Personal Wealth Management - Case Study Example

Personal wealth management Name; Course: Tutor: Date of submission: A. SHORT TERM AND LONGTERM OBJECTIVES Short Term Reducing the Credit card bills Ensuring sustainable living standards is one of the ways that effectively steer planners towards achievement of the set goals. The couple currently has a relatively large amount of credit card bill accruing. Therefore, a reduction of the credit bills means that the couple will have increased their net worth through reduction of the value of liabilities. The couple has credit card bill amounting to $20,000 which also implies that they will incur additional expenses in accumulated interest rates. The ultimate plan is to keep the value of credit card bills lower than they are in the current financial structure. The plan of the couple is to cut the credit card bill from an average of $20,000 to below $10, 000. This can only be achieved through adoption of payment strategies that will discourage use of the credit cards or a credit card service provider who charges lower rates. Purchasing appropriate amounts and types of insurance The couple currently has house and household insurance only. This means that they are not insured against a number of risks among them disability, death or even the automobile insurance. Among the goals of the couple is to develop plans on the best available package for their insurance needs. Among the couple’s short term goals is to have an insurance cover for all the assets as well as a well structured life insurance plan that will not significantly affect their standards of living and the current savings plan. Long term New experience: Running own business One of the goals and objectives of the couple is to have a whole new experience with regard to employment. At the current age, the couple has acquired a lot of experience and skills in their respective fields. It is undisputed that they both have high levels of expertise through which they can effectively run a business. The couple has knowledge from past learning activities and handling of challenges during their time as employees. Therefore, by applying these skills, the couple will be able to effectively place their business in a competitive position. One of the main determinants of how effective the business will be according to the views of the couple is the source of capital. The couple does not plan on obtaining capital through loans but instead plan on accumulating enough to start and run the business. The couple is convinced that they can run a retail store successfully in the local center. Since Fergie is the one with the ‘business mind’, they plan to start the business after Fergie retires on his 60th birthday. The business requires $250,000 as start up capital. On top of the 250,000 requirement, the couple expects to be able to have in the superfund an amount that can pay them a level annual pension, which can meet their living expense, as well as maintain their current living standards. For this to be possible, they need an extra $350 on top of their normal current living expenses. A round the world’ cruise on the Costa Darwindia The couple has a plan to have a two months trip around the world along the Coasta Darwindia. This is a plan that requires an estimated cost of $45,000. The trip is required to act as a reward upon retirement. Therefore, alongside other retirement plans, the couple has to save towards achievement of this goal. With the current financial structure of the couple’s life, they have to develop a plan through which they can add to their current savings while still maintaining the standard of living. Lay basis for a comprehensive Will and Estate plan It is of paramount significance to ensure that every hard earned penny ends up in the right hands. This highlights the need to have a plan that elaborately describes the respective portions and values that goes towards different responsibilities. Although, their son does not live with them, it is the desire of the couple to ensure that he leads a stable life. The couple plans to develop a plan of how to assign their accumulated funds and assets to the intended beneficiaries. Norton and Fergie plan on passing down their house and other assets to their son. Additionally, all the shares will be transferred to him as part of the family’s source of constant income to ensure stability and sustenance. However, this process requires adequate time to plan and ensure compliance to the set regulations. The couple sees it prudent to leave an inheritance for their only son. They plan to pay off all the debts on their house to pass down to the son when its debt free. However, they intend not to pass down the two cars to their son, and will sell them after retirement and buy a truck for the business. They also plan to give their son the direct shares in the four stocks they own, and the two mutual funds. B. FINANNCIAL TABLES Norton and Fergie's Personal Income Statement Income Wages and salaries Norton 90,000 Fergie 50,000 Total wages 140,000 Interests and dividends interest on cash in bank 187.5 interest on term deposit 300 interest from managed funds 4000 Dividends: Woolworths 182.7126   Telstra   493.3921   AGL Energy 292.0419   Myer   856.4477 employer superannuation contribution 12600 18912.09 Total Income 158,912 Taxes Norton Fergie Income tax: 21250 8550 Medicare Levy 1350 750 22600 9300 31900 Expenses Daily Living