Warren & Amanda: Part 3, Wealth Protection
Warren and Amanda tell you about their plans to upgrade their automobile insurance. Specifically, they would like to add several types of coverage, including road hazard glass coverage and rental car coverage. Recall that they are both 24 years old. Over the last two years, Warren has had one minor at-fault accident and a ticket for distracted driving, and Amanda has had three speeding tickets. They know that adding coverage will increase the cost of their insurance and they are wondering if switching insurance companies will help. They are also wondering if they could be sued, in the event that either of them were to cause a major accident. You have suggested that they purchase tenant’s insurance, but they do not think it is necessary.
- With regard to their automobile insurance, comment on
- Their level of need to add different types of coverage to their policy. /2
- The associated costs of adding different types of coverage. /2
- Any potential consequences of switching to a less expensive auto insurance company. /2
- Any things that they should consider before switching to any other insurance company. /2
- Describe tenant’s insurance. Would tenant’s insurance be appropriate for Warren and Amanda? /4
Warren & Amanda are happy with the group insurance benefits that they have through their respective employers. They are concerned however, wondering if they have adequate coverage in the event of long-term disability. Fortunately, they both have coverage at work that will provide 90 percent replacement of after-tax income. They have asked you to explain their “definitions” of disability, because their coverages are different. Amanda’s policy has regular occupation coverage while Warren’s policy has any occupation coverage. They would like to understand these definitions.
- Explain to Warren & Amanda how they could benefit from an evaluation of the definition of disability in their group disability insurance policies. Is it likely that they also have coverage for critical illness through their employers? What are the advantages of purchasing critical illness insurance? /4
Amber and Warren have equal coverage under group life insurance. Although their salaries are different, in both cases the policy would pay the equivalent to one year of salary. They do not believe that their coverage is adequate, so they are trying to decide between purchasing additional term life insurance or permanent life insurance. They are leaning towards term insurance because of its low premiums. They have not had much excess cash flow recently; hence, they are reluctant to spend more on permanent insurance. That said, Amber is interested in learning more about the loan feature on permanent policies, thinking that this would give them an option to better fulfil their liquidity needs.
- Comment on
- Their need for life insurance. /2
- Whether term life insurance is their best choice, if you think that they need life insurance at all. /2
- Amanda’s interest in using the loan feature within a permanent life insurance policy. /2
Part 4: Personal Investing
Between watching financial news and hearing about a co-worker’s success in turning a $5,000 stock investment into a $10,000 stock investment in 6 months, Amanda & Warren are now more convinced than ever that their financial future lies in stocks. Recall that the couple was intrigued with how well Warren’s aunt did financially, by working for and investing in her employer, a Canadian schedule I bank, for over 40 years. They would still like to enjoy the same kind of lifestyle that she has now, but they don’t want to wait for retirement – they’d like to see significant growth in their financial assets over the next few years. Also, it seems that Amanda has taken on Warren’s investing interests – both of them are now quite excited about high tech investment prospects. Subsequent to your first meeting, Amanda withdrew $6,000 from her RRSP account and invested this in the stock of a high-tech electrified vehicle manufacturer called “High-Tech Electric”, or HTE, a company very similar to Tesla. She was excited when soon after her purchase the value of her HTE shares increased to almost $8,000. More recently, the company announced that it had been named in a major class-action lawsuit, and Amanda’s investment value dropped to $5,500. The subject of the lawsuit was an infringement of patent law, where the plaintiff alleged that HTE had ripped off its technology from another company. Amanda was not concerned – she has been reading several blogs that suggest HTE will be fine and that the lawsuit is frivolous. She is sure that the rapid change in value resulted from a temporary “blip”, and that the company’s share price will rebound quickly. She is getting ready to invest substantially more money in HTE as soon as possible because she believes that it is the best opportunity to maximize growth. Amanda does not think that diversification is useful for anyone with some knowledge and skill; in fact she believes that diversification is for anyone that is not able or willing to make their own decisions.
Warren has heard that bonds and mutual funds can be part of a good strategy for diversification, but he believes that bond returns are low, and that mutual fund returns are not much better. He is open to hot tips from co-workers or financial industry people. He has read that companies will sometimes misstate their financial information, but he does not think such misstatements have much effect on a company’s stock price.
