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final exam review AAEC 2104
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This 36 page Study Guide was uploaded by Jennifer Cartwright on Thursday May 5, 2016. The Study Guide belongs to AAEC 2104 at Virginia Polytechnic Institute and State University taught by Dr. White in Spring 2016. Since its upload, it has received 83 views. For similar materials see Personal Financial Planning in Agricultural & Resource Econ at Virginia Polytechnic Institute and State University.
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Date Created: 05/05/16
Chapter 1: Financial Planning: The Ties That Bind Why Personal Financial Planning? o Reasons: Money doesn’t have instructions on how to use it Harder to save Achieve goals in life Reduces stress in the long run What can be accomplished? o Be able to manage for emergencies o Be able to make big purchases, special expenses, and reach your goals o The ability to increase in your investments toward retirement o Maximize the after tax income Planning Process o Ongoing process o 5 steps: Evaluate financial condition Define financial goals Develop into a plan of action Implement your plan Review Evaluate Current Financial Condition o Important questions to ask yourself What do you own? What do you owe? What do you earn? What do you spend and what are you spending it on? Define Goals o Short term = less than 1 month o Intermediate = 110 years o Long term = more than 10 years o Goals will change and you may have to revise them. o SMART Specific, measurable, attainable, rewarding, time Develop a plan o Write down your goals to make them real o Have them be organized and include deadlines o BABE RUTH RULE!!!!! o Flexible Change as needed Be prepared for unexpected o Liquidity Being able to get cash quickly o Protection Have insurance o Managing taxes Keep more of your earnings Implement o Use the plan Review o Go back over and see what needs to be changed, if anything. Life Cycle of planning o Early Years (college) Expenses tend to be greater than income o Earning years (first job after graduation) Just starting in the work force Good time to focus on starting a family and paying student loans o Golden Years Prime earning years o Retirement Years Expenses tend to be more than earnings due to medical bills Principle 1: Best Protection is Knowledge o Stay up to date on your financial matters o Rely on trustworthy sources Principle 2: Nothing happens w/o a plan o Saving requires thinking and planning o People tend to spend money without thinking Principle 3: TVM o Time Value of Money o Risk o Inflation o Opportunity cost o Money isn’t worth the same in the future as today Principle 4: Taxes Affect Personal Finance Decisions o Taxes influence actual earnings o Want to maximize the after tax return Principle 5: Stuff Happens… the Importance of Liquidity o Have money for the unexpected o w/out liquid funds: long term investments will be liquidated Results: Lower price Tax consequences Missed opportunities o w/ nothing to sell: Higher interest when borrowing money quickly Principle 6: Smart Spending Matters o Reduce spending for a fast way to increase financial situation o Consider your wants vs. your needs o Comparison shop Babe Ruth Rule! Principle 7: Protect yourself Against Emergencies o Get to know your insurance before an accident o Know what the policies cover o Insurance is for major emergencies (ie. Medical, auto, homeowner’s) Principle 8: RiskReturn Trade Off o High risk is high return, low risk is low return Principle 9: Diversification Reduces Risk o Don’t put all your money into one investment o Reduces your risk exposure Principle 10: Just Do it! o Make the commitment to start o Use your time wisely o Take action Chapter 2: Measuring your Financial Health o Balance Sheets o Own and how you have paid for it o Own vs. owe o Assets: what you own o Liabilities: what you owe o Net worth: Financial value Assets Liabilities o Balance sheets: Assets o Monetary assets: savings, checking, cash, emergency funds, etc o NonRetirement Investments: stocks, bonds, life insurance, real estate, etc o Retirement Assets: IRA, 401(K), etc o Housing o Automobiles o Personal Property: collections, clothing, etc o Other: anything not listed above o Classifications: Monetary (liquid) Investment: Retirement and NonRetirement Tangible o Balance Sheets: Liabilities o What you owe as of today o Current liabilities are due within the year Payables: bills you owe and haven’t paid Utilities, taxes, insurance premiums, etc. o Noncurrent liabilities Remaining on each loan Auto loans, mortgage, student loans, etc o Balance sheet: Net Worth o What you are financially worth o Net worth = Assets Liabilities o Positive: if negative = insolvent o Income Statement o Tracks money over a period of time o Easier to do monthly basis o Can: Identify ways to reduce spending Project future budget Determine how