Gabriel and Sarah Cantrell, both age 34, were married four years ago. Gabe and Sarah have one daughter, Joyce, who is now age three. They also have a young son, Lee, who is age one. Gabe and Sarah live at 1315 Devonshire Drive in Anytown, Anystate, 88901.

 

Gabe works for TG Ag Services as a sales representative. He has been working since heturned age sixteen and has spent the last five years with an agricultural services company. Gabe earns $95,000 per year and has been with his current employer 4 years.

Sarah started working when she was fifteen years old. She is the general manager of a chain of popular discount stores. She earns $100,000 per year and has been with her current employer for 8 years.

Other Information

Economic Assumptions(Unless otherwise specified)

• Inflation: 3.5 percent
• All income and expense figures are given in today's dollars.
• Planned retirement age: sixty-seven for both
• Federal marginal tax bracket: 22 percent
• State marginal tax bracket: No state income tax
• All nominal rates of return are pretax returns.

Income Issues

Both Gabe and Sarahassume that their salaries will increase at the rate of inflation.

Statement of Financial Condition

Before meeting with you, Gabe and Sarah prepared the following information.

The Cantrells' Fixed and Variable Expenses

Expenses	Amount	Frequency
Health Insurance premium(under Sarah's group health plan)1	$4,800	Annually
401(k) contribution (Gabe)2	$3,800	Annually
401(k) contribution (Sarah)2	$5,000	Annually
SS/Medicare (FICA) withholdings (combined)	$14,900	Annually
Federal tax withholdings (combined)	$33,000	Annually
Mortgage payments	43,200	Annually
Credit card payments	$6,000	Annually
Auto insurance	$2,400	Annually
Homeowner's insurance	$1200	Annually
Subscriptions	$480	Annually
Cell phone	$1,800	Annually
Home Internet	$1,100	Annually
Hobbies (Sarah)	$1,450	Annually
Recreation/entertainment	$4,800	Annually
Groceries	$6,000	Annually
Food away from home	$3,000	Annually
Real estate taxes	$1,480	Annually
College loan - Gabe	$7,200	Annually
Private mortgage insurance	$1000	Annually
Household maintenance	$750	Annually
Other Home Expenses	$750	Annually
Utilities	$3,300	Annually
Clothing	$2,200	Annually
Furnishings	$750	Annually
Child care3	$7,200	Annually
Eyeglasses	$300	Annually
Medical deductibles and co=pays	$500	Annually
Unreimbursed medical expenses	$1000	Annually
Gasoline	$1,100	Annually
Car registrations	$1,000	Annually
Personal property tax	$1,500	Annually
Charitable contributions	$1200	Annually
Vacations	$6,000	Annually
Gifts to family members	$1,000	Annually

¹Pretax Section 125 plan expenses

²Pretax contributions

³The child care provider is licensed in Anystate.

Note: Last year, the Cantrells paid $711 in Anystate sales taxes.

The Cantrell's Assets

Asset	Amount	Ownership
Financial Assets
Checking account	$350	Joint
Savings account	$500	Joint
EE savings bonds	$1,000	Joint
Sarah Section 401(k) Plan	$70,000	Sarah
Gabe Section 401(k) Plan - Current Employer	$24,000	Gabe
Gabe Section 401(k) Plan - Previous Employer	$20,000	Gabe
Large-cap funds	$5,000	Gabe
Mid-cap funds	$2,500	Gabe
Small-cap funds	$2,500	Gabe
Government bond funds	$1,000	Sarah
Mid-cap funds	$2,500	Sarah
Small-cap funds	$1,000	Sarah
Other Assets
Primary residence	$500,000	Joint
Buick SUV	$22,000	Joint
GMC pickup	$9,800	Joint
Collectibles	$1,200	Joint
Golf clubs and equipment	$3,800	Joint
16' sailboat	$9,600	Joint
Furniture	$13,000	Joint
Other assets	$4,700	Joint

The Cantrells' Liabilities

Liability	Amount	Ownership
Visa credit card4	$12,000	Joint
MasterCard5	$5000	Joint
Mortgage	Unknown	Joint
College loan - Gabe6	$25,000

⁴17.95 percent APR

⁵14.25 percent APR

⁶4.5%

Gabe and Sarah purchased a new home when they first married. They made a down payment of $10,000 and the original mortgage was $490,000 for thirty years. interest. Gabe and Sarah have made precisely 48 payments on the mortgage. The current replacement cost of the home is $600,000. The original mortgage terms are 30 years at 4.5% interest.

