Personal Financial Planning Theory and Practice - · PDF filePersonal Financial Planning...

Personal FinancialPlanning Theoryand PracticeMichael A. Dalton, PhD, JD, CLU®, ChFC®, CFP®

James F. Dalton, MBA, MS, CPA/PFS, CFA®, CFP®

Randal R. Cangelosi, JD, MBA

Randall S. Gutter/, PhD, CLU®, ChFC®

Scott A. Wasserman, CPA/PFS, CLU®, ChFC®, CASL®, RFC®, CFP®

7TH EDIT ION

KAPLAN) SCHWESER

About the Authors Hi

Preface xi " - -"

Acknowledgments and Special Thanks xv

Professional Focus xvii

BASDC FDWAWCDAL PLAWWOMG SKILLS 3

1. Introduction to Personal Financial Planning 5

Personal Financial Planning Defined 6

Benefits of Personal Financial Planning 6

Financial Success is a Relative Concept 7

Resource Allocation in Financial Planning 8

Why do People Hire Professional Financial Planners?

9

The Financial Planner's Pyramid of Knowledge 10

Basic Financial Planning Skills 11

Basic Financial Planning Tools 12

Core Topics 12

The Financial Planning Profession 14

2. External Environmental Analysis 17

The External Environment 18

Analyzing the External Environment 20

Why Study the External Environment? 21

The Economic and Legal Environments 21

Importance of the Economic Environment 22

The General Economy 23

Business Cycles 28

Inflation 31

Monetary and Fiscal Policy 34

The Nature of Interest Rates 36

Expansion and Recession 37Forecasting the Economy—Index of LeadingEconomic Indicators 37

Importance of the Legal Environment 39

Torts 39

Property Ownership 41

Consumer Protection 41

Worker Protection (Employer/EmployeeRelations) 45

Financial Institutions 46

FDIC Insurance 48

Negotiable Instruments 51

Investor Protection (The Securities Acts of 1933and 1934) 52

Forms of Business Organizations 53

Importance of the Social Environment 54

Importance of the Technological Environment 55

Importance of the Political Environment 56

Importance of the Taxation Environment 56

Communication and Internal EnvironmentalAnalysis 65

Communication Skills 66

Be Respectful of Your Client 67

Communicate with Your Client 67

Professional Liability 70

Common Law Liability to Clients 70

Common Law Liability to Third Parties 70

Statutory Liability 71

Educate Your Client 71

Understand the Client's Thinking Phase 72

Internal Analysis 75

Life Cycle Positioning 75

Life Cycle Phases and Characteristics 77

Attitudes and Beliefs 80

Special Needs 81

Financial Position 84

Client's Perception of Financial Situation 85

Personal Financial Statements (Preparation andAnalysis) 101

Introduction 102

Decision-Making Uses of Financial Statementsand Financial Statement Analysis 103

xxiv Contents

Rules Regarding Financial Statements 103

Preparation of Financial Statements 104

The Statement of Financial Position 104

Statement of Financial Position Terms andPresentation Order 104

Categories and Classifications of Assets 105

Categories and Classifications of Liabilities106

Valuation of Assets and Liabilities 107 - ..

The Nelson Family Statement of FinancialPosition 108

Valuation of Assets and Liabilities-^-The Nelsons1 1 1 ?

Information Sources 111

Identification of Ownership of Assets andLiabilities 113

Footnotes to the Statement of FinancialPosition 114

The Personal Statement of Cash Flows 114

Statement of Personal Cash Flows Terms andOrder of Their Presentation 115

Information Sources 115

Compromise in Information Reporting 118

The Relationship of the Statement of FinancialPosition to the Personal Statement of CashFlows 118

