Module 1
Introduction to the
Financial Planning
Process
David Mannaioni, CPCU, CLU, ChFC, CFP®
7481
© 1982, 1985, 1991, 1996, 2002–2015, 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 www.cffp.edu, or you may call the Student Services
Center at 1-800-237-9990.
Table of Contents
Welcome ................................................................................... i
How to Study this Material .................................................... iii
Introduction to the Financial Planning Process
& Insurance Course ........................................................... iii
Significance of Learning Objectives .................................. vi
The Learning Process ....................................................... viii
Study Plan/Syllabus ................................................................ 1
Learning Activities ............................................................. 2
Chapter 1: The Financial Planning Process ........................... 5
Critical Skills of Planners ................................................... 6
The Steps of the Process ..................................................... 9
Financial Planning Practice Standards .............................. 11
Chapter 2: Personal Financial Statements ........................... 42
Business Financial Statements vs. Personal Financial
Statements ........................................................................ 43
Financial Statements in Personal Financial Planning ......... 45
Statement of Financial Position ......................................... 45
Cash Flow Statement ........................................................ 53
Chapter 3: The Analysis ....................................................... 58
The Emergency Fund ........................................................ 58
Debt Management ............................................................. 63
Sources of Income ............................................................ 66
Savings and Spending Patterns .......................................... 67
Ratio Analysis .................................................................. 68
Analyzing Sequential Financial Statements ........................ 68
Other Areas of Analysis ..................................................... 70
Chapter 4: Budgeting ............................................................ 72
What is a Budget? .............................................................. 72
Basic Considerations ......................................................... 73
Getting Started .................................................................. 76
Chapter 5: Debt Management ............................................... 89
Consumer Debt .................................................................. 89
Chapter 6: Achieving Special Goals .................................... 106
Step 1: Define Goals in Terms of Dollar Amounts
and Time Frames ............................................................. 106
Step 2: Gather Data to Determine Existing Resources ...... 107
Step 3: Analyze the Issue and Solutions. .......................... 108
Step 4: Develop and Present the Appropriate Vehicles
and Strategies .................................................................. 109
Steps 5 and 6: Implement the Action Plan, and
Schedule and Monitor Results ......................................... 110
Chapter 7: To Lease or Buy ................................................ 111
Types of Leases ............................................................... 111
Considerations in the Lease versus Buy Decision ............. 112
Chapter 8: College Funding ................................................ 116
College Funding Methods ................................................ 117
Investment Vehicles ........................................................ 125
Other Sources of Funds for Education Goals .................... 128
Chapter 9: Special Needs Planning ..................................... 134
Divorce/Remarriage Planning .......................................... 134
Charitable Planning ......................................................... 138
Needs of the Dependent Adult or Disabled Child ............. 138
Terminal Illness Planning ................................................ 139
Closely Held Business Planning ....................................... 140
Summary .............................................................................. 141
Module Review ..................................................................... 143
Questions ......................................................................... 143
Answers ........................................................................... 177
References ............................................................................ 222
About the Author ................................................................. 223
Index ..................................................................................... 224
Welcome
W
elcome to the first course in your journey to become a Certified
Financial Planner certificant. You have chosen a career that will
make a significant positive impact on people’s lives. Helping people
become financially secure brings more than financial rewards to people. Years in
the future, your clients will tell you how it let them accomplish dreams they thought
would be only dreams. They will tell you how it reduced their stress, changed their
marriages, and set future generations on the path to the same success.
You will work hard to earn this designation. The material and expectations are
graduate level. Just like CPAs, you are gaining a profession, not just a designation.
We are committed to helping you achieve this designation and have success in this
profession. Our goal for you is that by the end of this program you will:
1. be successful in passing the CFP Certification Examination and
2. be a competent beginning planner.
There are six courses you will complete:

Financial Planning Process and Insurance

Investment Planning

Income Tax Planning

Retirement Planning & Employee Benefits

Estate Planning

Financial Plan Development
Each of the first five courses have multiple modules, which means volumes of
reading, memorizing, understanding, and applying concepts. This first course has
nine modules. We encourage you to start reading your material prior to attending
i
© 1981, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
the online classes or viewing the recordings. We also encourage you to take the
time during your studies to explore the topic in real life by applying the
knowledge you are learning to your own life. While studying this first module,
pull out your insurance contracts and read them. Meet with your P&C agent and
go through a review of your coverage. You may even want to work with friends,
family, or clients in this area. By experiencing and applying the knowledge in real
life, you will better understand and remember the concepts. Each course offers you
knowledge that has direct application to your life. The last course is entirely different
because you are creating a detailed, comprehensive plan utilizing the knowledge you
have learned.
Once you have completed all the coursework, you will need to do a review.
Research has shown that those testing quickly after their coursework do better on
their exam, so plan your course work with that in mind.
When you complete these courses and accomplish this goal, you will also be
committing to being a lifelong student as the landscape is ever changing. We
hope to have a lifelong relationship with you as a provider of CE and someday
perhaps you will return to gain your master’s degree in financial planning.
Again, congratulations on taking this step. Don’t hesitate to reach out to the
resources at the College if we can help.
David Mannaioni, CPCU, CLU, ChFC, CFP®
Financial Planning Process and Insurance
303-220-4911
David.Mannaioni@cffp.edu
Michael B. Cates, MS, CFP®
Income Tax Planning
303-220-4832
Mike.Cates@cffp.edu
Jason Hovde, CIMA®, CFP®, APMA®
Investment Planning
303-220-4836
Jason.Hovde@cffp.edu
Kristen MacKenzie, MBA, CFP®, CRPC®
Retirement Planning & Employee Benefits
303-220-4826
Kristen.MacKenze@cffp.edu
Kirsten Waldrip, JD
Estate Planning
303-220-4851
Kirsten.Waldrip@cffp.edu
ii
© 1981, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
How to Study this Material
P
lan to invest from 100 to 150 hours of study time for this first course in
the CFP Certification Professional Education Program. If you study at
least 10 hours each week, you should be able to work through the
materials in about 12 weeks. With an additional two weeks for review, you
should be ready to sit for the first exam in about 14 weeks. This means that, on a selfstudy basis, you should be able to complete this course within four to six months.
A number of study plans will work, but the steps outlined below have proven to
be effective.
1. Read the Learning Activities section in the Study Plan/Syllabus chapter to
know which readings match each Learning Objective.
2. There is no supplemental textbook required with this course; all of the course
material is contained in the 10 modules. Write in the answers to the review
questions for each learning objective. If you just read the modules, you will
retain only about 10% of what you read—hardly sufficient to pass the endof-course test. If you physically write in the answers to all the questions, you
will increase your retention by a multiple of four to six times.
3. Read the answers to the review questions and compare your answers to the
approved solutions. If your answers are sufficiently close, move on; if not,
rewrite the correct answer so that you will better remember the correct answer.
Introduction to the Financial Planning
Process and Insurance Course
Imagine that it is five years from today and you are sitting in your office
reviewing the appointments for the next few days. Your first is a client who will
be retiring in just one month. The plan you put together for them has allowed
them to shorten the amount of time it would take to get there. You’ll be
reviewing their cash flow distribution plan for year one. You make a note to
iii
© 1981, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
remind them that they need to send you the information from their employer
about converting the group term insurance before the 30 days expire since the
client has some health problems and to have your assistant send a congratulations
basket to his office the day before retirement.
The next meeting is a prospect who is a referral from one of your favorite clients.
The client was so impressed with how you worked with his estate attorney and
family, he has been telling all his friends. The prospective client expressed
interest in you helping him with his estate plan and investments. You know the
company he works for so you are betting he has significant nonqualified deferred
compensation agreements. You will need to complete some analysis on
managing the deferred compensation and check for concentration issues because
he is retiring in one year. You make a note to tell your assistant to get the new
client folder ready.
The third appointment is going to be a tough one. You advised the clients to purchase
disability coverage but they declined. Now they regret it and are asking for your help
in determining what their new lifestyle will look like since a disability struck. They
aren’t in terrible shape but you have rerun some projections looking at safe
withdrawal rates so you can discuss their new retirement projection. You make a
note to evaluate both annuities and a reverse mortgage line of credit to see whether
those strategies could improve their situation.
You have two investment management reviews (both clients will be very happy),
and a meeting with parents and their grown child to talk about structuring
funding for grandchildren’s education.
The journey to this future starts with a substantial introduction to the basics of
financial planning and insurance analysis. This course will not make the student
an expert in these areas. The most effective professional financial planner is one who
learns to bring the experts together as a team. The modules in this course are:

Introduction to the Financial Planning Process

Regulatory and Ethical Considerations for Financial Planners
iv
© 1981, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.

Introduction to the Time Value of Money

Introduction to Risk Management and the Insurance Industry

Introduction to Life Insurance and Annuities

The Life Insurance Selection Process

Health Care

Disability Income and Long-Term Care Insurance

Property and Liability Insurance
Competence in financial planning requires the ability to communicate with the
myriad experts who are needed to put together and implement a client’s financial
plan. Accountants, attorneys, insurance specialists, bankers, investment advisers,
and trust officers are all integral members of the team. Someone has to
coordinate their efforts, and that person is the financial planner. Most financial
planners have one area of expertise because it is virtually impossible to be an
expert in all areas. Most importantly, though, they have a broad understanding of
all the facets of planning so they can provide an integrated approach. The CFP
Certification Professional Education Program will give the student an adequate
understanding of the basics of each area so that he or she can be the leader of the
financial planning team.
Upon successful completion of this course, you will be able to:

explain and initiate the process of personal financial planning

provide competent counsel to individuals regarding their existing risk
management programs and to recognize when the services of a specialist are
required

understand the regulatory, legal, and ethical issues surrounding financial
planning
v
© 1981, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.

understand and apply the time value of money concepts and use a financial
function calculator

understand and apply the principles of risk management

identify risk exposures

compare insurance companies and policies and determine the benefits
provided by a given insurance policy

understand the differences among the various forms of insurance

prepare a life insurance needs analysis

understand the history and organization of the insurance industry, the legal
atmosphere in which it operates, and the “language” of insurance

construct and interpret personal financial statements and explain issues
related to personal budgeting

explain different forms of debt and their uses, and the issues involved in the
lease versus buy decision

identify sources and strategies for college funding

explain issues related to special planning needs
Significance of Learning Objectives
Learning objectives, also referred to as LOs, form the foundation of each lesson.
They direct you to the critical components on which you will be evaluated, and
so they are the keys to successful completion of this course.
The learning objectives in this course are organized into three categories that
correspond with three increasingly complex levels of learning. The pyramid
below demonstrates the hierarchy of those levels and their interrelationships.
With the bottom level forming the foundation of the learning pyramid, you can
see how the three levels of learning support build on each other.
vi
© 1981, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Evaluation
Synthesis
Analysis
Application
Comprehension
Knowledge

Top level learning objectives involve critical thinking by analyzing,
synthesizing, and evaluating information. Example: Analyze a client’s
financial statement to identify strengths and weaknesses.

Middle level learning objectives involve applying knowledge to a specific
task. Example: Construct a personal financial statement that includes a
client’s emergency fund assets.

Bottom level learning objectives involve basic knowledge and
comprehension of information. Example: Identify the financial assets
appropriate for inclusion in a client’s emergency fund.
Each level of learning is accompanied by specific behaviors you are expected to
demonstrate upon mastery of individual learning objectives.
Note: As you progress through this course, keep in mind that most practicing
financial planners conduct their daily business using skills at the higher levels of
learning. The skills developed at the lower levels support those processes by
providing the fundamental building blocks of financial planning activity.
vii
© 1981, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Study Tips
In the Study Plan/Syllabus chapter of this module, you’ll see a smaller
version of the learning pyramid identifying the level of each learning objective.
As you master each learning objective, you’ll know where it fits in the hierarchy
of learning.
Each learning objective is individually numbered (corresponding with the
module number) for review purposes. In addition, learning objectives are boxed
to make them stand out from the surrounding text. Look for the boxes throughout
each module to guide your studies.
The Learning Process
Learning Activities
In this course, you’ll find three different types of learning activities:
Readings. Since there is a substantial amount of material covered in each of the
modules, it is recommended that you pace yourself, and spread out the readings.
Do not rush through this material. “Cramming” does not work well, and will not
provide you with the preparation you need for both the end-of-course exam and
the CFP® Certification Examination. A steady, methodical approach will enable
you to retain and assimilate more of the material as you work through each of the
modules. It is recommended that you read the material related to the classes that
are recorded BEFORE attending the class or listening to the recording.
Review questions. Through the completion of written problems, you will be able
to demonstrate an understanding of the various financial planning issues in this
course. Review questions have been designed to highlight the relationships
between concepts, and your written responses will reinforce what you have
learned by enabling you to express ideas in your own words. Writing the answers
to the review questions is a critical step in your learning process, since it provides
an opportunity for you to internalize key issues and relationships and it increases
retention by a factor of four to five times. Your responses also provide an
excellent tool for final review prior to the course examination.
viii
© 1981, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Study Plan/Syllabus
T
he goal of this module is to introduce the financial planning process as
well as some of the basic issues that are often involved in personal
financial planning. These include financial statements, the emergency
fund, debt, budgeting, college funding, the lease versus buy decision, and special
needs planning.
The chapters in this module are:
The Financial Planning Process
Personal Financial Statements
The Analysis
Budgeting
Debt Management
Achieving Special Goals
To Lease or Buy
College Funding
Special Needs Planning
The material in this module focuses on the process of financial planning as well
as some of the basic issues involved in the process.
Study Plan/Syllabus

1
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Upon successful completion of this module, you will be able to describe the
steps of the financial planning process, prepare and interpret basic personal
financial statements, recommend appropriate assets to use for an emergency
fund, analyze a client’s financial situation to identify issues related to
budgeting, discuss debt management and the lease versus buy decision, as
well as recognize special needs planning issues and what to do about them.
To enable you to reach the goal of this module, material is structured around the
following learning objectives:
Learning Activities
Learning Activities
Learning Objective
2

Readings
Module Review
Questions
1–1
Explain the what and
why of the steps in the
financial planning
process.
Module 1, Chapter 1: The
Financial Planning Process
1, 2
1–2
Explain the rationale for
gathering specific
financial information.
Module 1, Chapter 1: The
Financial Planning Process
3–5
1–3
Construct and interpret
personal financial
statements.
Module 1, Chapter 2:
Personal Financial
Statements
6–20
1–4
Recommend assets
appropriate for use in
an emergency fund.
Module 1, Chapter 3: The
Analysis
21–23
1–5
Analyze a client’s
financial situation to
identify issues related to
budgeting.
Module 1, Chapter 4:
Budgeting
24–35
Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Learning Activities
Learning Objective
Module Review
Questions
Readings
1–6
Explain different forms
of debt and their uses.
Module 1, Chapter 5: Debt
Management
36–42
1–7
Explain the issues
involved in the lease
versus buy decision.
Module 1, Chapter 6:
Achieving Special Goals
43, 44
Module 1, Chapter 7: To
Lease or Buy
1–8
Identify sources and
strategies for funding a
college education.
Module 1, Chapter 8:
College Funding
45–50
1–9
Explain issues related to
special planning needs.
Module 1, Chapter 9: Special
Needs Planning
51, 52
Not only must a planner understand the stages of the financial planning process,
he or she must understand what fits into each stage and what does not. You will
be expected to know the critical components of each step and how it relates to the
CFP Board Practice Standards. LO 1-1 focuses on the important aspects of each
of the stages in the financial planning process. There are times when a client is
looking for answers before enough questions have been asked. Being able to
explain the process and reasons why will help keep the client on track. This leads
to proper planning and satisfied clients.
LO 1-2 identifies the basic need to understand why each piece of necessary
information is gathered from the client. Each bit of information helps complete
the picture of where the client is at the beginning of the financial planning
process. Understanding why information is obtained allows a planner to develop
a logical method of asking questions that should gradually give him or her a
nearly complete understanding of the client’s situation.
Study Plan/Syllabus

3
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
LO 1-3 focuses not only on the need to understand what a financial statement
says, but also on the need to understand the basis of financial statements well
enough to be able to create them from raw data. The creation of the statement of
financial position and the cash flow statement requires an understanding of what
information is used to develop them. The planner needs this basic understanding
to be able to explain the statements to a client and how the information is used in
the development of the financial plan.
LO 1-4 asks that the student be able to decide which assets are appropriately
placed in an emergency fund. Every client should have an emergency fund in
place; the fund should consist of assets that are readily available for any
unexpected need that arises.
LOs 1-5 and 1-6 deal with the client’s budget and debt management.
Recognizing how cash flow and each asset and liability relates to a client’s
financial condition and being able to analyze how it impacts the client’s ability to
reach established goals is a significant part of the financial planning process.
LO 1-7 introduces the various factors that enter into the lease versus buy
decision-making process.
LOs 1-8 and 1-9 deal with special planning issues. College funding is a common
financial planning need. You will be expected to know the basics of the various
sources of education funding.
4

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Chapter 1: The Financial Planning
Process
Reading this chapter will enable you to:
1–1
Explain the what and why of the steps in the financial planning
process.
F
inancial planning is a process—the integrated, coordinated, ongoing
management of an individual’s financial concerns. A financial plan is
more than a big document, a stack of investments and insurance policies,
or a file of information about a specific client.
Prior to the advent of financial planning as a profession, most individuals dealt
with a number of specialists who often did not work with each other to
coordinate their efforts on behalf of the common client. Instead, the client had to
try to integrate all the separate areas of his or her financial life. Unfortunately, the
diversity of approaches of the various specialists made it difficult, if not
impossible, for many people to put together a comprehensive financial plan. The
profession of financial planning was created over a quarter of a century ago to
address this problem.
The good financial planner is the quarterback, or coach, of the team of advisers.
Frequently, a financial planner works as a generalist rather than having a specialty
within the financial planning areas of concern. The process of becoming a CFP®
certificant requires mastering the languages of insurance, investments, taxes,
employee benefits, retirement planning, and estate planning. The planner is in the
unique position of understanding all of the experts, coordinating their work, and
translating for the client. In a world of ever-increasing financial complexity, more
and more people seek the assistance of someone who can focus on and keep up with
the changes that affect them. This person is the financial planner.
Chapter 1: The Financial Planning Process

5
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Critical Skills of Planners
Communication. Perhaps the most important skill of a planner is the ability to
communicate complex issues to clients in a way clients understand, empowering
them to act on the information. You may be a great technical planner but you and
the client have wasted time if a client:

doesn’t understand the problem and the consequences of not addressing the
issue

doesn’t go through the process of evaluating your recommendation and the
options

doesn’t make an informed decision and implement a solution
Notice that these are all items the client must be able to complete; it is the
responsibility of the planner to not only tell clients these facts, but make sure
they understand and have the information and skills to complete these items.
Communication skills are a significant factor in how well the financial planning
relationship works. Unfortunately, while many people think of themselves as
good communicators, behavioral economic research shows that we are usually
not as good as we think we are. Consumers report that they frequently find
financial planners difficult to understand and, as a result, a significant number of
planners’ recommendations are not implemented. We strongly urge you to
become a student of communications and behavioral economics so that you can
lead clients through the decision making process.
The following are some basic concepts to apply throughout the planning process.
Engage clients in a discussion about the issue. Since people hear and see
information through their own “lens,” don’t assume that just because you
explained something that your client has the same understanding.

6

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.

Explore issues before numerical analysis. Your client won’t solve a problem
he or she doesn’t recognize he or she has. Before you delve into solutions
and strategies, make sure that the client has sufficient time and conversation
so they recognize the issue and want your input in solving it. When the client
can tell you the consequences of not addressing an issue, you know that he or
she understands the problem and has motivation to solve it.

Learn the skills of having tough conversations and be willing to bring up
questions and issues that may cause discomfort and conflict. When we care
deeply about what is being discussed (the issues are important and/or the
outcomes uncertain, which is just about all financial planning situations), we
may perceive the conversation as being difficult.

Listen openly. Listening is of equal or greater importance than talking (and
talking is crucial). Dialogue is a conversation between two or more people;
an exchange of ideas or opinions. At its best, it is not a debate, or an attempt
to convince the other person. Rather, good dialogue provides an opportunity
for joint exploration leading to greater understanding.

Engage clients and encourage them to define characteristics they want in
solutions. This will build ownership and encourage implementation.

Learn to use confirmation skills that include questions such as: “What do you
think the consequence of not acting on this issue would be?” “How do you
think this strategy would benefit you?” “Would the disadvantages of this
strategy impact you?” “What do you think the best solution would be?”

Develop ranges of solutions so that you can always show the client a way
that they can succeed. For example, with a client who has not been saving
you might say, “Our first goal may be replacing 50% of your income at age
70 and when you are saving enough for that, we can drop the target age down
or increase the income.”
Chapter 1: The Financial Planning Process

7
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.

Remember that as a financial planner, you are a facilitator. It is not up to you
to present the one right answer. In addition to being a financial planning
“expert” resource, your primary contribution may be to help clients explore
options, discuss their feelings about those options, and help them make a
decision with your input (note that the decisions are theirs, not yours, which
is why Step 4 in the financial planning process is worded “Developing and
Presenting Financial Planning Recommendations and/or Alternatives”).

Emotions can play a big part in the conversation and decision-making
process. Studies have shown that many investors’ portfolios underperform
the market as a result of the emotional reactions of investors. For example,
fear of loss can result in making poor choices. The reasons for making a
considerable number of these choices have roots in the individual’s past. The
emotional impact of significant events in a person’s life often contribute to
making inappropriate financial choices today. These “scripts” can impact an
individual’s financial situation in ways that may seem—to the planner—
irrational. Helping the individual gain insight into emotional roadblocks to
better financial health can be one of the most significant activities a planner
can undertake.
Analysis skills. One of the great things about the financial planning profession is
we get to be both analytical and people oriented. Your ability to dissect issues,
create spreadsheets, utilize financial software, understand mathematical formulas
and the implications of them are all part of the planner’s job. Every year new
research is completed providing improved technical knowledge in retirement
planning and investment management. Tax laws change and as a planner, you
will be required to not just learn the new laws but also figure out the
consequences of the changes to your clients and how it may impact the products
and recommendations you are making and have made in the past. One of the
challenges to overcome is building a learning lifestyle into your practice. Many
planners spend hours attending conferences, gaining CE (continuing education)
credits, and even acquiring their master’s in financial planning all in an effort to
keep their analytical skills and technical knowledge current. Common types of
analytical projections and skills you will need to learn include:
8

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.

use of financial planning/estate planning/retirement software programs

portfolio analysis and tracking programs

use of Excel spreadsheets to create an analysis of client issues

use of Excel spreadsheets to model results of a specific strategy compared to
an alternative

tax projection programs

detailed comparison of products, features, and benefits and drawbacks in
fields of investments and insurance
Problem solving skills. Financial issues are complex and intertwined in people’s
lives, so it is no surprise that even if we analyze an issue and can clearly see what
the client needs to accomplish, there may be challenges the client will need to
overcome in order to implement the recommendation. Learning to lead clients
through the decision making process and uncovering and resolving barriers along
the journey is important. Again this is an area that would benefit you to develop
these skills. You will utilize these skills and provide assistance for clients
through the financial planning process.
The Steps of the Process
The financial planning process consists of six logical, identifiable steps.
Although these steps are generally taken in order, it is possible that more than
one step might be taken at a single client meeting.
Chapter 1: The Financial Planning Process

9
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Figure 1: The Financial Planning Process
Financial Planning Process Steps
Step 1: Establishing and Defining the
Client- Planner Relationship
Step 2: Gathering Client Data,
Including Goals
Step 3: Analyzing and Evaluating the Client’s
Financial Status
Step 4: Developing and Presenting Financial
Planning Recommendations and/or Alternatives
Step 5: Implementing the Financial Planning
Recommendations
Step 6: Monitoring the Financial Planning
Recommendations
Note: The steps listed above are as identified in the Practice Standards published
by the Certified Financial Planner Board of Standards Inc. (Understanding the
steps and what is done in each is more important than their exact wording.)
It may be helpful for planners and clients to consider the following questions as
they work through the financial planning process.

What is the client’s current condition?

What needs attention; what’s not working right, or for what situations would
they like to prepare?
10

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.

What are the consequences of not addressing their concerns or making the
proper preparations?

What are the likely outcomes of any suggested courses of action; how do any
recommendations specifically address their concerns?
Financial Planning Practice Standards
The Certified Financial Planner Board of Standards Inc. (CFP Board) developed
Practice Standards for the ultimate benefit of consumers of financial planning
services. When you gain your CFP mark, you will be agreeing to abide by these
standards. These Practice Standards are intended to:
1. assure that the practice of financial planning by CERTIFIED FINANCIAL
PLANNER™ professionals is based on established norms of practice;
2. advance professionalism in financial planning; and
3. enhance the value of the financial planning process.
The Practice Standards establish the level of professional practice that is
expected of certificants engaged in financial planning.
The Practice Standards state:
The Practice Standards apply to certificants in performing the tasks of
financial planning regardless of the person’s title, job position, type of
employment or method of compensation. Compliance with the Practice
Standards is mandatory for certificants whose services include financial
planning or material elements of the financial planning process, but all
financial planning professionals are encouraged to use the Practice
Standards when performing financial planning tasks or activities addressed
by a Practice Standard.
Chapter 1: The Financial Planning Process

11
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
The Practice Standards are designed to provide certificant with a framework
for the professional practice of financial planning. Similar to the Rules of
Conduct, the Practice Standards are not designed to be a basis for legal
liability to any third party.
As you work through the planning process, read the standard that applies to this
process. It will help you better understand what is expected of you as a Certified
Financial Planner professional.
Step 1: Establishing and Defining the Client-Planner
Relationship (Practice Standards 100 Series)
The CFP Board Practice Standards are the definitive set of rules for CFP
practitioners. In each step, we are providing you with the direct language from
the standards. It is this information that you will be tested on and expected to
know well for the comprehensive exam. The standard for step one is listed here:
100-1: Defining the Scope of the Engagement
The financial planning practitioner and the client shall mutually define the
scope of the engagement before any financial planning service is provided.”
Explanation of this Practice Standard
Prior to providing any financial planning service, the financial planning
practitioner and the client shall mutually define the scope of the engagement.
The process of “mutually-defining” is essential in determining what activities
may be necessary to proceed with the engagement.
This process is accomplished in financial planning engagements by:
1. Identifying the service(s) to be provided;
2. Disclosing the practitioner’s material conflict(s) of interest;
3. Disclosing the practitioner’s compensation arrangement(s);
12

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
4. Determining the client’s and the practitioner’s responsibilities;
5. Establishing the duration of the engagement; and
6. Providing any additional information necessary to define or limit the
scope.
The scope of the engagement may include one or more financial planning
subject areas. It is acceptable to mutually define engagements in which the
scope is limited to specific activities. Mutually defining the scope of the
engagement serves to establish realistic expectations for both the client and
the practitioner.
As the relationship proceeds, the scope may change by mutual agreement.
As this explanation from the CFP Practice Standards states, the very first step is
to define and establish the relationship. You will notice that it incorporates
significant disclosures so that the client will have adequate information to retain
your services and prevent misconceptions. During the first meeting with a client,
the financial planner and the client need to mutually define the scope of the
engagement before the financial planning practitioner provides any financial
planning services. Note that this is a mutual process. The client should not dictate
what he or she expects of the planner without the planner agreeing that he or she
is both willing and able to perform the services requested. Also, the planner
should determine if the services requested are warranted and appropriate. This is
true in the reverse as well. The planner should not tell the client what services the
planner thinks the client needs unless the client understands why they are
necessary and agrees they should be provided.
What is involved in “mutually defining”? It includes: (1) identifying the service(s) to
be provided and whether or not the planner is engaged in financial planning; this step
determines the requirements (non-financial planning engagements have slightly
different disclosures and steps than the following); (2) disclosing the financial
planner’s compensation arrangements; (3) determining the responsibilities of the
client and the financial planner; (4) establishing the duration of the engagement; and
Chapter 1: The Financial Planning Process

13
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
(5) providing any additional information necessary to define or limit the scope of the
engagement. The scope can include one or more financial planning subject areas
(e.g., estate planning, income tax planning, etc.), and it may change by mutual
understanding as the engagement proceeds.
CFP practitioners are required to deliver in writing a scope of engagement for
each client that incorporates the above components. The CFP Board website has
examples of scopes of engagement and critical disclosures. Creating or learning
your firm’s scope of engagement will be one of your first tasks to accomplish
when you earn your designation. If the planner is a Registered Investment
Adviser and/or a CFP certificant, delivery of additional disclosure documents are
required by law and/or the CFP Board’s Standards of Professional Conduct;
Code of Ethics and Professional Responsibility; Practice Standard 100-1.
Reading the next portion of the module chapter will enable you to:
1–2
Explain the rationale for gathering specific financial information.
This step in the process is the basis for all planning. By necessity, it requires the
most attention.
Step 2: Gathering Client Data Including Goals (Practice
Standards 200 Series)
The CFP Board Practice Standards description reads:
200-1: Determining a Client’s Personal and Financial Goals, Needs and
Priorities
The financial planning practitioner and the client shall mutually define the
client’s personal and financial goals, needs and priorities that are relevant to
the scope of the engagement before any recommendation is made and/or
implemented.
14

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Explanation of this Practice Standard
Prior to making recommendations to the client, the financial planning
practitioner and the client shall mutually define the client’s personal and
financial goals, needs and priorities. In order to arrive at such a
definition, the practitioner will need to explore the client's values,
attitudes, expectations, and time horizons as they affect the client’s
goals, needs and priorities. The process of “mutually-defining” is
essential in determining what activities may be necessary to proceed
with the client engagement. Personal values and attitudes shape the
client’s goals and objectives and the priority placed on them.
Accordingly, these goals and objectives must be consistent with the
client’s values and attitudes in order for the client to make the
commitment necessary to accomplish them.
Goals and objectives provide focus, purpose, vision and direction for the
financial planning process. It is important to determine clear and
measurable objectives that are relevant to the scope of the engagement.
The role of the practitioner is to facilitate the goal-setting process in
order to clarify, with the client, goals and objectives. When appropriate,
the practitioner shall try to assist clients in recognizing the implications
of unrealistic goals and objectives.
This Practice Standard addresses only the tasks of determining the
client's personal and financial goals, needs and priorities; assessing the
client's values, attitudes and expectations; and determining the client's
time horizons. These areas are subjective and the practitioner’s
interpretation is limited by what the client reveals.
Financial goals are the heart of the financial planning process, because they
define what the client wants to achieve through financial planning. Each
detail of the financial planning process is directed by the financial goals of
the client. The importance of this stage is such that if it is not given the full
attention it requires, the rest of the process has no focus. Frequently
Chapter 1: The Financial Planning Process

15
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
exploring and documenting goals will actually be part of establishing the
relationship. Some planners complete some of the soft data gathering
session as part of identifying the scope of engagement. Once the engagement
is determined, the summarized goals and concerns are sent to the client along
with the list of documents needed.
The planner assists the client in establishing realistic goals and quantifying them
in terms of measurable objectives. Goals such as “to be successful” or “to live the
good life” are too nebulous. Financial goals should be quantified in dollar
amounts and have established time frames instead of remaining general in nature.
Quantifying goals makes it easier to estimate savings needed to accomplish the
goal and establish patterns that lead to success. It is important to remember that
the assumptions and goals will shift over time and that our calculations are
estimates. Our process makes it easy for clients to think they will just have “a
plan.” In reality, there will be many iterations of plans over their lifetime.
Planning is a process not a deliverable.
Data Gathering
Data gathering cements the relationship with the client and solidifies the client’s
goals for them. Failure to adequately record all objective and subjective information
may prevent the planner from addressing the client’s motivations, which could result
in the client’s failure to carry out the plan.
The quantity and type of data collected reflects the goals of the client in seeking
financial advice. When a client comes to a financial planner for assistance in
developing a comprehensive financial plan, the data gathered must be extensive.
This is because the planner will assess the client’s risk management program,
investments, tax planning, retirement planning, and estate planning, among other
areas of consideration, and then make recommendations relating to each of these.
On the other hand, the client may come to the planner for specific advice relating
to a smaller area of expertise, such as risk management issues or investment
selection. In these cases, data gathering is limited to issues relating to the specific
16

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
area of concern to the client. It should be noted that the financial planning
process does not change for individuals desiring specific financial help as
opposed to comprehensive help; it still involves setting goals, gathering and
analyzing information, recommending strategies for achieving goals, and
implementing and monitoring plans for changes.
An individual coming to a planner for comprehensive financial planning usually
has some specific reasons for doing so. These reasons normally are transformed
early in the planning relationship into well-defined goals that the client hopes to
achieve through financial planning. The goals may be as varied as the clients
themselves: to do a better job of allocating funds to investments and having them
grow, to plan for retirement or for children’s education, to minimize taxes, or to
simply get one’s financial life under control. Achieving these goals becomes
central to the plan developed by the planner.
However, the planner must also take into account issues that the client may not
have considered on his or her own. For example, an important part of ensuring
the achievement of financial goals is instituting protection against events causing
unanticipated financial difficulty that would hinder long- or short-term goals. If
the client were to experience a period of disability, the financial losses associated
with this could hinder plans for educating children in the near future, unless the
planner anticipates this possibility. In addition, comprehensive planning should
always consider financial needs that exist for all clients, such as retirement and
estate planning.
Planners typically start with identifying the goals clients want to achieve because
they are usually most important to the clients and the motivating factors.
Examples include future major purchases, such as a new home, boat, or car;
travel plans; funding a new business; or providing education for children in
addition to creating a secure retirement Clients also generally want to protect
themselves and their families from adverse occurrences. Clients may not be able to
articulate these goals to ensure adequate protection against personal risks (including
unemployment, disability, death, medical expenses, long-term care issues, property
Chapter 1: The Financial Planning Process

17
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
losses, and liability losses). Because clients may have many objectives they would
like to attain, their financial objectives should be ranked in order of importance after
a discussion of the implications of not addressing issues immediately.
For example, retirement may be more important to a client but before
funding retirement is put ahead of funding a term life policy, they must
recognize that the family would be in severe financial straits if a car
accident takes a parent’s life, and then agree to accept that risk before
prioritization. Depending on the nature of the objective, certain constraints, or
limiting factors, need to be considered. Some constraints, such as the availability
of cash flow and existing resources, will be identified to a degree in the data
gathering stage. Later in the financial planning process, the financial planner
needs to consider all factors that might restrict the range of alternatives
appropriate to meeting client needs and achieving client objectives.
The gathering of quantitative and qualitative data is accomplished through a
variety of methods. Refining your process for data gathering is one of the
most critical components to a successful planning practice. Some advisers
have forms they complete; others have forms that they request the client
complete in person or online. Some data gathering forms include everything
needed for specific financial planning software. Other data forms only include
goals and attitudes. The benefit of asking about goals in person is that you
can ask clarifying questions and see the physical reactions to questions.
Forms that clients take home allow them to think more about the answers, but
be careful how much and what information you ask clients to complete. Many
questions that seem simple to you can be confusing to clients, which will
cause them to lose interest in the process.
Many planners have turned interested clients into those who don’t return
phone calls because the clients have not been able to complete the
questionnaire due to lack of understanding, frustration, or not knowing the
answers to their own goals. Some practices involve technical support staff,
such as para-planners, in data gathering to add an additional perspective to
the client’s needs, or simply to facilitate the gathering of facts. It is
18

