826.81. Using the formula A=P (1+r) ^n (Altfest, 2007, pg. 45) we substitute the available elements of the equation so that we have it in the form 13826.81=P (1.0235) ^4. To get the principal we divide 13826.81 by 1.0235^4 as shown below P=13826.81/1.0235^4 P=£ 12600 The amount that when invested at 2.35% for four years to generate £ 13826.81 is therefore £12600 References Altfest, L. J. (2007). Personal financial planning. Boston, McGraw-Hill Irwin. French, D. W. (2006). Introduction to personal financial planning & investing. Dubuque, Iowa, Kendall/Hunt Pub. Garman, E. T., & Forgue, R. E. (2011). Personal finance. Australia, South-Western Cengage Learning. Garrett, S. (2012). Personal finance workbook for dummies. Hoboken, N.J., Wiley Hallman, G. V., & Rosenbloom, J. S. (2003). Personal financial planning. New York, McGraw-Hill Harrison, D. (2004). Personal financial planning: theory and practice. Harlow, Financial Times Prentice Hall. Hodgetts, R. M. (2003). Personal financial management: a strategic planning approach. Reading, Mass, Addison-Wesley. Little, K. (2007). Personal finance at your fingertips. New York, Alpha Books. Llp, E. &. Y., Nissenbaum, M., & Raasch, B. J. (2004). Ernst & Youngs Personal Financial Planning Guide. Hoboken, John Wiley & Sons. Swart, N. (2002). Personal financial management. Lansdowne, Juta. Read More