HIGH 5 General Principles of Financial Planning

Question 1

Education Tax Credits & Deductions

Lifetime Learning Credit

($2K)

Answer 1

Benefits
1. Provides annual taxpayer reimbursement for qualified tuition and related expenses per family in the amount of $2,000 per year BUT the taxpayer must spend $10,000 annually on qualified educational expenses to qualify for the full credit

Requirements
1. This tax credit is available for tuition and enrollment fees for undergraduate, graduate, or professional degree programs

2.) Neither requires enrollment in a degree program nor necessitates at least half-time enrollment

3.) Can be claimed for an unlimited number of years

4.) Phaseout based on the taxpayer’s MAGI (Consolidation Appropriations Act, 2021)

a.) Single: $80,000–$90,000
b.) Married filing jointly: $160,000–$180,000
c.) Married filing separately: not available

Question 2

If multiple kids, which combo provides best tax benefit?

(AOTC $2500 & Lifetime Learning Credit $2000)

Answer 2

1. If 2 or more kids in the same house incur qualified expenses in the same year the parents may claim:

a) AOTC for each child
b) Lifetime Learning Credit for the family
c) Lifetime Learning Credit for one child & AOTC for the other child

2. Only 1 credit is allowed per child/year.

*You CANT use AOTC & LLC in same year for the same child

Question 3

Education Tax Credits & Deductions

1. American Opportunity Tax Credit

($2500)

*NO ROOM & BOARD

*The student is ineligible for the American Opportunity tax credit if he has a felony drug conviction.

Answer 3

1. Equals 100% of the first $2,000 of qualified expenses paid in the tax year, plus 25% of the next $2,000
2. The maximum credit allowed in a given year is $2,500 per student, if there are $4,000 of qualifying expenses
3. Requirements
   a.) Available for qualified tuition, enrollment fees, related expenses and expenses for textbooks and other course materials incurred and paid in the first four years of postsecondary education for the taxpayer, spouse, or dependent.
   *ROOM & BOARD ARE EXCLUDED.

b.) Student must be enrolled no less than 1/2 time to be eligible
c.) In 2023, the credit is subject to a phaseout based on the taxpayer’s MAGI
(Married filing jointly: $160,000–$180,000)
(All other taxpayers: $80,000–$90,000)
d.) Up to 40% of the eligible AOTC credit is refundable, so even those who owe no tax can get up to $1,000 of the credit for each eligible student as cash back. For example, if a taxpayer owes no taxes and is eligible to take the maximum AOTC of $2,500, he will receive a tax refund of $1,000 (40% of $2,500).

Question 4

Coverdell Education Savings Accounts

(2K/year per child)

Answer 4

1. Benefits
   Contributions grow tax free & distributions are tax free if used for qualified educational expenses
2. Requirements
   Child has to be under 18 (unless child has special needs)
3. Contributions
   No contributions after 18 y/o (unless child has special needs)
   Phaseout limits for 2023
4. Single taxpayers: $95,000–$110,000 modified AGI
5. Married filing jointly: $190,000–$220,000 modified AGI
6. Rollover
   When beneficiary reaches 30 y/o, the account must be distributed to them w/in 30 days. Subject to income tax and 10% penalty.

Account may be rolled over to younger sibling (tax-and penalty-free).

If the new beneficiary is a generation below the generation of the original beneficiary, the distribution is treated as a taxable gift.

Question 5

Section 529 Plan (Type 1)

1. Prepaid Tuition Plan

*Lock in Today’s Dollars
*Only certain school

Answer 5

1. Allow parents to PREPAY TUITION today at a PARTICULAR school for an individual in the future
2. The plan will lock in TODAY’S PRICES but subjects the participant to risks
   a.) The beneficiary may choose a school different from the one named in the plan
   b.) The beneficiary may not be accepted into the school named in the plan

Question 6

Section 529 Plan (Type 2)

2. College Savings Plan

Answer 6

1. Allows an individual to make contributions today into a savings fund
2. Earnings grow tax-deferred
3. If the proceeds are used for higher education expenses, the distributions are received income tax-free

Question 7

Savings Bonds

Series EE/I

Answer 7

1. If the bonds are redeemed during a year in which the taxpayer or taxpayer’s family member has qualified higher education expenses (529 or CESA), bond interest avoids taxation (within limits).
2. Face values start as low as $25 and increase up to $10,000
3. They must be purchased after 1989 to be eligible for special tax treatment & in purchased in parent’s name
4. Owners must redeem the bonds in the same year that the student/child’s qualified higher education expenses are paid
5. The exclusion is subject to a phaseout in the years in which the bonds are redeemed and the tuition is paid.
   The modified adjusted gross income phaseouts for 2023 are
   $91,850–$106,850 for single returns
   $137,800–$167,800 for joint returns
   Married taxpayers filing separately do not qualify for the exclusion.

