MBA-0000

Wealth Management

Block

1
FUNDAMENTALS OF WEALTH MANAGEMENT

UNIT 1
Introduction to Wealth Management 07

UNIT 2
Understanding the Wealth Management Process 26

UNIT 3
Client Profiling 38

UNIT 4
Personal Financial Planning 49
Expert Committee

Dr. J. Mahender Reddy Prof. P. A. Kulkarni

Vice Chancellor Vice Chancellor
IFHE (Deemed University), Hyderabad Icfai University, Dehradun

Prof. Y. K. Bhushan Dr. O. P. Gupta

Vice Chancellor Vice Chancellor
Icfai University, Meghalaya Icfai University, Nagaland

Dr. Lata Chakravorty Prof. D. S. Rao

Director Director
IBS Bangalore IBS Hyderabad

Prof. P. Bala Bhaskaran Dr. Dhananjay Keskar

Director Director
IBS Ahmedabad IBS Pune

Prof. P. Ramnath
Director
IBS Chennai

Course Preparation Team

Shri T. S. Rama Krishna Rao Prof. Hilda Amalraj

Icfai University IBS Hyderabad

Dr. Y. G. Sivaram Prof. Bratati Ray

Icfai University IBS Kolkata

Ms. C. Padmavathi Dr. Vijaya Lakshmi S

Icfai University IBS Hyderabad

Ms. Sudha Dr. Vunyale Narender

Icfai University IBS Hyderabad

Ms. Sunitha Suresh Prof. Arup Chowdhury

Icfai University IBS Kolkata

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COURSE INTRODUCTION
Liberalization of Indian economy during the 1990's drastically changed the economic
scenario of the country and put the economy on the path of development. Since then,
there has been no looking back as the economy has been growing continuously. This
resulted in an increase in GDP and the income levels of the people and thus the savings.
Young Indians started getting more money in their paychecks. This multiplied the
number of young millionaires and billionaires. Thus, now, India doesn't lag behind the
race as far as the number of HNIs (High Net Worth Individuals) is concerned. These
HNIs have had high aspirations and big dreams for the future.
Hence, there is a need for proper financial planning and investment management of the
wealth generated by these HNIs. This new business horizon of Wealth Management is
knocking at the doors of Indian Banks. Almost every leading bank has got into the
business of Wealth Management through Private Banking. This in turn has brought the
need for more and more number of expert wealth managers who can effectively manage
the wealth of these HNIs.
This course deals with all the aspects of Wealth Management. This involves basic
introduction to Wealth Management, Personal Financial Planning, Investment
Management, and last but not the least, the marketing aspects of this profession. Hence,
this course aims at developing the skills and knowledge set of the learner to become a
successful Wealth Manager.
The first block discusses the fundamentals of wealth management. It enables the reader
to understand the concept of wealth management in detail. It also mentions the process
of wealth management which begins with Client Profiling and Personal Financial
Planning. This complete block makes the reader aware of all the dimensions in which
wealth management operates.
The second block deals with all investment products available for investment. This
block facilitates the learner to comprehend the important features of these investment
products. It specifically discusses mutual fund investments in detail. Hence, it provides
detailed information on all the investment products to the learner.
The third block explains one of the core aspects of wealth management. This helps the
learner to analyze the different investment products from the point of view of the
investor's personal financial planning. This goes into the details of asset allocation and
portfolio management. This block also makes the learner aware of measurement and
review of portfolio performance.
The fourth block stresses upon the marketing skill sets required to promote the growth
of wealth management business by satisfying the current clients and attracting new
ones. This block therefore tries to explain the reader about the importance of
relationship management in the profession of wealth management.
The important topics/contents covered in this course are:
• Introduction to wealth management and its process;
• Significance of client profiling and personal financial planning;
• Investment products, alternative investment options;
• Mutual Funds;
• Asset Allocation and Portfolio Management;
• Marketing of financial products;
• Behavioral skills for wealth management; and
• Investor psychology.
BLOCK 1 FUNDEMANTALS OF WEALTH
MANAGEMENT
This block introduces the fundamentals of Wealth Management. It enables the reader to
understand the basics of wealth management and its process in detail. It also gives a
clear understanding of client profiling and personal Financial Planning. Thus, this
complete block makes the reader aware of all the dimensions in which wealth
management operates.

Unit 1 outlines the concepts of Wealth and Wealth Management. This unit discusses the
state of world’s wealth and also analyses the world wealth report. It mentions the key
drivers of wealth management. Besides, it provides a comprehensive view of wealth
management with special reference to India.

Unit 2 deals with the process of wealth management. The unit elaborates savings cycle
and wealth cycle. Further, it discusses wealth accumulation and client segmentation.
This unit also gives an overview of Private Banking through which the wealth
management services are offered.

Unit 3 discusses client’s goals and the constraints to achieve these goals. It details the
principles of asset allocation and life cycle investment guide. Overall, this unit makes
the learner comprehend the process and importance of scanning the client through client
profiling, which is the base for personal financial planning.

Unit 4 outlines all the important aspects of Personal Financial Planning. It enables the
reader to understand the need for and rewards of personal financial planning. It also
elaborates the steps to be followed by the financial planner while doing personal
financial planning for the client. Further, it gives diminutive details of Tax, Insurance,
Retirement and Estate Planning.
UNIT 1 INTRODUCTION TO
WEALTH MANAGEMENT
Structure
1.1 Introduction
1.2 Objectives
1.3 Concept of Wealth Management
1.4 Evolution of Wealth Management
1.5 Wealth Management Process and Role of Wealth Manager
1.5.1 Role of Wealth Manager
1.6 State of World’s Wealth
1.6.1 HNWI Population
1.6.2 HNWI Wealth
1.6.3 Ultra-Hnwi Population
1.6.4 Global HNWI Population
1.6.5 HNWI Wealth Forecast
1.6.6 The Global Financial Crisis
1.6.7 World’s GDP in 2008
1.6.8 National Savings and Personal Spending in 2008
1.7 HNWI Financial Assets Allocation
1.8 Worlds HNWIs Allocations of Passion Investments
1.9 Key Drivers of Wealth Management
1.10 World Wealth Report Analysis
1.11 Wealth Management – The Indian Perspective
1.12 Summary
1.13 Glossary
1.14 Suggested Readings/Reference Material
1.15 Suggested Answers
1.16 Terminal Questions

1.1 INTRODUCTION
The word ‘Wealth’ is derived from the old English word ‘weal’, which means ‘well-
being’ and ‘th’ means ‘Condition’. ‘Wealth’ signifies condition of well-being. In
Economics, the word ‘Wealth’ is commonly referred to as the value of assets owned
minus the value of liabilities owed at a point of time. A person is known as wealthy,
affluent, or rich if he has accumulated substantial wealth relative to others in their
society or reference group. An individual may be good enough in earning and saving
but this doesn’t ensure his well-being in future. This has resulted in a need for experts
who can lend their advice to manage the accumulated and expected to be accumulated
wealth. And thus wealth management has arrived to stay from being the buzzword to
the ‘new kid on the block’ in the banking and financial services industry.
Wealth Management
1.2 OBJECTIVES
After going through the unit, you should be able to:
• Understand the concept of Wealth Management;
• Comprehend the Wealth Management Process;
• Assess the role of Wealth Manager;
• Analyze the World Wealth Report;
• Have an understanding of the key drivers of Wealth Management; and,
• Understand Wealth Management – The Indian Perspective.

1.3 CONCEPT OF WEALTH MANAGEMENT

Wealth Management as a profession can be described as the extended concept of
financial planning. According to Sonu Bhasin, senior Vice-President and Head of
Wealth Management Group Axis, the emphasis on the word ‘wealth’ seems to suggest
to most people that wealth management addresses the need of High Net Worth
Individuals (HNWI) to manage their wealth. But, except for private banking, wealth
management is for everyone and certainly not restricted to only High Net Worth
Individuals. Wealth management caters to all the financial needs of wealthy individual
or wealthy families throughout the life cycle.

Box 1: What is Wealth?

Adam Smith, in his seminal work The Wealth of Nations, described wealth as “the
annual produce of the land and labor of the society”. Technically it is defined as “The
present value of all the future cash flows that are expected to flow in from one’s
assets”.

Box 2: Wealth Management – What is the Mix?

Wealth management is a comprehensive mix of asset, debt, tax, and risk management
strategies. These solutions normally cover critical issues such as: Asset allocation,
estate and trust planning, retirement planning, business succession planning,
employee’s stock options, and equity strategies.
Wealth Management is defined as: “A comprehensive service to optimize, protect and
manage the financial well-being of an individual, family or corporation.” The
definition thus covers advice on loans, investment and insurance giving a broad
picture of how investors should best deploy their financial resources. A broader
description may include tax advice, estate planning, business planning, charity
foundations and other financial needs.
Source: Portfolio Organizer, October, 2005.
In simple words, Wealth management is an investment advisory discipline which
includes financial planning, investment portfolio management and a number of
aggregated financial services. Wealth management firms classify their clients into old
money segment, which consists of the owners of traditional inherited fortunes and
new money segment which consists of the managers, company owners, software
professionals, real estate dealers, etc. This division of HNWI is important to a
wealth manager as the products, services, risk propensity, willingness to obtain
advice, attitude towards wealth and services required depend on the origin of the
fortunes.
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 Introduction to Wealth Management
1.4 EVOLUTION OF WEALTH MANAGEMENT
The concept of wealth management started originally in the US in 1990s after the
dotcom bubble bust when there was a sharp decline in the indices of world stock
markets and many investors lost precious money investing in poor financial
instruments. It was the time when new set of professional financial planners looked at
new ways to earn profits by coordinating with the clients on sustained basis. Since then
the concept and practice of wealth management has spread across the world. The main
idea of wealth management is to help wealthy individual investors or families get a
complete perspective of their wealth.
The concept of wealth management has established itself so firmly that it has given rise to
a new breed of professionals for managing wealth of individuals and families. This has
reached an industry status by exploring the terrain of the unconventional investment
avenues which are, in other words, alternative investments like hedge funds, real estate,
private equity, gold, antiques and art forms.
However, the concept of wealth is only relative. It not only varies between societies, but
also varies often between different people, sections, and regions in the same society and
also between nations. We need to know here that in many countries wealth is also
measured in terms of accessibility to essential services like health care, or the
possession of crops and livestock. Countries are also distinguishable on the basis of
their affluence. Consequently, Luxembourg, Norway, Qatar, Iceland, Ireland, Denmark,
Switzerland, Sweden, Netherlands, and UK are amongst the wealthiest countries in the
world and the poorest countries are Republic of the Congo, Republic of Liberia,
Republic of Zimbabwe, The Solomon Islands, Republic of Somalia, Union of the
Comoros, Guniea – Bissau, Central African Republic, Niger and Ethiopia.
Rank Country GDP – per capita
1 Luxembourg $1,10,032
2 Norway $83,702
3 Qatar $80,211
4 Iceland $63,875
5 Ireland $62,482
6 Denmark $59,728
7 Switzerland $58,412
8 Sweden $49,091
9 Netherlands $48,169
10 UK $48,072
Source: CIA World Fact Book, 2008.
Table 1: Richest Countries in the World
Rank Country GDP – per capita
1 Republic of the Congo $300
2 Republic of Liberia $500
3 Republic of Zimbabwe $500
4 The Solomon Islands $600
5 Republic of Somalia $600
6 Union of the Comoros $600
7 Guniea – Bissau $600
8 Central African Republic $700
9 Niger $700
10 Ethiopia $700
Source: CIA World Fact Book, 2008.
Table 2: Poorest Countries in the World
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Wealth Management
1.5 WEALTH MANAGEMENT PROCESS AND ROLE OF
WEALTH MANAGER
Wealth management process is an iterative process. Thorough understanding of this
process is essential for a successful relationship between an investor and the wealth
manager. Wealth management process is broken down into four clear steps:

Understanding Client’s Needs and Goals: Understanding client’s needs and goals is
the first step in the process of wealth management. This step includes gathering data and
defining priorities of the client/investor. Advisors should have a clear understanding of
the client’s profile, priorities/preferences and their total financial picture. They should
have clear focus on the investments the client wish to select.

Formulating Wealth Management Strategy: Advisor formulates wealth management

strategy that serves as the best guide in choosing clients investment portfolio. While
developing this plan, wealth manager should help clients in determining specific goals
including hidden, evaluating existing portfolio, determining cash flow needs of the client and
the constraints. It also consists of investment objectives, investment time horizon, risk
tolerance, expected return. An investor’s risk tolerance varies according to age, income
requirements, financial goals, etc.

Implementing the Wealth Management Plan: After understanding the client’s needs
and goals and formulating the investment strategy, the third step involves the client
acceptance to the advisors investment strategy and its implementation.

Monitoring, Evaluating and Reporting of Investment Performance: Monitoring,

evaluating and reporting of investment performance is an ongoing process. It helps in
monitoring the implemented investment strategy of the investors to know whether it is
generating the desired results. It is also necessary for the advisors to keep update
information on client’s current status, changes in tax laws if any, change in the
investment plan etc. Effective monitoring and reviewing of investment plan helps in
exploring new investment opportunities that generate best returns. Communication also
plays a vital role in building a successful and positive relationship between the client
and the advisor.

The process of wealth management can be described in brief with the help of following
diagram

Source: http://www.morgankeegan.com/MK/WealthMgmt/default.htm.
Figure 1: Wealth Management Process

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 Introduction to Wealth Management
1.5.1 Role of Wealth Manager
With the increasing awareness of the investors about investment options, the need for
the services of a wealth manager came into fore. Ideally, a wealth manager is more
objective in analyzing the portfolio to fit the long-term and short-term goals of the
investors. Wealth manager first scrutinizes the client’s financial condition and then
decides on the asset mix that will fetch the best desired returns on the given risk profile
of the client. In the process, wealth managers use in-built techniques to provide
personalized investment advices on the products, from mutual funds to insurance to
equity, depending on the various aspects like risk-return profile, liability profile and
long-term financial goals and objectives of the clients. A wealth manager also looks into
the areas of client’s investments, tax management, legal solutions, charity and also the
distribution of the wealth. The ultimate idea is to proactively and consistently deliver
customized and unbiased financial solution of the highest quality to its clients.
Reliability and reputation of wealth manager depends on the ability to ensure that the
clients receive the best products and services.
A wealth manager needs to focus on the following:
i. Accumulation of Wealth: The customer’s wealth should grow.
ii. Preservation of Wealth: The customer’s wealth should be well protected.
iii. Transfer of Wealth: Smooth transfer of customer’s assets to his legal heirs at a
minimum cost.

Self-Assessment Questions – 1

a. What do you mean by Wealth Management? Discuss the process of wealth

management in brief.

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

b. Write a short note on evolution of wealth management.

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

1.6 STATE OF WORLD’S WEALTH

World Wealth Report released in June 2009 indicates that, 2008 ushered in an
unprecedented global downturn that originated in 2007. Financial crisis soon expanded
into the larger economy, affecting mature and emerging markets alike. World equity
markets lost a decade of gains, and volatility reached record levels. HNWIs lost
confidence in markets, regulators and their financial advisory firms. Restoring trust and
confidence in the markets and the industry are the main themes of the report. The report
identifies High Net Worth Individuals (HNWIs) population along with HNWIs and
Ultra-HNWIs wealth forecast. It further discusses about GDP and national savings. It
identifies HNWIs financial assets allocation as well as allocation of passion investments.

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Wealth Management
1.6.1 HNWI Population
According to the report, at the end of 2008, the world’s population of High Net Worth
Individuals was 8.6 million down by 14.9% from the previous year (see Figure 1), and
their wealth had dropped 19.5% to $32.8 trillion (see Figure 2). The declines were
unprecedented, and wiped out two robust years of growth in 2006 and 2007.
(US$ in million)

Note: High Net Worth Individuals (HNWIs) have at least US$1 million in investable assets excluding primary
residence, collectibles, and consumer durables.
Ultra-High Net Worth Individuals (Ultra-HNWIs) hold at least US$30 million in investable assets, excluding
primary residence, collectibles, consumables, and consumer durables.
Source: Capgemini Lorenz Curve Analysis, 2009.
Figure 1: HNWI Population, 2005-2008 (by Region)

The most significant declines in the HNWI population was in North America
(–19.0%), Europe (–14.4%) and Asia Pacific (–14.2%). Apart from the declines, there
are certain developments in HNWI populations like:
Though US faced decline in the number of HNWIs by 18.5 % in 2008, still it is the largest
home to HNWIs with 2.5 mn. In Europe, HNWI population declined widely by country.
Number of HNWIs shrank by 26.3% in UK, 12.6% in France, and 2.7% in Germany.
Japan which accounts 50% of HNWIs in Asia-Pacific declined by 9.9% only. Even
Hong Kong (–61.3%), and India (–31.6%) suffered greater losses.
1.6.2 HNWI Wealth
HNWI are also experiencing decline in wealth in regions – North America (–22.8%),
Asia-Pacific (–22.3%), and Europe (–21.9%) respectively, which are depicted in the
figure 2. Latin America suffered relatively less degree of loss (–6%). HNWIs in Brazil
saw decline in their wealth by 8.4% in 2008.
(US$ in trillion)

* The 2007 number for Europe was restated from 10.6 to 10.7 as a result of updated data becoming available.
Source: Capgemini Lorenz Curve Analysis, 2009.
Figure 2: HNWI Wealth Distribution, 2005-2008 (by Region)
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 Introduction to Wealth Management
1.6.3 Ultra-HNWI Population
Ultra-high-net-worth individuals faced extensive losses and consequently, the
population of Ultra-HNWI fell by 24.6% as the group’s wealth dropped by 23.9%,
pushing large number of Ultra-HNWI into ‘mid-tier millionaire’ bracket. Decline in
Ultra-HNWI numbers had a disproportionate effect on the overall HNWI wealth. At the
end of 2008, Ultra-HNWIs accounted for 34.7% of global HNWI wealth, but only 0.9%
of the total HNWI population. North America still accounted for the highest percentage
of Ultra-HNWIs i.e. 30.6% in 2008.

Source: Capgemini Lorenz Curve Analysis, 2009.

Figure 3: Geographic Distribution of HNWIs and Ultra-HNWIs, 2008 (by Region)

1.6.4 Global HNWI Population

US, Japan and Germany together accounted for 54% of the world’s HNWI population in
2008, which is up slightly from 53.3% in 2007 (see figure 4). China’s HNWI population
surpassed that of UK and took fourth place in 2008. Even, Brazil surpassed Australia
and Spain to reach 10th place among HNWI population globally. Financial crisis also
impacted HNWIs differently in different types of economies – Hong Kong’s HNWI
population took by far the largest hit with 61.3% drop. Russia’s HNWI population
declined 28.5%. At the same time, even UK experienced 26.3% drop in its HNWI
population in 2008.
(in thousand)

*2007 data has been revised

Source: Capgemini Lorenz Curve Analysis, 2009.

Figure 4: HNWI Population by Country, 2008
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Wealth Management
1.6.5 HNWI Wealth Forecast
Estimates suggest that HNWI financial wealth is expected to reach US$48.5 trillion by
2013, growing at an annualized rate of 8.1%. Asia-Pacific and North America are
expected to lead in HNWI financial wealth and it is predicted that Asia-Pacific may
actually surpass North America by 2013.
HNWI Wealth Forecast is presented in the following graph:
(US$ in trillion)

*2007 number for Europe was revised from 10.6 to 10.7

Source: Capgemini Lorenz Curve Analysis, 2009.
Figure 5: HNWI Financial Wealth Forecast, 2006-2013F (by Region)
With commodities and manufacturing capability, Latin America is expected to return to
growth, when US and Asian economies start picking up. Europe’s economic recovery
lags behind as several major countries there continue to face difficulties. Even in Middle
East, growth is likely to be slower than what has been in the past, as oil is expected to
be less dependable driver of wealth in future.
1.6.6 The Global Financial Crisis
Several important trends over the last 10 years, marked run-up and unfolding of the
economic crisis, which made events more fathomable. These include:
• Current account imbalances between creditor and debtor nations widened over a
10-year period.
• Low yields prompted an extensive search for returns.
• Increased complexity and opacity of many products intensified systemic risk.
Financial crisis that started in 2007, continued till 2008 and expanded into the general
economy in mature markets and culminated in global economic downturn. Export
driven countries were hit hard, particularly Asia as global demand dried up. Even other
countries and markets especially developing world were struck by fall in foreign
investment and demand. Even the macro economic factors like GDP, savings and
consumption were hit hard.
1.6.7 World’s GDP in 2008
World’s GDP slumped in 2008; still it managed to produce 2% growth as compared to
3.9% in 2007 and 4% in 2006. GDP in G-7 countries declined and ended the year with a
growth of 0.6%. Though, the crisis spread worldwide, some regions like Latin America
(4%), Middle East and North Africa (5.8%) posted strong GDP growth for 2008, which
shows that these regions are yet to experience economic fallout.

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 Introduction to Wealth Management

*Economist Intelligence Unit, Regional Data, March 2009, Capgemini Analysis.

Source: Economist Intelligence Unit – April 2009, Real GDP Variation over Previous
Year.
Figure 6: Real GDP Growth Rates, 2007-2009
1.6.8 National Savings and Personal Spending in 2008
Very few funds are available for future investments as national savings decreased
worldwide in 2008. Ratio of combined national savings to GDP fell to 22.6% as against
23.1% in 2007. As a result of eroded consumer confidence and scarce credit, 2008 saw a
global slowdown even in consumer spending. In US, the consumer spending grew by
0.2% in 2008 against a gain of 2.8% in 2007. In Europe, personal spending grew 1% in
2008 as against 2.2% in 2007. Market capitalization affects the HNWI wealth
generation, as a significant portion of their wealth is invested in stock markets. Global
drop in equity market capitalization explains the decline in the wealth of the HNWIs.

Source: World Federation of Exchanges, April 2009.

Figure 7: Market Capitalization by Region, 1999-2008
Primary drivers of wealth like equities, fixed income, real estate, experienced mediocre
response in the first half of 2008 and later were hit by a massive sell-off in the fourth
quarter as investors turned to safe havens like cash and gold. Commodities and
currencies, which are considered as the secondary drivers of wealth also lost value in
2008. As per the World Wealth Report, some of the significant events during the year
include:
• Global equity market capitalization dropped nearly 50% below 1999 levels.
• Faith in equity market diversification proved to be misplaced.
• Global investors fled to fixed-income securities.
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Wealth Management
• Commodities saw a boom to bust cycle.
• Real estate is another case in which clear but steady down trend in the first half
of the year was followed by sharp losses in the second.
• Few hedge funds escaped the losses, with alternative strategies.
• Most currencies had a mixed year. US dollar ended higher.
During these conditions any recovery will be slow, there is no clear consensus on when
and how the global economy will recover, and here are some key factors that come to
the fore:
• US is crucial for global economic recovery.
• China is an important engine for growth.
• Interdependence of the global economy still prevails.
• Recovery of the global banking system is critical.
• Global fiscal and economic policies and politics will shape the road to recovery.
1.7 HNWI FINANCIAL ASSETS ALLOCATION
HNWIs increased their proportion more in tangible investments and reduced in equities
and alternative investments in 2008. Figure 8 gives the breakdown of HNWI financial
assets, for the years 2006-2010. The financial assets discussed below are equities, cash
based investments, fixed income investments, real estates, alternative investments and
home region investments.
Equities: The proportion of equities dropped by 8%. North American HNWIs also
reduced their exposure to equities to 34% from 43% in 2007. The exposure still was 9%
above the global average allocation to equities.
Cash Based Investments: Worsening of global banking and financial crises and credit
tightening made HNWIs more risk averse in 2008. There is an increase of exposure by
HNWIs to cash based holdings in 2008. It increased to 21% of overall portfolio up by
7% from pre-crisis levels in 2006. The proportion of cash based holdings was high in
Japan by 30%. HNWIs across Asia held high cash outside of an account – 29%
reflecting the lack of confidence in emerging market banking system. Even North
America held the lowest amount of cash as a percentage of their total portfolio.
Fixed Income Investments: HNWIs continued to allocate increasing proportion of
their investments to fixed income investments in 2008. Latin America HNWIs allocated
highest proportion – 40%. Asian HNWIs allocated smaller proportion – 17% of the
overall portfolio to fixed income investments.

a Includes: Structured products, hedge funds, derivatives, foreign currency, commodities, private equity, venture capital.
b Includes: Commercial Real Estate, REITs, Residential Real Estate (excluding primary residence), Undeveloped Property,
Farmland and other.
Source: Capgemini/Merrill Lynch Financial Advisor Surveys 2007, 2008, 2009.
Figure 8: Breakdown of HNWI Financial Assets, 2006-2010F
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 Introduction to Wealth Management
Real Estate: Real estate investments picked up in 2008 rising to 18% of total HNWI
financial assets from 14% in 2007. Overall, residential real estate accounted 45% of
total HNWI real estate investment at the end of 2008. Luxury residential dropped in
2008 to levels seen in 2003 and 04. Middle East and Asia pacific had highest HNWI
allocation to real estate investment and greatest proportion of residential real estate.
Both the regions experienced boom in real estate investment over the last few years.
Drop in user demand and lack of available financing declined the prices of real estates
in the fourth quarter of 2008.
HNWI holding commercial real estate accounted for 28% of total HNWI real estate
holding. Latin America HNWI had the highest allocation in the world – 31% in
commercial real estate. Since there are more assets for disposal and they have broader
and diversified portfolio’s than HNWIs, Ultra-HNWI held more in commercial real
estate in 2008 when compared to HNWIs. HNWIs reduced their holdings of Real Estate
Investment Trusts (REIT) in 2008. REITs are liquid, so HNWIs were quick to sell of as
real estate begun to turn negative. HNWI real estate holding is reduced from 22% in
2006 to 17% in 2007 and 10% in 2008.
Alternative Investments: HNWIs also reduced their holding of alternative
investments in 2008. Hedge funds investments accounted 24% by end of 2008 as
against 31% in 2007. HNWIs shifted to more traditional investment vehicles. HNWIs
in Europe and Latin America saw a drop in allocation of hedge funds to 18% and 32%
respectively. Commodities accounted 13% at the end of 2008 as compared to 10% in
2007. Even HNWIs in North America gave highest allocation to commodity
investment – 16%. Foreign currency investments were only 14% of overall HNWI
alternative investments, but were higher in Japan (27%) and 25% in rest of Asia.
Structured products allocation jumped to 21% in 2008 from 15% in 2007.
Home Region Investments: North American HNWIs increased their own domestic
holdings up 8% from pre-crisis level in 2006. Economies of Asia pacific and Latin
America increased home region investment from 2006 to 2008 by 18% and 25%
respectively. Latin America experienced steep increase in home region investments
rising from 20% of global investments in 2006 to 45% in 2008.
In Asia, pacific home region investment accounted for 68% of overall HNWI
investment a level only second to North America where 81% is domestic.
However, HNWIs are expected to remain moderately conservative in their investment
allocations with capital preservation being a priority. Looking towards 2010, as the
economic conditions improve, the profiles of HNWIs are likely to shift to equities,
alternative investments, and fixed income holdings. There would also be increasing
allocation of cash and short-term deposits into long-term and higher yielding
investments. At the regional level, there will be shift in home region HNWI investment
activity too.