The Statement of Changes in Net Worth 118

Nelson Example Recap 121

Financial Analysis of Personal,FinancialStatements 121

Ratio Analysis 122 \

Vertical Analysis 134

Growth Analysis 137

Limitations of Financial Statement Analysis137

Sensitivity Analysis 138

Risk Analysis 138

Budgeting 138

Description 138

Nelson Budgeting Plan 139

Saving and Consumption Habits 142

Debt Management 142

Personal Use—Assets and Liabilities 142

Home Mortgages 143

5. Establishing Financial Direction: The FinancialPlanning Process 153

~- The Financial Planning Process 154

Step 1: Establishing and Defining the Client-PlannerRelationship 157

Step 2: Gathering Information Necessary to Fulfillthe Engagement 158

Identifying Relevant Environmental Information158

Establishing Financial Goals 159

Developing Financial Objectives 162

Step 3: Analyzing and Evaluating the Client'sCurrent Financial Status 165

Step 4: Developing and Communicating theRecommendations 167

Selecting the Most Appropriate Strategy 170

Communicating the Recommendations 173

Step 5: Implementing the Recommendations 173

Step 6: Monitoring the Recommendations 174

Chapter 5 Supplement 179

Calculations for Retirement Needs and KeyWest Home for the Nelsons 179

BASIC FINANCIAL PLAWIMOWG TOOLS 1183

6. Time Value of Money 185 :

Understanding Time Value of Money 186

Future Value and The Power of CompoundInterest 187

Basic Tools for Time Value of Money (TVM)Analysis 188

Timelines 188

TVM Tables 189

Financial Calculators 190

Computer Software 191

Accumulation Schedules 191

Future Value of an Ordinary Annuity (FVOA) 192

Future Value of an Annuity Due (FVAD) 192

Present Value of a Dollar (PV) 193

Present Value of an Ordinary Annuity(PVOA) 193

Present Value of an Annuity Due (PVAD) 194

Other TVM Concepts 195

Uneven Cash Flows 195

Contents XXV

Combining Sum Certains with Annuities 196

Net Present Value Analysis 196

Internal Rate of Return (IRR) 197

Yield to Maturity 198

Solving for Term Given the OtherVariables 199

Selecting the Rate of Interest for Accumulatingor Discounting 200

Serial Payments 201 • .. _ -

Perpetuities 202

Other TVM Tools 203

Amortization Tables 2Q3

The Rule of 72 205 '

7. Education Funding 215

Introduction 216

Issues and Goals 217

Information Gathering 218

Determining Financial Need 220

Financial Aid Programs 223

Federal Pell Grants 224

Stafford Loans 224

PLUS Loans 226

Consolidation Loans 226

Campus-Based Student Financial Aid 227

State Governmental Aid 228

Other Financial Aid Sources 228

Tax Advantages From Education Expenses and TaxIssues 230

Qualified Tuition Programs 230

Prepaid Tuition Plans 231

College Savings Plans 231

Coverdell Education Savings Accounts(ESAs) 234

Traditional IRA 235

Roth IRA 235

The American Opportunity Tax Credit 236

The Lifetime Learning Credit 236

Series EE Bonds 237

Uniform Gift to Minors Act 237

Uniform Transfers to Minors Act 238

Interest on Education Loans 238

Employer's Educational AssistanceProgram 238

Equity Lines of Credit 238

Highlights of Benefits for Higher Education . 239

Education Funding/Savings Regimen Example 241

Investment Strategies to Accomplish EducationGoals 244

INSURANCE PLANNING 253

8. An Introduction to Insurance and RiskManagement 255

Introduction 256

Understanding Risk 257

Risk Classification 257

Pure Versus Speculative Risk 257

Dynamic Versus Static Risk 257

Subjective Versus Objective Risk 258

Particular Versus Fundamental Risk 258

Financial Versus Nonfinancial Risk 258

Probability of Loss 259

Law of Large Numbers 259

Responses to Pure Risk 260

Risk Avoidance 260

Risk Reduction' 261

Risk Retention 261

Risk Transfer 261

Insurance as a Risk Management Tool 262Transfer of Losses 262

Sharing Losses with Others 263

Self-Insurance 264

Causes of Insured Losses 265

Perils 265

Hazards 265

Adverse Selection 266

Insurable Losses 266

Insurance Versus Gambling 266

Requisites for an Insurable Risk 267

The Law of Insurance Contracts 268

Elements of a Valid Contract 269

Legal Principles of Insurance Contracts 270

Legal Form 273

Distinguishing Characteristics of InsuranceContracts 273

The Law of Agency . 274

Agents and Brokers 274

Agency Relationships 275

xxvi Contents

9.