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
important that the planner gives thought to what he or she hopes to
accomplish for clients, and structure the data gathering process accordingly.
Based on your practice style, you may gather the goals and qualitative
information as part of defining the scope of engagement.
A secondary, but important, benefit of the data gathering session is that it
provides an excellent opportunity to begin educating the client about the
implications of possible problems uncovered during the session. Clients will not
solve problems they don’t believe they have, and hearing about a problem for the
first time along with a solution makes it difficult for clients to choose to solve the
problem. The entire process is facilitated, and implementation much more likely,
if clients have more than one opportunity to explore a problem before making a
decision on fixing it.
You will hear planners talk about gathering qualitative and quantitative data. The
more difficult information to gather comes from the soft questions frequently
referred to as qualitative data. The soft questions are designed to find out what
people want, how they feel, and who they want to benefit. From this dialogue,
you can summarize the client’s goals and concerns that will be addressed during
the planning process. The areas you may explore with clients in a comprehensive
plan would include the following:
Retirement. Generally, this is a high priority goal for most financial planning
clients. You will need both subjective and factual information regarding the
retirement that clients envision for themselves. Until you have done some
quantitative analysis, you may not know whether a client has the resources to
reach their goal, so you may wish to set an ideal goal and a minimum goal so that
you can bring back a plan to the client that will work. Ideal age, income, inflation
assumptions, variations in income, medical expenses during retirement, life
expectancy, and tax assumptions can all be part of this discussion. Capturing the
client’s own words describing their lifestyle goals can be helpful later in the
process. These will be used to establish concrete goals to compare with their
resources to determine what they need to accumulate to achieve their goals.
Chapter 1: The Financial Planning Process

19
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Education or other accumulation goals. Collecting target dates, target amounts
or ranges, expectations about contribution ability, and importance of the goal,
along with contingency plans, will give you the information you need to assess
which strategies can most efficiently help the client achieve his or her goals.
Many clients are not clear on the costs of college or the options for financing college.
You can help lead the discussion by having the costs, potential strategies, and options
at your fingertips during the discussion of goals. Four years of community college
while living at home requires dramatically different plans than six years away from
home at an Ivy League school. Educational expenses have increased substantially in
the past few years and are expected to continue to do so, making it necessary to plan
education funding many years before enrollment. You will also need to determine
whether they have funds earmarked for this goal within their current resources
that may not be clearly marked.
Emergency reserves goal. The process of setting up an emergency fund will help
you and the client understand what could go wrong and how he or she could be
prepared. Engaging the client at this point will ensure that the goal is accepted.
Clearly identifying which funds can be used for emergency reserves versus other
goals will also be important.
Debt management goals and concerns. Direct discussions on use of debt and
strategies for managing and retiring play an important role in freeing up
resources to accomplish goals and have an impact on contingency plans. It also
plays a role in defining an appropriate amount of life and disability insurance,
and establishing emergency fund targets.
Investment management concerns. Uncovering the client’s loss tolerance, risk
tolerance, and sophistication level with investments will allow you to craft a
portfolio that a client will be more likely to adopt and follow during down
markets. Subjective investment data provides information regarding how the
client makes investment decisions, what the client expects from investments,
what the client knows about investing, how the client views risk, and so on. In
addition, the client is asked which of his or her investments have been earmarked
for specific goals, and thus are unavailable for repositioning. Structuring an
investment portfolio is covered in the next CFP course, Investment Planning.
20

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Health insurance concerns. Exploring this area will allow you to find out about
health problems that may impact the family in an unobtrusive way. Additionally,
knowing whether transitions in coverage may occur or unsatisfactory coverage
exists can impact contingency planning and cash flow.
Disability contingency plan. Planning for disability is frequently overlooked by
clients. The likelihood of disability is greater than the likelihood of premature
death for most wage earners, and it is important that clients be financially
prepared for the impact of disability if other goals are to be met. No one likes to
think that they will become disabled but most recognize the validity of having a
contingency plan. Exploring the consequences of a disability with current
benefits will set the stage for interest in creating a plan that will allow the family
to avoid poverty, and give you the information to complete an analysis and
evaluate options for improving their contingency plan. Gathering information on
group coverage, potential family support, and personal coverage will help you
create the disability protection plan and impact emergency reserves, life
insurance, and cash flow.
Loss of life contingency plan. Having clients explore what would financially
happen upon the death of a spouse and the consequences to children opens their
eyes to the need for appropriate insurance. Taking clients through what
percentage of their current expenses would have to be cut and what they would
cut to reach that amount is enlightening. Defining insurance needs without this
discussion results in off-the-cuff guesses without real thought. After the current
situation is discussed, it is important to define the desired goal including potential
for additional future funding, such as replacing health insurance, weddings, etc.,
in addition to which goals for children and surviving spouse should be funded in
case of death of other spouse. This will impact life insurance analysis, cash flow,
and emergency reserves as new premiums would need to be built into emergency
reserve projection.
Long-term care needs contingency plan. Raising this issue at all ages will bring
out concerns, if they have them, both for themselves and parents in the right age
range. This area frequently needs to be discussed a few years in a row before
Chapter 1: The Financial Planning Process

21
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
action is taken. Discussion about expectations of when, why, and how much
long-term care could cost along with how the expenses would be financed, if
needed in the future, will determine whether self-funding or products will
eventually be needed to address this potential issue. Clients in their 50s need to
develop a plan for dealing with these potential expenses as many clients in their
60s will not be able to qualify to purchase long-term care. This not only impacts
long-term care, but cash flow now and in retirement.
Property and liability concerns. It’s important to explore the habits, lifestyle,
volunteer activities, pets, and possessions of a client to uncover risks a client
faces. Any one of the activities listed—sports, hobbies, service on boards of
directors, partnership activities, charity work, etc.—may result in legal liability
and require insurance coverage. This information will be weighed to determine
the benefits and costs of ensuring that the client’s risks are adequately covered.
Learning what clients understand about risk protection will help you formulate an
appropriate plan. A client who has two houses, multiple staff, volunteers on a
board, likes mountain climbing, owns a fishing boat, snowmobiles, and horses
has entirely different risk issues than one who is sedentary, has few possessions,
doesn’t drink, has no children or pets, and drives only five miles to work every
day. Without knowing these facts, your property and liability coverage may not
match the client’s needs. In addition to a liability risk assessment, the needs to
protect property should be uncovered. This will impact cash flow and risk
management analysis.
Legal documents and estate planning distribution plan. Having the right legal
documents in place with the correct representatives is an important part of every
contingency plan. Discussing the wishes of the client regarding provision for
dependents and others after his or her death, who would handle their financial
affairs in case of an incapacity, who will make medical decisions if the client is
incapable, who has rights to access medical information in the family, and what
rights and responsibilities the clients have for other family members are all
important issues. Discussing these issues helps clients get clarity on what they
want, which can then be compared to the documents and state laws that will
determine whether if happens will match what they want to happen. At this time
22

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
it is also important to discuss what inheritances they may have coming or people
that they may need to care for in future years. Gifts that they have made or
received also need to be explored for estate planning purposes.
Anticipated changes in lifestyle, family, health, or other concerns. Opening up
discussion to what else should be talked about will raise any concerns or goals
that the clients have not raised. It also gives the clients a time to provide you
important information that they think you need. Issues such as,” I have cancer,”
“I want to take care of a disabled niece,” “I’ll be inheriting $5 million,” “I’m
getting a divorce,” “My son is a drug addict,” and “I want to be a missionary and
leave my company” are all examples of things that could be raised. If you have
made the client feel comfortable sharing with you, a multitude of issues will be
shared. Health concerns are important to consider in assessing the client’s
potential for achieving future goals, insurance needs and insurability, and special
estate planning needs.
This is also a good time to ask clients to project planned or potential changes in
their income and expenses over the next few years, and identify target cash flow
that you can use to accomplish their goals. Some individuals will have
established a plan of saving and investing or will have made saving and investing
an important use for income. However, many new clients may not have
considered the importance of having a savings target each year as a means of
achieving financial planning goals. These questions help the client focus on the
need to do this. Whether the client succeeds in achieving saving and investing
goals indicates the client’s level of discipline in limiting consumption. It also
may indicate to the planner the amount of effort that will be required to have the
client exercise adequate discipline in adopting and following the developed plan.
This is also a good time to bring up the concept of a budget and find out how the
clients manage their outlays. The process of budgeting and outflows will be
addressed later in this module.
Quantitative data to collect through interview process. Some data you will want
to collect cannot be found on statements but is factual in nature. Family member
names and birthdates help to ascertain when future normal retirement benefits
Chapter 1: The Financial Planning Process

23
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
may be available, to plan a schedule for financing the children’s education, and
to determine insurability and life expectancies, among other uses. Names and
contact information for other advisers are needed because as mentioned before,
you may be the quarterback but their specialized skills will be needed. The
current market value of a residence and other personal property is needed for
assessing property and liability coverage, along with implications for debt
restructuring and possible resource in case of death, disability or other risks.
Details on client owned businesses will lead to a discussion of how much and
what business documentation will be needed.
When possible for accuracy, it is best to acquire the statements and policies
rather than interviewing the clients about investments and insurance products that
they own. The benefit is that you will have accurate information and any face-toface time can be spent on understanding their goals and issues. The following is a
list of commonly requested documents required when completing a
comprehensive plan and what you can learn from them. The list will be reduced
if your scope of engagement limits the analysis areas.
Last two pay stubs. This allows you to see income, employee benefit deductions
indicating which plans they are participating in, tax withholding, and qualified
plan contributions. For example, knowing that a client has not signed up for
group disability would change your analysis and options if you see it is available
in his or her employee benefit package. Widely varying incomes due to
commissions could have impacts for budgeting and emergency reserves. A high
number of exemptions claimed in withholding could indicate taxes may need to
be scrutinized to see if they may owe at the end of the year, and clients may
forget about existing 401(k) loans, which would show as a reduction to income.
Three years’ tax returns including supporting documents such as W2s. These
show you variation in income, interest, dividends and capital gains trends,
dependent status, current itemized deductions, charitable activities, business
relationships, AMT carry-forward, and what is being phased out, which can limit
available strategies. You will be able to identify potential changes that could
improve their tax management and possibly investment returns. This information
24

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
enables the planner to assess the importance of a particular income source and to
plan for its potential replacement in case it is suddenly discontinued (such as
salary during a wage earner’s disability). In addition, it helps the planner assess
the client’s ability to meet financial goals by allocating some of the income to
savings and investments or consumption, as appropriate. By looking at the tax
return and comparing it to investment and bank statements, you can see whether
earnings are being reinvested or being spent to support lifestyle. Contributions to
IRAs, education savings programs, etc. can be confirmed. Rental property, royalties,
or other forms of income that may not have formal statements will be uncovered.
Cash flow statements. For clients who use programs such as Quicken or Mint,
bringing cash flow statements can be very helpful and save the adviser time.
Constructing outflow statements can be time consuming, and clients frequently
do not know where their money goes. Many advisers will introduce clients to
programs such as Mint.com, which can capture the last three to six months’
spending and categorize them quickly. You can back into spending by using the
taxable income and subtracting taxes and savings, adding increases in credit or
spending of assets to arrive at what was spent during the year. This will give you
an estimate of lifestyle costs but no ability to find potential savings.
If you do get cash flow statements, you can learn what their intentional savings
plans are versus actual behaviors, debt repayment plans to calculate debt ratios,
and potential opportunities for restructuring cash flow to free up funds to
accomplish goals. This can help you determine whether more focus needs to be
on cash flow management or investment management. You can learn how well a
client manages his or her money and whether debt is an issue to be addressed.
Benefit package descriptions. Policies that explain the group life insurance
amounts for completing life insurance analysis; medical, dental and vision
coverage to help you understand potential out of pocket costs; flexible
spending plan opportunities for potential tax savings; sick days, short-term
and long-term disability benefits for disability analysis; long-term care
options offered by employers; 401(k), pension, and other retirement
Chapter 1: The Financial Planning Process

25
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
opportunities and rules for your retirement, life, and disability analysis.
Knowing why they selected the benefits they did and did not select will help
you understand the client’s reasoning process. Both of these may impact your
contingency planning.
Copies of personal insurance policies and latest statements. The face pages on
personally owned medical, automobile, homeowners, umbrella, life, disability,
long-term care policies, professional and business policies, etc. will let you know
exactly the type, constraints, owners, coverage, and premiums to ensure accurate
analysis. You will need to explore the value of property and assess potential risks
through the interview process in order to evaluate the adequacy of their risk
program. In addition to evaluating the adequacy of coverage, the type of policy
and riders will be important. For example, the client may have the right amount
of life insurance but it may be a term policy which will terminate before the need
ends. Knowing whether health insurance is provided through employers,
Medicare with or without supplements, or through the exchanges can let you
know the time frame for making potential changes. You cannot complete a risk
assessment without this information.
Investment and bank statements including retirement accounts. Gathering year
end and current statements will let you see ownership, value, basis, and dates of
acquisitions, which all have potential tax implications. Based on the size of the
client’s estate, you may need to gather further information for estate tax analysis
such as state of domicile at time of acquisition (community property laws follow
the asset even when the client moves). Having the exact names and shares will
give you the information to complete an accurate asset allocation. This will also
let you determine the appropriate returns to use in projecting retirement,
education, and goal calculations.
Knowing exact ownership is important because some methods of titling assets
involve automatic transfer of a deceased owner’s interest to another owner, thus
avoiding the probate estate, while other methods involve the distribution of property
through the probate process, requiring adequate provisions in the will. The titling of
assets may also be important in the lifetime distribution of property or division of
26

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
property between spouses, if required by court action or other legal reason. In
addition, there are important estate tax considerations related to titling for large
estates. Always note how property is owned (joint tenancy with right of survivorship,
tenancy by the entirety, tenancy in common, community property, etc.), with whom
any joint property is held, and which spouse owns each item of property.
Note: Joint tenancy provides that each party owns an undivided interest with both
having the right of use and of survivorship; meaning that upon the death of one
joint tenant, the other has it all. Tenancy by the entirety is joint ownership
between spouses, in which both have the right to the entire property and upon the
death of one, the other has title (right of survivorship). Tenancy in common is
title to property held by two or more persons, in which each has an “undivided
interest” in the property and all have an equal right to use the property, even if
the percentage of interest is not equal. There is no right of survivorship if one of
the tenants in common dies, and each interest may be separately sold, mortgaged,
or willed to another.
Upon the death of a tenant in common there must be a probate (court-supervised
administration) of the estate of the deceased to transfer the interest in the tenancy
in common. Community property is a form of title ownership in “community
property states,” where spouses are deemed to share equal ownership of all
property obtained during the marriage regardless of which spouse obtained it.
However, discussing the details of the various forms of ownership is beyond the
scope of this module.
Social Security statement. You will have a more accurate projection of the
family’s benefits in case of a client’s death, a client’s benefits in case of a
disability and at retirement, along with a sense of their earnings history.
Liability contracts/debt statements including family loans. Having actual
balances, rates, ownership, terms, and prepayment penalties will help you project
future cash flow, potential debt restructuring opportunities, and project more
accurate retirement, life and disability analyses. In addition, debts generally must
be repaid upon the death of the individual, which affects estate and insurance
Chapter 1: The Financial Planning Process

27
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
planning. Knowing the interest rate and terms of the debt are especially important
if the debt is deductible, such as business loans, first and second mortgages, and
investment interest expenses because of the impact on tax projections.
Copies of wills, durable powers of attorney, trusts, prenuptial agreements,
divorce decrees, business entity formation, gift tax returns and other legal
documents. These will allow you to know what the client does and doesn’t have
addressed and how recently the documents were created. You can also discover
the important people and roles they will play in the client’s estate. Once you have
gathered both the quantitative and qualitative data, you need to organize and
summarize it.
You are also legally required to keep the information. Most advisers have moved
to electronic storage systems. It is important to document the date and by whom
the information was compiled. The date is important because the information
provided is accurate only as of the date specified. A financial statement without a
date is fairly useless, especially if you are trying to track progress towards goals.
Priorities. Clients typically have a number of goals they hope to achieve through
the planning process. Sometimes no amount of planning can help the client
achieve all goals within the desired time frame, given available resources.
Therefore, time frames must be expanded, dollar amounts required must be
decreased, or goals must be modified or given up altogether. During the data
gathering stage, clients are asked to prioritize their goals so that the financial
planner can help the client achieve the most important goals within the desired
time frame. If the financial planner finds that not every goal can be met
satisfactorily, the client will need to be presented with options as to how some
goals may be altered to make them achievable.
Financial statements. The final step in Step 2 of data gathering is the
construction of financial statements. It may seem at first like it is analysis, but it
is simply organizing the information you have collected into a consistent and
usable format. Financial statements enable the financial planner, the client, and
other advisers to obtain a clear picture of the client’s situation in a minimal
28

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
amount of time. The two statements used most frequently by planners are the
statement of financial position and the cash flow statement. The statement of
financial position, also known as a balance sheet, presents the client’s assets,
liabilities, and resulting net worth at a given point in time. It is useful for having
the client verify that you have all of their basic assets and liabilities listed
correctly with the correct ownership. If you build your financial plan with the
incorrect assets and liabilities, you will find yourself trying to present a plan that
is incorrect and having to redo the plan. By having clients confirm it, you will
avoid a major waste of time. The cash flow statement presents the client’s cash
inflows and expenditures for a given period of time. Having the client confirm
the cash flow statement means you and the client are clear on what funds are
available to be dedicated to achieving his or her goals. You will learn about
constructing both of these statements in Chapter 2. Some advisers also create a
list of insurance policies as part of this process and ask clients to review to make
sure no important policies are missed.
Most planners have a data form completed for each client stored either
electronically or in a paper file. Some advisers use financial planning software to
create the net worth and cash flow statements so the information forms the basis
for the analysis. Many software programs allow you to print the financial
statements separate from the analysis.
Step 3: Analyzing and Evaluating the Client’s Financial
Status (Practice Standards 300 series)
300-1: Analyzing and Evaluating the Client’s Information
A financial planning practitioner shall analyze the information to gain an
understanding of the client’s financial situation and then evaluate to what
extent the client goals, needs and priorities can be met by the client’s
resources and current course of action.
Chapter 1: The Financial Planning Process

29
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Explanation of this Practice Standard
Prior to making recommendations to a client, it is necessary for the financial
planning practitioner to assess the client’s financial situation and to determine the
likelihood of reaching the stated objectives by continuing present activities.
The practitioner will utilize client-specified, mutually agreed upon, and/or
other reasonable assumptions. Both personal and economic assumptions must
be considered in this step of the process. These assumptions may include, but
are not limited to, the following:

Personal assumptions, such as: retirement age(s), life expectancy(ies),
income needs, risk factors, time horizon and special needs; and

Economic assumptions, such as: inflation rates, tax rates and investment
returns.
Analysis and evaluation are critical to the financial planning process. These
activities form the foundation for determining strengths and weaknesses of the
client’s financial situation and current course of action. These activities may also
identify other issues that should be addressed. As a result, it may be appropriate
to amend the scope of the engagement and/or to obtain additional information.
In this stage of the financial planning process, the planner reviews all of the data
and relevant documents, and, if necessary, requests from the client missing data
needed to develop the financial plan. Once all the information is available, the
planner analyzes it to identify strengths and weaknesses in the client’s total
financial situation with respect to the achievement of stated goals. In most cases,
part of this task is completed through use of financial planning software for the
long-term projections of goals and some risks.
30

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Software varies in its ability to analyze specific issues. Almost all software is
good at calculating such things as retirement and education. Some software can
handle disability or estate planning, and other packages have very rudimentary
programs that will not do a competent job past the very basics. Learning the
strengths and drawbacks of available tools is an important part of being a
financial planner. In addition to using software, many advisers find they must do
calculations by hand or use a spreadsheet. It is helpful to keep a running list of issues,
questions, calculations needed or additional information needed as each document is
reviewed and information entered into the financial planning software.
The planner might find some areas that need immediate attention, such as the
inadequacy of the emergency fund or the existence of risk exposures that are not
adequately managed. Identifying existing or potential problems that can
negatively affect the client’s ability to achieve objectives is an important part of
financial planning. Once the list of issues has been clarified, the planner
considers the various options available (products and strategies) to help the client
achieve goals, and evaluates them in terms of the client’s situation. Solutions
must be considered from the perspective of the entire situation.
If you recommend the client save the right amount for retirement in his or her
qualified plan but they won’t be able to pay their mortgage or purchase needed
disability insurance, the plan will not work. You may identify your first choice
solution for every issue and then realize you may need to use some second or
third choices when the entire plan is considered as a whole. Note that this stage
generally does not involve the client, except as a source of information.
When available resources are compared to the client’s objectives, it may be
necessary to modify the priority of objectives, the objectives themselves, or the
client’s attitude about his or her current lifestyle and/or available resources.
Economic conditions, both current and forecasted, are considered in this stage of
the process.
Chapter 1: The Financial Planning Process

31
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 4: Developing and Presenting the Financial Planning
Recommendations and/or Alternatives (Practice
Standards 400 series)
Preface to the 400 Series
The 400 Series, “Developing and Presenting the Financial Planning
Recommendation(s),” represents the very heart of the financial planning
process. It is at this point that the financial planning practitioner, using both
science and art, formulates the recommendations designed to achieve the
client’s goals, needs and priorities. Experienced financial planning
practitioners may view this process as one action or task. However, in reality,
it is a series of distinct but interrelated tasks.
These three Practice Standards emphasize the distinction among the several
tasks which are part of this process. These Practice Standards can be
described as, “What is Possible?” “What is Recommended?” and “How is it
Presented?” The first two Practice Standards involve the creative thought,
the analysis, and the professional judgment of the practitioner, which are
often performed outside the presence of the client. First, the practitioner
identifies and considers the various alternatives, including continuing the
present course of action (Practice Standard 400-1). Second, the practitioner
develops the recommendation(s) from among the selected alternatives
(Practice Standard 400-2). Once the practitioner has determined what to
recommend, the final task is to communicate the recommendation(s) to the
client (Practice Standard 400-3).
The three Practice Standards that comprise the 400 series should not be
considered alone, but in conjunction with all other Practice Standards.
32

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
400-1: Identifying and Evaluating Financial Planning Alternative(s)
The financial planning practitioner shall consider sufficient and relevant
alternatives to the client’s current course of action in an effort to reasonably
meet the client’s goals, needs and priorities.
Explanation of this Practice Standard
After analyzing the client’s current situation (Practice Standard 300-1) and
prior to developing and presenting the recommendation(s) (Practice Standards
400-2 and 400-3) the financial planning practitioner shall identify alternative
actions. The practitioner shall evaluate the effectiveness of such actions in
reasonably meeting the client’s goals, needs and priorities.
This evaluation may involve, but is not limited to, considering multiple
assumptions, conducting research or consulting with other professionals. This
process may result in a single alternative, multiple alternatives or no
alternative to the client’s current course of action.
In considering alternative actions, the practitioner shall recognize and, as
appropriate, take into account his or her legal and/or regulatory limitations
and level of competency in properly addressing each of the client’s financial
planning issues.
More than one alternative may reasonably meet the client’s goals, needs and
priorities. Alternatives identified by the practitioner may differ from those of
other practitioners or advisers, illustrating the subjective nature of exercising
professional judgment.
400-2: Developing the Financial Planning Recommendation(s)
The financial planning practitioner shall develop the recommendation(s)
based on the selected alternative(s) and the current course of action in an
effort to reasonably meet the client’s goals, needs and priorities.
Chapter 1: The Financial Planning Process

33
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Explanation of this Practice Standard
After identifying and evaluating the alternative(s) and the client’s current
course of action, the practitioner shall develop the recommendation(s)
expected to reasonably meet the client’s goals, needs and priorities. A
recommendation may be an independent action or a combination of actions
which may need to be implemented collectively.
The recommendation(s) shall be consistent with and will be directly affected
by the following:

Mutually defined scope of the engagement;

Mutually defined client goals, needs and priorities;

Quantitative data provided by the client;

Personal and economic assumptions;

Practitioner’s analysis and evaluation of client’s current situation; and

Alternative(s) selected by the practitioner.
A recommendation may be to continue the current course of action. If a change
is recommended, it may be specific and/or detailed or provide a general
direction. In some instances, it may be necessary for the practitioner to
recommend that the client modify a goal.
The recommendations developed by the practitioner may differ from those of
other practitioners or advisers, yet each may reasonably meet the client’s
goals, needs and priorities.
400-3: Presenting the Financial Planning Recommendation(s)
The financial planning practitioner shall communicate the recommendation(s)
in a manner and to an extent reasonably necessary to assist the client in
making an informed decision.
34

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Explanation of this Practice Standard
When presenting a recommendation, the practitioner shall make a reasonable
effort to assist the client in understanding the client’s current situation, the
recommendation itself, and its impact on the ability to meet the client’s goals,
needs and priorities. In doing so, the practitioner shall avoid presenting the
practitioner’s opinion as fact.
The practitioner shall communicate the factors critical to the client’s
understanding of the recommendations. These factors may include but are not
limited to material:

Personal and economic assumptions;

Interdependence of recommendations;

Advantages and disadvantages;

Risks; and/or

Time sensitivity.
The practitioner should indicate that even though the recommendations may
meet the client’s goals, needs and priorities, changes in personal and
economic conditions could alter the intended outcome. Changes may include,
but are not limited to: legislative, family status, career, investment performance
and/or health. If there are conflicts of interest that have not been previously
disclosed, such conflicts and how they may impact the recommendations
should be addressed at this time.
Presenting recommendations provides the practitioner an opportunity to
further assess whether the recommendations meet client expectations, whether
the client is willing to act on the recommendations, and whether modifications
are necessary.
Chapter 1: The Financial Planning Process

35
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
The Practice Standards clearly set out an expectation that the adviser use current
analytical knowledge and tools to methodically and objectively analyze the situation
versus picking products from their stable of offerings. Notice that it doesn’t say that
the adviser not use products outside of his or her company or require that “the
absolute best” product be chosen. The emphasis is on analysis and thoughtful
consideration of issues, strategies, and products that will help the client achieve his or
her goals. You are to employ strategies and products that are in the best interest of
the client. It is the fiduciary standard plus objective analysis that sets financial
planners apart from other advisers.
In this stage, first the planner identifies appropriate techniques for achieving client
objectives in light of the economic environment. In investment portfolio
construction, for example, asset categories consistent with the client’s objectives and
constraints are identified during the analyzing and evaluating stage of the financial
planning process. Second, the planner selects alternative investments within those
categories, exercising appropriate care. A similar selection process is used in
identifying appropriate insurance products, forms of business operation, intra-family
transfers, tax strategies, retirement plans, and estate planning techniques.
The financial planner further evaluates alternative solutions and develops an
integrated set of recommendations to meet client requirements. Frequently, a
schedule for implementing recommendations is developed and incorporated into
the financial planning recommendations. Some recommendations will be a slam
dunk—easy to understand and easy to implement. Other recommendations may
take time and further exploration by the client. Some recommendations, such as
going without medical insurance, may have such high potential consequences
that the planner must encourage addressing these first even if it isn’t where the
client would prefer to put their time, money, and energy.
Ideally, recommendations are written and prepared so that clients can easily
understand and make informed decisions. Some companies restrict written
recommendations being provided to clients. In those cases, having written
recommendations can help the adviser be prepared to help the client through the
decision making process. Good recommendations will:
36

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
1. Briefly outline the problem and the potential consequences of not addressing the
problem. People don’t solve problems that they don’t understand, or see the
impact of the negative consequences. Phrases such as, “At your current savings
rate, you will need to reduce your current expenses by 48% by retirement” are
more meaningful than “You won’t achieve your retirement goal.”
2. Provide a clear, actionable recommendation that leaves no doubt what the
planner believes is in the best interest of the client to implement. “Buy life
insurance” is not as clear as “Buy $850,000 of 20-year renewable term
insurance and a $150,000 universal life policy on John,” for example.
3. Detail a list of advantages and disadvantages that tells the clients the
pertinent facts they should know in making a decision. If you don’t share
disadvantages of a strategy or product, it creates distrust and clients feel the
need to research for themselves, which can lead to procrastination and
inaction.
4. Highlight the second best alternative from the adviser’s viewpoint so the
client can see that there are options available and you considered them. Not
knowing alternatives makes clients feel they are being sold and backed into a
corner. Giving alternatives also shows that you evaluated options, and
documents your compliance with the CFP Practice Standards.
5. Show clients that the costs of the alternatives you are recommending will fit
within their budget or require changing the budget constraints they provided
you. This action makes it easy for clients to visualize implementing the
solution and helps clients make informed decisions.
In this step, it is critical to adequately address the qualitative data—i.e., the
client’s answers to the “soft” questions. Regardless of what recommendations the
quantitative data may indicate, if the client perceives that the answers to the soft
questions have not been adequately addressed, the next stage is likely to be an
exercise in futility.
Chapter 1: The Financial Planning Process

37
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 5: Implementing the Financial Planning
Recommendations (Practice Standards 500 series)
500-1: Agreeing on Implementation Responsibilities
The financial planning practitioner and the client shall mutually agree on the
implementation responsibilities consistent with the scope of the engagement.
Explanation of this Practice Standard
The client is responsible for accepting or rejecting recommendations and for
retaining and/or delegating implementation responsibilities. The financial
planning practitioner and the client shall mutually agree on the services, if
any, to be provided by the practitioner. The scope of the engagement, as
originally defined, may need to be modified.
The practitioner’s responsibilities may include, but are not limited to the
following:

Identifying activities necessary for implementation;

Determining division of activities between the practitioner and the client;

Referring to other professionals;

Coordinating with other professionals;

Sharing of information as authorized; and

Selecting and securing products and/or services.
If there are conflicts of interest, sources of compensation or material
relationships with other professionals or advisers that have not been
previously disclosed, such conflicts, sources or relationships shall be
disclosed at this time.
38

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
When referring the client to other professionals or advisers, the financial
planning practitioner shall indicate the basis on which the practitioner
believes the other professional or adviser may be qualified. If the practitioner
is engaged by the client to provide only implementation activities, the scope
of the engagement shall be mutually defined in accordance with Practice
Standard 100-1. This scope may include such matters as the extent to which
the practitioner will rely on information, analysis or recommendations
provided by others.
500-2: Selecting Products and Services for Implementation
The financial planning practitioner shall select appropriate products and
services that are consistent with the client’s goals, needs and priorities.
Explanation of this Practice Standard
The financial planning practitioner shall investigate products or services that
reasonably address the client’s needs. The products or services selected to
implement the recommendation(s) must be suitable to the client’s financial
situation and consistent with the client’s goals, needs and priorities.
The financial planning practitioner uses professional judgment in selecting
the products and services that are in the client’s interest. Professional
judgment incorporates both qualitative and quantitative information.
Products and services selected by the practitioner may differ from those of
other practitioners or advisers. More than one product or service may exist
that can reasonably meet the client’s goals, needs and priorities.
The practitioner shall make all disclosures required by applicable regulations.
Notice in this stage of the process, the client and financial planner agree on the
implementation plan, including responsibilities of various parties. It is helpful to
have a form that allows the client to determine if they are going to implement
each recommendation and the actions to take. It is also helpful to make notes as
you work through the recommendations with the client. Recommendations may
require using the assistance of other professionals as needed.
Chapter 1: The Financial Planning Process

39
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
The planner’s role in coordinating the activities of the client and the other
advisers is critical. Without implementation, the plan has no value.
Step 6: Monitoring the Financial Planning
Recommendations (Practice Standards 600 Series)
Monitoring 600-1: Defining Monitoring Responsibilities
The financial planning practitioner and client shall mutually define monitoring
responsibilities.
Explanation of this Practice Standard
The purpose of this Practice Standard is to clarify the role, if any, of the
practitioner in the monitoring process. By clarifying this responsibility, the
client’s expectations are more likely to be in alignment with the level of
monitoring services which the practitioner intends to provide.
If engaged for monitoring services, the practitioner shall make a reasonable
effort to define and communicate to the client those monitoring activities the
practitioner is able and willing to provide. By explaining what is to be
monitored, the frequency of monitoring and the communication method, the
client is more likely to understand the monitoring service to be provided by
the practitioner.
The monitoring process may reveal the need to reinitiate steps of the financial
planning process. The current scope of the engagement may need to be modified.
At some point earlier in the planning process, the planner established a client file
and a system for periodic review and revision. The scope of engagement defined
the planner’s role in monitoring. Due to liability concerns, many companies
require that the planning engagement be terminated within a certain period, such
as six months or one year, and that a new engagement must be created if the
relationship continues past that point. If the planner is managing investments or
40

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
products, the expectation is that the planner will monitor the performance of
investments or the products and the general economic environment as it relates to
those products.
In general, however, when a strong planning relationship is established, clients
are expecting their planner to be monitoring changes in tax law, economics,
products and how it will impact the client’s situation. Clients expect their planner
to be constantly considering additional financial products and strategies for
possible inclusion in the client’s plan as opportunities and changes occur. At
regularly scheduled reviews with the client, the planner evaluates the progress
toward the client’s goals and whether shifts to the prior strategies and
recommendations need to be made. The client’s objectives, health status, income,
or other personal circumstances may have changed. If this is the case, the
financial planner returns to the early stages of the process, re-evaluating goals
and gathering additional data, to make recommendations that meet the client’s
new requirements.
When changes in the economy, tax laws, or other issues arise that are likely to
affect the client’s financial situation, the planner should let the client know that
the implemented financial planning recommendations are being monitored.
Clients rely on their planner’s advice, and, if that advice is not timely, the planner
has let them down.
Chapter 1: The Financial Planning Process

41
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Chapter 2: Personal Financial
Statements
Reading this chapter will enable you to:
1–3
Construct and interpret personal financial statements.
A
mong financial advisers, little debate exists concerning the fundamental
role of financial statements in the financial planning process. Along
with gathering information about client needs, objectives, resources,
expenditures, attitudes, and constraints, the preparation of financial statements is
an indispensable means of evaluating the client’s situation and the ability to
achieve client objectives.
Financial planners, attorneys, investment specialists, accountants, insurance
agents, and other financial advisers use the same basic financial information
about a client. The degree of detail involved and the manner of presentation vary
depending upon the specific reason for preparing and analyzing financial
statements. In general, the personal financial planner uses the statements and
other information to identify (1) existing or potential financial problems, and (2)
resources available for attaining client goals. Constructing pro forma (i.e.,
projected) statements and/or comparing statements prepared at different points in
time can be extremely helpful, not only in developing a financial plan, but also in
tracking its success. In addition, the statement of financial position, with some
modification, is an essential tool in calculating estate taxes.
42

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Business Financial Statements vs. Personal
Financial Statements
When a business firm develops a financial plan, it usually begins with an
evaluation of financial statements and management reports to determine the
business’s strengths and weaknesses. When a bank considers whether to grant a
line of credit to a business, it closely reviews the applicant’s financial statements.
Institutional investors scrutinize a firm’s published financial statements to
evaluate the business in terms of financial soundness and growth potential. In
other words, numerous business decisions of an economic nature are made only
after an analysis of an entity’s financial information. To facilitate the accurate
communication of such information, standardized business financial statements
are prepared for use by bankers, stockbrokers, current and potential investors,
accountants, and the government.
There is no lack of accounting guidelines on business financial statements.
Unfortunately, standardized forms are not always appropriate to the personal
financial planning process because the purposes of business and personal
financial statements differ. In general, business statements are constructed for
external audiences, such as existing stockholders and potential owners. When one
considers the family as an economic entity, it is clear that there are no external
owners. However, personal financial statements sometimes are created for
external audiences, such as lenders.
In business financial statements, assets are considered to be business-owned
economic resources that are expected to benefit future operations. It would be
difficult to apply such a definition to all of the assets of an individual or family.
Preparers of business financial statements categorize assets and liabilities
according to their relationship to the operating cycle of the firm. Concepts such
as current asset, operating cycle, current liability, and working capital lose much
of their force and usefulness when applied to the family unit.
Chapter 2: Personal Financial Statements