to save or invest per month o Income Statement: Income o List all sources of cash income Gross salary, investment income, other income, tips, scholarships, etc o Total all income based taxes Local, state, and federal FICA: social security (6.2) and medicare taxes (1.45) FUTA: Unemployment o Gross income – income taxes = take home pay Take home pay for first job: gross income * (125%) o Income Statement: Savings and Investments o Amount you have added to your savings throughout a given time period o Amount invested that same period o Aim for 10% gross income going towards savings and investments o Income Statement: Expenses o List all household expenses o Ways to list: Housing Includes, rent, repairs, utilities, etc Food Grocery and nongrocery Clothing and personal care Clothes, toothpaste, etc Transportation Loan payments, gas, rental/lease, repairs, etc Medical Copays, prescription, etc Insurance premiums Auto, life, health, etc Recreation other o Expenses: Beware o Common mistakes: Don’t double count credit card payments Categorized according to proper expense Don’t forget nonregular payments Insurance premiums Don’t include investments o Budgeting o Review Look over income statement and goals o Estimate income and expenditures for the upcoming months o Fudge factor 1020 o Track expenses and adjust at the end of the month accordingly o Negative: Check math See what you can reduce of expenditures Is a life style change needed? o Positive: Increase spending Invest for retirement Pay debts faster Donate Increase expenses for a little while (treat yourself) o Financial Ratios o Allow you to gauge financial condition o Liquidity o Debt Repayment ability o Savings o Financial Ratios: Liquidity o Tells you how many months of living expenses you have o Monetary assets/ monthly living expenses o Bench mark: 36 months o Financial Ratios: Debt Payment o Total Debt payments/ gross income o Benchmark: less than 3840% o Financial Ratio: Savings o Saving and Investments/ Gross income o Benchmark: greater than 10% o Based on stage of life o Financial Health o Take a look at everything Balance sheet Income statement Financial ratios o Track changes o Record Keeping o Why do it? Prepares taxes Track finances Emergencies 5 d’s Disease, disability, divorce, disasters, death o How? File cabinet, envelopes, computer, accounting service o What to keep? Tax records Investment records Insurance records Retirement records Estate planning documents Debt records Receipts for major purchases Balance sheet Income statement Warranties, contracts, deeds, etc Household inventory o How long? Tax records: 37 years Debt records: life Investment records: life Real estate records: life Estate planning records: life Benchmark Liquidity 36 months Debt Payment Ratio Less than 3840% Savings ratio Greater than 10% Chapter 3: Time Value of money Time Value of Money o Risk, Inflation, Opportunity Cost Type of Time Value Problems o Future Value (lump sum) o Present Value (lump sum) o Annuities and Loan payments o Future Value of Annuities o Present Value of Annuities o Perpetuities Time Value Secrets o Lump sum vs. annuity Lump sum: one time event Annuity: series of cash flow o PV vs. FV FV: what it will be worth in the future PV: what it is worth today Solving TVM problems o Use financial calculator o Use factors from the book o Use formulas o TVM calculators online Using Financial Calculator o Convention Use positive number for PV Positive means the amount deposited into account Use negative for FV Equals the amount available For PMT: Positive for deposits Negative for payments Use End for loan Payments Use begin for pretty much everything else o Future Value of Lump Sum (FV) Investments worth in the future FV = compounding Compound interest For annual compounding (once per year) FV = PV*(1+i) n o FV = future value of investment made today o PV= investment made today o I= annual interest rate o N= number of years FV factor tables o FV= PV*FV factors Non annual compounding FV = PV*(1+i/m) (n*m) o M = number of compounding per year o Rule of 72 Estimate of the number of years to double your money Years= 72/annual return Annual return = 72/years o Present Value of Lump Sum (PV) PV = ‘discounting’ n PV = FV/[(1+i) ] Non – annual compounding PV = FV/[(1+i/m) (n*m] o Annuities Constant streams of cash flow over a period of time Loan payments Lottery winnings Monthly retirement investments o Terminology Compound or Regular Annuity: cash flows occur at the end of each period Annuity Due: cash flows occur at the beginning of each period o Types of Annuity Problems FV of Annuity (FVA) Regular investments worth in the future PV of Annuity (PVA) Stream of future cash flows worth now Annuities Calculating the periodic cash flow itself Loan payments o FV of Annuity Regular investments worth in the future FVA = Annuity * FVA factors End of period payments (he uses beginning of period payments) Multiply the factor