Designing Financial Plans
Many opportunities, demands, achievements and dreams in life are related to money. Financial planning not only involves money budgets, but also a way to enhance the quality of your life. As there are no canned itineraries (guided travel tours) for the journey of life, we must be well-prepared in order to achieve your financial goals.
Different stages in life have different financial needs. Below are the important components in the financial planning process:
- Career planning: Set career goals and plans for promotion
Cash management: Includes management of debt, income and expenses
- Investment management: Ways to accumulate and create wealth
Risk management: Ways to manage accidents and losses, with the most important being insurance planning
- Tax management: Ways to legally alleviate the burden of taxes
- Retirement planning: Plan ahead to achieve maximum protection after retirement
- Estate planning: Designate inheritors aptly to avoid unnecessary conflicts and taxes
- Asset protection: Ways to protect personal property to avoid the loss of assets
Financial Needs in Different Stages of Life
As one ages, the environment, conditions, wishes and limitations of life also change. Important moments in life, such as getting married, having children, purchasing property and getting retired, directly affect our financial decisions. For every decision, we must take into account the life cycle of wealth, which includes wealth creation, accumulation, consolidation, and distribution. A clear understanding of the needs in different life stages is important and helps get yourself well prepared and dreams to come true.
From learning to talk as a toddler to attending kindergarten, secondary school and university to graduation, we are continuously learning and accumulating knowledge in order to fully prepare ourselves to live and work in our society. As full-time students do not have income, they mainly rely on their parents for their daily expenses and thus do not have much financial pressure. Nevertheless, we should still establish correct values and attitudes towards money and financial planning from a young age by learning useful financial knowledge, so that we will be ready for the future.
2. Entering the Workforce
Since fresh graduates do not have much working experience, they do not usually have a very high salary from the first job they take. But, at the same time, young people usually do not yet have much family burden. Therefore, to take advantage of this early stage, you’ll probably want to start putting your extra money in a savings account. With good management, our assets will stably grow year by year, hence allowing us to be prepared for future pursuits such as marriage and home purchase.
3. Forming a Family
(i) Getting Married
Getting married is a matter of making life commitments, and accordingly the associated expenses can be quite overwhelming. All soon-to-be newlyweds want a perfect wedding with the best of everything, such as banquet, suits and gowns, photography, decoration, limousine, honeymoon etc., each and every one of which can be very costly. A survey conducted in 2011 revealed the average expenses on weddings of the 1900 couples interviewed to be over $260,000, which is higher than the same figure from the previous year by almost 10%.
With increasing inflation, the upward pressure on wedding cost is inevitable. Furthermore, a lot of couples tend to overspend in a big way. Quite a number of couples face the problem of over budget and are forced to take out personal loans from finance companies or banks, resulting in a huge financial pressure after marriages. Therefore, planning ahead not only help you to avoid these hardship, but also to build a strong financial foundation for your relationship. We should start savings or financial planning right after landing our first job, in a way to ensure wedding can happen at the best time of our lives.
(ii) Purchasing Property
In Chinese tradition, buying property is an important stage in life and often happen simultaneously with marriage. With surging property prices and inflation in recent years, the purchase of a new home immediately after marriage has become a challenge. There are two main options for accommodation after marriage – renting or buying. This decision has become an important part of financial planning in matrimony.
Recently a TV series that dramatizes the difficulties of Hong Kongers to buy their own flats has become widely popular, as the general public identifies with the situation in the drama where the pace of salary rise can never reach the pace of surging property prices. In an interview with 2000 prospective brides and grooms who planned to get married before 2013, 93% hoped that they could buy their own homes after their nuptials but only 45% of them thought they had the ability to do so. In fact, a lot of young people nowadays need parental financial assistance for down payment burden in purchasing a home. Even so, young people still need to be very cautious when selecting a mortgage plan in order to make future payments easier to budget.
There are currently 3 main mortgage plans on the market, including prime rate, HIBOR, and the less common fixed-rate mortgage. Prime rate mortgage is said to be the most conventional mortgage plan, where the interest rate is fixed on a certain percentage below the prime rate. If banks raise their interest rates and cause the prime rate to increase, the borrower’s periodic payment also increases. Since banks in Hong Kong adjust the prime rate based on the US interest rate, the prime rate in Hong Kong is likely to remain at a low level as the US Federal Reserve has recently announced that interest rates to stay lower for longer. Currently, large banks and small banks in Hong Kong have kept the prime rate at 5% and 5 respectively.