- Comment on each of the following elements of the couple’s investment plans:
- Level of diversification. /2
- View on bonds and not including them in their portfolios. /2
- View on mutual funds and not including them in their portfolios. /2
- “Hot tips” as a source of trading information. /2
- Based on your comments in parts A to D of the previous questions, what might be a suitable portfolio for Warren & Amanda? /4
- How would your answer to Question 2 be affected if they were:
- 40 years old? /2
- 80 years old, and experiencing increases in healthcare costs? /2
- Explain to Warren why misleading financial statements may be more common than he believes and why misleading financial statements can negatively affect a stock’s price. /4
Part 5: Retirement and Estate Planning
Warren & Amanda thinks it is realistic to retire in 41 years, when they both turn 65. They are aware that some financial services companies promote earlier retirement dates, but at the moment they see no reason to plan for this. Neither of them earns a huge salary, and they both enjoy their careers. As a dual-income household they would like to “set the bar high” and try to build up a retirement account worth $2 million.
Amanda mentions that they want to pay for their children’s post-secondary education expenses (if they have children) in the event of their deaths. They do not have wills, and they wonder how important it is for them to have wills.
- Regarding their target wealth:
- How much will they have in 41 years if they save and invest $500 per month at an annual interest rate of 6 percent compounded annually? /2
- How much will they have to save per month at an annual interest of 6% compounded annually, to reach their $2.0 million goal in 41 years? /2
- Assuming zero growth in their deposits, if Warren & Amanda were to retire after only 31 years instead of 41 years, what impact could this decision have on their account size? /2
- Assuming 41 years again, how much will they have if their annual contributions grow at a rate of 2.5% per year, compounded annually? /2
- Re-do the calculations you did in part a, assuming full employer matching. /2
- Focusing for a moment on Amanda’s Money Purchase Pension Plan at work, how will her pension adjustment for CRA be calculated? How will this affect her RRSP contribution room in the following year? /4
- To reach their savings goals, should Warren & Amanda make deposits inside an RRSP or TFSA account? Discuss. /4
- If Warren & Amanda really want to provide for their children’s post-secondary education, how can a will help them to achieve that goal? What else might they consider, to help ensure that their children can access post-secondary education? /4
- Should the couple have wills? Discuss. /4
1.Liability Coverage: liability coverage comes to an rescue where the vehicle has met an accident due to own negligence or fault by covering the cost of repairs and replacement of damaged property including covering the medical bills in case of injury or hospitalisation.
Warren & Amanda should add this type of coverage to their insurance policy as Warren is accused of minor at fault accident and Amanda has had three speeding tickets i.e. more prone to accident for rash driving.
2. Collision Coverage: This type of coverage provides for cost of repairs of the vehicle which met accident whether caused by own fault or not. And in case the cost of repairs is more than the current market value of the vehicle, the insurance company is liable to pay the current market value of the vehicle.
Warren & Amanda should also add this coverage to their policy as this will help in reduction of losses in case of accident.
3. Personal Injury Coverage: It will cover all medical costs associated with the accident. All medical cost incurred for driver and passengers thereof will be borne by the insurance company even if in case of own fault of the driver.
Warren & Amanda should go for this type of coverage as this will reduce their medical costs in case of accident.
4. Uninsured Motorist Protection: This type of coverage will help in reduction of repair cost when the insured person wants compensate repair costs of any other uninsured vehicle which is hit by your own vehicle. The insurance company will pay the additional or total amount so that you will overcome the damage or medical bills very easily.
It is in the option to Warren and Amanda to add this type of coverage as this will come to rescue only when the vehicle is met accident with uninsured vehicle and the other vehicle is demanding the associated costs.
5. Comprehensive Coverage: This type of coverage will cover all the risks associated to the vehicle otherwise than automobile accidents such as damage by floods, fire, theft or weather damage.
It is advisable to Warren & Amanda to add comprehensive coverage to their policy as it will help in reducing all the costs.
So, basically Warren & Amanda should buy the maximum coverage that they can afford. Because buying the minimal level of insurance may be cost effective but it would not protect them adequately after an accident or damage.
In most of the cases there will be no extra service charge to be charged by the insurance companies for adding additional risk coverage policies to taken insurance policy. But there will be a hike in amount of premium due to addition of certain type of coverage.