43
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
In business situations, attention is focused on four principal financial statements:
the balance sheet, the income statement, the statement of retained earnings, and
the statement of changes in financial position, previously known as the cash flow
statement. Those who use these financial statements are also generally able to
analyze them.
The balance sheet for an individual is called the statement of financial position.
In business, it is useful in assessing the fundamental soundness of the business
entity, its debt and equity structure, the makeup of its assets, and its ability to pay
debts. For individuals this statement serves a similar purpose in delineating the
relationship between assets and liabilities and establishing a family’s net worth.
The income statement, also known as an earnings statement or statement of profit
and loss, reports the profit performance of the company. Assuming that the
information is fairly and accurately presented, the income statement reveals the
ability of managers to earn a profit for owners. The “bottom line,” which is the
profit or loss presented on the income statement, is often one of the most
important determining factors in business decisions.
However, as discussed below, an income statement may not provide an accurate
reflection of cash flows for individuals, as it includes depreciation, tax write-offs,
and more such items that are unique to businesses. This is why a cash flow
statement is needed for the assessment of an individual’s or family’s financial
position. Thus a personal income statement, referred to as the cash flow statement
for the family, also has a bottom line. This bottom line is referred to as the
family’s net cash flow. Then, depending on the financial transactions that take
place in terms of cash flows, the client’s net worth may increase, decrease, or
stay the same.
The statement of changes in financial position for a business explains the change
in working capital (net income, plus or minus cash gains or losses from
operations, investments, and financing activities) between reporting dates. It also
indicates other sources and uses of funds, such as the sale of noncurrent assets or
the issuance of long-term debt by the company.
44

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Financial Statements in Personal Financial
Planning
As we have seen, financial planners generally use these two basic personal
financial statements: the statement of financial position and the cash flow
statement. (See Exhibits 1 and 2 in this chapter.) Many financial planners find
that calendar year statements are most useful, primarily because they correspond
to a client’s tax records; however, financial statements, and even projected budgets,
can be prepared for any period or date. Where appropriate, pro forma statements, or
projected budgets, can be constructed based on realistic assumptions.
The basic format of financial statements, as introduced in this module, is used
throughout the CFP Certification Professional Education Program. In actual
practice, additions or modifications may be required to meet a planner’s specific
needs. Even planners who use commercial software find that the financial
statements included often need modification. The most important aspect of
personal financial statements is that they communicate information. As long as
the preparer and the client understand the statements, their failure to mirror the
standards of business statements is irrelevant.
Statement of Financial Position
The financial planner needs to have a clear picture of the client’s financial assets
and liabilities. Use of the data survey form provides much essential information, but
frequently it is only from analyzing the statement of financial position that the
financial planner develops a clear picture of the client’s current situation. In many
cases, it is also the first time the client has a clear picture of his or her situation.
The statement of financial position is a profile of what is owned (assets), what is
owed (liabilities), and the client’s net worth on a specific date. Net worth is the
residual value after liabilities have been subtracted; that is, assets minus liabilities
Chapter 2: Personal Financial Statements

45
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
equals net worth. Because assets usually are presented on the left side of the
statement and liabilities and net worth on the right side, the relationship between the
components of the statement of financial position can be expressed as follows:
Assets = Liabilities + Net Worth, or
Net Worth = Assets – Liabilities
Many planners prefer a vertical format with net worth at the bottom of the
column. This approach allows them to line up prior or subsequent statements on
the same page for purposes of comparison.
It is common practice to liken the statement of financial position to a snapshot of
the client’s financial situation. From month to month or year to year, values
within the statement can change significantly as new snapshots are taken.
Appropriate financial management will improve the client’s financial condition,
generally leading to an increase in net worth, just as proper action by a patient and
physician usually will improve the patient’s physical condition. As a measure of the
patient’s physical condition, today’s blood pressure reading does not forecast the
person’s condition tomorrow or next week. In the same way, a specific statement of
financial position cannot be used to forecast the financial future of the client.
However, just as the physician checks blood pressure readings to determine the
patient’s condition, the personal financial planner compares successive statements to
identify trends in the client’s financial well-being.
The statement of financial position represents the result of all of the client’s past
financial activities. Depending on the nature and purpose of those financial
transactions, the client’s net worth will stay the same, increase, or decrease over
time. The personal financial planner can help the client become aware of how
specific financial transactions affect his or her financial position. Notice that
while it seems as if there is no change in net worth by shifting savings to a
personal computer, this is a depreciating asset versus an appreciating asset, which
will impact the net worth over time. Additionally, if you are financing a
depreciating asset with credit, it will compound your loss in future years even
more. However, technically in year one, it doesn’t impact your net worth. This is
shown in Table 1.
46

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Table 1: Examples of Transactions Affecting a Client’s Net Worth
Assets =
Liabilities +
Net Worth
Withdraw $5,000 from savings
account to pay for a vacation:
Savings Account
–$5,000
no change
–$5,000
no change
no change
Withdraw $2,000 from savings to
purchase a $2,000 personal
computer:
Savings Account
–$2,000
Personal Property
+$2,000
Withdraw $2,000 from savings and
charge $1,000 to a credit card to
purchase a $3,000 personal
computer:
Savings Account
–$2,000
Credit Card Balance
Personal Property
+$1,000
+$3,000
no change
Withdraw $5,000 from savings and
charge $2,000 to a credit card to pay
for a $7,000 vacation:*
Savings Account
Credit Card Balance
–$5,000
+$2,000
–$7,000
*Note that until the vacation is taken, the tickets and reservations worth $7,000 would be shown
as an asset if they were refundable.
Chapter 2: Personal Financial Statements

47
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Assets
Assets may be separated into three major categories: cash/cash equivalents,
invested assets, and use assets. Under invested assets, it is helpful to subcategorize the investments into: After tax, tax advantaged, and qualified assets so
you can easily see the breakdown of accessible investments.
The categorization of an asset depends in part on why the asset was acquired
and/or how the client views and uses the asset. For example, if the client has built
up a rare coin collection, displays it in the home, and has no intention of selling
it, the coin collection should be classified as a use asset (on the other hand, if the
client plans to sell the collection, it might be considered an invested asset). If the
client owns a mountain condominium that is used from time to time but also is
thought of as an investment in real estate, the client and planner will have to
determine the most appropriate placement of that asset (i.e., invested or use).
Cash/cash equivalents. Cash/cash equivalents are low-risk assets that may be
readily converted to cash. Typically, the cash/cash equivalents category will
include assets such as checking accounts, savings accounts, and money market
funds and accounts. This category could also include short-term certificates of
deposit (CDs) with a maturity date of 90 days or less. Some of these assets will
be earmarked for the client’s emergency fund, which is discussed later in this
module. Cash/cash equivalents are sometimes listed as invested assets (which, in
the broadest sense might make sense, especially when the cash is earning
interest). However, for our purposes, we will keep the two categories separate.
Invested assets. Included in the second category, invested assets, are bonds,
mutual funds, stock, gold, gems and precious metals, collectibles, investment real
estate, fine art, ownership interests in closely held businesses, vested pension
benefits, and similar assets. Longer term CDs would also be considered invested
assets. Many advisers find it helpful to separate invested assets into taxable, tax
advantaged, and retirement plans. Quickly seeing how much of their invested
assets could supplement emergency funds or are available as opportunity funds
48

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
versus those that may have tax penalties can be helpful information. A client
whose invested assets are all in qualified plans will need a larger emergency fund
than one who has a year’s worth of expenses in after-tax investments.
Use assets. The third category, use assets, includes the client’s residence,
automobiles, boats, recreational real estate, and personal effects such as
furnishings, clothes, jewelry, and similar assets.
Difficult-to-categorize assets. The cash surrender value of life insurance policies
creates a problem. Life insurance is a unique asset. It doesn’t fit cleanly into any
of the categories. For this reason, some planners and clients put it in its own
category. For some clients, whole life insurance is a cash or cash equivalent.
They want to use it as such. Others, especially those who have a variable life
insurance policy, look at it as an invested asset. Remember, however, that the full
value of the asset may not be available. For example, you can borrow against a
cash value life insurance policy but not the full value. If you liquidate the asset,
there would be taxes to pay. The full value should be carried on the balance
sheet, but footnotes should recognize that the full amount may not be available.
Remember that the key to financial statements is communication. These items
often are explained through footnotes found in the bottom margin of most
financial statements.
Note: There are additional issues that make life insurance an unusual asset.
When life insurance needs or estate values are being determined, the cash value
of any policy should be ignored, and the total death benefit used instead. When
circumstances dictate that life insurance will be kept beyond retirement, the cash
values may not be available for retirement income needs.
Some practitioners prefer to list the client’s residence as an invested asset. The
reason for this is specifically related to retirement planning. When some people
retire, they intend to sell their home and take advantage of the tax code provision
that allows them to avoid taxes on the gain from the sale. Then they intend to
move to a smaller residence, using the balance of the cash received to enhance
their retirement income. The placement of the residence on the statement of
financial position is affected by the point of view and intentions of each client.
Chapter 2: Personal Financial Statements

49
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
An effective data gathering session will help the practitioner determine the
appropriate place to list the client’s home. Keep in mind that if the client’s
intention is to sell the present residence and move into a smaller one, at least
some of the proceeds of the sale will end up being used for the new residence,
thus limiting the amount that may be used to help fund retirement income.
In this module, no separate category for business assets and liabilities is used;
however, in the case of a sole proprietorship, both business assets and liabilities
should be shown separately from personal assets. Partnership interests and
ownership of stock in a corporation can be shown under the invested assets
category. It is also important to note if a business owner personally signs for a
business liability, it is a contingent liability on their personal financial statement.
Asset Valuation
Assets are shown at fair market value (the price at which a willing and
knowledgeable buyer would purchase an asset from a willing and knowledgeable
seller) on the statement of financial position, unless there is good reason for
doing otherwise. For example, in the case of direct participation programs
(limited partnerships), it is advisable to use original cost unless another reliable
value is available. If the partnership interest has been held for quite a while and is
considered an income-producing asset, the planner might use the present value of
future income streams. On the other hand, there may be situations in which
determining the value is difficult; in such cases, a zero amount can be used.
In the case of assets subject to penalty for early withdrawal, the fair market value
still is presented on the statement of financial position, unaffected by potential
penalties. If there is a known sum of money or asset that is to be received by the
client (such as proceeds of a life insurance policy or the sale proceeds of an
asset), the financial planner will have to make a decision concerning its inclusion
on the statement as a receivable, footnoting as needed.
One item is often ignored, because it isn’t actually an asset—i.e., an inheritance.
With some clients, inheritance of a known amount may be quite certain. It may
be that the death has occurred but the distribution of the estate assets hasn’t taken
50

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
place. The circumstances may be such that there is no concern about whether the
inheritance will take place, only when it will occur. In this case, some note of it is
appropriate, especially when dealing with estate planning.
The financial planner may find it useful to classify assets and liabilities by using
C and S, or Client 1 and Client 2, for clients ), JT for joint tenancy, CP for
community property, and suitable abbreviations for other types of co-ownership.
It is important is that you are quickly able to ascertain ownership.
Liabilities
Liabilities can be listed to reflect either the order in which payments are due or
the order of shorter-term to longer-term obligations. Another style is to list
liabilities related to depreciating assets separate from those for appreciating
assets. The outstanding principal balance as of the date of the statement
constitutes the liability amount. If the client is delinquent in payments, then the
amount overdue, along with accrued interest, should be added to the outstanding
principal balance. The financial planner will have to make decisions about
including contingent liabilities, footnoting as needed.
Net Worth
Net worth is the difference between assets and liabilities. It fluctuates from
statement to statement, depending on the financial transactions that take place
between the dates of statement preparation. Comparison of net worth values over
time can reveal how well the client is doing in achieving financial goals that
involve a permanent increase in net worth. For planning purposes, it is helpful to
observe how the amount of net worth is reduced after subtracting the value of
home equity, personal property, and/or retirement benefits. Exhibit 1 provides a
good example of a statement of financial position.
Chapter 2: Personal Financial Statements

51
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Footnotes
Footnotes are an integral part of all personal financial statements and should be
taken into consideration when the financial planner evaluates the client’s
situation. Footnotes clarify items in the statement or indicate values or
circumstances not disclosed in the body of the statement. They can also indicate
relevant contingencies, such as an inheritance or a pending lawsuit that may
affect future assets or liabilities.
Exhibit 1: Example Family
Statement of Financial Position
as of December 31, 201X
ASSETS1
Cash/Cash Equivalents
Checking account
Credit union savings account
Money market account (W)
Life insurance cash value
Total Cash/Cash Equivalents
Invested Assets
Stock portfolio
Limited partnership2 (H)
IRAs3
LIABILITIES AND NET WORTH
Liabilities5
Credit card balance
$950
Auto note balance
4,920
Mortgage balance
87,900
Total Liabilities
$3,050
4,000
7,500
8,000
$93,770
$22,550
$7,800
6,500
8,740
Vested portion of pension plan4
Total Invested Assets
Use Assets
Residence
Automobiles
Personal property
Total Use Assets
TOTAL ASSETS
10,240
$33,280
Net Worth
$177,060
TOTAL LIABILITIES
$270,830 AND NET WORTH
$270,830
$135,000
28,000
52,000
$215,000
1
Presented at fair market value; all assets held in joint tenancy with rights of survivorship except
as noted
2
Estimated value as of 6/30/1X
3
Client $4,800; spouse $3,940
4
Client $7,400; spouse $2,840
5
Principal only
52

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Cash Flow Statement
Whereas the statement of financial position indicates what the client owns at a
given point in time (a static snapshot), the cash flow statement reveals the client’s
cash receipts and disbursements over a specific period of time, usually one year
(more like a dynamic moving picture). It summarizes the inflows and outflows of
cash and reveals the client’s pattern of spending, saving, and investing. Sample
cash flow statements in this module are for the year just ended. Please note again
that a cash flow statement is not technically the same as an income statement. An
income statement is most often used in a business context, and focuses on a
company’s financial performance. Revenue is recognized as income, but may not
immediately result in a cash flow (think accrual accounting).
A cash flow statement is used in personal as well as business situations, and
focuses on the flow of cash into and out of a person’s core financial accounts (as
the name implies). Income statements are seldom, if ever, used in a personal
financial planning context (except where personally owned businesses are
involved). A cash flow statement, on the other hand, is one of the two primary
financial statements used to evaluate an individual’s financial situation.
As a projection of cash flows, the pro forma cash flow statement is a planning tool
that projects the anticipated inflows and outflows for a future period. It can be
prepared on a monthly, quarterly, or yearly basis. Its projections are based on
established patterns of inflows and outflows, on the client’s goals for the designated
period, and on the effects of either implementing or not implementing the
recommended financial plan. No pro forma statements are presented in this module.
Chapter 2: Personal Financial Statements

53
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Inflows
Inflows include gross salaries and wages, interest and dividend income, rental
income, tax refunds, and other monies received by the client. If funds are
withdrawn from savings or if invested assets are liquidated, the planner should
list such inflows under a special inflow category of savings and investments to
identify clearly the source of the cash. Note that because this is a record of cash
flows, amounts to be invested (e.g., dividends) would be recorded as an inflow
when received as well as an outflow when reinvested (in the savings and
investments category). You will see this issue of dividends and interest being
handled in two different methods. If a client is reinvesting all of their dividends
and interest, it may be left off the financial statement by some practitioners.
Others will carry them as both an inflow and an outflow. The net effect is the
same but lenders and some planners see that as a choice that could be changed if
circumstances dictated. During a layoff or use of emergency fund, the cash flow
could be turned on. If this is done, it does impact growth of the portfolio and
assumptions about investment returns would need to be modified.
Outflows
Outflows should be divided into three categories: savings and investments,
fixed outflows, and variable outflows. Fixed outflows are relatively
predictable and recurring expenses over which the client does not have much
control. Typical fixed outflows are note payments, mortgage payments, and
insurance premiums. Variable outflows are those over which the client can
exercise some degree of control, such as expenditures for food,
transportation, clothes, and entertainment. Before constructing a cash flow
statement in this course, students should take note of the general types of
outflows categorized as fixed and variable in Exhibit 2.
54

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Acquiring the information to complete this component can be challenging. Many
clients have no idea where their funds are utilized. You may find it helpful to
clients to introduce them to programs such as Mint.com, which will take credit
card statements and checking accounts and combine them into a cash flow
tracking tool that takes very little effort to learn and maintain. This becomes a
valuable tool for both the adviser and the client. If clients do not have this
information, you can discover what is spent by determining taxable income
minus savings and taxes plus increases in credit and withdrawals from
investments. What is left over is spent on lifestyle. Subtracting the known fixed
expenses leaves you with a variable amount.
Note that in the Exhibit 2 cash flow statement, taxes and FICA are listed as fixed
outflows. Some practitioners are more comfortable showing income taxes as a
variable outflow. The ability to affect income taxes through various investment
options and income planning is the rationale for this position. If a planner or
accountant is more comfortable with taxes as a variable outflow, then that is
acceptable as long as the client has a good understanding of the financial statements.
When an individual purchases an item with a credit card, no cash outflow has
occurred. It is not until a payment is made to the credit card company or
individual store that cash is disbursed. When the credit card purchase takes place,
an additional liability develops, which affects the statement of financial position.
The financial planner could list as a separate variable cash outflow, all payments
made to reduce credit card balances (consumer debt reduction). Unless the client
uses one specific credit card for transportation, another for clothing costs, a third
for entertainment, and so on, there is no way to easily isolate the specific type of
outflow—e.g., food, transportation, education, or personal care.
The financial planner can create additional subcategories of fixed and variable
expenses, as needed. Savings and investments should always head the list of
outflows. By taking this approach, especially on a pro forma cash flow statement, the
“pay yourself first” theory can be reinforced with the client. When a client has
dividend and interest income that is reinvested automatically, the proper treatment on
the cash flow statement is to include the dividend and/or interest as inflow, and then
Chapter 2: Personal Financial Statements

55
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
include the amount under the outflows category of savings and investments for
reasons previously listed. It can also be helpful to create a pro forma showing what
cash flow will look like after implementing the adviser’s recommendations.
Net Inflow (Outflow)
This figure is determined by subtracting total outflows from total inflows (similar
in concept to net worth, but dealing with the flow of money during a specified
time period). Because the cash flow statement reports only actual inflows and
outflows of cash over a period of time, the net inflow or net outflow for the
period can be a positive amount, a negative amount (indicated with parentheses
and indicating a net outflow), or zero. It should not be assumed that a net inflow
represents funds that are available for savings or investment or to be used to help
achieve financial goals. Typically, a net inflow exists due to differences in the
timing of inflows and outflows.
The method of structuring the cash flow statement used in this course, as
described in the preceding paragraph, often provides valuable insight for the
planner into the client’s spending habits. Does the client spend more than he or
she makes (net outflow)? Or perhaps there is a real net inflow (rather than timing
differences) that may be identified for additional savings or investments. Finally,
in some instances, planners will find that a family spends more than is being
made, in which case we are encountering a net outflow or a deficit. This is
perhaps far more important information for the planning process than simply
making the inflow and outflow balance equally.
56

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Exhibit 2: Cash Flow Statement for Example Family
For the Year Ending December 31, 201X
INFLOWS
Gross salaries
$
Dividend income
61,600
790
Interest income
720
Payment from trust account
3,000
TOTAL INFLOWS
$
66,110
TOTAL OUTFLOWS
$
65,970
NET INFLOW
$
140
OUTFLOWS
Savings and Investments1
Fixed Outflows
Mortgage payments2
$
3
Auto loan payments
2,880
1,340
Total Fixed Outflows
$
$
16,470
$
43,200
12,650
Food
5,900
Transportation
1,450
Clothing/personal
4,800
Entertainment/vac
9,500
Medical/dental care
1,200
Utilities/household
Miscellaneous6
3,800
Total Variable Outflows
6,300
12,250
Insurance premiums4
Variable Outflows
Taxes5
$
3,900
1
Includes $4,000 IRA contributions and $2,300 deposit to money market account
Includes principal, interest, taxes and insurance (PITI)
3
Includes principal and interest
4
Automobile, homeowners, and life insurance premiums
2
5
FICA, federal and state income taxes
6
Includes credit card payments of $1,500
Chapter 2: Personal Financial Statements

57
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Chapter 3: The Analysis
A
fter setting financial goals and gathering data, the next step in the financial
planning process is analyzing the information. This is done to determine the
steps that need to be taken to move the client from where he or she is now to
where he or she would like to be, as defined by the client’s goals.
This is the part of the process where the plan begins to take form. During the
analysis of the information, the planner identifies the strengths and weaknesses in
a client’s plan. It is in this phase that the importance of good data gathering
becomes obvious.
Reading this chapter will enable you to:
1–4
Recommend assets appropriate for use in an emergency fund.
All financial plans need a base. That base is often the simplest form of savings—
i.e., liquid savings and money that can be accessed without delay, penalty, or
incurring debt. These funds are generally the basis of the emergency fund.
The Emergency Fund
How Much
It is recommended that individuals retain a sufficient amount of liquid assets at all
times to handle emergencies so they will not have to borrow money or liquidate
investments at a potentially inopportune time. However, because investments with
the greatest liquidity tend to have the lowest earnings, it is important that the amount
that is held out for an emergency fund is not excessive. A good rule of thumb is that
the client should have the equivalent of three to six months of fixed and variable
expenses in liquid accounts for emergencies. This would exclude the expense of
income-related taxes and contributions to savings and investments.
58

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Where did this rule of thumb come from? From a theoretical point of view, the
worst emergency is one where a client loses his or her income due to the loss of a
job or a disability. If the individual is not earning an income, income taxes won’t
be paid (with the exception of taxes on investment income). Likewise, if there is
no income, the client will not be adding to savings and investments; rather, he or
she will be drawing on savings and investments. This rule of thumb came about
prior to pre-tax medical premiums, flexible spending plans, and a host of other
important benefits that are not incorporated into this calculation.
If a client has child care costs of $5,000 per year, medical insurance they have to
pay on an after-tax cost of $8,000 per year, and are using the flex plan to pay
medical expenses of $2,500, these numbers should be factored into the
emergency reserve calculation. Most test questions will not incorporate this
information, but for your client’s sake, you need to examine emergency fund
needs with these in mind. Other emergencies can also take large chunks of
money. Lawsuits, serious illnesses, major dental work, a child’s illness requiring
a parent to take time off, etc. can constitute a need for cash in a short amount of
time. When adequate disability income insurance is in place, some practitioners
recommend that the emergency fund be sufficient to cover the waiting period
before benefits become payable (which typically is from three to six months).
Which investments?
In essence, the appropriate vehicles for an emergency fund are cash and/or cash
equivalents, as defined in Chapter 2 of this module. Vehicles included are
checking accounts (excluding funds to be utilized for normal expenses, which
from a practical standpoint means that you should reserve an amount equal to one
month’s expenses, and can use any remaining checking amounts for an
emergency fund), savings accounts, and money market accounts or funds, which
all can be converted to cash quickly, if needed. When determining amounts to be
used for emergency funds, you do not need to “make up the difference” between
what is in checking and the amount of monthly expenses. For example, if
monthly expenses are $5,000, but there is only $4,000 in checking, you do not
Chapter 3: The Analysis

59
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
need to hold back $1,000 from savings when considering how much is available
for the emergency fund. In this example, you simply would not use any money
from checking, but all of the savings account would be available for use.
A certificate of deposit may be appropriate if it matures in the near term;
however, generally speaking, CDs with maturity dates of more than 90 days are
not appropriate for emergency use because of the early withdrawal penalties
frequently assessed. Life insurance cash values are another potential source of
emergency funds, although students should note that life insurance policies
contain delay clauses that enable an insurance company to delay payment of cash
values for up to six months. Additionally, all of the cash value may not be
available. These clauses usually affect payment only during periods of extreme
economic distress; however, since emergencies may happen at any time, it is
important that clients be prepared to handle them, whenever they might occur.
Life insurance cash values normally should be used as a source of emergency
funds only as a last resort, which means that, for this course, unless you are given
a compelling reason to use life insurance cash values for an emergency fund, do
not do so. Some clients will argue that they have lines of credit and do not need
as much in reserves. If an income source is disrupted, banks can pull lines of
credit, including second mortgages. Relying on credit adds serious risk.
Table 2: Overview of Emergency Fund Assets
Appropriate:
Inappropriate:
Cash/Cash Equivalents
Equities
Money Market
Debt/Debt Instruments
Short-term CDs (< 90 days)
Life Insurance Cash Value
Savings
Anything that creates a debt or liability
Checking: but must reserve an
amount equal to one month’s
expenses
60

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
A further discussion of life insurance cash values is in order here. While
insurance policies have a provision that allows the insurance company to delay
distributions on policy loans for up to six months, it is rarely used, and most
companies have never used it. The type of emergency experienced is the primary
factor in determining the appropriateness of using life insurance cash values. If a
car needs major repairs or a leaky pipe causes expensive water damage, the use
of cash values may be appropriate. In the case of a disability or the loss of a job,
cash values may not be a good source of emergency funds. The use of cash
values results in either an increase in debt or a loss of needed life insurance.
When a person is not earning an income due to a job loss or disability, increasing
debt is not a good choice. The need to maintain existing life insurance is
increased, especially in the case of disability. Jeopardizing the existence of that
insurance would simply be bad planning.
Please note that this position may conflict with the position taken by some
experts. The decision to use cash values is a matter of perspective (however, for
the exam, you should take the perspective that life insurance cash values should
not be used).
Just as life insurance cash values are generally inappropriate for emergency
funds, credit cards are a bad choice for funding emergencies. The use of credit
cards increases the debt load and can easily make financial problems worse.
Another controversial emergency fund vehicle is Roth IRAs invested in money
markets. The advantage is that one can access contributions without tax at any
time while still having some creditor protection. The disadvantage is that the
accounts may be more highly leveraged using growth investments for retirement.
Additionally, the earnings cannot be accessed without tax or penalty except under
certain circumstances.
Chapter 3: The Analysis

61
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Flexibility
A recommendation that the client hold funds somewhere between three to six
months’ expenses should be based on the client’s individual situation. The most
conservative approach, obviously, is to retain at least six months’ expenses, but
some situations may warrant less. For instance, if the client has several sources of
income, or if the sources of income are particularly stable, three months’
expenses may be sufficient. For example, a family where both clients are
working, have rental income from several properties and ongoing distributions
from a trust. The gap of losing one salary may be very minimal. On the other
hand, a sole support of a family with no other sources of income that owns a own
business or is based solely on commissions with a large number of children may
need an amount greater than six months. The financial planner uses the statement
of financial position and cash flow statement to ascertain what cash/cash
equivalents are currently in place and whether the client’s emergency reserve is
adequately funded.
A different category of emergency fund may be set aside for all unplanned, large
expenses that the individual cannot reasonably meet out of income. These may
include medical and dental expenses that are not covered by insurance, home or
automobile repairs that must be made to ensure safety and well-being, and
emergency travel. It also is available to replace short-term losses of income
resulting from unemployment, disability, or death of a breadwinner. It is
important that clients recognize that money drawn for emergencies from
established emergency funds must be replaced as soon as possible to manage
future emergencies. Amounts for this category of emergency fund should be
determined based on client objectives, available resources (including sources of
income), insurance coverage and deductibles, the age of equipment (e.g., a new
furnace is not likely to break down, but one that is 40 years old may not last
much longer), and the like.
62

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Opportunity Funds
Some financial planners also recommend that clients set up “opportunity funds,”
which are liquid or semi-liquid accounts available for large purchases of a
nonemergency nature that the client may wish to make, such as cars, jewelry,
furniture, or travel. Such funds would prevent the client from having to borrow to
attain these items. Some planners use opportunity funds for investing purposes,
ensuring that clients have liquid funds available to take advantage of investment
opportunities that may arise.
Debt Management
Debt can be an important tool for clients in obtaining what they want and
managing outflows, or it can be a drain on their resources. In general, debt is best
used for large purchases, especially those that normally create equity, such as a
mortgage for home ownership, where it would be difficult for clients to obtain
the item for cash. However, entering into debt requires (1) the payment of
interest, which increases the cost of obtaining the item, and (2) periodic
repayment of principal, which limits funds available for other consumption and
savings. Therefore, consumer debt (credit cards, automobile loans) should be
avoided as much as possible. This is particularly true for individuals who are
unable to control spending when consumer debt is readily available. In addition,
while mortgage interest is deductible for income tax purposes, interest on
consumer debt is not.
Therefore, any financial benefit of carrying balances on credit cards or financing
other purchases, such as automobiles, is reduced. Although some situations will
require the use of consumer credit for the individual to obtain a needed item or
service, consumer credit generally should be used for convenience only—i.e., to
consolidate bills into one payment and to delay payment for an item until the
billing date. One benchmark sometimes used by financial planners is that
payments on consumer debt should not exceed 20% of net income (gross income
minus taxes).
Chapter 3: The Analysis

63
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Some loan officers use this and the following rules of thumb in assessing whether
a home mortgage will be offered to a prospective borrower.

Monthly housing costs (including principal, interest, taxes, fees, and insurance)
should be no more than 28% of the prospective borrower’s gross income.

Total monthly payment on all debts should be no more than 36% of gross
monthly income. According to the underwriting guidelines for Fannie Mae,
this includes:

monthly housing expense (including taxes and interest)

monthly required payments on installment/revolving credit monthly
mortgage payments on non-income-producing property

monthly alimony, child support, or maintenance payments
While the purpose of these benchmarks is to assess an applicant’s ability to assume
additional debt, they also may be useful for financial planners in assessing whether
current debt appears to be excessive, given the client’s resources. Notice that
housing costs include items that are not debt. Taxes, insurance, and association fees
are part of housing costs. However, even though they are expenses rather than debt,
they are included in the “total debt” benchmark. Further, these benchmarks are all
mutually exclusive. If any one of the benchmark percentages is surpassed, the
client’s situation must be evaluated to try to bring the debt under control. Each
client’s circumstances will be different. A client with a given level of debt and
$1,600 of property taxes is in a much different situation than a client with the same
level of debt and $7,500 of property taxes.
Table 3: Debt Management Rules of Thumb
64

Type of Debt
Rule of Thumb
Consumer debt
20% or less of net monthly income
Housing costs
28% or less of gross monthly income
Total debt
36% or less of gross monthly income
Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Two Primary Forms of Debt-to-Income Ratios
1. There is a debt-to income ratio known as the front-end ratio that indicates the
percentage of income that goes toward housing costs, which for homeowners
includes PITI (principal, interest, taxes, and insurance premiums) and also
homeowners’ association dues when applicable. This ratio varies depending
on which set of guidelines used, but for purposes of this course, housing
should not exceed 28% of gross monthly income. This gross income includes
dividends and interest, even if they are being reinvested.
2. The second debt-to income ratio is known as the back-end ratio. This ratio
identifies the percentage of income that goes toward paying all recurring debt
payments, including those covered by the front-end ratio, and other debts
such as credit card payments, car loan payments, student loan payments,
child support payments, alimony payments, and legal judgments. In
computing this, it is important to use the minimum required debt payment
versus the amount the client is paying. For example, if a client is putting
$500 to the credit card debt but the minimum payment is $150, the $150
would be counted toward the debt. The reason is that the client chooses a
higher payment but would not be required to maintain that payment. For this
course, the maximum measure for back-end ratio for all debt is 36%, as
illustrated previously.
Nonmortgage Debt-to-Income Ratio
There is one more measure of debt, the nonmortgage debt-to-income ratio, and
much like the debt-to-income ratio, this ratio compares the annual payments to
service debt. However, this measure excludes the mortgage and uses a person’s
annual take-home pay (or net income). The ratio simply provides insight into
what amount of after-tax income is going toward nonmortgage debt. A ratio of
15% or lower is healthy, and a ratio of 20% or higher is considered a warning
sign that nonmortgage debt is excessive. The nonmortgage debt-to-income ratio
is calculated as follows:
Chapter 3: The Analysis

65
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Nonmortage debt-to-income ratio =
Annual nonmortgage debt repayment
Annual net income
Gross Income versus Net Income
For mortgage lending purposes, the debt-to-income calculation is always based
on gross income. Gross income is a before-tax calculation. The reason for the use
of gross income in both front-end and back-end ratios is the tax-favored status
afforded mortgage interest payments. Because consumer debt is afforded no such
tax-favored status, this calculation is done on a net income, or after-tax basis.
Net-Investment-Assets-to-Net-Worth Ratio
The net-investment-assets-to-net-worth ratio compares the value of investment
assets (excluding equity in a home) with net worth. It is useful in showing how
well an individual is advancing toward capital accumulation goals. An individual
should have a ratio of at least 50%, and the percentage should get higher as
retirement approaches. Younger individuals will most likely have a ratio of 20%
or less because they have not had the time to build an investment portfolio. A
family with a statement of financial position showing that they have a ratio of
only 18% indicates that they are not progressing well in their goal of
accumulating capital. This information should be used to help guide the client in
developing his or her financial plan. The ratio is calculated as follows:
Net -investment -assets- to-net - worth ratio =
Net investment assets
Net worth
Sources of Income
An individual or family that has several sources of income frequently is in a more
secure financial position than one where all income comes from only one source.
While having only one source of income is not necessarily a weakness, it does
require greater planning to ensure that if the income were to become unavailable,
the family or individual would have some means of surviving financially. On the
66

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
other hand, when an individual or family has many sources of income, the loss of
any one source does not create as great a financial problem for the family, and
fewer resources may need to be allocated to contingency planning. Sources may
include salaries or wages, investment income, trust income, alimony, child
support, commissions, residuals, payments from judgments, gifts, etc. Sources of
income are identified on the cash flow statement.
It is the sources of income, combined with their relative amounts, which drive the
decision as to what multiple of expenses is adequate as an emergency fund.
Savings and Spending Patterns
An established habit of saving and investing is beneficial and usually necessary
to achieve goals. Many financial planners recommend that clients allocate at least
10% to 15% of gross income to savings and investments. However, some clients
will need to save far in excess of this amount to achieve the goals they have set.
The financial planner can ascertain whether the client has been allocating this
amount to savings by reviewing the client’s cash flow statement. Employer
contributions to qualified plans count toward this savings ratio, so it isn’t quite as
daunting as it seems at first glance.
The cash flow statement also will show whether clients are living within their
means. If the clients are able to save a reasonable amount on a regular basis, do
not borrow heavily for regular expenses, and/or have not been required to
liquidate investments to meet regular living expenses, they probably are living
within their means. The absence of one of these points does not necessarily prove
that the clients are not living within their means, but does indicate an area that the
planner may need to watch in the future or about which further information
should be requested. If the clients are having problems in this regard, they
probably would be good candidates for budgeting.
Another factor that may point to the need for budgeting are large miscellaneous
expenses (i.e., expenses that cannot be accounted for) on the cash flow statement.
By understanding the nature of the clients’ expenses, the financial planner is
better able to assess how dollars should be allocated to achieve goals.
Chapter 3: The Analysis