The prime rate mortgage plan used to be the most popular option since the periodic payments are relatively more stable and borrowers will not go greatly over budget. Moreover, the cash rebates are usually higher in the prime rate plan. However, with near-zero US interest rates, banks are no longer able to reduce prime mortgage rates by much. Hence, the prime rate plan is gradually being replaced by the increasingly popular HIBOR plan.
The HIBOR plan benchmarks the interest rate against the Hong Kong Inter-bank Offered Rate (HIBOR) and adds a certain percentage (such as 2.2%) on it. Borrowers have the choice to peg the interest rate of their mortgage loans to the HIBOR of different periods of time, such as 1, 3, 6 or 12 months. HIBOR is mainly affected by the amount of funds in the market. Usually when the availability of funds in the market increases, HIBOR decreases; and when there is a shortage of funds, HIBOR will be greatly increased. Thus, borrowers who use HIBOR as a benchmark (particularly 1 month HIBOR) may face big fluctuations in their periodic payments. As for the fixed-rate plan, banks will fix the interest rate of a certain period of time (such as the first 3 years), and the interest rate becomes variable afterwards. Some banks could fix the periodic payment throughout the entire life of the mortgage under the fixed-rate plan.
Below is an example of the calculation of the monthly payment for reference. In the example, the property is worth $3 million, with a down payment of 30%, a mortgage loan of 70%, a term of 20 years and an interest rate of 2.5%p.a.a. The monthly payment required is $11,128. See below for the figure:
4. Child Education Planning
To be sure, having children involves huge expenses, in particular the children educational costs. To nurture a child to success is the dream of every parent. Whether in Hong Kong or overseas, education is very expensive. If you want to find out the future costs of education, you should first choose the school your children will enroll in and take into account the factors of inflation to arrive an estimation of future expenses.
University Tuition Costs:
Source: Hong Kong Education Bureau 2018
Here is an example of a 4-year bachelor’s degree program in a US university: Assume the age of enrolling is 19, with the tuition fees increasing by 5% annually and annual investment returns of 8%, the monthly savings required are as follows:
As we can see, the earlier you start saving up for your kids’ education, the less you need to save in each month. Therefore, now is the right time to start preparing for the bright future of your children!
After years of hard work, it is time to take a rest and start reaping what you have sowed. In retirement, our living expenses mainly come from MPF and our own savings. How much protection should we expect from MPF? How much savings do we need in order to lead a worry-free retired life?
We will first talk about MPF. Assume you start participating in the MPF scheme at age 21, MPF can save a maximum of $2,000 for you per month. When you retire at age 65, the total contributions are $1,080,000. With life expectancies becoming longer, 20-year-olds can live until age 85 or even later. In the 20 years after retirement, how much is money does one need? If you rely completely on MPF, its investment returns need to be extremely high, but the expectation could be unrealistic. According to the research report published by the MPFA, the average return rate of the MPF over the past 10 years (2000 to 2010) is 5.5%, barring all fees and payments. With an annual inflation rate of 2%, the average net annual return is only 3.5%. Generally speaking, MPF is only enough to cover living expenses for 10 years after retirement. If we solely rely on the MPF, we will not be able to support ourselves in retirement.
Calculating Post-Retirement Financial Needs
Since everyone has different expectations on their quality of life, the financial needs after retirement cannot be determined in a straightforward fashion. For normal employees, the living expenses after retirement are at least 70-80% of those before retirement. For example. if you retire at age 65, having 20 years of golden days ahead, your pre-retirement expense is 80% of your income, then the retirement amount needed is 12 or 13 times your annual salary at the time of retirement. Financial planners in Europe and the US often suggest that every working individual should have assets that are worth at least 10 times their annual salary at retirement. If you have less than that amount, you have the choices of postponing your retirement, working part-time after retirement or lead a more conservative retirement life.
To find out how much money is enough for retirement, you first have to answer the following questions:
1. Age of retirement: In how many years do you plan to retire?
2. Years of life after retirement: Equals to the difference between life expectancy and the retirement age. According to the Census and Statistics Department’s estimates, the life expectancies of males and females in Hong Kong in 2039 are 86 and 92 respectively. Thus, people will spend around 25-30 years of life in retirement (see Table 1 below).
3. Living expenses after retirement: When you are completely retired, how much will you spend per month? You can estimate the amount required to maintain your quality of life from your current monthly expenditure (see Table 2 below).
4. Expected inflation rate: The annual increase in general price level, 3% is a suggested rate.
5. Expected rate of return on investment: Since we do not suggest high-risk investments after retirement, the expected rate of return should not be high, 5% is a suggested rate.