Important Features of Insurance Contracts 276

Exclusions 276

Riders and Endorsements 277

Valuation of Insured Losses 277

Deductibles and Co-Payments 278

Coinsurance 278

Individual Loss Exposures and Insurance Coverages279

Perils That Can Reduce and/or Eliminate theAbility to Earn Income 279

Perils That Can Destroy or Deplete ExistingAssets 280

Characteristics of Insurance Companies' 281

Types of Ownership 281

Insurance Underwriting 281

Reinsurance 282

Insurance Regulation 282

National Association of InsuranceCommissioners (NAIC) 282

Selecting an Insurance Company 283

Rating Agencies 284

Additional Considerations 285

The Risk Management Process 285

Determining the Objectives of the RiskManagement Program 286

Identifying the Risk Exposure 286

Evaluating the Identified Risks 286

Determining and Selecting the Best RiskManagement Alternative 287

Implementing a Risk Management Plan Basedon the Selected Alternatives 288

Periodically Evaluating and Reviewing the RiskManagement Program 288

Managing Life, Health, and Disability Risks 293

Introduction 295

Identifying Risks Associated with Premature Death295

Premature Death 295

Inadequate Financial Resources 295

Estate Preservation 296

Measuring Needs Related to PrematureDeath 297

Human Life Value Approach 298

Financial Needs Approach 299

Capital Retention Approach 303

Measuring Disability Income and Long-Term CareNeeds 305

Disability Income Needs 305

Long-Term Care Needs 307

Individual Life Insurance Policies 307

Term Life Insurance 308

Whole Life Insurance 312

Universal Life Insurance 318

Modified Endowment Contracts (MECs) 323

Group Life Insurance 325

Life Insurance Policy Selection 326

Life Insurance Policy Illustrations 327

Life Insurance Policy Replacement 328

Life Insurance Policy Provisions 329

Grace Period 329

Incontestability 329

Entire Contract Clause 330

Misstatement of Age or Gender 330

Assignment 330

Suicide 330

Reinstatement 331

Policy Loan Provision 331

Automatic Premium Loan 331

Beneficiary Designations '331

Aviation Exclusion 332

War Exclusion 332

Survivorship Clause 332

Simultaneous Death Provision 332

Life Insurance Settlement Options 333

Interest Only 333

Fixed Amount 333

Fixed Period 333

Life Income 333

Life Income with Period Certain 333

Life Income with Refund 334

Joint and Last Survivor 334

Annuity Contracts 334Types of Annuities 334

Annuitization 336

Taxation of Life Insurance and Annuities 337

Tax Treatment of Life Insurance 337

Taxation of Lifetime Benefits 337

Taxation of Benefits Received after Death340

Contents xxvii

Viatical Agreements 340

Annuities 341

Individual Health Insurance 341

Purpose 342

Cost Concerns 342

Eligibility 342

Major Medical Insurance 342

2010 Health Care Reform Legislation 343

Medical Expense Insurance 345

Health Savings Accounts (HSAs) 346

Eligibility 346

Long-Term Care Insurance 349

Disability Income Insurance 353Overview 353

Characteristics 354

Health and Disability Insurance PolicyProvisions 357

Rights of Renewability 358

Group Health Insurance 359

Eligibility 359

Characteristics 359

Group Disability Income Insurance 361

Business Uses of Life Insurance and Other EmployeeBenefits 366

Buy-Sell Agreements 366

Types of Buy-Sell Agreements 366 ••

Nonqualified Plans 368

Key Person Life Insurance 370

Business Overhead Expense Insurance 371

Other Employee Benefits 371

Problem 1 378

Problem 2 379

Case 380

Insurance Information 380

Relevant External Environmental Information381

10. Personal Property and Liability Insurance 385

Introduction 386

Personal Property and Liability Insurance 386

Homeowners (HO) Insurance: BasicCoverage 387

Section I Coverage 389

Section II Coverage 393

Homeowners (HO) Insurance: Basic Forms 397

HO-2: Broad Form 397

HO-3: Special Form 397

HO-4: Tenants or Renters 397

HO-5: Comprehensive Form 398

HO-6: Condominium Owners 398

HO-8: Modified Form for Special Risks 398

Homeowners (HO) Insurance: AdditionalCoverages 399

Homeowners (HO) Insurance: Endorsements 400

Replacement Cost for Personal Property 400

Inflation Protection 400

Earthquake Endorsement 400

Water Backup Coverage 400

Building Law and Ordinance Coverage 401

Personal Injury 401

Open Perils 401

Homeowners Insurance ContractualConditions 401

Section I Conditions 401

Section II Conditions 404

Sections I and II Conditions 405

Automobile Insurance 407

Personal Auto Policy (PAP) Coverages 407

Policy Overview 408

Part A: Liability Coverage 409

Part B: Medical Payments 413