Insurance Information

Life Insurance and Planning Issues

• Gabe and Sarah would like you to analyze their life insurance situation using thefollowing assumptions and facts: Final expenses are expected to be $9,500 each.
• Estate administration costs are anticipated to be $3,500 each.
• All outstanding liabilities will be paid at the first death.
• Gabe and Sarah would like to pre-fund $10,000 in child care expenses at thedeath of the first spouse.
• Gabe and Sarah would like to pre-fund college costs in the event of a spouse'sdeath. They plan to invest any insurance proceeds for this goal in a tax-advantaged educational savings plan.
• Gabe and Sarah can earn 7 percent before taxes on life insurance proceedsboth prior to and throughout retirement.
• Gabe and Sarah anticipate that their marginal federal tax rate will increase to25 percent in retirement.
• Gabe and Sarah would like to replace $58,000 in retirement income for thesurviving spouse.
• Gabe and Sarah are willing to use all of their retirement savings to offset lifeinsurance needs.
• In the event of either spouse's death, the other spouse plans to stop workingat age sixty and begin taking early retirement survivor benefits (if available).
• For conservative planning purposes, the Cantrells do not plan to use interestand/or dividends as an income source when determining insurance needs.
• Gabe's employer provides a term policy for two times his salary at no cost,which continues during periods of disability but terminates at retirement.Sarah is the beneficiary of the life insurance policy.
• Sarah's employer also provides two times her salary in term coverage at nocost, which continues during periods of disability but terminates at retirement.Gabe is the beneficiary of the life insurance policy.
• The surviving spouse's income is not expected to change after the death of thefirst spouse.

The Cantrells'Social Security Survivor Benefit Information:

Beneficiary	Amount (Monthly)1
Sarah and children (until last child turns age 18)	$2,582.50
Gabe and children (until last child turns age 18)	$1,843.10

¹Income test limits could apply. Seessa.govfor more information.

Additional Insurance Information and Financial Planning Issues

Both TG Ag Services and Dave's Discount Store are large employers in the area; eachemploys more than twenty people at any given time. The Cantrells do not currentlyhave disability or long-term care insurance policies. Both are healthy, with both sets ofparents still alive and well. Their home is currently covered by an HO-3 policy with aninflation rider and a $1,000 deductible. The HO-3 includes an 80% coinsurance clause. Both automobiles are insured with a split-limit coverage of $250/$500/$100 and a $500 deductible.

Retirement Information

The following information should be used when evaluating the Cantrells' current retirement planning situation:

• Gabe and Sarah anticipate being in a combined federal and state 25 percentmarginal tax bracket after retirement (Gabe and Sarah are considering movingto another state at retirement).
• Gabe and Sarah are comfortable assuming they can generate a 7.00 percent annualized rate of returnbefore retirement.
• When retired, Gabe and Sarah would prefer to maintain a conservative growthasset allocation that will generate a 3.5 percent annualized rate of return.
• If they retired today, Gabe and Sarah would like to replace 80 percent of theircombined income.
• At retirement, Gabe will be eligible to receive $1,563 in monthly Social Securitybenefits.
• At retirement, Sarah will be eligible to receive $1,096 in monthly Social Securitybenefits (Note: This figure is different from the amount shown in theSocial Security Survivor Benefit InformationTable).
• Gabe and Sarah are comfortable assuming a life expectancy of 100 hundredyears.
• Gabe currently contributes 4 percent of his salary to his company's 401(k) plan;his employer matches 50 percent on the first 6 percent contributed. He has participated in the plan since first becoming eligible 3 years ago. The 401k plan has a 2 to 6 year graded vesting schedule. Gabe also has a vested balance of $20,000 from a previous employer's 401(k) plan. To this point, he has left the account in the previous plan.
• Sarah currently contributes 5 percent of her salary to her company's 401(k)plan; her employer matches 50 percent on the first 5 percent contributed, up tothe maximum annual limit. She has participated in the plan since first becoming eligible 3 years ago. The 401k plan has a 2 to 6 year graded vesting schedule.
• Inflation before and after retirement is assumed to be 3.50 percent.
• Contributions to 401(k) plans will increase by 3 percent even though salariesare expected to increase by the rate of inflation.