1.8 WORLDS HNWIs ALLOCATIONS OF PASSION

INVESTMENTS
Financial crisis and economic uncertainty of 2008 impacted HNWI investments in
passion and life style spending on luxury goods makers, auction houses and high end
service providers. Global demand was weaker for luxury collectibles, luxury
consumables, art and jewelry. HNWI spending patterns also varied from region to
region between wealthy and emerging nations and between wealth bands.
Luxury Investments: Luxury collectibles continued to account for the largest portion
of HNWIs passion investments in 2008 – 27% of the total. Global average allocation to
luxury collectibles was up from the pre-crisis level of 26% in 2006. However, there was
an outright decline in demand for all major purchases in the collectibles bracket in 2008.
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Wealth Management
Fine Art: Fine Art was the primary passion investment for Ultra-HNWIs accounting for
27% of their total passion investments and the second largest for HNWIs accounting for
25% in 2008. Global fine art auction sales totaled $8.3 billion in 2008 down $1 billion
from 2007 with US fine art sales generating $2.9 billion down $1 billion from 2007.
With the change in the profile of art buyers, the demand increased for more traditional
types of art. More European and Latin American HNWIs invested in fine art than Asian,
North American and Middle Eastern counterparts. Investors from emerging markets
helped in raising the art sales and the prices have come down globally, allowing
collectors and connoisseurs to buy at more reasonable prices.

a “Luxury Collectibles” represent luxury automobiles, boats, jets, etc.

b “Other Collections” represents coins, wine, antiques, etc.
c “Sports Investments” represents sports teams, sailing, race horses, etc.
d “Miscellaneous” represents club memberships, guns, musical instruments etc.
Source: Capgemini/Merrill Lynch Financial Advisor Surveys 2007, 2009.
Figure 9: HNWI Allocations of Passion Investments 2006 vs. 2008
Jewelry, Gems and Watches: Jewelry, Gems and Watches take the third largest share
of passion investments globally. They receive the highest allocation in Asia and Middle
East. HNWIs allocated proportionately more to this category in 2008 as they were
perceived as safer tangible investments that retain long-term value. On the other hand,
Ultra-HNWIs devoted relatively low percentage to this category. Overall growth of
global jewelry slowed in 2008 to 2.5% from 9% in 2007. Watches were the only
category in which healthy sales growth was evident due to emerging market demand.
Sports Investments: Investments in sports and other collectibles accounted for 7% and
12% respectively. They were steady compared to the pre-crisis levels of 2006 but
became weaker in 2008.
Health/Wellness Investment: Life style spending was more on health/wellness and
dropped on luxury travel. 54% of the HNWIs globally and 64% in Asia pacific region
increased their spending on high end spa visits, fitness equipment installations, and
preventative medicine procedures. Economic uncertainty reduced the HNWIs spending
on luxury and experiential travel. 40% of HNWIs overall and 55% of HNWIs in North
America reduced their spending on luxury travel. Even purchases of luxury
consumables fell. 43% of global HNWIs and 60% of those in North America spent less
on luxury consumables in 2008.
Philanthropy: Philanthropy though a passion for many HNWIs and Ultra-HNWIs,
faced little change in allocation of HNWI wealth in 2008 in the first half. However, the
impact was severe in the fourth quarter of 2008. Real impact of financial crisis became
more evident in 2009.

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 Introduction to Wealth Management
1.9 KEY DRIVERS OF WEALTH MANAGEMENT
Wealth management industry is growing at a fast pace in order to meet expanding
marketing opportunities. The key drivers of wealth management – wealth accumulation,
equitization, retirement provisioning, financial liberalization and deregulation, and
corporate restructuring are discussed below:
Wealth Accumulation: Wealth is expected to grow faster than GDP in most developed
countries. The current ratio of wealth to GDP is low but is expected to increase, which
will benefit the wealth management businesses across the world. Private wealth being
the key driver of institutions asset growth. It will help the asset management industry.
Investment banks and securities businesses also benefit with increasing capitalization
levels and higher trading volumes.
Equitization: Equity markets have seen development and continued growth over the
past few years. Investors or market participants invest greater share into equity.
Equitization provides opportunities for wealth to grow as assets are shifting to higher
margin asset classes. Equitisation also results in more corporates resorting to more
employee compensation packages that include Employee Stock Option Plans (ESOPs),
and Discounted Share Purchase Programs (DSPP).
Retirement Provisioning: Each country follows its own regulatory agenda. Pension
reforms are on the agenda of many governments across the world. Shift of unfunded to
private funded pension is likely to take place. Institutional asset management is the
sector that is most impacted by this trend. This will also influence the demand for
retirement planning and estate planning.
Financial Liberalization and Deregulation: Deregulation and financial liberalization
contributed significantly to the expansion of wealth management industry as well as the
quality and variety of services offered. Further financial liberalization is expected to
bring benefits to investment banking and securities firms.
Corporate Restructuring: Increasing competition for corporations results in
restructuring and consolidation of their activities and structures due to liberalization of
trade and technological progress. As economies mature and structures move from
traditional to more sophisticated sectors, restructuring of companies are likely, which
could lead to wealth creation for entrepreneurs, thus creating new opportunities for
wealth managers.

1.10 WORLD WEALTH REPORT ANALYSIS

For 13 years, Capgemini and Merrill Lynch have collaborated to identify and
objectively analyze the investment needs of the world’s High-Net-Worth Individuals
(HNWIs) – defined as people with more than US $1 million in financial asset wealth,
excluding primary residence. Their World Wealth Report (WWR) is widely read by top
executives in the banking, securities and insurance industries as well as those in the
luxury goods markets. It is viewed as the global benchmark in terms of numbers and
wealth of HNWIs, and is sourced in hundreds of media reports throughout the year. No
other report provides such a comprehensive view of Global HNWIs: their size,
behaviors and implications for the financial services industry. The WWR is updated
annually and uses a proprietary Lorenz curve methodology.
The report has built a strong and lasting reputation as the industry benchmark for
HNWIs market sizing – originally at a global and regional level but today increasingly
at a country level. The report includes three sections that cover:

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Wealth Management
• HNWI market sizing and review of global economic drivers impacting HNWI
behavior.
• Investing behaviors and asset allocation trends of HNWIs.
• Key industry issues facing financial service institutions, financial advisors and
HNWIs alike.

Box 2: HNWI Sector Highlights – 2009

The following are the HNWI sector’s population and wealth projections:
• The world’s HNWI population and its wealth ended 2008 below levels seen at
the close of 2005.
• Global HNWI wealth totaled US$32.8 trillion, a 19.5% drop from 2007.
• 8.6 million Individuals Worldwide held atleast US$1 million in financial
assets, a decrease of 14.9% from year before.
• Ultra-high-net-worth individuals faced losses and in consistency with the
wealth, population of Ultra-HNWIs decreased by 23.9%.
• HNWI financial wealth is projected to reach US$48.5 trillion by 2013,
advancing at an annual growth rate of 8.1%.
• Total number of millionaires declined across all major geographies but the
declines varied markedly. US saw a decline of 18.5%, UK 26.3%, Hong Kong
61.3% and India 31.6%. At the other end of the spectrum were Japan with
only 9.9% decline, Germany with 2.7% and France with 12.6%.
• US still have the highest concentration of millionaires with almost 2.5 million
HNWIs.
• There are shifts in the concentration of millionaire population. While US,
Japan and Germany still account for 54% of HNWIs in the world, China has
now moved into 4th position surpassing UK. Similarly Brazil has moved
ahead of Australia and Spain and is now in the 10th position.
Source: www.in.capgemini.com
Over the years, the WWR has covered a variety of research topics in its featured
spotlight section including:
2000: Focus on the Ultra-HNWI sub-segment.
2001: Size, growth, nature and types of specialized investments.
2002: Comparison of European and North American high-net-worth behaviors and
operating models.
2003: Impact of new market realities – changes in needs, behavior and investment
attitudes of HNWIs.
2004: The demand for institutional-like services and the implications for wealth
management providers.
2005: The challenges facing mid-tier millionaires and rise of the Virtual Service
Network.
2006: Increased international awareness leading to internationalization of portfolios and
need for creating of specialist teams for wealth strategies.
2007: Focus on the growing need for wealth management firms to create more
customized infrastructure and service models aligned with unique needs of clients in
any given market.

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 Introduction to Wealth Management
2008: Meeting diverse client needs in growth markets requires flexible service models
and technology strategies.
2009: Optimizing Client-Advisor-Firm dynamics as wealth management firms tackle
crises and look forward.

Self-Assessment Questions – 2
a. What are the Key Drivers of Wealth Management?
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
b What have been passion investment avenues for HNWIs?
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………

1.11 WEALTH MANAGEMENT – THE INDIAN PERSPECTIVE

The wealth management concept is growing fast in India with increasing income levels,
household saving and increasing HNWIs. In this background, certain major Indian and
global players have emerged in the area of wealth management. UBS Wealth
Management, Merrill Lynch GPC, Credit Suisse Private Banking, HSBC Private Bank
and Citigroup Private Bank are some of the leading names in the list of global players.
The Indian players are Punjab National Bank, State Bank of India, Canara Bank, ICICI
Bank, HDFC Bank, ABN AMRO Bank, Citibank, HSBC bank, and Standard Chartered
Bank.
The wealth management industry in India has been on a noteworthy growth trail with
considerable growth in the levels of income and wealth over the last few years. India, an
emerging economy and one of the Brazil, Russia, India and China (BRIC) countries,
consists of a large proportion of young population with about 54% of the population
below 25-years of age. There has been considerable growth in India’s economy and
GDP as also the young employed population.
Coupled with this, the increase in the number of HNWIs and the size of middle class
has led to increased scope for growth in the wealth management business. Financial
intermediaries have started recognizing the wealth management business as a profitable
avenue. According to Barclays Capital, “India is the second most attractive market for
wealth management after China, even though revenue growth in this sector in Asia is
expected to fall significantly over the next two years”.
According to the recent World Wealth report, 2009, India’s HNWI population shrank by
31.6% to 84000, the second largest decline in the world after fastest growth rate of
22.7% in 2007. Suffered declining global demand for its goods and services and had a
drop in market capitalization of 64.1% in 2008 after rising to 118.4% in 2007. The GDP
growth rate in India was 9.1% in 2007, which has come down to 6% in 2008 and 5% in
2009. According to the head of global wealth management at DSP Merrill Lynch,
despite the decline, Asia Pacific including India remains an important market for wealth

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management providers worldwide. By 2013, Asia pacific will overtake North America
under HNWI financial wealth. According to investment banking firm, Barclays Capital
survey of Asia’s leading wealth managers, “China and India continue to be viewed as
the most attractive markets in Asia, both in terms of potential for business expansion
and expected revenue growth rate.” India from its current position of 14 would become
the eight largest wealth market by the year 2017.

1.12 SUMMARY
In Economics, the word ‘Wealth’ is commonly referred to as the value of assets owned
minus the value of liabilities owed at a point of time. A person is known as wealthy,
affluent, or rich if he has accumulated substantial wealth relative to others in their
society or reference group.
Wealth management has arrived to stay from being the buzzword and ‘new kid on the
block’ in the banking and financial services industry. Wealth Management as a
profession can be described as the extended concept of financial planning.
Wealth management firms classify their clients into old money segment, which consists
of the owners of traditional inherited fortunes and new money segment which consists
of the managers, company owners, software professionals, real estate dealers, etc.
Wealth manager focuses on accumulation, preservation and transfer of wealth.
World wealth report identifies the trends and forces driving HNWI client behavior and
focuses on specific opportunities that wealth management firms and Advisors can
pursue directly to help craft mutually value-creating relationships moving forward into
the future.

1.13 GLOSSARY
World Wealth Report identifies and analyzes the investment needs of the world’s high
net worth individuals. It gives a view of global HNWIs: their size, behavior and
implications for the financial services industry.
HNWI means High Net Worth Individuals.
Gross Domestic Product or GDP is the total value of goods and services produced in a
country in a year. It represents the economic health of a country and is the sum of total
consumption in the country, government expenditure, investments and net exports. (net
exports = exports less imports).
Ultra High Net Worth Individual is a person who has at least US$30 million in
financial assets.

1.14 SUGGESTED READINGS/REFERENCE MATERIAL

• World Wealth Report Cap Gemini and Merrill Lynch.
• David Maude. Global Private Banking and Wealth Management: The New
Realities. England: Amazon, 2006.

1.15 SUGGESTED ANSWERS

Self-Assessment Questions – 1
a. Wealth management is an investment advisory discipline which includes
financial planning, investment portfolio management and a number of
aggregated financial services.

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 Introduction to Wealth Management
Process of Wealth Management: Wealth management process is an iterative
process. It can be divided into four clear steps:
Understanding Client’s Needs and Goals: This step includes gathering data
and defining priorities of the client/investor. Advisors should have a clear
understanding of the client’s profile, priorities/preferences and their total
financial picture. They should have clear focus on the investments the client wish
to select.
Formulating Wealth Management Strategy: Advisor formulates wealth
management strategy that serves as the best guide in choosing clients investment
portfolio. While developing this plan, wealth manager should help clients in
determining specific goals including hidden, evaluating existing portfolio,
determining cash flow needs of the client and the constraints. It also consists of
investment objectives, investment time horizon, risk tolerance, expected return.
An investor’s risk tolerance varies according to age, income requirements,
financial goals, etc.
Implementing the Wealth Management Plan: After understanding the client’s
needs and goals and formulating the investment strategy, the third step involves
the client acceptance to the advisors investment strategy and its implementation.
Monitoring, Evaluating and Reporting of Investment Performance:
Monitoring, evaluating and reporting of investment performance is an ongoing
process. It helps in monitoring the implemented investment strategy of the
investors to know whether it is generating the desired results. It is also necessary
for the advisors to keep update information on client’s current status, changes in
tax laws if any, change in the investment plan etc. Effective monitoring and
reviewing of investment plan helps in exploring new investment opportunities
that generate best returns.
b. Evolution of Wealth Management: The concept of wealth management started
originally in the US in 1990s after the dotcom bubble bust when there was a
sharp decline in the indices of world stock markets and many investors lost
precious money investing in poor financial instruments. It was the time when
new set of professional financial planners looked at new ways to earn profits by
coordinating with the clients on sustained basis. Since then the concept and
practice of wealth management has spread across the world. The main idea of
wealth management is to help wealthy individual investors or families get a
complete perspective of their wealth.
The concept of wealth management has established itself so firmly that it has
given rise to a new breed of professionals for managing wealth of individuals
and families. This has reached an industry status by exploring the terrain of the
unconventional investment avenues which are, in other words, alternative
investments like hedge funds, real estate, private equity, gold, antiques and art
forms.
However, the concept of wealth is only relative. It not only varies between
societies, but also varies often between different people, sections, and regions in
the same society and also between nations. We need to know here that in many
countries wealth is also measured in terms of accessibility to essential services
like health care, or the possession of crops and livestock.
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Wealth Management
Self-Assessment Questions – 2
a. Following are the key drivers of wealth management:
Wealth Accumulation: Wealth is expected to grow faster than GDP in most
developed countries. The current ratio of wealth to GDP is low but is expected to
increase, which will benefit the wealth management businesses across the world.
Private wealth being the key driver of institutions asset growth. It will help the
asset management industry. Investment banks and securities businesses also
benefit with increasing capitalization levels and higher trading volumes.
Equitization: Equity markets have seen development and continued growth over
the past few years. Investors or market participants invest greater share into
equity. Equitization provides opportunities for wealth to grow as assets are
shifting to higher margin asset classes. Equitisation also results in more
corporates resorting to more employee compensation packages that include
Employee Stock Option Plans (ESOPs), and Discounted Share Purchase
Programs (DSPP).
Retirement Provisioning: Each country follows its own regulatory agenda.
Pension reforms are on the agenda of many governments across the world. Shift
of unfunded to private funded pension is likely to take place. Institutional asset
management is the sector that is most impacted by this trend. This will also
influence the demand for retirement planning and estate planning.
Financial Liberalization and Deregulation: Deregulation and financial
liberalization contributed significantly to the expansion of wealth management
industry as well as the quality and variety of services offered. Further financial
liberalization is expected to bring benefits to investment banking and securities
firms.
Corporate Restructuring: Increasing competition for corporations results in
restructuring and consolidation of their activities and structures due to
liberalization of trade and technological progress. As economies mature and
structures move from traditional to more sophisticated sectors, restructuring of
companies are likely, which could lead to wealth creation for entrepreneurs, thus
creating new opportunities for wealth managers.
b. Passion Investment by HNWIs includes – luxury investment, fine art, Jewelry,
Gems and Watches, Sports & Health/Wellness Investment

1.16 TERMINAL QUESTIONS

A. Multiple Choice
1. In Economics, the word ‘Wealth’ is commonly referred to as the value of
___________.
a. Assets
b. Real Estate
c. Cash
d. Assets owned minus the value of liabilities owed at a point of time.
e. Gold.
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 Introduction to Wealth Management
2. Wealth Management as a profession can be described as the extended concept
of ___________.
a. Retirement Planning.
b. Tax Planning.
c. Financial Planning
d. Insurance Planning
e. Estate Planning.
3. ___________ is considered as passion investment.
a. Equity investment
b. Debt investment
c. Mutual fund investment
d. Investment in Jewelry, Gems and Watches
e. Investment in FD.
4. The wealth management concept is growing fast in India due to___________.
a. Infrastructure development
b. Improvement in standard of living of the people
c. Increase in foreign currency reserves
d. Reduction in interest rate
e. Increasing income levels, household saving and HNWIs.
5. The concept of wealth management started originally in ___________.
a. Brazil
b. China
c. Indonesia
d. France
e. US.
B. Descriptive
1. Briefly assess the role of wealth manager.
2. Discuss the important points of World Wealth Report Analysis.
3. Enunciate the prospects of Wealth Management from the point of view of the
Indian Perspective.

These questions will help you to understand the unit better. These are for your
practice only.

25
UNIT 2 UNDERSTANDING THE
WEALTH MANAGEMENT
PROCESS
Structure
2.1 Introduction
2.2 Objectives
2.3 Savings Cycle and Wealth Cycle
2.4 Wealth Accumulation
2.5 Wealth Preservation and Wealth Transfer
2.5.1 Advanced Wealth Transfer Techniques
2.6 Client Segmentation
2.6.1 Ultra-High-Net-Worth Individuals
2.6.2 High-Net-Worth Individuals
2.6.3 Mass Affluent
2.6.4 Client Expectations
2.6.5 Client Profiling
2.7 Private Banking
2.7.1 Private Banking Ranks
2.7.2 Family Office
2.7.3 Offshore Investment
2.7.4 Onshore Investment
2.8 Summary
2.9 Glossary
2.10 Suggested Readings/Reference Material
2.11 Suggested Answers
2.12 Terminal Questions

2.1 INTRODUCTION
Wealth management process is developed by a firm keeping in mind the client.
It is a conservative process. The process includes client profiling i.e., collecting personal
details, understanding current financial situation, and identifying the family condition.
Before actually starting the investment process, it is also essential to know the
investment objectives and risk tolerance level of the client. The next step in wealth
management process includes asset allocation where allocating differing weighting and
types of assets to individual clients to tailor for their needs. Structuring implementation,
communication and reviewing and monitoring all the aspects of portfolio performance
and objectives also constitute wealth management process. In this chapter, we are going
to discuss about wealth cycle, expectations and segmentation of the client,
accumulation, preservation and transfer of wealth, along with a brief description on
private banking.
 Understanding the
Wealth Management Process
2.2 OBJECTIVES
After going through the unit, you should be able to:
• Understand Savings Cycle and Wealth Cycle;
• Strategize Wealth Accumulation;
• Determine Client Segmentation; and,
• Assess the role of Private Banking.

2.3 SAVINGS CYCLE AND WEALTH CYCLE

‘Savings’ refers to preserving money for future use by putting it in the form of a deposit
in a bank or investing in different products. The significance of savings depends on the
investment decisions an individual takes. The plan of investment should combine both
the investment goals and income needs. This plan should focus on specific
circumstances and identify the best possible options for growth, security, risk and
diversification. Savings cycle leads us to the concept of ‘Wealth Cycle’.1 The key to
wealth creation is innovation. Wealth creation stems from the successful
implementation of higher value strategies developed from new ideas. An American
author, Ralph Waldo Emerson rightly said in the early 19th century: “It requires a great
deal of boldness and a great deal of caution to make a great fortune, and when you have
it, it requires 10 times as much skill to keep it.” Wealth Cycle consists of four phases –
Wealth Creation, Wealth Enhancement, Wealth Preservation, and Wealth Distribution,
which are discussed briefly below:
WEALTH CREATION
‘Wealth Creation’ is the first pillar in wealth cycle. It is the base for wealth
accumulation process. Typically, for a HNWI, the liabilities tend to be higher than their
income. Their financial decisions mostly relate to the short-term and they often adopt
the characteristics of an aggressive investor, seeking ways to maximize the returns on
their investments, investigating tax-effective savings, taking ‘first mortgage’, building a
deposit through investment in shares or establishing adequate insurance covers etc.
WEALTH ENHANCEMENT
‘Wealth Enhancement’ comes into focus once wealth is created and established. The
primary objective of this cycle is to multiply or enhance the returns on the accumulated
assets having lower risks or better capital protection. During this cycle, through proper
asset allocation, investors are able to determine their areas of financial interest and
investment products that suit them for the purpose of generating higher levels of income
and at the same time taking into consideration taxation issues and debt management.
WEALTH PRESERVATION
‘Wealth Preservation’ becomes prominent after a substantial amount of wealth has been
built up. Here, the key strategy is to ensure that wealth is well-managed with
‘protection’. The focus during this stage is to manage the portfolio in such a manner as
to generate higher levels of income, while minimizing risk. Very often, it is observed
that investor or a family does not come along this stage. As a result, they lose almost
everything in the end as a result of not having a proper wealth management structure.
WEALTH DISTRIBUTION
‘Wealth Distribution,’ is the last stage in the wealth cycle. In this phase, an individual
ensures that one’s assets or wealth or even businesses are distributed in the most

1 Insights into wealth cycle, http://wealthcycle.blogspot.com/, July 5, 2007.

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Wealth Management
optimal way, according to his/her wish. As in the case of ‘wealth preservation’ most
individuals and families often ignore the stage of ‘wealth distribution’. For achieving
success during this phase, estate and succession plans should be put in place, well in
advance, to ensure that the family wealth and the family business are handed over to the
succeeding generations in an orderly manner. It is only through trusts or wills wealth
distribution to succeeding generations is made certain.
Let us proceed to the wealth accumulation, preservation and transfer processes.

2.4 WEALTH ACCUMULATION

The entire global economy is now on a growth line as the emerging markets are also
getting strongly integrated with the global economy. Also, new wealthy investors are
emerging in large numbers. Hence, wealth creation activity no longer remains as the
privilege of the advanced markets as the emerging markets have also begun to have
their share. Wealth accumulation enters the market. It is exponential. Regular
investment and compound are key to wealth accumulation. There are certain strategies
to be followed for a successful wealth accumulation program which are as follows:
• At least 10% of the earnings must be saved and such savings should take place
consistently and throughout the earning years.
• The amount utilized for spending purposes should be examined on a periodic
basis and reviewed to see how spending can be cut back.
• Focus should be on reduction of debt by consolidation of debt on yearly basis
rather than paying off high interest debt. This step would result in considerable
reduction of liquidity burden.
• Adequate knowledge about the benefits that can be derived through tax-deferred
savings in the form of Individual Retirement Account (IRAs), annuities, life
insurance and tax-qualified retirement plans etc.
• Development of a sound investment strategy is the priority in a wealth
accumulation strategy and this strategy should include short-term, medium and
long-term planning.
• The time horizon has to be determined. The issue here is the time taken for
money to grow before its requirement arises. While making these estimates, the
impact of inflation should be factored.
• Risk tolerance must be assessed. For this purpose, the extent to which an investor
would be prepared to ride out fluctuations in the value of investments in order to
achieve higher long-term returns should be assessed.
• Diversification of money among different kinds of investments through an asset
allocation process should be implemented.

2.5 WEALTH PRESERVATION AND WEALTH TRANSFER

‘Wealth preservation’ and ‘Wealth transfer’ processes involve planning for the
accumulation, preservation, management and transfer of wealth, as well as the
management of personal affairs during an individual’s lifetime. The activities relating to
compensation planning, employment agreements, options under retirement plans and
individual retirement accounts, personal and business income tax planning, tax return
preparation, investment book-keeping, asset-custody arrangements, property ownership
alternatives, premarital and post-marital agreements and planning for the possibility of
mental or physical disability are major components in this process.
28
 Understanding the
Wealth Management Process
2.5.1 Advanced Wealth Transfer Techniques
An Advanced Wealth Transfer Technique includes planning for large estates with a
variety of assets, including securities, real estate, closely held business and art
collections. There are a variety of sophisticated advanced wealth transfer techniques like
annuity trusts, family limited partnerships, and limited liability companies, installment
sales of assets, qualified personal residence trusts, charitable remainder trusts, gift trusts
and irrevocable life insurance trusts.
Having dwelt into the wealth accumulation, preservation and transfer process, let us
discuss the defining functions of a wealth manager, namely private banking, family
office, offshore and onshore investments.
Now we will look at the client segmentation in detail.

2.6 CLIENT SEGMENTATION

With the changing clients needs, attitude and behavior, advisors/managers have to be
more conscious about the type of clients they decide to serve, taking into account the
sources of their wealth and the level of service clients are expecting. Client
Segmentation involves delivering products and services to distinct client groups. It
means that the advisor has to be familiar with two facets of client needs – products, and
services that best meet the client’s investment objectives and style of manager that best
suits the client. In simple words, client segmentation is simply grouping of clients. The
most common and basic approach of client segmentation is by wealth. Other
segmentation criteria include family back ground, work experience, sex and age. Most
of the wealth managers segregate their clients based on client profitability.

Box 1: Client Segmentation Process

Client Segmentation is a critical step towards greater efficiency and improved

practice profitability. Segmentation process takes time but easy to maintain. The
following are the steps in client segmentation process:
i. Define Client Value: Identify the drivers of profitability, or value, in your
client relationships.
ii. Quantify Client Value: Create a rating system to gauge each client on each
driver of value.
iii. Test Your Rating System: Rate a subset of clients, in order to test the
suitability of your rating model.
iv. Rate Clients: Rate each client, on each driver of value, and then sum those
ratings to generate a composite ‘value rating’.
v. Define Segments: Create scoring ranges that link your composite scores to a
segment (e.g., a rating of 35-40 may be a platinum client).
vi. Track Segmentation Data: Enter each client’s segment in your contact
management system.
vii. Define Update Processes: Create processes to update client segment ratings
and to rate new clients.
Source:
http://www.advisorimpact.com/ussite/download/client_segmentation_workbook.pdf

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Wealth Management
Client segmentation along with flexibility to meet individual client needs is regarded as
one of the best practices in achieving client centric approach. Just as countries can be
distinguished on the basis of their wealth, the personal net worth of individuals is
another factor that separates the wealthier from the less affluent. While a personal net
worth of US$1,000,000 in most parts of the United States would place a person in a
wealthy group, such amounts in developing countries would constitute an extraordinary
amount of wealth that can be clearly classified under ‘super-wealthy’ category.
Segmentation based on wealth may not adequately address the clients needs as clients
with similar levels of wealth may have different needs. The three most important client
segments include Ultra-High-Net-Worth Individuals (UHNWI), High-Net-Worth
Individuals (HNWI), and Mass affluent.
2.6.1 Ultra-High-Net-Worth Individuals
Ultra-HNWIs are defined as those individuals or families having investable assets of
US$30 million or more, excluding primary residence, collectibles, consumables, and
consumer durables. Ultra- HNWIs suffered more extensive losses in financial wealth
than the HNWI population as a whole. The Ultra-HNWI population fell 24.6%, as the
group’s wealth dropped 23.9%, pushing many down into the ‘mid-tier millionaire’ pool
in 2008.
2.6.2 High-Net-Worth Individuals
HNWIs are individuals with high net worth. HNWIs are defined as those having
investable assets of US$1 million or more, excluding primary residence, collectibles,
consumables, and consumer durables. HNWI population declined from 10.1 million to
8.6 million in 2008.
2.6.3 Mass Affluent
The term ‘Mass affluent’ is used to refer to the growing high-end of the mass market.
This term is most commonly used by the financial services industry to refer to
individuals having investible assets between US$100,000 to US$1,000,000.
Having segregated the clients, we will now focus on the client expectations of different
segments of clients and client profiling briefly.
2.6.4 Client Expectations
In the competitive scenario of today, wealth advisory firms are competing fiercely to
find ways of improving their existing client relationships. They are providing new tools
to increase advisor effectiveness, maximizing technology investments, and controlling
the cost of client-advisor interactions without jeopardizing relationships. As a result, the
wealth advisory firms have focused on developing some need-based approaches for
providing the most adaptable wealth management services to the clients by offering a
package of products and services. These firms are also resorting to innovations by
adopting new client segmentation approaches using criteria which are beyond ‘assets
under management’ to achieve optimal product and service bundling.
The mass-affluent segment has witnessed the highest growth rate which led to the
increase in the expectations of the value-added services from the financial service
providers to fulfill the need for higher returns on investments by leveraging alternate
investment opportunities. The firms are also developing customized servicing
approaches and advisor practice models in order to optimize the lifetime value of
advisor/client relationships. At an advanced level, such wealth management advisor

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tools are leveraging sophisticated technology platforms, which support delivery to ensure
long-term relationships with high net worth clients.
The success of a wealth management team depends on its timely, efficient and seamless
participation with a proven record of honoring and strengthening client relationships.
The team would comprise specialists from different areas. For the purpose of
identification and documentation of assets, the services of trained and experienced
on-staff specialists in tax law, engineering and construction are required. The Certified
Public Accountant (CPAs) and engineers provide the necessary expertise in asset
review, classification, research and reporting.
2.6.5 Client Profiling
Client profiling, is a useful concept in understanding the client’s circumstances,
requirements, objectives in all aspects. It is about gathering information on income,
expenditure, assets and liabilities of the client. It helps advisors in establishing a long
term relationship with the client. It figures out client financial personality. It assists in
identifying, discussing, quantifying and prioritizing the client’s needs. Any change in
the life of the client may be subjected to change in investment strategy. It ensures that
adviser has a permanent record of the clients and update it regularly as and when
required and especially at the time of advising. Detailed description about client
profiling will be given in Chapter 3 titled “Client Profiling”.

