The Planning Cycle

A Consumer's Guide to Planning for Financial Security

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Why Do We Accumulate Assets?

History tells us that people have always been desirous of owning property. Somehow we feel more secure when we are in possession of something tangible. Beyond the mere satisfaction of owning an asset, of watching it grow, is the basic fact that someday our ability to earn money will stop.

We also know that most people would like to have the ability to retire before age 65, however, people are living longer than ever before.

This puts a huge strain on people's life savings.

Types of Assets

Most people have four types of assets:

	Personal Assets- such as a home, car and savings.		Business Assets- these may include company sponsored insurance programs and retirement plans, and sometimes, ownership in businesses.		Life Insurance- not only in death benefits, but also cash values.		Government Programs- such as Social Security Benefits.

Even though not normally considered an asset, Social Security can provide valuable benefits at retirement, disability and death.

How Much Do We Accumulate?
Few People accumulate all that they and their families need. From a recent study by the Social Security Administration we can draw the following conclusions:

Where Will You Be?

For every 100 people starting their careers the following situations exist at age 65...

It really is a paradox that in the world's richest nation millions of people live in poverty. These people didn't plan to fail - They failed to plan.

Why Do People Fail to Plan?
The accumulation funnel (below) shows how we try to accumulate assets. It has two siphons that illustrate some of the reasons why it is so difficult to build enough capital.

Objectives of Financial Profile
Before exploring the two siphons in detail, let's state the objectives of Financial Profiles:

1. To help us overcome financial roadblocks while alive.
2. To plan for cash needs at death.
3. To create sufficient income from our assets for ourselves and our family when our ability to earn stops.

Roadblocks While Alive

Inflation

Since 1950 there has been only one year in which prices did not increase. Inflation appears to be here to stay. In the short run, hopefully, our earnings will keep pace. However, investing for the future creates a different kind of problem. We will have to try to make investments that do have a reasonable chance of providing a hedge against inflation. To take advantage of these types of investments usually requires a significant amount of money to start with. This underscores the importance of starting early on some type of accumulation plan to form a pool of capital.

Tax Deferral

Inflation may be the cruelest tax of all! However, income taxes also strip us of our ability to accumulate money. While it is usually not possible to totally avoid income taxes, there are ways to postpone the tax. Deferral or postponement has two advantages:

1. We may be in a lower tax bracket later in life.
2. The fund will grow faster if no taxes have to be paid while the assets are building.

The “good news” about tax deferral is that it is not something that is only available to the “rich.” Each of us can usually take advantage of one or more such plans in our investment program.

Investment Strategy

One of the first things we need to understand about investments is that, usually, the greater the rate of return offered, the greater the risk. Wealthy people who can afford to lose some of their capital can take chances in an effort to obtain high rates of return. For most of us, however, this is not a prudent course of action. There are at least two reasons for this:

The money we wish to invest has been difficult to accumulate and we simply cannot afford to lose it.

Losses are difficult to overcome. For example, let's assume we pay $5,000 for a stock and the stock drops in value to $2,500. At that point we have suffered a paper loss of 50%. But at the same moment our stock will have to appreciate by 100% to get back to its original value. So the best strategy may well be to invest for safety first, and return second.

The Threat of Disability

A 25 year old person has a one in four chance of being disabled for 90 days or more before age 65. According to a recent Social Security report the average duration of Social Security disability claims is 12 years. That staggering statistic makes it all too clear that it is terribly important to plan adequately. The question we might ask ourselves is, “If I were sick or hurt tomorrow and couldn’t go to work, how long could I live on my savings?” Until we can build our estates, the only practical way to protect ourselves against a prolonged disability is by having adequate disability income insurance.

The Need For Investment Savings

Consumptive saving, for example, saving money for a vacation, is a great idea, but it does not create capital for the long haul.

Thus, sooner or later, in addition to saving for future spending, we will have to save for long-term investment purposes.

The Need to Save First

If someone asked us whether we are satisfied with our savings and investments, few of us would respond positively. Why is this so? Because most of us spend first and try to save and invest what little is left.

