1. INSU 432 LIFE INSURANCE Chapter 12 Professional Financial Planning DORFMAN 1

2. *PROFESSIONAL FINANCIAL PLANNING  Understand the financial planning process  Understand the role of insurance products play in a comprehensive financial plan  Describe a needs-based purchase of life insurance  Explain how life insurance can be used to fund business continuation agreements  Describe some aspects of the taxation of life insurance benfits 2

3. Typical questions for personal financial planning  How much money will my family need in the event of a premature death?  How much money should I save to finance a child’s college education?  How much money do I need to save for retirement? And, what is the most tax- efficeint way to hold these savings? 3

4. The Financial Planning Process  The description of the process is that of interest to people considering pursuing a career as a professional financial planner and for people who want to complete their personal financial planning in an organized way with a knowledge of tax, social security rules and benefits, investment alternatives, life insurance, property insurance, emplyee benefits esp. Retirement and health insurance plans. 4

5. PROFESSIONAL FINANCIAL PLANNER  Fee-only planners : charge hourly or flat rate to clients  Fee-based planners : charge a fee based on a percentage of the assets they managed.  Fee-offset planners: charge a set fee with and reduce it in case of commission  Commission-based planners : earn income by generating sales of securities, life insurance policies and other services. 5

6. THE PROFESSIONAL FINANCIAL PLANNING PROCESS  Step 1: Motivate and educate clients  Step 2 : Collect data  - cash budget can be developed from tax returns and checkbook records.  Adjusted cost basis: net cash outflowfor purchased property, purchase price and any expenses incurred to acquire a property..  - risk attitude ; risk tolerant,risk averse, risk neutral( fair trade-offs between loss and gain) 6

7. THE PROFESSIONAL FINANCIAL PLANNING PROCESS  Step 3 : Develop goals- developing a plane forces people to identify the goals they value most and allows them to rank the needs, desires and tastes.  Step 4: Implement plants  Sucha as to make wills  Step 5: Review and update plans  Plans change 7

8. THE EARLY ADULT YEARS  There are no set boundries for the early adult years. The characteristics of this period include first jobs, first children and an accumulation of debt, especially mortgage loans on first houses.  Life insurance is a guarantee of future purchasing power if people die prematurely. 8

9. The Needs-Based Purchase of Life Insurance  A needs analysis can identify the financial problems caused by a premature death.  A needs-based purchase means people purchase life insurance in an amount equal to the difference between the assets required to complete a financial plan and the assets available to meet the needs. 9

10. Permanent and Term Insurance  If some needs for life insurance are not a function of time, that is, the needs exist at all ages, they are called PERMANENT NEEDS.  A need for life insurance that comes to a foreseeable end is called a TEMPORARY NEED. 10

11. POSTDEATH RESOURCES  Burial Fund(P)  An Education Fund(T)  An Income Fund(T)-after a death of the wage earner`s death  A Debt Retirement Fund(T)-to pay for the credit cards etc. if the breadwinner dies prematurely.  A Estate Preservation Fund(P)-( burial costs, court courts, attorney fees, federal transfer, state death tax) 11

12. An Equation for the Needs- Based Purchase of Life Insurance Life Insurance= Financial - Available Purchased Needs Assets 12

13. Total need for postdeath funds available from the total assets to meet the needs.  Social security benefits  Death benefits from employment such as group life insurance  Savings accounts, investments and other liquid assets  Proceeds from life insurance policies already owned  Business interest, home equity and other nonliquid assets 13

14. THE MIDDLE YEARS  At some point in the financial life cycle, children become independent, mortgages are repaid and families accumulate savings.  There is a change in the financial concern from the problems in the early adult years to the reiterment funding..which occurs likely beween the ages 40 and 60. 14

15. The Same Sequence of Steps is followed for the middle years as for the early years.  1.Collect and analyze data and other relevant information.  2.Specify the financial  3.Implement the strategy  4. Monitor and modify the plan to meet changing circumstances and goals. 15

16. STEP 2: SPECIFY THE FINANCIAL GOALS  In many ways, specifying financial goals for retirement while a person is still in middle age is more difficult than developing financial goals during the early adult years. e.g. Estimates of retirement needs made by a 50 year old may involve expenditures planned for 40 years in the future. 16

17. The Role of Life Insurance and Annuties in the Middle Years  Premature Death Protection Priority attention should be made during middle ages plans for premature death or disablility. Retirement Funding Annuity; insurers guarantee each annuitant a stream of income that will last until death occurs. 17

18. THE LATER YEARS  At some point, people must transfer their wealth from one generation to another. We call the process of planning the transfer fo wealth estate planning. ( logical and economic transfer of assets) A WILL is a legal document in which a person directs the disposal of his or her assets at death. PROBATE is the name for the legal (court- supervised) process of transferring property at a person’s death. A person dying without a will is said to have died interstate and some (40% of all). All states have laws prescribing the interstate distribution of property. 18

19. BUSINESS USES OF LIFE INSURANCE  Business firms often purchase life insurance for the following reasons:  To provide benefits for employees  To protect the firm against the financial problems caused by the loss of a key person  To aid in transferring business ownership 19

20. GROUP LIFE INSURANCE  Firms buy group life insurance as an employee benefit. Many employers, including the federal government, provide group life insurance as benefit.  The purpose is to help attract, motivate, and retain employees. 20

21. KEY EMPLOYEE LIFE INSURANCE  If a business were to lose a key person, its earning power could be harmed.  Key employee employee life insurance can protect business firms from financial problems caused by such losses.  The first step in the risk management process is to identify the key person. It may be the president, the chief researcher, a top salesperson or an engineer. Losses of key people have the potential of causing severe losses, more so than property losses. 21

22. KEY EMPLOYEE LIFE INSURANCE  Another business use of life insurance is to provide a means of rewarding and retaining valuable personnel. The split- dollar life insurance plan allows firms to achieve this.  Both employer and employee pay a part of the premium for an insurance policy having a saving feature. 22

23. The split-dollar life insurance plan  The employer receives an amount equal to the savings value at the employee’s death. The employee`s beneficiary receives and amount equal to the face value less the saving value.  eg. If the employer paid 25000 $ over 15 years than this cash value will be deducted form 100,000 of face value and $75,000 will be paid to the beneficiary. 23

24. FUNDING BUSINESS CONTINUATION AGREEMENTS WITH THE LIFE INSURANCE  Partnerships, sole proprietorships and closely held corporations often need to purchase life insurance to facilitate the transfer of ownership when a proprietor dies.  If a proprietorship is sold at a predetermined price at the owner`s death the this will relieves the spouse.  The buyouts allows the continuation of the business.(buy and sell agreement) 24

25. THE BUY AND SELL PLANS  Each partner(share-holder) can purchase life insurance on every other partner(shareholder) this is called the cross-purchase plan.  The partnership(corporation) can purchase the insurance on each partner (shareholder); this is called the entity plan. The second alternative involves a much smaller number of policies. If there are eight partners that means 56 policies in total. Under the entity plan only eight policies would be needed. Due to tax applications the cross-purchase may be favored. 25