Adding more coverage to the policy will lead to higher coverage to the vehicles as well as higher premiums to the insurer. The cost of adding coverage policy to the existing policy will depend on the type of coverage and the related period in which it is adeed. For example in case of hurricane or on the basis of metrological surveys, if a person adds comprehensive coverage to the vehicle it will lead to higher premiums other wise than taken in a normal period in which such warnings are not given by the metrological departments. So the cost of adding more coverage to an existing insurance policy will depend upon the timing of such addition. Any addition of coverage in wrong time may lead to higher costs.
There is no such consequences of switching to less expensive auto insurance company . Before switching the insured person shall go through all the terms and conditions mentioned in the insurance policy for taking cover . It is not harmful to take a less expensive insurane cover from a company if it is providing same degree of cover as of the highly paid insurance companies. Taking less expensive insurance cover will result in lowering premium cost on account of the insured person.
Before switching to any other auto insurance policy the insured person should conduct a proper market survey for identifying the most beneficial and loyal insurer. This will also include drafting of an ideal insurance plan.
Warren & Amanda should consider all the relevant market factors of the new company and shall switch accordingly.
They should compare various auto insurance policies by means of premium and coverage of risks and should select the best one which is providing higher coverage at a reasonable premium. They should also consider the reputation and performance of the insurance company.
They should also look for the claim settlement statistics and customer service provided by the insurance companies. And also before switching they should ensure that their current insurance policy is cancelled to avoid double costs.
Tenants’ insurance is a type of policy which provides benefits to the owner of the houses but it does not include coverage for the dwelling, or structure, with the exception of small alterations that a tenant makes to the structure. It covers liability coverage and the personal property of tenant against fire theft and vandalism. It also provides for expenses to the owner when the house become uninhabitable. It mainly protects the tenant’s personal property and provide them with liability coverage but do not insure the actual dwelling. It’s significantly less expensive than a homeowners policy. The owner of the building is responsible for insuring the dwelling itself but bears no responsibility for the tenant’s belongings.
As autos are exluded from the definition of personal property, tenant’s insurance can not be taken against auto by Warren & Amanda.
Group Disability insurance is a type of insurance policy which provides for coverage to a member of the group who is unable to work due to a disability. This type of insurance policy replaces the lost income and wages due to disability for a limited period of time with a maximum benefit of approximately 60% of earnings before such disability. So, Warren & Amanda shall be given a 90% of current earnings in case of disability.
Critical illness insurance generally covers a person when she/he is diagnosed with such severe cirtical diseases like cancer or heart attack or stroke. you if you are diagnosed with cancer or have a heart attack or stroke. And critical illness insurance is different from group disability insurance. In critical illness insurance the insured shall be given a lump sum money for curing the disease or for adjusting life with such disease. While disability insurance provides for a monthly payment to the insured at the time of recovering.
So as their employer had provided group insurance benefits it will not cover critical illness.
Advantages of Critical illness policy:
- No depletion of savings: Taking a critical illness policy may result in savings as the insured person don’t need to spend his savings at the time of critical illness as the critical illness policy comes for rescue to the insured person.
- Flaw less life style: This type of policy ensures the insured person for having a flawless enjoyable life as his disease is covered. The insured person has no need to worry in case of any minor checkups as claim for such expenses may be easily available on submission of bills.
- Multiple claims: This type of policy doesn’t restricts the time of claims as the insured person can claim any time and even in multiple times by presenting the valid medical bills.
Solution 4 (A)
There are several reasons for which Warren & Amanda should go for life insurance. Some of them are discussed as follows:
1. Post Death Benefits: The most important aspect of life insurance is that it provides financial help to the family members of the person insured after his death. It is more helpful when the person insured is the only earning member of the family or the major part of income is earned by the insured individual. It provides coverage for the lost income to the family members. This also helps the family members to pay several debts after death such as any outstanding home loan or vehicle loan or any other loan in the case may be.
2.Best time to get insured: Warren & Amanda are only 24 years old. So it is the best age to get insured. It is cheaper when a young person buys an insurance cover. So Warren & Amanda should buy life insurance at this young age as it would be cheap now.
3. Tax saving : Buying insurance also results in savings of tax. Because premium paid for life insurance is eligible for deduction while calculating taxable income of a person.
4. Forced Savings: Taking a life insurance policy compels a person to deposit premium every month which a person could not save normally.