67
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Ratio Analysis
CFP Board has identified liquidity ratios for the analysis of financial statements
as one of the topics that may be included on the Board certification examination.
Although liquidity ratios are not directly applicable to personal financial
statements, they are useful for evaluating small business interests with which
clients may be associated. One liquidity ratio that may be useful is the current
ratio, which is the ratio of current assets of a business (cash/cash equivalents,
receivables, and inventory) to current liabilities (liabilities that are due within one
year). Obviously, the higher the ratio, the greater the firm’s ability to satisfy
current debts with current assets. Another ratio for analysis is the acid test ratio,
or quick ratio, which is the ratio of cash/cash equivalents and accounts receivable
to current liabilities.
One ratio that does apply to personal finances is the emergency fund ratio of
cash/cash equivalents to expenses. A simple example of this is where a person
has $10,000 in liquid savings, and total fixed and variable expenses of $47,000
per year (excluding income taxes, FICA, savings, and investments). The ratio is
10,000/47,000 = .21. The emergency fund should generally be between three and
six months of expenses. Since three months is one-fourth of a year (.25 or 25%),
and six months is half a year (.50 or 50%), this person, with 21% of expenses in
his or her emergency fund, is not yet prepared for an emergency.
Analyzing Sequential Financial Statements
When a client first comes to a financial planner for assistance, it is possible that
previous financial statements will not be available for perusal. However,
assuming that the client and planner have an ongoing professional relationship, it
will be possible in the future to analyze sequential statements of financial
position and cash flow statements to determine financial progress.
68

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
As was stated earlier, net worth is the bottom line for an individual. Proper
financial management generally produces an increase in net worth by reducing
liabilities or increasing assets, or both. It should be noted, however, that a
decrease in net worth might be entirely appropriate, as in the case of a retiree
depleting accumulated assets over the course of retirement. Increases and
decreases in net worth should not be considered strengths or weaknesses in and
of themselves; rather, the financial planner should consider the financial events
that created the changes in net worth and evaluate whether the financial strength
of the client has been enhanced or depleted as a result.
Another example serves two purposes. When children attend college, the
family’s assets generally decrease by the amount of savings and investments that
are consumed in paying for the education. At the same time, there is no
measurable increase in any financial asset. Most agree that a college education is
clearly an asset, but it is the asset of the child. The student’s “personal net worth”
increases as the family’s financial net worth decreases.
While changes in net worth can be seen in successive statements of financial
position, the events causing these changes may become more evident from
reviewing cash flow statements. These show outflows to savings and
investments, reduction of debt, and purchases. Additionally, they show inflows
from external sources. Outflows to fixed and variable expenses, other than debt,
generally do not affect the statement of financial position, unless investments have
been liquidated to facilitate the outflows. Net outflows to savings and investments
may increase net worth because asset values of these vehicles then should increase.
Outflows to debt (e.g., loan payments) should increase net worth by reducing liability
balances, assuming additional debt has not been taken on. The effect of financial
transactions upon net worth was illustrated earlier in this module.
It should be noted that changes to net worth sometimes will occur regardless of
whether the client makes any changes in allocating income. For instance, some
assets fluctuate in value due to market conditions.
Chapter 3: The Analysis

69
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Other Areas of Analysis
Other analyses—of risk exposures and coverage, investment portfolio allocation,
extent of income taxation, resources for retirement, and estate taxation and
planning—all begin with personal financial statements. These areas, though
briefly addressed below, are essentially beyond the scope of this module but are
addressed in other components of the CFP certification program.
Risk Management
Coverage of risk exposures is essential in ensuring that clients are able to
continue to meet goals despite a loss they may experience. Risk exposures that
most people face include premature death, disability, illness, property loss and
damage, liability, long-term care expenses and unemployment. With the
exception of unemployment, the best means of covering these risks for most
people is through insurance. Determining the adequacy of risk management
techniques currently in place is covered in detail in later modules.
Investment Planning
It is important that investments be structured in a manner consistent with the
client’s risk tolerance level and economic conditions. The portfolio should
feature adequate diversification of investments to minimize potential risks.
Finally, the investments should be appropriate for the goals of the client in terms
of time frames, liquidity and marketability, form of return (i.e., current income or
capital appreciation), and safety. These issues are discussed more fully in
investment planning modules.
Tax Planning
For most people, achieving goals involves reducing expenses as much as possible
to reallocate dollars toward goals. An important means of doing this may be the
minimization of income taxes through the judicious use of available deductions,
exemptions, and credits. A client who is paying more taxes than legally required
negatively affects his or her financial situation. The financial planner can help the
70

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
client reduce taxes by considering the client’s goals and objectives and arranging
his or her financial affairs to take advantage of favorable tax provisions. These
issues are discussed more fully in income tax planning modules.
Retirement Planning
Planning for retirement is essentially a lifelong endeavor, which increases in
importance as the client nears retirement age. When information is being
analyzed during the early stages of the financial planning process, the financial
planner considers whether the client has begun planning for retirement. The
planner evaluates whether plans in place appear to be adequate (assuming
continued allocation of resources to this goal) in terms of dollar amounts
positioned for retirement. Additionally, the appropriateness of vehicles selected
or available, both individually and as a composite, must be reviewed. Analysis of
retirement planning is discussed in greater detail in retirement planning and
employee benefits modules.
Estate Planning and Legal Documents
Finally, ensuring that a client’s wishes with regard to estate planning are properly
handled is critical to the financial future of the client’s entire family. The
financial planner reviews estate-planning techniques in conjunction with the
client’s wishes. This is done to ensure that all property will be distributed in the
proper amounts to the proper beneficiaries, that estate settlement costs and estate
taxes will be minimized consistent with client goals, and that care of dependents,
financially and physically, has been adequately attended to. Estate planning
issues are discussed in estate planning modules.
Priorities
In financial planning, correcting weaknesses should take top priority. Funds
should first be used to solve immediate problems; then the achievement of other
goals can be addressed. Therefore, it may be necessary to delay the achievement
of some client goals or to alter them slightly. Operating from a position of
financial strength is the best long-term position to take regarding the fulfillment
of client needs and wishes.
Chapter 3: The Analysis

71
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Chapter 4: Budgeting
Reading this chapter will enable you to:
1–5
Analyze a client’s financial situation to identify issues related to
budgeting.
Having a roadmap increases the chances of reaching a destination. A budget
helps clients actively manage their money so they can reach their financial goals.
What is a Budget?
A
budget is a tool used to plan and evaluate spending patterns. It is an
estimation of all income and expenses and a financial road map for dayto-day living. A family that operates within a budget generally has
fewer financial problems than a family that pays bills when they come and then
sees what is left at the end of the month. Often there is too much month left at the
end of the money. Success in following a budget doesn’t mean the client brings
in exactly the projected income and spends exactly the amount projected for
expenses. Success is generally measured by adding up all of the pluses and
minuses in each category of spending, and finding that the bottom line is more or
less what the budget projected it would be. A budget, however, is useless unless
the clients consistently compare what they are actually spending to their target.
Tracking, evaluating, and discussing living into the budget will increase the
chances of the budget accomplishing its goal. A budget that is developed and put
away for the year only to be pulled out at tax time will not accomplish its goal.
72

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Basic Considerations
Making it Work
A client with no record of his or her financial history will have a difficult time
developing a first-time budget. However, online banking and credit programs
have made setting up a budget much easier than it was in the past. Many banks
and credit cards allow users to categorize expenses and download them into a
spreadsheet for easy manipulation. Free programs such as Mint.com allow users
to connect the secure program to the online banking, investment, and credit card
accounts so expenses can be automatically integrated from various sources. With
just a few clicks, the last three months’ history from a client’s two checking
accounts, money market, IRAs, and four credit cards can be combined and
reviewed. The programs make it easy to put in rules, such as always make
Kroger’s receipts a grocery expense, which can speed up the process in the
future. Spending about 20 minutes per month can allow individuals to easily
track and analyze their budget. An added bonus is that much of the information
needed for tax preparation will be compiled by tax time.
A budget is initially based on historical spending—how much was spent on food,
housing, entertainment, etc. It is then modified to reflect the client’s desires and
realities. Planning for expenses reduces questions regarding affordability of
something like a car, new refrigerator, or vacation. The desire to meet financial
goals generally provides motivation to stay within a budget. As the year
progresses, moving spendable dollars from one category to another is allowed.
Budgets are not intended to set rigid dictatorial limits. Budgets are guidelines.
The exact cost of most things we use changes over time—sometimes up,
sometimes down.
Chapter 4: Budgeting

73
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Reasons for Using a Budget

to accomplish specific financial goals by dedicating the right amount for the
time frame

to avoid the need to use credit cards or other forms of debt for expenses that
can be anticipated. (If you own a car, it will need repairs at some point and/or
you will need tires, etc. Budgeting allows you to plan for the expense.)

a written plan, including goals such as a vacation or paying down debt, will
let everyone in the family know why spending is being limited in one area or
another and get everyone engaged in staying on track

when the family economics are complex—e.g., when income and/or
expenses are widely fluctuating

when it is important to keep track of spending in one specific area or by
specific individuals

when the family believes it is important to establish financial incentives for
its members

when a family wants to shift or improve control of household expenses
Budgeting Advantages

Budgeting allows you to choose where you want your resources to go rather
than be driven by habit.

Family stress and conflicts over money can be resolved before they become
issues.

Chances of achieving financial goals increase if attention is paid to making
sure the resources to save for the goal are available.
74

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.

Budgeting provides a way to measure financial performance. It is a selfevaluation of progress. For example, if you know what you want to spend at
the grocery store this week, you have a much better chance of actually
spending that or less. If you don’t know, you will just buy whatever seems
like a good idea at the time.

Budgeting reveals wasteful or inefficient spending patterns.

Budgeting requires the family to identify and deal with potential financial
problems before they arise and consider possible alternative courses of
action.

Budgeting may be used to establish financial goals and determine the
feasibility of meeting them.
Budgeting Disadvantages

It takes time to develop a budget and time to review it routinely. Without
routine review, there is no benefit.

Initially, there may be family conflicts on what is important and where to cut
expenses. (It’s best if each client focuses on what they can do to cut expenses
versus telling the other spouse how they should change!)

If inaccurate information is used to develop the budget, it will be of little or
no value.

Using a budget as an absolute control of spending may preclude a client from
taking advantage of opportunities that might aid in the reaching of goals.

Keeping accurate spending records is often difficult, and some people resent
it. However, if the client does not keep accurate spending records, the
budgeting process will be wasted and will merely increase the client’s stress.

For the client who is successfully working toward his or her financial goals,
it may seem like an intrusion or an indication of mistrust.
Chapter 4: Budgeting

75
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Getting Started
The primary purpose of budgeting is to guide and evaluate spending patterns.
Begin by gathering information that shows the client’s spending history. Most
clients who do not have a budget will not have cash flow statements. This would
include prior tax returns, paystubs, statements of financial position, downloaded
information from the bank or check registers and bank statements, downloaded
charge account statements, or 12 months of credit card statements. Once this
information is compiled, the client will then need to evaluate and modify initial
estimates based on reasonable expectation of special circumstances or potential
changes in the family’s economic world, including general increases in inflation
for this year from last.
Some financial planners require their clients to obtain and install a personal
finance software program before starting this process. This program can be set up
so that clients will automatically create a budget based on how they code their
expenses. The benefit of using personal computers in this manner is that the
computer does all of the addition and it provides a printed statement showing
where money is being spent.
General Guidelines

76
Limit the budget period to no more than one year. This allows goal setting
for a manageable time frame. Note that the 12-month period may be any 12month period. If a client’s income is adjusted every year in March, a 12month period starting then is as good as using a calendar year. Most clients
wanting to change spending patterns will need to break the budget into
monthly expenditures and track cumulative patterns. The advantage of
monthly tracking is that you can incorporate such items as birthday
celebrations, holiday spending, auto tag licenses due, school clothes, and
back-to-school fees. Non recurring expenses generally make up more than
20% of a budget.

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.

Keep the budget simple and short. Avoid too much detail, which can make it
hard to follow and confusing. The miscellaneous category can provide funds
for the occasional cash purchase of a bouquet of flowers or a late night snack
from the drive-through.

Keep it flexible. Most expenses will not follow a predictable path. Flexibility
allows the client to deal with emergencies, opportunities, and difficulties that
may arise.

Avoid information that won’t add to the process. For example, it doesn’t
matter if food was purchased at the grocery store or the health food store—
it’s all food.

Design the budget with specific goals in mind. If it doesn’t matter to a client
where the money is going or whether they will have an adequate emergency
or retirement fund, budgeting is a waste of time.

Budgets should be consistent in form and content from year to year. If the
categories constantly change, there is no way to measure progress. This does
not mean that the categories should not change when warranted.

Budgets are not only guides to spending and saving, they are tools for selfevaluation. When the client’s reality doesn’t match the plan, the differences
must be evaluated. If the differences more accurately reflect normal spending
patterns, the budget should be modified accordingly.

When designing the budget, keep in mind things that may be different than in
the past. These might include expected changes in income, changes in the
status of family members, changes in activities, and changes in personal
goals. These variables will affect the resulting budget.
Following a budget and maintaining the required records to determine whether
the client is living within the budget is not easy. It sometimes can feel intrusive,
but the financial rewards are significant.
Chapter 4: Budgeting

77
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Creating a Budget
There are a number of steps in the process of establishing a budget. They
generally flow from one to the next.
Step 1. Identify the client’s financial goals and determine what is required to
reach them.
Step 2. Estimate income from all sources.

salary, wages, bonuses

self-employment income

real estate, other than the client’s personal residence(s)

dividends

interest, both taxable and nontaxable

trust income

other fixed income such as alimony or annuities

variable sources of income
Note: Some families have income that fluctuates. In this situation, two budgets
should be prepared—one with expected income and another with a more
conservative estimate that reflects situations such as receiving fewer
commissions or less income from investments. Another alternative is to allocate
income over the excess to an account to cover variable expenses such as clothing,
vacations, etc.
Step 3. Estimate expenses. These should be divided between fixed and variable.
In the context of a budget, fixed expenses are those that must be made, and
variable expenses are those that are somewhat or completely discretionary. You
78

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
may also want to make a category of annual expenses that are estimated but not
clear as to when they will be needed. For example, a client may know he or she
typically spends $1,000 on medical expenses, $2,000 on car repairs and tires,
$2,000 on household maintenance, and $1,000 on gifts. During the year, these
add up to $6,000. This means out of every month, the client needs to set aside
$500 for these expenses. If the car breaks down in February and he or she only
saved $1,000 toward the $2,000 expense. The next two months may consist of
replacing the $1,000 pulled from savings to meet the bill. By estimating the
varying expenses and building it into the monthly budget, surprises and credit
card use will be minimized.
Fixed expenses (suggested):

housing: mortgage, rent, assessments

income taxes (based on certain planning techniques, some planners prefer to
list income taxes as a variable expense)

FICA

property taxes (if not included in housing)

local taxes

automobile note payments

debt repayment (sometimes this is considered a variable expense, depending
on the nature of the debt, and may also carry the minimum payments as a
fixed expense and additional debt reduction as a variable expense)

medical, long-term care, life and disability insurance premiums

property and liability insurance premiums

child care required for work
Chapter 4: Budgeting

79
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Variable expenses: (Some of these may be considered fixed rather than
variable expenses)

utilities ( many clients are on budget billing, in which case it can be under
fixed expenses)

entertainment/recreation

medical/dental out-of-pocket expenses

transportation/parking

current education expenses

household maintenance and supplies

vacations

food, groceries

clothing, including laundry and dry cleaning

gifts and contributions

household furnishings

education fund

savings/investments

miscellaneous
It is important to remember that for one person a given expense may be fixed,
and for another the same expense is variable. A client’s budget should represent
his or her perspective.
80

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Step 4. Compare income and expenses to determine if expected expenses are
equal to or less than expected income.
Step 5. If expenses are too high, attempt to identify potential sources of
additional income or places where expenses can be cut. Sometimes, having a
garage sale can knock out a bill, which will bring expenses in line. Other times it
may take much more effort to rearrange the expenses so they can fit within
income. If expenses are lower than expected income, apply the excess to the
categories of expenses that will bring the family closer to its goals.
Step 6. Present each category of income and expense as a percentage of the total.
This will make year-to-year comparisons easier. It may also lead to more
efficient use of resources.
Step 7. Once the budget is finalized for the year, it is important for the client to
establish a process and time at the end of each month to review the budget and
make adjustments. If too much money was spent on food this month, the food
budget, or some other budget, for next month may need to be tightened so that
the ultimate goal can be reached. Comparing actual spending to the budget is the
critical part. Programs such as Mint or Quicken can allow a client to set a target
and then have emails automatically sent to anyone on the list when the budget is
exceeded. That type of accountability makes a big difference. Some financial
coaches will set clients up with “budget buddies” to create accountability.
Examples
At the end of this chapter are two examples of budgets. The first one shows a
budget in balance. Note that all of these numbers are rounded to the nearest $100.
This emphasizes the general nature of expense estimates. Also note that items
included under the fixed and variable categories have some flexibility. The best
procedure is to discuss whether an expense should be categorized as fixed or
variable. Once determined, you should keep the categories the same from year to
year for comparison purposes.
Chapter 4: Budgeting

81
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
The second budget essentially shows what happens if one family member’s yearend bonus or other compensation isn’t what is expected. In this example, the
earnings for family member 1 are $15,000 below the expected level. Even with a
$4,500 reduction in income taxes and a $200 reduction for Social Security taxes,
the budget ends up with a $4,500 shortfall. Assuming the possibility exists that
the $15,000 may not be there, this family should reevaluate its expenses to bring
the budget back into balance. If the money later shows up, it can then be
distributed according to the wishes of the family. A budget that won’t work on
paper will never work in real life.
Following the two examples is a blank form you can use as a guide for your own
personal budgeting.
These examples were recreated with permission from The Tools and Techniques
of Financial Planning, National Underwriter, using Financial Planning Toolkit,
with permission from Leimberg & LeClair Inc. Identification of an expense as
either fixed or variable does not mean that item must be categorized as such. The
samples simply provide placement as suggested by Leimberg & LeClair Inc.
Sample Family Budget #1—Annual Income Report for 201X
Amount
Percentage of Total
Income
Salary/bonus 1
$ 125,000
74.4%
Salary/bonus 2
30,000
17.8%
Self-employment (business)
-
0.0%
Dividends (close corp. stock)
-
0.0%
Dividends (investments)
3,000
1.8%
Interest (savings account)
2,000
1.2%
Interest (bonds, taxable)
5,000
3.0%
Interest (bonds, exempt)
3,000
1.8%
Trust income
-
0.0%
Rental income
-
0.0%
Other
-
0.0%
$ 168,000
100.0%
Total annual income
82

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Sample Family Budget #1—Annual Expenditures/Fixed Expense Report for 201X
Amount
Percentage of
Total Income
Housing (mortgage/rent)
Utilities and telephone
Food, groceries, etc.
Clothing and cleaning
Income taxes
Social Security
Real estate taxes
Transportation
Medical/dental expenses
Debt repayment
Housing supplies/maintenance
Life insurance
Property and liability insurance
Current school expenses
$
15,500
7,000
10,500
7,000
28,000
7,700
5,000
8,000
8,000
5,000
6,000
8,000
5,000
4,500
9.2%
4.2%
6.3%
4.2%
16.7%
4.6%
3.0%
4.8%
4.8%
3.0%
3.6%
4.8%
3.0%
2.7%
Total fixed expenses
$ 125,200
74.9%
Sample Family Budget #1—Variable Expenses Report for 201X
Amount
Percentage of
Total Income
Vacation, travel
Recreation, entertainment
Contributions, gifts
Household furnishings
Education fund
Savings
Investments
Other expenses
$
4,000
5,000
7,500
5,000
5,000
3,000
2,500
5,000
2.4%
3.0%
4.5%
3.0%
3.0%
1.8%
1.5%
3.0%
Total variable expenses
$
37,000
22.2%
Chapter 4: Budgeting

83
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Sample Family Budget #1—Net Income Report for 201X
Percentage of
Total Income
Amount
Total annual income
$ 168,000
100.0%
Total fixed expenses
(125,200)
74.9%
(37,000)
22.2%
5,800
2.9%
Total variable expenses
Net income
$
Sample Family Budget #2—Annual Income Report for 201X
Percentage of
Total Income
Amount
84

Salary/bonus 1
$ 110,000
72.0%
Salary/bonus 2
30,000
19.6%
Self-employment (business)
-
0.0%
Dividends (close corp. stock)
-
0.0%
Dividends (investments)
3,000
1.9%
Interest (savings account)
2,000
1.3%
Interest (bonds, taxable)
5,000
3.3%
Interest (bonds, exempt)
3,000
1.9%
Trust income
-
0.0%
Rental income
-
0.0%
Other
$
-
0.0%
Total annual income
$ 153,000
100.0%
Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Sample Family Budget #2—Annual Expenditures/Fixed Expense Report for 201X
Amount
Percentage of
Total Income
Housing (mortgage/rent)
Utilities and telephone
Food, groceries, etc.
Clothing and cleaning
Income taxes
Social Security
Real estate taxes
Transportation
Medical/dental expenses
Debt repayment
Housing supplies/maintenance
Life insurance
Property and liability insurance
Current school expenses
$
15,500
7,000
10,500
7,000
23,500
7,500
5,000
8,000
8,000
5,000
6,000
8,000
5,000
4,500
10.1%
4.6%
6.9%
4.6%
15.4%
4.9%
3.3%
5.2%
5.2%
3.3%
3.9%
5.2%
3.3%
2.9%
Total fixed expenses
$ 120,500
78.8%
Sample Family Budget #2—Variable Expenses Report for 201X
Amount
Vacation, travel
4,000
2.6%
Recreation, entertainment
5,000
3.3%
Contributions, gifts
7,500
4.9%
Household furnishings
5,000
3.3%
Education fund
5,000
3.3%
Savings
3,000
2.0%
Investments
2,500
1.6%
Other expenses
5,000
3.3%
37,000
24.3%
Total variable expenses
$
Percentage of Total
Income
$
Chapter 4: Budgeting

85
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Sample Family Budget #2—Net Income Report for 201X
Total annual income
Total fixed expenses
Total variable expenses
Net income
Amount
Percentage of
Total Income
$153,000
($120,500)
($37,000)
100.0%
-78.8%
-24.3%
($4,500)
-3.1%
Blank Sample Family Budget
Annual Income Report for 201X
Am ount
Salary/bonus 1
Salary/bonus 2
Self-employment (business)
Dividends (close corp. stock)
Dividends (investments)
Interest (savings account)
Interest (bonds, taxable)
Interest (bonds, exempt)
Trust income
R ental income
Other
Total annual inco me
86

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Percentage of
Total Income
Blank Sample Family Budget
Annual Expenditures/Fixed Expense Report for 201X
Amoun t
Percentage of
Total Income
Housing (mortgage/rent)
Utilities and telephone
Food, groceries, etc.
Clothing and cleaning
Income taxes
Social Security
R eal estate taxes
Transportation
Medical/dental expenses
Debt repayment
Housing supplies/maintenance
Life insurance
Property and liability insurance
Current school expenses
Total fixed expenses
Blank Sample Family Budget
Variable Expenses Report for 201X
Amoun t
Percentage of
Total Income
Va ca tion, trave l
R ecrea tion, e ntertainment
Contributions, gifts
House hold furnishings
Education fund
Savings
Investments
Othe r e xpense s
Total variable expenses
Chapter 4: Budgeting

87
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Blank Sample Family Budget
Net Income Report for 201X
Amoun t
To tal annua l income
To tal fixed exp ens es
To tal vari ab le exp en ses
Net in come
88

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
P ercentage of
Total Income
Chapter 5: Debt Management
Reading this chapter will enable you to:
1–6
Explain different forms of debt and their uses.
U
sing debt is one way in which consumers are able to achieve financial
goals. Debt enables consumers to make acquisitions immediately,
without having to save. For most people, entering into debt at some
time during their lives can be beneficial. However, there is a cost to incurring
debt, which can negatively affect a client’s financial situation. The cost of debt—
interest and fees—and its impact on the client’s financial situation, both positive
and negative, must be considered carefully. This chapter will consider consumer
debt and the most common long-term debt, home mortgages.
Consumer Debt
Although touched on in our section on ratio analysis, consumer debt bears
reexamination. It is short-term debt used by consumers to acquire products and
services. Some examples of consumer debt include credit card debt, auto loans,
and personal lines of credit. Credit may either be secured or unsecured. A
secured debt is one for which collateral is used to back the promise to repay. If
the borrower does not repay the loan, the lender can repossess the collateral. An
auto loan typically is secured. With unsecured debt, no specific property is
pledged. The lender can, however, pursue legal action against the debtor. Credit
cards are one form of unsecured debt. Generally, interest rates on secured debt
are lower than on unsecured debt because the risk to the lender is greater if the
debt is unsecured. This explains why the interest rate for an auto loan may be
substantially lower than credit card interest rates.
In evaluating consumer debt, the financial planner should consider the costs of
debt for the consumer and the amount of debt. The costs to consider include the
interest payable, any initiation fees, and any bargaining power forgone as a result
Chapter 5: Debt Management

89
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
of using credit rather than cash. For credit card debt, some additional
considerations include annual fees, transaction fees, and grace periods. A grace
period is the time following a purchase of goods after which interest is charged.
Many credit cards have a grace period of approximately 25 days, which keeps the
debtor from incurring interest charges on any purchase as long as the loan
amount is repaid within 25 days. However, some credit cards have very short or
no grace periods so interest costs are incurred sooner. Cards that permit a cash
advance usually charge interest from the date of the advance.
Short-term debt is probably best used for purposes of convenience. Many
“experts” state that depreciating assets should generally not be purchased using
debt because the cost of debt cannot be recovered. Examples of depreciating
assets would be automobiles and computers.
For the well-disciplined individual, consumer debt may be an excellent tool for
maximizing financial resources. The advantage of this approach is that invested
dollars earn money. First, the client should put all earnings into an interest-bearing
account. Second, a credit card should be used to pay as many expenses as possible,
including groceries. Third, the client should pay all credit card bills as close as
possible to the due date in order to avoid paying interest—so that as much time as
possible passes between the date of purchase and the date the bill is paid. If $3,000
per month in expenses is handled this way, the client will earn $150 per year on the
delayed payments if the interest-bearing account pays 5%. Further, the client should
take advantage of “90 or 180 days same as cash” offers, which are essentially
interest-free loans for three to six months. The retailer, through a credit organization,
allows the customer to take merchandise home. As long as the bill is paid before
the end of the period of 90 or 180 days, no interest is owed.
If the retailer will not reduce the cost of the item as an alternative to the 90- or 180day grace period, the money that would have been paid for the item should be put in
an interest-bearing account. The three or six months of interest is money in the
client’s pocket. The importance of discipline cannot be overstated. If a client is
careless, this approach to money management can increase costs significantly.
90

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Helping clients restructure and gain control of their consumer debt is one way
that advisers can help clients free up cash flow for achieving goals. Many times,
even clients who are good accumulators become careless with their debt
management. Strategies such as annual review of credit cards, interest rates and
fees can result in savings.
For clients who have multiple credit cards, creating a cascading payment
schedule, such as cards with the lowest interest rates receive minimum payments
and the rest of the money available for debt reduction going to the highest
interest rate card. When that card debt is retired, the next highest rate card gets
the continued contribution. Another alternative is taking the smallest debt and
paying it off first with the minimum going toward other debt. This provides a
psychological boost by whittling away a payment. This strategy is especially
helpful if cash flow is extremely tight or there is a potential change in income,
such as maternity leave or job loss, on the horizon because it minimizes the
required minimum payments.
Alternatives for stable clients who are good at controlling cash flow can include
refinancing debt through home equity or, in some cases, through 401(k) loans.
Both of these strategies are NOT good alternatives for clients who are having
difficulty controlling their spending as it will deplete their assets and give them a
feeling of freed up cash flow. Having all debt paid off (perhaps other than
mortgage) entering retirement is a critical component of retirement success.
When investment returns are less than the cost of credit, it may make sense to
redirect additional savings to paying off expensive debt as long as the
understanding is that the freed up funds will then be redirected.
Mortgages
Unlike most consumer debt, a home mortgage is used to purchase an appreciating
asset. Therefore the cost of debt is not as high when compared with the benefits of
home ownership. Given the high cost of houses, it would be difficult, if not
impossible, for many people to own a home without incurring debt. Mortgages are a
type of secured debt: if the homeowner defaults on payments, the lender is able to
foreclose on the residence.
Chapter 5: Debt Management

91
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
There is actually an advantage in using debt to finance an appreciating asset. It is
called leverage. Assume you purchase a home for $150,000 and make a down
payment of $10,000. You will be borrowing $140,000 with principal and interest
payments around $980 per month (30 years at 7.5%). Assume also that the home
increases in value by 4% in one year. The value of the home is now $156,000.
You started with $10,000 invested in the house, and now you have $16,000 in
equity. We’ll ignore the small amount of principal paid the first year. The value
of your investment has grown by $6,000, which is 60% in the first year. (Future
years’ returns will gradually decline.) Since the interest payments are tax
deductible, the actual cost to you was probably less than $630 per month, which
is probably less than the cost of renting a similar home. Don’t worry about the
details of this concept; it is included merely to illustrate the advantage of
borrowing to purchase a home.
The most significant cost of a mortgage usually is the interest payable on the
outstanding principal, which is based upon a stated interest rate. Home mortgage
interest rates are influenced by the prevailing level of long-term interest rates in
the economy, which reflect inflationary expectations. Interest rates offered by
different lenders vary slightly, so it may pay the borrower to shop around.
Additional costs of a mortgage include loan origination fees, appraisal fees,
credit reporting costs, title search costs, and points, which represent prepayment
of interest. One point is equal to 1% of the mortgage amount.
If the mortgage amount is $100,000 and the lender is charging two points, the
cost of the points would be $2,000. Typically, the borrower is offered several
interest rate and point combinations by the lender. Higher points will be offered
with a lower interest rate, and vice versa. If the borrower is planning to stay in
the home for a short time, it may make sense to accept the option of low points
and a higher interest rate because the short-term cost will be reduced. It may also
be possible for the borrower to negotiate with the lender regarding points and
interest rates, which could reduce costs.
92

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Home ownership has several tax implications. First, points paid are generally
deductible for the buyer of a home. Second, home mortgage interest is generally
deductible. Capital gains on a home are taxed only under certain circumstances. The
details of the taxation on the sale of a residence are beyond the scope of this module.
Types of Mortgages
There are many innovative mortgage options available. This chapter will focus
on some of the more popular ones.
Table 4: Overview of Types of Mortgages
Mortgage
Description
Government Guaranteed
GNMA
U.S. government agency fully guaranteeing the mortgage
FHA
Insured by the Federal Housing Administration (FHA); FHA sets
maximum interest rate, limit of insurance, and loan term
VA
Guaranteed by the Department of Veterans Affairs in the event of
default; honorably discharged veterans of the U.S. armed forces are
eligible; VA sets maximum amount of guarantees, interest rates, and
maturities
Lenders & Guarantors
FNMA
Not government guaranteed, but federally chartered and implicitly
taxpayer backed with lower rates available
FHLMC
Similar to FNMA, implicitly taxpayer backed, but not government
guaranteed.
Conventional
Involves only lender and borrower; there is no outside agency
guaranteeing or insuring the mortgage
Interest Rate Status
Fixed rate
Monthly payments are fixed at the outset of the loan and remain the
same over the term of the loan; term of the loan typically is 15 to 30
years
Adjustable
rate
Interest rate on the mortgage may change periodically, which may
increase or decrease the payment amount
Chapter 5: Debt Management

93
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Mortgage
Description
Payments & Payoffs
Biweekly
Requires payment every two weeks or twice monthly; enables interest
savings for the borrower
Monthly
Payments made once a month
Graduated
payment
Monthly payments increase over the term of the loan; may create a
problem with reverse amortization
Interest-only
Rate tied to index; eventually must be converted to regular (p + i) fixed
or adjustable rate loan
Balloon
Low monthly mortgage payments for a limited period of time with a
large (balloon) payment at end of the term
Reverse
Allows individuals, over age 62, who own their home to put a mortgage
on it and receive payments. Amounts received must be repaid when
owner leaves home.
VA mortgages. VA mortgages are guaranteed by the Department of Veterans
Affairs (formerly called the Veterans Administration) and are available only to
eligible veterans. They may be either fixed rate or graduated payment mortgages.
FHA mortgages. FHA mortgages are guaranteed by the Federal Housing
Administration. They may be either fixed rate or graduated payment mortgages.
Conventional mortgages. Conventional mortgages are those that are made by
commercial lenders in the private sector. These may also be called conforming
loans, because they conform to Fannie Mae and Freddie Mac dollar limit
requirements. For example, a single-family home might have a conforming loan
limit of $417,000 (amounts are higher in Alaska, Hawaii, and some other areas).
Loans above that amount are known as jumbo or nonconforming loans.
Nonconforming loans often are also known as subprime loans and have higher
down payment and/or higher interest rate requirements. Loans for those with
damaged credit may also be called nonconforming.
Fixed rate mortgage. One of the most widely used types of mortgages is the
fixed rate mortgage. With a fixed rate mortgage, the interest rate does not change
over the repayment period, which is quite long—usually 15 to 30 years. The
94

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
payment amount is fixed at the outset, based upon the interest rate charged on the
loan, the repayment period, and the original loan balance. Generally, payments
are made monthly by the borrower and include both payment of interest and
repayment of principal. The percentage of interest included in each payment is
very large in the early years but is reduced with each payment because it is based
upon the outstanding principal balance.
For example, a $100,000 mortgage with terms of 6% annual interest for 30 years
would require a monthly payment of $600. The first payment would consist of
$500 in interest payment and only $100 of principal repayment. The last payment
would consist of $3 in interest and $597 in principal repayment. In this example,
the principal portion of the payment does not exceed the interest portion of the
payment for almost 20 years. (Many financial function calculators facilitate
calculation of amortization of loans. See your calculator user manual for
assistance in performing these calculations. There are also widely available free
amortization programs on the Internet.)
Adjustable rate mortgage. An adjustable rate mortgage features an interest rate
that varies with interest rate changes in the economy. Because the interest rate
changes, the payment amount also varies. Changes in rates are usually tied to
changes in a stated economic index. Frequently, adjustable rate mortgages feature
limits on how often and how much interest rates may change. With a fixed rate
mortgage, the lender bears most of the risk of changes in interest rates because if
the prevailing level of interest rates rises, the lender is committed to lending
money at the agreed-upon rate. On the other hand, if interest rates drop, the
borrower generally has the option of refinancing at a lower interest rate. With an
adjustable rate mortgage, borrowers bear most of the risk of changes in interest
rates. The precise amount of risk depends on the restrictions placed upon interest
rate changes in the initial agreement.
Many adjustable rate mortgages have an initial period during which no interest
rate changes will occur (e.g., five years). Following the initial rate guarantee
period, most adjustable rate mortgages limit the amount of rate increase per year,
Chapter 5: Debt Management

