You are an independent financial planner in Sydney, Australia. It is currently April 2020 and you have just concluded a meeting with your client below.

Client: Muhammad.

Marital Status: Single, Divorced in 2008.

Age: 60.

Address: 161 Sussex St, Sydney, NSW 2001

Relations: Ariff, aged 30. Siti, aged 28. (Children from marriage)

Muhammad is an operations manager at a factory (manufacturing plant) that makes furniture, mostly tables, and chairs. He earned $AUD 71,000 in the 2019 tax year and even with the current pandemic, he is expected to maintain the same income for the following 3 years. After the 3 years, Muhammad expects his average income to increase at a rate of 2% per annum for the following 5 years until he retires at the ripe old age of 68. Although he currently receives an income tax refund of $AUD 800, Muhammad has to pay an annual fee for his union membership which costs AUD $1,420. This fee is automatically deducted from his payslip by his employer at the factory. Muhammad's employer also provides him with extended health care insurance. He currently has no life or disability insurance.

From his most recent tax return, we can see that his DEDUCTIONS are:

1) Australia Pension Plan / Employment Insurance (APP/EI) $AUD 3,754

2) Federal Tax $AUD 9,142

3) Provincial Tax $AUD 4,521

Muhammad also has a multitude of PERSONAL EXPENSES. These include:

1) Mortgage Payments, $AUD 1,500 per month.

2) Property Taxes, $AUD 400 per month.

3) Property Maintenance, $AUD 40 per month.

4) Utilities (Gas, Hyrdo, Water), $AUD 220 per month.

5) Property Insurance, $AUD 240, per year.

6) Car Expenses (Petrol, Oil, etc.), $AUD 300 per month.

7) Car Insurance, $AUD 120 per month.

8) Groceries, $AUD 300 per month.

9) Eating at Restaurants, $AUD 180 per month.

10) Internet & Phone Bill, $AUD 140 per month.

Muhammad also regularly buys lottery tickets. He spends about $AUD 100 per month on tickets but says that he wins back $AUD 500 per year. He also takes an annual vacation each year which costs $AUD 2,400. Muhammad insists that he does not have a budgeting framework in place to manage his expenditure. He claims to be unaware of where his money goes but appears to have $AUD 80 per month which he spends on other miscellaneous items.

In the divorce settlement, Muhammad managed to keep hold of his house but in doing so, has had to pay a considerable sum of money from his savings to his ex-wife. He has $AUD 1,350 in his account and about $AUD 250,055 in his RRSP. Muhammad's notice of assessment from the Australia Taxation Office shows that he has $AUD 85,000 of unused RRSP contribution room. All of the money in his RRSP account is invested in GICs as he does not understand stocks and how they work. Muhammad also has a Tax Free Savings Account (TFSA) with a current value of $AUD 15,012 which he intends to use on a retirement vacation once he finally retires from his job at 68. The funds are invested in the TFSA paying 1.2% per annum with interest compounded monthly. Muhammad deposits $AUD 100 per month to his Tax-Free Savings Account with an automatic withdrawal at the bank.

Even though, he has told us that his openness to making bigger investments, Muhammad's lack of knowledge in stocks ultimately decides what he does with his money. At the current moment, he only holds low-risk fixed income products such as the GICs and interest-paying bank accounts. If Muhammad's investment portfolio was properly diversified he will earn 6% per annum.

Other than that, Muhammad has also recently inherited a corporate bond from his late father. The bond has a face value of $AUD 30,000 with a 4% coupon rate paid twice a year until the year 2028. Muhammad was advised by some of his work colleagues to sell the bond as he might get a decent price for it. Currently, in the market, the yield on similar bonds is 1.5% and Muhammad has come to seek advice as he wants to decide if he should hold on to or sell the bond. Muhammad also wants to know if he has to pay tax on the inheritance.

Among the ASSETS that Muhammad has included:

1) House, $AUD 1,000,000. (Bought for $AUD 300,000 20 years ago)

2) Car, $AUD 3,000.

