Practicing Financial Planning For Professionals and CFP Aspirants12th Edition by Sid Mittra – Test Bank
Part A: Long Essay Questions
Question 1: Describe the major emerging trends in financial planning.
Answer 1: There are several major emerging trends in financial planning.
- Changing Family Patterns
Nontraditional families are becoming more prevalent. The latest data from the US Census Bureau reveal that the ratio of all the US households consisting of married couples with children precipitously declined from 45 percent in 1957 to 19 percent in 2014. Over the same period, however, single-person households increased from 11 percent to a whopping 28 percent. Another interesting trend relates to same-sex couple households for whom we now have reliable data. According to the Census Bureau, these households recorded a dramatic increase from approximately 594,000 in 2000 to 902,000 in 2010, an increase of 52 percent.
Where traditional families exist, progressively these families are becoming less capable of financially assisting their aging parents and their children. The implications are clear. In contrast to a society that traditionally buttressed each individual with a network of family support, the 21st century is marked by an increasing need for individuals taking full responsibility for meeting their own financial goals.
- The Reality of American Dream
The proverbial American Dream is now a bad dream. Mortgage payments on a home absorb 28–36 percent of the average 30-year-old’s salary today, compared to just 14 percent in 1949. Family expenses have also risen. According to the US Department of Agriculture estimates, for a two-parent, two-child family, the cost of raising a child born in 1996 through the age of 18 averaged $222,250 for those in the middle income group, and 323,964 for those in the highest income group. For a child born in 2013, these figures would have risen from $245,340–407,820. The estimate for the middle-income families is also significantly higher than the cost estimated for a child born in 1996 (excluding college). With costs of education rising about 8 percent on average per year – faster than wages or inflation – the pressures put on tomorrow’s parents to save for raising and educating their children can only increase. All this must be viewed against the backdrop of falling median household income adjusted for inflation. According to the Census Bureau, after adjusting for inflation, median household income dropped 7 percent during 2000–2010.
- Realities of Retirement
Based on the current trends, an average American is expected to enjoy a longer retirement period, partly because in America the average life span is lengthening. In 2015, in the USA the average life expectancy was 78.80 years (81.2 years for women and 76.4 years for men). Biotechnological advances are expected to stretch life expectancy in the future. As a result, the children and grandchildren of the current generation could live to be 100 or older. Another reason for longer life spans is the trend of early retirement. That is the trend of retiring before the age of 65. A 2015 TIAA-CREF study1 revealed that nearly half of the Americans (46 percent) are concerned about running out of money in retirement. Some of this concern may be justified by those 39 percent of Americans who say that they are not familiar with their retirement plan investment options – an increase from 33 percent in 2014.
Alarmingly, despite the number of people who are unfamiliar with the investment options in their retirement plan, the vast majority of respondents (85 percent) say that they feel comfortable with the choices they have made. This gap highlights individuals’ need for advice and education on how to save enough to create a steady stream of income in retirement.
Americans reaching retirement over the past 20 years face their different retirement problems than their predecessors. In response to a significant change in the retirement environment, since the mid-1980s, retirement patterns have dramatically changed. As a result, reports another TIAA-CREF study, a century-long trend of American men toward earlier retirement has stopped.
Dramatic Changes in the Retirement Environment
Today, Americans reaching traditional retirement ages face a dramatically different retirement environment than those before the mid-1980s. It is a “Brave New World” for retirees compared to the mid-1980s. Here is a list of key structural changes noted in the TIAA-CREF study that appear permanent:
- Elimination of mandatory retirement for most American workers.
- Reduction of work disincentives, or retirement incentives, in Social Security and in employer pension plans.
- A less burdensome work environment owing to technology and workplace options. Living longer and healthier lives means that people can postpone retirement.
- Gradual increase in the Social Security retirement age from 65 to 67 resulting in an across-the-board benefit cut.
- Fewer firms offering employer-sponsored postretirement health insurance.
- Ongoing concerns about the health of the Social Security, Medicare and Medicaid trust funds.
- The decision to retire in stages, utilizing bridge jobs between full-time employment and complete retirement.
- The need for new education and retraining meeting the demands of a changing labor market, a situation that older workers progressively find more difficult.
- Husbands and working wives (on average three years younger than their husbands, and more of them working) coordinating their retirement. If wives retire at the age of 62 to qualify for Social Security, then that pattern would push husbands’ retirement age to 65.
These changes are a mixed blessing for older workers; they share a characteristic: They make work after the traditional retirement age more attractive. Clearly, these changes are here to stay.
Equally important, as a result of the 2008–2009 collapse of stock and real estate markets, the mismatch between future retirement-income needs and current personal savings has become apparent. Based on a 2010 Wells Fargo Retirement Survey, three out of four surveyed feared that they will work in retirement. Worse, some 25 percent would need to work during retirement. And approximately 25 percent surveyed indicated that they would have to work until the age of 80 to reach a comfortable retirement. Sadly, this is the new retirement “reality” for most Americans today.
Question 2: Financial planning is a dynamic, integrative process. Explain this statement.
Answer 2: “Personal financial planning” or “financial planning” denotes the process of determining whether and how an individual can meet life goals through the proper management of financial resources. Financial planning integrates the financial planning process with the financial planning subject areas. In determining whether the financial planner is providing financial planning or material elements of financial planning, the CFP Board considers factors such as: client’s understanding and intent in engaging with the certificant, the degree to which multiple financial planning subject areas are involved, the comprehensiveness of the data gathering, and the breadth and depth of the recommendations.