in the table (1 + I/Y) to convert to BGN o Perpetuities Annuities that last forever Easy way to estimate asset value PVP= Annuity/ Annual Return Use Equation Net Worth Assets Liabilities Take home pay Gross income – income taxes Take home pay first job gross income * (125%) Liquidity ratio Monetary assets/ montly living expenses Debt Payment/income ratio Total debt payments/ gross income Savings ratio Savings and investment/ gross income Future Value (lump sum) PV*(1+i) n FV factor table PV*FV facto(n*m) Non annual compounding (FV) FV = PV*(1+i/m) Non – annual compounding PV = FV/[(1+i/m) (n*m] (PV) FVA Annuity * FVA factors PVP Annuity/ Annual Return Chapter 4: Federal Income Taxes Why do we pay income taxes? o Help fund national, state, and local efforts Running the government and government programs Roads, bridges, schools, libraries National defense Police/fire departments o Want to maximize your after tax income Marginal vs Average Tax rates o US uses a progressive tax system Tax rate goes up as income goes up o Everyone starts out paying the same rate o Marginal tax rate = taxes owed on the next dollar earned o Average tax rate = total taxes/ taxable income Takehome pay o Gross income minus Federal income taxes withheld State income taxes withheld FICA:7.65% o Filling out a W4 form More exemptions you list, less income tax withheld General Info o Determine if you have to file: Single, not dependent (gross income is over 10,300) Dependent (unearned income greater than 1,00 or earned income greater than 6.300) o Determine which file to use 1040EZ, 1040A, 1040 The “Theory” of Income taxes o Look at IRS Form 1040 Address and personal info Filing status Exemptions Income Adjustments to income Taxes and tax credits Other taxes Payments Refunds/ amount owed Address and Personal Info o Use IRS labels if possible o Name and Address o SSN o State income tax forms Filing Status o Single o Married, filing jointly o Married, filing separately o Head of household with dependents o Qualifying widower with dependent children Exemptions o An allowance for you and your dependents 4,000 per exemption o Claim yourself Unless you’re a dependent under your parents o Claim your spouse and dependents Dependents are qualifying child or relative Under 19; under 24 AND full time student Any age if permanently disabled Didn’t pay more than ½ of own support for the year Lived with you for at least ½ the year (time at college counts) Income o List your gross income for the year by source Support with w2 o Wages, salaries, tips o Interest earned taxable and tax exempt Schedule b o Dividends ordinary, qualified Schedule b o Business or farm income Schedule c or f o Capital gain/loss from sale of assets Schedule d o IRA distributions, pensions, unemployment o Other income Adjustments o Reduce total income Total Income – Adjustments = Adjusted Gross Income AGI o Main adjustments for students/ graduates Moving expenses (jobrelated) Self – employment items ½ SE tax, retirement contributions, health ins premiums Traditional IRA contributions Student loan interest payments (up to 2500) Tuition and fees deductions (up to 4000) Tax and credits o Standard deduction vs itemized deduction Reduces taxable income Use larger of the two o Standard deduction = 6,300 for singles 12,600 for married/joint o Itemized deductions Use Schedule A o Itemizable Expenses Medical and dental expenses (only amount over 10% AGI) State and Local income taxes or sales tax Real estate and personal property taxes Interest paid Gifts to charity Casualty and theft losses Unreimbursed job expenses o Deductions for exemptions 4,000 per exemption o Taxable income o Tax o Alternative Minimum Tax o Tax Credits Directly reduce your tax liability o Child/elder care o Education credits American Opportunity Credit Up to 2500 per students Only for the first 4 years of higher education Lifetime up to 2,00 per return Can’t use if you claim tuition/fee adjustment Can’t use if you’re a dependent Other taxes o Primarily selfemployment taxes Schedule SE o Add to your income taxes to get Total Tax Payments o All tax payments made during the year o Income tax withheld (w2) o Estimated tax payments Primarily for businesses o Earned income credit For lowincome family o Add to get total payments Refund/Amount Owed o If Total Payments > Total Tax means Refund Otherwise you owe more income taxes o Can receive refund directly into bank account Legally Reducing Your Taxes o Reduce your taxable income Make retirement contributions o Increase your adjustments Make traditional IRA contributions Roth for students Student loan interest, moving expenses, etc. o Standard vs Itemized deductions Take the larger of the two For most students use standards o Increase itemized deductions Houserelated deductions Mortgage interest, property taxes Incure medical expenses in the same year All elective surgeries in the same year Increase charitable donations o