Part C: Uninsured Motorists 414

Part D: Coverage for Damage to Your Auto415

Part E: Duties After an Accident or Loss 417

Part F: General Provisions 417

Legal Liability 417

Personal Umbrella Liability Policy 418

Purpose 418

Characteristics 418

Exclusions 419

Business and Professional Use of Property andLiability Insurance 419

The Commercial Package Policy (CPP) 419

Inland Marine Policies 420

The Businessowners Policy (BOP) 420

Business Liability Insurance 420

xxviii Contents

Workers' Compensation 420

Business Auto 421

Business Umbrella Liability 42,1

Malpractice Insurance 421

Errors and Omissions 421

Product Liability 422

Cases .427

The Bannisters 427

The Nelsons 430


11. Social Security and Other Social Insurance 435

Overview of the US Social Security System 436

The History of Social Security Benefits '438

Social Security Taxes and Contributions 439

The Social Security Trust Funds and Their RelativeSolvency 440

Social Security Benefits—Eligibility andCalculations 441

Covered Workers and Insured Status 441

Social Security Beneficiaries 442

Social Security Retirement Benefits—A CloserLook 443

The Social Security Statement 444

The Retirement Benefit Calculation 445

Taxation of Social Security Benefits 454

Other Social Security Benefits 455

Disability Benefits and Disability Insured 455

Family Benefits 455

Survivors Benefits 456

The Maximum Family Benefit 457

Medicare Benefits 458Other Medicare Health Plan Choices 461

Applying for Medicare Benefits and Coverage461

Supplemental Security Income Benefits 462

Filing for Social Security Benefits 462

Social Security Changes for 2011-2012 463

Other Issues 464

Effect of Marriage or Divorce onBenefits 464

Change of Name 465

Leaving the United States 465

INVESTMENT, ONCOME TAX, BUSINESS,RETIREMENT A N D ESTATE PLANNING 4 7 3

12. Introduction to Investment Concepts 475

Introduction to Investing 476

The Investment Planning Process 476

Establishing Financial Goals 477

Investment Policy Statement 477

Typical Financial Planning Goals 478

Budgeting 478

Methods of Increasing Savings 479

Direct Versus Indirect Investing 480

Investment Risks 480Systematic Risks 482

Unsystematic Risks 483

Risk and Return 486

Investment Choices 487

Lending Investments 487

Ownership Investments in Business (Commonand Preferred Stock) 487

Ownership Investments in Real Estate 488

Derivatives 489

Tangible Assets 492

Natural Resources 492

Measures of Risk 492

Beta 492

Standard Deviation 493

Normal Probability Distribution 493

Semivariance 494

Coefficient of Variation 495

Measures of Return 495

Simple Rate of Return 495Compound Rate of Return 495

Holding Period Return 496

Arithmetic Mean 496

Geometric Mean 496

Internal Rate of Return 498

Real Rate of Return 498

Modern Portfolio Theory 499

Efficient Frontier 500

Asset Allocation 502

Asset Allocation Using Mutual Funds 503.

Contents

Diversification 505

Covariance 505

Correlation Coefficient 506

Coefficient of Determination' 508

Investment Strategies and Theories 508

Efficient Market Hypothesis 508

Active Versus Passive Investing 510

Indexing 510

Market Timing 511 ;

Buy and Hold 511

Behavioral Finance 511

12. Supplement A: Fixed-Income Securities 517

Basic Concepts of Lending Securities 518

Valuation of Fixed-Income Securities 518

Basic Calculation Example 519


Current Yield 520

Yield to Maturity 520

Yield to Call (YTC) 522

Comparing Corporate Returns and MunicipalsReturns 522

Types of Fixed-Income Securities 523

The Money Market 523

Government Debt Securities 525

US Savings Bonds 527

Municipal Bonds 529

Corporate Bonds 530

Convertible Bonds 532

Asset-Backed Securities 532

Rating Agencies1 534

Risks of Fixed-Income Securities 536

Interest Rate Risk 536

Default Risk 536

Reinvestment Risk 537

Purchasing Power Risk 537

Call Risk 537

Volatility of Fixed-Income Securities 537Coupon Rate 537

Maturity 538

Term Structure of Interest Rates 538

Yield Curves 538

Yield Curve Theories 540

Duration and Immunization 541

Calculating Duration 542

Duration as a Measure of a Bond'sVolatility 542

Using Duration to Immunize BondPortfolios 545

Traditional Methods of Immunizing BondPortfolios 546

12. Supplement B: Equity Securities 549 :

Introduction 550

Basic Concepts of Ownership Investments 550

What Ownership Means 550

Types of Equity Securities 552Common Stock 552

Preferred Stock 556

Foreign Securities 556

Risks of Equity Securities 557

Market Risk 557

Interest Rate Risk 558

Business Risk 558 .