Muhammad is considering purchasing a new car as his current model is extremely old and does not have much value. The dealership is offering him a new one at $AUD 27,000. The way the deal is structured, Muhammad would be made to pay a $AUD 3,000 down payment and then be charged 4.99% APR compounded monthly, with monthly payments for a 4-year term. He wants to know if replacing his car and taking on a new debt is actually feasible since he always feels as though his money just disappears.

Among the DEBT that Muhammad has included:

1) Outstanding Mortgage, $AUD 85,500 (5 years remaining, just renewed for a 5-year term at 2% fixed rate), (Monthly mortgage term from expenses above at $AUD 1,500 per month expected to stay the same)

2) Credit Card Debt, $AUD 4,000 (Currently pays $AUD 80 per month, the interest rate at 13.25%)

3) Line of Credit for Home Renovation, $AUD 12,000 (Currently pays $AUD 250 per month, the interest rate at 2.99% per annum)

The following TAX INFORMATION applies to Muhammad:

1) Average Tax Rate. 25%

2) Marginal Tax Rate, 29%

With the $AUD 250,055 in his RRSP, Muhammad intends to retire in 8 years at the age of 68 with zero debts. He is currently contributing $AUD 300 to the account per month. Although he acknowledges that it is only a small contribution, Muhammad indicates that he intends to increase this contribution over the next 8 years before he retires. He also intends to retain 70% of his current income in his retirement years in order to maintain a decent standard of living.

In order to maintain his current lifestyle after he retires, Muhammad would require $AUD 50,000 per year before taxes and indexed for inflation of 1.5% for 15 years. Muhammad predicts that he would earn an annual return of 4% on his investments, compounded annually during his retirement and that he will also incur a marginal tax rate of 29%.

Although he recognizes the importance of having a Will or a Power of Attorney, Muhammad is unsure which one of his children he should nominate.

As his parents are both deceased, the only asset left for Muhammad to inherit after settling his parents' estate was the aforementioned corporate bond from his late father. As they are both adults, Muhammad's children are both living independently of him. Siti (daughter) is working as a data analyst at a local IT firm while Arif (son) has his own business in which he owns and operates a local restaurant that he started about 2 years ago. Due to the ongoing pandemic, Arif's business is failing and he may be forced to shut down and declare bankruptcy soon. Other than that, Muhammad is also currently dating. His partner has been talking about moving in with him soon but Muhammad is worried that if this were to happen, he would lose half his home should they separate. Ideally, Muhammad wants his home to be shared by his children when he eventually passes away but he is weary from his divorce and is keen to avoid a similar situation.

For this question we will have a number of assumptions:

1) Muhammad is healthy and is expected to live until at least 82. (Currently 60)

2) Inflation rate is 1.5%

3) Muhammad does not plan to leave his current home and will live in it throughout his retirement.

4) Muhammad will only start contributing to his APP (Australia Pension Plan) at age 68.

5) Rate of Return on Investments is 6% pre-tax.

6) Muhammad will be entitled to the maximum amount of Old Age Security Payments which will commence at age 68.

7) When he retires at age 68, his retirement income will be paid annually from the RRSP account at the beginning of each year.

QUESTIONS:

1) Identify Muhammad's Goals.

2) Create a cash flow statement for Muhammad.

3) Create a net worth statement for Muhammad.

4) Calculate the following ratios and explain them:

a) Liquidity Ratio.

b) Asset to Debt Ratio.

c) Investment Asset to Total assets.

d) Debt Payments to Net Revenue Ratio.

5) If Muhammad buys a new car and takes on the loan offered, how will it impact his Debt Payments to Net Revenue Ratio? Should he take the loan or not?

6) Justify 2 reasons for and 2 reasons against Muhammad using an Investment Loan to save for his retirement. Should he use one?

7) What are the implications of Muhammad's girlfriend moving in with him under common law?

8) How much will Muhammad have in his TFSA at 68?

9) Provide 3 financial planning suggestions that you think are important to Muhammad based on the info presented in the case.

Answer rating: 100% (QA)

1Identify Muhammads Goals 1 Maintain his current standard of living after his retirement 2 Ensure that his children are taken care of in the event of his death 3 Have sufficient retirement income at a... View the full answer