Expenses 49400 interest payments on: Mortgage 33600 credit card 3400 personal loan 4800 overdraft 840 42640 Total Deductions 123940 Total amount available for savings 34,972 Taxation The table below represents the tax schedule for the financial year 2011/12. The tax rates are exclusive of the 1.5% medical levy. 0 - $6,000 Nil $6,001 - $37,000 15c for each $1 over $6,000 $37,001 - $80,000 $4,650 plus 30c for each $1 over $37,000 $80,001 - $180,000 $17,550 plus 37c for each $1 over $80,000 $180,001 and over $54,550 plus 45c for each $1 over $180,000 From the table, the following are the taxes levied on the incomes of Norton and Fergie. Norton earns 90,000 therefore; his salary is between $80,001 and $180,000. Income Tax=$17,550 + 37% of ($90,000 - $80,000) =$17,550 + 0.37*10,000 =$21,250. Medical levy = 1.5% of the gross income =1.5% of $90,000 =0.015*$90,000 =$1,350 Fergie earns 50,000 therefore; his salary is between $37,001 and $80,000. Income Tax=$4,650 + 30% of ($50,000 - $37,000) =$4,650 + 0.30*13,000 =$8,550. Medical levy = 1.5% of the gross income =1.5% of $50,000 =0.015*$50,000 =$750. C. ASSET ALLOCATION One of the assets owned by Norton and Fergie is the balanced fund. This is an investment that is divided into two and has different asset mix (ATO. 2012). Balanced Fund 1 invests 50% of $40,000. This represents $20,000. Balanced fund 2 invests the remaining part of the invested value, which is 50% and is worth $20, 000. The table below illustrates the different asset allocation within the two funds. Balanced Fund 1 Balanced Fund 2 Asset % Amount % Amount Total Australian shares 30 6000 45 9000 15000 International Shares 20 4000 25 5000 9000 Listed property 15 3000 5 1000 4000 Australian fixed interest 20 4000 10 2000 6000 International fixed interest 0 0 5 1000 1000 Cash 15 3000 10 2000 5000 TOTAL 20000 20000 40000 Other than the fund, Norton and Fergie own assets either directly or indirectly. The table below is an illustration of the allocation of assets with regard to Australian shares, international shares, listed property, direct property, Australian fixed interest, international fixed interest and cash. Asset Allocation Australian shares Balanced Fund 15000 International shares Balanced Fund 9000 Listed property Balanced Fund 4000 Direct shares 32,000 Direct property Town House 700,000 2 cars 50,000 Households and other items 84,000 Australian Fixed interest Balanced Fund 6000 Term Deposit 12150 International Fixed interest Balanced Fund 1000 Cash: Cash in Bank 7,500 Cash under balanced fund 5000 Cash Management Trust 120,000 Superannuation 150,000 D. STENGTHS AND WEAKNESSES LIQUIDITY RATIOS: i) Basic Liquidity Ratio = Liquid Assets / Monthly Expenses Liquidity ratios provide a platform for evaluation of a firm’s ability to meet the required responsibilities during declining levels of income (ATO. 2012). The Liquidity ratio highlights the effectiveness with which the couple can deal with sudden crises or opportunities. For instance, in case of an appliance breaks down in the house; the ability of the couple to timely replace it depends on the amount of liquid assets available to them. The couple has a vast set of assets that can be liquidated, but has only $7,500 in the bank. Therefore, to calculate the value of the liquidity ratio, the liquid assets will be $7,500 while the monthly expenses are $3800 since the couple uses $950 per week. Basic Liquidity Ratio = $7,500/$3,800. This yields 1.9737 months. This is a weakness in the couple’s financial structure as it implies that the liquid assets available to them cannot last beyond the second month in times of declining incomes. Therefore, it is important that the couple develop strategies of ensuring there are adequate liquid assets. DEBT RATIOS: i) Debt to income ratio Debt to income ratio= total debt payments/ total income ii) Debt ratio= debts payable/ gross income iii) Consumer Debt Ratio=all debts except mortgage/after tax income NET WORTH RATIOS: i) Net Worth= Total Assets-Total Liabilities The Net Worth is the purest measure of wealth (Barbara, 2012). Norton and Fergie have a net worth of $730,050. The couple has a relatively high level of wealth which is a clear indication that Norton and Fergie have enough resources to effectively support their daily lives. The value of assets is higher than the liabilities; thus, the couple has the ability to sustain and support themselves. ii) Total Debt-to-Net Worth=Total Liabilities/Net Worth (should be below 1) Debts are one of the things that cannot be avoided. However, it is important to keep track of one’s level of debt. One of the most effective ways of evaluating the debt levels is through comparing the debts to be paid to the net worth to obtain the total debt to net worth ratio (Barbara, 2012). This ratio will indicate the amounts owed by both Norton and Fergie and their ability to offset the debt using the available resources. The value of the total liabilities is $465,600 while their Net Worth is $730,050. This implies that the total debt to net worth ratio is 0.6378. This is a positive indicator of the debt levels of the couple. A ratio that is below one highlights that the couple are well placed and can comfortably offset their debts with the assets that they currently own (Barbara, 2012). iii) Tangible Net Worth= (Net Equity in home+ Tangible Assets)/Net Worth This ratio is a measure of all the tangible assets that exist physically (Barbara, 2012). The ratio is based on the assumption that the value of tangible assets will not be adversely affected by increase caused by the level of inflation (Barbara, 2012). Norton and Fergie’s net equity in home and all tangible assets is made up of the town house valued at $700,000, two cars worth $50,000 and personal property worth $84,000. This adds up to $834,000. Therefore, Norton and Fergie have a tangible net worth given by: Tangible Net Worth= $834,000/$730,050 =1.1423. With a value of tangible net worth greater than 1, it is evident that the couple is well placed with regard to changes in the level of inflation. E. SUPERANNUATION The couple needs to have enough in their super fund to cover for their after-retirement expenses. The rationale behind superannuation is to enable the current employee enjoy the same standard of living after retirement (Barbara, 2012). Norton and Fergie both invest in medium and high risk funds, where they pull funds together with other investors to obtain high returns. These funds have managers who buy and sell assets to make capital and income gains, which are transferred to fund members’ portfolio proportional to member share ownership. Each member must make annual contributions into the fund, although other more regular streams of payments are available. Together with their contribution is the compulsory deposit made by the employer into their fund of choice. The type of fund an employee chooses goes a long way in determining their ultimate return on the investment. The employer contributes the current 9% contribution (CCH Australia Limited, 2011). The employer can make contributions through the personal deductible under the concessional contributions (CCH Australia Limited, 2011). The government can make-contributions for an individual but only limited to $1000 (CCH Australia Limited, 2011). It is clear that Norton and Fergie are eligible to the government co-contribution as their salary income accounts for more than 99% of their total income. Analysing Norton and Fergie’s government co-contribution, assuming they split all other incomes equally, Norton = 1000 - (((90243.5-22600)-$31,920)) x 0.0333) = 1000, as it goes over the limit. Fergie = 1000 - (((50143.5-9300)-$31,920)) x 0.0333) = 340 However, the biggest chunk of contribution can be made by the couple through concessional contributions. An individual can choose to increase the portion of salary they contribute directly to the superfund (CCH Australia Limited, 2011). This contribution is usually done by the employer on his behalf and is referred to as salary sacrificing (CCH Australia Limited, 2011). Another way is for the individual to increase his contribution in excess of the concessional tax cap and incur additional taxation (marginal tax) (CCH Australia Limited, 2011). There are other ways such as couple contributions, but it all depends on the amount an individual intends to build in his super fund. The long term objectives of the couple will dictate how much they will need after retirement. The employer in both cases makes a SGC contribution of 9%. Without individual contributions, the couple accumulated fund comes to the following figure Norton Fergie Salary 90000 60000 monthly contribution 0 Government co-contribution 1000 340 employers contribution 7200 5400 Rate of return 8% 0.08 no of years to retirement 18 20 Accumulated amount $375,248.11 262673.6751 Fund Balance $150,000.00 599402.9249 Total $1,237,324.71 Norton and Fergie retirement consists of two forms; two one pay offs and a level annuity for the rest of the couples lives. Assuming that Norton will live longer, the couple uses her expectancy to compute how much funds they will need in their superfund at retirement. The annuity commences when she gets to 62, and continues indefinitely. Using the AGA life table 2000-02, an annuity of one paid to a 62 year old female has a PV value of 23.71 (FACSIA, 2012). Therefore, the couple needs to have 23.71*67600 for lifestyle needs Objectives costs Business Capital 250000 Lifestyle expense & 1554729 Trip to Costa Darwindia 45000 Total requirement 1849729 If the couple continues with the current plan, they will not be able to get to their objective, as they are short by 605, 405. Norton and Fergie need to increase their contribution into the superfund in order for them to realize their long term goals. Norton and Fergie can increase their personal contributions by increasing their personal contributions into the fund. A personal contribution is a concessional contribution which is charged at the rate of 15% (FACSIA, 2012). For the next 10 years, Fergie can contribute up to $25,000 into his superfund without having to attract the 31.5% marginal rate. This is salary sacrificing. Also, the couple can sell some of its short term investments and invest the money into the fund to increase the accumulated fund. According to the tax laws, proceeds from the sale of short term investment are tax at concessional rate (FACSIA, 2012). INSURANCE ARRANGEMENTS Risk is a part of life just as it is a part of investment (Barbara, 2012). In making an investment decision, it is imperative for the decision maker to factor in risk. The ideal situation is to eliminate risk, but since risk is formed by interlinking loops with knock-on effects on each other, these might not be possible. The couple has invested in various assets, both fixed and security assets. Risk