This is illustrated by the first circle. Few people set aside a definite amount first and spend the balance as illustrated by the second circle.

Usually, people in the first circle end up with little or no savings or investments. Conversely, people in the second circle accumulate dollars for future use. In other words, they generally have money when they really need it.

In Summary

The roadblocks to creating an estate are formidable! Only by proper planning can we hope to overcome them. Now let's turn to the problems our heirs face after our death.

How Much Money Would It Take To Replace You?

Of course, no amount of money in the world can replace our loved ones and the experiences we share throughout a lifetime. Unfortunately, we do not always know how long we have together. While money can never replace a loved one, we can use life insurance to help replace their income and keep the family in their same lifestyle. One of the primary uses of life insurance is to replace any income lost due to the death of an income-earning individual. There are only two things that make money, people at work and money at work. Knowing this, we can look at an example of how much money it would take to replace the amount of income you provide to your family.

How much Is $ 1 Million Dollars Really Worth?

Most people think that $1,000,000 dollars is a lot of money and certainly in many cases, it can be. But just think for a moment of how much you expect to earn over your lifetime. Think of how much you have already earned since you began working. One of the first areas of consideration in determining the amount of life insurance you should have is your income and how much of it you would need to provide to your family in the event of your death. The death of a family member is usually a traumatic time, and this is dramatically compounded when that family member is counted on to provide income. So, how much capital would you need to replace the income you provide? Let's look at an example. What rate of return do you think you could get on an investment while remaining relatively conservative? In many cases 7% would be attainable, considering various market factors. For this example, we'll use 7%.

So,

$ 1,000,000 x 7% = & 70,000

But now, we must take into account inflation, which changes over time and will fluctuate due to a variety of circumstances in the financial world.. For this example, we will assume inflation is at 2%.

So,

$ 1,000,000 x 7% (-2% inflation) = $ 50,000

Based on these assumptions, you can see that $ 1,000,000 of capital may only replace about $ 961 of weekly income for your family and this is before we take taxes into account. Would that be enough money to keep your family in their accustomed lifestyle? Would that be enough income to maintain the house, the children's education, and other obligations your family would continue to have? Would your family need more or less than that amount per week to pay the bills?

Keep in mind that this only takes into account replacing your income, there are often many expenses that can come up after someone dies. Would you want to make sure the mortgage was paid off? To make sure your children's college funding was completed? What would you want to occur in the event of your death?

Cash Needs At Death

Immediate Money Fund

There is nearly always a need to pay for such things as medical, hospital and burial expenses. Additionally, there may be attorneys' and executors' fees, taxes and Probate Court costs. Except in large estates, an amount equal to 50% of annual income may be sufficient for this fund.

Debt Liquidation Fund

Before an estate can be closed, all indebtedness will have to be satisfied to the fullest extent possible.

Emergency Fund

If an emergency such as unexpected car repairs or medical bills comes up, we usually pay for it over a period of time out of current income or out of savings. In the event of the death of a wage earner, it might be difficult or impossible to find the money for such a contingency. In view of this, most people like to establish an emergency fund. One half of their annual income is an amount that many people choose for this purpose.

Mortgage/Rent Payment Fund

Many families who own a home like to provide a fund to help pay off the mortgage in the event of the death of a wage earner. If the mortgage has a low interest rate, the insurance proceeds could be invested to help with mortgage payments. Additionally, many times survivors will want to pay off a mortgage in order to have a debt-free home. While this may not make “economic sense,” it may well make “peace of mind” sense.

Those who are presently renting may want to provide a rent payment fund equal to 10 years of rent payments. It could be used to help continue rent payments, or, as a down payment on a home or condominium. With inflation pushing rents ever higher, survivors might indeed welcome the relatively fixed payment a home or condominium may provide.