Financial Risk 559

Exchange Rate Risk 559

Country Risk 559


Time-Weighted and Dollar-WeightedReturns 560

Total Return 561

Dividend Yield 561

Equity Markets and Benchmarks 562

Primary Market 562

Secondary Market 563

Market Indexes and Averages 564

Benchmarks 566

Purchasing Equity Securities 567

Long Positions 567

Short Positions 567

Margin Accounts 568

Trading Securities 569

Methods of Analysis 571

Technical Analysis 571

Fundamental Analysis 572

Valuation Models 573

Valuing Preferred Stock 573

XXX Contents

Constant Growth Dividend DiscountModel 573

Price-to-Earnings (P/E) Ratio 574

Valuing the Company versus Valuing theStock 574

Capital Asset Pricing Model 576

12. Supplement C: Mutual Funds 579

Types of Investment Companies 580

Unit Investment Trusts 580

Exchange-Traded Funds (ETFs) 581

Closed-End Investment Companies 582

Open-End Investment Companies (MutualFunds) 583 \

Mutual Fund Fees 586 *

Loads or Sales Charges 586

Other Mutual Fund Fees 586

Mutual Fund Classification 587

Load versus No-Load Funds 587

Classes of Load Fund Shares 587

Expense Ratios for Different Types ofFunds 588

Advantages of Mutual Funds 588

Low Initial Investment 589

Diversification 589

Ease of Access 589

Professional Management 589

Liquidity 590

Transaction Cost Efficiency 590

Variety of Mutual Funds 590

Shareholder Services 590

Types and Objectives of Mutual Funds 591

Money Market Mutual Funds 594

Fixed-Income Mutual Funds 594

Equity Mutual Funds 595

Hybrid (or Balanced) Funds 596

Foreign Mutual Funds 596

How Do Professional Investment Advisers SelectMutual Funds? 596

Performance Measures 597

Jensen's Alpha 597

Sharpe Ratio 598

Treynor Ratio 599

Information Ratio 599

Issues to Look for When Managing Portfolios ofMutual Funds 600

Changing Asset Size 600

Style Drift 600

Manager Changes 600

Built-in Gains 601

Portfolio Turnover 601

13. Individual Income Tax and Tax Planning 605

Income Tax Planning 606

History 606

Objectives of the Federal Income TaxLaw 607

Individual Income Tax Rates 608

Ordinary Rates 608

Capital Gain Rates 608

Determining Income Tax Liability 613

Total Income and Gross Income 613

Adjusted Gross Income (AGI)^, 614

Itemized Deductions and the StandardDeduction 615 \

Personal and Dependency Exemptions 617

Taxable Income and Tax Rates 619

Tax Credits 620

IRS Guidance 620

Penalties and Interest 621

Audit Process 623

Selection and Screening Process 623

Types of Audits 624

Outcomes of Audits 624

Payroll Taxes 627FICA Taxes for Employers andEmployees 628

Self-Employment Tax 629

Federal Unemployment Tax Act 630

Tax Avoidance versus Tax Evasion 631

Tax-Advantaged Investments ' 631

Investment in Tax-Exempt Securities 632

Tax Shelters 632

Acceleration of Deductions 633

Deferral of Tax Gains 634

Exemption Opportunities 635

Conclusion 636

Contents xxxi

Case Scenario 644

Personal Background and Information 644

General Goals (Not Prioritized) 644


Investment Information 645

Income Tax Information 645

14. Business Entities 653

Business Entities 654

Sole Proprietorship 655 .