Self-Assessment Questions – 1
a. What does Client Segmentation involve?
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
b. What is meant by the term mass affluent?
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………

2.7 PRIVATE BANKING

The term ‘private’ refers to the customer service being rendered on a more personal
basis than in mass market retail banking. In simple terms, Private Banking is defined as
“Personalized financial and banking services that are traditionally offered to a bank’s
rich, High Net Worth Individuals (HNWIs)”.
It forms an important and exclusive subset of wealth management.
Earlier, private banking was exclusively, for high-net-worth individuals with liquidity
over $2 million. With the change in time, it is now possible for private investors to open
private banking accounts with as little as $250,000. Private banking provides services
like wealth management, savings, inheritance and tax planning to their clients. Some of
the key private banking challenges include need to restore confidence, difficult asset
and revenue growth, growing need for holistic advice, emergence of alternative
providers, client relationship management tools, component based approach, partnering
and outsourcing, financial importance2. Switzerland is the major location for private

2 European Wealth and Private Banking Industry Survey 2005, IBM Business Consulting
Services.
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banking. The five largest private banking in US as on June 30, 2008 are Merill Lynch
($9.05 trillion), City Global Wealth Management ($843 billion), Bank of America Global
Wealth ($653.2 billlions), Wachovia ($551 billion), Morgan Stanley Global Wealth
Management ($423 billion).
2.7.1 Private Banking Ranks
According to Reuters the top global private banking institutions in the year 2008 are
displayed below. These institutions gathered more than $1 trillion in assets under
management for private clients.
Table: Global Private Banking Ranks, 2008
Rank ’08 Company Rank ’07
1 UBS ($100 billion) 1
2 Citigroup ($80 billion) 2
3 HSBC ($60 billion) 3
4 Credit Issue ($50 billion) 4
5 Merill Lynch ($40 billion) 5
6 DBS Group ($30 billion) N
7 BNP Paribas ($30 billion) 8
8 JP Morgan Chase ($25 billion) 7
9 Deutsche Bank ($25 billion) 6
10 Morgan Stanley ($20 billion) N
Rankings: ‘n’ denotes not in top 10.
Source: www.reuters.com
2.7.2 Family Office
A ‘family office’ refers to a private company that manages investments and trusts of a
single wealthy family. Traditional family offices provide personal services such as
managing household staff and making travel arrangements, property management,
day-to-day accounting and payroll activities, and management of legal affairs. A family
office costs over $1 million to operate, so the family’s net worth usually exceeds $500
million.
The first family office in the United States was formed during the late 19th and early
20th century as a result of the tremendous wealth created during the Industrial
Revolution. A traditional family office is a business run by and for a single family. Its
sole function is to centralize the management of a significant family fortune. Typically,
these organizations employ staff to manage investments, taxes, philanthropic giving,
trusts, and legal matters. The purpose of the family office is to transfer effectively
established wealth across generations.
The family office invests the family’s money, manages all of the family’s assets, and
disburses payments to family members as required. The office operates like a
corporation with a president, CFO, CIO, etc., and a support staff. Family offices are
built around direct assets like real estates or indirect assets like equity investments, a
more aggressive and well-capitalized office also engages in private equity placement,
venture capital opportunities, and real estate development. A good example of such an
investment office is Fid equity Group of Companies or Guggenheim Partners.

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Box 2: ICICI Bank’s Entry into Private Banking

ICICI Bank, which is one of the largest banks with respect to market capitalization
offers a range of banking services is now opening its door to private banking. Bank’s
relationship manager acts as a financial doctor, analyzes client’s financial goals, and
ascertains risk appetite for financial assets and finally monitoring and reviewing of
the portfolio on periodic basis. ICICI Bank, wealth management team has a
dedicated wealth manager, who is the face of the bank. Wealth manager will be the
personal guide and will work in achieving financial goals. ICICI Bank has set up a
portfolio Building Approach that helps in understanding the financial goals,
investment planning, portfolio construction, portfolio maintenance and review, which
are discussed briefly below and depicted in the figure below:

Understanding Financial Goals: Investment process starts with understanding the

investors background, investment objectives, risk tolerance and existing investment
pattern. Client Profiling also helps in evaluating risk appetite and understanding
investment objectives, which are kept in mind while building the investors portfolio.
Investment Planning: An investment plan is constructed based on the investment
goals, wealth requirements, investment horizon and risk profile. Evaluating and
realigning the investments as per the suggested allocation is also taken care.

Portfolio Construction: Appropriate solutions for implementing investment plans

involve execution of investments in debt, equity, structured products and alternative
investments.

Portfolio Maintenance: Monitoring the investments and rebalancing the portfolio

for maintaining asset allocation and aligning the portfolio to changes in
macroeconomic factors.

Portfolio Review: As investment preferences or financial goals change periodically,

reviewing the portfolio and implementing the changes in asset allocation is done to keep
the investors portfolio healthy.

Figure 1: Portfolio Building Approach

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Wealth Management
There are certain challenges pertaining to private banking operations in ICICI Bank, which
are represented in the figure below:

Figure 2: Challenges Aplenty

Source: ICICI Bank.

2.7.3 Offshore Investment
Offshore investment is the mechanism of serving clients wishing to manage their wealth
outside their own country of residence. It is for reasons like financial confidentiality,
legal system flexibility, tax considerations, lack of appropriate products and services on
shore, low level of trust in domestic financial markets and governments. This is a
commonly accepted solution for reducing excessive tax burdens levied to both large and
small-scale investors similarly in most countries. Certain offshore domiciles are viewed
as ‘Tax havens’ used to conceal or protect illegally acquired money from law
enforcement agencies in the investor’s country.
Legitimate investors also take advantage of higher rates of return or lower rates of tax
on that return offered by operating via such countries. The added advantage is that all
such operations would not only be termed legal, but are also less costly than the
solutions offered in the investor’s own country.
The taxes levied by an investor’s home country are critical to the profitability of any
given investment. The ‘tax’ factor has emerged as the strongest driving force behind
‘offshore’ activity. Due to solutions offered through offshore activities, investors are
showing keenness in conducting such investment activities in a profitable manner.

2.7.4 Onshore Investments

Onshore investment in wealth management is the provision of products and services
within the client’s main country of residence. It is the opposite of offshore investment.
Onshore investing is not popular as it does not reduce the position of tax burden to the
investor; it is not as less regulated as offshore investment; and even the behavior of the
offshore investment provider is not as free as it is in a more regulated environment.

Self-Assessment Questions – 2
a. What is meant by Private Banking?

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

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 Understanding the
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b. What is Family Office?

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

2.8 SUMMARY
Wealth Cycle consists of four phases – Wealth Creation, Wealth Enhancement, Wealth
Preservation, and Wealth Distribution.
Client Segmentation means that the advisor has to be familiar with two facets of client
needs – products and services that best meet the client’s investment objectives and style
of manager that best suits the client.
In the competitive scenario of today, wealth advisory firms are competing fiercely to
find ways of improving their existing client relationships. They are providing new tools
to increase advisor effectiveness, maximizing technology investments, and controlling
the cost of client-advisor interactions without jeopardizing relationships.
Earlier, private banking was exclusively, for high-net-worth individuals with liquidity
over $2 million. With the change in time, it is now possible for private investors to open
private banking a

2.9 GLOSSARY
Private Banker is an individual who is employed in a private bank. Private banker is a
point of convergence between the bank and customer.
Wealth Planner is someone who is responsible for planning the creation and the
maintenance of wealth for a client by defining a road map for the future, taking into
account fiscal, personal and professional consequences of these recommendations.
Net Worth is the total of equity share capital and reserves. It is also the value of total
assets minus total liabilities.

2.10 SUGGESTED READINGS/REFERENCE MATERIAL

• Dimitris N Chorafas, Wealth Management, Elsevier Ltd., 2006
• Jonathan Reuvid, Handbook of Personal Wealth Management, Korgan Page Ltd,
2010

2.11 SUGGESTED ANSWERS

Self-Assessment Questions – 1
a. Client Segmentation involves delivering products and services to distinct client
groups. It means that the advisor has to be familiar with two facets of client
needs – products and services that best meet the client’s investment objectives
and style of manager that best suits the client. In simple words, client
segmentation is simply grouping of clients.
b. The term ‘Mass affluent’ is used to refer to the growing high-end of the mass
market. This term is most commonly used by the financial services industry to
refer to individuals having investible assets between US$100,000 to
US$1,000,000.
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Self-Assessment Questions – 2
a. Private banking is nothing but the personalized banking, investment, and other
financial services rendered by banks to private individuals investing sizable
assets. In simple terms, Private Banking is defined as “Personalized financial and
banking services that are traditionally offered to a bank’s rich, High Net Worth
Individuals (HNWIs)”.
b. A ‘family office’ refers to a private company that manages investments and
trusts of a single wealthy family. Traditional family offices provide personal
services such as managing household staff and making travel arrangements,
property management, day-to-day accounting and payroll activities, and
management of legal affairs.

2.12 TERMINAL QUESTIONS

A. Multiple Choice
1. ‘Wealth Distribution,’ is the ___________ stage in the wealth cycle.
a. First
b. Second
c. Middle
d. Last
e. Insignificant.
2. Offshore investment is the mechanism of serving clients wishing to manage their
wealth __________.
a. Outside their own country of residence.
b. Inside their own country of residence.
c. Outside their own state of residence
d. Only (a), (b) and (c) of the above.
e. Inside their own state of residence.
3. Savings cycle leads us to the concept of __________.
a. Income cycle
b. Growth cycle
c. Wealth cycle
d. Life cycle
e. Productivity cycle.
4. From the point of view of Wealth Management, Client profiling, is a useful
concept in understanding __________.
a. Nature of the client
b. Credit worthiness of the client
c. Client’s family back ground
d. Client’s business/profession
e. Client’s circumstances, requirements & objectives in all aspects.
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 Understanding the
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5. The Profession of Wealth Management is significantly expanding in _______.
a. Greece
b. Pakistan
c. Ireland
d. Spain
e. BRIC.
B. Descriptive
1. Discuss Saving and Investment Cycle.
2. What are the strategies to be followed for successful wealth accumulation
program?
3. State the importance of Client Profiling in Wealth Management.
4. What is the strongest driving force behind ‘offshore’ Investment activity? Why?

These questions will help you to understand the unit better. These are for your
practice only.

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UNIT 3 CLIENT PROFILING
Structure
3.1 Introduction
3.2 Objectives
3.3 Client’s Goals and Constraints
3.4 Data Gathering
3.5 Identifying the Client’s Needs
3.6 Life Cycle Investment Guide
3.7 Characteristics of Private Banking Clients
3.8 Summary
3.9 Glossary
3.10 Suggested Readings/Reference Material
3.11 Suggested Answers
3.12 Terminal Questions

3.1 INTRODUCTION
Client profiling is a useful concept in understanding the client’s circumstances,
requirements, and objectives in all aspects. It is about gathering information on income,
expenditure, assets and liabilities of the client. It helps advisors in establishing a long
term relationship with the client. It figures out the client’s financial personality. It
assists in identifying, discussing, quantifying and prioritizing the client’s needs. Any
change in the life of the client may be subjected to change in investment strategy. It
ensures that the adviser has a permanent record of the clients which is updated regularly
as and when required and especially at the time of advising.

3.2 OBJECTIVES
After going through the unit, you should be able to:
• Summarize the Client’s Goals and Constraints;
• Understand the Principles of Asset Allocation;
• Draft Life Cycle Investment Guide;
• Determine the Characteristics of Private Banking Clients; and,
• Identify the Client’s Needs.

3.3 CLIENT’S GOALS AND CONSTRAINTS

Client profiling is done through a detailed questionnaire. It captures soft facts of the
client such as the client’s personal details, goals and objectives. This profiler assists
both the client and the advisor in assessing the current situation. The advisor has to
ensure that due protection is given to the client’s liabilities and family standards even
after the client’s retirement or critical illness or even after death.
Investment planning along with other types of planning such as estate planning, tax
planning, and retirement planning should also be done. Even the client’s risk profile is
to be determined. Any change in the life of the client, changes in the financial
requirements, risk profile, and investment strategy need to be profiled. Client profiling
should not be merely a process of filling a form. It is a detailed examination of the
 Client Profiling
client’s status in all aspects. The advisor should have a permanent record of the client’s
financial position and should review it regularly especially at the time of advising or
preparing an investment strategy.
Careful financial planning starts with client profiling. In client profiling, the advisor
should instruct the client in setting goals, prioritizing goals and identifying the
constraints that limit the client from achieving their goals and objectives.
SETTING GOALS
Goals are the expected circumstances that a client/investor plans to achieve at a certain
point of time. Goals should be specific, attainable, realistic and timely. Successful
wealth management depends on thorough understanding of the client’s goals.
Goal-setting is one of the major components of personal as well as financial
development of an individual. It is the responsibility of the wealth manager to educate
the clients in setting the goals. Goals are of three types – hidden goals, time-bound
goals, and consumption-oriented goals.
Hidden Goals
Clients sometimes do not provide their investment goals explicitly or ignore issues that
are critical to the return-generating process. For example, the risk issue, when the clients
are questioned about their investment goals, they often discuss the expected returns than
the risks they are ready to assume. Wealth management requires the client to clearly
define the hidden goals. Determining the hidden goals should be the first priority of the
wealth manager. The wealth manager should determine the expected and unexpected
risks and also their associated costs. The resources required to fund these risks are also
to be set aside. Defining and quantifying clearly, the hidden goals is necessary to assure
that adequate resources are available to fund the cost of risk.
Time-Bound Goals
Time plays an important role in investment return expectations. Having a clear
understanding of the client’s time frame assists the wealth manager in fitting better
strategic choices, which in turn help in accomplishing the client’s goals.
Time-bound goals are again divided into two types:
Intermediate Goals: Goals that are anticipated, finite, in time are intermediate goals.
These goals will be completed before retirement. School education and marriage are
some of the examples of intermediate goals.
Lifetime Goals: Goals of financial independence, post-retirement are lifetime goals.
These are also called retirement goals. They differ from individual to individual.
Estimation of mortality is an additional dimension that assumes greater importance in
determining lifetime goals.
Consumption-Oriented Goals
A client instead of preserving the capital establishes the goal of retiring from the current
employment along with sufficient wealth to fund the current living expenses regardless
of the capital. The capital may increase, preserve or diminish. Setting goals in terms of
consumption has two key benefits – motivation and measurement.
PRIORITIZING GOALS
The second step involves prioritization of goals. Often, the clients have too many
financial goals that require the advisor’s assistance in prioritizing them. Prioritization is
the client’s responsibility and making the client understand and prioritize the goals is
the wealth manager’s ultimate responsibility. The client should be able to discriminate
between the short-term and long-term goals. Sometimes, clients misprioritize the goals
due to lack of thorough understanding of investments and tax consequences.
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CONSTRAINTS
Every client faces some kind of constraints constantly. These constraints limit the
clients from achieving their goals. Time horizon, liquidity and marketability, risk, risk
profile and tax planning come under such category. These constraints are discussed
briefly below:
Time Horizon
The goals set by the clients should be time-specific. Time horizon is defined as the
length of the time for an investment to yield returns. The advisor has to educate the
client about the importance of time horizon including the mortality determination for
retirement. This will not only give the client an understanding but also the ownership in
time horizon for each goal. Since time horizon is the important factors of all, the time
frame required for achieving the objective tends to change the risk profile of investment.
Goals with short time horizon require low risk portfolios, which are different from those
goals with long time horizon. Since wealth management process is a long-term process,
it is advisable for the clients to plan for five years.
Liquidity and Marketability
These terms are often used interchangeably and are misunderstood by the clients and
advisors while communicating with each other. The wealth manager should be able to
guide his clients about the investment attributes in terms of ‘Appropriate’ and
‘Inappropriate’.
Liquidity refers to the ability of the client to convert the investments to cash quickly
independent of economic changes and without the risk of any financial loss. Liquidity
investments include money market funds, T-bills, cash, and most fixed annuities.
Wealth managers should evaluate the degree of liquidity required by the client. Some
clients do not require any special liquidity, others require large degree of liquidity.
Therefore, depending on the goals, wealth managers should determine in which markets
the investment should be made to meet liquidity goals.
Marketability measures the client’s ability to convert investment into cash. It is not
independent of any loss or economic changes. Marketable investments include high
quality stocks, bonds, and open-end mutual funds. Marketability and liquidity are
similar except that in liquidity the value of security is preserved, whereas in
marketability, security can be bought or sold.
Risk
Risk is defined as ‘Uncertainty of Outcome’. It is not rational to think about the returns
without talking about risk. Risk is defined as the difference between the actual
and expected return on the investment. Clients can be risk-averse orrisk-tolerant.
Risk-averse client is one who is not prepared to take risk. For example, the client who is
not ready to bear the risk, will put his money in a bank with low but guaranteed interest
rate, rather than in stocks. Risk-tolerant client has the ability to handle the declining
returns of his/her portfolio. Therefore such clients are ready to invest in stocks that
generate high returns but have a chance of becoming worthless.
Risk Profile
Asset allocation of the client depends on the investor’s risk profile. Investors risk profile
aims at understanding the client’s attitude towards risk and expectations of returns. It
helps in resolving any dissonances in terms of return expectations and appetite for risk
that the client is willing to assume. The risk tolerance level is dependent on the factors
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 Client Profiling
such as age, financial responsibilities and income earning capacity. These factors are
important and have to be taken into cognizance in the wealth management process.
These factors help in deciding the risk level of an individual in an investment.
Age: An individual’s ability to earn enough future income depends on the age of the
young investor. Person who is and who can recover from investment losses can pick up
riskier investments. A person who is nearer to retirement has to choose less risky
investments or conservative investments because of time deficiency to recover from
losses.
Financial Responsibilities: Financial responsibilities play a key role in deciding the
risk profile of the client. If the client is burdened with financial responsibilities, he/she
may prefer less risky investments. A person with less financial responsibilities picks up
risky investments with high returns.
Income-earning Capacity: An individual whose income is high or has the ability to
earn high income in the future can invest in high risk-high return assets. Individual with
modest income has to invest in conservative investments.
Tax Planning
The client has to bear in mind any changes with respect to his/her personal income tax
rates. Budget incentives, changes in tax rates and inclusion or exclusion of certain tax
savings instruments will help a client in planning their income tax.

Self-Assessment Questions – 1

a. In client profiling, the advisor should instruct the client in ………………..

– Setting and prioritizing goals
– Identifying the constraints that limit the client from achieving their
goals and objectives.
– Both
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
b. Define risk.
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………

3.4 DATA GATHERING

Data gathering is one of the important steps in wealth management process. The goal of
data gathering process is ‘know the client’. Data collected will be accurate and
quantitative in nature. Gathering maximum and up-to-date data from the client helps the
wealth manager in effective asset allocation. The quality of wealth management
depends on the quality of the data gathered from the client. Data can be gathered
through personal interview or through a questionnaire. Personal interview is always the
preferred way to handle data gathering. Data gathering process also provides
opportunity to assess the client’s level of investment knowledge. Strengths and
weaknesses of his current investment portfolio can also be shared.

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Data gathering of the client is a step-by-step process as given below:
• The personal details gathered include current age, spouse’s age, expected
retirement date, family size, number of dependents etc.
• The wealth manager collects information on the existing portfolio of the client.
This includes the amount of funds invested and the asset classes, across which
funds have been invested.
• The wealth manager also has to make assumptions about the returns expected by
the client from investments in various asset classes and tax status of those
returns; and
• The wealth manager has to make sure that information related to the
post-retirement sources of income is also collected. There are two types of
post-retirement assumptions – income sources independent of the investment
portfolio, and post-retirement expenses.

3.5 IDENTIFYING THE CLIENT’S NEEDS

Successful wealth managers are those who understand the needs of their clients and
address them proactively. Wealth management firms and advisors have to believe that
their most valuable assets are their clients and should make sure that they have a good
and long standing relationship with them. Client’s needs are the basis of any wealth
management solution, so firms have to understand and respond to those needs first.
Even at the time of framing an investment strategy, it is essential to first identify the
changing needs of the clients accurately. As wealth management firms increasingly
compete for the HNW clients, and the clients themselves become more demanding, the
pressure is on firms to understand the essence of client needs in existing and growth
markets.
Firms with advisory centric approach focus on translating client needs into financial
objectives. According to the BCG report titled ‘Taking the Client’s Perspective’,
success of wealth management depends on a detailed understanding of the client, in
particular identifying the needs and expectations as well as differing investing styles of
the clients.
Identifying and understanding the client’s needs is easy if the advisors look at the things
from the client’s perspectives by making sure that good quality of client service is
provided, client’s information is kept confidential, good quality of investment advice is
provided, interacting more with the clients, taking their advice on investment portfolio,
documenting all the information, analyzing them and making the changes necessary. It
is best that the advisor anticipates the client’s needs and satisfies them before they are
asked to. But, the real differentiator is to identify the client’s needs and opportunities,
which the clients have not even recognized.
The World Wealth Report, issued by Merrill Lynch and Capgemini, found that wealth
management firms are turning towards dynamic, need-based client service approach.
“Leading wealth management firms understand that to be successful, their service
model must be tailored to the individual needs of the client,” said Robert J. McCann,
President of Merrill Lynch’s Global Private Client Group.
Historically, wealth management firms have used Asset Under Management (AUM) to
determine, which products and services will be offered to the individual clients,

42
 Client Profiling
believing that it was a good indicator of identifying the client’s needs. Ongoing
changing client needs are having more emphasis on how wealth management firms
evaluate the effectiveness of their service models. Identifying, understanding and
satisfying the client’s needs are of paramount importance in attracting and retaining
HNWI clients.
Using static segmentation criteria to offer increasingly commoditized wealth
management products and services is becoming outdated. The new models that the
firms are adopting take a multifaceted and dynamic approach to client service. These
models put the client’s needs first, taking into account a multitude of behavioral,
demographic and investment characteristics that describe each client’s wealth
management requirements. Advisor practice models, service approaches and product
offerings can be tailored to meet the client’s needs and continuously refreshed as the
firms identify the changes in the client’s behavior.
There are four key steps that financial services firms are taking to successfully
implement a dynamic needs-based approach to client service, which include:
Segmenting and Determining the Client’s Needs in Addition to AUM: Segmenting
clients according to their interests, frequency of firm interaction, communication
preferences and financial behavioral attributes.
Product and Service Selection Based on the Firm’s Strategy and Client’s Lifetime
Value: Analyzing the client’s needs and creation of tailored offerings to meet the
unique needs of clients. For bridging the gap between the client’s needs and product and
service offerings, the firm must decide to build additional capabilities, partner with a
third party, or to decline certain business opportunities to ensure consistency with the
firm’s overall strategy.
Selecting a Service Approach and Practice Model: Determination of a service
approach to fit the needs of clients and to deliver service through multiple channels and
practice models.
Staying Current with the Client’s Needs: Effectively addressing and anticipating the
profiles of the ever changing needs of the clients, firms should continuously monitor
and update the behavior patterns of the clients.
Thus, those firms who understand their clients are able to leverage their existing
strengths to transform and adapt their service delivery and technology to cater
effectively to client needs in their target growth markets.

3.6 LIFE CYCLE INVESTMENT GUIDE

Life cycle investment planning is a dynamic process. Investment goals and targets
change with the changing environment and situations as the clients progress through
various stages of his/her life. They need to be updated and revised at the right time. A
person may have to face contingencies such as unemployment, illness, disability, etc.
Investment planning provides the requisite cushion for such contingencies. Investment
goals associated with the various phases of a client’s life are known as client’s life cycle
needs. Life cycle investment planning is classified into three phases, which include
accumulation phase, conservation/ protection phase, and preservation, and gifting phase.
ACCUMULATION PHASE
The first stage in the life cycle investment process is called accumulation phase. In this
phase, the individual starts his/her life from being dependent on his/her parents, builds
up his/her savings and investment portfolio with the intention of having a nest egg for
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retirement. In this stage, the client assumes greater investment risk to attain higher
returns. The client can see the increase in his income as well as savings. In this stage,
the client is basically the receiver of the compounding value of his wealth. Some of the
common investments in this early stage of life cycle are – purchasing a house,
children’s education, and maintaining the requisite standard of living.
CONSERVATION/PROTECTION PHASE
Protection phase is the second stage in the life cycle investment guide. This is the
dominant phase in the life of the client. The client strengthens the assets that are
accumulated already. Individual earnings and savings reach their peaks. In this phase,
the client’s risk-undertaking levels are reduced and they are satisfied with lesser returns.
Loss aversion is the dominant factor in this stage. Common investment goals in this
stage include children’s education, retirement savings and gifts to beneficiaries,
charities, and well-wishers. After this stage, he/she has to take care of his/her retirement
needs.
PRESERVATION AND GIFTING PHASE
Preservation and Gifting Phase is the last stage in the life cycle investment plan of the
client. It is the stage that starts soon after the client retires and continues till the life
expectancy. In this stage, the client is more concerned with preserving capital rather
than enhancing the investment returns. Investments in this stage are more conservative
compared to the other two stages. In this stage, the client seeks the planner’s assistance
in gifting income and property to his/her beneficiaries.
Self-Assessment Questions – 2
a. What are the key steps to successfully implement a dynamic needs-based
approach?
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
b. What does investor’s risk profile aim at?
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………

3.7 CHARACTERISTICS OF PRIVATE BANKING CLIENTS

The term ‘private’ refers to the customer service that is delivered on a more personal
basis via dedicated bank advisers. Private banking should not be confused with private
bank. In simple terms, private banking is defined as “Personalized financial and banking
services that are traditionally offered to a bank’s rich, High Net Worth Individuals
(HNWIs)”.
Earlier, private banking was exclusively meant for high net worth individuals with
liquidity over $2 million. With the change in time, it is now possible for the private
clients to open private bank accounts with as little as $250,000. Apart from providing
advice on investments, it also addresses the client’s entire financial situation. Some of
the private banking services include: protecting assets, increasing assets, providing
special financing solutions, retirement planning, wealth accumulation for the future
generations. A high level form of private banking is often referred to as wealth
management.

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 Client Profiling
Private banker is a professional working in private banking. Private banker brings
together private banking, asset management, online brokerage, wealth structuring and
financial planning services. Private bankers use various methods in segmenting the
target market. Private banker subdivides the clients into groups with respect to their
preferences. Some of the segmentation alternatives are geographic, demographic,
psychographic, volume, and benefits.
With changing client’s expectations of wealth management services, private banking
clients are becoming more diversified in their approach, global in thinking,
sophisticated, risk-averse, aggressive and active. As per IBM, European Wealth and
Private Banking Industry survey, 2005, the key private banking challenges are:
• Restoring confidence;
• Addressing the growing needs of high quality and holistic advices;
• Enriching the client experiences;
• Enhancing client relationships; and
• Managing tools for financial performance besides having a good quality of top
managing team.
The key characteristics of private banking clients are – sophistication, advice, buying
behavior, relationship fragmentation, and regional differences. Each of these
characteristics is discussed below:
SOPHISTICATION
Clients are adopting increasingly sophisticated approach to wealth management. This
approach is driven by increasing access to financial news, information and familiarity of
investments. A sophisticated client is one who is considered to have a good investing
experience and knowledge to weigh the risks and merits of investment opportunity.
Clients with hyper sophistication do similar mistakes as that of normal investors such as
chasing performance, accepting excessive risks, and undiversified portfolio.
ADVICE
With the increased sophistication, time spent on wealth management needs by the
clients is very less. At the same time even the demand and array of products of the
clients are becoming more complicated. Though advice-seeking pool of the clients is
large but is currently under served. Some clients want advice all the time, all
clients want advice some time but many clients are unsatisfied with the advice they get
most of the time. Wealthy clients seek advice in relation to family dynamics and
intergenerational planning of wealth transfer. The top clients who are elderly, require
advice relating to intergenerational planning of wealth transfer as they have to consider
family members education, retirement planning, and wealth preservation for the future
generations.
BUYING BEHAVIOR
Clients have increased access to products through various channels and therefore they
no longer view it as value proposition of the advisor. Since large array of investment
services are being offered to clients, they are interested in those investments that ensure
greater transparency regarding risk and return such as hedge funds. Clients prefer some
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types of hedge funds and other alternative investments, as they offer greater returns
even at the time of economic downturn. Clients seek the services of wealth managers in
respect of the fees, risks, performance and pricing mechanisms of such investments.
According to the IBM European Wealth and Private Banking survey, many clients feel
that the traditional providers may not offer either the best practice solutions or meet the
demands of new products and services of best quality.
RELATIONSHIP FRAGMENTATION
More than 60% of the clients are with more than one provider. Clients are able to
compare wealth managers through various dimensions. They are less tolerant of the
providers, who are down to poor service, weak investment performance, or reporting
flaws. There are certain key findings which wealth management firms need to focus to
improve their relationship with clients – tailor reporting preferences to client needs,
providing holistic advice about the client’s assets and liabilities, proposing more
innovative solutions, proactivity in the relationship and understanding of the client’s
personal and business situations. Above all, clients prefer wealth managers who has the
quality of client service, confidentiality and security, quality of investment advice;
image and reputation etc.
REGIONAL DIFFERENCES
Despite globalization and international lifestyles, the service and product needs of
clients vary across geographical regions. For example, European clients focus more on
tax-efficient investment products, and advisory services. They have fewer wealth
management relationships. They are more interested in real estate. Asia-pacific clients
hold higher proportion of their wealth in cash, real estate, and privately held businesses.
They require integrated private corporate banking services. They place strong emphasis
on confidentiality.