Estate Information

Both Gabe and Sarah have professionally prepared wills; each leaves their respective assets to the surviving spouse. Each will namestheir attorney as the estate executor, and in the event of a simultaneous death it isassumed that Gabe will predecease Sarah. Other estate planning assumptions include:

• Funeral and burial expenses will be $7,500 each.
• Estate and legal costs will be $2,000 each.
• Executor fees will be approximately 2 percent of the gross estate before themarital transfer.
• The net growth rate of the survivor's estate is estimated to be 4 percent annually.
• All individually owned assets that pass via property law or contract (e.g., IRAs,qualified plans, bank accounts, life insurance) name the surviving spouse asthe primary beneficiary; no contingent beneficiaries have been named.
• No other estate planning documents are known to exist.The table belowprovides a summary of the current yield and rate of return informationapplicable to this case.

Yield and Rate of Return Information:

Investment Class	Yield
Checking account	0.00%
Savings account	3.00%
Taxable money market fund	3.50%
EE and I bonds	3.50%
Loan Rates
Thirty-year mortgage1	6.50%
Five-year mortgage1	6.00%
Home equity line of credit1	7.25%
Home equity loan1	7.35%
Five-year auto loan	7.90%
Personal loan	8.50%

¹APR includes closing costs over the life of the loan.

Goals and Objectives

The Cantrells' primary financial planning objective at this point is to fully fund four years of college for their two children. Gabe and Sarah have already been in contact with the universities they hope their children will attend. Gabe and Sarah learned that the annual cost of college (including tuition, room, and board), in today's dollars, is $25,000 at each school. College costs are estimated to increase by approximately 5 percent annually.

Gabe and Sarah would like to have the total amount needed to pay for each child's college costs available on the first day of college. Given their combined moderate level of risk tolerance, Gabe and Sarah are comfortable planning for college expenses using a 6.00 percent annualized rate of return assumptions. Gable and Sarah would also like to use a tax-advantaged investment to save for college.

Their second goal is to retire at age 67, using the assumptions already listed.

In preparation for a meeting with the Cantrells, you have been given a monitored list of mutual funds used by your firm. Your firm's investment committee will allow you to use any of the funds listed in Table VII.6 when developing investment recommendations.

Mutual Funds Approved for Cantrell Recommendations

Market Indexes

	RoR*	SD	Corr ( r ) with Index	Yield
T-bills	4.00%	2.00%	1.00	4.00%
Equity market	12.00%	17.00%	1.00	2.00%
Bond market	8.00%	9.00%	1.00	4.70%

Approved Equity & Commodity Mutual Funds

Fund	Fund Objective	RoR*	SD	Market Correlation (r)	Yield
Super Big Fund	Large-cap fund	13.00%	18.00%	0.95	2.00%
Maxi Fund	Large-cap fund	12.20%	17.40%	0.92	2.00%
Multivariate Fund	Mid-cap fund	14.00%	18.30%	0.90	1.00%
Germain Fund	Mid-cap fund	13.30%	16.90%	0.89	1.25%
Efficacy Fund	Small-cap fund	11.00%	19.00%	0.85	0.25%
Software Fund	Small-cap fund	12.00%	21.00%	0.70	0.00%
Clinical Fund	International fund	10.00%	13.00%	0.68	2.00%
Image Fund	International fund	9.80%	11.00%	0.63	1.00%
Measures Fund	Precious metals fund	6.00%	13.00%	0.40	0.50%
Thumb Fund	Real estate fund	11.00%	11.00%	0.99	4.00%
Factors Fund	Real estate fund	9.90%	12.00%	0.89	5.30%
Column Averages		11.11%	15.51%	0.80	1.75%

Approved Bond Mutual Funds

Fund	Fund Objective	RoR*	SD	Market Correlation (r)	Yield
Alumni Fund	Gov't bond fund	7.80%	8.00%	0.95	4.50%
Bush Fund	Gov't bond fund	8.20%	8.50%	0.90	5.00%
National Fund	Corporate bond fund	8.40%	9.00%	0.98	5.10%
CDR Fund	Corporate bond fund	7.56%	9.20%	0.85	5.40%
Fast Fund	High-yield bond fund	9.90%	13.00%	0.75	7.00%
Mobile Fund	High-yield bond fund	10.30%	12.80%	0.60	8.20%
Column Averages		8.69%	10.08%	0.84	5.87%

*Rates of return include yields.

Question

Sarah and Gabe have asked you tocalculate their adjusted gross incomebased on the information in the financial statements you have prepared. They want to make certain they have not overlooked items in doing their taxes themselves in the past. They want to better understand the components of adjusted gross income and explain what is meant by "for AGI and from AGI." As part of your explanation, please explain which IRS forms and schedules are used in determining "for AGI" and "from AGI" tax return entries and which lines on Form 1040 are used to report the relevant data.