Management Operation and Decision Makingof a Proprietorship 655

Legal Liability of a Proprietorship 655

Taxation of a Proprietorship 655

Partnership 657

Management Operation and Decision Makingof a Partnership 657

Legal Liability of a Partnership 658

Taxation of a Partnership 659

Family Limited Partnership 661

Management Operation and Decision Makingof a Family Limited Partnership 662

Legal Liability of a Family LimitedPartnership 662

Taxation of a Family Limited Partnership 662

Limited Liability Partnership 663

Management Operation and Decision Makingof a Limited Liability Partnership 663

Legal Liability of a Limited LiabilityPartnership 663

Taxation of Limited Liability Partnerships 663

Corporation 663

Management Operation and Decision Makingof a Corporation 664

Legal Liability of a Corporation 664

Taxation of a Corporation 665

S Corporation 667

Management Operation and Decision Makingof an S Corporation 668

Legal Liability of an S Corporation 668

Taxation of an S Corporation 668

Limited Liability Company 670

Management Operation and Decision Makingof a Limited Liability Company 670

Legal Liability of a Limited LiabilityCompany 670

Taxation of a Limited Liability Company 671

Selecting the Proper Business Legal Form 672

Simplicity of Formation and Operation 673

Ownership Restrictions 673

Limited Liability 674

Management Operations 674

Tax Characteristics 674

Business Entity Financial Statements 675

Balance Sheet 675

Income Statement 676

Statement of Cash Flows 676

15. Introduction to Retirement Planning 701

Introduction 702

Basic Factors Affecting Retirement Planning 702

Remaining Work Life Expectancy (RWLE) 702

Retirement Life Expectancy (RLE) 704

The WLE-RLE Relationship 705

Savings Concepts 705

Savings Amount 705

Savings Rate 706

Timing of Savings 707

Investment Decisions , 708

Inflation 709

Defining Retirement Goals (needs) 709

Planning for Retirement—Pretax or AfterTax 710

Wage Replacement Ratio (WRR) 711

Calculating the Wage ReplacementRatio 711

The Sources of Retirement Income 714

Social Security • 715

Private Pension and Company-SponsoredRetirement Plans 715

Personal Savings 715

Work 716

Qualitative Factors in Retirement—Advising Clients717

Summary of Factors Affecting Retirement Planning718

Risks to Financial Independence 719

Contents

Capital Needs Analysis 720

Basic Planning—Pure Annuity Model 720

Accurate Assumptions Are Essential 722

Advanced Planning—Capital Preservation (CP)Model 722

Advanced Planning—Purchasing PowerPreservation (PPP) Model 724

16. Basic Retirement Plans 731

Retirement Plans 732

Qualified Retirement Plans 733

Characteristics of Qualified RetirementPlans 734

Disadvantages.of Qualified RetirementPlans 737

Benefits of Tax Deferral 742

Types of Qualified Retirement Plans 744

Pension Plans 744

Profit-Sharing Plans 745