3.8 SUMMARY
Client profiling covers accurate information on the income, expenditure, assets and
liabilities of the client. It captures soft facts of the client such as the client’s personal
details, goals and objectives.
Careful financial planning starts with client profiling, proceeds with the advisor
educating the clients in setting goals, prioritizing goals, the constraints that the client’s
may face while investing or may stop them from achieving their goals and objectives.
The four principles of asset allocation are – risk and reward are inter-related; risk
depends on the time horizon of investment; dollar cost averaging, and risk depends on
the total financial situation.
Life cycle investment planning is a dynamic process. It is done in three stages, which
include accumulation phase, conservation/protection phase and preservation, and gifting
phase.
Private Banking is defined as “Personalized financial and banking services that are
traditionally offered to a bank’s rich, High Net Worth Individuals (HNWIs)”. Some of
the key characteristics of Private banking clients are sophistication, advice, buying
behavior, relationship fragmentation and regional differences.
Wealth management firms and advisors have to identify and understand that their most
valuable assets are their clients and should make sure that they have a good and long
standing relationship with them.

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 Client Profiling
3.9 GLOSSARY
Asset Allocation is the process of deciding the proportion of funds to be distributed
across a set of asset classes.
Risk is the chance of an outcome not occurring as planned.
Dollar Cost Averaging means a periodic investment program in which an investor
makes regular purchases of the same dollar amount into the same security.

3.10 SUGGESTED READINGS/REFERENCE MATERIAL

• Harold Evensky, Wealth Management: The Financial Advisors Guide to
Investing and Managing Your Client’s Assets./The IRWIN / IAFP Series in
FP, McGraw-Hill,1997
• Lawrence J. Gitman, and Michael D. Joehnk. Personal Financial Planning. US:
South Western Thomson Learning, 2002.

3.11 SUGGESTED ANSWERS

Self-Assessment Questions – 1
a. In client profiling, the advisor should instruct the client in setting goals,
prioritizing goals and identifying the constraints that limit the client from
achieving their goals and objectives (c).
b. In general terms, Risk is nothing but ‘Uncertainty of Outcome. In the investment
world, Risk is defined as the difference between the actual and expected return
on the investment

Self-Assessment Questions – 2
a. There are four key steps that financial services firms are taking to successfully
implement a dynamic needs-based approach:
Segmenting and Determining the Client’s Needs in Addition to AUM:
Segmenting clients according to their interests, frequency of firm interaction,
communication preferences and financial behavioral attributes.
Product and Service Selection Based on the Firm’s Strategy and Client’s
Lifetime Value: Analyzing the client’s needs and creation of tailored offerings
to meet the unique needs of clients. For bridging the gap between the client’s
needs and product and service offerings, the firm must decide to build additional
capabilities, partner with a third party, or to decline certain business
opportunities to ensure consistency with the firm’s overall strategy.
Selecting a Service Approach and Practice Model: Determination of a service
approach to fit the needs of clients and to deliver service through multiple
channels and practice models.
Staying Current with the Client’s Needs: Effectively addressing and
anticipating the profiles of the ever changing needs of the clients, firms should
continuously monitor and update the behavior patterns of the clients.
b. Investors risk profile aims at understanding the client’s attitude towards risk and
expectations of returns.
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3.12 TERMINAL QUESTIONS
A. Multiple Choice
1. Private banking is ___________.
a. Banking services to all retails investors
b. Banking services to all corporate clients
c. Financial and banking to a bank’s rich, High Net Worth Individuals
(HNWIs)
d. Only (a), (b), and (c) of the above
e. Banking services to its loyal customers.
2. Accumulation phase is the _________ phase of Life Cycle Investment Planning.
a. Last.
b. Second.
c. First
d. Third
e. Middle.
3. Liquidity is related to the ability of the client to ________________.
a. Raise the funds
b. Buy the investment product
c. Gain returns on the investment
d. Convert the investments into cash
e. Sell the investment in one product and to make the same amount of
investment in the other.
4. Asset allocation of the client basically depends upon his ___________.
a. Behavior
b. Preferences
c. Likes and dislikes
d. Knowledge of investment
e. Risk profile.
5. In the life cycle investment plan of the client, Preservation and Gifting Phase
starts soon after the client ______________.
a. Makes investment
b. Desires to make additional investment
c. Doesn’t want to make fresh investment
d. Wants to discontinue SIP
e. Retires and continues till the life expectancy.
B. Descriptive
1. Explain the need for defining the goals and constraints in Investment Planning of
a client.
2. Enunciate the characteristics of Private Banking Clients.
3. What is Life Cycle Investment Planning? What are its objectives?
These questions will help you to understand the unit better. These are for your
practice only.

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UNIT 4 PERSONAL FINANCIAL
PLANNING
Structure
4.1 Introduction
4.2 Objectives
4.3 Need for Personal Financial Planning
4.4 Rewards of Personal Financial Planning
4.5 Proforma of Financial Statements
4.6 Steps in Personal Financial Planning Process
4.7 Need for a Financial Planner
4.8 Constraints of Personal Financial Planning
4.9 Tax Planning
4.10 Insurance Planning
4.11 Non-Life Insurance
4.12 Retirement Planning
4.13 Estate Planning
4.14 Summary
4.15 Glossary
4.16 Suggested Readings/Reference Material
4.17 Suggested Answers
4.18 Terminal Questions

4.1 INTRODUCTION
In today’s competitive and complex world, a person has an array of choices for
everything he needs such as place to live, career, savings and investments etc. It is
becoming increasingly difficult for a person to develop financial strategies that best help
in improving his lifestyle. Even availability of sufficient funds worries the individual
about his/her future. The best way one can achieve one’s financial objectives is through
Personal Financial Planning (PFP). PFP helps in defining one’s financial goals and in
developing strategies to achieve those goals. The need and steps involved in Personal
Financial Planning of an individual are discussed below in detail.

4.2 OBJECTIVES
After going through the unit, you should be able to:
• Understand the need for Personal Financial Planning;
• Assess the rewards of Personal Financial Planning;
• Understand proforma of Financial Statements;
• Outline the steps involved in Personal Financial Planning Process;
• Understand the need for a Financial Planner;
• Determine the framework for Tax Planning;
• Figure out adequate cover and product for Insurance Planning; and,
• Strategize Retirement and Estate Planning.
Wealth Management
4.3 NEED FOR PERSONAL FINANCIAL PLANNING
Personal Financial Planning can be defined as “Taking conscientious and systematic
steps towards fulfilling one’s financial goals”. It refers to the proper planning and
implementation of well-coordinated plans to achieve financial objectives. It is a
dynamic process. It helps individual deploy scarce available resources in a wise manner.
Savings and investments made today have to match the future goals. To make sure that
this happens, proper projection of the future needs and evaluation of the future course of
actions become necessary. Planning in financial areas is necessary for the people
whether they are rich or poor. If a person has huge cash reserves, he can plan to invest
and spend it wisely. Similarly, a person, who has low or inadequate funds, has to plan to
get more benefit out of scarce funds.
Let us take example of the following situations:
• Rohan, a software engineer, has two kids and a dependent wife. Rohan is
thinking of securing his children’s future. What should he do?
• Riya has just joined a marketing firm. She has to repay her education loan and
support her family. How can she make it possible with her meager salary?
• Siddhartha received ten lakh rupees from his mother’s estate, on his twenty sixth
birthday. He has no idea what he should do with this money.
All these people are facing a common problem. They face uncertainty over their future
financial plans. Let us see how a financial plan can help them:
Personal financial planning is an ongoing process of an individual and systematic
analysis of personal financial obligations, funds requirements, available funds, income
generation, and allocation of funds on the basis of priority. It leads to better utilization
of available financial resources and reduces the financial crisis of individuals. It is a life
long activity.

4.4 REWARDS OF PERSONAL FINANCIAL PLANNING

Any change in the life of an individual changes his personal financial planning process.
There are three long-term rewards of personal financial planning – improved standard of
living, wise-spending patterns, and wealth accumulation. The three rewards of personal
financial planning are discussed below:
IMPROVED STANDARD OF LIVING
Personal financial planning helps manage one’s resources and control undue expenses.
Standard of living represents the quality of a person’s lifestyle. A person can maintain
his/her standard of living or even improve it by planning efficiently his/her income and
expenses and then provide for investment to meet the future contingencies. Quality of
life is tied with material as well as non-material items. Even money for health,
education, entertainment contributes to the quality of life.
Increasing of two-income families increases spending capacity and also the aspirations
for future requirements. As the income increases, the need for planning also increases,
so that money can be managed in a wise manner.
SPENDING MONEY WISELY
Spending money wisely is another pay-off of personal financial planning. An individual
always has two options with him/her with respect to his/her hard-earned money – spend

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it or save it for the future. Sometimes, it is important for an individual to forgo his/her
current needs to save for the future. Thus, if money needs to be spent, it should be spent
wisely. Put differently, one should think of what manner of spending or what type of
spending in what combination – gives the most satisfaction for each rupee spent.
Current Needs
The current needs of a person are dependent on the level of spending on the basic
necessities of life such as food, clothing, shelter, etc., and his/her propensity to
consume. Everybody spends money on these basic necessities of life, but the quantity
and quality differ from person to person. People can easily get influenced by various
attractive schemes for buying expensive consumer durables, clothes, large houses, etc.,
irrespective of their current income. Personal financial planning thus helps in making a
person realize that he/she has to strike a balance between his/her current expenses and
future requirements.
The average propensity to consume refers to the average inclination of an individual to
spend a rupee of income on the current needs than to save for the future needs. People
with higher inclination to consume are said to have a higher average propensity to
consume. Some people tend to spend almost equally on all the current needs, while
some others overspend on some needs and are extra cautious about others. As the
income of the person increases, the propensity to consume decreases. The proportion of
money spent on current needs as a proportion to the total income falls. It is not
uncommon to find some people with a lower income range spending more on current
needs, even in absolute terms, compared to another class of persons in a higher income
range. This is dependent purely on the individual attitudes of people.
Future Needs
Future needs can be taken care of by allocating a part of the current income for saving
or investment. This allocation of a part of the income for the future depends on the
current income of the individual. If a person earns less, it may not be possible for
him/her to allocate a sizeable portion for the future requirements. But as the income of
the person increases, he/she can devote a bigger chunk of his/her earned income to
saving or investment purposes.

At the same time, it should be said that irrespective of the level of income, it is
imperative for a person to save for the future, for any financial plan to succeed.
Individuals need some savings for the later years of life. There may also be other needs
that call for a lump sum to be spent later, like for the college education of a child. It thus
becomes necessary to plan ahead in order to meet these huge expenses. Saving for such
needs may also require sacrificing some of the current needs in order to be able to meet
these future needs comfortably.

WEALTH ACCUMULATION
Personal financial planning plays an important role in accumulating wealth. There is a
general tendency among people to accumulate wealth, which may be in the form of
tangible or intangible assets. Personal financial planning can help a person to formulate
a plan for investing in assets at the right time, without disturbing the current income.
Assets can also be subdivided into earning assets and tangible assets. Buying a car is a
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long-term investment, but the asset does not generate any income. On the other hand,
investment in fixed deposits, bonds, and stocks generates income. They are known as
earning assets. Thus, an individual has to decide whether he/she should invest in earning
or tangible assets. Again, within tangible assets, he/she has to select between those that
generate income, like a commercial real estate, and those that result in only capital
appreciation, like land. His/her decision will help chalk out his/her future strategy for
investment planning. The goal of most people would be to accumulate as much wealth
as possible while maintaining the desired standard of living.

Box 1: Financial Objectives

Every person has his or her own financial objectives in life with respect to the career
chosen, attitude, values, and basic needs. But, the objectives can be generally
categorized as follows:
i. Protection against personal risk resulting from:
• Premature death.
• Disability losses.
• Unemployment.
• Property and Liability losses.
ii. Capital accumulation aimed at meeting:
• Family needs.
• Educational needs.
• Emergency needs.
iii. Provision for retirement income.
iv. Reducing tax burden:
• During one’s lifetime.
• At death – when property is passed on to others.
v. Estate planning (investing for the heirs).
vi. Investment and property management.

Source: Academic Wing Research Team.

4.5 PROFORMA OF FINANCIAL STATEMENTS

Before one starts the process of personal financial planning, it is necessary to assess the
financial position of a person. This can be done by preparing personal financial
statements. A financial statement is defined as “the financial records of the
person/entity”. In the case of wealth management, financial statements refer to the
personal financial record of the investor/client. They are the planning tools that give
up-to-date information on the well-being and financial status of the individual both in
the short and long-term. They are understandable and reliable statements. They are the
corner stones of personal financial planning. They are prepared by professionals,
providing them the basis for making investment decisions. It not only provides

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information about financial condition but also the changes and the performance of the
client more clearly. There are two types of personal financial statements –
Balance Sheet, and Income and Expenditure statement.
BALANCE SHEET
Balance sheet is also called as the statement of financial position. It is a report of what
the investor owes, owns and net worth. Net worth is equivalent to the take value of
assets – the total number of liabilities. It is a statement that summarizes the financial
condition of an individual at a certain point of time. Let us see below what do assets,
liabilities, and net worth mean?
Assets
Items that a person owns. It can be an item purchased for cash or financed with debt and
can be shown in balance sheet. But the items that are taken on lease cannot be shown in
balance sheet. All the assets are recorded at market value in balance sheet. There are
four categories of assets – liquid assets, investments, real property, and personal
property. Liquid assets are low risk financial assets that can be converted into cash
easily with no loss in value. Investments earn a return rather than provide a service.
Real and personal property are tangible assets that one can use in everyday life. Real
property refers to immovable property, which has long life and can appreciate or
increase in value for example, land. Personal property refers to movable property. They
are short-term in nature and can depreciate or decrease in value with the passage of
time. They include equipment, automobile, furniture, clothing or jewelry.
Balance Sheet

Liabilities Amount Assets Amount

Utilities Cash on hand
Rent Savings account
Insurance premiums Deposits
Taxes Stocks
Medical Bonds
Loans Mutual funds
Travel Real estate
Others Others

Liabilities
Liabilities represent, those that a person owes. It is something one owes and must repay
in future. It can be short-term and long-term liability. Liabilities include credit card
charges, installment loans and real estate mortgages. Short-term liabilities are those that
are due within one year of the date of balance sheet. Long-term liabilities are those that
are due one year or more from the date of balance sheet.
Net Worth
Net worth is the amount of money left after selling all owned assets at their estimated
market value and paying off all liabilities. In personal finance, net worth is the
individual’s net economic position.

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INCOME AND EXPENDITURE STATEMENT
Income and expenditure statement is also referred to as Profit and Loss Statement (P&L).
It is a measurement of financial performance. It traces the client’s income, expenditure
and other expenses.
Income and Expenditure Statement
(Amount in Rs.)

Income

Wages and salaries

Bonus and commission

Pension and annuities

Investment income

Other income

Total

Expenses
Housing
Utilities
Food
Transportation
Medical
Clothing
Insurance
Taxes
Others
Total
Cash Surplus – Deficit
The income and expenditure statement has three major parts: income, expenses, and
cash surplus or deficit. The statement is prepared on cash basis, which means that only
those transactions that involve actual cash are recorded. Income is earnings received
which include wages, salaries, income, bonuses, commissions, interests, dividends, and
proceeds from the sale of assets. Expenditure is money spent on living expenses and
taxes or repaying debts. Cash surplus or deficit is the excess amount of either income
over expenses that are used for savings or expenses over income resulting in insufficient
funds.

Self-Assessment Questions – 1

a. Briefly explain the rewards of Personal Financial Planning.

…………..……………………………………………………………………..
…………..……………………………………………………………………..
…………..……………………………………………………………………..

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 Personal Financial Planning
b. What is net worth?
…………..……………………………………………………………………..
…………..……………………………………………………………………..
…………..……………………………………………………………………..

4.6 STEPS IN PERSONAL FINANCIAL PLANNING PROCESS

Having discussed the personalized financial statements, it is now necessary to follow
the steps in personal financial planning process. Personal financial planning is an
ongoing process. The process can be better depicted in the following manner:
Step I : Defining financial goals.
Step II : Developing financial plans and strategies to achieve goals.

Step III : Implementation of financial plans and strategies.

Step IV : Evaluating the progress and results of plans.

Step V : Redefining goals.

STEP I: DEFINING FINANCIAL GOALS

Like professional and personal goals, an individual also needs to identify his/her
financial goals. A person has to list down his/her priorities with respect to financial
requirements. Financial goals include long-term goals, short-term, and intermediate goals.
For proper utilization of financial resources and forecast of the future financial position
of an individual, defining financial goals in the light of present financial position is
important.
Financial goals are determined by financial desires. A person may have a desire to be
financially secure after the age of 60; a housewife may have a desire to secure her 10-
year-old daughter’s future. A software engineer would like to start his/her own company
after five years. These are all desires, originating from human needs and wants.
Financial goals are defined in different ways as under:

• Goals should be specific in terms of what amount a person is ready to part with
to start an investment program, the time period and the purpose for such an
objective.

• Goals should not be set too high or too low. They should be realistic in nature.

• Goals should involve the whole family to avoid future conflicts and improve the
chance of achieving them.

• Goals are not static. They change as the person’s life situation changes.

• Goals should have target dates, so that one can achieve or complete financial
activities within those dates.

Types of Financial Goals

The next most important element in financial planning is to understand the various types
of financial goals and how to use them in practice.

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Long-term Goals: Long-term financial goals represent the goals that will be able to
achieve over a long period of time, say three to six years. They may extend beyond a
period of six years. They are the most important goals. The time period should not be so
long that the goals become unrealistic to achieve. It is possible that the goals change
over a period of time and thus need to be revised on a regular basis.
The following table describes an individual’s long-term goals:

Goal Priority Target Date Cost Estimate

Taking a home loan High 2007 Rs.5,00,000
Making investment in real estate Medium 2009 Varies
Taking a vacation in Venice Medium 2008 Rs.50,000
Source: Academic Wing Research Team.
Table 1: Long-term Goals
Short-term Goals: Short-term goals are set for a period of one year or less. They are
immediate goals in the form of expenses in the current period, such as education
expenses for a child newly admitted in nursery school. To attain long-term goals, it is
essential to attain current short-term goals. The short-term goals also provide for the
surplus required for savings, which are crucial for the long-term goals. The following
table provides a description of a person’s short-term goals:

Goal Priority Target Date Estimate

Buying school uniform for children High Dec., 2009 Rs.1,500
Buying a new cooking gas range High Nov., 2009 Rs.2,000
Buying a new seat cover for the car Medium Jan., 2010 Rs.1,500
Buying a new crockery set Low Jan., 2010 Rs.1,500
Source: Academic Wing Research Team.
Table 2: Short-term Goals
Intermediate Goals: Intermediate goals fill up the gap between the short-term and
long-term goals. They are generally spread over a period of two to five years. The
following table describes an individual’s intermediate goals:
Goal Priority Target Date Cost Estimate
Repaying education loans High Dec., 2009 Rs.1,00,000
Taking a week long vacation Medium June, 2010 Rs.8,000
Source: Academic Wing Research Team.
Table 3: Intermediate Goals
Prioritize these goals on the basis of the urgency in fulfilling them. By doing so, an
individual will be able to identify the goals that he/she has to concentrate on
immediately and which of them can be deferred for some time.
STEP II: DEVELOPING FINANCIAL PLANS AND STRATEGIES TO
ACHIEVE GOALS
Having identified and defined the financial goals of an individual as per his/her current
financial status, the next step in personal financial planning process includes developing
the financial plans and strategies to achieve those goals. These financial plans include
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Asset Acquisition Planning, Liability and Insurance Planning, Savings and Investment
Planning, Employees Benefit Planning, Tax Planning, Retirement and Estate Planning,
and Contingency Planning, which are discussed below:
Asset Acquisition Planning
Asset planning is the first form of financial planning. A person in his/her lifetime
decides to acquire certain assets, which may vary from acquiring a car to a house or
investments in the form of buying stocks, bonds, etc. The assets acquired may range
from liquid assets to real estate property to personal assets. Cash held and balances in
savings accounts are examples of liquid assets, while assets such as automobiles,
household furniture, appliances, and jewelry are examples of personal assets. Land and
structures fixed to it, like houses, etc., constitute real assets.
Liability and Insurance Planning
Another form of personal financial planning is liability and insurance planning.
Liability is something we owe – debt. Liability is created by borrowing money. Debt
may be in the form of education loans or automobile loans or credit card payments. A
person may have to manage his/her debt in the same way as managing his/her assets.
Apart from managing one’s debt, one also has to provide insurance coverage. Insurance
reduces financial risk. It protects both income and assets. Thus, it is essential to have an
adequate insurance cushion for a smooth living. Insurance planning is discussed in
detail in the later part of this chapter.
Savings and Investment Planning
As a person’s income increases, the importance of savings and investment will also
increase. Person, who has just entered the earning stage, starts saving for meeting
unexpected situations. At a later stage, it is essential to start investing in investment
instruments such as bonds, saving schemes, and personal property to accumulate
wealth. The final wealth accumulated depends substantially on the return earned from
the investments made initially.
Employee Benefit Planning
Generally, large firms provide employee benefits in the form of life and health
insurance, disability insurance, reimbursement plans for education or it may be in the
form of pension or retirement plans. Apart from these traditional plans, firms
now-a-days also give benefits in the form of stock options, health and child care
expenses, vacation leave, sick leave, etc. An individual should try to integrate his/her
own personal plans with the benefit plans provided by the organization to achieve better
personal financial planning. Plans such as deferred retirement plans offer tax benefits.
Similarly, there are certain retirement plans, which allow one to borrow loans. Insurance
policies provided by the organization should also be duly supplemented by personal
policies.
Employee benefits like group insurance and stock options offered by the employer
should not be depended on too much. In today’s uncertain employment conditions, one
should be prepared for eventualities like a loss of job – either through layoffs or
dismissal – and having to run the family without a job for sometime.
Tax Planning
Tax planning assumes importance for an individual, once he or she falls in the tax
bracket. Taxation becomes a headache, as it is difficult to understand the intricacies of
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changing taxation laws and benefits. There are various exemptions and deductions
available under different sections of the Income Tax Act for different purposes and
based on different criteria. Not considering the tax benefits available when planning the
investments, can result in loss of a substantial portion of the return to taxes. Hence, tax
planning and personal financial planning go hand in hand. A person should understand
the implications of the taxation laws and make suitable arrangements for proper
investment plans to minimize the costs of taxation.
The following figure gives a brief summary of how financial goals of an individual
change over a period of time:

Source: Lawrence J. Gitman, and Michael, D. Joehnk. UK: Personal Financial Planning.
Ninth Edition. UK: Thomson Learning Publishers, 2001.
Figure: Personal Financial Planning Life Cycle
Retirement and Estate Planning
One of the main long-term goals of personal financial planning is to make proper
retirement plans. Apart from maintaining one’s standard of living and meeting all
necessities in life, one has to take care of his/her retirement days. Old age brings with
itself increased medical expenses and other requirements. Thus, investment in a
retirement plan is of utmost importance for a person, who is approaching middle age.
Retirement planning is always advisable to start well in advance, rather than after one is
into the late 40s or the 50s. This is because, investments made early in life multiply with
accrual in interest and the final sum available will be much more. Apart from retirement
plans, estate planning should also be done carefully for passing on the wealth to the
legal heirs. Estate planning is a complicated topic that calls for an understanding of
wills, trusts, and their legal aspects. Retirement and estate planning are discussed in
detail in the later part of this chapter.
Contingency Planning
The different components of personal financial planning are asset planning, insurance
planning, investment planning, tax planning, estate, and retirement planning. Above all,
there is one more planning, in which proper and immediate steps are to be taken by the
management or employees when an emergency occurs. It is called contingency
planning. It has three main components – protection, detection and recoverability. This
planning plays an important role in the event of flood, fire, accident, illness or any other
unexpected events. It is a plan devised when something unexpected is likely to occur or

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occurs at any time and may put strain on one’s life and work. Personal financial
planning includes planning for meeting those needs or situations that are unforeseen.
Contingency planning is not just about disasters, but about preparing of events, such as
loss of data, supplier or other disruptive unknown events. It is therefore important for
every person to prepare to make contingency planning as a part of every day plan.
Often, these plans are devised by governments/businesses/organizations. They are also
called ‘back-up plans’/‘worst case scenario plans’ or ‘Plan B’. It consists of if-then
statements, which define solutions and deploy when the problems occur.
They are required to help governments/business/individuals to recover from serious
incidents in minimum time with minimum costs and disruption. Contingency plan
requires an investment of time and money. It is not an expensive planning. During the
times of crisis, contingency plans are often developed to explore and prepare for any
eventuality. During the cold war, many governments made contingency plans to
protect themselves and their citizens from nuclear attack.
Benefits of Contingency Planning: Benefits of contingency planning are listed
below:

• It enhances the efficiency and aptness of responding to emergencies;

• It helps in boosting the coordination mechanisms;
• It helps teamwork;
• It reduces uncertainty and delays with respect to the unexpected events; and
• It increases the power of thinking in terms of the most possible outcomes.
On one side, contingency planning has the benefits mentioned above, and on the other
side is the most important disadvantage that contingency planning is a difficult and
time-consuming process.
Obstacles in Contingency Planning: Apart from the above mentioned benefits and
drawbacks of contingency planning, below listed are certain obstacles:

• As the possibility of occurrence of crisis is low, people often feel less urgency to
create a contingency plan;
• Political sensitivity plays an important role in obstructing the preparation of
contingency plan;
• Lack of required financial resources; and
• Number of competing priorities.
To be effective, contingency plan needs to be an ongoing process by reviewing and
updating regularly and making sure that all those involved in this plan are familiarized
about their roles and responsibilities.
Contingency Plan Process: Contingency planning process contains six steps, which are
discussed briefly below:

• Identifying the contingencies and targets that need to be achieved;

• Prioritizing the contingencies and developing strategies;
• Estimating the costs and benefits associated with the strategies;

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• Implementing the strategies as needed;
• Evaluating the plan to make sure that it is effective; and
• Reviewing the plan regularly.
Contingency planning should not be ignored as it helps in gaining significant insight
into the risks an organization faces. Thus, contingency planning will have to be always
flexible and responsive as the future is unpredictable and conditions and situations that
arise are difficult to forecast. It reduces cost, improves efficiency, and expands
solutions.
STEP III: IMPLEMENTATION OF FINANCIAL PLANS AND STRATEGIES
After preparing and analyzing financial plans and environment, the next important step
is implementation of financial plans and strategies. This is the real and practical aspect
in the personal financial planning process. Here, it is necessary to understand the
volume of risk involved in the financial plans. A home loan may invite increased bank
interest. To overcome this problem, an alternative course of action has to be developed
at the preparation of financial plans. The plans also must be characterized by flexibility.
Based on the changes in the environment and time requirements, the plans have to be
modified and implemented to reach the financial goals of individuals.
STEP IV: EVALUATING THE PROGRESS AND RESULTS OF PLANS
To review and evaluate the financial progress of an individual, the life period must be
subdivided into specific intervals. Generally, programs should be evaluated yearly to
assess the progress and results. At the end of each year, review the financial plan to see
whether the individual has stuck to it or not. While evaluating the results of financial
plans, find any deviations between the expected results and actual results, and also the
reasons for deviations. Finally, draw a course of action to reduce deviations.
STEP V: REDEFINING GOALS
Static is not a symbol for development. So, goals setup should not be static. Update the
financial goals especially the medium and long-term goals in line with the significant
changes in the financial environment. Innovations and technological changes bring a
change in the lifestyle of an individual. The standard of living and income changes also
bring the necessary changes to redefine the financial goals of the individual. The
financial goals must be changed from time to time to suit the present environment. At
the time of redefining the financial goals, the financial position of the individual and
his/her present income must be clearly analyzed as defined in the first step. Hence, the
process of personal financial planning is defined as a cyclical process which is never
ending.