95
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
or overall, or both (e.g., 1% annual increase with a 5% total increase cap).
Frequently, initial interest rates on adjustable rate mortgages are lower than on
fixed mortgages due to the decreased risk to the lender.
Biweekly mortgage. The payments on a fixed rate mortgage are sometimes
structured to be payable on a biweekly basis. With a biweekly mortgage,
payments are made every two weeks; 26 payments are made each year. The
payment amount is usually half of the payment that would be made under a
monthly repayment structure. Using the previous mortgage example, if payment
was structured on a biweekly basis, the payment amount every two weeks would
be $300. With a monthly structure, the annual mortgage payment was $7,200
($600 × 12). However, since the biweekly structure requires 26 payments, the
annual amount paid is $7,800 ($300 × 26). The additional $600 paid in the
biweekly mortgage is applied to the principal balance, resulting in a shorter
mortgage payment period and reduced interest costs.
A biweekly payment schedule is typically made through formal arrangement, but
many lenders permit additional payment toward principal at any time without a
prepayment penalty. The same results may be achieved informally if the
borrower simply pays more than what is required. Some borrowers merely pay
the next month’s principal with each payment. This way they take off a month
from the end of the mortgage period with every payment. If you are not working
through a specified program, it is important that you retain the records of
additional payments until the loan is completed.
Interest-only mortgage. A variation of the adjustable rate mortgage is the
interest-only mortgage. While some interest-only mortgages allow the borrower
to have a fixed rate for the life of the loan, most loans are arranged so that
interest rates vary with the market. The interest rate that is applied to the loan is
usually tied to an index such as the LIBOR (London Interbank Offered Rate).
With most interest-only loans, borrowers make only interest payments for some
predetermined period (e.g., 5, 10, or 20 years). Eventually, of course, the
principal will have to be repaid, resulting in a significant increase in payments.
The owner could sell the house at this point, which might mean that no principal
96

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
payments will have been made. Good for low payments, but not so good in
creating owner-equity. Interest-only mortgages are often used to allow a
borrower to qualify for more house than he or she otherwise could. At the least,
caution should be encouraged when using this type of mortgage, to help ensure
that the borrowers can afford any eventual increase in payments. This type of the
loan has led to many foreclosures; the client would have been better off renting.
Balloon mortgage. A balloon mortgage is a mortgage in which the borrower makes
fixed payments, which are based upon the established interest rate for a long-term
mortgage. However, payments are made only for a short duration, frequently five or
seven years, and then the borrower is required to pay off the remainder of the
mortgage in a lump sum. The payments with some loans may be limited to interest
only. The interest rate on a balloon mortgage is usually more favorable than for
typical 30-year mortgages because of the shorter time frame for repayment and the
smaller risk to the lender of variance in prevailing interest rates. Although the balloon
payment may be difficult for many borrowers to make, forcing them to refinance at
potentially higher interest rates, a balloon mortgage may be appropriate for
borrowers who plan to sell their homes before the fixed payment period is over.
Again, this is a calculated risk that could have severe consequences.
If the client is unemployed at the time that the balloon is due, he or she may not be
able to qualify for a new mortgage, resulting in a forced sale. It works well for clients
purchasing homes during high interest rate periods who want to refinance when rates
drop and have large 401(k) balances they could borrow against, those with enough
invested assets to finance the house without borrowing, or those who have access to
family loans if necessary when the period ends and rates have not dropped.
Graduated payment mortgage. A graduated payment mortgage is a mortgage
that is payable over a long time period, such as 30 years, and has a fixed interest
rate. The payments are lower for the first few years of mortgage repayment
(although they sometimes increase each year), then adjust to a higher fixed
payment that continues for the remainder of the repayment period. This type of
mortgage may be appropriate for people who anticipate increases in income with
some certainty, enabling them to afford a higher payment in the future than they
Chapter 5: Debt Management

97
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
can currently afford. However, you should use caution when considering a
graduated payment mortgage because of several disadvantages. Some of the
disadvantages of this type of loan include:

higher payments during the second period of the loan than if the loan had
been a standard fixed rate loan

higher interest costs

negative equity buildup in the early years of repayment because the payments
during that period typically are not sufficient to pay the interest due (often
called negative or reverse amortization, because the amount of the loan is
increasing)
Most people should be very cautious when considering this type of mortgage.
The upside may allow someone to qualify for a mortgage that he or she otherwise
would not have. The downside is that negative amortization may result in the
borrower having to come up with additional money when the house is sold.
Reverse mortgage. Occasionally, making use of the equity in a home is needed
or desirable to achieve client goals. There are several ways of utilizing home
equity, including selling the home to receive the proceeds or taking out a secured
loan against the equity in the home. Loans that require repayment over a fixed
period are generally called a second mortgage. A reverse mortgage may be
another option.
Reverse mortgages have been around since 1988, but in 2012 they underwent a
fairly extensive overhaul. This shifted the product from a program of last resort
sought after by financially burdened seniors to a financial planning tool used by
many retirees of all lifestyles, and even now includes an option to purchase a home.
There are several ways of utilizing home equity, including: selling the home,
refinancing, taking out a second mortgage, using a home equity line of credit
(HELOC), or obtaining a reverse mortgage. The idea behind a reverse mortgage
is simple: equity in a home is often a major financial asset for seniors. All of the
98

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
more conventional options to access home equity would require the homeowner
to either sell the home, then facing another scenario of still needing a place to
live, or endure the burden of high monthly payments with a refinance or HELOC.
Reverse mortgages utilize the equity in a home, allow the borrower to remain in
the residence and remain the homeowner, while eliminating a monthly loan or
mortgage payment.
Also known as a home equity conversion mortgage (HECM), a reverse mortgage
allows seniors to receive money from their homes without having to make any
repayments for as long as they remain in the home and maintain up-to-date
property taxes, homeowners insurance, HOA fees, utilities, and general upkeep.
Borrower requirements:

be 62 years old or older (for married couples, both spouses must be 62 to
both be included on the loan)

own the home (although the house does not need to paid off completely)

occupy the home as the primary residence

attend a third-party counseling session

there are no income or credit requirements
Properties that qualify are limited to the following:

single family homes

1-4 unit homes with one unit occupied by the borrower

HUD-approved condominiums or townhomes

manufactured homes that meet FHA requirements
(All properties must meet FHA property standards and flood requirements.)
Chapter 5: Debt Management

99
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
The reverse mortgage amount will be based on:

age of the youngest borrower

current interest rate

lesser of appraised value or the FHA insurance limit
Reverse mortgage funds may be released using one of six plans:

Tenure, which is equal monthly payments as long as at least one borrower
lives and continues to occupy the property as a principal residence.

Term, which is equal monthly payments for a fixed period of months
selected.

Line of credit, which is unscheduled payments or installments at times and in
an amount of the borrower’s choosing until the line of credit is exhausted.

Modified tenure, which is a combination of line of credit with monthly
payments for as long as the borrower remains in the home.

Modified term, which is a combination of line of credit with monthly
payments for a fixed period of months selected by the borrower.

Purchase, which is the purchase of a new home.
A HUD/FHA-guaranteed mortgage is a non-recourse loan, which means the
borrower is never financially responsible for repayment because the loan is
secured by the home. A reverse mortgage does not require repayment as long as
the home is the borrower’s principal residence. Once that is no longer true,
whether due to death or leaving the residence for more than 12 consecutive
months, the loan must be repaid. This can be done by selling the house, or by
using other available funds. HUD/FHA guarantees that the maximum loan
repayment amount will not exceed the value of the home. Higher home values,
lower interest, and greater age normally equal higher amounts that can be
100

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
borrowed. Funds received from a reverse mortgage may be used for anything,
such as health care expenses, postponing Social Security benefits, eliminating
mortgage payment, vacation, gifts, etc.
Reverse mortgages are also available to purchase a home through the reverse
mortgage for purchase program (HECM for Purchase)—even if the senior has
never owned a home. The borrower and residence requirements are the same as a
traditional reverse mortgage and the borrower will still not have a mortgage or
loan payment. These loans cannot be used on new construction until the home
has its “Certificate of Occupancy.” With a reverse mortgage for purchase, the
borrower must have a down payment (required investment). This down payment
can come from various sources including: proceeds from the sale of another
home, savings, inheritance, or other HUD approved funds the borrower has had
for over 90 days. The funds cannot be borrowed. The down payment changes
based on the age of the homeowner and the value of the home being purchased.
As is the case with a traditional reverse mortgage and Reverse Mortgage for
Purchase, the borrower will always retain the title to the home and live mortgage
payment free.
Recent research has shown that utilizing a reverse home equity line to provide
cash flow in down markets can extend the life of a portfolio and increase the
chances of the portfolio lasting the client’s lifetime. It can be used to even out
taxes and cash flow by providing chunks of money rather than liquidating
qualified plans all in one year. This money may be used to help pay for health
care expenses or home health care services toward the end of life without
worrying about liquidating investments or qualified plans, etc.
There are, of course, fees associated with any mortgage and that applies to
reverse mortgages as well. It is important to shop reverse mortgages and
understand the specific structure, costs, and fees. There are important factors to
consider including closing costs, interest rate assumptions, anticipated amount of
time in residence, resources available to repay any loans beyond the residence,
and inflation assumptions. The complete analysis is beyond the scope of this
module. Many planners locate and find a reverse mortgage specialist that they
respect to facilitate the analysis.
Chapter 5: Debt Management

101
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Buying versus Renting a Home
Occasionally, a consumer will be interested in comparing the cost of renting a
home with the cost of home ownership. To perform this analysis, the financial
planner considers all cash flows resulting from both renting and owning, and then
compares them. To enhance the accuracy of this calculation, the financial planner
must estimate how these costs will change over time. Obviously, this analysis
requires estimating the length of time that the home will be owned and using an
identical time period in considering home rental. (In some cases, the agreement
to rent a home is a lease agreement. The two terms are essentially synonymous.)
The cash outflows resulting from renting a home may include but are not limited
to, the following: security deposit, periodic rent payments, insurance costs, and
utility costs. Inflows resulting from renting a property would include the return of
a security deposit at the end of the rental period, and may include inflows relating
to the increased savings that the person is able to achieve if costs are lower due to
renting. Income received from subletting a room would be included.
The cash outflows resulting from home ownership may include, but are not
limited to, the following: down payment, closing costs, monthly payment of
mortgage principal and interest, property taxes, insurance costs, utilities, and
home maintenance costs. When the house eventually is sold, if the sale price is
expected to be below the purchase price, this loss would be included as a cash
outflow. Cash inflows relating to home ownership include a reduction in taxes
due to the deductibility of points, interest, and property taxes (which would be
calculated using the taxpayer’s marginal tax bracket). Additionally, any rental
income received if any or all of the residence is rented for a period of time, and
the difference between the purchase price and sale price of the home when sold if
the house appreciates in value over the holding period (minus required taxes on
any reportable capital gain) would be inflows.
The result of a rent versus buy analysis is affected by the individual’s marginal
tax bracket: the higher the tax bracket, the greater the tax savings associated with
deducting the interest expenses and property taxes of home ownership. In
102

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
addition, the longer the individual or family plans to stay in the home, the more
favorable is home ownership. The costs of buying and selling a home are
relatively high and typically offset any possible capital gain if the period of
ownership is short. In addition, since the most widely used type of mortgage is
fixed rate, savings may result from owning because the mortgage payment stays
level. Rental costs, on the other hand, typically increase due to inflation and the
supply and demand for rentals. (For additional discussion, see Chapter 7, “To
Lease or Buy.”)
Refinancing a Home
Individuals may wish to refinance a mortgage for a variety of reasons, but
probably the most prevalent reason in recent years has been to take advantage of
declining interest rates. By refinancing, homeowners are able to reduce their monthly
payments, reduce the time period for repayment, or both, thereby reducing interest
costs. In addition, refinancing gives the owner the possibility of freeing up some of
the equity in the home. However, refinancing may be necessary when interest rates
are high—for example, when a person needs to acquire cash and home equity is the
only source. Such refinancing has the opposite effect: payments are increased and/or
the time period for repayment is increased.
When a person refinances his or her mortgage, the original mortgage is paid off
using the funds provided by the new lender. The individual is then responsible
for repaying the new lender in accordance with that lender’s terms. The costs of
refinancing are similar to the original costs of obtaining a mortgage. A new
appraisal may be necessary, which increases costs. When evaluating whether a
client should refinance a mortgage, the financial planner must consider these
additional costs and compare them with benefits. The length of time that the
individual expects to own the home is important to this analysis: costs associated
with refinancing are less likely to be significant if the person plans to own the
home for a long period of time and can counterbalance the costs with lower
payments. A standard calculation to determine the payback period for refinancing
is dividing the total closing costs by the monthly savings. If the closing costs will
Chapter 5: Debt Management

103
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
be paid back through lower monthly payments in just a few years and the client is
planning on staying in the house at least that long, it will be beneficial. If the
payback period will extend several years and there is a slight chance the client
may not stay in the home that many years, it is probably not a wise move.
Using Home Equity to Achieve Goals
Home equity—the difference between the market value of the home and the
principal balance of the mortgage—is an asset that can be used to achieve other
goals. To convert this asset into dollars, a homeowner could sell the home, repay
any mortgage principal balance remaining with the proceeds, and use the
remainder as he or she sees fit. Obviously, for many people selling the home
would not be beneficial. Another method of using equity in a home to achieve
financial goals is through a home equity loan. Note that state law may preclude
the use of home equity loans for any purpose unrelated to the home.
Second mortgage. A home equity loan may be secured through a second
mortgage. The amount of credit is based on a percentage of the individual’s
equity in the home, such as 70%, 75%, or 80%. Because it is secured, the interest
rate tends to be lower than for other loans with similar repayment periods. The
repayment period is typically established when the loan is granted, as are other
terms of repayment. These vary among lenders.
If a homeowner defaults on the original and second mortgages, the first mortgage
holder gets paid first on the sale of the house. The second mortgage holder gets
paid second if there is enough money to pay off that loan as well. In places where
real estate market values have declined, owners often find themselves owing
more than the home is worth. If default occurs in that case, when the house is
sold and the lender(s) paid off, any remaining balance on the loans is still owed
by the borrower.
Home equity line of credit. Another type of home equity loan is a line of credit,
the amount of which is based upon the equity in the home. The homeowner may
access this line of credit at any time once it has been established. No repayment
104

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
obligation exists until funds from the line of credit are accessed. Interest paid on
both types of home equity loans generally is tax deductible, but restrictions
apply. (These tax issues are beyond the scope of this module.)
Using an equity line of credit in conjunction with consumer credit can be a
powerful financial management tool. If purchases are required where a plan of 90
or 180 days same as cash is available and the cash is subsequently not available
to pay off the debt, an equity line of credit can be extremely useful. Consumer
credit interest is not deductible, but the interest paid on an equity line of credit
usually is deductible. This single factor generally makes this type of debt
preferable. Additionally, the equity line of credit usually has an interest rate that
is much lower than the consumer credit rate.
Not all clients are willing to use a home equity loan to achieve their financial goals
because it entails taking on additional debt. For those who are willing, it is important
to weigh the costs and risks of using home equity to achieve financial goals against
the benefits of doing so. The consequences of being unable to repay a home equity
loan can be harsh, because it may become necessary to sell the home. However,
home equity is a potential source of funds to be considered in attempting to achieve
client goals.
Chapter 5: Debt Management

105
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Chapter 6: Achieving Special
Goals
E
arlier sections in this module outlined the broad areas of analysis that
must be undertaken in comprehensive financial planning to strengthen
the client’s overall financial situation. This section focuses on the
procedure for planning for special goals that the client hopes to achieve, such as
major purchases (a new home, automobile, boat, etc.) and future changes in lifestyle
(early retirement, travel, return to school, establishment of new business, etc.). This
procedure roughly mirrors the steps of the financial planning process, assuming that
the planning engagement has been established. If this component was not part of the
original engagement, a new scope of engagement must be processed.
Step 1: Define Goals in Terms of Dollar
Amounts and Time Frames
Nebulous goals are difficult to achieve because they create no commitment on
the part of the client. Goals that are specific in dollar amounts and time frames,
on the other hand, create an obligation on the part of the client and suggest a
strategy for realizing the goal. For example, suppose a client wishes to
accumulate $20,000 for the purchase of a boat in three years, and has no assets
that can be immediately repositioned to meet this goal. Assuming the client can
earn 8% annual interest compounded monthly on investments, she will need to
save approximately $493 each month to achieve the goal. However, if the client
is able to save only $450 each month, she may have to assume greater investment
risk to achieve a higher potential return.
In this case, she will need to earn 14% annual interest compounded monthly to
meet her goal. Together, the client and planner will need to consider whether
achieving the goal is worth the increased financial risk, or whether the plan for
106

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
achieving the goal should be altered in some way. For example, rather than
assume increased investment risk, the client could delay the purchase of the boat
for an additional three months or plan for a less expensive boat.
Step 2: Gather Data to Determine Existing
Resources
In the example above, if the client already had assets in place that could be used
to achieve the goal, less (or possibly no) additional savings would have been
required. Therefore, it is important that the planner consider the client’s current
resources to determine if and how they might be used to achieve goals. The
planner considers both lump-sum assets and periodically recurring inflows in
making this assessment. Additionally, the planner must consider the impact using
these assets may have on other goals. In the previous example, the client may be
able to purchase the boat now but will have to delay retirement by three years if
they do so. That is a tradeoff the client and planner would need to discuss.
Reviewing the client’s statement of financial position identifies lump-sum assets
that may be available. Initial candidates for inclusion are cash/cash equivalents
and invested assets. Use assets generally are not available for repositioning and
rarely are considered in determining which existing assets are available to
achieve goals. An exception to this rule is home equity, which is sometimes used.
In addition, cash/cash equivalents or invested assets that already have been
earmarked for other purposes or goals should not be construed as being available.
For instance, funds set aside for emergency purposes should not be viewed as
available for repositioning or liquidating, except for emergency use. In addition
to the existing assets listed on the statement of financial position, the financial
planner should also consider assets that may become available in the near future,
such as an inheritance or judgment.
The financial planner also should take into account periodically recurring funds
that may be reallocated toward the achievement of goals. Some examples include
income from savings and investments that are reinvested, outflows to
Chapter 6: Achieving Special Goals

107
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
investments, and expenses that are likely to discontinue in the near future (such
as auto payments or child support payments). These sources can create funds
available for meeting goals, as can inflows that are expected to begin in the near
future (such as alimony, income from a second job, or a pay increase). Again, it
will be important to ascertain the impact on other goals, such as retirement, if the
current retirement plan is assuming dividends and interest are being reinvested.
Step 3: Analyze the Issue and Solutions.
Determine if Additional Resources are Needed
If the resources currently in place are sufficient to meet the client’s goals, no
further action is needed. In some cases, resources may be sufficient to achieve
goals but may require repositioning to achieve the goal effectively. In most cases,
existing resources will serve only as a base that will need to increase to achieve
the goal.
Explore and Evaluate Potential Strategies/Products for
Achieving Goals
In this step, all potential strategies or products that might be used to help the
client achieve goals are considered. Different types of goals entail different types
of strategies: for instance, if the client’s goal is to fund retirement, the types of
vehicles, such as 401(k)s and Roth IRAs, that may be appropriate are quite
different from the vehicles that may be appropriate to fund a child’s education,
such as 529 or Coverdell plans. In the example of the client wishing to purchase a
boat, the strategy of saving and/or investing to achieve the goal may involve a
number of different investments in after tax investments : savings accounts,
money market funds or accounts, CDs, income or growth-and-income mutual
funds, individual securities, and so on.
108

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Consider Client Constraints Affecting Selection of
Vehicles and Strategies
A client will invariably have a number of constraints that may limit the options
available for achieving goals. Some of these include the availability of funds
required for the goal and the time frame established in the initial step. For
instance, if the client hopes to purchase a boat within three years, it would not be
wise to invest in a bond that does not mature for ten years. Other constraints
include such factors as whether resources available are lump sum, periodically
recurring, or some combination of the two; the client’s risk tolerance level; the
economic environment; the client’s preference; and the client’s tax situation.
While some of these factors seem obvious, it is important not to overlook them.
Step 4: Develop and Present the Appropriate
Vehicles and Strategies
Selecting appropriate vehicles and strategies requires taking into account the
constraints identified above. Once the alternatives have been evaluated, the
planner chooses the strategy and vehicles that will most effectively achieve the
client’s goals within the context of other financial issues. The planner then
develops a presentation that will allow the client to understand the issues and
constraints, explore the advantages and disadvantages of the chosen strategy, and
present an alternative so the client can make an informed decision about
implementing the plan. The client presentation should include schedules for
actions to be taken by the client and planner to ensure that goals are met. For
instance, in the case of the client who wants to purchase a boat in three years, a
plan of saving and investing must be instituted, because the client has no lumpsum assets available to achieve her goal. The client and planner may need to
identify how current consumption and savings patterns may have to be arranged.
The vehicles selected for this client will take into account the time frame,
tolerance for risk, appropriateness of funding through periodic cash flows rather
than a lump-sum amount, liquidity and marketability, diversification needs, and
Chapter 6: Achieving Special Goals

109
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
so on. The planner should have available alternative time lines, goals, and
alternate solutions to discuss with the client. It can be difficult to overcome all of
the constraints affecting achievement of a goal, and, in some cases, compromises
may be necessary.
Steps 5 and 6: Implement the Action Plan,
and Schedule and Monitor Results
During these two steps, the action plan established in the previous step is put to
work. Because circumstances change, the planner and client will need to monitor,
on an ongoing basis, whether the plan is on target with respect to achieving the
goals. In the case of the client wishing to purchase a boat, monitoring results will
involve determining if investments have been made as planned, if they have been
yielding estimated earnings, and so on. For example, if an unexpected expense
has precluded the client’s ability to invest funds during a given month, the goal
or the plan for achieving it may need to be adjusted. Similarly, if a windfall is
received, the goal may be able to be achieved earlier.
110

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Chapter 7: To Lease or Buy
Reading this chapter will enable you to:
1–7
Explain the issues involved in the lease versus buy decision.
F
inancial planners are often asked about leasing versus buying. More and
more products now offer a lease option. A client may consider leasing his
car, home, furniture, computer, ski equipment, and even clothes and
jewelry. Sometimes the choice to lease is clear. At other times, there is no easy
answer. Generally, the planner can best help a client by educating him or her
about the options and the pros and cons of each.
Who are the parties to a lease? The person or business that owns the asset and
leases it to another is called the lessor. The person who leases, or rents, the asset
is called the lessee.
How is the payment determined? The lease payment is based on the amortized
cost of the initial price of the asset minus the residual value expected at the end
of the lease. In a simplified example, a person leases a $26,000 car for four years.
At the end of four years, the expected residual value of the car will be $16,000.
The lease payment is based on paying for the $10,000 of value used plus interest.
Types of Leases
Closed-end lease. This is sometimes called a fixed-cost lease. With this type of
lease, the lessee agrees to pay a stated monthly fee for the use of the asset for a
specified period of time. In long-term leases, there may be an automatic
adjustment for inflation. At the end of the lease period, the lessee can walk away
from the asset. Provisions regarding unusual use or damage that may create an
additional financial obligation for the lessee are often included in fixed-cost
leases. So, it is not absolutely true to say that such a lease will never have any
Chapter 7: To Lease or Buy

111
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
additional end-of-lease costs. It is more correct to say that a closed-end lease usually
has no additional end-of-lease costs, but excessive wear and tear or property damage
may require an additional payment. This type of lease is more often used for
businesses to acquire equipment, rather than for consumer use. However, closed-end
leases are also an option for consumers wanting to get an automobile.
Open-end lease. This is sometimes called a finance or equity lease. This type of
lease generally has a lower monthly payment, but at the end of the lease, the
lessee may owe the lessor additional money if the asset rents or sells for an
amount that is less than the value projected at the time the lease was initiated.
This type of lease is often used (along with closed-end leases) for consumer
automobile acquisition.
Lease agreements may make maintenance and upkeep the responsibility of the
lessor, or those expenses may be made the obligation of the lessee. If structured
improperly, lease agreements may be treated as a form of financing, which will
change any income tax rules applied to the lease payments.
Considerations in the Lease versus Buy
Decision
Obsolescence is the consideration that usually applies to renting smaller
items. Computers, children’s skis, formal wear, and some jewelry have a
limited useful life for a specific user. An individual who, for whatever reason,
needs to have the latest and greatest computer equipment should lease rather
than buy. Most personal computers today are obsolete by the time they are
placed on store shelves. Children can outgrow ski boots and skis in one
season. If there are no siblings to whom the skis might be passed down,
leasing them for a season would be far less expensive than buying them new
every year. Unless an individual has many formal functions to attend,
purchasing formal wear may not make sense. Additionally, most people do
not want to wear the same formal attire to many functions. A short-term lease
of two or three days may be adequate.
112

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
There is no simple answer to the question of whether to buy or lease. Regarding
home ownership, the rule used to be that a home would always appreciate in
value. This is no longer necessarily the case. There are communities throughout the
nation where home values have decreased. Generally, this is a temporary trend, but if
a person has to sell at the wrong time, a substantial loss may be suffered.
An assumption that a home will appreciate at about the rate of inflation is
generally reasonable. A potential cloud on the real estate horizon is the
possibility that, as baby boomers age, they will begin moving out of the large
homes they own now into smaller homes, possibly patio homes or townhomes.
This shift in the market could cause the value of large single-family homes to
drop. Only time will tell if this proves to be the case.
The consumer price index includes a factor for housing. A renter who does not
live in a state with rent control will usually have rent increases that reflect
inflation. A homeowner will generally have level payments for principal and
interest, with taxes and insurance increasing over time. Generally, the long-term
cost of purchasing is more stable and level than the long-term cost of renting.
Table 5 summarizes key factors in determining the appropriateness of leasing or
buying for an individual.
Chapter 7: To Lease or Buy

113
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Table 5: Considerations in the Lease versus Buy Decision
Automobile
Person
should
consider
leasing/
renting if
he/she:
Person
should
consider
buying if
he/she:
General
issues
114

Home

wants to have a new car every
two to four years

does not have the funds for
a down payment

doesn’t like to borrow money


does not have the funds for the
20% or more down payment

will not drive the car more than
12,000 to 15,000 miles per year
has temporary housing need
(e.g., moving to a new city
for a job change and does
not know the city or how
long the job will last)

expects his or her housing
needs to change
substantially in the
foreseeable future and does
not now own a home

is looking for a job or
changing careers, which
would likely require him or
her to move within a few
years

is not willing to deal with
the general maintenance
requirements of ownership

uses his or her car for business

needs a lower monthly car
payment and is willing to give
up ownership for the lower
payment

keeps a car for many years


drives well over 15,000 miles
per year
intends to live in an area for
many years

wants to improve the
appearance or structure of
the residence

can benefit from the income
tax advantages of
ownership

The most obvious issue is
income tax considerations.
Generally, the interest
portion of the monthly
mortgage payment for a
residence is deductible from
income.

wants to carry just the state
minimum of liability insurance

wants to stop making payments
eventually

Leasing companies often
require higher limits of liability
coverage. If a client would not
otherwise have this higher
amount of liability insurance,
the cost of insuring the leased
car will be higher.
Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Automobile
Home

In some states, the cost of
registering a leased vehicle is
higher than that for registering
a purchased vehicle.

At the end of a leasing period,
any mileage over a stated
amount and any damage or
apparent abuse will result in
additional costs.

Leasing generally does not
affect any other lines of credit a
client may have.

Leases often require a damage
or security deposit. The
opportunity cost of not having
these funds available is part of
the cost.

Some lease agreements require
a “capitalized cost reduction”
payment at the inception of the
lease. This is a nonrefundable
payment that serves to reduce
the remaining value of the asset
that is used to determine the
lease payments. It is essentially
a down payment on an asset
that is to be rented.

Property taxes paid are
generally deductible for tax
purposes.

A renter who improves a
rental unit may do so at his
or her expense; however,
when the renter leaves, the
owner of the unit benefits
from the improvement. If
anything was attached to
the structure by the renter,
generally the renter must
leave it as a fixture, and it
becomes the property of the
owner.
Chapter 7: To Lease or Buy

115
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Chapter 8: College Funding
Reading this chapter will enable you to:
1–8
Identify sources and strategies for funding a college education.
T
he cost of a college education is rising faster than the rate of inflation.
The smallest increase occurred in 2013–2014 at 2.9%. In 2012 the
increase of college costs was 4.5% and inflation was 2%. The average
inflation in college costs over the past decade is 5% according to the College
Board, which compiles a survey every year. However, the picture is complicated
because the cost for one student at an institution can vary significantly from
another depending on financial circumstances, academic or athletic abilities, type
of studies, etc. Another factor that impacts the cost of college is student aid,
which has varied dramatically.
About two thirds of full-time students receive aid of some form. The range of
average tuition and fees ranged from $7,750 at public universities to $37,171 at
private universities per year. Tuition and fees constitute about 39% of the total
budget for in state students living on campus and about 20% of those who pay for
off-campus housing. You can find more about costs, aid, and trends at
http://trend.collegeboard.org.
Compounding the increasing cost of college is the relationship between the
minimum wage students can earn and college costs. A student is no longer able
to work summers and part-time jobs and cover a large portion of costs; that
strategy no longer works. A student would need to work part-time just to cover
the cost of tuition without living expenses, books, etc. This makes it difficult to
complete college in under seven years. Statistically, students in this situation fail
to complete college and end up with high student debt but no offsetting ability to
earn a higher income.
Given these figures, parents must develop a savings program to accumulate the
funds necessary to meet these expenses.
116

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
College Funding Methods
Historically, the three means of financing a child’s college education have been:

from the current income of parents or relatives

with student loans, grants, or scholarships

from a parent’s or relative’s personal savings
Many states have programs in which a parent may pay for a child’s future tuition at
current rates. The program generally guarantees that an amount adequate to pay
tuition for any state school will be available when the child is ready to start college.
The use of these prepaid tuition programs generally does not affect the ability to
use the various tax-incentive programs.
Section 529 plans (called qualified tuition programs by the IRS) provide another
state-based tax-deferred savings option. These plans vary by state, but may allow
a substantial amount of money to be saved for college on a tax-free basis (more
than $300,000 in some states). Many plans allow out-of-state contributions, and
do not require attendance at an in-state college. The parent (or other account
owner) controls distribution of the funds (unlike an UGMA/UTMA account or
Coverdell Education Savings Account, where the child technically controls
distribution). Many states offer state tax deductions for making contributions to
529 plans.
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)
generally allows for all withdrawals from Section 529 plans to be income tax free
as long as they are used to pay for qualified college expenses. Qualified expenses
include items such as tuition, mandatory fees, books, supplies, and equipment
required for enrollment or attendance. Room and board expenses may also be
eligible. On the other hand, distributions above basis that do not pay for qualified
expenses will likely be taxable as ordinary income. Further, taxable distributions
may also be subject to a 10% additional tax. Several Section 529 plans have
Chapter 8: College Funding

117
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
recently come under fire for having fees that are perceived as being excessive. As
is the case generally, careful program evaluation (initial as well as ongoing) can
help to determine which plans are worthy of use.
EGTRRA also created several additional changes to Section 529 plans. An
account can now be transferred to: a child or grandchild, a stepchild, siblings and
their children, parents and step-parents, “in-laws,” spouses of the preceding
people, and a child’s first cousin. This allows the tax-free status of the account to
remain if the primary child decides not to go to college. The law provides for
rollovers from one 529 plan to another. This offers a good alternative for parents
who decide they don’t like their current 529 plan.
Another method of saving/investing for education is Coverdell Education
Savings Accounts. The annual Coverdell account contribution limit is $2,000 per
beneficiary (subject to modified adjusted gross income limits), and qualified
distributions from a Coverdell account can be used to pay for both qualified
elementary and secondary school expenses as well as college expenses and
expenses for “special needs” students. Coverdell account balances must be
distributed within 30 days of when the beneficiary reaches age 30 or if the
beneficiary passes away (if earlier).
A donor can make a contribution to a Coverdell account and a Section 529 plan
in the same year for the same beneficiary. While the money in a Coverdell
account grows, all income taxes are deferred and withdrawals made for qualified
educational expenses are not taxable. Accounts may be owned by the student or
the student’s parent. Money must be used by the time the beneficiary reaches age
30 (of course, beneficiaries may be changed). There are adjusted gross income
(AGI) phaseouts for contributions to a Coverdell plan: $95,000–$110,000
(single) and $190,000–$220,000 (joint). (Note: Although a more in-depth
discussion of Coverdell accounts or Section 529 plans is beyond the scope of this
module, an excellent resource for this information is the website
www.savingforcollege.com.)
118

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Lifetime Learning and American Opportunity Tax Credits
In an effort to stimulate college attendance, the government has created several
tax credits and deductions. These have changed over the tax years and are subject to
income tax phaseouts. The tax deductibility is covered more in depth in the Income
Tax Planning course of the CFP Certification Professional Education Program.
There are several important differences between the AOTC and the Lifetime
Learning credit. The Lifetime Learning credit is available annually for an
unlimited number of years; it is available for expenses related to acquiring or
improving job skills (such as continuing professional education through
qualifying institutions), and it is available for undergraduate, graduate, or
professional degree expenses. Qualified education expenses include tuition, but
amounts paid for books, supplies, and equipment are included only if required to
be paid to the institution as a condition of enrollment or attendance.
You cannot claim both the AOTC and Lifetime Learning credits in the same tax
year for the same student. However, in the same year you can claim the AOTC
for one student and the Lifetime Learning credit for another (assuming the
requisite education expenses exist for both).
There are also at times “above the line” deductions for qualified higher-education
expenses that have been allowed to expire and then retroactively reinstated. The
changing nature of the deductions means that it is more critical to plan in advance
for college, and the planner must annually evaluate which strategies can be most
tax beneficial in that year.
Of the first three funding methods, the ability to draw from one’s personal
savings (or other dedicated education fund), particularly if the money is
earmarked for college, is clearly superior. Using current income—the “pay as
you go” method—is expensive, because it fails to account for the time value of
money. Similarly, relying on student loans, grants, or scholarships has some
disadvantages. The availability of such money has diminished in recent years
because of federal budget cutbacks, a trend likely to continue.
Chapter 8: College Funding

119
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
What, then, is the best way to structure a savings plan to fund college expenses?
The answer involves two elements:

maintaining the funds in a manner that will take maximum advantage of tax
deferral opportunities and

selecting proper investment vehicles to achieve the greatest possible return
consistent with preservation of the funds
Series EE and I Savings Bonds
The savings bond education tax exclusion permits qualified taxpayers to exclude
from their gross income all or a portion of the interest earned on the redemption
of eligible Series EE and I bonds issued after 1989.
To qualify for the exclusion, the bondholder(s) must be at least 24 years old
when the bond is purchased. To qualify for this exclusion, the taxpayer, the
taxpayer’s spouse, or the taxpayer’s dependent at certain postsecondary
educational institutions must incur tuition and other educational expenses.
Persons with incomes above certain thresholds may not be eligible to participate.
This phaseout restriction will be in place when the distribution occurs so it is
important to monitor the client’s income compared to the phaseout. Series EE
bonds can be converted tax free to 529 plans but again, there are income
restrictions. Monitoring this situation can be a great added benefit for clients
owning Series EE bonds.
Eligible educational expenses include tuition and fees (such as lab fees and other
required course expenses) required for enrollment or attendance at an eligible
educational institution. Payments to qualified state tuition programs are also
eligible. However, expenses relating to any course or other education involving
sports, games, or hobbies are eligible only if required as part of a degree or
certificate-granting program. The costs of room and board, as well as books, are
not eligible expenses. The amount of eligible expenses is reduced by the amount
of any scholarships, fellowships, employer-provided educational assistance, and
other tuition reduction. Eligible expenses must be incurred during the same tax
year in which eligible bonds are redeemed.
120