Child/Home Care Fund

When either spouse dies there are many functions they were performing that might necessitate the hiring of someone else to do. For example, there are many ways in which a mother or father can never be replaced but there are some ways in which they must be replaced. Someone must cook, wash, iron, sew, mow the lawn, repair the faucet, paint, and so on. Hiring someone else to perform these functions will require more than a little money. The amount required will vary depending upon many factors such as the ages of the children.

Educational Fund

If we live, it may be possible to cover educational and vocational expenses either out of current income or by borrowing. But, if we die, the money will have to come from somewhere else. In view of this, many families set up a fund to help provide the money in the event of a wage earner's death. $50,000 per child is usually the minimum that is required.

A Sample Case

Let's take a look at a Cash Needs analysis for a family with two children, where both parents are working.

Income Needs at Death or Disability

In addition to cash needs, there may be income needs that have to be provided for at the time of the death or disability of a wage earner. This will be especially true for those of us with a spouse and children.

According to a government study by the Bureau of Labor Statistics, in order for a family to “remain in their own world” after the death or disability of a wage earner, it requires about 70% of their gross income before death. So by multiplying total family income (both spouses, if working) by 70% we can arrive at our income objective.

Social Security Benefits

In certain cases a part of our family's required income may be provided by Social Security survivor or disability payments.

It is beyond the scope of this discussion to explain how to calculate the amount of capital needed to satisfy our income objective. Suffice it to say that additional life and disability insurance may well be required.

Setting Priorities

Right about now you are probably saying to yourself, “I have many financial needs, but on my present income, I can't begin to do all of the things Financial Profiles suggests”.  Planning for financial security is a long-range process that usually takes most of our lives. What we need to do is to set priorities.

The advice given by most planners is to start with a savings account and adequate life and disability insurance. These three, along with possible home ownership, can form the nucleus of our plan. The savings provide a financial reserve which is important. The insurance buys us the necessary time to complete our plan. For even with the best of planning, premature death and disability can totally destroy any plan.

Future Planning

There are three cornerstones to financial security: accumulation, retirement, and protection. Once our protection needs have been satisfied against death, disability, property loss and liability, we can begin planning for the accumulation and retirement cornerstones.

Accumulation - 5 Years or Longer

While we may want to accumulate money for such things as a second home, frequently accumulation planning involves building a fund to educate our children. Financial Profiles is designed to calculate the amount that has to be set aside to meet a given objective. It is important to start a plan as early as possible in order to minimize borrowing when children go to school. It is a basic truism that when we save, interest works for us, while when we borrow, interest works against us.

Retirement Planning

During our lifetime we will earn a fortune! When we retire it  won't matter how much we earned, what will matter is how  much we kept. If we start early enough, compound interest    can really help us. For example, a 35 year old person wanting   to accumulate a quarter of a million dollars has to save only $2,000 per year or $60,000. The other $190,000 will come from interest earned. Financial Profiles is designed to help us analyze and plan for our retirement needs.

Who Can Help Us?

As the years go by and our plan grows in complexity, we may well be calling upon a whole series of experts to help us. Included in this group may be an accountant, attorney, a trust and investment officer of a bank, stockbroker and real estate expert.

However, for most of us, the first person who can help us is a professional insurance agent who specializes in Financial Profiles. Such a person can help us to take the four steps necessary to achieve financial success:

1. Set financial goals
2. Prioritize them
3. Initiate a plan of action
4. Review and update the plan regularly

A Final Word

There you have it the story of Financial Profiles. If your Financial Profile shows that you require more capital, life and disability insurance may well enable you to provide an immediate and economical solution to your problem.

Were it not for insurance, we would have to save, and save and save some more, to create a pool of capital as quickly as possible. We would not have the luxury of “time”!  Insurance provides us “time” because the capital is created immediately even if premature death or disability deprives us of adequate “time”.

The foregoing is a paradox which is not generally understood. People feel that when they buy insurance they have less money to spend. In reality, quite the opposite is true. Once adequate insurance is in place, we can spend more of our income with a clear conscience, because we and our loved ones will be provided for should we become disabled or die prematurely.

Information provided from © 2006 Financial Profiles, Inc. All Rights Reserved.