4.7 NEED FOR A FINANCIAL PLANNER

With increasing variety and complexity of financial products, it becomes difficult for
the individuals to take time in deciding the best investment they can choose or even
expertise to take up personal financial planning. Depending on the various issues
involved in personal financial planning, it is advisable to appoint a financial
planner/advisor, who assists the individual in planning his/her finance. Financial
planner is an individual or a firm, which helps the clients in establishing the long-term
and short-term financial goals and developing and implementing financial plans in
achieving those goals. He is also called financial advisor or wealth manager. His main
service is to prepare financial plan evaluating the client’s personal financial situation.
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Financial planners are of two types – Commission-based planners, and fee-only
planners. Commission-based planners are those who earn commission on the financial
products they sell. Fee-only planners are those who charge only fees based on the plan.
There are financial planners, who take hybrid approach. They collect both fee and
commission on the products they sell. Having discussed the need, importance and types
of financial planners, let us now look into the requisites of a good financial planner.
REQUISITES OF A GOOD FINANCIAL PLANNER
The financial planner should be a professional and an expert, who has studied and
earned a designation of Certified Financial Planner (CFP), or Chartered Financial
Consultant (ChFC).
Every client should research on the financial planner if any, spending law suits,
complaints by regulator, bankruptcies, and convictions. The cost of personal financial
planning services depends on the type of the financial planner, complexity of the
client’s financial situation and the services required by the client.
• The Financial planner should be honest and reputable;
• He should have knowledge in broad areas of tax planning/investments and estate law;
• He should have the ability to understand the various stages of client’s life cycle
and wealth cycle;
• He should have understanding of appropriate asset allocation strategies;
• He should have capacity for independent judgment and balanced thinking to
judge matters in a right way considering swinging market sentiments;
• He should adopt an organized way of working by pooling information on the
client’s needs, his specific investment strategies;
• He should maintain regular contact with clients, especially when the portfolio
is declining and help them overcome setbacks and assure growth in the future;
• His personal financial planning should be at the macro level rather than the
individual level for the overall well-being of the client;
• The financial planner should link his remuneration to the overall achievement of
the client’s goals, ensuring consistency.
OTHER PLAYERS OF PERSONAL FINANCIAL PLANNING
The other players of personal financial planning are mentioned below:
Life Insurance Companies: Life Insurance Companies are investment managers. They
collect premium to meet the claims and make profits. They maximize the people’s
savings by making insurance-linked savings adequately. They meet the various life
insurance needs of the client.
Banks: Banks are the traditional source of personal financial planning. Banks focus on
fund management and personal financial planning process, offering their own products
and other fund managers’ products.
Stock Brokers: Stock brokers are regarded as regulated professional brokers, who buy
and sell shares or other securities on behalf of the investor. They cater to the wealthy by
offering limited services revolving around securities listed on the stock exchange. Some
stock brokers broaden their activities into personal financial planning, retirement
planning, funds management and financing and advising on unlisted securities. They are
governed by SEBI and associated with stock exchange rules and regulations.

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Trustee Companies: Trustee Companies provide a wide range of wealth management
services, which include estate planning, administering deceased estates, etc. It refers to
the ability of the institution’s trust department to act as a trustee – someone who
administers financial assets on behalf of another. They are supervised by Attorney
General or Equivalent. They are required to maintain sufficient capital and insurance.
They are required to fulfill their responsibilities in ethical, efficient and professional
manner.
Fund or Asset Managers: They develop and offer the products that are sold by agents
or distribution houses. As the number of such planners increases the role of financial
planners in such distribution arrangements will also increase. Asset management
companies are targeting wholesale investors and other fund managers are targeting retail
investors.
Accountants: Accountants are the people who have expertise skills in people’s
finances. They disclose or provide assurance about financial information that helps the
investors in making allocation decisions.

4.8 CONSTRAINTS OF PERSONAL FINANCIAL PLANNING

Though personal financial planning is a process to effectively manage the finances and
investments of the clients in order to achieve their financial goals, yet it is not away
from constraints. Below are the three important constraints of personal financial
planning:
Inadequate Resources: Though it is advisable to start personal financial planning for
an individual at an early stage, but inadequate resources constrain the individual in
doing so.
Inappropriate Products: Another important constraint of personal financial planning
is dearth of appropriate products. No appropriate product that suits the investment
parameters of the investor adds to the constraints of personal financial planning process.
Time Horizon and Risk Tolerance: Knowing the time horizon is very important,
when it comes to planning the finance of an individual. Generally, time horizon
represents the time over which the investment is made or held. Time horizon depends
on the investor’s objectives. Time horizon is closely bound with risk tolerance level
of the investor. An investor’s risk tolerance depends on various factors such as age,
income, financial goals etc.
Let’s have a look at the important components of personal financial planning.

4.9 TAX PLANNING

Tax planning is defined as “Considering the tax implications of an individual
throughout the year with the goal of minimizing the tax liability”. Tax planning is an
essential part of personal financial planning. Tax liability can be minimized by taking
care of all tax exemptions, rebates, deductions, and allowances. While understanding
what tax planning is, it is also necessary to understand what tax planning is not. It is not
tax evasion, not difficult and not just putting money in 80C investments. Tax
consequences have to be considered while making any financial decisions:
• There are two types of taxes – Direct, and Indirect taxes.
• Direct taxes such as income tax, wealth tax are collected directly by the
government. They form 30% of government’s revenue.
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• Indirect taxes comprise excise duty/sales tax/customs duty, and they form 70%
of the government’s revenue.
SIGNIFICANCE OF TAX PLANNING
Tax planning is basically an ongoing and year-round activity.
• It involves use of investment vehicles, retirement programs/estate distribution to
reduce/shift/defer taxes;
• It reduces taxes by using the techniques that create tax deductions; shifts taxes by
using gifts or trusts to shift some of the income to other family members who are
in lower tax brackets;
• Deferring taxes can be done by reducing or eliminating taxes today by pushing
them to the future;
• By way of tax planning, one can take advantage of all deductions and tax
provisions to minimize tax liability, and
• Tax planning is closely related to many personal financial planning activities –
investment/retirement and estate planning.
BASIC ASSUMPTIONS OF TAX PLANNING
There are two basic assumptions of dignified and honorable tax planning:
i. All relevant facts are clearly presented to the tax authorities, and no material
information is deliberately concealed with intent to defraud.
ii. There are no bogus transactions or make-believe devices resorted to in order to
circumvent any legal provisions.
METHODS OF REDUCING TAX
The two methods of reducing tax are:
Tax Evasion: Practice by a person, organization or corporation avoiding paying taxes
by illegal means.
Tax Avoidance: Using legal methods to modify an individual’s financial position, so as
to reduce the amount of tax owed.
A Simple Example of Tax Planning
Harish Mehta has an income of Rs.1,86,000. The details of his income are as follows-
Mehta gets a salary of Rs.12,000 p.m., long-term capital gains on account of shares of
Rs.20,000, and interest from bank deposits of Rs.22,000.
Thus, Mehta’s gross income for the assessment year 2008-09 will be as under:

Particulars Rs.
Salary (Rs.12,000 x 12) 1,44,000
Interest on bank deposits 22,000
Long-term capital gains on shares 20,000
1,86,000
To reduce his tax liability, he contributes Rs.55,000 towards PF, LIC policies, National
Savings Certificates, etc., eligible for deduction under Section 80C. His taxable income
(assessment year 2008-09) is given in the table below. As shown in the table he needs to
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pay a tax of only Rs.103, on a gross income of Rs.1,86,000. The other side of the
picture is that in order to save income tax, he has to commit a cash outflow of Rs.55,000
for Section 80C schemes. Having done so, and paid a tax of Rs.103, Harish is left with
only Rs.1,30,897 in cash, i.e., Rs.1,86,000 minus Rs.55,103. Without such tax planning,
Harish would have had to pay a much higher tax.

Particulars Rs.

a. Salary 1,44,000

b. Interest on bank deposits 22,000

Gross total income 1,66,000

Less: Deduction u/s 80C 55,000

Net income 1,11,000

Tax on Rs.1,11,000 100

Add: education cess @ 3% on Rs.100 3

Total tax (A) 103

c. Long-term capital gains on securities for the assessment year 2008-09 are exempt –

Total Tax (A) + (B) 103

Surcharge Nil

Total Tax Payable 103

Table: Taxable Income of Harish Mehta for the Assessment Year 2008-09
Typically, while tax planning will indeed save you from tax, it will also reduce the
funds immediately available to you for expenditure. This is so because you have to lock
up your funds in various stipulated tax savings investment schemes. Thus, due to tax
planning, the cash immediately available to Harish is reduced to only Rs.1,30,897, out
of his income of Rs.1,86,000.
On the other hand, if he had not done tax planning, he would have to pay a tax of
Rs.7,416 and be left with available cash of Rs.1,78,584. The following table gives two
options:

S. No. Particulars (1) (2) (3) (4) (5)

Gross Total Income Funds Locked Funds Available
Income Taxes after Tax up in Savings for Immediate
Payable Schemes Use (3) – (4)
Rs. Rs. Rs. Rs. Rs.
1. With Tax Planning 1,86,000 103 1,85,897 55,000 1,30,897
2. No Tax Planning 1,86,000 7,416 1,78,584 – 1,78,584

Table: Tax Planning and No Tax Planning

• With tax planning, Harish has funds (after tax) of Rs.1,85,897
i.e., Rs.1,30,897 immediately and Rs.55,000 locked up for several years.
• Without any tax planning, his total funds (after tax) would be Rs.1,78,584 – all
of it available immediately.
Which is the preferred alternative? Harish is the best person to answer that.
It depends on his needs, what stage of his life he is in, and his investment options. For
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instance, after the age of fifty or fifty-five, he would probably have little need to save
for the family and so it may be advisable to pay the tax and not lock up his funds in the
long-term investments simply to save taxes. If his children are on their way to being
well settled, the only investment he needs to consider may be those offering him
relatively assured income in his retired life, rather than those which are predominantly
geared to saving him taxes.
How to Maintain Zero-tax Status through Fixed Income Investments?
Zero-tax status can be achieved by selecting a careful mix of fixed income investments.
Earlier Finance Act contained a Section 80L, under which, interest income from some
specified investments was eligible for deduction to an amount of Rs.12,000 general
deduction and Rs.3,000 additional benefit in respect of interest from government
securities. It may be noted that, with the deletion of this section, the interest on deposits
at banks is no more lucrative since the interest on bank deposits becomes taxable with
no tax relief. 8.5% tax-free SLR power bonds, interest from savings certificates issued
by the central government, interest on securities or deposits of the central government,
provident fund, post office savings bank account etc., are few fixed income earning
investments. A broad outline of a plan which can be refined and improved to suit the
specific needs in consultation with tax consultant is given below:
a. You will only invest in the following fixed income securities:
• 6% tax-free SLR power bonds.
• Public Provident Fund (8% p.a.).
• 7% Capital investment bonds.
• Post office savings bank account.
b. A portion of the income will also be reinvested to save on taxes.
The following incomes are exempt from income tax:
• Basic exemption of income (assessment year 2008-09) – Rs.1,10,000.
• Under Section 10: Income from certain sources like PPF, tax-free public
sector bonds – No Limit.
Hence, full advantage will be taken of all these benefits in planning the investments. Let
us now look at the case of investment of Rs.17,00,000.
Case - Total Investment of Rs.17 lakh
Particulars Investment (Rs.) Income (Rs.)
Non-convertible debentures (8% p.a.) 15,00,000 1,20,000
Tax free bonds (6% p.a.) 2,00,000 12,000
Total 17,00,000 1,32,000
Of the total income of Rs.1,32,000, the interest of Rs.12,000 from tax free bond is
exempt Hence, the taxable income is Rs.1,20,000; the tax on which works out to
Rs.1,030.
Thus,
Rs.
Taxable Income 1,20,000
Less: Tax 1,030
Income after tax 1,30,970
Post-tax return on investment of Rs.17 lakh 7.7%
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In case you do not require the interest income immediately, you can achieve a zero-tax
status by investing Rs.10,000 in Public Provident Fund (PPF). You will then be eligible
for deduction under 80C on deposits made in PPF, and there will be no tax liability. The
interest on PPF of Rs.800 is tax-free under Section 10.
Thus,
Particulars Rs.
Total income ( 1,32,000 – 12000) 1,20,000
Less: Invested in PPF 10,000
Taxable Income 1,10,000
Tax Nil
Post-tax income 1,32,000
Post-tax return on investment of Rs.17 lakh 7.76% (this year)
7.81% (next year considering tax-free
PPF interest of Rs.800)

TAX PLANNING THROUGH LONG-TERM CAPITAL GAINS FROM EQUITY

SHARES
The equity shares of well-managed companies afford excellent opportunities for
tax planning through long-term capital gains. Shares held for more than
12 months are treated as long-term capital assets. Long-term capital gains arising out
of securities sold on the stock exchange are exempt u/s 10(38).
As far as possible, you should sell your shares only after holding them for
12 months or more. Otherwise, your gains will be taxed as the short-term capital gains.
With the insertion of a new Section 111A, short-term capital gains arising from the sale
of securities are taxable at the rate of 10%. However, it should be noted that in view of
the above changes made, a tax at the rate of 0.125% is to be levied on the value of all
transactions of purchase of securities that take place in recognized stock exchanges in
India.
Illustration 1
Mr. Kapoor or purchased 100 equity shares of ABC Ltd. On 18th July, 2006 at Rs.600
and sold them in May, 2007 at Rs.3,000 per share.

Particulars Rs.

May, 2007 Sale value 3,00,000

July, 2006 Cost of acquisition 60,000

Short-term capital gains 2,40,000

Capital gains tax @10% 24,000

Education cess @3% (for the assessment year 2008-09) 720

Total tax payable 24,720

If the above shares had been sold in the month of August 2007 or thereafter, he would
not have paid any capital gains tax as the long-term capital gains are tax-exempt.

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Self-Assessment Questions – 2
a. State the significance of Tax Planning.
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
b. What is contingency planning?
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
CAPITAL GAINS TAX
Any profit or gain arising from the sale or transfer of a capital asset is chargeable to
tax under the head ‘capital gains’. It is deemed to be the income of the previous year
in which the transfer of the capital asset took place. Capital gains arising from the
transfer of immovable property are chargeable to tax in the previous year, in which
the effective transfer of title is conveyed and registered. There are two types of capital
gains – short-term and long-term. Short-term capital gain refers to the capital gain,
which has been obtained from the full value of consideration from the transfer of
short-term capital assets after reducing permitted deductions. Long-term capital gain
refers to the capital gain, which is obtained from the full value of consideration from
the transfer of long-term capital assets after permitted deductions.
Exemptions from Capital Gains
Certain exemptions are provided from taxation of capital gains. These exemptions are of
two types:
a. Exemption of capital gain under various sub-clauses of Section 10 of the Income
Tax act. It contains exempted capital gain in the hands of the various categories
of persons.
b. Exemption of capital gain under Sections 54, 54B, 54D, 54EC, 54ED, 54F and 54G:
i. Profit on the sale of property used for residence (Section 54);
ii. Capital gain on the transfer of land used for agricultural purposes not to
be charged in certain cases (Section 54B);
iii. Capital gain on compulsory acquisition of lands and buildings not to be
charged in certain cases (Section 54D);
iv. Capital gain not to be charged on investment in certain bonds (Section
54EC);
v. Capital gain on transfer of certain listed securities or unit, not to be
charged in certain cases (Section 54ED);
vi. Capital gain on the transfer of certain capital assets not to be charged in
case of investment in residential house (Section 54F); and
vii. Exemption of capital gains on the transfer of assets in the cases of shifting
of industrial undertaking from urban areas (Section 54G).
CHARITY AND TAX
Donations for charity come under Section 80G of the Income Tax Act, 1961. This
section has classified charity funds under various heads, each of which gives the donor a
different kind of tax rebate. For all charity donations, the deductions are made directly
from the gross total income of the assessee.
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The deduction under Section 80G is available to any taxpayer (may be individual,
company, firm or any other person) and calculated under the following three steps:
Step 1: Gross qualifying amount.
Step 2: Net qualifying amount.
Step 3: Amount deductible.
Step 1: Gross Qualifying Amount: Gross qualifying amount is the aggregate of the
donations made to any of the institutions/fund. Donations made in kind shall not be
included.
Step 2: Net Qualifying Amount: Net qualifying amount is limited to 10 percent of gross
total income of the assessee as reduced by the following:
a. Amount deductible under Sections 80CCC to 80U (but not Section 80G);
b. Such incomes on which income tax is not payable;
c. Long-term capital gains; and
d. Incomes referred to in Sections, 115A, 115AB, 115AC, or 115AD.
Step 3: Maximum Deductible Amount: Where the aggregate of the sums mentioned in
(u), (v), (w), (x), (y), or (z) supra exceeds 10 percent of the adjusted gross total income,
then the amount in excess of 10 percent of the adjusted gross total income will be
ignored while computing the aggregate of the sums in respect of which deduction is to
be allowed.
The following amendments have been made in Section 80G with effect from the
assessment year 2001-02:
a. In the case of an assessee, being a company, deduction will be available if a
donation is given to the Indian Olympic Association or to an institution notified
under Section 10 (23) for –
• The development of infrastructure for sports and games in India; or
• The sponsorship of sports and games in India.
b. The aforesaid amount of donation along with other donations referred to in
subclauses and clause (b) of Section 80G(2) cannot exceed 10 percent of the
adjusted gross total income.
c. 100 percent of the donation referred to in (1) supra [subject to the maximum of
(2) supra] will be deductible under Section 80G.
With effect from the assessment year 2003-04, the following kinds of donations have
been included for Section 80G:
• Donations made to an authority constituted in India by or under any law enacted
either for the purpose of dealing with and satisfying the need for housing
accommodation or for the purpose of planning, development or improvement of
cities, towns and villages, or for both.
• Donation by a corporate-assessee to an association or institution established in
India, as the central government may, having regard to the prescribed guidelines,
by notification in the Official Gazette, specify in this behalf.
For the purpose of Section 80G, an association or institution having its object the
control, supervision, regulation or encouragement in India of such games or sports as
the central government may, by notification in the Official Gazette, specify in this
behalf, shall be deemed to be an institution established in India for a charitable purpose.

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4.10 INSURANCE PLANNING
“Insurance is not for the person who passes away, it is for those who survive,” goes a
popular saying that explains the importance of Insurance Planning1.
No one likes to lose anything they acquire and plan. But some unforeseen events cause
loss to the person or the family members concerned. Unpredictable events such as
accidents, serious illness, death of a family member result in substantial financial
burden to the family. In addition, even disasters such as flood, earthquake and fire cause
loss to personal property. This is where insurance comes into picture. Insurance is an
important part of personal financial planning process. It not only protects a person from
losing assets but also the dependents from financial loss. It is concerned with providing
adequate coverage against insurable risks. It is in short acts as a guard that protects a
person from the contingencies that surround. Thus Insurance planning means figuring
out adequate cover against "insurable risks" and getting the maximum out of the
premium a person pays.
Insurance planning thus involves predicting or anticipating losses, which occur to assets
by weaving insurance into one’s financial plans. Insurance is of two types – Life
insurance and Non-life insurance. Life insurance is defined as a contract (policy) in
which an individual or entity receives financial protection or reimbursement against
losses from an insurance company. The company pools the client’s risks to make
payments more affordable for the insured. Non-life Insurance/general insurance
comprises insurance of property against fire, burglary etc., personal insurance such as
accident and health insurance, and liability insurance, which covers legal liabilities.
There are also other covers such as errors and omissions insurance for professionals,
credit insurance etc.
Concept of Risk
Risk is the outcome of uncertainty. The concept of insurance revolves around
uncertainty. The individual is exposed to various kinds of risk in his various stages of
life cycle, which has a direct impact on the financial condition of the family. Risk
avoidance and loss prevention and control are the steps to avoid a loss before the risk
occurs. Risk assumption and insurance are economical ways of covering loss. Risk
avoidance, loss prevention, risk assumption, and insurance are discussed briefly below:
Risk Avoidance: Risk Avoidance is the simplest way of dealing with risk. Avoiding
risk is by avoiding the act that creates it. Though it is one of the effective ways of
handling the risk, it is not free from its costs. One has to take care that the estimated
cost of avoidance should be less than the estimated cost of handling it in another way.
Loss Prevention and Control: Loss prevention is defined as ‘an activity that reduces
the probability of occurring a loss’. Loss control is defined as ‘an activity that reduces
the severity of loss’. They are the important parts of managing the risk. Insurance
provides a reasonable means of handling risk only when the people use loss prevention
and control measures.
Risk Assumption: Risk Assumption is the choice to bear or accept the risk of loss. It is
an effective way to handle small exposures when insurance is too expensive and large
exposures that can not be prevented.

1 http://www.bajajcapital.com/financial-planning/insurance-planning/importance.php
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Insurance: Insurance is a policy or a contract where an individual or entity receives
protection against losses. It is a contract between the insurance company and the insured
under which the company agrees to pay for the losses occurred. The company accepts
the risks that occur to the insurer, as the former makes profit by collecting the premiums
from a large number of policyholders. Insurers combine the loss experiences of large
number of people, to estimate the risk of loss faced by the whole insured population.
Each insured person contributes a small amount known as insurance premium, which
will be reimbursed for any covered losses. In any type of insurance, the insurer has to
decide to whom it can provide insurance and at what rates. This process is called
underwriting. It is an art rather than a science. Underwriting standards vary from one
insurance company to another. Insurers try to improve their underwriting capabilities to
set the rates that provide adequate protection to the policyholders.
BENEFITS OF LIFE INSURANCE
In addition to providing financial security to dependents, life insurance can be beneficial
in many other ways. The benefits that are offered by some types of life insurance
policies are – protection from creditors, vehicle for savings and tax benefits. These
benefits are briefly discussed below:
Protection from Creditors: When the insured dies, his/her assets and liabilities are
transferred or given to the heir after all legitimate claims of the estate are deducted. A
life insurance policy can also be structured in a way that death benefits are paid to the
beneficiary under the policy and not to the estate. Even if the liabilities are more than
the assets, the death proceeds will not be used to pay-off the debts due to the creditors.
Vehicle for Savings: Life insurance policy can also be used as a saving and investment
tool. Variable life policies, which are discussed later in the chapter, are more of a saving
and investment tool than a life insurance policy. But all insurance policies should not be
construed as investment vehicles. In case of many policies, it may be found that the
returns are less as compared to other investment tools. Thus, the main reason why
insurance policies are sold is that it gives financial protection to the survivors in the
event of the death of the insured. The savings feature of a life insurance policy is just a
byproduct in an insurance policy.
Tax Benefits: Life insurance proceeds are not subjected to income tax. The value of
any premiums agreed to be returned or the value of any benefit by way of bonus or
otherwise, over and above the sum actually assured (which is to be or may be received
under the policy by any person), will not be taken into account for the purpose of
calculating the actual capital sum assured. The amount received on the maturity of the
policy by the policyholder or the beneficiary is exempt from tax.
NEED FOR LIFE INSURANCE
Personal life situation and other financial resources play a key role in determining the
need for life insurance. The major purpose of life insurance is to provide financial
security to the dependants of the insured in the event of his/her death. The other benefits
that life insurance provides are secondary. Life insurance needs change through out the
life. Some assume that life insurance is an easy and good way to save money for future
needs but there are other high income savings that give high and better returns. It is also
wrongly assumed that every person needs life insurance. A single individual without
any responsibilities doesn’t need any life insurance. A person feels the need of life
insurance either when he gets married or when children enter the picture. The life
insurance requirements change both in terms of the amount of insurance and the type of
policies based on their changing objectives and building assets.
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CALCULATING INSURANCE NEEDS
There are two commonly used techniques in estimating an individual’s life insurance
needs – multiple earnings approach, and needs approach.
Multiple Earnings Approach
The multiple earnings approach is a simple and popular approach. In this technique, to
calculate the amount of life insurance to be bought, the annual gross earnings of a
person are multiplied with an arbitrarily selected number. It can be in the form of
multiples such as 5, 10 or 15 times earnings. A person who is earning Rs.1.2 lakh per
annum, with a multiple of 3.5 will have a life insurance coverage of Rs.4.2 lakh. Most
of the life insurance agents have abandoned this approach. This method fails to take into
consideration the financial obligations of a person and his/her financial resources in
addition to his/her life insurance.
Needs Approach
The needs approach involves the following three steps:

• Estimating the total economic resources needed to meet the obligations, if he/she
is to die.
• Determining financial resources that may be left over after death; and
• Deducting the resources from the amount needed to find out the additional life
insurance cover needed.
While assessing the economic needs of a family, various criteria should be taken into
consideration such as premature death, divorce, etc. In case of single parents, with no
additional resources, require large amount of life insurance for dependents. For two
income families, which depend on the income of both the spouses adequate insurance is
required. In case of families having children from prior marriages, a greater coverage is
required for the dependent children. The need approach is calculated in three steps, that
are discussed in detail below:
Assessing Economic Needs
Life insurance plays an important role in providing financial security to the dependents
on the event of the death of the income producer. Life insurance can also provide money
for the following needs – family income, additional expenses, debt liquidation,
surviving spouse’s income, special financial needs and liquidity. These needs are
discussed briefly below:
Family Income: The principle need of the insured is to make sure that his/her family
lives comfortably with a good standard of living even after his/her death. It is first
necessary to estimate the amount required to cover all expenses – housing rent, utilities,
food, clothing, and medical expenses. Other expenses include taxes, insurance, traveling
and savings. An important point concerning family income is many families depend on
two incomes. Traditionally, insurance was provided against the death of father. But as
the importance of working women increased, insurance is even provided to mother as
there is a chance of death of a working mother. This in turn may have a devastating
effect on the family structure as well its budget.
Pay-off Debts: Most insured prefer to leave their family without any debt by trying to
pay off all the debts before they leave. Debts include credit card charges, installment
loans, home mortgages etc.

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Surviving Spouse’s Income: As children become financially independent, the
household expenses decrease. But the surviving spouse may need monthly support for
the rest of her life. Thus, an estimate has to be made with respect to her life expectancy
and the financial support needed by her.
Special Financial Needs: Certain special needs of the family need to be accounted for.
It can be either in the form of a child’s higher education, disabled dependent, etc.
Liquidity: There are people who have huge properties, but very low cash. Thus, a very
high percentage of their wealth is in the form of non-liquid assets. Life insurance
proceeds help in settling their mortgage payments and maintaining their assets.
Available Resources
After estimating the lifetime financial needs of the family, the next step of the insured
includes listing all the available resources to meet those needs and estimating a rough
value of those resources:
• Proceeds from the employer-sponsored group life insurance policies;
• Death benefits payable from accumulated pension plans and profit sharing
programs;
• Income earned by the surviving spouse or children; and
• Real estate, jewelry, stocks, bonds, and other assets that can be liquidated.
Needless Resource
Needless Resource is the last step in the needs approach. After estimating the economic
needs and the available resources, it is necessary to assess whether the family requires
any life insurance or not. It is necessary to subtract the total available resources from the
total needs. If the result is positive i.e. if the total available resources are more than
needs then there is no need for life insurance. On the other hand, if the needs are more
than the available resources then they require additional life insurance.
TYPES OF LIFE INSURANCE
Life insurance needs are not static. The policy that is suitable today may not be suitable
after some years. It is therefore necessary to review and adjust the programs after every
5 years. There are three types of life insurance discussed in detail below:
Term Insurance
The first basic need of life insurance is to provide a lump sum amount to the family in
the event of the untimely death of the breadwinner. This is called ‘term insurance’ or
‘temporary insurance’. Here, the lump sum insurance amount is payable only if the
death of the insured occurs during a selected period. If the insured survives till the end
of the selected period, nothing becomes payable. There are two common types of term
insurance – Straight term policy and decreasing term policy.
Straight term policy is for a specific time period with coverage being unchanged
throughout the effective period. It is usually for a period of 1, 5, 10, 20 etc. The amount
of coverage does not change and annual premium may increase each year.
Decreasing term policy is one which maintains constant premium through all periods
but decreases the amount of protection.
With regard to term insurance, there are two most important provisions given to the
insured – renew ability, and convertibility provision.

