Case Studies
Retiring with Confidence
LIFETIME INCOME PLANNING
The Client
A corporate jet pilot and his wife want to retire and move to Arizona. They are in the process of building a retirement home in Arizona, while putting their current residence on the market in Pittsburgh.
The Challenge
The clients want to know if the husband should take a lump sum from his retirement savings plan, or if they should take the annuity. They also want to know if their investments will provide adequate income to satisfy their current standard of living for the next 35 years. They are concerned about the rising cost of health care, as well as possible long-term care expenses. Finally, currently both age 60, they want to know if they should work in Arizona, and when they should take Social Security retirement benefits.
The Solution
Retirement planning issues can be very numerous and confusing. The most important question is, “What is the probability that we may outlive our assets/income?” Retirees must have a high degree of confidence that their planning and investments will carry them through the rest of their lives. Retirement planning analysis using a technique called Monte Carlo Simulation (MCS) is an excellent tool used to measure the probability of assets/income sustaining these retirees for their lifetimes.
Traditional financial planning models use rate of return assumptions that do not vary with time. These assumptions often reflect average historical rates of return earned by particular asset classes or combinations thereof over an extended period. Returns have historically fluctuated from year to year in an unpredictable fashion, and future rates of return cannot be guaranteed or even predicted with certainty. In essence, traditional financial planning models failed to account for one of the most important elements—risk.
MCS projects cash flow and net asset values multiple times—each under a different set of conditions—to yield a range of possible outcomes. Monte Carlo analysis is, therefore, able to incorporate uncertainty or risk into the planning process by demonstrating how different assumptions about the future can impact the likelihood of your meeting or exceeding clearly defined financial planning goals.
The MCS report used in this case study relies on variable rates of return, which fluctuate at random from year to year. The software tool used to produce this Monte Carlo analysis applies these variable rates to selected assets (or combinations thereof) over time, and records the aggregate net asset values at the end of the defined projection period for each iteration or trial. The results of the individual trials are then analyzed, summarized and plotted graphically. A trial whose ending net asset value equals or exceeds a target is considered a success. Conversely, a trial whose ending net asset value falls below a target is considered unsuccessful. A success rate can be computed by dividing the number of successful trials by the total number of trials.
The Benefits
After using the Monte Carlo software to measure the clients’ success rate, it was determined that their probability of exceeding their target was almost 100 percent. It gave them great confidence and affirmed in their minds that their hard work and diligence to prepare for retirement had paid off huge dividends. They were also better able to determine whether the husband would have to work and at what ages they should take Social Security retirement benefits. Furthermore, the analysis compared two different scenarios, enabling them to see the benefit of taking the lump sum vis-à-vis an annuity.
Meeting Financial Dreams and Goals
COMPREHENSIVE PLANNING
The Client
A retired physician and his wife are multimillionaires who were seeking a second opinion with their current estate plan. Due to prudent investing during his working days, almost 75 percent of their net worth consists of Individual Retirement Accounts. The clients’ primary residence is located in Pennsylvania, while they also maintain a second home in Florida. They have three children, all who are married and have children of their own. The clients have 12 grandchildren. They both have the desire to give to charities rather than have a portion of their estate go to the government in death taxes. Finally, they feel confident their current estate plan is adequate and that their children and grandchildren will receive a substantial inheritance. However, they don’t want their heirs to receive their inheritance outright—they prefer their heirs receive their inheritance in a controlled fashion.
The Challenge
After evaluating their current financial situation, it was calculated that over one-third of their estate, should they both pass away today, would go to the federal and state governments through death and income taxes. The IRAs would be taxed three times: Federal Estate Tax, Pennsylvania Inheritance Tax, and Income in Respect to Decedent Tax (IRD). Additionally, wealth would be passed directly to each of their three children and wouldn’t be protected from possible divorce, litigation, or creditors.
The Solution
A comprehensive estate plan was designed to “zero-out” Federal Estate Taxes and to minimize Pennsylvania Inheritance and IRD taxes as follows: 1) A Family Trust was designed to pass wealth estate tax-free to the children and grandchildren. The physician and his wife would be grantors and co-trustees of the trust. Upon their passing, a bank would assume trustee duties to ensure the provisions of the trust were properly carried out. 2) Several charities were named as contingent beneficiaries of the IRAs, so when the husband and wife were gone, the remainders would be bequeathed to those charities and would pass estate and IRD tax-free. 3) The Family Trust purchased a 2nd to Die Life Insurance Policy on husband and wife in the amount bequeathed to charities. Premiums would be paid from taking distributions from the IRAs.
The Benefits
The comprehensive plan achieved all the couple’s desires and goals. First, the children and grandchildren would receive inheritance estate tax-free from the Family Trust at the couple’s passing, funded by the life insurance policy death benefits. The trust protected and controlled the inheritance and achieved the couple’s desires even after their passing. By bequeathing the IRAs to charities at their passing, the proceeds would receive a charitable tax deduction that would avoid any death taxes or IRD taxes. Because of this comprehensive plan, the couple would leave a legacy not only to their family, but also to the community.
Managing the Unexpected
INVESTING FOR GENERATIONAL SECURITY
The Client
The family breadwinner passed away, leaving the surviving widow and her two children to face future financial obligations. Even though substantial insurance proceeds provided a certain level of security, the family had little experience with finances and faced an overwhelming amount of paperwork, financial anxiety, and worry about the future. Specific issues included:
• How to invest the funds
• Expected annual earnings on the investments
• Annual and monthly budgeting to meet living expenses
• Tax implications
• Need for client to seek employment to supplement investment income
• Should I pay off my house, or does keeping the mortgage make more sense?
• Life insurance for the widow
• Future college costs
The Challenge
Helping the customer put a plan in place to ensure a secure financial future while supporting them through an extremely difficult time. Evaluating how to manage two pools of assets, taxable and tax-deferred, so the client could meet living expenses and minimize income tax ramifications.
The Solutions
An overview of fundamentals of investments and financial planning took place during several initial meetings. Discussed were the role of major asset classes in a diversified portfolio and expected returns from asset classes over time. Meetings with the middle-school-age and high-school-age children provided them with the basic tools of investing. As a teaching tool, the three family members built sample portfolios, for which investments were tracked for several months.
To facilitate an appropriate investment strategy and manage client expectations, regular meetings were held with the client to review investment types and diversification, budgeting, and sufficiency of disbursement funds. A thorough review of their estate plan (insurance, wills, trusts) was performed to ensure that the children were financially secure and supervised in the event of their mother’s death.
The Benefit
The client has a plan in place about which they can be confident, thus providing security for them at such a challenging time.