Defined Benefit and Defined ContributionPlans 748

Target/Age-Weighted Plans 749

Contributory Versus NoncontributoryPlans 750

Corporate Versus Keogh Plans 750

Other Tax-Advantaged Plans 752

Individual Retirement Accounts (IRAs) or IRAAnnuities 752

Simplified Employee Pensions (SEPs) 754

SIMPLE IRA Plans 754

SIMPLE 401 (k) Plans 755

Section 403 (b) Plans 756

Nonrefundable Credit for ElectiveDeferrals 756

Distributions from Qualified and Other Tax-Advantaged Plans 756

Nonqualified Plans 757

Deferred Compensation Plans 758

Split-Dollar Life Insurance 759

Employee Stock Option Plan 759

Section 457 Plans 759

The Financial Planner's Role In Retirement Planning760

17. Introduction to Estate Planning 769

Basics of Estate Planning 770

Estate Planning Reform 770

Estate Planning Defined 771

The Objectives of Estate Planning 771

The Estate Planning Team 772

The Estate Planning Process 772

Collecting Client Information and DefiningTransfer Objectives 773

Basic Documents Included in an Estate Plan 774

Wills 774

Power of Attorney 777

Durable Power of Attorney for Health Care orProperty 777

Living Wills and Advance MedicalDirectives 777

Side Instruction Letter or Personal InstructionLetter 778

The Probate Process Defined 778

Property Passing Through Probate 779

Property Passing Outside of the ProbateProcess 780

Advantages of the Probate Process 781

Disadvantages of the Probate Process 781 (..

Ownership and Transfer of Property ,781

Probate and Property Interests (Title andOwnership) 782

Less than Complete Ownership Interests 784

Interest for Term 784

Methods of Transfer 784

Consequences of Property Transfers 785

Introduction to Trusts 785

Living Trusts 788

Grantor Trusts 788

Reducing the Gross Estate 789The Use of Life Insurance in EstatePlanning 790

Common Estate Planning Mistakes 791

Invalid, Out-of-Date, or Poorly DraftedWills 791

Simple Wills ("Sweetheart" or "I Love You"Wills) 791

Improperly Arranged or Inadequate LifeInsurance 791

Contents xxniii

Possible Adverse Consequences of Jointly HeldProperty 792

Estate Liquidity Problems 792

Wrong Executor/Trustee/Manager 792

The Unified Gift and Estate Transfer TaxSystem 792

The Federal Gift Tax System 794

Purpose and Definition 794

Annual Exclusion 794

Applicable Credit Amount; LifetimeExemption 797

Qualified Transfers 798

Gifts to Spouses 798 ^

Payments for Support 799

Reporting and Paying Taxes 799

The Federal Estate Tax System 804

Purpose and Definition 804

Reporting and Paying Taxes 805

The Gross Estate 805

Deductions from the Gross Estate 807

The Charitable Deduction 808

Definition 808

Types of Charitable Bequests 809

The Marital Deduction 810

Definition 810

Qualifications for the Marital Deduction 810

Direct Bequests to a Spouse 810Qualified Terminable Interest Property Trust(QTIP) 811