Use any tax credits that might help Education credits, child/elder care, etc o Qualified dividends Hold stocks at least 60 days o Taxexepmt ncome Municipal bonds Chapter 5: Cash Management Liquidity vs Savings o Liquidity: rapid cash needs o Savings: emergency needs Cash Management o Build checking account o Build emergency funds o Use cash to pay debts Where to keep cash o Checking accounts o Savings accounts o Money market deposit accounts o Certificates of Deposits o Money Market Mutual Funds o Asset management accounts o US Series EE bonds Comparing Different Accounts o Rate of return Annual percentage yield Always compare after tax apy After tax apy= pre tax apy * (1mtb) o Safety FDIS or FSLIC MMMFs not insured, fairly safe o Look at convenience, fees, customer service Institutions o Commercial banks Full service Online banking o Savings and loans and savings banks Primarily loans o Credit unions Member owned Lower interest rates Usually higher rates of return o Online deposit accounts Primarily savings o Brokerage firms Asset management accounts What to look for in an institution o Services and product Checking, savings, debit/credit card, atms o Safety Track record o Fees and charges o Convenience and customer service Checking account o Opening account Look at: fees, operating hours and locations, atm, customer service o Using Deposit paycheck and other funds Write checks as needed Record in check register Online banking o Balance check book Mark off all deposits and checks that have cleared Take the ending balance from monthly statement Add any deposits that haven’t cleared from register Subtract any checks that haven’t Adjusted balance = checkbook balance o Types of Checks Cashier’s check Write a check to bank plus fee o They pay check out of their funds funds Certified check Personal check guaranteed by bank Money order Travelers check Cash management o Electronic fund transfers o Smart cards and stored value card Chapter 6: Credit Cards and Open Credit What is Credit? o Credit is buying something today with the obligation to pay later o Consumer credit Nonmortgage credit purchases Auto loan, credit card, vacation loans o Open or Revolving credit Borrow up to credit limit Variable payback Minimum payment to full amount Interest charges build on the outstanding balance Open or Revolving Credit o EX: Credit cards Open accounts at stores Operating lines of credit Home equity line of credit Main Factors o Interest Rate (apr) Measure by annual percentage rate APR is the estimate of actual annual cost of the account Allows comparison of different accounts Different rates Purchases rate Balance transfer rate Chas advances rate Default rate May be fixed or variable Fixed rates on credit cards can change over time o 45 days notice from company Variable rate o Variable rates usually tied to an index o Variable rate may change each month Teaser rates Short term low rates After stated term, rate increases o Calculating the balance owed Average daily balance method Add up each day’s balance, divide by number of days Previous balance method Uses the previous statements ending balance Higher interest charges Adjusted balance method Subtracts any payments from previous balance Lower interest charges than PBM o Cash Advance Borrow cash against your credit limit Pay advance fee High apr on advances Starts accruing immediately o Grace period Time from initial purchase to first interest charges No grace period if there is an outstanding balance o Annual Fee Fee charge just to have card o Other Fees Minimum interest charge Balance transfer fee Cash advance fee Late fee Over the limit fee Types of open credit o Bank credit cards Issued by banks o Variations of bank credit cards Premium or platinum cards Affinity cards Secured credit cards Collateral o Travel and Entertainment cards Not revolving entire balance each month Probably an annual fee o Single purpose cards Used for only one store Good way to limit spending o Charge accounts Use product/service today, pay at the end of the month Advantages of Credit Cards o Convenience o Safer o Great for emergences o Helps with record keeping o Internet shopping o Helps build credit history o Extra warranties and consumer protection Disadvantages o Typically spend more with credit card vs cash o Easy to lose track of purchases o Fees and interest charges o Live above your means now but pay for it later o Destroy your credit history if used unwisely Getting a credit card o 5 c’s of credit Character: measure by credit score/history Capacity: current income Capital: value of investment assets Collateral: only for secured credit cards Conditions: overall economy Troubleshooting credit card situation o Determne how long it will take to pay balance in full o Switch to lowest apr card possible o Use savings to reduce credit card balances o Pay credit card balances with home equity line o Work with creditor Credit history o Creditors