Question 8

Financial Aid

Expected Fam. Calculation (EFC)

Income
1. Parents
2. Students

Answer 8

1. Parents
   22%-47% of MAGI above the income protection allowance.
   Distributions from a parent owned account is NOT considered income in EFC calculations.
2. Students
   50% of income above protected amount
   Protected amount = $7040

Question 9

Financial Aid

Expected Fam. Calculation (EFC)

Assets
1. Parents (5.64% max)
2. Students (20%)

Answer 9

1. Parents: (MAX 5.64% included in EFC)
   Includes non-retirement accounts over income protection allowance, savings, investments (529)
   *home value & retirement accounts NOT included
2. Students (20% of assets included in EFC)
   Includes brokerage accounts
   UGMA/UTMAs
   Bank, savings accounts, CDs

Question 10

Expected Family Contribution (EFC) Formula

Answer 10

EFC =
(22-47% parent income +
5.64% parents assets)
+
(50% of student income + 20% student assets)

Question 11

Illusion of Control

(Cognitive Biases)

Answer 11

You believe you can control the outcome of an event when you cannot

Question 12

Money Illusion

(Cognitive Biases)

Answer 12

You have a tendency to think $1 has the same value today, tomorrow, and into the future without considering inflation.

Question 13

Conservatism

(Cognitive Biases)

Answer 13

You initially form a rational view but fail to change that view as new information becomes available

Question 14

Hindsight Bias

(Cognitive Biases)

Answer 14

You have a selective memory of the past and have a tendency to remember your correct views and forget your errors

Question 15

Confirmation Bias

(Cognitive Biases)

Answer 15

You look for ways to justify your current beliefs

Question 16

Mental Accounting

(Cognitive Biases)

Answer 16

You tend to place money into separate mental “accounts” based on the purpose of these accounts
*debt reduction
*vacation fund
*savings account

Question 17

Self Attribution Bias

(Cognitive Biases)

Answer 17

Taking credit for your successes and blaming others or internal influences for your failures

Question 18

Anchoring Bias

(Cognitive Biases)

Answer 18

You make a irrational decision based on information that should have no influence on the decisions

Question 19

Adjustment Bias

(Cognitive Biases)

Answer 19

Involves clients clinging on to an initial estimate and not adjust-ing for new information.

Question 20

Prospect Theory

(Emotional Biases)

Answer 20

Clients fear losses much more than valuing gains.
They will often choose the smaller of two potential gains if it avoids a sure loss.

Question 21

Loss Aversion

(Emotional Biases)

Answer 21

You fear losses much more than you value gains and you prefer avoiding losses to acquire the same amount and gains

Question 22

Overconfidence

(Emotional Biases)

Answer 22

You believe that you can control random events merely by acquiring more knowledge and consider your abilities to be much better than they are

Question 23

Self Control Bias

(Emotional Biases)

Answer 23

You lack self discipline in favor immediate gratification over long term goals

Question 24

Status Quo Bias

(Emotional Biases)

Answer 24

You are comfortable with an existing situation which leads to an unwillingness to make changes even though the changes are beneficial

Question 25

Endowment Bias

(Emotional Biases)

Answer 25

You think an asset you own is worth more than it is because it’s yours

Question 26

Regret Aversion Bias

(Emotional Biases)

Answer 26

You do nothing out of fear that your decisions or actions could be wrong

Question 27

Affinity Bias

(Emotional Biases)

Answer 27

You make decisions based on how you believe the outcomes will represent your interests and values

Question 28

Outcome Bias

(Cognitive Biases)

Answer 28

The tendency for individuals to take a course of action based on the outcomes of prior events.
An investor may choose a particular stock because that stock had superior performance over the past three years. However, this same investor would be ignoring the current conditions that may be applicable to the stock’s performance in the future.

Question 29

SERIAL PAYMENTS

Assume Craig wants to save $50,000 (in today’s dollars) for his son’s college expenses in 5 years. Craig is comfortable using an inflation rate of 4% and an investment rate of return of 8%. Calculate the serial payment that Craig will make at the end of the third year.

Answer 29

The answer is $10,415.99.

Step 1: Determine PMT at the beginning of the first year.

END MODE
50,000 FV
5 N
3.8462 I/YR [(1.08 ÷ 1.04) – 1] × 100 = 3.8462
Solve for PMT = 9,259.7823, or $9,259.78
Step 2: Multiply by 1 + inflation rate, to find the payments due at the end of each year.

$9,259.78 × 1.04 = $9,630.17 (first year)
$9,630.17 × 1.04 = $10,015.38 (second year)
$10,015.38 × 1.04 = $10,415.99 (third year)

Question 30

To determine whether the items should be included in the statement of Financial Position

Answer 30

To determine whether the items should be included in the statement of financial position, the asset or liability should have the following characteristics:
1. The asset or liability is a fixed and determinable amount.
2. The receipt or payment is not contingent on the occurrence of a particular event.
3. The receipt or payment does not require future performance of service.

Question 31

PV of Single Sum

Stuart expects to receive $5,000 at the end of each of the next four years. His opportunity cost is 14% compounded annually. What is this sum worth to Stuart today?

Answer 31

END mode
PMT= 5,000
I/YR = 14
N= 4
FV= 0
Solve for PV = (14,568.56), or $14,568.56

Question 32

Solve for PMT

Tina wants to purchase a home 6 years from today for $150,000. To attain this goal, how much should Tina invest at the end of each 6-month period if she expects to earn a 12% annual rate of return, compounded semiannually, on her investments?

Answer 32

END mode
FV = 150,000
I/YR = 6 (12 ÷ 2)
N = 12 (6 × 2)
PV = 0
Solve for PMT= $8,891.55