Power of Appointment Trust 811

Optimizing the Marital Deduction 812

The Bypass Trust (Credit Equivalency) 812

The Mechanics of the Bypass Trust (CreditEquivalency) 813

Effect of Portability 814

Use of Disclaimers 815

Alien Surviving Spouses 815

Generation-Skipping Transfer Tax (GSTT) 815

The Role of the Financial Planner in EstatePlanning 816

Concluding Comments on the Unification Schemeof Gifts and Estates 817

Case Scenario 828


General Goals (Not Prioritized) 828




Education Information 830

Gifts, Estates, Trusts, and WillInformation 830

Relevant External EnvironmentalInformation 830

THE FINANCIAL PLANNINGPROFESSION

18. The Practice of Financial Planning 849

Introduction 850

The Financial Planning Profession 850

Financial Planning Institutions 851

Financial Planning Professionals 853

Compensation Methods 856

Compliance Issues 857

Developing a Professional Practice 859

Building a Practice 859

Maintaining Clients 860

Education and Continuing Education 861

Technology 861

19. Ethical Responsibilities 865

Introduction 866

Ethics, Law, and Codes of Ethics 866

CFP Board and the Standards of ProfessionalConduct 867

Note on Civil Liability 868

Code of Ethics And ProfessionalResponsibility 869

Rules of Conduct 870

Defining the Relationship with Clients(RuleD 870

Information Disclosure (Rule 2) 871

Client Information and Property (Rule 3) 872Obligations to Prospective and Current Clients(Rule 4) 873

Obligations to Employers (Rule 5) 874

Obligations to CFP Board (Rule 6) 874

xxxiv Contents

The Practice Standards 875

The 100 Series 875

The 200 Series 876 ,

The 300 Series 876

The 400 Series 876

The 500 Series 877

The 600 Series 878

Candidate Fitness Standards 878

Disciplinary Rules and Procedures 880

Notes on Burdens of Proof 880

Grounds for and Forms of Discipline 881

Report, Findings of Fact, andRecommendation 883 «

Conviction of a Crime or ProfessionalSuspension 884

Settlement Procedure 885

Required Action After Revocation orSuspension 885

The Importance of Ethics 886

APPENDICES 8 8 9

Appendix A Comprehensive Financial PlanningCase 891


Mark Lane (age 30) 891

Ava Lane (age 30) 891

The Children 891

The Lanes 892

Economic Information 892

Bank Lending Rates 892


Life Insurance 892

Health Insurance 893

Long-Term Disability Insurance 893

Renters' Insurance 893

Automobile Insurance 893



Retirement Information 894

Gifts, Estates, Trusts, and Will Information 894

Personal Statement of Cash Flows 895

Statement of Financial Position 896

Information Regarding Assets and Liabilities 896

Home Furnishings 896

Automobile 897

Student Loan 897

Stereo System 897

Requirements 897

Appendix B Time Value of Money Tables 899

Appendix C Regulatory Requirements 913

Regulatory Requirements—Federal SecuritiesRegulation 913

Introduction 913

The Securities Act of 1933 913

The Securities Exchange Act of 1934(SEA) 915

The Investment Advisers Act of 1940 916

Registration of Investment Advisers 917

Reform of Previous Acts 919

FINRA 920

Appendix D CFP® Certification Examination PrincipalTopics 921

Appendix E CFP® Certification Examination Job TaskDomains 925

Appendix F Standards of Professional Conduct (effec-tive July 2008; revised March 2009) 931

Glossary 973

Index 1001

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