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Renewability provision is one where insured can renew his/her policy for another term
of equal length. Every person choosing a term insurance has to ensure that it has a
guaranteed renewability provision.
Convertibility provision allows the insured to convert the term insurance policy into a
whole life policy. Conversion does not require any evidence of insurability. It assures
that conversion does not loose the insurance protection given to the insured and at the
same time it gives life long protections. It is suitable to those who require protection
throughout their life and at low cost.
Pure Endowment
Under pure endowment, there is accumulation of savings for a specific purpose. Here,
the lump sum insurance amount is payable only if the insured survives till the end of the
selected period. If the insured dies during the period of insurance, nothing becomes
payable.
These two concepts ‘term insurance’ and ‘pure endowment’ are the basic elements of
every life insurance product. By combining these two elements in different proportions,
different products of life insurance have been developed. The proportions of these two
elements in the mixture depend on the different needs of individuals, which can be met
by life insurance. These two elements are, therefore, called the ‘basic building blocks’
in all life insurance products.
A pure endowment or ‘savings only’ insurance is seldom issued by insurance
companies as a separate policy. But, term insurance has always been one of the major
products used by every life insurance company.
Endowment Assurance

Another popular plan of life insurance is the Endowment Assurance. The insurer agrees
here:
• To pay the insurance money in the event of the death of the insured during the
endowment term, and

• To pay the insurance money in the event of the insured surviving till the end of
the endowment term.
Endowment Assurance is a combination of two elements viz., Term Insurance and Pure
Endowment. Premium rates under Endowment Assurance will be usually high
compared to the whole life insurance plan for the simple reason that the insurance
company will have to pay a maturity benefit also at the end of the specified term. But, if
the period of insurance is very long, the rate is only slightly higher than the whole life
insurance.
Endowment Assurance is a very sound plan for all types of customers. It provides an
incentive to save. It is an instrument to build up a corpus to provide for the old age.
Even if the period of saving is cut short by the untimely death of the insured, the policy
provides a substantial lump sum money to the family. Endowment Assurance can also
be utilized to accumulate a fund for a specific purpose such as education of children,
marriage of daughters, start-in-life for sons or for a donation to a ‘philanthropic cause’.

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Whole Life Insurance
As compared to the term insurance (which provides risk coverage during
a specified period), whole life insurance covers the risk death of the insured, whenever
it may happen. It means that there is no fixed term under whole life insurance. It is
therefore aptly called ‘term insurance for the longest term’.
There are two variations in the whole life insurance product. The first one is Pure Whole
Life Insurance where under premiums are payable continuously throughout the life of
the insured till death. Risk coverage is for the entire duration of life and the insured
amount is paid on the happening of the death of the insured at any time. The second one
is the Limited Payment Whole Life Insurance where under premiums are payable for a
limited and shorter period at the option of the insured or till death whichever is earlier.
Risk coverage is however throughout the life of the insured.
Whole Life Insurance is a permanent type of plan of insurance. Premium rate is low but
higher than that of the Term Insurance Plan. Whole Life Policy provides permanent
protection at moderate cost. Unlike the term Insurance Plan, there is no need to make
special provisions here for renewal. The plan provides adequate and permanent
protection to the family. Its moderate cost enables the people with limited income also
to have sufficient cover. Even if the premium payment is stopped, there will be cash
value, subject to certain conditions. This cash value can be utilized to keep the policy in
force for a limited period or in the alternative, the policy can be converted into a
reduced paid-up policy.
Universal and Variable Life Insurance

Universal and Variable Life Insurance are the types of permanent life insurance and
both have the potential to accumulate cash value. How the cash value is invested by the
insurance company is one of the key differences between the two. In respect of
Universal Life Insurance, investment of cash value will be done by the company as part
of its own investment but with a guaranteed minimum return. On the other hand, in
respect of Variable Life Insurance, the policy owner will have a choice to choose the
way the cash value under his/her policy can be invested. One way to describe how both
the policies work is to think of them as a bucket, called the contract fund, into which net
premiums are paid and from which most charges and fees are taken.
When the premiums are paid, deductions are taken for such things as charges for
premium taxes and, in some cases, sales fees. The balance of the premium, or net
premium, is allocated to either the insurance company’s general account (Universal) or
separate account (Variable), and accumulate into the policy’s contract fund.
Each month, deductions are made from the contract fund to pay the cost of insurance,
which increases over time, and other charges for administration and any additional
benefits.
LIFE INSURANCE CONTRACT FEATURES
The following key features are found in most of the insurance contract features:
Beneficiary (Nominee) Clause
All life insurance policies have one or more beneficiaries. A beneficiary is the person
who receives the death benefits of the policy on the insured’s death. Under life
insurance, every policyholder needs to name a primary beneficiary and a contingent
beneficiary. Immediately after the death of the insured, the primary beneficiary receives
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the benefit. If the primary beneficiary does not exist at the time of the insured’s death,
the contingency beneficiary receives the benefit. If both the primary and contingent
beneficiaries do not survive the insured, the death proceeds will pass to the estate of the
insured and distributed according to the will of the insured. If no will exists, the
proceeds will be distributed according to the state law.
At the time of naming the beneficiary, care should be taken so that the identification is
very clear. There should be no confusion with respect to the identification of the
beneficiary. For instance, if a person has named his wife as the beneficiary for his
insurance proceeds, then there may be confusion, in case he divorces and remarries.
There may be confusion with respect to the person to whom the death proceeds are
entitled.
Survival Clause
In case both the insured and primary beneficiary lose their lives in a common disaster,
then the death benefits will go to the contingent beneficiary. But if, the primary
beneficiary survives the insured, even by few minutes, then the death proceeds will go
the primary beneficiary’s estate and not to the contingent beneficiaries. In other words,
the death benefit will be entitled to the beneficiaries of the primary beneficiary. Thus, a
‘survival clause’ is included in the policy to ensure that in case both the insured and
primary beneficiary die in a common disaster, and the primary beneficiary survives for a
short time, still the contingent beneficiaries would be entitled to receive the death
benefits.
Irrevocable Beneficiary
The beneficiaries named can be changed any time, until and unless, the person is not
named as an ‘irrevocable beneficiary’. Thus, if a person desires to change the
beneficiary, he can do so any time.
Settlement of the Insurance Proceeds
The insurance proceeds can be settled through various ways. It can either be settled
according to the wishes of the insured or the policyholder before his/her death or it may
be according to the beneficiary, at the time of the insured’s death or when the policy
matures. The different settlement options are:
Lumpsum: The most common settlement procedure is to pay the death proceeds in the
form of a lump sum amount, which can be used by the beneficiary to invest or use for
any other purpose.
Interest: Under this arrangement, the insurance company will only pay interest to the
beneficiary at some guaranteed specific rate. This method is useful when the beneficiary
does not require the principal amount.
Fixed Period: The face value of the policy along with the interest will be paid to the
beneficiary over a fixed time period.
Fixed Amount: In this arrangement, the policy proceeds are paid in the form of regular
payments, till the total proceeds are fully paid.
Life Income: Under this arrangement, the insurer agrees to pay a specific amount for
the rest of the life, based on the sex, age when the benefit starts, life expectancy, face
value of the policy, and the interest rate assumptions. This settlement option is suitable
for the beneficiaries, who do not want to outlive the benefit from the insurance
proceeds.
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Policy Loans
A policy loan is a loan made by the insurance company to the policyholder. The policy
loans are available on all life insurance policies and secured by the cash value of the
policy. These loans are repaid, but the balance amount and the interest at the time of
death of the insured are deducted from the proceeds of the policy. Policy loans should
be taken only in case of severe emergency as they reduce the death proceeds. If loans
are taken without any urgent need, it defeats the ultimate aim of providing financial
protection to the dependents. As these loans are less expensive than those offered by
other institutions, people tend to borrow against their life insurance policies.
Payment of Premiums
Life insurance contracts specify how the premiums ought to be paid. They are normally
paid in advance. The policyholders may pay annually or quarterly or semi-annually or
even monthly. If the premiums are paid more often than annually, the insurers may
charge a fee. The premium may be paid directly to the agent or mailed to the insurer. In
some cases, the insurer may deduct the premium amount directly from the bank account
of the insured. If a person dies after paying premium more than one month in advance,
the insurance company generally refunds the premium along with the death proceeds.
Grace Period
There is a grace period of one month, in case a person makes a late payment of the
premium. This grace period is given so that the insured does not lose his/her insurance
protection in case he/she makes a late payment of the premium. In case the insured dies
during this grace period, the face amount of the policy after deducting the unpaid
premiums will be paid.
Non-Forfeiture Options

In case of non-forfeiture option, even when the policy is terminated prior to maturity,
cash value of the policy along with some benefits is paid. There are generally two
options discussed hereunder:
• Paid-up Insurance: In this, the policyholder receives the policy proceeds as that
of a terminated policy with a lower face value;
• Extended Term Insurance: The accumulated cash value is used by the insured
to buy the term life policy for the same face value as that of the lapsed policy.
The policy period is based on the amount of term protection and a single
premium payment, which is equal to the total cash value.
Policy Reinstatement
Reinstatement revives the original contractual relationship between the insured and the
insurer. The policyholder needs to reinstate the policy within a specified period after the
lapse of the policy. Before going for a reinstatement, the policyholder should determine
whether buying a new policy would be more beneficial.
Change of Policy

In many life insurance contracts, there is a provision for the insured to switch over from
one policy to another. A policyholder may decide that he/she would like to have a paid-
up policy at the age of 65, then the current whole life policy. If the policyholder makes
such a change there may not be any penalty. In case the insured wants to change from
higher to lower premium policies, he/she will need to prove insurability, which will
reduce the possibility of adverse selection.
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OTHER POLICY FEATURES
A part from the afore-discussed policy features the other policy features include,
multiple indemnity clause, disability clause, guaranteed purchase clause, suicide clause,
exclusions, participation, living benefits, which are discussed below:
Multiple Indemnity Clauses
Multiple indemnity clauses provide double or triple of the face value if the insured dies
in an accident. This clause is considered irrational by many insurance companies as it
provides no protection in the event of death due to illness.
Disability Clause
Disability clause contains a waiver of premium benefit or is coupled with disability
income. Under the waiver of premium condition, the payment of premium on life
insurance contracts is waived if the insured becomes permanently disabled before the
age of 60. In case of disability income, the insured is granted not only the waiver of
premium but also monthly income. The disability riders are available to the insured at a
small cost and are added to the whole life policies, but are not available on term
policies.
Guaranteed Purchase Clause
A policyholder, who has a guaranteed purchase option, can purchase additional
coverage at stipulated intervals. There is no need for him/her to provide evidence of
insurability. This option is generally offered to a whole life policyholder under the age
of 40 years.
Suicide Clause
All life insurance contracts have a suicide clause, according to which the policy is void
if the insured commits suicide within the specified time period. The time period is
generally one year and if the insured takes his/her life after the lapse of this specified
time period, the policy proceeds are paid.
Exclusions
As in the case of all insurance policies, a life insurance policy also provides various
exclusions such as aviation and war exclusion. Aviation exclusion provides that no loss
is covered if the insured is an inexperienced pilot or is using a military aircraft. This
exclusion does not cover fare paying passengers of commercial airlines. War
exclusions, on the other hand, provide that if the insured dies as a result of war, the
insurance premium along with interest will be paid back. This exclusion is provided to
guard against adverse selection. In addition to all this, if a person has a hazardous
occupation or hobby, the insurer may not provide coverage or it may provide coverage
at an additional cost.
Participation

Policy dividends reflect the difference between the premiums charged and the premiums
paid, which are necessary to fund the mortality experience of the insurance company. In
a participating policy, the policyholder receives these policy dividends. A base premium
schedule is prepared by the insurance company for participating policies on the basis of
its mortality or investment experience plus a margin. If the company’s loss experience is
more favorable than expected, a return is made to the policyholder in the form of policy
dividends.
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Living Benefits

Many insurance companies provide living benefits, which allow the insured to receive a
certain percentage of his/her death benefits prior to death. If the insured suffers from
terminal illness and is expected to die within a specified period, the insurer may offer
living benefits free of charge. Insurance companies are marketing living benefit riders,
which allow advance of policy death benefit, such as 2 or 3 percent per month to pay for
medical expenses. The rider may cost extra, in addition to the life insurance premium
and benefits are capped as a percentage of death benefits.
BUYING A LIFE INSURANCE POLICY
One of the most important tasks is to select an appropriate life insurance policy. The
first important thing in life insurance is to understand the features of the life insurance
policy. The next step is to estimate the life insurance cover needed to cover the financial
requirements of the dependents. A proper understanding of the provisions of the life
insurance policies should be followed by a search for the right insurance company.
The following section unfolds the various aspects of choosing a life insurance policy:
Review Needs and Coverage
Life insurance policies are used as savings vehicles to fill the gap in the financial
resources that will be needed after death by the dependents. In case of young families,
guaranteed renewable and convertible term insurance should form an important part of
insurance protection. These policies provide insurance coverage at the least cost and
help in preserving the funds for other saving goals. In case of older people, term policies
are more beneficial. Most families also obtain whole life policies, which provide
continuous savings and permanent insurance. Similarly, whole life, variable life, and
single whole life policies should be purchased when the main aim is to save and not to
obtain protection against financial loss resulting from death.
Compare Costs and Features
Various insurance companies provide the same insurance coverage at different rates.
Thus, polices provided by the various insurers should be properly compared. The best
way to go for insurance shopping is to use the Internet. With a click, a number of
insurance quotes of various companies are available. An individual can know various
discounts available regarding different policies and the physical examination that a
person has to go through, on the web. If a person has a health problem, it would be
better to examine all the available insurance policies and select the one that is most
beneficial. It is also important to analyze the time period for which the rates will be
locked in and the rates for the renewal of the policy. A comparison should be made
among policies having the same provisions and amounts. For instance, a term life policy
should not be compared with a whole life policy. In case of cash value policies, interest-
adjusted cost indices should be compared.
Selection of a Company
The important part of buying a life insurance policy is to select an appropriote insurance
company. In addition to providing reasonably priced products, the insurer should also
provide attractive contract features, good customer service and a sound financial track
record. The insurance company should have the financial strength to survive and should
have been in business for around 25 years. In other words, the insurance company
should be there to pay death proceeds when the insured dies. There are certain other
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factors also, which should be considered such as the reputation of the firm, commission
of the agent, etc. Choosing insurance companies has been made easy by the credit rating
agencies. The credit rating agencies assess the insurance companies on the basis of their
debt structure, pricing practices, management strategies, and claims paying ability.
Selecting an Agent
Life insurance agents play an important role in the life insurance business. Selection of
an insurance agent is important, as one has to depend on him/her for various financial
decisions. Before choosing an agent, it is important to consider his/her professional and
formal education.
Other Types of Life Insurance
Other Life insurance policies include joint life insurance, survivorship life insurance,
group life insurance, credit life insurance, mortgage life insurance, industrial life
insurance and deferred premium life insurance, which are discussed below:
Joint Life Insurance: Joint life insurance is also called as first-to-die insurance. It pays
full death benefit when the spouse dies. It is most suitable to two income families.
When both the earners are killed in a common disaster, the family receives double the
death benefit.
Survivorship Life Insurance: Survivorship life insurance is also called as last-to-die
insurance. This policy pays benefit upon the death of the second insured. It is suitable to
pay estate taxes.
Group Life Insurance: A master policy is issued along with a certificate to each
member of the group. Premium is based on the group rather than individual.
Credit Life Insurance: Banks, Finance and other lenders sell this insurance in
conjunction with loans. It is one of the most important and expensive form of life
insurance. It is a term policy of less than 5 years. One cannot ignore or reject the loan
because the borrower is not interested in insuring for credit life policy.
Mortgage Life Insurance: Mortgage life insurance is a form of term life policy where
the mortgage balance will be paid on the event of the death of the borrower. Even
mortgage life insurance is expensive.
Industrial Life Insurance: Industrial life insurance is a type of whole life insurance,
issued with small face amount say Rs.1000 or less either weekly or monthly. The term
industrial has come into vogue because this policy is first started with small industrial
wage earners.

4.11 NON-LIFE INSURANCE

Insurance other than life insurance is called non-life insurance or general insurance.
General insurance comprises of insurance against fire, personal insurance – accident,
health insurance, liability insurance, critical insurance.
PERSONAL ACCIDENT INSURANCE

Personal Accident Insurance makes provision for the payment of fixed compensation
for accidental body injury resulting in death or disablement. The amount of claim
payable is related to the amount insured under the policy. Disablement could mean
permanent disablement such as loss of limbs, paralysis or temporary disablement, that

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is, inability to continue one’s occupation or profession or business for a temporary
period. In India, accident insurance became a non-tariff class of business from
01.04.1994. In Personal Accident Insurance, accident needs to be the sole and direct
cause for death i.e., accident should be the proximate cause of disability or death. In
case of partial and or temporary disability, a part of amount is usually paid. Insurers also
pay weekly compensation in case of disablement, which is a percentage of the capital
sum insured.
LIABILITY AND PROPERTY INSURANCE

In the insurance context, a trilogy can be written: ‘life, health and property’. After
insuring one’s life and health, the next step for an individual is to go for property
insurance. Property insurance, in particular, guards against catastrophic losses of real
and personal property caused by perils such as fire, theft, vandalism and other
calamities. Property of an individual includes his residence and its contents, vehicles
owned etc. Liability insurance protects against financial consequences that arise from
the insured’s responsibility for property losses or injuries to others.
HEALTH INSURANCE

A person may have been saving for future needs in the form of various saving schemes.
But, all his savings may go down the drain if he falls ill or meets an accident. Thus, the
financial condition of the whole family would be in jeopardy, if he or she is the only
breadwinner of the family. Thus, in addition to investing in various savings tools, it is
essential for an individual to obtain an appropriate health policy at the right time.
After understanding the significance of health insurance, let us define what health
insurance is. It can be defined as “any form of insurance whose payment is contingent
on the insured incurring additional expenses or losing income because of incapacity or
loss of good health”. Health insurance can be classified into three main categories:
Medical Expense Insurance: The expenses of the insured, such as hospital, physician
and other health care expenses are covered.
Long-term Care Insurance: Long-term insurance policies promise to pay expenses if
the incapacity prohibits the insured’s activities of daily life.
Disability Income Insurance: Disability income policies replace lost income when the
insured is disabled as a result of sickness or injury. Payment is made because physical
or mental incapacity prevents the insured from working.
Benefits of Health Insurance

Apart from providing protection to the insured, health insurance provides benefits as a
long-term savings tool and reduces undue mental tension at the time of critical illness or
disability. Taking this into consideration, the benefits of health insurance can be
underlined as follows:
Savings Tool

People may prefer to save in various saving instruments than buying a health policy.
But these savings involve a lot of time and may not be available at short notice and at
the time of need. A saving program will yield very little in the beginning, while an
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insurance policy guarantees the full value and also various other benefits mentioned in
the policy. Thus, if a person is unable to save sufficient amount in the early stages of his
life, he should atleast obtain a health insurance policy to meet any contingency related
to his health or disability.
Safety and Beneficial Instrument

Health insurance policy can be used as an accumulation plan. In addition to this, tax
benefits are also available on the health polices, which increase its attractiveness as a
saving tool.
Minimizes Worry

A health policyholder need not worry about the medical expenses incurred or loss of
income in case of disability. The health policy takes care of all this and thus reduces
undue tension on the part of the individual and his family.
Promotes Thrift

Health insurance policy may also lead to compulsory savings, if it is in the form of cash
value policy. In case of cash value policy, if there is no claim made by the policyholder
earlier, the whole sum insured is paid back. Thus, it leads to accumulation of savings
through health insurance.
TYPES AND SOURCES OF HEALTH CARE PLAN
The health care industry is in its nascent stages in India. Although after independence,
considerable progress has been made in the form of increased medical facilities,
eradication of various diseases, the health care services sector is yet to develop to its full
potential.
The various health care providers and the services available are as follows:
Indemnity Plans
Till 1988, indemnity plans were the most dominant health care plans and accounted for
about 70% of the health insurance market. Under this plan, the organization from which
insurance is purchased is separated from the insurer. The insurance company either pays
the provider or reimburses the insured for the expenses incurred. The insured needs to
submit claims for receiving payment. The reimbursement is around 80% of the costs
after the deductible is paid. The deductible is the amount not covered under the policy
and is paid by the insured himself.
Managed Care Plans
Managed care plans are the fastest growing segment of the health industry. Around 60%
of the Americans are covered under these managed care plans. Under the managed care
plan, the user needs to make monthly payments to the organization that provides the
health services. Under this arrangement, the insurance companies may not be involved
at all. At present, there are many insurance companies, offering both the managed care
and indemnity plans. The following are the main features of the managed care plan:
a. Managed care plans use various strategies to provide cost-effective managed
care;
b. A small fee is paid by the user for office visits; and
c. No deductible is paid.

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Managed care plans are again categorized into Health Maintenance Organizations
(HMOs), Individual Practice Association (IPA), Preferred Provider Organizations
(PPOs), Exclusive Provider Organization (EPO) and Point of Service plans (POS).
These different types of managed care plans are discussed below:
Health Maintenance Organization (HMO): HMO is an organization, which consists
of physicians, hospitals, which provide health care services to its members. About 80
million people in the US are covered by HMOs. The HMO plan provides outpatient
care, x-ray, laboratory services, maternity care, mental health care, minor surgery etc. A
monthly fee is paid by the member, which varies according to the number of people in
the family. The advantage of HMOs is that it reduces the costs of health care and uses
the resources efficiently. It works on the principle of ‘preventive medicine’. The
members do not have to worry about deductibles, exclusions or filing insurance claims.
The main disadvantage is that the members are not free to choose their own physician.
Individual Practice Association (IPA): In the case of Individual Practice Association,
the medical facilities are not provided from a central facility. The physicians of IPA
provide medical services to members and non-members of IPA alike. Although the
service arrangements of an IPA are similar to an HMO, the physical facilities are
different. Payment is made by the member monthly and large varieties of services are
availed. Thus, IPAs have more appeal as they allow the member some choice with
respect to the physician.
Preferred Provider Organization (PPO): The PPOs have both the characteristics of a
HMO and an insurance plan. It provides greater flexibility than the HMO, with a
network of doctors and hospitals. In addition to that, it also provides insurance coverage
for the medical services, which are not provided by a HMO network. This organization
is either administered by an insurance company or a service provider.
It contracts services from a group of designated doctors and hospitals, who accept a
negotiated fee schedule.
Exclusive Provider Organization (EPO) and Point of Service Plan (POS): Under
EPO arrangement, services are provided by the provider to the members at a reduced
cost but reimbursement is made only when the affiliated providers are used. If the
members use the provider that is not affiliated, then he needs to bear the whole cost. The
Point of services plan allows members to use the services of physicians outside the
network. The payment is made similar to the indemnity plan. Under the plan, payment
is made after deducting a deductible.
Providers of Health Care
Major providers of health care are managed care organizations, Blue Cross and Blue
Shield Plans, and health care insurance companies. In addition to this, services can also
be obtained through group/individual plans, and also from government agencies. The
healthcare providers are group versus individual health care, private insurers, and
government-sponsored healthcare.
Group Vs. Individual Health Care: Group plans can be obtained either from the
employer or any other professional association or directly from the provider. In case of
group health insurance, the health care contract is written between a group and a health
care provider, i.e., it can be a private insurance company, Blue cross/Blue shield or any
other managed care organization. A group plan provides a variety of services such as
dental, vision care, medical expense coverage etc. The services provided under the plan
are according to the negotiations between the insurer and the group.
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If a person works in an organization having more than a few employees, then one would
be easily covered under a group health care plan. With the high cost of health
insurances, the employers generally require the employees to pay a portion of the cost.
In some cases, the group may also go for self-insurance. In such cases, the employer
may take the responsibility to make full or partial payment.
At a point of time, group health care was considered superior to the individual coverage.
But now the differences between group and health coverages have narrowed and a
number of advantages of group health have disappeared. This is due to the fact that
many employers now do not guarantee universal coverage and are shifting a high
premium cost to the employees. Individual coverage is more beneficial with the rise of
downsizing, as the employees need to take individual coverage with the loss of group
benefits. Individual coverage is also beneficial as the insured can tailor the coverage
according to his needs. It is also possible that group insurance is taken up as a
foundation or fundamental coverage and then supplemented with individual coverage.
Private Insurers: Private insurers sell a variety of indemnity and managed care plans.
The most popular private insurers are Aetna, Prudential and Cigna in the US managed
care plans are offered by organizations, which only provide managed care and also by
other organizations, which offer indemnity plans in addition to managed care plans such
as blue cross/blue shield.

The most popular private insurers in India are Bajaj Allianz Life Insurance Company
Limited; Birla Sun Life Insurance Co. Ltd; HDFC Standard life Insurance Co. Ltd;
ICICI Prudential Life Insurance Co. Ltd.; ING Vysya Life Insurance Company Ltd; Life
Insurance Corporation of India; Met Life India Insurance Company Ltd; SBI Life
Insurance Co. Ltd; Tata AIG Life Insurance Company Limited and Tata AIG General
Insurance.
Blue Cross/Blue Shield: Blue Cross and Blue Shield are medical plans and not
insurance policies. In these medical plans, the member needs to pay the amount in
advance. Under this type of arrangement, blue cross enters into a contract with various
hospitals to provide health care services to the members covered by it. On the other
hand blue shield plans provide surgical and medical services. Both these plans serve as
an intermediary between the physicians and the members of the group. At present, Blue
shield and Blue cross have combined to form as one single service provider, to compete
with the private insurers.
Government-Sponsored Health Care
Federal and state agencies also provide health care coverage. Coverage for illness,
accidents and disability is provided by the government through social security
administration programs and workers’ compensation program, which covers medical
expenses, rehabilitation and disability.
Social Security Medicare Program
The social security medicare program not only provides old age and survivor’s benefit
but also health insurance. The health care coverage is provided under two plans:
Medicare and disability income. Medicare as a health care plan is designed to help
people above the age of 65. But, now it also includes individuals under the age of 65,
who receive monthly social security disability benefits. Medicare can be sub-divided in
two categories, basic hospital insurance and supplemental medical insurance.
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Basic Hospital Insurance

Also commonly known as ‘Part A’, it provides inpatient hospital services for the first 90
days of illness, after applying a deductible for the first 60 days. It also covers post-
health services such as nursing care, rehabilitation, home health care etc.
Supplementary Medical Insurance (SMI)

Also commonly known as ‘Part B’, it is a voluntary program, in which the members pay
premiums, which are then matched with the government funds. The SMI program is for
anyone above the age of 65. It covers the following:
a. Physician’s services
b. Home health service
c. Medical and health services
d. Psychiatric care.
Workers’ Compensation Insurance

Workers’ compensation programs are mandatory. The program has been designed to
reduce the burden of job-related illness or injury to the workers. Employers need to bear
the entire cost and self-employed employers need to make a contribution both for them
and their employees. Workers’ compensation insurance covers the following basic
areas:
Medical and Rehabilitation Expenses: Hospital, surgical and other expenses incurred
to help the employees to rejoin their jobs as quickly as possible.
Disability Income: A specified percentage of pre-disability wages is paid. The amount
paid is limited to maximum amount such as one and half times of the weekly wages.
Lump Sum Payments: Lump sum amount is paid to employees who suffer from
dismemberment due to work-related hazards. It may also be paid to beneficiaries in the
event of death.
Second Injury Funds: Second injury funds is for the employers who may employ
someone, who is already handicapped and is further injured on the job at the workplace.
LONG-TERM CARE INSURANCE
Long-term care is the delivery of medical and personal care other than the hospital care
to people suffering from chronic diseases resulting from illness or frailty. Due to
increasing health services, the mortality rates have reduced and people are living for a
longer period than before. Elderly people after reaching certain age cannot take care of
themselves and thus require long-term care.
Long-Term Care Insurance Provisions
Long-term care is an area of personal financial planning, which should not be neglected
by an individual. Long-term care is still evolving and its significance can be understood
by going through the following provisions or features:
Type of Care: Long-term care provides benefits both for the nursing home services and
also for the services provided in the insured’s home. These services may be in the form
of physical therapy, home health aides etc. Financial planners recommend, including
both of these services. There are many policies, which also cover adult day care,
community care programs, etc.
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Eligibility Requirements: There are certain provisions which determine whether the
insured would receive the payment or not. These provisions are known as gatekeeper
provisions. For instance, one of the gatekeeper provisions is that the insured should be
unable to perform his daily living activities such as bathing, dressing, eating etc.
Services Covered: Several levels of services are provided such as skilled, intermediate
and custodial. Skilled care is required when a person needs constant attention from a
physician. Intermediate care is provided when medical attention is required but not
constant attention of a physician. In case of custodial care, assistance is required for
daily activities, but no medical attention is required.
Daily Benefits: Long-term care benefits also provide reimbursement on a daily basis.
The maximum amount given by the insurer depends on the amount of premium paid by
the insured.
Benefit Duration: The maximum duration of benefits vary from one year to the entire
life time of an individual. The financial planners recommend for purchasing a policy for
a duration of 3 to 6 years so that care is provided for a longer period than an average
period.
Waiting Period: Waiting period is also called elimination period. It is the period after
which the insured meets the policy’s requirements. The insured needs to pay the
premium during the waiting period or the elimination period. This period is generally
for 90 or 100 days. Although, for the waiting period, the premium is lower, the insured
should have the sufficient amount for meeting his expenses during his period.
Renewability: Long-term care policies include a guaranteed renewability to ensure
continued coverage for lifetime as long as the insured pays premium. It also contains
optional renewability where the insured is allowed to continue insurance only at the
option of the insurer.
Pre-existing Conditions: Many health insurance policies have pre-existing conditions
clause for a period of 6-12 months. On the other hand, some policies do not include
such clauses at all.
Inflation Protection: Many health insurance policies provide riders that increase
benefits with the increase in the rising costs. Benefits can be increased by paying
additional premium by the insured.
Premium Levels: Premiums charged for the long-term insurance are expensive and
vary according to the policies of the insurance companies. It is generally recommended
by the financial planners to buy insurance policies at a young age.
Selecting a Long-Term Care Insurance
Though long-term care insurance policies have improved still they are expensive. An
individual needs to understand the significance of long-term care. The impact of
prolonged stay in a nursing home can be great financial burden to the family. Before
obtaining a long-term care policy, an individual needs to analyze the following aspects:
Assets: Substantial assets should be available with a person to avail the benefits of
long-term care. A person should be able to afford to pay the premiums. In many cases,
people having sufficient assets prefer self-insurance.
Premiums: Premiums of many policies can be around 5% to 7% of the annual income
of a person. Thus, people prefer investing the amount otherwise than spending on
insurance, which would be available in the future.