report to credit bureaus Credit limits Outstanding balance Payment history Date opened Judgement, collections o Used to calculate credit score Chapter 7: Consumer Loans Basics of Consumer Loans o Single payment vs. Installment o Secured vs. Unsecured Secured – guaranteed by collateral Default on loans means repossession or foreclosure Unsecure no guarantee o Fixed vs. Variable Interest Rate Fixed stays constant for life of loan Variable is tied to some index Loan contracts o Legal document that spells out terms Who How much Repayment terms What is collateral Acceleration clause Default actions Auto Loans o Usually secured by auto o Terms 36 years Longer term means higher apr o Usually fixed rate o Lenders want to see: Credit score higher than 650 or 675 Income or employment verification Balance sheet Student Loans o Federal direct/ Stafford loans Limits on how much you can borrow per year No interest payments til after grad First payments are 6 months after grad Relatively low interest rates o Plus/Plus direct Usually higher borrowing limits Interest rates tied to tnotes Begin making payments immediately o Perkins loans Exceptional financial need Loans come from school o Private loans Higher interest rates Probably unsubsidized Student loans: Repayment o Standard (10 years, fixed payments) o Graduated plan (10 years, payments start low and increase every 2 years) o Extended plans (1225 years, fixed or graduated payments) o Income based repayment plan Up to 25 years Financial hardship Maximum monthly payment = 15% of monthly discretionary income AGI150% of poverty guideline Payment changes as income changes After 25 years of payments, remaining balance may be forgiven o Income Contingent Repayment plan Up to 25 years Montly payments are based on household income, family size and amount of loans After 25 years of payments, remaining debt is forgiven o Income Sensitive Repayment plan Up to 10 years Payments based on your income o Pay as you earn plan Again, must have financial hardship to qualify Monthly payments capped at 10% of discretionary income Up to 20 years Outstanding balance will be forgiven Student Loan consolidation o One big loan instead of several smaller loans o Fixed interest rate for life of laons o Must have graduated, left school, or dropped below ½ time to qualify o Stretch payments up to 30 years Student loan other o May qualify for deferment or forbearance o Loan forgiveness Teacher loan forgiveness Public service loan forgiveness Student loan vet program o Feds will pay off up to 25,000/year o NIFA designated vet shortage areas Max 3 years Home Equity Loans/LOCs o Borrowing against the equity in your house (up to 85%) o HEL = borrowing a stated amount o HELOC= revolving credit up to a credit limit o Interest is tax deductible Effective interest rate = APR * (1MTB) People use HEL/HELOCs to pay off higher interest debt o Typically, lower APR than consumer loans Payday Loans (avoid) o Short term loans for cashstrapped o Fee involved each time Cost of Installment Loans o Simple interest method Pay interest on the principal outstanding Stated interest rate = APR o Addon or Discount Methods Avoid All interest is based on original loan amount Stated interest rate is lower than actual APR Prepayments on Loans o Read contract o Prepayment penalties May have one time fee May have a fee per payments May use the rule of 78s for addon loans o Compare penalties and fees to interest savings Sources of Consumer Loans o Commercial banks o Credit unions o Savings and loans o Point of – purchase o Payday lenders, check cashing firms, pawn shops Getting Loans misc. o How to increase odds of getting a loan Have a good credit score Make a large down payment Prove cash flow ability Pledge something for collateral Get a cosigner Choose a variable rate loan and/or shorter term Look for someone to guarantee the loan Power payments o When you finish paying off a loan Apply that same payment to another loan Really Hard Times o Bankruptcy A tool for improving your debt situation Chapter 7 straight Chapter 11 business Chapter 12 farm Chapter 13 wageearner Chapter 7: Big bopper o Most severe form of bankruptcy o Eliminates debt o May lose personal assets o Stays on credit report for 10 years o Last resort Chapter 13 wage earner o Easier to qualify for o Plan to repay your creditors o Protects you from creditors o Stays on credit history for 7 years Chapter 11: Basics of Investing Key points o Know your goals and risk tolerance o Pay yourself first o Brainless, painless investing o Don’t put all your eggs in one basket o Review and revise investments periodically Main questions o Why do you want to invest o When will you need the money o How much risk are you comfortable taking Goals and Risk tolerance o Also need to know your risk tolerance o Main determinate is time ST – safe assets LT incorporate riskier investments Main aspects o Safety o Income o Growth o Tax implications