Question 3: What are the key content areas of financial planning?
Answer 3: The key content areas of financial planning are:
- Risk management and insurance
- Cash and debt management
- Investment planning
- Funding education
- Income tax planning
- Retirement planning and employee benefits
- Estate planning
Note that some of the areas overlap. For instance, investment planning may indirectly result in tax planning. Similarly, part of savings planning may influence retirement planning.
Question 4: What is meant by the statement “financial planning is both an art and a science?”
Answer 4: The financial planner needs to acquire the quantitative technical skills to assess the current situation, evaluate alternative products, and strategies and formulate planning recommendations. The planner also needs the interpersonal skillset to communicate with the client and nurture the relationship.
The “science” of financial planning pertains to technical competencies and practical knowledge within the core topic areas – cash and debt management (including financial statement analysis and cash flow projections), risk management and insurance, investment planning, funding for education, income tax planning, employee benefit analysis, retirement planning, and estate planning. Prepared with a solid technical background, the planner is able to assess the data, synthesize strategies, and identify products that will improve the client’s probability of reaching the stated goals.
Question 5: Describe the three stages of the typical client’s life cycle.
Answer 5: Every person passes through three broad economic stages or cycles; namely the accumulation stage, the consolidation stage, and the spending/gifting stage. Each stage presents a different challenge, as detailed below.
- The Accumulation Stage: This describes the “starting out” period. During this phase, generally when adults are in their 20s or 30s, an individual, or a couple, is focused on promoting a career, starting a family, acquiring personal assets, and buying a home. Because people in this stage earn relatively low incomes but generate large cash outflows, planners should expect to find the following:
- Extensive use of credit to buy a home and accumulate personal assets
- Low savings rate
- Educational loan payments
- The need to save for children’s education
- The need to hedge income risks through the life and disability insurance
- The Consolidation Stage: During this stage, corresponding to middle age (typically 40s, 50s, and early 60s), most people manage to progress in their careers and succeed in generating substantial disposable income. For many of these families, after graduation from college children are gone, leaving behind their parents as empty nesters. During this stage, planners normally expect to notice a shift in clients’ priorities toward retirement, although in some cases clients may divert their attention instead to career changes or to climb up the social ladder by buying bigger homes and embarking on extensive travels. In few cases, during this stage prudent clients become interested in discussing their long-term care needs.
- Spending and Gifting Stage: The postretirement period is characterized by the depletion of assets. During this stage, spending generally exceeds the family’s earnings and passive income streams, and attention is diverted to developing a sound saving withdrawal strategy. Of course, interests and concerns of the people passing through this stage are hardly uniform. Some plan to spend many active retirement years, while others gravitate toward a sedentary existence. Ultimately, however, in almost all cases, people become engrossed with health care concerns. During this stage, the three priority needs that planners expect clients to have are:
- Need to budget retirement expenses
- Manage health care costs that consume a large portion of the budget
- Develop an estate plan and a systematic gifting plan
- Special Situations: Similar to life-cycle commonalities, there are several special situations that always present some commonality in terms of needs and planning priorities. Examples of special situations include:
- Loss of spouse (widow or widower)
- Nontraditional families
- Single parenting
- Dependents with special needs
- Dependent elderly parents
- Permanent disability
- Terminal illness
- Loss of job or job change
- Planning for military families
- Monetary windfalls (i.e., “sudden money”)
Consider, for example, the case of single parents. While each single parent is unique with respect to goals, dreams, interests, values, and experiences, they all have certain common characteristics. These include, but are not limited to, the following: high priority for life and disability insurance coverage, urgent need for updating the will naming a designated guardian for the child, making adjustments in the family budget to allow for escalating childcare costs including higher education, and other important tax-related matters. If the single-parent status is the result of a divorce, then a whole slew of other important planning issues surface that need to be considered when planning for these single parents. See Chapter 18 for planning issues relating to divorced clients.
Question 6: What credentials and experience are desirable for maintaining a high standard in the financial planning profession?
Answer 6: Besides an undergraduate or graduate degree with a concentration in personal financial planning, it is desirable for the planner to hold the CFP® certification mark (or other equivalent marks). The CFP Board requires a minimum amount of work experience prerequisite for giving the CFP® certification mark to those with a baccalaureate degree. Finally, all CFP® registrants are required to maintain continuing education credits; the requirement is based on a two-year period. These credit hours must be earned in two areas: (a) ethics (minimum number of hours as specified by the CFP Board’s Code of Ethics and professional responsibility and (b) the remaining hours can be represented by one or more of the specified areas. The intent of continuing education is to ensure that certified planners maintain their competencies.
Question 7: Is it possible for the financial planner as a businessman to be ethical and still stay in business for very long?
Answer 7: Absolutely. To say that financial planners must maintain the highest level of ethical standards, of course, is not to deny the fact that they are also entrepreneurs, engaged in a business to make a profit. However, that is not the real issue. The key point is this: A less-than ethical financial planner concentrates on making money by engaging in activities that may harm the client, whereas an ethical financial planner always serves the client’s interests first, and the planner’s income is generated as a by-product of that service.