1 Financial Re-Engineering I & II DETERMINING A COLLEGE BUDGET Steven I. Yeh, JD, MBA Steven Yeh has been certified by the American Education Foundation.

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Financial Re-Engineering I & II

DETERMINING A COLLEGE BUDGET

Steven I. Yeh, JD, MBA

“Steven Yeh has been certified by the American Education Foundation (“AMEDF”) as an instructor for college planning programs. Steven Yeh is also a registered representative offering securities and financial planning services through Lincoln Financial Advisors, a broker-dealer and investment advisor with a branch office located at 6255 Sheridan Drive, Suite 300, Amherst, NY 14221. There is no relationship between the AMEDF and Lincoln Financial Advisors.”

CRN 0407-4049

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COLLEGE COST ISSUES

• How to limit the # of years of total college costs (undergraduate and graduate studies)

• How to determine budget• Identify the proper techniques to controlling

college expenses (need-based aid maximization, merit aid & cost reduction)

• Use answers to determine proper college cost filter (MyRoad)

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Financial Re-Engineering:An Overview

• Internal evaluation of ability to pay for college expenses

• Balancing current college needs with other crucial needs

• Current issues: Sandwiched generation (college, nursing care, retirement), Defined Contribution experiment (Social Security?) , Self-directed investing (1929 & 2000?)

• Tasks required for individual planning conference– Worksheets and statements

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The Process of Planning

• 5-Step Process: EFC, Cash-flow, Protection Need, Retirement Projection, and Rate of Return evaluation

• Key is manageability: most have no written plan

• Proper use of debt in educational financing• Balancing short and long-term needs to

prevent sacrificing necessities

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Case Study:

• Father age 45, mother age 40, children ages 17 and 15

• 6 years of anticipated colleges expenses with 2 years of overlap

• Income 1 is a gross of $60k less $5k for 401(k) and $10k for taxes

• Income 2 is a gross of $45k less $4k for 401(k) and $8k for taxes

• Assets consists of a home valued at $200k with a mortgage of $120k, $40k in CD, IRA1 of $40k and IRA2 of $20k in mutual funds, 401(k)1 of $60k and 401(k)2 of $30k; student UTMA of $20k

• Issues: what can this family afford for college costs, and are the parents contributing enough towards their retirement needs?

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BUDGET?

• FM 1 YR = $ 25,538

• FM 6 YRS = $ 139,228

• IM 1 YR = $ 21,683

• IM 6 YRS = $ 122,398

COST & EFC SUMMARY

• Pay from income, assets, or both?

• What are the impact of paying college costs?

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Assumptions:

• Necessary expenses monthly estimated

• Assume survivor need at 70% of current income

• Both are insured through employer for 3x salary with no personally-owned life insurance

• Assume retirement age is 65, and life expectancy till age 90

• Assume retirement income need at 70% of current

• Retirement portfolio’s average return is 7% during accumulation, 4% during distribution; year 2002’s portfolio average, however, was a loss of –19.4%

• COLA & inflation estimated at 3% for entire period; PLUS ability to borrow based on interest rate of 5%; HE borrowing at 7%

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Questions to Answer

• Short term:– What is the monthly free

cash flow?– How long is this cash flow

expected to be available?– Is income adequately

protected?– How much can afford based

on cash flow• Pay direct• Pay with debt

– Which assets can be used without jeopardizing aid?

• Long-term:– Assuming current actions,

will will there be enough to retire?

– Which assets can be used for current (college) needs without jeopardizing future needs?

– Where and how can my financial position be improved?

• Risk and task reduction• Increase returns

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Summary of Initial Analysis and Example of Actions

• Shortages: not adequately protected against premature death of both earners ($748k and $429k)

• Not enough to retire based on current assumptions

• Cover with 10-Yr level term policy and allocate cost to cash flow

• Increase projected rate of return to 10% for retirement portfolio based on analysis of investor profile

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Answers to Questions:• Short term:

– Monthly discretionary cash flow is $460

– This cash flow available for max of 20 years

– Incomes are adequately protected against premature death

– Afford based upon cash flow• Pay direct of $33,120• Pay with PLUS debt of

$43,000 (5%)• Pay with home equity debt

of $60,000 (7%)

– CD can be used for college

• Long-term:– Assuming current actions,

we will have enough to retire?

– Cannot use retirement assets

– Portfolio Issues:• Is projected long-term return

assumptions realistic?

• Is my portfolio well matched to our investor profiles?

• What are the dangers present in our portfolio that may contribute to failure to reach our goals?

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BUDGET?

• FM 1 YR = $ 25,538

• FM 6 YRS = $ 139,228

• IM 1 YR = $ 21,683

• IM 6 YRS = $ 122,398

COST & EFC SUMMARY

• $ 33K income + $ 40k CD + $20k UTMA = $93K

• Sufficient income protection and retirement needs on track

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COST & EFC AFTER• FM 1 YR = $ 18,538

• FM 6 YRS = $ 111,228

• IM 1 YR = $ 16,683

• IM 6 YRS = $ 102,398

BUDGET?• $ 43k (PLUS) + $ 40k (CD) + $18k + $18k (Unsub Stafford) = $

119k

• Assumption of 4-year college terms, cash flow discipline, and meeting targeted ROR

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Budgeting Keys

• Separate and identify non-discretionary spending (housing, child-care, transportation, food, medical, debts)

• Set parameters for discretionary needs (clothing, furnishings, personal care & cash, edu., entertainment & vacation, charity)

• Set time limit of 1 hour for discretionary needs (not over think)

• Determine ideal cash-flow model• Review and compare to current lifestyle• Discipline

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Steps to Rate of Return Determination :

• Determine profile

• Assign proper benchmark– Appropriate volatility (standard deviation) and

past returns trade-off

• Analyze & compare

• Periodic review & update

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Wrap-up• Participant Activities:

– Forward copies of tax returns, W2, asset statements (all pages) incl. 401(k), 403(b), brokerages and investments

– Complete worksheets on expenses, desired income levels for protection and retirement, pension and direct income sources, and risk tolerance questions

– AMEDF Resource Center (www.amedf.org; Resources) for PLUS/Stafford apps & calculators, scholarship search, SAT diagnostics

• Program Advisor Activities:– Process and generate gap

analysis to determine discretionary income, debt carrying ability, protection needs, and retirement projections

– Available to assist in implementing improvement strategies (independent and not part of the Scholars Program)