identification Norton and Fergie have invested in securities and fixed assets. These investments can easily be wiped out in case of negative economic turns. The couple’s direct shares in Woolworth, Telstra, AGL Energy and Myer and their two mutual funds are subject to speculative risk. Therefore, they all are subject to market gains and losses. The other assets, i.e. the car and the home are subject to pure risk. Morton and Fergie pay a mortgage for their house throughout their working life it would be unreasonable for them to leave it exposed to extraneous losses. The property runs the risk of being broken into and their valuables stolen; flooded and valuables damaged, or burned and liquidating their life effort. The car has similar risks, as it can be stolen or burned in a fracas. It would be unfortunate for the couple to strive this hard in buying the assets only to lose them to avoidable risks. The car can also be subject to the risk, but worse as it is can easily be subjected to legal liability. In case Norton or Fergie while driving their New Ford were to cause an accident, they would lose as a result of negligence, and without a risk management plan, they would be required to pay the loss from their own savings. Finally, the couple plans are hinged on their survival. In case either Norton or Fergie die, the one left would be able to meet the financial obligations the couple committed themselves to as he or she would have to depend on one income. Moreover, death is just one such scenario, there are other scenarios such as sickness or disablement, which would require specialized medical care. With age, health-related risks are accentuated. Risk Evaluation Risks have a financial bearing, and affect either corporate or personal financial positioning (Barbara, 2012). The couple has revenue streams that it needs to evaluate its risk. The risk involved with the assets includes loss of income, car related risks, and personal risks. The couple makes the following incomes that are subject to systematic risks. income streams from investments at risk Cash management trust 4512 UBS trust rate at 3.76% Transactional Account 189.66 Mutual fund 1 4000 Assume a rate of 10% for balanced fund Direct shares dividend Total income 8701.66 In terms of the car related risks, the car runs the risk of breakdown from mechanical problems, loss from fire, theft and legal liability risks that arise as a result of negligence on the part of the driver. This could be Norton or Fergie and they would have to pay for incurred loss. It would involve the justice system to quantify the damage, which normally includes medication costs, compensations, and repair costs among any other loss decided by the court. In tabular form, this is the risk associated with the cars. car related risks Theft, fire, or complete breakdown 50000 Assumes the car has no residue value, cannot function or cannot be recovered for the three scenarios Legal liability Unlimited The cost of the risk can be greater than what the couple owns The couple personal risks involve premature death and disablement costs. Norton and Fergie do not need to provide for their son as he is fully independent and can take care of his needs. In case of premature death, there are costs inflations related to death, such as burial costs, estate administration and final medical care; all these costs have no provision in the couple’s financial plan. The surviving spouse will have to settle the debts the couple contracted together, which may likely be financially constraining. In case of disablement, there are medical expense incurred, specialized costs that come with the disability and income issues, as an individual cannot function normally. Management of risks The couple needs to invest in risk management. Without protection, the guarantee of a secure future is only but a dream. Savings and investments alone do not guarantee a secure future. A strategy needs to be adopted to protect investments. Each asset may have different investment strategies, as the risks facing the assets may not be identical. Recommending a solution for each asset seems appropriate in this scenario. Norton’s and Fergie’s cars need protection from theft, fire and mechanical damage. These risks are best protected through insurance or an appropriate financing strategy. A comprehensive motor insurance cover has clauses that protect against these risks. It also pays any compensations relating to the car. Norton and Fergie can rest as they are assured that any damage to themselves or the other party in an accident situation will not require them to pay compensations from their savings. Installation of alarm systems or tight security locks would also reduce the change of theft. Other actual controls may include investing in fire-proof technology cars and fire extinguishers. Norton and Fergie personal risks have no control strategy. Their premature death risk can be managed by taking a life cover. There are various types of life covers tailored to suit the needs of the insured. There is the term life policy and the whole life policy. A term policy insures the holder for a specified period, usually one, three and five years (Barbara, 2012). The insured pays premiums in advance in the form of an annuity for the period of the policy. In case the policy holder dies within the insured period, the beneficiary is paid a sum assured within 12 months of the event (Barbara, 