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Family History: There may be adverse family history of various diseases requiring
long-term care such as cancer.
Availability of Family: The cost of long-term care can be reduced, if there are family
members who are willing to take care of the insured in his later years.
In addition to the guidelines discussed above, the following aspects should also be taken
into consideration before selecting a long-term care policy:
Buy the Policy while you are Healthy: If a person contacts a disease, he becomes
uninsurable. Thus, the best time to insure oneself is in the early 50s or 60s.
Buy the Right Type of Coverage: The right kind of coverage should be bought. The
coverage obtained should not be over and above the actual coverage required. The
policy should cover skilled, intermediate and custodial care. Costs can be reduced by
increasing the waiting period before the benefit starts. The longer the costs are covered,
the lower will be the premium.
Understanding the Policy: Understanding the policy is very essential that the policy is
properly understood and only then obtained. One of the thumb rules used is that 80% to
90% of the nursing home costs should be covered.
DISABILITY INCOME INSURANCE
Disability income insurance provides weekly or monthly payments, when the insured is
unable to work due to illness, injury or any other disease. Disability income insurance
comes to rescue when the sole earning member of the family becomes sick for an
extended period and there is an adverse impact on the financial condition of the family.
This insurance is obtained by every individual who is the sole earner for the family.
Most of the employers provide disability insurance at advantageous rates. The coverage
available is generally voluntary and the person may have to bear the whole cost. Social
security programs also provide disability benefits, if the disability last for at least one
year. The actual amount paid is a percentage of the previous monthly earnings.
Disability Insurance Needs
The main aim of disability insurance is to provide income at the time the insured is
unable to earn for the family. Disability insurance helps in maintaining the same
standard of living at the time of financial crises or difficulty. An individual should take
into consideration the following measures before obtaining disability insurance:
Take Home Salary: Disability benefits are not always exempted from tax. Thus, a
person may be able to replace only his take home salary.
Disability Benefits from Various Sources: Disability benefits from the government or
employer programs may be available in the form of social security benefits.
Other Benefits: Benefits may also be available through employer-sponsored disability
plans or through group disability benefits. All these benefits should be added and
deducted from the current monthly take home salary. The difference would be the
estimated disability benefits required to maintain the current after tax income.
Disability Income Insurance Provisions
Disability insurance policies have various standards and conditions, which must be
satisfied before getting the benefits. Some policies will have a residual benefit option
for which partial benefit is paid if a person can work part time or at a lower salary. In

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case of individual disability policies, presumptive disability clause provides that when
both the hands, eyes and hearing become dysfunctional, full benefits will be received
even if the person is able to earn in some capacity or the other. In addition to this, there
are certain other provisions which need to be taken into consideration:
Benefit Amount and Duration: Disability insurance pays a flat monthly payment. The
insurers rarely pay more than 60% to 70% of the insured’s gross income. The monthly
payments would be paid for a few months or for a lifetime. Many disability policies
may be for a short period of 2-5 years or even for lifetime.
Probationary Period: A probationary period of a week to a month is included in the
policy starting from the day the policy is issued. If any disease or illness occurs during
this probationary period, it will not be covered. This helps in reducing the costs of the
insurer.
Waiting Period: Also known as elimination period, it ranges for a period of one month
to one year. Longer waiting period can be chosen if a person has enough funds to meet
any contingency. This would help in reducing the premium cost.
Renewability: Most of the policies have renewable guarantee or are non-cancellable.
Premiums are raised if the loss experience of the insured’s in the same class worsens.
Other Provisions: In many disability policies, insurers offer the cost of living
adjustment, guaranteed insurability option and waiver of premium. Disability income
insurance is a part of the overall personal financial planning. Thus, it is essential to
strike a balance between the cost and the coverage available.
BUYING HEALTH CARE INSURANCE
Health insurance coverage needs to be managed and systematically planned.
A study should be made about the resources that are available for use and identify the
gaps in protection available already. The criterion which is adopted in purchasing a
health care policy is as under:
Matching Needs and Resources: In case of a health policy, losses covered are against
illness or accident. The health policy covers the expenses of medical bills,
rehabilitation, counseling and loss of income due to inability to work. Although it is not
possible to estimate medical expenses, long-term care expenses can run into lakhs.
Thus, it is essential to estimate one’s total insurance needs and the resources available.
After this, the various sources of coverage should be identified, i.e., the various
provisions of the policies and the extent of coverage provided. If any gaps are identified
relating to the coverage available, then steps should taken to fill up the gaps by taking
an appropriate policy.
Components of the Health Care Plans: The health insurance plan not only covers the
costs of illness or accident but also provides for risk reduction. As in the case of other
insurances, the risk in health insurance can also be dealt with in three ways or methods
as discussed hereunder:
Risk Avoidance: Risk avoidance is the best way to avoid exposure, even in health
insurance. A non-smoker does not have to worry about getting cancer due to smoking.
Loss Prevention and Control: A number of diseases and ailments can be avoided if
one follows a healthy life style. People face health problems due to smoking, having
alcohol, use of drugs, improper diet and lack of regular exercise etc. These routine
habits lead to illnesses such as heart ailments, cancer, tuberculosis, mental disorders
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etc. In addition to the health problems, one should follow various safety rules such as
driving safely on the highways and avoiding driving under the influence of alcohol.
Thus, loss prevention should be a priority to avoid health hazards.
Risk Assumption: The next step in the health care plan is risk assumption. Risk
assumption relates to the risk retained by an individual. There are certain risks, which
have small loss potential. Thus, it is economical to pay a small loss than paying high
premiums. Having insurance plans with deductibles is also a form of risk assumption, as
the insured has to bear a part of the claim amount. Similarly in case of co-insurance, the
insured needs to bear certain percentage of the claim amount. Thus, deductibles, co-
insurance and internal limits are various forms of risk assumption.
PURCHASING HEALTH INSURANCE
After understanding the intricacies of various health care plans and the major providers,
an individual needs to formulate a plan incorporating the basic principles of risk
avoidance, risk assumption, prevention and control, and then decide to shop for a health
insurance policy. In addition to this, an individual needs to take into consideration the
following points:
Cost of Coverage: Buying health insurance is similar to buying a car. In both the cases,
payment will have to be made, whether in the form of installments or premiums. As in
the case of a car, one needs to compare the features of the various models, similarly the
features of the various policies will have to be compared before making the decision for
buying a policy.
Selecting Health Care Insurance as an Employee Benefit: Many individuals obtain
health insurance from their employers. In some cases, employers offer only one plan to
the employees and pay for it. In this case, the employee should analyze the plan and
decide whether he should be a part of it or not. The employers have also started offering
cafeteria plans, which provide a menu of benefits, which can be chosen by the
employee. The menu should be chosen, taking into consideration one’s family needs. If
the spouse is also employed, then care should be taken that his or her benefit package is
also analyzed before taking any decision.
Quality of Agent and Company: Health care plans should be obtained from an agent,
who is able to answer all queries about the policy. The health care insurer should be
able to settle the claims promptly. Apart from getting information from the agent,
advice from friends who have gone through various claim experiences should also be
obtained.
CHOOSING A HEALTH CARE PLAN
After reviewing the various health providers and health plans, a choice has to be made.
An individual needs to review his needs and the coverage already available from the
employers or any other government agency. A choice should be made after analyzing
thoroughly the benefit plan available from the employer. Before choosing a plan, the
benefit package of the spouse should also be analyzed to check that there is no clash or
conflict over the benefits availed. A person generally has to decide whether to go for a
managed care or an indemnity plan.
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Before choosing a health care plan, the following points should also be taken into
consideration:
Freedom of Choice: A person needs to decide whether to continue the services of his
current doctor or join a managed care arrangement.
Out of Network Service Provider: Out of network service provider should be checked
whether reimbursement would be there, if the services of out of network service
provider are availed. For some people who visit their doctor once a year only, managed
care is cheaper alternative.
Coverage: An individual needs to check whether all the services needed by him are
covered in the plan or not.
Managed Care: Managed care is also essential to check the credentials of the
participating doctors and physicians.
Age and Health Condition: Age and health should be taken into consideration before
joining any health plan, whether it is a managed care or an indemnity plan.

Self-Assessment Questions – 3

a. What is Insurance Planning?

…………………………………………………………………………………
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4.12 RETIREMENT PLANNING

Retirement planning is an important aspect of personal financial planning and is
incomplete without it. Retirement planning is a forward-looking planning. Deciding
when to begin retirement life is a big question. Individuals are so much involved in
issues like buying a house, changing jobs or starting a family that no time is found to
decide on when to start retirement. Irrespective of age and financial picture, planning
for retirement should not be ignored. The power of compounding becomes beneficial
when early retirement planning is made.
The first step in retirement planning is to set retirement goals, which are subjected to
change depending on the situation and conditions of your life. The next step is to know
how much to invest to achieve the retirement goals. The final step is to formulate
investment program. Retirement planning is closely related to investment and tax
planning. Investment and investment planning are the two core vehicles, which are used
in building up investment for retirement.
The three big pitfalls with respect to retirement planning are – planning for retirement is
started too late; very little portion of investment is kept for after-retirement purpose, and
investment is made too conservatively. Many people find it hard to put money for
retirement in their late 20s and 30s. They often think of their retirement investment only
after their 30s or 40s. It is often observed that the more time they take to investment for
retirement the less return they are going to have. Sometimes, because of family needs or
other financial concerns people start investing too little for their retirement. Last but not
the least it is also seen that the people become too conservative and fail to achieve full
potential of their retirement programs.

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The size of one’s retirement investment depends on when the investment program has
started and at what rate of return. For realizing the retirement, it is always essential for a
person to consider the age at which he/she retires and their financial position at
retirement. The financial position depends on the plans, more importantly on the career
and lifestyle. It is very important for every person to plan carefully. It is therefore
always essential to make sure not to satisfy low and short run desires at the cost of high
and long-run objectives.
Retirement goals should be set in a realistic manner. They should be reviewed annually
by a knowledgeable and experienced retirement professional. The sooner an individual
starts planning for retirement the better it is. Without planning, it is not possible to meet
both financial and non-financial goals. Planning allows assessing situations and
identifying potential problems. Advanced planning allows improving the situation and
helps in dealing the potential problems in an improved manner. Therefore, savings
earlier rather than late will help in accumulating the funds for retirement.
This can be illustrated with an example:
Monthly Savings to Accumulate Rs.1,00,000

Number of Years before Retirement Monthly Savings required to

You Start Saving Accumulate Rs.1,00,000 (8% interest) (Rs.)

10 550

20 170

30 70

40 30
Monthly savings to accumulate is important for the employers to help their employees
for their retirement. Government should encourage employees and the employers for
preparation of retirement, promote the availability of alternative options available for
retirement. To maintain the standard of living, pension plans must be encouraged and
facilitated.
Early Retirement Plan is Very Important to Avail the Advantage of Time Value of
Money: Let's compare two friends: Suresh and Ramesh. Suresh starts saving Rs750 per
year from the time he is 15 and stops investing to his nest egg at the age of 30.
On the other hand, Ramesh starts investing Rs5,000 per year when he is 30 and
continues investing this amount every year till he is 60.
If both earn 15% post-tax return per annum on their investments, who will have more
wealth when they retire at age 60?
Suresh. His Rs750 annual savings between age 15 and 30 will aggregate to Rs27.17
lakhs by age 60, whereas, Ramesh’s Rs5,000 annual savings between age 30 and 60 will
aggregate Rs25 lakhs.
But here the question arises – why think about retirement at an early age? People are
spending more time in retirement, say, 16-20 years of life after retirement. Private
pension and government benefits are not sufficient to maintain and cover the standard of
living. Inflation is a big question. Therefore, it may be assumed that inflation may
diminish the purchasing power of retirement savings.

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Conducting a Financial Review in Retirement Planning: Review of assets like
housing or land: if it is owned, probably the single and the biggest asset, or else, if there
is large equity then it can be converted into an annuity mortgage or sold and the
proceeds invested for regular income. If there is any asset in the form of life insurance,
then the cash value of life insurance can be converted into annuity. Other form of assets
like stocks and bonds should also be reviewed.
Estimation of Retirement Expenses: Spending patterns keep fluctuating. There may
be expenses which may be reduced or increased. Expenses like formal clothes may be
reduced and more casual outfits may be preferred. Housing expenses may be paid off
but insurance and house tax may go up. Miscellaneous expenses like gifts, medical
expenses, health and life insurance, expenses for leisure activities etc., may go up.
Planning for Retirement Housing: Deciding where to live and considering the cost
and standard of living and other expenses.
There are certain tips to be followed in retirement planning:
a. One should recognize the importance and the need for retirement planning;
b. Current assets and liabilities need to be analyzed;
c. An estimation of retirement spending needs should be made;
d. Retirement housing needs to be identified;
e. Retirement income should be determined; and
f. Based on the retirement income, one should prepare a balanced budget.
SOURCES OF RETIREMENT INCOME
The three sources of income for the retired people are social security, assets and pension
plans. The amount of income retired individuals receive will vary and depends on the
levels of pre-retirement savings.
Social Security: Social security benefits cannot be predicted before. Forty to sixty
percent of the wages he/she is earning in the year before retirement is provided as social
security. It is considered a base for planning retirement income. Average and upper
middle income families increase their social security benefits by way of pensions and
annuities. These two popular sources of income are discussed in detail in the later part
of this chapter. There are two basic social security retirement benefits – old-age benefits
and survivor’s benefits.
Old-age Benefits: Workers, once they reach the age of 65, and if they are fully covered
under social security, will start receiving, old-age benefits. But if one retires earlier, say,
at the age of 62 then he or she may receive a reduced benefit that is 80% of the full
amount. If the retiree has a spouse of 65 years or older, then the spouse may be entitled
to benefits equal to one-half of the amount received by the retired worker. If both
husband and wife are salaried then in such a case both may be eligible for social
security benefits. When they retire they can avail the retirement benefits in two ways:
(a) Avail the benefits to which each is entitled from his or her account. (b) Take
husband and wife benefits and benefits of the higher-paid spouse. If each takes his or
her own full share then there will be no spousal benefits; therefore, it will be more
effective to take the benefits of the higher-paid spouse.
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The flag of life insurance reached Indian shores during the rule by East India Company.
We cannot, at the same time, forget that our own society had already developed a potent
instrument to provide social security in the shape of ‘Joint Family System’ whose utility
cannot be underestimated. When the modern concepts of insurance were not known, the
joint family system in our country looked after all members, widows or orphaned
children included, very effectively. But, with the slow but steady abuse and
disintegration of that system, emergence of life insurance became inevitable
alternative to provide social security to the families of the deceased individuals.
Survivor’s Benefits: The spouse is eligible to receive the survivor’s benefits from
social security if a covered worker dies. These payments include a small lump sum
payment and monthly benefit checks. The eligibility of a surviving spouse includes that
he or she must be at least 65 years of age or should have a dependent and unmarried
child of the deceased worker in his or her care. For qualifying for full benefits, the
surviving spouse must be at least 65 years of age, reduced benefits are payable between
ages 60 and 65. If the children of the deceased worker are 16 years of age and the
spouse is less than 60 years of age, then the monthly benefits cease to exist and do not
resume until he or she turns 60. This period is called widow’s gap.
Social security payments are paid to individuals by filing an application with social
security administration. To be eligible for retirement benefits, all workers be employed
for 40 quarters in the job. The amount of social security benefits set by law is difficult
to predict. According to social security administration, all covered workers are provided
with a social security statement that contains information about the lifetime earnings of
the worker, time period of working, amount of monthly benefits. This statement also
estimates the amount of benefit an individual’s children or spouse can receive on his
death or how much one can receive on his disability.
PENSION PLANS
Pension is providing people income when they are no longer into the process of regular
income. It is a kind of retirement plan that is exempt from tax. Pools of funds are set
aside by the employer for the employee’s future benefits which are then invested on the
employee’s behalf to receive retirement benefits. Employee Retirement Income Security
Act (ERISA) is a law passed in 1974, to ensure that the workers eligible for pensions
receive benefits. Widespread Keogh Plans, Individual Retirement Arrangements (IRAs),
and other programs lessened the urgency of small firms in offering their own company
pension plans.
In India, the government is the major player in the field of pension plans. Apart from the
government, private employers and insurance companies are forgoing ahead in this
field. Employer benefits provided in India are in the form of Employee’s Provident
Fund Scheme, Employee Pension Fund Scheme, Employee Family Pension Scheme,
Employee’s Deposit Linked Insurance (EDLI) Scheme, Employee StateIinsurance
Scheme of India. (Refer Annexure given at the end of this chapter.)
Employer-sponsored Programs
Employer sponsors two types of pension plans – basic, and supplemental plans. Basic
plans are those where in employees participate automatically after a certain period of
employment. Supplement plan is a voluntary program, which enables the employees to

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increase the funds set aside for retirement. Before discussing in detail about both the
plans, it is required to understand the key features of employer-sponsored pension
plans – participation requirements, contribution, vested interest, retirement age, and
methods of computing benefits. These features are used in evaluating the employee’s
participation in any of these employers-sponsored pension plans. They help in providing
a rough estimating of the future income levels, investment returns etc.
Participation Requirements: For employees to participate in the program has to meet
certain criteria – years of service, minimum age, level of earnings, employment
classification.
Contribution: Employee’s payment towards pension depends on the type of plan one
chooses. There are two types of plans – non-contributory and contributory pension
plans. Under non-contributory pension plan, the employer pays the total cost of benefits.
Under contributory pension plan, both the employer and employee share the cost. In
today’s business environment, contributory pension plan is the most preferred. The
employee’s share is between 3-10% of total wages and is deducted through payroll
deductions.
Vested Interests: Not every employee has the right to earn retirement benefits. There
are certain non-forfeitable rights to receive benefits, which are to be met by the
employee. The employee has to be employed for 25 years or more and any employee
having less number of years employed is not entitled to any benefit. ERISA was against
this criterion. According to ERISA, employees with not more than 10 years of
employment are liable to receive benefits.
Retirement Age: All the retirement plans specify when the employee is eligible for the
benefits. There are other pension plans that provide for early retirement age. Employees
receive fewer benefits due to prior retirement. Many retirement plans give workers the
option of retiring after a stated number of years of service at full benefits regardless of
their age at that time.
Methods of Computing Benefits: The two most commonly used methods of
computing benefits are – defined contribution plan, and defined benefits plan.
Defined Contribution Plan is a pension plan where the employer and employee
contribute fixed contributions to the individual’s account. At retirement, the worker is
paid the level of monthly benefits those contributions purchase. It makes no promises
except the returns the fund managers have been able to obtain. The ‘cost’ of a defined
contribution plan is defined, but the ‘benefit’ from a defined contribution plan depends
upon the investment results. Though it is perceived that the participant has control over
investment decisions, the sponsor retains more responsibility over investments,
including investment options, and administrative providers.
Defined Benefits Plan is a pension plan in which the employer promises to pay the
specified benefit on retirement. It helps an employee determine his/her retirement
income. The benefits are given regardless of the investment returns.
If the investment returns fall short, the employer has to pay the difference to meet the
agreed benefits. The number of years of service and the amount of earnings are the two
important factors that determine the benefits, an employee receives.
Other defined benefit plans may pay benefits based on only earnings or only years of
service or with no criteria. Many defined benefit plans also increase benefits
periodically to make retirees maintain their own standard of living. Regardless of the
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methods, the employee is concerned with only final take home pay. Employees have to
take up the responsibility as the companies are changing from defined benefits plan to
defined contribution plan.
Qualified Pension Plan is a pension plan that meets certain criteria based on Internal
Revenue Code (IRC). Employees on whose behalf the contributions are made need not
include these in their taxable income until they are received. Sometimes, these
contributions are also not counted as taxable income in the year in which it is made.
Any investment income is tax-free under this plan.

Box 2: New Pension Scheme

New pension plan came into effect from May 1st, 2009. All central government
employees who joined service on or after January 2004 are covered under NPs. It is a
fund management system and a voluntary scheme. Any individual between 18-55
years can apply for NPS. Once the scheme is joined PRAN (Permanent Retirement
Account Number) is given to check the funds online or as and when required. The
Pension Fund Regulatory and Development Authority (PFRDA) have been assigned
the work of protecting people of NPS. It is a government regulatory body of India.
PFRDA will appoint a professional who will invest money on behalf of members and
charge fees for his service. PFMs are required to offer three kinds of products – Safe,
Balanced and Growth products.
The benefits of joining NPS – Voluntary, flexible, simple, portable and regulated.
Tax Benefits: The returns earned from NPS are tax free. NPS falls under Exempt-
Exempt-Tax system, which means, the maturity amount withdrawn will be taxed,
which is unlike other pension schemes like PPF, EPF, ULIPs.
Risks:
• There is no guarantee on investment. Benefits depend on the amount invested
and investment growth to the point of exit.
• Past performance of the fund manager doesn’t guarantee future performance of
the investment.
• All the investments are subjected to market risks.
• Investment risks such as trading volume, settlement risk, liquidity risk, default
risk, including possible loss of principal.
• The investment value in NPS may go up and down depending on the factors
affecting the financial markets.
Returns: As other investment schemes, even NPS don’t guarantee any predefined fixed
return. The return is dependent on the growth of the funds for a particular period of
time. The funds in NPs are invested in equity, debt and government bonds. 50% of the
funds are invested in equity, 20% are invested in government bonds and 30% in debt
instruments. This allocation is only till the individual reaches 35 years. After 35 years
of age, the percentage of allocation changes and the funds invested in equities go
down and funds invested in government bonds and debt go up. While reaching 60
years of age, the allocation of funds to equities would be 10% and 80% of funds are
invested in bonds. It doesn’t enjoy any benefits from employer but enjoys higher rate
of return in long term as it is a mix of debt, equity and bonds.

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NPS contains two tiers. Tier-I is compulsory and consists of employee’s contribution
@10% of pay + DA + DP. This cannot be withdrawn during service and payment only
after 60 years. Tier-II is optional. It can be withdrawn at any time by time. Funds
deposited under both the tiers are invested and returns are reinvested in funds.
60% of the savings are withdrawn at retirement and remaining 40% would be used to
purchase an annuity scheme from a life insurance company which will pay monthly
pension for the rest of the life.
Source: www.pfrda.org.in
Supplemental Plans
Profit Sharing Plan: Under this plan employees are allowed to Participate in
companies’ earnings. It is also called ‘deferred profit-sharing plan’ or ‘DPSP’. This is a
way of giving ownership to employees in the company. One advantage from the firm’s
viewpoint is that the employee has no specific levels of contribution or benefits.
Contributions depend on the profit the employer makes. For providing reasonable
returns employers pay some amount as contribution to profit-sharing plans. These
contributions to profit-sharing plans are invested in certain stocks, bonds, securities
issued by the employer itself.
Thrift and Savings Plan: Thrift and savings plan is a plan used to supplement pension
and other benefits in which the firm makes equal set of contribution as that of an
employee. It is a defined contributions plan. These contributions are invested in
different types of securities. Employer’s contributions and earnings are not included in
the employee’s taxable income until withdrawn by the employee. This plan is liberal
and has more withdrawal privileges. Employees who terminate from this plan can rejoin
only after a period of say, one year.
Salary Reduction Plan/401(K) Plan: 401(K) plan is a defined contribution plan, which
is employer-sponsored plan. According to 401(k) plan, a portion of the covered
employee’s pay is withheld and invested in some qualified investments. Taxes on both
contributions and earnings are deferred making the plan tax-free. They are highly
attractive tax shelters. They offer ways to tax savings as well as plan for retirement.
This plan offers several investment options such as equity, fixed income, mutual funds,
stocks, and other investment-bearing vehicles.
Self-directed Retirement Programs
Individuals apart from participating in employer-sponsored pension plans, can set up
their own retirement plans. There are two basic self-directed retirement programs –
Keogh and SEP plans, and Individual Retirement Arrangements (IRAs). These plans
can be set up by anybody.
Keogh Plan: Keogh plan was introduced in 1962. It is also known as HR (10) plan. It is
a part of self-employed individual retirement act. It allows self-employed individuals to
set up tax-deferred retirement plans for themselves and their employees. Any
individual who is self-employed can set up a Keogh account. Keogh accounts are
opened in banks, insurance companies, brokerage firms, mutual funds, and other
financial institutions. They are self directed retirement programs in which the
individuals decide themselves which investment to buy/sell. Any income earned from
investments can be reinvested in the account, and which is too tax-free. All the
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investment returns and earnings are kept in the account until the individual turns 591/2.
One can withdraw the funds from the account when an individual is 701/2. Once the
individual starts withdrawing, these funds are treated as ordinary income and are
subjected to income tax.
Individual Retirement Arrangements (IRAs): Individual Retirement Arrangements
(IRAs) is an investing tool. It is also called individual retirement account. It is a tax-
sheltered retirement plan. It provides tax advantages for retirement savings in the US.
They are designed to encourage investment savings on the part of individual or by
sheltering investment income earned in these accounts from income tax. There are four
types of IRAs – deductible IRAs, non-deductible IRAs, Roth IRAs, and Simplified
Employee Pension Plan.
Deductible IRAs: These are also called before-tax IRAs. Taxable income cannot be
reduced by contributions to IRAs. These IRAs can be opened by any one irrespective of
the place of employment, income level or by couples. All earnings in the account are
tax-free. Tax rates apply only when the withdrawals take place.
Non-deductible IRAs: These are also called as after-tax IRAs. Taxable income cannot
be reduced by contributions to IRAs. One need not pay tax on earnings until withdrawal
takes place.
Roth IRAs: All earnings in the account and all withdrawals from the account are
tax-free.
Simplified Employee Pension Plan: Simplified employee pension plan is also called
SEP-IRA plan. It is the pension plan that is specially intended for the
self-employed persons and small businesses without any employees. This plan gives the
ability to set aside money for retirement. It is easy to set up and inexpensive to
administer. Employers make contributions to IRAs and the employee takes the
responsibility of making investments. Employers have flexibility in terms of
contributions percentage as well as towards less risk and less cost in accounting. There
are no complicated forms to complete and no annual reports for the employer to file
with the IRS. Some of the benefits for the employees are a SEP IRA plan makes it
easier to attract and retain valuable employees; assist in providing retirement income for
the eligible employees, and traditional IRA contributions can also be made to a SEP-
IRA plan.
ANNUITIES
Annuities is an investment product created by the Life Insurance Company that provides
a series of payments over a period of time. Period during which premiums are paid
towards purchase of annuity is called accumulation period; and period during which
annuity payments are made to annuitant is called distribution period. The entire fund is
refunded along with some addition either on the death of annuitant or after the expiry of
the annuity periods. Annuity that generates income during one’s retired life is called
pension plan. Under pure life annuity contract, the guaranteed amount is paid to the
individual by the Life Insurance Company until the annuitant dies.