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
A child can be named as a beneficiary on a bond. However, the child cannot be a
co-owner of the bond. The only eligible owners are the taxpayer (purchaser) and
his or her spouse. Additionally, spouses must file a joint tax return to qualify for
the tax benefit. The income phaseout range to determine qualification for the
education tax exclusion is $77,200–$92,200 (single) and $115,750–$145,750
(joint) for 2015. There are additional requirements and limitations.
Direct Transfers and Custodial Accounts
In formulating a college savings plan, it is wise to consider how the funds will be
held for the child’s benefit. This leads to a consideration of income shifting, a process
typically accomplished by either transferring funds directly to the minor child’s
control or establishing a custodial or trust arrangement on behalf of the child.
A direct transfer of assets into the child’s name is simple, inexpensive, and may
avoid taxation of the income at the parent/donor’s presumably higher marginal
tax rate. A direct transfer also works well if certain investments—for example,
Series EE government bonds—are the subject of the gift. In that case, taxes may
be deferred until the child is of college age.
Custodial accounts are a second way of building a college fund. Sometimes
referred to as a “poor man’s trust,” since they have virtually no administrative
costs, custodial accounts involve naming an individual as the manager of
property belonging to a minor child. There are two types of custodial accounts.
Assets can be set aside in:

a state-sanctioned Uniform Gifts to Minors Act (UGMA) account

in some states, in a Uniform Transfers to Minors Act (UTMA) account
Some states may only allow one type of custodial account (e.g., an UGMA),
while other states may allow either or both. A practitioner should consult
individual state law to determine which of these custodial arrangements is in
effect in his or her state.
Chapter 8: College Funding

121
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
To most parents, a custodianship is preferable to a direct transfer of property to a
minor. Almost any type of property may be placed under a custodian’s care;
however, in states where only the UGMA has been adopted, some restrictions on
permissible investments may apply.
Custodial arrangements also have some disadvantages. The child/ beneficiary
must be given the right to possession of the property on reaching the age of
majority (age 18 in most states). This must occur even though the child may
choose not to use the funds for his or her college education, a choice that is
usually contrary to the donor’s wishes. Predicting how well an 18-year-old would
handle $100,000 when they are 9 years old is risky business! Also, a custodial
account is relatively inflexible in avoiding the so-called kiddie tax. A formal trust
may be a better way to minimize these problems.
The kiddie tax applies to unearned (i.e., investment) income greater than $2,100
(indexed annually for inflation) received by children under age 19, or under age
24 if a full-time student. In essence, the first $1,050 of unearned income is not
taxed because it is offset by the limited standard deduction, the second $1,050 of
unearned income is taxed at the child’s marginal tax rate, and all unearned
income exceeding $2,100 is taxed at the parents’ marginal rate. In general,
investment vehicles selected for education funding when the child is subject to
the kiddie tax should, perhaps, be structured for growth rather than income to
avoid the kiddie tax. As a result of the increased ages at which the kiddie tax is
likely to have an impact, many funding techniques that involve placing assets in
the child’s name have become much less attractive. This may make 529 plans
and Coverdell accounts more beneficial (from a tax standpoint). Certain trusts
may also be useful.
Trusts
Trusts used in college education funding come in three basic forms:

a minor’s trust, established under the provisions of Internal Revenue Code
(IRC) Section 2503(c)
122

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.

a current income trust, structured according to the terms of IRC Section
2503(b)

a demand, or Crummey invasion, trust
It is not important to understand the details or legal ramifications and
requirements of these trusts, just the general benefits and/or problems. However,
it is important to understand that the costs to establish and maintain a given trust
may make it a less desirable alternative (especially considering that Section 529
plans and Coverdell ESAs can be used so effectively for college funding).
Minor’s trust [2503(c)]. A minor’s trust is designed to use the $14,000 ($28,000
for a married couple) annual gift tax exclusion, although it may permit
accumulation of income on behalf of the child under the trust terms. Its form is
dictated by IRC Section 2503(c), which provides that a gift to an individual under
21 will not be considered a gift of a future interest as long as the property and its
income are payable to the child at 21. In addition, the minor’s trust permits
income to escape the kiddie tax by allowing the trustee to accumulate more
income at the trust’s separate tax bracket. Unfortunately, changes in tax law have
resulted in the income retained in trusts being taxed at the highest personal rate,
even at relatively low levels. The full meaning of this is beyond the scope of this
module. Simply put, if money is put into this kind of trust for a child, the
potential taxes may be higher than the child’s or parent’s tax brackets.
Additionally, the funds generally must be given to the child when he or she
reaches age 21.
Current income trust [2503(b)]. The current income trust must have its income
paid out at least annually to the beneficiary with no discretion left to the trustee
to accumulate income. This typically presents problems in avoiding the kiddie
tax; however, it has a substantial offsetting advantage to many grantors (the
persons putting the money in the trusts). The trust property, or principal, need not
be distributed to the child at any specified age. This ensures the segregated funds
are used only for the purpose they were intended—that is, the child’s college
education. With this kind of trust, it is important to invest in things that increase
Chapter 8: College Funding

123
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
in value but don’t pay income while the child is young. Without this approach, all of
the income earned in the trust will be paid to the child, and the fund won’t grow.
Again, further details on this type of trust are beyond the scope of this module.
Crummey trust. The final form of trust is the demand, or Crummey invasion,
trust, which is an effective mix of the best attributes of the minor’s and current
income trusts. It transfers money from one individual to a trust for the benefit of
another. It is done in such a way as to avoid gift taxes and keep the money out of
the estate of the person making the gifts. It permits the beneficiary to withdraw
from the trust an amount equal to the lesser of the annual addition to the trust or
the annual gift tax exclusion. In addition, rather than requiring trust property to
be distributed to the beneficiary at age 21, the demand trust allows distribution at
any age chosen by the grantor. However, if the demand trust accumulates income
and it is taxed to the trust itself, the tax rates are high.
Using Retirement Plans to Fund College Expenses
An often overlooked means of saving for a child’s college education is a parent’s
retirement plan. Specifically, many qualified retirement plans permit a participant
to borrow from the plan without imposing the premature distribution penalty.
Even if the plan terms don’t allow for loans, a tax rule may offer relief.
Under the “substantially equal periodic payment” exception to IRC Section 72(t),
a participant can turn some or all of his retirement account (including an
individual retirement account) into a period certain or life annuity for
preretirement use at any time, without the usual 10% premature distribution
penalty. As long as the participant withdraws roughly equal amounts from his
retirement plan annually for at least five years following commencement of
distributions, or until reaching age 59½ (whichever is later), retirement money
can be used for any reason. A parent may find this exception useful in meeting
current expenses for a college-age child (but at the expense of his or her own
retirement savings).
124

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Unless a client is overfunded for retirement, this is generally not recommended.
This may be appropriate if a client has extremely large qualified plans that will
require substantial minimum required distributions in the future and a large
estate. Upon evaluation, a client may choose to utilize retirement assets to spread
out the taxation versus company stock or other assets.
An IRA owner may also be able to withdraw money from his or her IRA without
incurring the 10% early withdrawal penalty. Funds withdrawn to pay for
qualified higher education expenses for the taxpayer, spouse, children, or
grandchildren may qualify for this exemption. Any amount withdrawn will likely
be taxable as ordinary income for the year in which it was received.
Roth IRAs can be excellent sources for accumulation or supplements to 529
plans. Contributions to Roth IRAs can always be withdrawn without tax or
penalty. If an account has been owned for five years and a qualified reason exists,
the owner can also withdraw earnings without penalty but the earnings will be
subject to taxation if the distributions exceed the contributions. Only after the
owner attains age 59½ can the earnings be withdrawn without tax. By combining
529 plans and Roth IRAs, a parent can manage the taxes that can occur when
spending large chunks of money on education in a few years.
Investment Vehicles
The choice of an investment vehicle and asset allocation to fund a savings
program for college partly depends on the means used to accumulate the needed
savings. If a custodial arrangement is chosen, investments may be limited,
depending on whether the state has adopted the UGMA or UTMA. If a trust is
used, the corpus may need to consist of income-producing property to guarantee
the availability of the annual gift tax exclusion. However, the impact of the
kiddie tax is equally important.
As a rule, investments that generate growth of principal (as contrasted with
current income) should be more heavily relied on for a child who may be subject
to the kiddie tax. If the kiddie tax is not a consideration, investments producing a
Chapter 8: College Funding

125
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
high current yield may be sought. However, as the economy changes, and
depending on the risk tolerance of the individuals funding the plan, no single rule
or set of rules is appropriate. Additionally, what is appropriate for a 1-year-old
who will not make withdrawals for 18 years is different than the investment
allocation for the 17-year-old who will need one-fourth of the money next year.
A study of investment planning is required to provide appropriate
recommendations for each client.
In the early stages of saving for college, one investment option is a growthoriented stock mutual fund. Historically, growth funds have produced substantial
long-term returns in asset value without paying large dividends. Further, as the
child approaches college age, the fund may be set up to liquidate shares in
several stages, thereby avoiding potential stock market downturns.
Another option that is sometimes considered during the growth period of college
funding is either a variable annuity or life insurance policy. (Remember, though,
that a life insurance policy is primarily a risk management tool. There are
specific costs associated with a life insurance policy that likely will reduce
potential net returns. As a result, under normal circumstances, consider a
permanent life insurance policy only when there is a need for the insurance—i.e.,
a death benefit. Compare policy expenses and returns with returns from noninsurance products. However, especially if additional death benefit is needed, life
insurance may be a useful tool.) In the various versions of these vehicles, the
underlying account usually is invested in equities. Unlike the growth mutual fund
in a custodial account, however, the parent may maintain ownership, and tax
advantages still can be achieved.
With the annuity, a tax-deferred buildup of funds is possible, with payments
geared toward the child’s college entry date. With the life insurance variation,
loans may be taken against the policy’s accumulated cash value and used to pay
college expenses. If the policy ends, the entire gain on the policy is taxed as
ordinary income. The use of an annuity carries with it some potentially adverse
income tax consequences. If the money is taken out before the annuity owner is
59½, there is a 10% penalty tax on any amounts above original basis/investment.
126

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
All gain is taxed as ordinary income with gain being taxed before basis. It is
important for the planner to project the tax consequences including penalties
when considering using annuities or life insurance for college funding.
Eventually, growth funds will normally need to be converted to income.
Certificates of deposit, money market funds, and bonds are among the potential
investments. Some investment firms have created special “inflation-proof” CDs that
guarantee the rate of return will match any annual rate of tuition increase. These are
valuable if college tuition continues to rise; however, if the rate of tuition increase is
relatively low, it should be easy to get a better return elsewhere.
Money market funds provide a fixed return geared to prevailing market interest
rates. Bonds come in all varieties, both taxable and tax exempt, and may prove
profitable if interest rates are expected to decline in the near future. If held to
maturity, bonds provide a determinable yearly income that may be used to pay
college expenses. So-called zero-coupon bonds also are often used, because they sell
for a fraction of their ultimate value yet return the full-face amount at maturity.
Matching the bond duration to the client’s time frame is critical when utilizing bonds.
You will learn more about duration in investment planning modules.
Start Planning Now
The most important consideration in planning for college costs is to begin saving
as early as possible. Getting family involved in a 529 gifting program at a child’s
birth can be a huge boon. Some families encourage donations to college funding
in place of expensive gifts. Research shows that children who know that there are
savings programs established for their education have a higher percentage of
attending and finishing college. All advisers should recommend a simple plan to
their clients and encourage them to stick to it. As in many other investment
ventures, the key to success is the amount of time available and how well that
time is used. The earlier parents (and grandparents) begin to save, the lower the
regular contributions they will have to make.
Chapter 8: College Funding

127
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Other Sources of Funds for Education Goals
In many cases, parents will not have the money to invest or enough time for the
assets to grow in a plan to pay for their child’s education. These parents find that
they must depend on scholarships, loans, and grants to provide higher education
for their children. Sources of education funds that may be available for some
clients are described below. It is important to remember that private colleges and
universities may have their own criteria for determining financial aid
qualification. Good planning requires that you review requirements at both the
federal and the institutional level.
Scholarships
Full or partial scholarships (gifts of money applied toward a student’s
education) typically are available for academically or athletically gifted
students through the specific college or university they attend, or through
businesses, foundations, community groups, and other sources. Frequently,
the continued receipt of scholarship monies is contingent upon satisfactory
academic performance or other stipulations. Scholarships may also be based
upon financial need. When a scholarship is awarded to an individual eligible
for other need-based assistance, scholarship funds may reduce monies
available from other sources. The average scholarship was under $500 per
year in 2014.
Federal Grants
Federal grants are gifts by the federal government to a student to be applied
toward education funding. The student is not required to pay back the sum that
the government provides. A good resource for additional information can be
found at http://studentaid.ed.gov/students/attachments/siteresources/Funding_
Education_Beyond_HS_2011-12.pdf.
128

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Pell grants. Pell grants are available to undergraduates only and are distributed
on the basis of severe financial need. All students, including part-time students
(students who are attending school less than half time), are eligible for Pell
grants. The maximum amount available may change year by year, but will
seldom (if ever) be enough to completely pay tuition expenses (current maximum
is $5,550). Part-time students may be eligible for reduced grants.
Federal Supplemental Educational Opportunity Grants (FSEOGs). These
grants are funded by the federal government but are administered by individual
schools. FSEOGs are available to undergraduate students only and are needbased. These grants may be available to part-time students as well as full-time
students. Awards are limited based on the amount available (current amounts
range from $100 to $4,000). Pell grant recipients are given highest priority in
receiving FSEOGs.
Additional federal or state grants may be available. As part of the College Cost
Reduction and Access Act of 2007, a new grant was established. Congress
created the Teacher Education Assistance for College and Higher Education
(TEACH) Grant Program, which provides grants of up to $4,000 per year to
students who intend to teach in a public or private elementary or secondary
school that serves students from low-income families. In exchange for receiving
a TEACH Grant, recipients must agree to serve as a full-time teacher in a highneed field in a public or private elementary or secondary school that serves lowincome students. Failure to complete this service obligation will result in a
conversion of all amounts received to a Federal Direct Unsubsidized Stafford
Loan. Students enrolled less than full-time will have grant amounts reduced.
Additional requirements apply.
Chapter 8: College Funding

129
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Federally Funded Loans
Note: As of July 1, 2010, all loans come directly from the U.S. Department of
Education under the Direct Loan Program.
Perkins loans. Perkins loans are low interest rate loans funded by the federal
government but administered by individual schools. These loans are available
both to undergraduate and graduate students. They are need-based and are
available to students who are attending on at least a half-time basis and who have
an exceptional financial need. Students in a degree or certificate program who
temporarily drop below half-time status will likely be able to keep their existing
Perkins loan eligibility. However, if they drop out of the program, and continue
just taking a few classes, they will lose their eligibility.
Limits apply to the amount of funds that may be borrowed. These loans feature a
5% interest rate, which is not charged during the period that the individual is a
student. In addition, graduates are not charged interest until nine months
following graduation, leaving school, or dropping to less than half time, at which
time repayment begins. A student attending less than half time should check with
their financial aid administrator to determine the grace period before repayment
begins. The amount of loan money available to a student is also determined by
the school’s financial aid department. Repayment is typically for 10 years.
Stafford loans. Stafford loans (also known as William D. Ford Direct Stafford
Loans) are probably the most common of educational loans. These include both
direct subsidized and direct unsubsidized loans. Some loans, especially for
graduate students, may be partially subsidized, with the remainder unsubsidized.
If a student qualifies for a loan based on financial need, the loan generally will be
subsidized. The subsidy takes the form of the government paying the interest due
while the student is in school and during the six months following graduation.
Unsubsidized loans have interest due within 60 days of disbursement of the
money. A student may defer paying on the loan, but the interest usually continues
to accrue and will increase the total amount payable when repayment begins.
While in school, the student may pay interest only.
130

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Any student who is enrolled at least half time is eligible to apply for Stafford
loans (part-time students are not eligible). There are limits as to how much may be
borrowed each year—the cost of the student’s education less other loans or grants is
set as an alternative maximum to specific dollar limits published by the government.
Under the Bipartisan Student Loan Certainty Act of 2013, federal student loan
interest rates are tied to financial markets. Each spring interest rates are
determined for new loans being made for the upcoming award year, which runs
July 1st to the next June 30th. Each loan will have a fixed interest rate for the life
of the loan. For 2014–2015 the rates are as follows:
Loan Type
Interest Rate
Direct Subsidized Loans (Undergraduates)
4.66%
Direct Unsubsidized Loans (Undergraduates)
4.66%
Direct Unsubsidized Loans (Graduate or Professional Students)
6.21%
The normal repayment period is 10 years, but various repayment options, as well as
repayment term extensions, may be available.
Parent Loans to Undergraduate Students (PLUS). Under PLUS, parents may
borrow funds for their children’s undergraduate studies. The amount that can be
borrowed is unlimited, except that the total of all aid received cannot be higher
than the total cost of schooling. Part-time students are not eligible for PLUS
funds, but students enrolled in programs that are shorter than an academic year
may be eligible for reduced loan amounts. These loans are not need-based. The
interest rate charged in 2015 is fixed at 7.21% (prior to this, the rate had been
variable, but could not exceed 9.0%). Also, (and to confuse matters a bit),
graduate and professional students can borrow money directly (i.e., for
themselves) through the Grad Plus loan program.
Repayment begins within 60 days of taking out the loan, and although repayment
may be delayed until the student is out of school, the interest on the loan
continues to build during this time. As with Stafford loans, private lenders are the
source. Origination fees are charged, and insurance may be an added fee.
Chapter 8: College Funding

131
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Direct Consolidation Loans. This program allows for the combination of
multiple student loans into one loan. A parent loan cannot be consolidated with
student loans and become the student’s responsibility to repay. Under previous
iterations of the law, the interest rate varied depending on the weighted average
rates of the loans being consolidated, but could not exceed 8.25%. Currently, for
Direct Consolidation Loans, the interest rate remains the weighted average of the
interest rates on the loans included in the consolidation, rounded to the next
higher one-eighth of one percent. A change made in 2014 was the removal of the
8.25% cap.
The following table shows who is eligible for each type of grant or loan.
Table 6: Loan Eligibility
Available for:
Source
Pell Grants
Federal
Supplemental
Educational
Opportunity
Grants
TEACH Grant
Parent Loans to
Undergraduate
Students (PLUS)†
Perkins Loans
Stafford Loans
Undergraduate
Students
Graduate
Students
Part-time
Students
Half-time
Students
Full-time
Students
*























*Pell grants are awarded on a pro rata basis dependent on income and assets.
PLUS loans are also available to graduate and professional students.
†
132

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
College Work Study
Under this program, eligible students are provided employment, which may be
on or off campus, to help cover the cost of their education. Federal funds are used
by individual schools to administer the program. The government and the
employer share in the payments made to students. Eligibility is based on financial
need. College work study is available to both undergraduate and graduate
students, and to both part-time and full-time students. The program has a limit on
the number of hours worked, which is based on course load and academic
progress. Work study programs provide income to students that may be used to
defray college expenses. Undergraduate students are paid by the hour. Graduate
students may be paid by the hour or by salary.
State-Funded Financial Aid
The types of aid available vary from state to state; however, it should be noted
that state government is another source of education funding to be explored.
For a more comprehensive source of information regarding the various financial
aid programs, a free copy of The Student Guide can be obtained at
www.studentaid.ed.gov.
Chapter 8: College Funding

133
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Chapter 9: Special Needs Planning
Reading this chapter will enable you to:
1–9
Explain issues related to special planning needs.
S
pecial needs come in many forms. While many clients will have fairly
consistent planning needs, there will be clients with issues that make their
financial picture a little different. Some of the issues that will be described
in this chapter are listed below.

divorce/remarriage considerations

charitable planning

adult dependent

disabled child

terminal illness planning

closely held business planning
Divorce/Remarriage Planning
Divorce planning is somewhat of a specialty. There are many problems that are
unique to divorce. The best time to plan for divorce is prior to marriage. Of
course, this sounds strange. Few people get married with the intention of getting
divorced. Unfortunately, 50% of marriages do not work out, and divorce is the
result. A prenuptial agreement can reduce some of the significant financial
problems faced in divorce. Discussion of a prenuptial agreement may be difficult
(not exactly the most romantic topic), and there are legal implications (legal
counsel is required), but the conversation may be worthwhile—especially where
134

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
large amounts of assets may be involved. If a prenuptial agreement is in place
there is still significant planning that needs to occur. State laws control much of
divorce planning. Some states have formulas for child support but not
maintenance. Other states have very specific rules that define maintenance and
division of assets. Many states ignore basis or tax consequences in addressing
division of assets. Clients can come to an agreement without representation.
Many planners find that encouraging clients to use a mediator who is
knowledgeable about state laws and planning can allow a couple to create a
scenario that they can both live with. Problems such as not requiring a spouse to
refinance a mortgage can make the other spouse unable to secure financing to
purchase a residence. Business ownership and professional practices can end up
having both the value split and the income generated from the asset split, making
it difficult for the business owner to create the capital needed to continue
growing the business. Who receives which asset may be important. While each
spouse may receive stock with an FMV of $100,000, the one who receives the
$100,000 with a basis of $10,000 will not be as happy as the other who receives
stock that has a basis of $80,000. As a planner, you need to become aware of the
issues and guide clients to appropriate council, whether that is legal or mediation.
Divorce Issues
The problems associated with divorce involve three major areas: income,
property distribution, and child custody. Part of determining the mix of alimony,
property split, and child support will be the taxation of each of these. Therefore it
will be important to create a pro-forma for each of the divorcing individuals and
see how and when they may liquidate assets, their projected tax brackets, etc.
Income becomes an issue primarily because whatever income was available for
the support of one household must now be used, in some manner, to support two
households. The divorce agreement often provides maintenance for the spouse
who earned less income during the marriage and adequate financial support for
any minor children. Alimony is generally deductible to the payor and taxable to
the recipient. Child support is neither taxable nor deductible but it can determine
Chapter 9: Special Needs Planning

135
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
who takes the dependency deduction for the children. There are further tax
consequences and important rules to learn concerning transfer of retirement plan
benefits, division of property, etc. that are beyond the scope of this course. You
will learn more in Income Tax Planning.
One interesting fact that arises after a divorce is that of Social Security benefits.
When a couple was married for ten years or more, each person may choose between
their own Social Security retirement benefits or 50% of those of the ex-spouse. If
there has been more than one ten-year marriage for one or both of the divorcing
spouses, each individual may choose the spouse’s benefits or their own; whichever
is greater. More detail than this is beyond the scope of this module.
An increasing number of couples today are not in their first marriage, and more
first marriages are taking place when the spouses are older. People with more life
experience when they marry usually have more assets. A prenuptial agreement
allows each party to be comfortable in the knowledge that each spouse can retain
whatever assets he or she brought to the marriage if the marriage dissolves. However,
if one spouse retitles an asset to include the other spouse, it may become a marital
asset and defeat the intent of the prenuptial agreement. An individual in the throes of
a divorce may make decisions based more on emotions than rational thinking. The
financial planner specializing in divorce planning may be able to help steer a client
away from inappropriate emotional decisions, thus maximizing any benefits to be
realized and minimizing some of the emotional difficulties.
Dealing with the custody of children is generally beyond the scope of a financial
planner’s responsibilities. However, if the planner is working with the custodial
parent, control of finances may be critical. Child support payments are often
determined by a state-established formula, so it is not likely the planner will have
any input. Advising a divorced parent on how to reduce expenses and extend
available funds is, however, within the purview of the planner.
In counseling clients, a financial planner must be careful not to run afoul of the
unauthorized practice of law. However, a planner can make recommendations
that will ease the transition of divorce, should it occur. The planner can
136

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
recommend that each person have at least one credit card in his or her name to
establish a personal credit history. Each person should have a liquid cash account
in his or her name instead of having all accounts in both names. Each spouse
should be involved in the month-to-month finances of running the home so each
has a realistic idea of the costs involved and how those costs change over the
years. Budgeting that involves both spouses will help each of them understand
where the couple’s funds go each month.
Remarriage Issues
Remarriage, on the other hand, introduces different issues into the financial
planning process. Each spouse coming into the marriage generally is interested in
having his or her heirs get their assets when they die. The names of beneficiaries
on life insurance policies obtained during a prior marriage may have to be
changed. Planners should be careful in this area. Many divorce settlements
require that certain amounts of life insurance be maintained for the ex-spouse or
for child support obligations. There are court cases in which the first spouse
received the death benefits of group insurance because the original beneficiary
designation wasn’t changed. This has happened even after 10 or more years of
marriage to the second spouse, following a one- or two-year marriage to the first.
In general, beneficiary designations will go to the named beneficiary, which is
one more important reason to request statements and review beneficiary
designations every few years.
Estate planning is beyond the scope of this module. However, financial planners
should become familiar with how changing property titles to include a new
spouse, or to balance the estate and minimize estate taxes, may result in a loss of
premarital property. When working with clients in the area of estate planning, the
planner should warn clients of potential problems should there be a divorce
before either of them dies.
The laws of intestacy (dying without a will) differ from state to state. This can
create difficulties for persons involved in a second marriage, especially when
there are children from the first marriage. Careless estate planning may
Chapter 9: Special Needs Planning

137
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
ultimately leave everything to the children of a second spouse and disinherit an
individual’s children. Although the details of this issue are beyond the scope of
this module, it is important that financial planners be aware of potential problems
that may arise in a second marriage. You will be learning more about this area in
Estate Planning.
Charitable Planning
Most clients will make charitable donations each year. For some clients, this is an
important part of who they are. For those clients, learning how to efficiently gift
assets, such as appreciated stock versus cash, bundling contributions to offset
large gains, and use of various techniques that can allow a client to make
substantial gifts while meeting their own goals requires special expertise. You
will learn more about the taxation issues in income tax planning and estate
requirements in the Estate Planning course.
Clients who are charitably inclined are often asked to remember one charity or
another in their estate plan. Many well-to-do clients establish their own charitable
foundations. The details of these activities will not be discussed in this module,
but a competent financial planner will recognize charitable giving as an
important part of some clients’ financial plans. At a minimum, it requires
provisions in the will, and may require specialized trust documents as well. In
addition to helping a client find the appropriate professional to help design and
implement charitable giving plans, a planner can help the client balance
charitable giving with the need to meet basic family financial obligations. Gifting
will be covered in the Estate Planning course of this program.
Needs of the Dependent Adult or Disabled
Child
In addition to their other financial concerns, clients who support dependent adults
or disabled children generally are concerned about what will happen to these
individuals if they are not around to take care of them.
138

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
While the parents or children who provide the support are alive, they can provide
much of the needed care. They can also seek out required services.
Unfortunately, there are often needs that can only be met by a person who is
dedicated to supporting the adult dependent or the disabled child, or by a paid
support person. Paying for support services is often quite expensive. In many
cases, families establish special trusts to take care of dependent individuals for as
long as they live. A trust that meets certain requirements may still allow the
dependent person to receive state-provided support without having to be totally
impoverished. The planner can recommend an expert lawyer to prepare this trust.
Beyond the legal requirements, having a potential life-long dependent can change
the type and amount of life insurance purchased and the amount of disability
coverage needed. Whole life that will be there even if the parent lives to 110 may
be important. The planner will need to carefully assess the life expectancy of the
dependent, potential medical expenses, possible long-term care needs, the
financial support, and living requirements that will be needed in addition to
routine data gathering.
Terminal Illness Planning
Terminal illness planning is difficult for everyone involved. The person who
seems to have the easiest time with it is often the one who is terminally ill. Most
family members will not want to talk about estate plans, business continuation,
charitable issues, funerals, or financial decisions when facing the death of a loved
one. This is the time, however, that these issues must be discussed. One big
advantage of discussing them at this time is that, for the most part, circumstances
that will exist at death are known. Individuals drafting a will attempt to determine
what they want to happen when they die, not knowing which family members
will still be alive, and not knowing many things that might affect their wishes.
While decisions made during the dying process may be quite emotional, at least
the wishes of the terminally ill person can usually be known. This is a critical
time to make sure all legal documents are completed, current, and accounted for.
After death, the ill person’s input is unavailable, and for some time, emotions
will make decision making more difficult and possibly quite costly.
Chapter 9: Special Needs Planning

139
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Another issue that occurs during this stage is that clients and families are so
consumed with medical care and estate planning that they may ignore and miss
opportunities. For example, most employer group term insurance can be
converted to permanent coverage without insurability if done so within 30 days.
Some disability policies also have this conversion clause. The rates will be more
than a normal person would pay but would have great benefit for the terminally
ill person. Missing the deadline for conversion can be a very costly mistake. The
same problem can occur if the person who is ill is normally the one to pay bills
and handle financial issues. Many life insurance policies have lapsed just prior to
a client’s death because the check was not put in the mail in time. As a planner,
you can help the family avoid some of these pitfalls. That same pitfall can
happen to long-term care policies without adequate protection. Many policies
will allow the client to set up automatic notification if a payment is missed to a
third party.
Closely Held Business Planning
Most closely held businesses fail to survive their founder because no succession
planning is done. No one knows who is supposed to run the business, and to
make things “fair” to everyone, the founder often lets everyone share equally in
the business when he or she dies. Unfortunately, this generally leads to
disagreements as to how the business ought to be run, or whether the business
should be sold. Too often, the bickering continues long enough that the business
fails and the decedent’s lifetime of work becomes worthless.
While the details of planning for closely held businesses are beyond the scope of
this module, it is important for planners to recognize that a client who owns a
closely held business has additional financial considerations. Most businesses
will fail without adequate planning and adequate legal documentation. A planner
who does a good job can assure the client that the business will live on even after
the client dies and that the value of the business can be received by the family.
140

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Summary
T
he material in this module provided a comprehensive overview of the
financial planning process. It also introduced the basic financial
statements. Above all, the material in this module communicated the
importance of gathering adequate information and recognizing the many different
issues that a financial planner may face when counseling clients.
Having read the material in this module, you should be able to:
1–1
Explain the what and why of the steps in the financial planning
process.
1–2
Explain the rationale for gathering specific financial information.
1–3
Construct and interpret personal financial statements.
1–4
Recommend assets appropriate for use in an emergency fund.
1–5
Analyze a client’s financial situation to identify issues related to
budgeting.
1–6
Explain different forms of debt and their uses.
1–7
Explain the issues involved in the lease versus buy decision.
1–8
Identify sources and strategies for funding a college education.
1–9
Explain issues related to special planning needs.
Summary

141
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Before moving on to the next module, answer the Module Review
Questions that follow, and check your answers with those provided
(following the questions). Review the module text to help you master any
learning objective areas where you are not able to adequately answer
questions.
142

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Module Review
Questions
1–1
Explain the what and why of the steps in the financial planning
process.
1. Explain personal financial planning.
Go to answer.
2. Identify the functions completed in the six steps in the financial planning
process.
Go to answer.
1–2
Explain the rationale for gathering specific financial information.
3. How do the goals of the client affect the nature of information gathered in the
data gathering process?
Go to answer.
4. What specific information is gathered concerning each topic below, and how
is it used in the planning process?
a. retirement
Go to answer.
b. education or other accumulation goals
Go to answer.
c. emergency reserve goals
Go to answer.
d. debt management goals and concerns
Go to answer.
Module Review

143
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
e. investment management concerns
Go to answer.
f.
health insurance concerns
Go to answer.
g. disability contingency planning
Go to answer.
h. loss of life contingency planning
Go to answer.
i.
long-term care needs contingency planning
Go to answer.
j.
property and liability concerns
Go to answer.
k. legal documents and estate planning distribution plan
Go to answer.
l.
anticipated changes in lifestyle, family, health or other concern
Go to answer.
5. When you collect the following documents, what are you looking to learn
and give an example of how it could impact the financial plan?
a. last two paystubs
Go to answer.
b. three years’ tax returns including supporting documents such as W2s
Go to answer.
c. cash flow statements
Go to answer.
144

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
d. benefit package descriptions
Go to answer.
e. copies of personal insurance policies and latest statements
Go to answer.
f.
investments and bank statements including retirement accounts
Go to answer.
g. Social Security statement
Go to answer.
h. liability contracts/debt statements including family loans
Go to answer.
i.
1–3
copies of wills, durable powers of attorney, trusts, pre-nuptial
agreements, divorce decrees, business entity formation, gift tax returns,
and other legal documents
Go to answer.
Construct and interpret personal financial statements.
6. What is the significance of including the words “As of December 31, 201X”
in the heading of the statement of financial position?
Go to answer.
7. Describe briefly each of the three major components of the statement of
financial position.
Go to answer.
8. Using a simple formula(s), describe the relationship that exists among the
three major components of the statement of financial position.
Go to answer.
Module Review

145
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
9. Identify items that typically are placed under each of the asset categories on
the statement of financial position.
a. cash/cash equivalents
Go to answer.
b. invested assets
Go to answer.
c. use assets
Go to answer.
10. At what value are assets usually shown on the statement of financial
position?
Go to answer.
11. What is the significance of including the words “For the Year Ending
December 31, 201X” in the heading of the cash flow statement?
Go to answer.
12. Identify items that typically are placed under each of the following categories
on the cash flow statement. Do not include savings and investments.
a. inflows
Go to answer.
b. fixed outflows
Go to answer.
c. variable outflows
Go to answer.
146

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
13. Under what circumstances would the category “Savings and Investments”
appear as an inflow on the cash flow statement?
Go to answer.
14. What is the purpose of footnotes to personal financial statements?
Go to answer.
Read the client profile below to determine what additional data you will need to
gather from the client to create financial planning recommendations. Then,
answer questions 15-17.
William and Nancy Webb have come to you for assistance in developing a
financial plan. From your initial meeting with them, you have gathered the
following information. (Assume that today is January 6, 201X, and the
information provided is correct as of the previous December 31, 201X.)
Personal Information
William and Nancy Webb

married four years; live in Colorado

enjoy hiking and skiing

are in excellent health
William Webb

27 years old

assistant personnel manager at Brown’s Department Store

201X gross salary $52,000
Nancy Webb

25 years old

bookkeeper at Brown’s Department Store

201X gross salary $42,000
Module Review

147
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Matthew Webb

age 2, only child
Assets
[As of 12/31/1X; jointly owned with right of survivorship (JTWROS) unless
otherwise noted]
Automobiles

201X compact, fair market value (FMV) of $13,900, monthly payment of
$260 (principal and interest), note balance of $7,000, owned by William

201X compact, fair market value (FMV) of $6,900, owned outright by Nancy
Land (undeveloped) in Wisconsin

inherited by Nancy in 201X with FMV of $15,000
Blue-chip income stock portfolio statement shows

inherited by Nancy in 201X with FMV of $80,000 with basis of $78,720 and
dividend income in 201X of $3,200
Personal property

FMV of $15,000
Money market mutual fund

FMV of $4,250. It has a fluctuating dividend rate currently paying 2%.201X
dividends of $85 were automatically reinvested in fund
Savings account

$5,000 balance, currently paying 2% interest rate. Interest last year of $100
was paid.
Checking account

$5,650 balance. There is no interest on the account.
148

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
201X Tax Information
FICA: $3,978 on William’s wages and $3,213 on Nancy’s income.
Federal income taxes

$9,624. They claim standard married filing jointly with one dependent and
the child tax credit
State income taxes

$3,505 tax based on 4.63% Colorado tax
Property tax on inherited land

$174 annual cost
Insurance Information
Life Insurance
Policy 1
Policy 2
Person insured
William
William
Face amount
$52,000
$25,000
Cash value
N/A
$1,430
Type of policy
Group
term
Whole
life
Annual premium
Employer
paid
$270
Beneficiary
Nancy
Parents
Contingent
beneficiary
None
None
Policyowner
Employer
William
Module Review

149
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Health Insurance
Person(s) insured
Family
Type of policy
Comprehensive major medical
Coverages
80/20 coinsurance
$5,000 out-of-pocket maximum
Unlimited major medical
Deductible
$300 annual per person; $600
annual per family
Annual premium
$1,600 per year employee costs
Automobile Insurance
Type
Personal auto policy
Liability
$100,000/$300,000/$50,000
Medical payments
$5,000 per person per accident
Uninsured motorists
$25,000 per accident
Physical damage, own car
Actual cash value
Collision deductible
$500
Comprehensive deductible
$500
Total annual premium
$1,200
Disability Insurance

No personal coverage. Group information not provided.
Homeowners/Renters Insurance

None
Retirement/Estate Planning Information

IRA funds in balanced mutual fund, FMV of $10,500; includes $4,000
contributed in 201X
150

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.