Returns from investing o Income Interest Dividends o Capital gains Selling price Purchase price Diversification o Attempt to reduce risk exposure o Investing in different assets within Different industries and economies o Reduces risk exposure o Key Negative correlations Invest in different industries Invest in different assets What can you invest in? o Individual stocks, bonds, CDs o Mutual funds (active) o Index mutual funds (passive) o Asset allocation mutual funds o Real estate o Business assets Stocks o Corporate stocks Piece of ownership of the company Higher risk investment means higher return o Making money with stocks Dividends Capital gains Common Stock – Terms o Ticker symbol: stock market abbreviation for company o Last (close): last market price from previous day o Hi/Low: highest and lowest market prices during the trading session o Change: yesterday’s closing price minus previous day’s closing price o Sales (1,000s): trading volume for that stock o 52week Hi/Low: highest/lowest prices during the past year o Div Yield Total annual dividend/ current price Quarterly dividend/ current price Income stocks have high dividend yields Growth stocks have no/low dividend yiels o DRIPs Dividend reinvestment plans Take dividends in stock rather than cash o Beta: Measure of risk o Stock split Attempt by firm to manipulate stock price Convert existing shares into “new” shares Picking stocks o Earnings history o P/E ratios Price/earnings per share o Dividend Yield (quarterly dividends) (dividend per share/ price per share) * 4 o Beta Measure of volatility o 52 week High/Low Where is current price in relation? o Invest companies you know and understand Buying Stocks o Purchase through broker, financial planner, or directly from company DSP = direct stock purchase from company o Typically pay a commission on purchase and sale Up to 2% Mutual Funds o Very popular investment assets o “pool” of money invested by manager Main types of mutual funds o Money market o Capital preservation o Income o Growth o International o Specialty o Balance o Asset allocation Mutual Fund Loads and Fees o Frontend load: upfront fee that you pay when you purchase o CDSC: contingent deferred sales charge A fee you pay when you sell shares of a MF o 12b1 fees: a fee to cover marketing expenses o Operating fees: fees associated with managing the MF Lower fees for index or passive funds Actively managed MF have higher fees Typically .252.o% per year Types of shares o Class A: pay a front load fee: lower annual operating expenses o Class B: Pay a CDSC Higher operating expenses than A shares May convert to A shares after 710 years o Class C: constant load funds Highest operating expenses Not converted Choosing a mutual fund o Match stated goal for MF to your goal o Look at historical returns o Look at expense rations and loads o Look at manager and mgt. tenure o Different classes Basic investment strategies o Dollar cost averaging Investing the same dollar amount each period Great to do through automatic paycheck deductions Brainless, painless Just common sense in action Shorter Term investments o Under 3 years, keep it safe Savings, MMA, MMMF, CD Conservative bond utual fund o 510 years, can take more risk Keep a portion safe Invest a portion for growth and/or income As your goal approaches, move to safer investments Reallocation o Reallocation: changing the target percentages for stocks vs bonds over time 2 parts: Reallocate your existing portfolio Reallocate future contributions o Rebalancing: bring existing portfolio back into the target percentages Reduces your risk exposure Chapter 9: life and health insurance Main objectives: insurance o Insurance can reduce your financial risk o Life insurance Determine life insurance needs Understand the types of life insurance Design a life insurance program o Health care insurance o Disability insurance o Longterm care insurance The logic behind life insurance o Main reasons to have it Provide living income for your survivors Pay your debts Pay funeral expenses Leave a legacy o Insure people for their economic contribution to the household Wage earner Nonworking spouse Infants/children Life insurance terms o Insurance is based on risk pooling o Premium your regular payment to the ins. Co. o Face amount – amount of coverage provided o Owner= policy holder o Insured= the party who’s life is insured o Beneficiary= dudes who receive the proceeds Determining your life insurance needs o 2 main methods: Earnings multiple Multiply gross annual salary by 510 Needs approach Determine pv of your actual needs for insurance o Cash for financial expenses o Living income for survivors o Child’s education o Pay off mortgage, student loans, credit cards Types of life insurance o 2 major types: Term insurance Permanent or cashvalue insurance Term Insurance o Sole purpose is to provide death benefits to beneficiaries o Specified term o Has no face value o