Case Study
Date: 30 June 2016 (for completing relevant calculations)
Allan and Leslie Richardson recently read an article about personal finance in the local newspaper. The article discussed in detail common financial problems and dilemmas that families face through different stages of their life cycles. After reading the article, both of them felt an urgent need to seek advice from a financial planner.
The couple met at a university in Brisbane ten years ago as undergraduates and have been happily married ever since. Exactly twelve months ago, they decided to move to East Sydney when Allan agreed to take up a new position in the Sydney CBD. During your first meeting with them, Allan was quick to point out that he dislikes financial surprises. Leslie is willing to take some risk if the associated returns are worthwhile. Both of them do not spend a great deal of time tracking and understanding their finances.
Allan is currently 32 years old and works as a senior consulting engineer at a local telecommunication firm and earns a gross salary of $150,000 per year. Leslie, two years his junior, teaches at the local high school where she specialises in mathematics and science. She has a yearly gross income of $80,000. Their daughter, Hannah is 4 and their son, John is 2 years old. The children had their birthday about six months ago. They also have a polydactyl cat named Paws.
The Richardsons live in a three bedroom apartment which costs $7,000 per month to rent, but they are hoping to own a property in the next two to three years. In view of this, Allan has set aside a fund for their new home. The money is invested in a low risk managed fund earning stable returns for the last 5 years - the current balance is approximately $120,000. He also has a savings account balance of $65,000 that earns annual interest of 3 percent. They share a checking account that has a balance of $3,000 and the bank requires them to keep a minimum amount of $1,500 to earn annual interest of 1.5 percent. They took out a loan of $540,000 ten years ago to jointly own a house in Brisbane. The property currently generates a rental income of $500 per week.
They are somewhat concerned about the amount of personal income tax and medical levy withheld from them. They are not entirely convinced that the tax calculations are correct. In their regular weekend shopping, credit cards are often used. Their monthly balance always seems to hover around $2,500 at all times and they repay only 15% of the outstanding amounts at the end of each month. They use their card to draw cash from the ATMs to cover their daily household expenses even though they carry about $200 in cash between them.
Education is highly valued by the couple. After talking to her close friend, Leslie thinks that they should start thinking about saving for their children’s education expenses. To encourage their children to take up tertiary education, the parents are happy to set up an education fund for their children. The tuition fee per person is estimated to cost $34,000 per year at the commencement of the study and other related annual expenses would cost another $12,000 per year. The tertiary program will take three years to complete.
The couple believe they should save and be self-sufficient during retirement although they have yet to establish a retirement plan. To date, Leslie has accumulated $60,000 in her superannuation account while Allan has $83,000 in his account and has not named the beneficiary.
On a yearly basis, the following additional costs are estimated for the family:
Expenses Estimated cost
Utilities $5,000
Car usage/maintenance $8,000
Food and groceries $6,000
Entertainment $8,500
Miscellaneous expenses $4,000
The following additional information is available:
Superannuation dividend payments are approximately 5% indefinitely. In general, an increment of 3% in salary is expected every year.
The long-term return for equity investment is projected to be around 14% per year, whereas bond funds are expected to offer yield of 6% per annum. Investment in term deposits will generate average return of 5% per annum over the next 35 years. Return from low risk managed fund is approximately 7% per year. Average yearly return on all other investments is expected to be around 4% per year.
The life expectancy for Allan and Leslie are 80 and 85 years old respectively. The children are expected to be dependent on their parents until they turn 24 years old.
Tertiary education will commence when the children turn 19 years old.
Allan and Leslie are Australian residents.
For calculation of taxable income, use the relevant tax rates provided by the Australian Taxation Office (ATO).
Allan has tallied his work-related expenses for the year to be $6,000, which includes $2,000 for return bus fare from home to work during the year. He has also donated $600 to CARE Australia. Leslie has work-related expenses of $1,500, tax deductible gifts totalling $800 and paid $200 for tax return preparation.
Interest charged on the 20-year loan used to purchase their Brisbane property amounts to about $26,000 per year. Monthly loan repayment amounts to $4,187 (interest and principal). In addition, they pay annual agent fees of $1,820 and rates to the local council amounts to around $2,400 each year. A recent valuation report suggests a market value of $890,000 for the property.
Both Allan and Leslie provide approximately 9% superannuation contributions via salary sacrifice and their respective employers provide another 10% contribution into their superannuation funds.
For the use of credit cards, interest charged for unpaid balance is approximately 17% p.a. A yearly fixed rate of 7% will be incurred for all other types of loan.
All debts are amortised over the period of the loan. Mortgage repayments are made at the end of each month.
Required
Question 1 -10 marks
Help Allan and Leslie identify their short-term and long term financial goals.
Question 2 -15 marks
i.) Based on the information available to you, construct an income and expense schedule for the Richardsons.
ii.) Create a net worth statement for the Richardsons. Comment on whether they have a negative or positive net worth.
iii.) Using information from the above, calculate the following ratios (make sure you make a brief comment on each ratio).
a. Savings ratio
b. Liquidity ratio
c. Solvency ratio
d. Monthly debt service ratio
For the ratios, use the definitions provided by Taylor and Juchau (2016). Show details of your calculations and provide a brief analysis.
Question 3 -10 marks
Assuming 3 years from now, the couple decides to purchase their own property in Sydney. The estimated purchase price is $1,500,000. They are able to obtain 90% financing from the bank at a fixed rate of 7% for 20 years.
i.) How much do they have to pay the bank every year?
ii.)How much do they still owe the bank when Hannah goes to university?
(Present an amortisation table for their mortgage).
Question 4 -10 marks
Calculate the amount to be saved at the beginning of each year in order to accumulate $46,000 for Hannah’s education, assuming a discount rate of 12% on their savings.
If instead, they save money at the end of the year, how much do they have to put aside to meet the same education funding goal?
Question 5 -10 marks
Allan is doubtful about his tax calculation. Using the information provided, calculate the taxable income and tax payable for him. What tax planning advice can you offer to the couple?
Question 6 -10 marks
The Richardsons do not have a will. Advise them on the issues they should consider in drawing up a valid will (make sure you include the children in the will).
Question 7 -10 marks
Discuss the need for the following covers for both Allan and Leslie.
i. Total permanent disability
ii. Trauma
iii. Income protection
Question 8 -25 marks
Based on your discussion in parts 1 to 7, provide specific recommendations to allow the couple to achieve their desired goals. Advise them of any potential problems or issues they need to know and suggest alternative plans to overcome them. Support your recommendations with additional calculations.