William contributes $4,860 and Nancy contributes $1,260 to their 401(k)
plans.

Nancy changed jobs a year and a half ago and her current vested 401(k)
balance is $4,536. William has a vested balance of $13,300 in his 401(k)
plan.

have wills but no trusts
Additional Information

rent a two bedroom apartment for $1,300 per month, $15,600 per year

deposited $2,000 in money market mutual fund and $1,250 in savings
account in 201X

contributed $1,000 to charity in 201X

credit card balance is $400 as of 12/31/1X, which they pay off each month.

whole life insurance policy purchased by William’s parents when he was
very young. His parents turned the policy over to William before William
and Nancy were married

do not plan to have more children

moderate risk tolerance; desire growth rather than income from investments
Goals

want to purchase a house within five years

want to establish an education fund for Matthew

want to establish goals and plan for retirement

would like to learn more about investing (William’s parents are very well off
and he anticipates receiving an inheritance)
Module Review

151
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Additional Annual Cash Expenditures
Food
$7,200
Transportation
$7,180
Clothing/personal care
$6,415
Entertainment/vacations
$3,500
Medical/dental care
$3,960
Utilities
$1,440
Child care expenses
$7,200
Miscellaneous
$3,751
15. What additional information must be gathered from the Webbs before a
comprehensive financial plan can be developed?
Go to answer.
152

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
16. Construct a statement of financial position for the Webbs as of December 31,
201X.
William and Nancy Webb
Statement of Financial Position
As of December 31, 201X
ASSETS
Cash/Cash Equivalents
Checking account
Savings account
Money market fund
Life insurance cash value
Total Cash/Cash Equivalents
Invested Assets
Blue-chip income stock portfolio
Land
William’s 401(k)
Nancy’s 401(k)
IRA
Total Invested Assets
Use Assets
Automobile 1
Automobile 2
Personal property
Total Use Assets
TOTAL ASSETS
LIABILITIES AND NET
WORTH
Liabilities
$
$
Credit card balance
Auto note balance
Total Liabilities
$
$
$
$
Net Worth
$
TOTAL LIABILITIES
AND NET WORTH
$
$
$
$
Go to answer.
Module Review

153
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
17. Construct a cash flow statement for the year ending December 31, 201X, for
the Webbs.
William and Nancy Webb
Cash Flow Statement
For the Year Ending December 31, 201X
INFLOWS
Gross salaries
Dividends income
Interest income
TOTAL INFLOWS
OUTFLOWS
Savings and Investments
Fixed Outflows
Rent payments
Auto note payments
Insurance premiums
Property taxes
FICA
Total Fixed Outflows
Variable Outflows
Taxes
Food
Transportation
Clothing/personal care
Entertainment/vacations
Medical/dental care
Charitable contributions
Utilities
Child care costs
Miscellaneous
Total Variable Outflows
TOTAL OUTFLOWS
$
$

13,455
$
29,155
$
54,755
$
$
Go to answer.
154
$
Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
$
Read the client profile below to determine what additional data you will
need to gather from the client to create a comprehensive financial plan.
Then, answer questions 18-20.
You are a financial planner in Chicago. Leslie James has come to you for
assistance in developing a financial plan. From your initial meeting with her, you
have gathered the following information. (Assume that today is January 3, 201X, and
that the information provided is correct as of the preceding December 31, 201X.)
Personal Information
Leslie James

48 years old, divorced, no children; both parents deceased; no brothers or
sisters

senior executive at Simpson Mfg. Co.

gross salary of $334,000
Assets
(As of 12/31/1X)
Primary Residence

downtown condo on the lakefront, FMV of $1,092,000. She purchased it five
years ago taking out an $800,000 15-year mortgage loan at a 4.0% interest
rate. Her monthly payment is $5,917 ($71,004 per year), and she currently
has $584,473 principal left on her mortgage. Her association dues are
$16,200 per year and it covers all utilities and parking.

summer residence on lake in Michigan
The cottage on the lake was inherited from her mother. It has an FMV of
$482,000 and includes beachfront and a pier where she keeps a motorboat
and sailboat. While the house is livable in the winter, she seldom uses it and
normally closes it down in the fall.
Module Review

155
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Automobile

201X Mercedes; FMV of $42,020 with a note balance of $33,400 and
monthly payments of $680 ($8,160 per year).
Furnishings/personal property (residence and home in Michigan)

FMV of $534,000 worth of furnishings along with personal property
worth$118,000, which includes a motor boat, sailboat, jewelry, and
collectible art.
Stock/bond portfolio

FMV of $2,112,000 in a mixed portfolio. She promised to have the
statements sent to you. She inherited some of the money from her mother
four years ago. The basis is approximately $1.5 million. Interest was $20,696
and dividend distributions were $48,300. The dividends are reinvested but
not the interest.
Money market deposit account

$212,000 balance paying 0.2% interest

limited check writing privileges

annualized interest is $424, which is reinvested
Checking account

$63,530 is the non-interest bearing balance. Leslie admitted that she has been
intending on moving some of the money to either the money market or the
stock and bond portfolio but hasn’t gotten around to it for the last year.
156

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
201X Tax Information
FICA

$12,128. Leslie is subject to the additional Medicare tax.
Federal income taxes

$53,597
State income taxes

$15,554
Property taxes on residences

$16,240
Insurance Information
Life Insurance
Person insured
Leslie
Face amount
$50,000
Type of policy
Group term
Annual premium
Employer paid
Beneficiary
Church
Policy owner
Leslie
Module Review

157
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Health Insurance
Person(s) insured
Leslie
Type of policy
Comprehensive/ major medical
Coverages
80/20 coinsurance
$5,000 out-of-pocket maximum
Unlimited major medical
Deductible
$500 annual per individual; $1,000
annual per family
Annual premium
Employer paid
Disability Insurance
Person insured
Leslie
Monthly benefit
75% of salary
Elimination period
Benefits from 1st day for accident,
from 8th day for illness
Maximum benefit period
26 weeks
Annual premium
Employer paid
Michigan Residence Insurance
158

Type
HO-3
Dwelling
$400,000
Personal property
$200,000
Personal liability
$50,000 per occurrence
Medical payments to
others
$5,000 per person per occurrence
Deductible
$1,000
Annual premium
$2,020
Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Condominium Insurance
Type
HO-6
Personal property
$400,000
Personal liability
$50,000 per occurrence
Medical payments to
others
$5,000 per person per occurrence
Deductible
$1,000
Annual premium
$1,380
Automobile Insurance
Type
Personal auto policy (PAP)
Liability
$100,000/$300,000/$50,000 per
accident
Medical payments
$5,000 per person per accident
Uninsured motorists
$50,000 per accident
Physical damage, own
car
Actual cash value
Collision deductible
$500
Comprehensive
deductible
$500
Total annual premium
$2,840
Retirement/Estate Planning Information

vested benefits $622,050 through company-provided qualified pension plan

contributed $17,500 to 401(k) plan

no IRA established

will has been drawn; her church and a favorite charity are primary
beneficiaries
Module Review

159
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Additional Information

does not use credit cards

uses lake residence regularly; does not want to rent it out

no immediate plans to remarry

list of advisers has been supplied

no immediate changes to lifestyle are anticipated over next five years
Goals

wants to plan a trip around the world at retirement; estimated cost at $50,000

wants to continue donating to church aid program for children

wants to retire from company at age 55 and then do part-time consulting
Additional Annual Cash Expenditures
Food
$7,200
Transportation
$4,800
Utilities/household expenses
$3,800
Clothing/personal care
$10,200
Entertainment
$12,000
Medical/dental care
$5,700
Contributions to charity
$50,000
Household help
$14,230
Travel
$22,642
Miscellaneous
$7,501
18. What additional information must be gathered from Leslie James before a
comprehensive financial plan is developed?
Go to answer.
160

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
19. Complete a statement of financial position as of December 31, 201X, for
Leslie James.
Leslie James
Statement of Financial Position
As of December 31, 201X
ASSETS
Cash/Cash Equivalents
Checking account
Money market fund
Total Cash/Cash Equivalents
Invested Assets
Stock portfolio
Vested retirement
Total Invested Assets
Use Assets
Residence - condo
Cottage
Automobile
Furnishings
Personal property
Total Use Assets
TOTAL ASSETS
$
$
LIABILITIES AND NET WORTH
Liabilities
Auto note balance
$
Mortgage note balance
Total Liabilities
$
$
$
Net Worth
$
TOTAL LIABILITIES
AND NET WORTH
$
$
$
$
Go to answer.
Module Review

161
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
20. Construct a cash flow statement for the year ending December 31, 201X for
Leslie James.
Leslie James
Cash Flow Statement
For the Year Ending December 31, 201X
INFLOWS
Gross salaries
Dividend and interest income
TOTAL INFLOWS
OUTFLOWS
Savings and Investments
Fixed Outflows
Mortgage note payments
Auto note payments
Insurance premiums
Property taxes on residence
Condo association fees
FICA
Total Fixed Outflows
Variable Outflows
Taxes
Food
Transportation
Utilities/household expenses
Clothing/personal care
Entertainment
Medical/dental care
Contributions to church
Miscellaneous
Total Variable Outflows
TOTAL OUTFLOWS
$
$
$
$
$
$
Go to answer.
162

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
$
$
1–4
Recommend assets appropriate for use in an emergency fund.
21. Identify guidelines for and the purposes of the emergency fund.
Go to answer.
22. For each of the following client profiles, determine and justify the
appropriate emergency fund amount and the additional savings necessary to
build that fund.
a. John and Gloria Johnson
John and Gloria Johnson
Assets:
General information:

married seven years
Checking account
$22,600

John’s salary: $126,000
Savings account
$15,900

Gloria recently quit working to start
a family
Vested retirement benefits
$82,800
Life insurance cash value
$12,900
savings account interest amounts
to approximately $770 annually
Residence

Expenses in past year:
Automobiles
$36,200
Personal property

savings and investments
$18,600

fixed outflows
$43,268

variable outflows
$64,902
(taxes included of $26,771)
Recommended
emergency fund amount
and justification
$435,000
Current emergency fund
$158,000
Recommended additional
savings to build adequate
emergency fund
For 3
months’
expenses:
For 6
months’
expenses:
Go to answer.
Module Review

163
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
b. Mary Ebersol
Mary Ebersol
General information:
Assets:

divorced
Checking account
$4,000

Mary’s salary: $38,000
Money market account
$6,330

annual alimony: $12,000
(continues for 5 more years)
Income stock
$8,760
Individual retirement account

interest income: $450
Automobile

dividend income: $850
Personal property
$15,790
$8,200
$9,400
Expenses in past year:

savings and investments: $6,250

fixed expenses: $7,050

variable expenses: $21,000
Recommended emergency
fund amount and
justification
Current emergency
fund
Recommended additional
savings to build adequate
emergency fund
For 3
months’
expenses:
Go to answer.
164

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
For 6 months’
expenses:
c. Larry and Georgia Largent
Larry and Georgia Largent
General information:
Assets:

married
Checking account
$14,200

Larry’s salary/commissions: $75,000
Money market account
$16,000

Georgia’s salary: $86,000
Mutual fund

interest income: $1,280
Vested pension benefits

dividend income: $220
Residence
Expenses in past year:

savings and investments: $11,600

fixed expenses: $60,360

variable expenses: $51,540

taxes (not included in variable
expenses): $39,000
Recommended emergency
fund amount and
justification
$9,500
$51,000
$310,000
Automobiles
$17,200
Personal property
$73,000
Current emergency
fund
Recommended
additional savings to
build adequate
emergency fund
For 3
months’
expenses:
For 6
months’
expenses:
Go to answer.
Module Review

165
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Use the financial statements below from the clients introduced earlier to
answer questions 23 and 29.
William and Nancy Webb Statement of Financial Position
As of December 31, 201X
ASSETS 1
Cash/Cash Equivalents
Checking account
$
Savings account
Money market fund 2
Life insurance cash value
Total Cash/Cash Equivalents
$
5,650
5,000
4,250
1,430
16,330
LIABILITIES AND NET WORTH
Liabilities 4
Credit card 5
$
400
Auto note balance
Total Liabilities $
7,000
7,400
Invested Assets
Blue-chip income stock portfolio
$
Land
William's 401(k)
Nancy's 401(k)
IRA 3
Total Invested Assets
$
80,000
15,000
13,300
4,536
10,500
123,336
Use Assets
Automobile 1
Automobile 2
Net Worth
$
$
$
6,900
13,900
15,000
35,800
$
175,466
Personal property
Total Use Assets
168,066
TOTAL LIABILITIES
TOTAL ASSETS
1
Presented at fair market value
Check writing privilege
3
Balanced mutual fund
4
Principal only
5
Paid each month
2
166

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
AND NET WORTH
$ 175,466
William and Nancy Webb Cash Flow Statement
For the Year Ending December 31, 201X
INFLOWS
Gross salaries1
Dividends income
Interest income
TOTAL INFLOWS
OUTFLOWS
Savings and Investments2
Fixed Outflows
Rent Payments
Auto note payments
Insurance premiums
Property taxes
FICA
Total Fixed Outflows
Variable Outflows
Taxes
Food
Transportation
Clothing/personal care
Entertainment/vacations
Medical/dental care
Charitable contributions
Utilities
Child care costs
Miscellaneous
Total Variable Outflows
TOTAL OUTFLOWS
1
$
$
$
94,000
3,285
100
$
13,455
$
29,155
$
54,775
$
97,385
$
97,385
15,600
3,120
3,070
174
7,191
13,129
7,200
7,180
6,415
3,500
3,960
1,000
1,440
7,200
3,751
William $52,000; Nancy $42,000
2
IRA $4,000, money market mutual fund $2,000, savings account $1,250, money
market fund dividend $85, 401(k) contributions of $4,860 and $1,260
Module Review

167
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
23. Assume the Webbs want to build an emergency fund.
a. How much should the Webbs have in their emergency fund? Justify that
amount.
Go to answer.
b. Which of the Webbs’ “cash/cash equivalents” should be included in the
fund?
Go to answer.
1–5
Analyze a client’s financial situation to identify issues related to
budgeting.
24. How might the stability of income and number of sources of income affect a
client’s overall financial condition?
Go to answer.
25. What symptoms frequently are present if clients are not living within their
means?
Go to answer.
26. What is the current ratio, and how is it used?
Go to answer.
27. What is the acid test ratio, and how is it used?
Go to answer.
28. Using the Webbs’ financial statements (presented previously, in question 23),
identify their general financial strengths and weaknesses.
Go to answer.
168

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Use the information below to answer question 29.
Leslie James Statement of Financial Position
As of December 31, 201X
ASSETS
Cash/Cash Equivalents
Checking account
Money market fund
Total Cash/Cash Equivalents
Invested Assets
Stock portfolio
Vested pension benefits
Total Invested Assets
Use Assets
Residence - condo
Cottage
Automobile
Furnishings
Personal property
Total Use Assets
TOTAL ASSETS
$
$
$
63,530
212,000
275,530
LIABILITIES AND NET WORTH
Liabilities
Auto note balance
$
33,400
Mortgage note balance
584,473
Total Liabilities
$
617,873
2,112,000
622,050
2,734,050
$
4,659,727
TOTAL LIABILITIES
AND NET WORTH $
5,277,600
Net Worth
$
$
1,092,000
482,000
42,020
534,000
118,000
2,268,020
$
5,277,600
Module Review

169
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Leslie James Cash Flow Statement
For the Year Ending December 31, 201X
INFLOWS
Gross salaries
$
Dividend and interest income
334,000
69,420
TOTAL INFLOWS
$
403,420
$
403,420
OUTFLOWS
Savings and Investments
401(k) contributions
$
Reinvested dividends & interest
17,500
48,724
$
66,224
$
129,972
$
207,224
Fixed Outflows
Mortgage note payments
$
Auto note payments
71,004
8,160
Insurance premiums
6,240
Property taxes on residence
16,240
Condo association fees
16,200
FICA
12,128
Total Fixed Outflows
Variable Outflows
Taxes
$
69,151
Food
7,200
Transportation
4,800
Utilities/household expenses
3,800
Clothing/personal care
10,200
Entertainment
12,000
Medical/dental care
5,700
Contributions to charities
50,000
Household help
14,230
Travel
22,642
Miscellaneous
7,501
Total Variable Outflows
TOTAL OUTFLOWS
170

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
29. Using the financial statements constructed for Leslie James, identify general
strengths and weaknesses in her financial situation.
Go to answer.
30. What are some uses for budgeting?
Go to answer.
31. What are the advantages and disadvantages of budgeting?
Go to answer.
32. Identify the guidelines for implementing a budget.
Go to answer.
33. What are the steps in constructing an income/expenditure budget?
Go to answer.
34. Describe the rules of thumb (listed below) that may be used to assess whether
debt is excessive.
a. housing costs
Go to answer.
b. total monthly payments
Go to answer.
c. consumer debt
Go to answer.
35. Use the rules of thumb from the previous question to determine if the clients
introduced earlier are using excessive amounts of debt.
a. John and Gloria Johnson have a mortgage on their home with a current
balance of $395,975. Monthly payments, including principal and interest,
are $2,261. Annual property taxes and insurance total $7,704. In
addition, they have two auto notes with current balances totaling $26,536
Module Review

171
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
and monthly payments of $789. They currently have a total balance of
$1,200 on credit cards, but they pay balances off each month. The
Johnsons’ net income for the past year was $82,789. Their gross income
was $126,770.
Go to answer.
b. Mary Ebersol has a credit card balance of $5,760, on which she regularly
pays $450 each month. The annual interest charged on the credit cards is
18%. In addition, she is repaying a loan from a car. The current balance
is $3,234, and her monthly payment is $254. The annual interest rate is
9%. Mary’s net income for the past year was $40,335. Her gross income
was $51,300.
Go to answer.
c. Larry and Georgia Largent have a mortgage balance of $153,916 on their
home, with monthly payments, including principal and interest, of
$1,312. Annual property taxes and insurance on their home total $4,100.
In addition, they have a loan on a boat that has a current balance of
$17,391; monthly payments are $411. They do not use credit cards. The
Largents’ net income for the past year was $109,400. Their gross income
was $162,500.
Go to answer.
1–6
Explain different forms of debt and their uses.
36. How does debt affect a client’s financial situation?
Go to answer.
37. Define the following terms relating to debt.
a. consumer debt
Go to answer.
b. secured debt
Go to answer.
172

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
c. unsecured debt
Go to answer.
d. grace period (credit card)
Go to answer.
e. points
Go to answer.
38. What are the potential costs and benefits of consumer debt and home
mortgages?
Go to answer.
39. What are some tax implications of home mortgages?
Go to answer.
40. Describe the following types of mortgages.
a. fixed rate mortgage
Go to answer.
b. biweekly mortgage
Go to answer.
c. adjustable rate mortgage
Go to answer.
d. interest-only mortgage
Go to answer.
e. balloon mortgage
Go to answer.
f.
graduated payment mortgage
Go to answer.
g. conventional mortgage
Go to answer.
Module Review

173
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
h. VA mortgage
Go to answer.
i.
FHA mortgage
Go to answer.
j.
reverse mortgage
Go to answer.
41. What are the potential costs and benefits of refinancing a mortgage?
Go to answer.
42. Home equity is one potential source of funding for financial goals. What are
the different types of accounts that can access home equity?
Go to answer.
1–7
Explain the issues involved in the lease versus buy decision.
43. The decision whether to buy or lease a home may be important to the
budgeting process. What factors must the client consider when making this
decision?
Go to answer.
44. Explain open-end and closed-end leases.
Go to answer.
1–8
Identify sources and strategies for funding a college education.
45. There are a number of ways of planning for children’s education. What are
some characteristics of each of the following?
a. direct transfer of funds
Go to answer.
b. custodianship
Go to answer.
174

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
c. minor’s trust
Go to answer.
d. current income trust
Go to answer.
e. Crummey invasion trust
Go to answer.
f.
scholarships
Go to answer.
g. 529 plans
Go to answer.
h. Coverdell Education Savings Accounts
Go to answer.
46. How might a parent’s qualified retirement plan be used to fund a child’s
college education?
Go to answer.
47. How does the “kiddie tax” affect the funding of investment vehicles for a
child’s education?
Go to answer.
48. Describe characteristics of each of the following grants that may be available
for funding education.
a. Pell grants
Go to answer.
b. Supplemental Educational Opportunity Grants
Go to answer
c. TEACH Grant
Go to answer
Module Review

175
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
49. Describe characteristics of each of the following types of loans that may be
available for funding education.
a. Perkins
Go to answer.
b. Stafford loans
Go to answer.
c. PLUS loans
Go to answer.
50. Describe college work study programs.
Go to answer.
1–9
Explain issues related to special planning needs.
51. What are key issues that arise when a client seeks financial planning due to a
divorce?
Go to answer.
52. What are key issues that arise when planning for a permanently disabled
child or adult?
Go to answer.
176

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Answers
1–1
Explain the what and why of the steps in the financial planning
process.
1. Explain personal financial planning.
Personal financial planning is a process in which coordinated,
comprehensive strategies are developed and implemented for the
achievement of an individual’s or a family’s financial goals.
Return to question.
2. Identify the functions of the six steps in the financial planning process.
Step 1: Establishing and defining the client-planner relationship

Explain issues and concepts related to the financial planning
process. Explain services provided and documentation required.
Clarify client’s and planner’s responsibilities. Provide adequate
and appropriate disclosure. Complete a signed scope of
engagement.
Step 2: Gathering client data including goals

Obtain information through use of interview/questionnaire. Help
client identify and determine goals, needs, and priorities. Assess
client’s values, attitudes, and expectations. Determine client’s time
horizons and risk tolerance level. Collect all applicable records
and documents. Develop financial statements.
Step 3: Analyzing and evaluating the client’s financial status

Analyze and evaluate the client’s current general financial status,
emergency reserves, risk/insurance gaps, retirement planning,
Module Review

177
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
education and goal achievement, investments, taxation,
appropriate employee benefits use, estate planning, and how the
efficiency of the client’s plan can be improved.
Step 4: Developing and presenting financial planning
recommendations and/or alternatives

Prepare and present a financial plan tailored to the client—one
that covers the agreed upon scope of engagement. A
comprehensive plan includes an analysis of the client’s cash flow,
life, disability and long-term care contingency plans, property and
liability risk, goal achievement, income tax efficiency, employee
benefits use, investments, and legal and estate planning
documents. List the priority of each area of planning interest. Work
with the client to ensure that the plan meets the identified goals
and objectives; modify as necessary.
Step 5: Implementing the financial planning recommendations

Assist client with implementation of plan. Coordinate with other
professionals as necessary.
Step 6: Monitoring the financial planning recommendations

178

Regularly monitor and evaluate the progress of the plan and
changes based on client life circumstances. Review changes in
laws that affect the plan. Update client information regularly and
recommend changes to the plan as required.
Return to question.
Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
1-2
Explain the rationale for gathering specific financial information.
3. How do the goals of the client affect the nature of information gathered in the
data gathering process?
The quantity and type of information gathered is directed by the goals
of the client. If the client wishes to have a comprehensive plan
developed, the information gathered is extensive, covering all of the
areas discussed in this module. On the other hand, some clients want
specific advice relating to one or only a few areas of financial planning,
such as investment advice, education planning advice, insurance
analysis, etc. For more narrowly defined goals, the quantity of
information collected is smaller, relating only to the area(s) in question.
Return to question.
4. What specific information is gathered concerning each topic below, and how
is it used in the planning process?
a. retirement
Ideal age, income, inflation assumptions, variations in income,
medical expenses during retirement, life expectancy, tax
assumptions, and client’s own words describing lifestyle goals. These
will be used to compare with client resources to determine what
additional resources may be needed to achieve his or her goals.
Return to question.
b. education or other accumulation goals
Target dates, amounts or ranges, expectations about contribution
ability, priority of goals, and current and anticipated allocations,
which enable the planner to project progress effectively.
Return to question.
Module Review

179
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
c. emergency reserve goals
Establish the amount and resources for funding the goal and
reasons for emergency funds.
Return to question.
d. debt management goals and concerns
Use of debt, strategies for managing and retiring debt, defining
appropriate amount of life and disability insurance, and establish
strategy for freeing up resources from debt to goal
accomplishment.
Return to question.
e. investment management concerns
Risk tolerance, loss tolerance, sophistication level, past behaviors,
expectations of investments and investment advisory process, and
earmarking of investments for specific goals so that an
appropriate portfolio can be established.
Return to question.
f.
health insurance concerns
Current and future health concerns that may impact retirement
projections, life insurance, disability, emergency reserves, medical
accumulation plans, long-term care, and cash flow.
Return to question.
g. disability contingency planning
Assessing how clearly the client sees the need for disability
contingency plans, current group coverage, potential family
support, and personal coverage will provide the facts. The
analysis will impact disability planning, life insurance rider options,
emergency reserves, and cash flow.
Return to question.
180

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
h. loss of life contingency planning
Projection by clients of what would happen upon death of spouse
under the current scenario along with establishing desired goal.
Clients will need to determine which of their other goals, including
education, they wish to plan to fund in spite of a spouse’s death.
This will impact life insurance analysis, cash flow, and emergency
reserves.
Return to question.
i.
long-term care needs contingency planning
Expectations of the future and how long care may be needed
should be gathered in this phase. Costs of care and whether selffunding or products may be needed should be explored. This
could impact long-term care planning and retirement planning.
Return to question.
j.
property and liability concerns
Habits, lifestyle, volunteer activities, pets, and possessions should
be explored to identify potential liability concerns. Discussions of
property and expectations of recovery should also be gathered.
Impact will be on risk management and cash flow areas.
Return to question.
k. legal documents and estate planning distribution plan
Discussion of wishes of client regarding providing for dependents
and others, who would handle power of attorney in case of
incapacity, medical power of attorney, and roles they may be
expected to play occur in this section. Request of all legal
documents including divorce decrees, business contracts with
personal signatures, wills, trusts, etc. are discussed at this time.
This will impact life insurance, disability, retirement, and estate
planning analysis.
Return to question.
Module Review

181
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
l.
anticipated changes in lifestyle, family, health or other concern
This topic provides opportunity for clients to raise issues that you
or the client have not raised. Discussing a savings target for
solving goals and budgeting occur here.
Return to question.
5. When you collect the following documents, what are you looking to learn
and give an example of how it could impact the financial plan?
a. last two pay stubs
What you will learn: income, employee benefit deductions,
withholdings, qualified plan contributions, 401(k) loans.
Potential impacts: Income variation could help you determine
factors impacting emergency reserves; which benefits the client is
receiving could impact risk analysis and offer options for planning.
Return to question.
b. three years’ tax returns including supporting documents such as W2s
What you will learn: Variations in income, interest, dividends and
capital gains trends, dependent status, current itemized
deductions, charitable activities, business relationships, AMT
carry-forward, phased out strategies, contributions to IRAs,
education savings programs, rental income, business success,
etc. are all items that can be discovered through tax returns.
Potential impacts: Income tax projections, tax rate assumptions for
now and future years, which can impact retirement, life insurance
analysis, disability analysis, emergency fund target, and cash flow
in addition to offering opportunities for tax strategies that can free
up resources for achieving goals.
Return to question.
182

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
c. cash flow statements
What you will learn: intentional savings plans, debt reduction
costs, where the client’s money goes.
Potential impacts: how much flexibility you have in redirecting
funds to achieve their goals.
Return to question.
d. benefit package descriptions
What you will learn: potential risk management strategies such as
life insurance, disability and long-term care offerings, qualified
plan limits, pension plan descriptions, vesting schedules, open
enrollment periods. When combined with a pay stub, you can see
what the client is actually participating in.
Potential impacts: disability and retirement projections and
analysis; cash flow impact from out of pocket medical costs, flex
plan opportunities, credit strategies (if 401(k) loans allowed).
Return to question.
e. copies of personal insurance policies and latest statements
What you will learn: actual versus client understanding of what is
covered through the face pages of coverage. Face pages will tell you
type, constraints, owners, coverage, and premiums. Conversation
will uncover potential risks and appropriateness of policies.
Potential impacts: gaps in risk management, appropriateness or
inappropriateness of products solving risk gaps, cash flow, and all
risk management analysis.
Return to question.
Module Review

183
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
f.
investments and bank statements including retirement accounts
What you will learn: ownership, value, basis, dates of acquisition,
tax implications, and appropriate returns to use in projecting
retirement, education, and goals
Potential impacts: Ownership impacts estate and divorce
planning. Rates used for projecting retirement, life insurance
analysis, and disability analysis in the financial plan will have
significant impact.
Return to question.
g. Social Security statements
What you will learn: projected benefit for client and family at
retirement, benefit in case of client’s death or disability, earnings
history, accurate PIA to use in projections, and potential claiming
strategy options.
Potential impacts: This will impact retirement, life, and disability
analyses.
Return to question.
h. liability contracts/debt statements including family loans
What you will learn: debt obligations including ownership, actual
terms, interest rates, balances, terms, prepayment penalties,
family loans secured and unsecured, business loans, unused
credit, such as in home equity lines, etc.
Potential impacts: amount of funds needed to support debt
service, opportunities to restructure debt to free up cash, tax
consequences of current and anticipated debt structure.
Return to question.
184

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
i.
copies of wills, durable powers of attorney, trusts, pre-nuptial
agreements, divorce decrees, business entity formation, gift tax returns,
and other legal documents
What you will learn: what actions the client has taken and dates of
legal documents, important people and the roles they will play in
estate and contingency planning, how property will be disbursed,
and potential problems with current estate plan and legal
documents.
Potential impacts: Contingency planning and estate planning can
be impacted. Legal requirements can impact estate planning, life
insurance requirements, and disability analysis.
Return to question.
1–3
Construct and interpret personal financial statements.
6. What is the significance of including the words “As of December 31, 201X”
in the heading of the statement of financial position?
They indicate that the statement is a profile of the client’s assets,
liabilities, and net worth on a specific date.
Return to question.
7. Describe briefly each of the three major components of the statement of
financial position.
a. assets: what the client owns
b. liabilities: what the client owes
c. net worth: residual value after subtracting liabilities from assets
Return to question.
Module Review

185
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
8. Using a simple formula(s), describe the relationship that exists among the
three major components of the statement of financial position.
Assets – Liabilities = Net worth
Assets = Liabilities + Net worth
Return to question.
9. Identify items that typically are placed under each of the asset categories on
the statement of financial position. (For some clients, certain assets will be
more appropriately placed in different categories.)
a. cash/cash equivalents
Cash, checking account, savings account, money market fund,
cash surrender value of life insurance (some clients will prefer to
consider this an invested asset, especially if a variable life
insurance policy is to be used; others may want it in its own
category), certificates of deposit (if close to maturity or if penalty
for early withdrawal is low), etc.
Return to question.
b. invested assets
Stocks, bonds, collectibles for investment purposes, real estate other
than residence or other property for personal use, IRAs, vested
pension benefits, mutual funds, notes carried from others, business,
certificates of deposit, etc. Life insurance cash value may be included
here (see above).
Return to question.
c. use assets
Residence, automobiles, boats, campers, personal property,
antiques, jewelry, collectibles for personal enjoyment, etc.
Return to question.
186

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
10. At what value are assets usually shown on the statement of financial
position?
Assets are usually shown at current fair market value.
Return to question.
11. What is the significance of including the words “For the Year Ending
December 31, 201X” in the heading of the cash flow statement?
It indicates that the statement summarizes client’s cash inflows and
outflows over the past year (or other specified period of time).
Return to question.
12. Identify items that typically are placed under each of the following categories
on the cash flow statement. Do not include savings and investments.
a. inflows
Gross salaries, interest income, dividend income, withdrawals from
savings, liquidation of investments, funds received as a result of
borrowing, trust income, alimony received, insurance proceeds received,
etc.
Return to question.
b. fixed outflows
(Predictable, recurring outflows) mortgage note payments, insurance
premiums, car loan payments, etc. (some income taxes may be put here)
Return to question.
c. variable outflows
Food, transportation, entertainment, household expenses,
clothing, etc. (some income taxes may be put here)
Return to question.
Module Review

187
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
13. Under what circumstances would the category “Savings and Investments”
appear as an inflow on the cash flow statement?
Whenever funds are withdrawn from savings or when assets are
liquidated. On some statements you will see dividends and interest
claimed as an inflow and then represented as an outflow if they are
reinvested. Clients do not always reinvest, so it is important to
examine this as it is impacting the growth rate of the portfolio for the
future. Most financial planning software assumes all earnings are
reinvested.
Return to question.
14. What is the purpose of footnotes to personal financial statements?


To clarify items listed in the statement
To list values or circumstances not disclosed in body of statement
Return to question.
The answers to questions 15-17 are based on the client profile that follows
question 15 in the Questions section.
15. What additional information must be gathered from the Webbs before a
comprehensive financial plan can be developed?
188



list of advisers


copies of insurance policies

details about open enrollment and optional employee benefit
programs, such as long-term disability, that they may not be
utilizing

client’s wishes with regard to budgeting

date all property was acquired; cost or basis
details of any indebtedness not mentioned in fact pattern, such as
401(k) loans
copies of employee benefits booklets including profit sharing or
other pension plans
Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.

copies of wills, medical power of attorney, durable power of
attorney, living wills, and any other legal documents

additional information about goals (dollar amounts required,
priorities of goals, etc.)


What retirement plans do the Webbs envision at this juncture?

Are the expenses presented typical? Are any changes anticipated
in the near future?

additional details regarding investments, including specifics on
shares, lots, basis, risk tolerance, any earmarking of funds for
specific purposes, etc.