Primary advantage is affordability o Premiums increase at renewal Other types of term insurance o Renewable term insurance o Convertible term insurance o Decreasing term insurance o Return of principal term insurance o Group term insurance Permanent or CashValue Life insurance o Provides Death benefit Cash value Can borrow against the cash value Taxsheltered growth inside policy o Permanent type of insurance o 2 basic types: Whole life Provides a death benefit when the insured dies or reaches max stated age Death benefit = face value Premium has 2 parts Constant premiums set by insurance company Insurance company invest cash value Variable universal life Policyholder can increase or decrease premium Policy holder determines how cash value is invested Advantages: o Income tax shelter o Control over your investments o Higher potential returns Term Versus Cashvalue o Goals with a dropdead o For younger individuals o As you grow older Contract clauses o Common features in all insurance policies: Beneficiary provision Loan clause Policy reinstatement clause Change of policy clause Suicide clause Incontestability clause Settlement options Riders o Special provision added to the policy providing extra benefits or limiting the company’s liability Waiver of premium for disability Accidental death benefit Guaranteed increase in coverage without medical exam Cost of living adjustment Living benefits Child rider Health insurance o Basic health insurance: Hospital insurance: covers costs with hospital stay Surgical insurance: covers cost related to surgery Physician expense insurance: covers physicians’ fees outside of surgery o Dental and Eye insurance Usually not provided by employer Basic Health Care choices o What types of plans are available? Traditional feefor service You choose and pay your doctors Get reimbursed for medical expenditures Managed health care Limited choice of doctors, hospitals, etc Most expenses are covered o Copay= specific dollar amount/vist o Co insurance= % of expenses Private health care plans o Managed health care HMO pay for and provide health care services Point of service plan allows treatment from affiliated and non affiliated doctors Preferred provider organization is a cross between traditional and HMO o Group insurance Covers a group of individuals Usually much cheaper than individual plans Medicare o Provides medical benefits to Disabled Those over 65 who qualify o 3 main types of coverage Part A: hospital benefits Part B: voluntary supplemental insurance Part D: prescription drug coverage Part C: private version of A and B Medigap o Sold by private insurance companies to bridge the gap in coverage Total costs medicare coverage Standard policies, prices vary Medical Reimbursement accounts o Savings plans established by the employer o Employees withdraw funds to cover: Unreimbursed medical or dental expenses Contact lenses, prescriptions Scheduled surgery o Flexible spending accounts Use it or lose it o Health savings account For use with high deductible health plans Not use it or lose it COBRA and changing jobs o Under the consolidated omnibus budget reconciliation act: If company has at least 20 employees Continues your coverage for 1.5 – 3 years after you leave company You pay full costs of insurance Disability insurance o Disability insurance is like earningpower insurance Kicks in if you are unable to work Up to 65% of your salary o Most employers provide some level of disability insurance as part of the benefits package o Coverage = basic standard of living o Features that make sense: Own occupation vs any occupation Benefit duration: ST vs LT Waiting period Waiver of premium Noncancelable Rehab coverage Long Term Care insurance o Nursing home expenses o Protects against financial costs of alzheimers, strokes, or chronic diseases o Activities of daily living o Consider these provision: Type of care Benefit period Waiting period Inflation adjustment Waiver of premium o Daily benefit > 100/day o Medicare part A covers hospice care o Benefit period duration o At what age should consider ltc Estate Planning: Basics Estate planning o Deals with protecting and controlling your assets: While you are alive Upon your deth After death o Normally ignored until its too late o Death Tax Not a big deal for 98% of Americans Prior planning can reduce/eliminate your estate taxes Estate Taxes o Each taxpayer has unified tax credit Effectively allows you to pass an estate tax free o Tax rate is about 4555% of estate over the limit o Unlimited gifts to spouse Main tools o Durable Power of Attorney Gives someone the power to make decisions or take actions on your behalf Everyone over the age of 18 should have the durable POA o Advance Medical Directive Similar to living will Specifies the level of medical care you want Specify your “attorneyinfact” for medical decisions Everyone over the age of 18 should have one Specify a medical attorney in fact Will