2012). Alternatively, each spouse can purchase a whole life policy (Barbara, 2012). Unlike a term life policy, it guarantees payment throughout the life of the holder (Barbara, 2012). It is possible for the couple to take a multiple lives policy, which is cheaper than each spouse taking an individual cover. The most appropriate cover for the couple would be one that offsets their debts and gives them an allowance for adjustment. Assuming Fergie dies Assuming Norton dies Family income 95887 50887 Debt repayments 425600 425600 Car loan 40000 40000 Total Expenses 561487 516487 Less Recovarable Amounts Less Insurance benefits 0 0 Sale of investments 204150 204500 spouse Super 60000 90000 Additional insurance required 297337 221987 Due to the disparity in salaries, the two spouses would not need the same amount as sum assured. Fergie would need to get a cover that offers a lower sum assured as Norton earns more and would therefore require less support after his demise. On the other hand, Norton would have to take a cover that provides Fergie with a higher sum assured if Fergie is to offset the family debts. Other than for life cover, the couple needs to manage disability risk. The couple has the public Medicare, which covers up to 85% of medical fees. By virtue of being in the public insurance healthcare program, it automatically means that the couple does not have private medical care. This cover may mitigate basic healthcare risks, but it does not offer the flexibility of private healthcare. On top of that, it does not offer the much needed risk management of disability. Norton and Fergie need to also invest in a disability policy on top of their Medicare. A disability policy provides specialized healthcare for the insured in the unfortunate event of disability (Barbara, 2012). There are three types of disability policies, namely income protection, total and permanent and trauma insurance (Barbara, 2012). These policies offer a wide range of features for the insured, which include earnings replacement, total disablement lump sum benefit and automatic policy renewal. In specific, the trauma policy would be appropriate in its flexibility in addressing common traumas that come with lifestyle and diet such as cancer, stroke, terminal illness and coronary artery surgery. Such a policy will ensure the couple do not have financial strains if one or both of them become disabled. Moreover, trauma, life and total permanent disability benefits do not form part of taxable income, a plus for one to purchase the policy. However, the premium payments do not form part of deductibles. G. OPTIONS FOR LEGALLY MINIMISING TAXES There are a number of strategy that if well used can result into a significant amount saved from taxation. Among the strategies are: Tax deferred retirement plans Deferring tax through placing it in retirement plans is an effective way of minimising the tax incurred (Barbara, 2012). Also referred to as tax shelters, retirement accounts provide the taxpayers with a platform through which they can reduce the amount paid as tax (Schnepper, 2011). This is based on the concept that the placed amount will not be taxed until it is withdrawn, probably at a date after retirement (Schnepper, 2011). This is one of the most employable strategies since there are no limitations to the amount to place in the account which in turn adds to the value of the fund. A strategy that makes increasing the retirement fund is salary sacrificing in order to add on the superannuation contribution. Through salary sacrifice, the taxpayer is able to push forward the taxation date. However, this strategy is limited by the willingness of the employer to get into an agreement (Schnepper, 2011). Use of tax offsets and rebates When developing strategies on how to reduce the tax paid, this is one of the most effective and easily employable plans. The more the offsets and rebates received, the lower the amount of tax paid. Examples of offsets and rebates include the franking credits, medical expenses offset and the spouse superannuation contribution rebate (Schnepper, 2011). By investing in companies that pay franked dividends, a tax payer can effectively reduce the amount incurred by avoiding double taxation that occurs to investors that do not provide franked credits. The Medicare offset provides the tax payers with an offset upon exceeding a specified amount in medical expenses. For example, the offset entitles the taxpayer to get back 20% of the net medical expenses that are in excess of $1,500. Additionally, through plans such as the spouse superannuation contribution rate, it is possible to bring down the tax expenses (Schnepper, 2011). References ATO. 2012. Superannuations. Retrieved from http://www.ato.gov.au/superfunds/default.aspx Barbara, Smith. (2012) Self Managed Superannuation Fund Handbook: A Practical Guide to Starting and Managing Your Own Fund. John Wiley & Sons. CCH Australia Limited. (2011). Australian master superannuation guide 2010/2011. Sydney, NSW: CCH Australia. FACSIA. (2012). 4.9.5.46 Table of Life Expectancy - Payments Commenced on or after 01/01/2005 to 31/12/2009. Retrieved from http://guidesacts.fahcsia.gov.au/guides_acts/ssg/ssguide-4/ssguide-4.9/ssguide-4.9.5/ssguide-4.9.5.46.html Personal Wealth Management Lecture Notes Schnepper, J. A. (2011). How to pay zero taxes 2011: Your guide to every tax break the IRS allows. New York: McGraw-Hill. Read More