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CFP® Practice Question of the Week: Financial Planning

Five years ago, John and Barbara, who are in their mid-50s and have one adult child out of college, experienced a sharp increase in income (ten times) within a two-year period. Their lifestyle and the complexity of their financial situation increased respectively. Their income statement’s bottom line increased and their assets/liabilities expanded as well (third home, credit card debt, etc.). They had no retirement savings at age 50.  After consulting their accountant, they implemented a 401(k) and defined benefit plan with the dual purpose of deferring taxes and saving for retirement. John and Barbara’s increase in income was based upon Barbara’s success at a new business venture. John is the business manager of the venture. Their financial assumptions were based on unrealistic sales assumptions and they were not prepared for the recent recession or their parent company’s subsequent reorganization. Since the reorganization, their income fell by 65%. As a result, they had a mortgage on a second home in Las Vegas (purchased at the peak of the real estate market), less than one month of emergency reserves, and six-figure credit card debt. They were unable to fund their pension obligation (to themselves) and closed the plan, while also taking the maximum loans from their 401(k) plans to pay off their credit cards.

John and Barbara’s objectives include immediately establishing an emergency fund, determining how much income will be needed from investments to supplement Social Security and work in retirement, and preparing an exit strategy for real estate holdings.

Barbara feels that the economy is on the verge of a turnaround. She has an opportunity to expand her business and, if she is right about the economy, this will substantially grow revenue. She will need an additional $50,000 for this expansion. What is the most suitable recommendation for Barbara and John as it pertains to business expansion?

  1.   Borrow $50,000 from a home equity line of credit
  2.   Take a $50,000 loan from their 401(k)plans
  3.   Bring in a qualified partner who is able to commit the capital
  4.   Use part of the cash reserve to fund a portion of the expansion