o How to distribute your assets at your death o Can be very detailed o Name exector o Specify guardians for children Trusts o Powerful tools when used properly o Testamentary trusts Created by your will Great for utilizing each spouse’s unified tax credit Great for controlling assets from the grave o Living trusts Created while you are alive Good for privacy issues Titling or property o Huge impact on estate planning o Fee simple in one person’s name o Tenancy by the entirety o Join tenants 2 or more people Not divided or separable o Tenants in common 2 or more peoples Can be divided Beneficiaries o Pass assets by contract o Overrides will Life insurance o Not substitute for planning o Need qualified help using insurance for estate planning o Can be a powerful tool o Use life insurance proceeds to: Buy out someone else’s share Provide money to one heir and hard assets to another Pay significant estate taxes Gifting o Can gift unlimited amounts to spouse o Can gift up to 13,000/person/year o Unlimited gifts to recognized charities Chapter 10: Property and Liability insurance Personal Auto Insurance o Part A: liability coverage (other people) Covers Damage to others’ property Bodily injury to others Court fees and legal defense fees are covered Insurance company has a duty to represent you Tries to reduce their losses while protecting you These fees do not impact max paid for awards Doesn’t cover you for criminal charges 2 types of coverage Combined single limit o Combines property damage and bodily injury o Will pay up to limit Split limit o Coverage for: Bodily injury per person (100,000) Bodily injury per accident (300,000) Property damage (50,000) o Part B: medical expense coverage For injuries to you and any riders in your vehicle For injuries to you, your family, caused by other road vehicles If you are driving a car you don’t own Recommended min of 50,000/person o Part C: uninsured motorist protection Protects you, family, other drivers with your permission from uninsured motorists Also protects underinsured motorists o Part D: damage to your car 2 aspects Collision o Covers damage due to collision with another auto another object OtherThanCollision o Covers noncollision damage Deductibles on collision and comprehensive You pay the first part of the repair Insurance company pays the remainder You are responsible for anything over the limit Higher the deductible the lower the premium PAP exclusions o Not covered if: Intentional damage or injury Using vehicle without permission of owner Vehicle has less than 4 wheels You’re driving someone else’s vehicle on regular basis You own the auto, but its not listed on policy You carry passengers for a fee In a race or speed contest NoFault Insurance States o Idea is to lower legal costs, speed up payments o In an accident, your insurance company pays for injury/damages to you and your passengers o Main problem: Limits on medical expenses and other claims o Va is not a nofault state What determines premiums o Type of auto o Annual use o Driver characteristics o Driving record o Where you live o Your insurance credit score o Discounts Lowering Your premiums o Drive like you’ve got some sense o Shop around o Think about your car, location o Hang up and drive o Raise you deductibles o Revise your policy o Take a defensive driving course Homeowner’s Insurance o Peril = event that causes financial loss o HO policies cover several perils in one o Named peril policies Only cover perils specifically listen in the policy o All peril policies Covers all physical losses to the property, unless specifically excluded in the policy o 6 types HO 1: Basic HO 2: Broad form HO 3: special form HO 4: renters insurance Covers renter’s belongings, provides coverage for renter HO 6: condos Similar to HO 4, also covers alterations to unit HO 8: older houses Covers actual cash value instead of replacement value o Section of a HO policy Section 1: property insurance Protects your property from losses Protects you from losses due to peril Specifies max level of coverage 4 types of coverage o A: dwelling Protects house and attached structures Not business assets Stated dollar amount coverage o B: other structures Nonattached structures and landscaping Doesn’t cover damages to land or business assets Up to 10% of the dwellings coverage o C: personal property Covers any of your personal property Regardless of where it is located Covers personal property of your guests Up to 50% of dwelling coverage No covered: animals, pets, business assets o D: loss of use When you can’t live in your house due to covered perils Covers up to 20% of dwelling coverage for: Additional living expenses Fair rental value Prohibited use Section 2: personal liability insurance Protection for owner if someone is hurt o On the property o Due to owners’ actions Not business related Not for negligent operation of auto
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