Broker Check

The Power of Financial Planning - Part II: Financial Independence & College Funding

| April 27, 2018

There is investment planning, and then there is everything else when it comes to financial planning according to most financial planners. However, a proficient CFP® should know that “everything else” can be just as important, or in some cases, more important than the rate of return on your investments. In Part II (this article), we will discuss how a CFP® can help assure you are on track to becoming financially independent and, if applicable, how to properly save for your children’s education. In Part III, we will discuss the various ways a CFP® can assure that your family is financially protected from death, disability and a long term care event. In Part IV, we will discuss how a CFP® can help you with the confusing nature of investing your hard earned assets. Lastly, in Part V, we will demonstrate how a CFP® can provide a roadmap for your estate planning. If you missed Part I, we explained the differences between having a CFP® involved in your financial planning vs. the various other types of advisors, as well as the ethical ramifications of which type of advisor you choose.

The Roadmap to a Financial Freedom – Financial Independence

Some other advisors may call this retirement planning – am I on track in order to retire? We personally do not like that question nearly as much as asking this – am I on track in order to reach financial independence? Reaching this idea of financial independence means that you work because you want to, not necessarily because you have to. You CAN be financially independent and not be retired, but you cannot (or rather should not) be retired without reaching financial independence. This is especially true since retirement in the new century is becoming a choice as opposed to a necessity. Thus, we view your retirement savings not as your ticket to a life of luxury but, rather, as a vehicle that allows you to do those activities that you value most (which may or may not include working!).

It is critical to run some form of cash flow analysis to gauge exactly where you are at for reaching financial independence. The older you get, the more accurate such cash flows become, as the variable of time becomes less of a constraint. However, even if you are young, such analysis still provides a very valuable litmus test to see if you are at least heading in the right direction, even though plenty may change between now and 30-40 years down the road. The biggest issue we run across as financial planners is when we get involved too late; if a client meets with us for the first time at age 60 and only has a few hundred thousand dollars saved, there is no way to sugar coat the fact that they may have trouble reaching the goal of financial independence.

We have discussed such cash flows on a high level, so let’s now get into the granular details. The sophistication of the planning software becomes important. We have seen a variety of financial plans from other advisors – some utilize excel which naturally leads to some degree of human error; others use a very basic software package that simply lumps income/expenses into a single line item (which they use in order to keep costs down). CFPs® generally see the importance of utilizing a sophisticated software package that will have certain important capabilities.

First, in building an individual’s personal net worth statement, proficient planning software has the ability to first link all of your fluid assets and liabilities to their specific vendors (bank accounts, investment accounts, mortgage, etc.). For instance, such software will allow you to link your Chase checking account from the Chase website directly into the planning software. This will allow the client to have an up-to-date net worth that will update daily. It also feeds such information into the planning software, which allows the planner to quickly conduct a “check-up” down the road to see if the client is still on track. There are of course some assets that cannot be connected to such software, and we the advisors will have to manually input such information into the planning software in order to get a complete picture of your personal net worth statement.

Once we have this information, we then have the client provide their household income and expenses. A budget should be provided which details specifically how the client is cash flowing each month – this will tell the CFP® several things, but most importantly, this will provide a granular view of how the client spends their money. The CFP® should then take this information and include growth rates for each income and expense and project out in time, from now through retirement and in old age. The CFP® can then see the client’s current ability to save, and also whether additional saving is necessary provided their expenses and when they desire to retire. From here, the CFP® should then determine a recommended cash flow – this may mean that the client should save additional money, spend less, purchase insurance, change their estate planning, etc. The client may also want to see certain cash flow scenarios. This could be due to the fact that the client wants to retire sooner/later, purchase a home, etc. and see such effects on cash flow.

Education Funding

One portion of cash flow planning that may/may not have an effect on a client’s cash flow is whether or not they have children, and also whether or not they want to help pay for their children’s education. Thus, effective education funding strategies and utilizing the right tools for saving are essential.

The first thing that a skilled CFP® should do is determine what type of school the client wants to plan for. Does the client want to plan for a state university? Out of state university? A private university? Your child’s education can have very different funding needs depending on the type of school, so it is critical to get a preternatural understanding of what you want to plan for. The CFP® will then need to determine how much the client desires to fund – be it all, a portion, or none of their children’s college. Even if the answer is none, the client will then have an understanding of what type of loans their kids may be looking at in the future. If they plan on funding a portion/all of it, and/or already have funds to utilize, these can be baked into the plan.

The CFP® then should determine the growth rate of the college expense and the rate of return on the investments saved, and if the client is utilizing good planning software, this should provide a gauge as to how much the client needs to fund on a monthly/yearly basis in order to fully/partially fund their children’s collegial education.

So the next question – fund what? Well there are several financial products that can be used to save for college – 529 plans, Coverdell accounts, prepaid tuition plans, etc. We will save the explanation of each type for another article, but generally the best way to save for college is the use of a 529 plan. With this type of plan, after tax dollars are invested, grow tax free and so long as you utilize the plan assets for higher education – undergraduate/postgraduate/trade school tuition, room, board, and equipment, you will not pay any taxes for any capital gains. Also, some states offer an in state tax deduction (generally if you have residency in the state) for a certain amount of your annual contribution. It is essentially a “Roth” for college!

If you are unable to save for your children’s education or want your children to have some skin in the game, your CFP® should understand at least on a high level the differing types of loan options your children have currently for college. We have outlined this very thing in a previous series of articles, so if you want to learn more about them, please visit that page.

If you have any questions or would like to discuss any part of the above sections, we are here to help. Please do not hesitate to reach out to either of us.

Karen DeRose and Anthony DeRose are registered representatives of Lincoln Financial Advisors Corp.

Karen DeRose and Anthony DeRose are registered representatives of Lincoln Financial Advisors Corp.

Securities and advisory services offered through Lincoln Financial Advisors Corp., a broker/dealer (Member SIPC) and registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. DeRose Financial Planning Group is not an affiliate of Lincoln Financial Advisors.

*Licensed but not practicing on behalf of Lincoln Financial Advisors.