Solution 4 (B)
Term life insurance is a type of life insurance which provides coverage at a fixed rate of payments for a limited period of time i.e. the relevant term. After the expiry of that period, coverage elapses and the insured person had to cover his life with another policy with different terms & conditions. However if the person insured dies during the term period, the death benefits will be paid to the beneficiary as entered by the person in insurance contract at time of entering into that contract. And one of the biggest advantage of term insurance is that it is available in lower costs in comparison to other insurance.
Yes obviously choosing term insurance is the best type of insurance a person should go for. So, Warren & Amanda should go for term insurance.
Solution 4 (C)
Life insurance policies with loan feature have very attractive features and also very popular among the people. This type of policy comes to rescue of the person insured when he is in urgent need of money. the person insured can take loan as using the policy as collateral. However if the person fails to make the repayment, death benefits are also withdrawn from the policy.
Amanda can go for this type of policy.
There are 3 diversification levels. Some of them are discussed as follows:
- Low level of diversification
Organisations or companies that follow single or dominant business have low level of diversification. A single business is a company from which more than 90% of its revenue are generated. A dominant business refers to business which generates about 70-95% of its sales within a category of goods or services.
- Moderate to high diversification
Moderate to high diversification company earns at least 30% of its revenues from sources outside of the dominant business and also its units are linked to each other and shares resources, products, technology and distribution systems.
- Unrelated diversification
In this type of diversification levels, the businesses of the company are not linked to each other and does not share any resources at all.
Bonds are debt instruments issued by companies or organisation who are on need of money. In case of bonds the borrower company or organisations are obliged to pay interest or normally referred as coupon amount at regular intervals and also repay the originally borrowed amount after a specific period.
The main issues which comes with bond are interest rate risk, prepayment risk, credit risk, reinvestment risk, and liquidity risk. Also bonds suffer some limitations as interest received on bonds are taxable income and the person receiving such interest are liable to pay tax irrespective of the interest amount.
Mutual funds are managed by the Asset management companies which comprises of individuals who are experienced in movement of stock market. In mutual fund, a predetermined amount often referred as sip is deposited with the company and the company invests such amount into the market and returns the investors in form of dividend or interest. Asset management companies invests both in equity and debt market as per the choice of investors.
There are many issues for which mutual funds should not be included in the investors portfolio such as higher management fees,lock in clauses and wasted cash. Asset management companies demand a handsome amount of management fees from the investors for managing their portfolios. Also, there are certain lock in clauses present in the mutual fund portfolios for a specific period of time which demotivates the investors to invest in.
Here are some of the tips for trading in stock market:
- Investors should set long term goals in stock market. They should go for long term stocks of companies who are performing well and also don’t have any liquidity crisis in the near future.
- Investor should set his own risk tolerance level and should invest accordingly.
- The main and important tip for investors in a stock market that the investors should control his emotions with respect to his investments and invest or divest accordingly.
- The investors should also learn some basic stock market terms and their meanings before investing in the stock market.
- The investors should diversify his funds wisely to help him out from the unaccepted risks.
Best suitable portfolio for Warren & Amanda should contain the following features:
- Firstly the portfolio should be according to the financial capability of them. Their investments should not be higher than their earnings and should be as per their financial capability.
- They should go for mutual funds for better performance. Investment in mutual funds will eliminate the need of personal supervision on account of them and headaches. The managers of AMC will look after the funds invested. Although they will charge management fees, but it would be better from losing in stock market due to lack of knowledge & experience.
- They should advise the asset management company to invest in stocks which are high at returns with lower risks. Also the stocks invested should also have liquidity provisions.
- They also should build an emergency reserve for tackling any situation arose due in the future.
If Warren & Amanda were 40 years old, they could have some other investing options in addition to life insurance policy. The other investing options could be pension schemes, mutual funds or some less risky medium duration investment options. Investment in medium duration options will ensure elimination of financial crisis after their retirement and can also provide for health as well as living costs.
There are many investment options a person could choose at his medium age. Choosing any investment option at the age of 40 is less riskier than choosing it at old age i.e. after 60. At the age of 40, a person remains to be earning member and is able provide for maintenance costs.
So Warren & Amanda can go for several investments at the age of 40. They could also invest in annuity repayment plans which will repay them in regular intervals after retirement.
If Warren & Amanda were 80 years old, they have not enough time to invest in . if they are experiencing increased health care costs due to old age then they should liquidate their savings to meet those costs.
