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a. Income capitalization approach
= Net operating income/capitalization rate(Saez, and Zucman, 2016)
= 90,000 / .04
= $ 2,250,000
The above mentioned refers to an amount that needs to be insured by the client John and Laura. This is to cover their salary sufficiency after the retirement. Even both John and Laura have to meet out the cost of debt which is taken to purchase the house. The cost of debt is further adjusted to the rental value of the house which is taken as a benefit to be achieved.
Requirements of insurance depend on various factors. This depends on various factors including
Gross insurance to be taken into consideration = $ 2,250,000
(-) Available insurance = $ (1,276,000)
Net insurance cover required = $ 974,000
(-) Available net asset portfolio = $ (1,269,000)
However the client has sufficient net asset base to meet out the future challenges but still John and Laura has to go on the gross insurance approach to meet out the present requirements and ensure continuity of current earnings.
Net assets will be calculated as follows
Inherited shares Investments
Share portfolio of John
House property purchased
Existing loans are taken on car by Laura
Credit card debt
Current margin loan
Loan took on purchase of house property
Net assets (a) – (b)
b. Age to retirement lump sum approach
Instead of receiving series of monthly instalment after the retirement in this pension plan individuals receive a lump sum amount (Argento, et. al., 2015). The amount received after retirement is a calculation of the compounding factor and various another factor including age, a period of investments current salary structure, the interest rates prescribed in the annuity plan etc. In the present case study the interest rate prescribed discounted at the rate of 4 %. As per the current age status of John and Laura, they have almost 27 & 24 years left for the retirement at the age of 60. They can subsequently plan their investments and make subsequent outflow of funds accordingly to meet out their planned fund goal.
c. Advantage & disadvantage of using goal approach over age to retirement lump sum & income capitalization approach
The following below mentioned table describes merits and demerits of using goal approach instead of other two approaches used above
Income capitalisation approach/lump sum approach
In goal approach, all the practical factors are considered which are predicted by the client. For instance, an individual can plan for early retirement and set priority of expenses accordingly
This portfolio is prepared to justify the current earning level of individuals after the retirement. The further amount received in inheritance is also considered rather this is simply based on the individual’s net earnings.
The Widerapproach that is it covers all the sectors which describe any changes or alterations in the earning level.
Narrow approach just focus on pre-planned monetary chart
An individualcan customize its portfolio of investments according to its needs and requirement. This ensures a greater level of flexibility for the individuals
If one want to go for guaranteed income for life than it might go for income capitalisation approach but if it wants a fixed amount at the time of retirement than it may go for lump sum investment plan
If an individual has great financial skills and knowledge it can easily diversify its portfolio to meet out its end goals. However, the investor will high fund portfolio tends to invest through personal advisors.
The individualwill low financial knowledge tend to go for traditional plans which incorporate either going for lump sum plan or regular pension approach.
The analystcan design the portfolio with mix structure so that it can qualify the investment to cope up with the inflation factor. The investor seeks the future cost of living index keeping in relation to the present income status and invests accordingly in a diversified portfolio.
Only discount rate factor enhances the value of an investment which is lower than the inflation rate in the present case. On the long run going with this approach will eat out the money and curb the investment in real terms.
An investorcan set its future requirements and ensure availability of funds as and when required. For instance, an investor might require fund for its children education, funds for other social requirements, tour and travel expenditure etc. The analyst can manage the fund requirement appropriately while investing in funds with appropriate maturity and deadlines.
Retirement funds cannot be redeemed before the maturity period; it is an approach to investing funds.
On making the above comparison it has been observed that goal basis investments are a rather better way of ensuring future needs rather than the traditional approach of lump sum approach or regular pension income funds.
Facts of the case
1. No dependants with the client
2. Opting for best insurance policy for the client out of TPD insurance and life insurance
In the above case, clients do not have any liability in terms of dependents that might suffer financially in the case where a client is exposed to uncertain risk. Under the life insurance plan risk covered by the client in financial terms will be paid out to the nominee mentioned by the client at the time of taking policy in the subsequent event of the death of the client. Where in the case of Total & permanent disability insurance though the conditions are similar to life insurance but it pays to sufferer on the happening when client himself got disabled on the temporary or permanent basis.
In the present case, scenario client should be suggested to take TPD insurance over the life insurance plan as a client do not have any dependent to cover their financial risk. Rather TPD insurance will help the client to set as a backup in case when his permanent source of income get extinguished due to his disability reasons (Chetty, et. al., 2014).
However, client has an option to take fixed income plan bundled with life insurance policy that will help them to generate a good return after maturity of insurance plan.
Almy, R., 2014. Valuation and Assessment of Immovable Property. OECD Working Papers on Fiscal Federalism, (19), p.0_1.
Argento, R., Bryant, V.L., and Sabelhaus, J., 2015. Early withdrawals from retirement accounts during the great recession. Contemporary Economic Policy, 33(1), pp.1-16.
Chetty, R., Friedman, J.N., Leth-Petersen, S., Nielsen, T.H. and Olsen, T., 2014. Active vs. passive decisions and crowd-out in retirement savings accounts: Evidence from Denmark. The Quarterly Journal of Economics, 129(3), pp.1141-1219.
Merton, R.C., 2014. The crisis management in retirement planning. Harvard Business Review, 92(7/8), pp.43-50.
Saez, E. and Zucman, G., 2016. Wealth inequality in the United States since 1913: Evidence from capitalized income tax data. The Quarterly Journal of Economics, 131(2), pp.519-578.