Is there a possibility of increased income in the future? Any
promotions or job changes expected? Any anticipated
inheritances?


willingness to reposition current assets

desired guardian for Matthew in the event that both parents die
(The list could be quite long and encompass many more items.
The point is that you evaluate what you DON’T know in addition to
what you do know.)
Return to question.
What are their expectations of college costs and funding they wish
to explore for their son? Is it possible that William’s parents might
contribute to college funding?
What are the client’s wishes with regard to financial care of
dependents in the event of premature death (i.e., what income
reserve is needed for dependent care)?
Module Review

189
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
16. Construct a statement of financial position for the Webbs as of December 31,
201X.
William and Nancy Webb Statement of Financial Position
As of December 31, 201X
ASSETS 1
LIABILITIES AND NET WORTH
Liabilities 4
Cash/Cash Equivalents
Credit card 5
$
5,650
$
400
Checking account
Savings account
Money market fund 2
Life insurance cash value
Total Cash/Cash Equivalents
$
5,000
4,250
1,430
16,330
Auto note balance
Total Liabilities $
7,000
7,400
Invested Assets
Blue-chip income stock portfolio
$
Land
William's 401(k)
Nancy's 401(k)
IRA 3
Total Invested Assets
$
80,000
15,000
13,300
4,536
10,500
123,336
Use Assets
Automobile 1
Automobile 2
Net Worth
$
$
Personal property
Total Use Assets
$
168,066
6,900
13,900
15,000
35,800
TOTAL LIABILITIES
TOTAL ASSETS
$
175,466
1
Presented at fair market value
Check writing privilege
3
Balanced mutual fund
4
Principal only
5
Paid each month
2
Return to question.
190

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
AND NET WORTH
$ 175,466
17. Construct a cash flow statement for the year ending December 31, 201X, for
the Webbs
William and Nancy Webb Cash Flow Statement
for the Year Ending December 31, 201X
INFLOWS
Gross salaries1
Dividends income
Interest income
TOTAL INFLOWS
OUTFLOWS
Savings and Investments2
Fixed Outflows
Rent Payments
Auto note payments
Insurance premiums
Property taxes
FICA
Total Fixed Outflows
Variable Outflows
Taxes
Food
Transportation
Clothing/personal care
Entertainment/vacations
Medical/dental care
Charitable contributions
Utilities
Child care costs
Miscellaneous
Total Variable Outflows
TOTAL OUTFLOWS
1
$
$
$
94,000
3,285
100
$
13,455
$
29,155
$
54,775
$
97,385
$
97,385
15,600
3,120
3,070
174
7,191
13,129
7,200
7,180
6,415
3,500
3,960
1,000
1,440
7,200
3,751
William $52,000; Nancy $42,000
2
IRA $4,000, money market mutual fund $2,000, savings account $1,250, money
market fund dividend $85, 401(k) contributions of $4,860 and $1,260
Return to question.
Module Review

191
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
The answers to questions 18-20 are based on the client profile that follows
question 18 in the Questions section.
18. What additional information must be gathered from Leslie James before a
comprehensive financial plan can be developed?
192

additional information on investments: what specific stocks and
bonds are held, date of purchase and initial cost, breakdown of
current value, etc.

copies of tax returns

copies of insurance policies; no umbrella policy was mentioned;
no coverage on boats was included

employee benefits booklet; information was provided about shortterm disability but not long-term disability: Are there executive
compensation options that are not available to general
employees?

details of company pension plan

priority of goals; additional information on goals, particularly
church donations and retirement goals: Where does she plan on
living (where she decides to domicile will have impact on taxes,
retirement projections and estate planning)? Does she intend to
keep the Chicago downtown condo when she retires?

Are expenses typical? Any anticipated variations in the future? Is
there a reason for the auto loan versus paying for car in cash?

Any potential for increased income? (promotions, inheritances,
etc.)

willingness to reposition current assets (including use of home
equity) to pursue goals

risk tolerance level

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.

Leslie’s health status

breakdown of personal property between condominium and home
to evaluate insurance coverage

estate transfer wishes (to evaluate current will and ensure that
transfer established is in line with wishes)
Return to question.
19. Complete a statement of financial position as of December 31, 201X for
Leslie James.
Leslie James Statement of Financial Position
As of December 31, 201X
ASSETS
LIABILITIES AND NET WORTH
Cash/Cash Equivalents
Liabilities
Checking account
$
63,530 Auto note balance
$
33,400
Money market fund
212,000 Mortgage note balance
584,473
Total Cash/Cash Equivalents
$
275,530
Total Liabilities
$
617,873
Invested Assets
Stock portfolio
$ 2,112,000
Vested retirement
622,050
Total Invested Assets
2,734,050
$ 4,659,727
Use Assets
Net Worth
Residence - condo
$ 1,092,000
Cottage
482,000
Automobile
42,020
Furnishings
534,000
Personal property
118,000
Total Use Assets
$ 2,268,020
TOTAL ASSETS
1
2
3
$
5,277,600
TOTAL LIABILITIES
AND NET WORTH $
5,277,600
Presented at fair market value
Limited check writing privileges
Balance outstanding
Return to question.
Module Review

193
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
20. Construct a cash flow statement for the year ending December 31, 201X for
Leslie James.
Leslie James Cash Flow Statement
for the Year Ending December 31, 201X
INFLOWS
Gross salaries
$
Dividend and interest income
334,000
69,420
TOTAL INFLOWS
$
403,420
$
403,420
OUTFLOWS
Savings and Investments
401(k) contributions
$
Reinvested dividends & interest
17,500
48,724
$
66,224
$
129,972
$
207,224
Fixed Outflows
Mortgage note payments
$
71,004
Auto note payments
8,160
Insurance premiums
6,240
Property taxes on residence
16,240
Condo association fees
16,200
FICA
12,128
Total Fixed Outflows
Variable Outflows
Taxes
$
69,151
Food
7,200
Transportation
4,800
Utilities/household expenses
3,800
Clothing/personal care
10,200
Entertainment
12,000
Medical/dental care
5,700
Contributions to charities
50,000
Household help
14,230
Travel
22,642
Miscellaneous
7,501
Total Variable Outflows
TOTAL OUTFLOWS
Return to question.
194

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
1–4
Recommend assets appropriate for use in an emergency fund.
21. Identify guidelines for and the purposes of the emergency fund.
Emergency Funds
Suitable types of
funds
Purpose
To ensure:
To avoid:
That easily
accessible funds are
available for
financial
emergencies.
Cash/cash
equivalents

checking
accounts
(excluding
funds for
current
expenses)

savings
accounts

money market
mutual funds

money market
deposit
accounts
General guideline
Three to six months’
fixed and variable
expenses (excluding
income-related
taxes as well as
savings and
investments)
Having to liquidate
investments and
assets (nonliquid) or
borrow funds for
financial
emergencies.
Return to question.
22. For each of the following client profiles, determine and justify the
appropriate emergency fund amount and the additional savings necessary to
build that fund.
Module Review

195
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
a. John and Gloria Johnson
John and Gloria Johnson
General information:
Assets:

married seven years
Checking account
$22,600

John’s salary: $126,000
Savings account
$15,900

Gloria recently quit working to start Vested retirement benefits
$82,800
a family
Life insurance cash value
$12,900

Savings account interest amounts
Residence
$435,000
to approximately $770 annually
Automobiles
$36,200
Expenses in past year:
$158,000

savings and investments: $18,600 Personal property

fixed outflows: $43,268

variable outflows: $64,902 (taxes
included of $26,771)
Recommended
emergency fund
Recommended additional
amount and
savings to build adequate
justification
emergency fund
Current emergency fund
$20,350-$40,700
This amounts to
three to six months’
fixed and variable
expenses after
subtracting their
taxes and savings
and investments. In
the Johnsons’ case, it
may be wise to lean
toward the higher
amount since they
have only one major
source of income and
are planning on
having a child.
Savings account $15,900
Checking account: The
information provided
indicates that the balance
exceeds the amount
needed to meet upcoming
monthly expenses ($6,783)
by $15,817. Their current
emergency reserve is
$31,717.
Life insurance cash value:
These funds might be
appropriately used for a
temporary cash
emergency. However, for
loss of income due to
disability or job loss, using
these funds may just make
the situation worse.
For 3
months’
expenses:
For 6
months’
expenses:
$20,350
$40,700
– 31,717
- 31,717
Adequately
covered
$8,983
shortfall
$64,902 - $26,771 in taxes = $38,131, $38,131 + $43,268 =
$81,339/12 = $6,783.25 in monthly expenses, $20,350 for 3 months
and $40,700 for 6 months
196

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Return to question.
b. Mary Ebersol
Mary Ebersol
General information:
Assets:

divorced
Checking account

Mary’s salary: $38,000
Money market account

annual alimony: $12,000
(continues for 5 more years)
Income stock

interest income: $450
Individual retirement account

dividend income: $850
Automobile
Expenses in past year:

savings and investments: $6,250
Personal property

fixed expenses: $7,050

variable expenses: $21,000
Recommended
emergency fund amount
and justification
$7,013–$14,025
(Note: We do not
know how much to
allocate to taxes.)
These amounts cover
three to six months’
fixed and variable
expenses. In Mary’s
case, the midpoint of
the recommended
emergency fund range
may be appropriate
(approximately
$10,500). Although she
is the sole family wage
earner, she receives
substantial income from
two sources, and
smaller amounts of
income from two
investment sources.
Current emergency fund
Money market fund
$4,000
$6,330
$8,760
$15,790
$8,200
$9,400
Recommended
additional savings to
build adequate
emergency fund
For 3
$6,330 months’
expenses:
Checking account $1,662
(excess over expenses)
Adequately
Total available
$7,992
covered
(While there may be a
requirement to maintain up
to $1,000 in the checking
account to keep it free of
fees, the small monthly fee
for not maintaining the
balance makes the
checking account a
reasonable source of
emergency funds.)
For 6
months’
expenses:
$14,025
– 7,992
$6,033
shortfall
$7,050 + $21,000 = $28,050/12 = $2,337.50 in monthly expenses.
$7,012.50 for 3 months and $14,025 for 6 months.
Return to question.
Module Review

197
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
c. Larry and Georgia Largent
Larry and Georgia Largent
General information:

married

Larry’s salary/commissions: $75,000

Georgia’s salary: $86,000

interest income: $1,280

dividend income: $220
Expenses in past year:

savings and investments: $11,600

fixed expenses: $60,360

variable expenses: $51,540

taxes (not included in variable
expenses): $39,000
Recommended emergency
fund amount and
justification
$27,975–$55,950
These amounts cover three
to six months’ expenses.
The Largents have two
major sources of income, in
addition to two lesser
sources, making them more
financially stable than the
clients described in
previous examples. Given
their income situation, in
practice, an amount equal
to three or four months’
expenses might be
appropriate. However, one
source of income (Larry’s
commissions) is subject to
variability.
Assets:
Checking account
Money market account
Mutual fund
Vested pension benefits
Residence
Automobiles
Personal property
Current emergency
fund
Money market
account: $16,000
Excess checking
account: $4,875
Total: $20,875
$14,200
$16,000
$9,500
$51,000
$310,000
$17,200
$73,000
Recommended
additional savings to
build adequate
emergency fund
For 3
months’
expenses:
For 6
months’
expenses:
$27,975
$55,950
– 20,875
– 20,875
$7,100
shortfall
$35,075
shortfall
$60,360 + $51,540 = $111,900/12 = $9,325 in monthly expenses.
$27,975 for 3 months and $55,950 for 6 months.
Return to question.
198

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Use the Webbs’ financial statements (presented previously, in the answers to
questions 16 and 17 in the Answers section) to answer questions 23 and 28
below.
23. Assume the Webbs’ want to build an emergency fund.
a. How much should the Webbs’ have in their emergency fund?
$15,903, which is 3 months.
Justify that amount.
Three months of fixed and variable expenses (excluding income
taxes and FICA) should be included, considering that the Webbs
have two sizable sources of income and general financial stability.
($54,775 + $29,155) – ($7,191 + $13,129) = $63,610/12 = $5,301
for one month of expenses, $15,903 for three months
Return to question.
b. Which of the Webbs’ “cash/cash equivalents” should be included in the
fund?
Excess checking
Savings account
$349 ($5,650 - $5,301)
$5,000
Money market fund $4,250
$9,599
Since the cash value of the life insurance is such a minor part of
the available assets, including or excluding it is not much of an
issue. Generally, it should be used only as a last resort, after all
other resources have been tapped.
Return to question.
Module Review

199
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
1–5
Analyze a client’s financial situation to identify issues related to
budgeting.
24. How might the stability of income and number of sources of income affect a
client’s overall financial condition?
The greater the stability of income and the greater the number of
sources of income, the stronger the client is financially. Although
having only a few sources of income cannot necessarily be construed
as a weakness, having many sources of income creates greater
financial stability. The amount needed for emergency fund planning
reflects the stability of the client’s income sources. The more diverse
the income, the more flexibility there is in budgeting.
Return to question.
25. What symptoms frequently are present if clients are not living within their
means?

heavy consumer debt and/or borrowing to make ends meet

withdrawals from savings to meet regular living expenses

high miscellaneous expenditures

inability to save
Return to question.
26. What is the current ratio, and how is it used?
Current assets (cash/cash equivalents, receivables, and inventory)
Current liabilities
The current ratio measures a firm’s ability to satisfy current liabilities
with current assets.
Return to question.
200

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
27. What is the acid test ratio, and how is it used?
Cash / cash equivalents, receivables
Current liabilities
The acid test ratio measures a firm’s ability to satisfy current liabilities
with its most liquid assets (i.e., without liquidating inventory).
Return to question.
28. Using the Webbs’ financial statements (presented previously, in Questions
16 and 17), identify their general financial strengths and weaknesses.
Strengths

consumer debt payments are well below the 20% of net income
benchmark; no long-term debt

the client saved over 13.8% of gross income in past year
($13,455/$97,385)

clients appear to be living within their means; debts are low, funds
have not been borrowed in the past year to meet living expenses,
expenses appear reasonable in light of income

clients have $80,000 in an after tax portfolio in addition to qualified
plans
Weaknesses

clients do not have adequate emergency reserves; they should
increase reserves by at least $6,304 ($15,903 - $9,599)

they both work for the same company, which is riskier than
working for different companies
Module Review

201
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.

clients could be saving more and reducing taxes by contributing
more to their 401(k) plans

no renter’s insurance; if they have personal property of any value,
a fire or theft would mean they would have to absorb a loss
because they have no coverage

no long-term disability benefits for either of them

no life insurance on Nancy

inadequate life insurance on William

need legal documents beyond wills, such as medical power of
attorney, financial power of attorney, etc.
Return to question.
29. Using Leslie James’s financial statements (presented previously, in the
answers to questions 20 and 21 in the Answers section), identify her general
financial strengths and weaknesses.
Strengths

Consumer debt appears reasonable.

She has accumulated significant assets both through inheritance
and her diligence in saving.

She has more than 6 months of emergency reserves with the
$212,000 in the money market.
Weaknesses

202

Excess funds in her checking account are an indication that she
may not pay much attention to financial issues.
Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.

No long-term disability policy mentioned.

No umbrella coverage, boat coverage, or endorsements
mentioned on the policies.
Return to question.
30. What are some uses for budgeting?

to control and monitor household expenses

to pay down debt

to accomplish wealth accumulation and savings goals

to monitor investment performance
Return to question.
31. What are the advantages and disadvantages of budgeting?
Advantages

coordinates activities of client and planner in developing
objectives

reveals inefficient, ineffective, or unusual utilization of resources

enhances awareness of resource conservation

provides a means of self-evaluation

allows recognition and anticipation of problems before they occur

highlights the need for alternative courses of action

provides motivation for achieving goals
Disadvantages

conclusions may be misleading
Module Review

203
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.

record keeping may be difficult for some clients

may stifle risk taking
Return to question.
32. Identify the guidelines for implementing a budget.

Make the budget flexible.

Keep the budget period short enough to minimize guesswork.

Make the budget period long enough to set a proper investment or
planning course.

Keep the budget simple.

Keep form and content of budget consistent from year to year.

Eliminate extraneous information.

Do not attempt absolute accuracy.

Tailor the budget.

Make the budget a guideline against which results are measured.

Set consistent reviews

Consider variables in advance that could change budget items.
Return to question.
33. What are the steps in constructing an income-expenditure budget?
204

Estimate family income from all sources.

Estimate expenditures.

Determine excess or shortfall of income.

Consider methods of increasing income or decreasing expenses.

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.

Calculate both income and expenses in each area as a
percentage of the total to determine if there is a preferable
allocation of resources.

Compare actual expenses to the budget monthly.
Return to question.
34. Describe the following rules of thumb that may be used to assess whether
debt is excessive.
a. housing costs (front-end ratio)
(including principal, interest, taxes, insurance, association fees,
etc.) should be no more than 28% of the owners’ gross income.
Return to question.
b. total monthly payments (back-end ratio)
no more than 36% of gross monthly income.
Return to question.
c. consumer debt payments (nonmortgage debt-to-income ratio)
should not exceed 20% of net monthly income (total income minus
FICA and state, federal, and any local taxes)
Note: Notice the overlap between several of these measurements.
A financial institution may or may not use all three measurements—
generally it would use the measurements that make sense given the
reason for the analysis.
Return to question.
Module Review

205
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
35. Use the rules of thumb from the previous question to determine if the clients
presented previously are using excessive amounts of debt.
a. John and Gloria Johnson have a mortgage on their home with a current
balance of $395,975. The monthly payment, including principal and
interest, is $2,261. Annual property taxes and insurance total $7,704. In
addition, they have two auto notes with current balances totaling $26,536
and monthly payments of $789. They currently have a total balance of
$1,200 on credit cards, but they pay the balances off each month. The
Johnsons’ net income for the past year was $82,789. Their gross income
was $126,770.
The Johnsons are close to the limit for housing costs and longterm liabilities, but probably will grow into them financially. Shortterm debt payments are much less than 20% of net income, and
therefore are not of great concern. With the balances owed
compared to the payments, most likely one of the cars will be paid
off within the next year. Furthermore, the Johnsons regularly pay
off credit cards, minimizing interest expense. Note that while their
credit card balances total $1,200, they pay off the balances each
month. They are merely using the credit cards as a convenient
method of paying current expenses. This is essentially the same
as writing a check for these expenses, but overall it probably costs
them less over time. Thus, the monthly payment of all balances on
credit cards is not considered debt.
Return to question.
b. Mary Ebersol has a credit card balance of $5,760, on which she regularly
pays $450 each month. The annual interest charged on the credit cards is
18%. In addition, she is repaying a loan from a car. The current balance
is $3,234, and her monthly payment is $254. The annual interest rate is
9%. Mary’s net income for the past year was $40,335. Her gross income
was $51,300.
206

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Mary’s total monthly consumer debt payments are $704, which is
approximately 21% of her net monthly income of $3,361. This
exceeds the 20% guideline, but not by much. Given the high rate
of interest being charged on her loans, it would be wise for Mary
to consider paying off these loans as soon as possible. Another
option would be to obtain a consumer loan to pay off the credit
card debt over one or two years.
Return to question.
c. Larry and Georgia Largent have a mortgage balance of $153,916 on their
home; the monthly payments, including principal and interest, of $1,312.
Annual property taxes and insurance on their home total $4,100. In
addition, they have a loan on a boat: the current balance of the loan is
$17,391 and monthly payments are $411. They do not use credit cards.
The Largents’ net income for the past year was $109,400. Their gross
income was $162,500.
The Largents’ debts do not appear to be excessive in any way.
However, it may be wise to repay the boat loan to eliminate
nondeductible finance charges, or use a home equity loan (on
which interest is generally deductible) to finance the boat.
Debt
Measure
Housing
expense
Johnson
OK
$2,903

Ebersol
OK
N/A
11.4% of
net income
Not
OK OK

12.2% of
gross
income

$704
16.5% of
gross
income
gross
income
$789
Not
OK Largent
$1,654
27.5% of
gross
income
Monthly
$3,050
payment
28.9% of
on all debt
Monthly
consumer
debt
Not
OK

$704
21.0% of
net
income

$1,723

12.7% of
gross
income
 $411

4.5% of net
income
Return to question.
Module Review

207
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
1–6
Explain different forms of debt and their uses.
36. How does debt affect a client’s financial situation?
Debt enables a client to obtain items that he or she otherwise may not
be able to obtain. However, it creates an obligation to repay (which
may be difficult during a period of financial stress), limits cash
outflows that otherwise may be available for other consumption or
savings, and increases expenses (due to finance charges).
Return to question.
37. Define the following terms relating to debt.
a. consumer debt
Short-term debt used to acquire consumer goods.
Return to question.
b. secured debt
Debt that is backed by collateral.
Return to question.
c. unsecured debt
Debt that is backed only by the debtor’s promise to repay. No
collateral is involved. Interest rates tend to be higher for
unsecured debt than for secured debt because of higher potential
risk to the lender.
Return to question.
d. grace period (credit card)
A specified period for which no interest is charged on a new
purchase.
Return to question.
e. points
Prepayment of mortgage interest; one point is usually 1% of the
original mortgage amount.
Return to question.
208

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
38. What are the potential costs and benefits of consumer debt and home
mortgages?
Consumer debt
Home mortgage
Costs
Benefits
interest charges and fees

ability to purchase
products and services
immediately

convenience

allows people who would
not otherwise be able to
afford a home to purchase
a home
title search costs

tax benefits
interest charges

may appreciate in value
loan origination fees
appraisal fees
credit reporting costs
Return to question.
39. What are some tax implications of home mortgages?
Points paid are tax deductible for the buyer of a home, as is home
mortgage interest (generally). Capital gains may be income tax free.
(Exceptions and restrictions apply to both of these benefits.)
Return to question.
40. Describe the following types of mortgages.
a. fixed rate mortgage
A fixed rate mortgage has a fixed interest rate. Payment amounts
are likewise unchanged over the period of repayment. Repayment
typically takes place over 15 to 30 years on a monthly basis.
Payments consist of repayment of principal and payment of
interest, with early payments consisting of a larger percentage of
interest and later payments consisting of a larger percentage of
principal.
Return to question.
Module Review

209
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
b. biweekly mortgage
A biweekly mortgage is a fixed rate mortgage in which payments
are made every two weeks; 26 payments are made each year.
The payment amount is half of the amount that would be made if
the mortgage payments were monthly. Under a biweekly
mortgage, full repayment occurs more quickly, and interest costs
are thus lower.
Return to question.
c. adjustable rate mortgage
An adjustable rate mortgage features an interest rate that changes
with the prevailing rate of interest in the economy. Changes in the
rate are tied to changes in a specified economic series but
typically are limited in the initial mortgage agreement with respect
to how much and how frequently they may vary. The borrower
bears a greater degree of risk with an adjustable rate mortgage
than with a fixed rate mortgage.
Return to question.
d. interest-only mortgage
An interest-only mortgage is a variation of the adjustable rate
mortgage, although occasionally it can have a fixed rate for the life
of the loan. The interest rate is usually tied to an index such as the
LIBOR (London Interbank Offered Rate). With most interest-only
loans, borrowers make only interest payments for some
predetermined period (e.g., 5, 10, or 20 years), and then begin
making additional payments to reduce the principal.
Return to question.
e. balloon mortgage
A balloon mortgage is a mortgage in which the monthly payment
is calculated based upon a long-term mortgage at a given interest
210

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
rate. That payment is made for a relatively short period, such as
five or seven years. At the end of that time, the principal balance
of the mortgage is payable in full. The interest rate for a balloon
mortgage is typically lower than that for a standard fixed rate
mortgage because of the shorter repayment period and the
smaller expected variance of interest rates in the economy during
a shorter period.
Return to question.
f.
graduated payment mortgage
A graduated payment mortgage is payable over a long time period
and has a fixed interest rate. The payments are lower for the first
few years of repayment, then adjust to a higher amount that
remains fixed over the duration of the loan. Because the early
payments are lower than what would normally be required based
upon the stated interest rate, there typically is negative
amortization during that period. In addition, the payments during
the second period typically are larger than those that would have
been required using a standard fixed rate mortgage.
Return to question.
g. conventional mortgage
A conventional mortgage is one made by a commercial lender in
the private sector.
Return to question.
h. VA mortgage
A VA mortgage is guaranteed by the Department of Veterans
Affairs and is available only to eligible veterans.
Return to question.
Module Review

211
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
i.
FHA mortgage
An FHA mortgage is guaranteed by the Federal Housing
Administration.
Return to question.
j.
reverse mortgage
A reverse mortgage is a means of accessing equity in a home.
The homeowner is able to remain in the home and the lender
makes a lump-sum payment or monthly payments to him or her
based upon a percentage of the equity in the home, a stated
interest rate, and a specified payment period. As long as the
senior remains in the home, there is no debt repayment.
Return to question.
41. What are the potential costs and benefits of refinancing a mortgage?
The potential costs of refinancing are typically the same as those
involved when obtaining the original mortgage. If interest rates are
higher when the home is refinanced, interest costs will increase, but
the monthly payment may be lower due to a longer financing period.
The benefits of refinancing are greatest if interest rates are lower,
because not only will monthly payments be reduced, interest costs will
decrease.
Return to question.
42. Home equity is one potential source of funding for financial goals. What
means may be used to access home equity?
212

a reverse mortgage

a home equity loan

selling the home
Return to question.

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
1–7
Explain the issues involved in the lease versus buy decision.
43. The decision whether to buy or lease a home may be important to the
budgeting process. What factors must be considered when comparing leasing
a home with owning a home?
The costs of leasing must be compared with the costs of owning.
Identical time frames must be considered for both options. Potential
changes in costs for each option over the time frame must be
considered.
Return to question.
44. Explain the difference between open-end and closed-end leases.
An open-end lease includes the possibility that the lessee may face
additional expense at the termination of the lease. This outcome
would occur if the actual value of the leased item were different from
the value projected at the inception of the lease. If the value of the
item has not decreased as much as projected, the lessee may receive
a refund. However, this is not a common outcome.
In a closed-end lease, the lessee generally is free to walk away from
the leased asset at the end of the lease without being assessed any
additional costs. Some closed-end leases provide some protection for
the lessor by including provisions that might trigger additional
payments by the lessee. These payments might arise because a
specified mileage limit on a car has been exceeded or some property
has been subjected to unusual damage or abuse.
Return to question.
Module Review

213
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
1–8
Identify sources and strategies for funding a college education.
45. There are a number of ways of planning for children’s education. What are
some characteristics of each of the following?
a. direct transfer of funds

simple, inexpensive, avoids taxation of income at parents’ rate (with
the exception of the kiddie tax)

works best using investment vehicles that defer taxation, i.e., Series
EE bonds
Return to question.
b. custodianship

no administrative costs

involves naming manager of property for minor

nearly any type of property may be involved (though some
restrictions may apply in states that have adopted only the
UGMA)

child has right to receive property upon attaining the age of
majority, to use as he or she chooses

does not avoid kiddie tax
Return to question.
c. minor’s trust

214

designed to use annual gift tax exclusion (see annual limits,
which change every year)
Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.

gift to individual under age 21 is not considered a gift of a
future interest if property and income are payable to child at
age 21

escapes kiddie tax but is taxed at trust’s rate, which is
unfortunately a punitive one
Return to question.
d. current income trust

income must be paid out to beneficiary at least annually

trustee has no discretion regarding accumulation of income

more difficult to avoid kiddie tax

trust property need not be distributed to child at a specified
age
Return to question.
e. Crummey invasion trust
f.

beneficiary may withdraw an amount equal to the annual
addition to the trust or the annual gift tax exclusion, whichever
is less, during intervals specified in the trust agreement

trust property is distributed to the beneficiary at the age
chosen by the grantor

accumulated income is taxed at the trust’s rates
Return to question.
scholarships

generally for academically or athletically gifted students, but
may be need-based

available through colleges, businesses, foundations,
community groups, etc.
Module Review

215
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.

continued receipt of monies may be contingent upon fulfilling
requirements of provider

receipt of scholarship monies may reduce funds that may be
available from other sources, such as the federal government
Return to question.
g. 529 plans

Contributions can be limited by states but clients are not
restricted to their own state.

Funds accumulate tax free.

Contributions for qualified expenses are withdrawn tax free.

There may be a state tax deduction for contributions.

A disadvantage is that if funds are not utilized for qualified
education expenses, the earnings are taxed and may be
subject to penalty. Contributions may be withdrawn without
penalty.

Accounts can be transferred to other beneficiaries.
Return to question.
h. Coverdell Education Savings Accounts

Limited to $2,000 per year per beneficiary

Can be utilized for elementary and secondary school in
addition to college

Funds accumulate tax free and distributions are tax free if
used for qualified expenses.

Funds must be disbursed to beneficiary by age 30.
Return to question.
216

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
46. How might a parent’s qualified retirement plan be used to fund a child’s
college education?
Under some plans, funds may be borrowed without a premature
distribution penalty being assessed. In addition, funds distributed from
a pension plan in the form of a life annuity may avoid a premature
distribution penalty tax, even if distributions begin before the plan
participant attains age 59½. In general, the participant must withdraw
roughly equal amounts from the pension plan on an annual basis for
at least five years, or until reaching age 59½, to avoid the penalty tax.
(Additional rules apply.)
Return to question.
47. How does the “kiddie tax” affect funding of investment vehicles for a child’s
education?
The kiddie tax applies to unearned (i.e., investment) income greater
than $2,100 (indexed annually for inflation) received by children under
age 19 (or under age 24 if a full-time student). In essence, the first
$1,050 of unearned income is not taxed because it is offset by the
limited standard deduction, the second $1,050 of unearned income is
taxed at the child’s marginal tax rate, and all unearned income
exceeding $2,100 is taxed at the parents’ marginal rate. Therefore,
college-funding strategies for a child subject to the kiddie tax may
differ from strategies used for a child who is not subject to the tax (and
this now includes almost all college funding scenarios). In general,
investment vehicles selected for education funding when the child is
subject to the kiddie tax should, perhaps, be structured for growth
rather than income to avoid the tax.
Return to question.
Module Review

217
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
48. Describe characteristics of each of the following grants that may be available
for funding education.
a. Pell grants

federal grant available to undergraduates only

students who are less than full time receive a partial grant

criteria for receipt are financial need and availability of federal
funds

receipt of other grants and loans is sometimes contingent
upon applying for or receiving a Pell grant
Return to question.
b. Supplemental Educational Opportunity Grants

funded by federal government; administered by individual
schools

available to both part-time and full-time undergraduates

need-based grant
Return to question.
c. TEACH Grant
218


available to full-time undergraduate or graduate students
enrolled in a program leading to teacher certification

applicants must agree to teach in specified schools and
programs

students enrolled less than full-time will have grant amounts
reduced.
Return to question.
Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
49. Describe characteristics of each of the following types of loans that may be
available for funding education.
a. Perkins loans

funded by federal government; administered by individual
schools

available to graduate and undergraduate students

available to half-time and full-time students (a temporary drop
to part-time status may or may not require repayment to begin)

need-based loan

interest on loans is 5%, which is deferred during the period of
education

repayment begins nine months following graduation
Return to question.
b. Stafford loans

available to graduate and undergraduate students

not necessarily need-based, but interest subsidies during the
period of schooling (and the six months following completion)
are available for students demonstrating financial need

available for full-time students and for some students enrolled
in programs that take less than an academic year (for a
reduced loan amount)

loans are made by private lenders or the federal government

repayment period is normally 10 years, but may be extended
Return to question.
Module Review

219
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
c. PLUS loans

PLUS loans are available for parents of students

available through private lenders

available for undergraduate students

new program rules allow for loans to be made directly to
graduate and professional students

not available to part-time students (but students enrolled in
programs that are shorter than an academic year may be
eligible for reduced loan amounts)
Return to question.
50. Describe college work study programs.
220

funded by federal government; administered by individual schools

eligibility based upon financial need

available to graduate and undergraduate students

available to part-time and full-time students

students are provided employment to earn money while attending
school

number of hours worked limited by class schedule and academic
progress
Return to question.

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
1–9
Explain issues related to special planning needs.
51. What are key issues that arise when planning is due to a divorce?

income

property distribution

child custody

other issues relating to insurance planning, budgeting, other
transition plans, prenuptial agreements
Return to question.
52. What are key issues that arise when planning for a permanently disabled
child or adult?

financial support

living arrangement

physical support
Return to question.
Module Review

221
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
References
Certified Financial Planner Board of Standards Inc., Washington, DC.
www.CFP.net
The College Board. www.collegeboard.com.
College Savings Plans Network. www.collegesavings.org.
Federal Student Financial Aid. www.studentaid.ed.gov.
Leimberg, Stephan R., et al., The Tools and Techniques of Financial Planning,
9th edition. Cincinnati: The National Underwriter Company, 2010.
Lytton, Ruth H., et. al., The Process of Financial Planning: Developing a
Financial Plan. Cincinnati: The National Underwriter Company, 2006.
National Center for Home Equity Conversion on Reverse Mortgages.
www.reverse.org.
National Reverse Mortgage Lenders Association. www.reversemortgage.org.
Stone, Douglas, Bruce Patton, and Sheila Heen, Difficult Conversations, How to
Discuss What Matters Most. New York: Penguin Books, 2010.
U.S. Department of Education FAFSA. www.fafsa.ed.gov.
U.S. Department of Housing and Urban Development (HUD). www.hud.gov/.
222

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
About the Author
David Mannaioni, CFP®, CLU, ChFC, CPCU is an associate
professor at the College for Financial Planning. Utilizing his 30+
years of experience in the financial services industry, David also
maintains a financial planning practice where he works with his
clients in all areas of financial planning. In addition to his
certifications, David holds Life and Health insurance licenses in
several states, as well as the Series 6, Series 7, Series 63, and Series 24
registrations with FINRA. You can contact David at david.mannaioni@cffp.edu.
About the Author

223
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Index
A master index covering all modules of this course can be found in the Self-Study
Examination book.
current income trust, 123
Achieving special goals, 1, 106
charitable planning, 138
custodial accounts, 121
closely held business planning, 140
FSEOGs, 129
dependent adult or disabled child,
138
minor’s trust, 123
Pell grants, 129
divorce issues, 135
Perkins loans, 130
remarriage issues, 137
PLUS, 131
special needs planning, 1, 134
Section 529 plans, 117
terminal illness, 139
Assets, 48
asset valuation, 50
cash/cash equivalents, 48
Stafford loans, 130
Communication, 6
Data gathering, 14
Debt management, 1, 63, 89
invested assets, 48
consumer debt, 89
use assets, 49
Budget, 72
mortgages, 91
Debt-to-income ratio
fixed expenses, 79
back-end ratio, 65
variable expenses, 80
Buying versus renting a home, 102
Cash flow statement, 53
net inflow, 56
front-end ratio, 65
Emergency fund, 58
Financial planning, 9, 10
Financial ratios
College funding methods, 117
Coverdell Education Savings
Accounts, 118
Crummey trust, 123, 124
nonmortgage debt service ratio, 65
Inflows, 54
Kiddie tax, 122
Lease versus buy, 112
224

Introduction to the Financial Planning Process
© 1982, 1985, 1991, 1996, 2002–2015, College for Financial Planning, all rights reserved.
Leases, types of, 111
closed-end, 111
open-end, 112
Liabilities, 51
Mortgages, types of, 93
adjustable rate, 95
balloon, 97
biweekly, 96
conventional, 94
FHA, 94
fixed rate, 94
graduated payment, 97
interest-only, 96
reverse, 98
VA, 94
Net worth, 45, 51
Net-investment-assets-to-net-worth
ratio, 66
Nonmortgage debt-to-income ratio, 65
Opportunity funds, 63
Outflows, 54
Ratio analysis, 68
Refinancing a home, 103
home equity, 103
home equity line of credit, 104
second mortgage, 104
Statement of financial position, 45
Index

225
© 1981, 1985, 1996, 2002–2015, College for Financial Planning, all rights reserved.