At the age of 80, there is only limited number of beneficial investments that the person should make. They can invest in fixed deposits with medium duration i.e. neither as long as 10 years nor as short as 1 month. Also they could invest in annuity policies in which they have to invest lump sum amount and thereby receiving repayments at regular intervals.
However, if Warren & Amanda does not have that much of finance available to invest in FD or annuity policy, they could earn their living income by reverse mortgaging their fixed assets such as land, building or jewellery.
Misleading financial statements are very common in the current scenarios. These hurt the value of stake holders and share holders of the organisation and also lead to search and surveys by various government departments.
Financial statements are often misled by way of stating higher income and lower expenses by way of enhanced revenues. Investors fix the stock price after considering the revenue generated by the company for that particular period.
Warren & Amanda will have the following amount after 41 years old:
P( Annual Contribution) = $500*12= $6000
I = 6 %
T= 41 Years
A(Accumulated Amount)= $6000*((1+0.06)^1+(1+0.06)^2+………………….+(1+0.06)^41)
=$10,49,703 i.e. 1.04mn.
Goal= 2 mn
Annuity Factor @ 6% for 41 Years= 174.9505
Required Contribution per a year = 2 mn / 174.9505
Contribution Per month = $ 11431.80/12
= $ 952.65i.e. $ 953 apx.
If their is zero growth or no growth in their investments , Warren & Amanda will only receive the principal part of contribution after 31 years i.e 31*500*12 = $1,86,000 only.
If their investment grows at 2.5%.
P = $500*12 =$6000
I= 2.5% =.025
T= 41 Years
Annuity Factor for 41 Years = 71.8391
A = $6000 * 71.8391
= $4,31,038.85 i.e. .04mn
In an employer matching program, employer will contribute amount based on the contributions made by the employee.
P= $500*2*12 = $12,000
T = 41Years
Annuity Factor for 41 Years = 174.9505
A = $12000 * 174.9505 = $ 20,99,406.53 i.e. $2.09 Mn
Pension Adjustment is an estimation of the pension value of an individual assigned by Canada Revenue Agency each year. A member can choose to contribute the required pension adjustment amount to their registered retirement savings plan. In some circumstances this contribution may also be deferred until a time the tax deduction is more advantageous.
The pension adjustment is an aggregate of all individual and employer pension credits for the year. For each year of service, an employee receives a pension credit for each deferred profit sharing plan or benefit provision of an registered pension plan. For the most part, an employee participates in only one provision, so in most circumstances their pension credit will also be their pension adjustment.
The pension adjustment reduces the RRSP contribution roomby allowing the investor to contribute less for the current tax year.
The Tax-free Savings Account (TFSA) is a natural home for short-term savings, holding investments that pay interest and would otherwise be fully taxed. However, TFSA can be used for long term goals .
However registered retirement savings plan is more better than TFS account and also beneficial for long term. Income accruing from RRSP account are tax deductible and most beneficial tax shelter to the citizens.
So for making their goals achieved, Warren & Amanda should invest in RRSP account.
A will is a document that comprises that who will inherit the bank accounts, real estate, jewellery, cars, and other property after death of the will maker. A person can leave everything to another person or allocate specific possessions to separate individuals.
But a will is much more than a way of distributing property post death of a person– especially he/she have kids. For parents, making a will is the single most important thing that they can do to make sure that their child is cared for by the people. In some cases, wills also provides clauses for the education of children in case of death of parents.
So, Warren & Amanda can be helped by their for satisfying their children post secondary school needs after their death.
There are some other plans to help their children in the event of death of Warren & Amanda:
1.Backup plans: Warren & Amanda can make a suitable backup plan by purchasing a real estate property and directing that the rental income from such property be exclusively used for their educational purposes.
2.Life insurance policies such as term insurance or any annuity policies in the event of death to provide educational cost of children.
3. Setting multiple sources of income will also help the children for their post educational benefit.
A will is a document that comprises that who will inherit the bank accounts, real estate, jewellery, cars, and other property after death of the will maker. A person can leave everything to another person or allocate specific possessions to separate individuals.
But a will is much more than a way of distributing property post death of a person– especially he/she have kids. For parents, making a will is the single most important thing that they can do to make sure that their child is cared for by the people.
In your will, an another person shall be designated to take care of children upto becoming legal adults. After reaching adulthood, the property of parents are inherited to the children.
So, Warren & Amanda should have wills if they planning for children. Making a will will help them and their children in case of any mishappenings.
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