The benefits of annuities are composed of three parts – principle, interest and
survivorship benefit.

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The premium amount paid by the annuitant is called principle; amount earned on the
funds is called interest; and the benefits derived from the portion of principal and
interest and that are not returned to the annuitant prior to his/her death are called
survivorship benefits.
There are different types of annuities, which are divided based on the method of paying
premium; disposition of proceeds; inception date of benefits; and method of calculating
benefits.
Method of Paying Premium: According to this method, annuity is divided into two
types – single premium and installment premium.
Single Premium: Single premium is where the annuitant promises to pay single
payment with life insurance. It is the most recommended method of paying premium
due to its attractive tax features.
Installment Premium: Installment premium refers to annuity contract purchased
through periodic payments over a given period of time. This contract starts with large
initial payment followed by series of small installments.
There are plans that combine both single and installment premium methods. They are
called flexible plans. Under these plans, the investor starts with a single large initial
investment. The investor may also put more money and has no obligations of making
future payment at set intervals.
Disposition of Proceeds: Annuitants follow the principle of pay-now and receive-
later concept. According to annuity disbursement, you can take a lump sum payment or
annuitize the distribution into regular payments over a specific period of time. There are
various types of annuity disbursement options such as:
Life Annuity with no Refund: Life annuity with no refund is also called straight life
annuity. Under this the annuitant receives specified amount of income for life
irrespective of distribution period. The insurer distributes large amount for certain
period and no refund is made upon the annuitant’s death to the heirs or beneficiaries. It
is widely used by group annuity contracts and not by individuals.
Guaranteed Minimum Annuity: In this type of contract, the annuitant receives
minimum benefit and unlike life annuity with no refund, here the remaining benefits
after the annuitant’s death are extended to the beneficiaries. There are two forms of
guaranteed minimum annuity – period certain and refund annuity. As per the period
certain annuity, the annuitant is guaranteed minimum amount of monthly income for
minimum number of years. If annuitant dies, beneficiaries receive monthly benefits for
the balance number of period balance no of period. As per the refund annuity if the
annuitant dies, the beneficiary receives monthly payments/cash refund until total
purchase price is refunded.
Short-term Annuities: They are of two types – annuity certain, and temporary life
annuity. As per annuity certain, the annuitant receives monthly income for certain
period of time irrespective of his/her life contingency. Under temporary life annuity, the
annuitant receives benefits for a specified period and no future payments are made after
the annuitant’s death. It is most suitable to those who don’t have the beneficiaries.
Inception Date of Benefits: According to this, annuities are divided into two types –
immediate annuity, and deferred annuity.
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Immediate Annuity: Under this, the annuitant purchases annuity with a single payment
and receives benefit immediately after purchasing it.
Deferred Annuity: Under this type of annuity, the payment of annuity is delayed or
deferred for certain number of years. The annuitant purchases annuity either in lump
sum or in installments. It has numerous options for paying the premiums or for
receiving the proceeds. The advantage of using this annuity is the savings build up over
time and it is free from taxes. Most annuities purchased under group contract are
immediate annuity. Individuals prefer deferred type, especially single premium deferred
annuity because of its attractive tax features.
Method of Calculating Benefits: There are two methods of calculating benefits – fixed
annuity, and variable annuity method.
Fixed Annuity: Money put by the annuitant in this annuity is invested by the insurance
company as in the case of mutual funds. In this annuity, insurance company safeguards
the principal amount and pays a guaranteed rate of interest on the investment. Fixed
annuities don’t fluctuate. The principal amount is secured. Annuity is backed by life
insurance general account. It consists of a variety of investment vehicles. It is also
called investment earning annuity. Insurance companies pay the interest they want as
they are not required to stick to the rate they earn on general account. They are
conservative and low risk annuities.
Variable Annuity: Unlike fixed annuity, in variable annuity monthly income provided
by policy varies. Nothing is guaranteed. Even principal amount is not guaranteed. When
the annuitant buys a variable annuity, he/she should decide investment vehicles based
on their objectives and risk tolerance levels. The returns of the variable annuity depend
on the market.
An Annuity Alternative to Variable and Fixed Annuities: There is an alternative to
either/or of variable and fixed annuities. This is called the ‘Combination Annuity’. It is
partly fixed and partly variable. This type of annuity will allow the individual to receive
his annuity partly of in a fixed manner and part of it will be variable. The benefit of this
type of annuity is that it takes some of the uncertainty out of having only a variable
annuity. The percent in each part of the annuity can be set to each individual’s needs. It
does not have to be 50/50. It could be 75/25 or any other combination the annuitant
feels comfortable with. One of the other benefits of this type of annuity is that it will
protect the investor from a disinflation period.
There are six options allowed to the annuitant or his spouse (in case of his death)
regarding the type of annuity:
i. Pension for the life assured;

ii. Pension guaranteed for 5 years and then for life;

iii. Pension guaranteed for 10 years and then for life;

iv. Pension guaranteed for 15 years and then for life;

v. Pension for the life assured reducing to 50% to the spouse on the death of life
assured; and

vi. Pension for the life assured with the return of purchase price.

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4.13 ESTATE PLANNING
Estate planning is nothing but formulating a plan for proper distribution and disposition
of property to one’s family members. In other words, estate planning is the transfer of a
person’s property from one generation to another according to a person’s wishes and
discretion. Estate planning is important as it provides the disposition of property
according to the wishes of the individual after the death of the individual. It is the
process through which financial support is made available to the family members. It not
only helps in proper management of one’s financial affairs but also helps in comfortable
retirement. It is an ongoing process. Lack of adequate estate planning can cause undue
financial burden to the dependents. Along with other personal financial planning
activities, estate planning also plays a major role and it helps in minimizing taxes.
Estate planning can be said to be successful if it is able to achieve the following
objectives:
a. Determining the heirs or beneficiaries of the estate;
b. Providing financial support to the dependents;
c. Reducing the costs involved in the transfer of assets;
d. Planning the way the beneficiaries will receive the assets;
e. Determining how the estate property has to be distributed;
f. Providing appropriate liquid assets to meet the estate obligations;
g. Deciding on the executors and co-executors, who will settle the estate; and
h. Undertaking proper retirement planning.
NEED FOR ESTATE PLANNING
Estate planning should be a part of everyone’s financial plan, whether a person is
married with children or is single. It is essential to properly account one’s property and
provide financial help to the dependents when the person is no more. There are two
main areas of estate planning, which are discussed hereunder:
People Planning: People planning involve anticipation of the needs of one’s near and
dear ones. It is a process of providing adequate resources for the people for proper
continuation of their lives. People planning are important for the individuals, who have
minor children or dependents, who are mentally or physically handicapped.
Asset Planning: Asset planning is required when an estate involves a closely held
business. It is necessary to maximize the asset’s value both during the lifetime of the
owner and after his death.
ESTATE BREAK-UP – THE REASONS
An estate may shrink or reduce in value due to various reasons, which are beyond the
control of the individual. They are discussed hereunder:
Death-Related Costs: On the death of a person, a number of expenses remain unpaid
and bills to be settled. The expenses may be in the form of funeral expenses, medical
bills, probate expenses and other administrative expenses;
Inflation: Inflation is another problem, which may reduce the value of property;
Lack of Liquidity: The property may not be sold when needed, due to lack of buyers or
bargain at low value, and thus there may be difficulty in covering the unpaid medical
bills and other expenses;
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Improper Uses of Assets: Assets may be transferred to the beneficiaries, who are
unwilling or unable to handle them, and thus it may lead to misuse of property; and
Disabilities: The breadearner of the family may become disabled. It hampers the future
of the dependents and may diminish the value of the estate at an incredible speed.
ESTATE PLANNING PROCESS
The estate planning process consists of the following seven steps:
Estate Planning Goals: The first step is to assess the situation with respect to the family,
its financial condition, and accordingly formulate the estate planning goals;
Gather Data: Gather information required for proper estate planning with respect to the
information regarding the family;
Value the Assets: The next most important step is to value the estate. For this, a proper
list of assets has to be made and then the value of the assets should be determined;
Beneficiaries: The next step is to determine the beneficiaries who would benefit from
the estate;
Estimation of Transfer Costs: Transfer costs need to be estimated and a provision has to
be made for them;
Formulation and Implementation: The plan has to be implemented strictly, and advice
from the attorney can also be taken when needed; and
Review: Review is essential that the plan is properly reviewed after sometime to take
into consideration the inflation cost and various other factors, which may affect the
value of the estate.
INFORMATION REQUIRED FOR ESTATE PLANNING
The following information is needed for making an effective estate plan:
Basic Details: Personal data of the individual such as name, address, occupation, health
problems, marital status, education, wills, trusts, etc., as well as details about family
members.
Property: Value of marketable securities, value of real estate, and other properties.
Life Insurance: Type of policy, name of the insurance company and its address.
Health Insurance: Medical expense insurance details and disability insurance details.
Business: Names and addresses of businesses owned or jointly owned.
Income: Income of the individual, income of the spouse, and the dependents.
Finances: Finances of the family, economic objectives and needs of the family.
Liabilities: Amounts to be paid to the creditors.
Documents: Receipts of important documents deposited with institutions and copies of
original documents where they are available, and
Employee Benefits: Pension benefits and group insurance plans.
METHODS OF TRANSFERRING THE PROPERTY
The methods of transferring an individual’s wealth to others can be broadly classified as
follows:
a. Transfer during lifetime:
i. Lifetime gifts through irrevocable trusts and custodianship;
ii. Exercise of power of attorney; and
iii. Selling the property within the family.
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b. Transfers at death:
i. By will – outright transfer or through testamentary trusts; and
ii. Through life insurance benefit to individuals or trusts.
c. Annuities and other forms.
TOOLS FOR ESTATE PLANNING
There are broadly four different kinds of tools for planning the assets of the individual.
• Will,
• Trusts,
• Estate Planning Documents.
All these tools are discussed in detail below:
Will: A will is a written and legally enforceable expression or declaration of a person’s
wishes concerning the disposition of his or her property on death.
Intestacy: Intestacy is a situation when a person dies without making his will. In other
words, the person concerned failed to make his will to determine the proper disposition
of his property. Normally, the surviving spouse and children are the main beneficiaries.
If the deceased has no surviving spouse and children, the estate will be divided among
the surviving parents, brothers and sisters.
Will Preparation: A will generally names a person, to direct the disposition of his or
her property at his or her death. The person who makes the will is known as a testator
and he can change or revoke the will prior to his death. After the death of the testator,
the will becomes operative.
Will preparation and its cost depend on the individual circumstances. It also depends on
the complexity of the document. If the will is complex involving various properties and
individuals, it would be expensive than a will prescribing the property to be given to his
wife and children. A will not only distributes property but also takes into consideration
the various taxes due. Thus, preparation of a will requires thorough knowledge of
corporate, real estate and other related laws. It should also list the assets passing outside
the testator’s limits.
A will should provide the following information:
i. Information related to the distribution of the assets according to the testator’s
wishes and needs of the beneficiaries;
ii. The probable changes in the family circumstances after the execution of the will;
iii. Proper description of the testator’s desires in all the situations visualized in (ii) of
the above.
Attorney
A will should be drafted with the help of a knowledgeable attorney. Will preparation
involves a number of laws and taxes and thus should not be attempted by a layman.
Features of the Will
Most of the wills contain the following sections:
a. Introductory Clause: The introductory clause states the name and residence of
the testator. This information determines the law that will apply;
b. Direction of Payments: Direction of payments clause directs the payment of
expenses from the estate;
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c. Disposition: The disposition of the property is generally divided into three
categories. The first category relates to the list of the personal property including
each and every item and to whom it is to be given. This list does not appear in
the will as it may change. The second category relates to the distribution or
passing of money to a specific party or charity. The third category relates to the
distribution of residual assets;
d. Appointment Clause: Appointment clause gives names of the executors of the
will, trustees, their successors and guardians for minor children;
e. Tax Clause: In case no specified provision is made in the will, the taxes are
distributed among the beneficiaries, which result in the reduction of their share
of estate;
f. Simultaneous Death Clause: Simultaneous death clause provides for the
treatment of the property in case of simultaneous death of the spouse. It is
generally assumed that the spouse survives and according to this clause a
specific time period is specified for which the spouse has to survive such as 30 to
60 days to become the beneficiary;
g. Execution and Attestation Clause: The will has to be in writing and attested by
the testator at the end. This is done to avoid frauds, which are generally
committed during preparation; and
h. Witness Clause: The will has to be signed by a witness. It is required to make
sure that the will is of the deceased person only. There are generally two
witnesses who sign the will in the presence of one another. The witnesses have to
mention their respective addresses in the will.
Requirements of a Valid Will
There are three requirements of a will to be valid which are given below:
a. Sound Mind: To make a valid will, it is essential that the person be of a sound
mind. He should not have any form of mental illness. For this, the following
points need to be taken into consideration:
i. The person should know what the will is and is aware of its making and
signing;
ii. He should know what property he owns;
iii. He should have a proper understanding of the relations such as spouse,
children, etc.
iv. He should have a good knowledge of how to distribute the property.
b. Freedom of Choice: While preparing the will, the testator should not have any
undue influence in the form of coercion, threats, etc. as it may affect his freedom
of choice.
c. Proper Execution: The will should be properly executed. For that, the will
should be made in accordance with the laws of the state. In addition to this, it
should be demonstrated that the will is that of the testator only.
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Types of Wills
Wills are of the following types:
• Conditional or Contingent Wills: The will be operated only on the occurrence
of some contingency or when the condition expressed is satisfied. For example,
if a person makes a will saying that the will is effective only when he/she dies
due to cancer. If the person dies due to some other reason, the will he/she
prepared would be applied to intestacy i.e., the will prepared by the person who
has died not due to cancer is invalid;
• Joint Wills: Joint will is a will prepared by two or more persons. It will be
effective only after the death of both. It is not allowed to implement during the
lifetime of either. If one of the person dies his/her property and assets are passed
to the other. In a joint will, there is no changing or revoking of the will on the
death of any one person. One disadvantage of joint will is that the assets are tied
up till both the persons die. When making a joint will, the two people involved
must consider many things. First, they must decide on what property or assets to
include in the will. The couple must agree on who will inherit the remaining
assets after both of their deaths. An executor must be selected to handle the
execution of the joint will. If there are minor children involved, a guardian must
be chosen, as well as a person to manage the children’s assets. The joint will
must be witnessed, and then stored in a safe, accessible place;
• Concurrent Wills: More than one will is prepared by the testator on his
different properties. It is prepared to dispose of some of his property in one
country and some other in another country;
• Holograph Wills: Will which is in its entirety in the handwriting of the testator;
• Duplicate Wills: The testator for the sake of safety prepares a duplicate copy of
the will. It is the same as the original. One will be kept by the testator. The other
copy is kept in a safe custody with a bank or executor or trustee. Each copy has
to be duly signed and attested; and
• Privileged Wills: Privileged will can be oral or written. Any solider in actual
warfare or airman engaged or mariner at sea may pronounce his/her will mouth
in the presence of two witnesses. This pronunciation is privileged will. All the
others are unprivileged wills.
Changing or Revoking the Will

Until the death of the testator, the will cannot be operated. The will can be changed any
time as long as the testator is mentally capable. The will can be revised by the testator,
in case there is a change in the circumstances related to the beneficiaries or his own
financial stability. There may be births, deaths, marriage, and divorce in the family,
which may lead to a change in the will. A will can either be changed or revoked.
Changing the Will

The testator may draw up a codicil to make minor changes to an existing will. Codicil is
a small document reaffirming all provisions of the will except the one to be changed.
The codicil should also have witnesses and should be formally executed.

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In case there are a number of substantial changes number of changes are substantial, it is
better to make a new will than modifying the old one. The old will should be destroyed.
But in some cases, it is better to preserve the old will as it may become operative, if the
new will cannot be executed due to mental incapability of the testator or some other
reason.
Revoking the Will
A will can be revoked in two cases, either by the testator himself or by law of the state.
The testator can revoke the will in the following circumstances:
a. Drawing up another will, which will revoke all the previous wills.
b. Making a codicil, which revokes all other wills than the one being modified.
c. Making a will that is consistent with all the previous wills being made.
d. If the will is mutilated, torn or burnt with the intention of revoking it.
Sometimes through the right of election, that is the right given to the survivor – spouse,
to take a specified portion of the estate regardless of what will provides.
It is the right given by the state only to the surviving spouse.
Safeguarding the Will
The will should be kept safely and the copies of the will should be kept with the
attorney. The will may also be kept with the attorney who has drafted it. But this may
make the choice of the attorney to trouble the testator.
LETTER OF LAST INSTRUCTIONS
There may be some thoughts or wishes a testator wants his/her beneficiaries/ spouse
or children to follow, which are not allowed to include in will. A letter of last
instructions is prepared that contains suggestions or recommendations of the testator’s
wishes or thoughts. It is an informal memorandum having the following directions:
i. Funeral instructions.
ii. Place of the will.
iii. Suggestions with respect to the business.
iv. Personal matters which cannot be handled publicly.
v. Legal and accounting services.
vi. Suggestions for dividing the property.
vii. Explanations with respect to the actions taken in the will.

Administration of the Estate

People usually have assets, debts, etc. So at the time of death, the estate and the claims
with respect to liquidation, if any, have to be properly administrated. The legal process
by which a person’s final debts are settled and legal title to property is formally passed
from the decedent to his or her beneficiaries and heirs is called probate process. Local
court generally appoints a person to take care of all these matters, who is called an
executor. In some cases, the personal representative of the deceased person may take care
of all this. He may collect the assets, pay the bills, settle the claims, and distribute the
remaining assets to the entitled beneficiaries.

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TRUSTS
Another important tool available for estate planning – ‘Trust’ A trust facilitates the
transfer of income and property to another party. A trust is a legal relationship where
one of the parties known as the ‘trustor’ transfers the property to another party known as
the ‘trustee’ for the benefit of a third party known as the ‘beneficiary’. The property
placed in the trust is known as the trust principal. The trustee who holds the legal title
should use the property and the income generating from it for the benefit of the
beneficiary. A trust is generally in the form of a written document.
The trustor gives instructions with respect to the use of the property and how to use the
income generated from the property. The trust may be ‘living’ or ‘testamentary’. A
living trust is when the trust is funded during the life of the trustor, whereas the
testamentary trust is created by a will and funded by the probate process. A trust can be
revocable or irrevocable.
Purpose of Trusts
A trust is created mainly for the following main reasons:

Income Tax and Estate Tax Savings: A trust may be created to save taxes.
A person may transfer the tax burden to a trust and thus the income earned by the trust
properties will have a lower tax to pay.
Management and Conservation of Property: Trusts are also created for minors or
people who are incapable of handling their assets. People may be incapable due to their
wrong attitude towards life, are of young age or due to illness, etc. People who are very
busy or have less time for managing their financial affairs can also create trusts to
manage their assets and conserve them on behalf of their beneficiaries.
Selecting a Trustee
A trustee should have the following qualities:
a. Sound knowledge in managing the business or properties involved.
b. Knowledge of the beneficiaries needs and financial situation.
c. Skill in managing the trust.
d. Impartiality in decision-making.

Types of Trusts
The following are the most common forms of trusts:
Living Trust: A living trust is funded during the lifetime of the trustor himself. A trust
may be revocable or irrevocable and may function for a specified time or may continue
even after the death of the trustator:
Revocable Living Trust: Under this type, the grantor has the right to revoke and regain
the trust property. Revocable living trust offers three advantages – operations of the
management and income flow after the death of the grantor are as it is while he/she was
alive; terms and the amount of assets don’t become public knowledge, and the trustee
assumes the burden of investment decisions and management responsibility.
Irrevocable Living Trust: Under this, the grantor has the right to relinquish, revoke or
terminate the trust. The disadvantages include the grantor’s loss of trust property and
income it produces; the grantor’s forfeiture of the right to alter terms of the trust.
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Testamentary Trust: A trust created by the will of the deceased person is known as a
testamentary trust. The testamentary trust comes into existence only after the will is
probated. The property is transferred to the trustee to fund the trust. This may also be
directed by a court.
Irrevocable Life Insurance Trust: An irrevocable trust can be created where the main
asset is the life insurance of the trustor. Thus, the trustee can acquire the proceeds of the
policy as the policy will not be included in the estate of the trustor.
ESTATE PLANNING DOCUMENTS

Apart from the will and letter of last instructions, other documents are also there to
protect one’s interest and that of the family.
The following are the main documents:
Power of Attorney

If a person is affected by a serious illness, it is essential that an individual is named on

behalf of the testator to take care of his/her financial affairs. The power of attorney
transfers enormous powers to the named person. The power of attorney has to be
cleared by the firms where investments have been made by the individual. A power of
attorney can be held by anyone, a spouse or a relative, who is trustworthy.
Another important aspect of estate planning is determining the medical care to be
received by the testator. There are two documents that help in determining the medical
care, testator wish to receive – Living will and Durable power of attorney.
Living Will

Living will provides for the treatment that a person wants and to what extent. This
document helps in giving instructions relating to the medical care that a person may
require in case he or she is not in a position to give his consent or instructions.
Durable Power of Attorney

Through durable power of attorney, an individual makes healthy decisions for the
testator temporarily or permanently. Unlike the living will, instructions can be given for
any situation when the testator is unable to communicate his wishes and not only when
he is terminally ill.

4.14 SUMMARY
Personal Financial Planning refers to the proper planning and implementation of well-
coordinated plans to achieve financial objectives.
Before one starts the process of personal financial planning, it is necessary to assess the
financial position of a person. This can be done by preparing personal financial
statements.
Contingency planning is not just about disasters, but about preparing of events, such as
loss of data, supplier or other disruptive unknown events.
Financial planner is an individual or a firm which helps the clients in establishing the
long-term and short-term financial goals and developing and implementing financial
plans in achieving those goals.
Tax planning is defined as “Considering the tax implications of an individual
throughout the year with the goal of minimizing the tax liability”.
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The two basic assumptions of dignified and honorable tax planning are: All relevant
facts are clearly presented to the tax authorities, and no material information is
deliberately concealed with intent to defraud, and there are no bogus transactions or
make-believe devices resorted to in order to circumvent any legal provisions.
Capital gains arising from the transfer of immovable property are chargeable to tax in
the previous year, in which the effective transfer of title is conveyed and registered.
Insurance planning thus involves predicting or anticipating losses, which occur to assets
by weaving insurance into one’s financial plans. Insurance is of two types – Life
insurance and Non-life insurance.
Life insurance provide financial security to the dependants of the insured in the event of
his/her death the need of life insurance either when he gets married or when children
enter the picture. The life insurance requirements change both in terms of the amount of
insurance and the type of policies based on their changing objectives and building
assets.
There are two commonly used techniques in estimating an individual’s life insurance
needs – multiple earnings approach, and needs approach.
Three types of life insurance discussed in detail below: (i) Term Insurance, (ii) Pure
Endowment, (iii) Whole Life Insurance, (iv) Endowment Assurance, and (v) Universal
and Variable Life Insurance.
Retirement planning is a forward-looking planning. Deciding when to begin retirement
life is a big question. Individuals are so much involved in issues like buying a house,
changing jobs or starting a family that no time is found to decide on when to start
retirement.
The size of one’s retirement investment depends on when the investment program has
started and at what rate of return.
Retirement goals should be set in a realistic manner. They should be reviewed annually
by a knowledgeable and experienced retirement professional.
The three sources of income for the retired people are social security, assets and pension
plans.
Estate planning is important as it provides the disposition of property according to the
wishes of the individual after the death of the individual. It is the process through which
financial support is made available to the family members.
There are four different kinds of tools for planning the assets of the individual – Will,
Trusts, Power of attorney for asset management, and Living will and durable power of
attorney for healthcare.

4.15 GLOSSARY
Personal Financial Planning is the proper planning and implementation of well-
coordinated plans to achieve one’s financial goals.
A Financial Year begins on 1st April and ends on March 31st for income tax purposes,
although previously companies could choose one-year periods of their convenience.
Insurance is a contract (policy) in which an individual or entity receives financial
protection or reimbursement against losses from an insurance company.

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4.16 SUGGESTED READINGS/REFERENCE MATERIAL
• Victor Hallman, G. Personal Financial Planning. McGraw-Hill, 1993, 2003.
• G Victor Hallman & Jerry S Rosenbloom, Personal Financial Planning,
McGraw-Hill, 2003.
• Gitman. Personal Financial Planning, SouthWestern College Pub, 2007.

4.17 SUGGESTED ANSWERS

Self-Assessment Questions – 1
a. There are three long-term rewards of personal financial planning –
Improved standard of living: Personal financial planning helps manage one’s
resources and control undue expenses. Standard of living represents the quality
of a person’s lifestyle. A person can maintain his/her standard of living or even
improve it by planning efficiently his/her income and expenses and then provide
for investment to meet the future contingencies.
Spending Money Wisely: Spending money wisely is another pay-off of
personal financial planning. An individual always has two options with him/her
with respect to his/her hard-earned money – spend it or save it for the future.
Sometimes, it is important for an individual to forgo his/her current needs to save
for the future. Thus, if money needs to be spent, it should be spent wisely. Put
differently, one should think of what manner of spending or what type of
spending in what combination – gives the most satisfaction for each rupee spent.
Wealth Accumulation: Personal financial planning plays an important role in
accumulating wealth. There is a general tendency among people to accumulate
wealth, which may be in the form of tangible or intangible assets. Personal
financial planning can help a person to formulate a plan for investing in assets at
the right time, without disturbing the current income.
b. Net worth is the amount of money left after selling all owned assets at their
estimated market value and paying off all liabilities. In personal finance, net
worth is the individual’s net economic position.

Self-Assessment Questions – 2
a. Significance of Tax Planning
Tax planning is basically an ongoing and year-round activity.
• It involves use of investment vehicles, retirement programs/estate
distribution to reduce/shift/defer taxes;
• It reduces taxes by using the techniques that create tax deductions; shifts
taxes by using gifts or trusts to shift some of the income to other family
members who are in lower tax brackets;
• Deferring taxes can be done by reducing or eliminating taxes today by
pushing them to the future;
• By way of tax planning, one can take advantage of all deductions and tax
provisions to minimize tax liability, and
• Tax planning is closely related to many personal financial planning
activities – investment/retirement and estate planning.
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b. Contingency planning plans for proper and immediate steps are to be taken by
the management or employees when an emergency occurs.

Self-Assessment Questions – 3
a. Insurance planning means figuring out adequate cover against "insurable risks"
and getting the maximum out of the premium a person pays.
4.18 TERMINAL QUESTIONS
A. Multiple Choice
1. Personal Financial Planning includes _________________.
a. Insurance Planning
b. Tax Planning
c. Retirement and Estate Planning
d. Only (a), (b) and (c) of the above
e. Budgeting.
2. _______________ is the pure and cheapest form of insurance.
a. Term insurance plan.
b. Endowment plan.
c. ULIP
d. Money Back Plan
e. Annuity Plan.
3. As far as Income Tax is concerned, PPF comes under ______________.
a. EET
b. ETT
c. EEE
d. ETE
e. TEE.
4. Which of the following is/are correct?
a. A trust is a legal relationship where one of the parties known as the
trustee transfers the property to another party known as trustor for the
benefit of a third party.
b. The trustor transfers the property to the beneficiary under the legal
relationship of trust for the benefit of trustee.
c. Trust may be living or testamentary.
d. A testamentary trust is created by a will.
e. Both (c) and (d) of the above.
5. An estate may shrink or reduce in value due to various reasons, which are
beyond the control of the individual. Which of the following is not a factor that
reduces the value of the estate?
a. Death related costs.
b. Inflation.
c. Lack of liquidity.
d. Improper use of asset.
e. Disabilities.
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B. Descriptive
1. What is the need for Personal Financial Planning?
2. Elaborate the process of Personal Financial Planning.
3. What are the requisites of a good financial planner?
4. How would you determine the investment required to have happy post retirement
life? Discuss the steps involved in it.
5. What is Estate Planning? What are the tools for Estate Planning?

These questions will help you to understand the unit better. These are for your
practice only.

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NOTES

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NOTES

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Block Unit Unit Title

Nos.

I FUNDAMENTALS OF WEALTH MANAGEMENT

1. Introduction to Wealth Management

2. Understanding the Wealth Management Process

3. Client Profiling

4. Personal Financial Planning

II INVESTMENT AVENUES

5. Investment and Investment Products

6. Alternative Investment Options

7. Mutual Funds

III INVESTMENT MANAGEMENT

8. Asset Allocation

9. Portfolio Management and Performance

Measurement of Portfolios

IV MARKETING ASPECTS OF WEALTH

MANAGEMENT

10. Marketing of Financial Products

11. Behavioral Skills for Wealth Management

13. Understanding Investor Psychology