Furthermore, with advancements in medicine, life expectancies will continue to increase in the future, hence bringing more unknowns into retirement planning. According to the Census and Statistics Department’s population estimates from 2010 to 2039 (see table below), a male born in 2009 has a life expectancy of 79.8 years at birth, but his life expectancy increases to 82.6 years by the time he is 60. From this we can see that the difference between the life expectancies at birth and at age 60 is widening. Hence, the expected rate of return on investments needs to be raised a bit so as to take into account the extra expenditure required if you live longer than expected.
Table 1: Average life expectancy from 1898 to 2039
Assume you start saving today, how much do you need to save in each month to reach the goal of having 10 times your annual wage at retirement? Assume your wages are adjusted for inflation annually, the following table shows how much you need to save per month. If you have not reached 45 years old, you can assume an annual return of 5%. If you are over 45 years old, you should be more cautious and use 3% instead. From the table below, you will need to save 12 % of your income if you start saving at age 30. But if you start saving at age 40, you will need to save 22% of your income every month. MPF helps you save 10% (or $2000), and you will need to save up the rest on your own.
Planning for retirement is critical in life because it typically takes many years to accumulate the necessary funds to live comfortably in retirement. We need to take into consideration other factors such as inflation rate, post retirement income and expenditure, medical expenses etc. In addition, some may have other arrangements, such as emigration, supports for children, changes in lifestyle and arrangements of inheritance.
Obviously, our lives after retirement cannot be solely dependent on MPF without our own savings and investment plans. The earlier you start planning, the more significant is the compound effect and the more protected your retired life will be. As for investment strategies, younger people can be more aggressive to achieve a higher long-term average rate of return; in contrast, the closer to retirement age, the more conservative your investment should be.
Insurance is a form of risk management, allowing us to effectively manage or transfer risks. Otherwise, once unfortunate incidents happen, it is very easy for all your personal plans to dissolve and for your dependent family members to lose their support. Insurance is a form of protection for yourself and your family. No matter how old or how wealthy you are, you will face different risks in different stages of life and the ultimate loss can be eliminated or reduced by adopting suitable insurance planning.
While sickness and death are unavoidable in life, our needs change with different life stages and thus require different protections. Before we set up a suitable plan, we should consider the following according to our “Life Cycle”.
1. Confirm your current most important protection needs, which should be referenced in accordance with your stage in the “Life Cycle”. Then you can make the corresponding financial planning arrangements according to the order of importance.
2. Assess your income stability. This is one of the most important factors to the entire arrangement and has a significant effect on the choice of a suitable financial tool.
3. Under normal circumstances, save 10-15% of your income for personal financial planning. If possible, go through detailed financial analysis before confirming the ratio.
4. Clearly understand your responsibilities, including mortgage principal, children education costs, wedding expenses, living expenses after retirement, etc., before calculating the financial protection required.
5. Set your own financial goals and build a long-term plan accordingly. For instance, if you know that you need $5 million when you retire at age 65, calculate how much you should set aside each month.
Ensuring You Have Enough Insurance
1. Adequate insurance coverage
There should be comprehensive protection in all stages of life. This includes accidents, disability, life protection and targeted savings, etc. Furthermore, there should be enough retirement reserves at old age, medical protection at times of illness, and compensation for family after death.
2. Adequate sum insured
We have different needs in different stages of our “Life Cycle”. Therefore, you should consider how much you need to be adequately protected in different stages and to ensure that your policies are appropriate. For example, are there enough reserves for contingencies? Are there enough reserves for living after retirement?
Tips for Purchasing Life Insurance
- Compare the fees, coverage, exclusion contents and claims processing efficiency of different insurance companies.
- Choose a suitable plan with the help of an independent financial adviser. Not only does it save time, but also gives you unbiased advice to help you make the most appropriate decisions for yourself.
- Traditional life endowment insurance often has low returns, thus policyholders could consider “Term Life Insurance” to get the right protection at a substantially lower premium cost. The money saved can then be used for other long-term investments to enhance the overall return on your assets.
How to Calculate Sum Insured?
There are 3 ways to calculate the sum insured, namely the “Human Life Value Approach”, “Needs Approach” and the “Capital Retention Approach”.
1. Human Life Value Approach
This approach estimates the value of a human life by assuming that the insured dies today and such their family to lose their main source of income. In the approach, the annual income of the insured until their retirement is summed, net out all required expenditures such as taxes and personal living expenses, and resulting in the needed cost to support the family. This present value of this net amount is then the sum insured required.
2. Needs Approach
Assuming that the insured dies at this moment, this approach first calculates the immediate cash needed and monthly payments to his family, resulting in an amount (A).
At the same time the net assets (B) of the insured is valued: If the net asset is positive, then the sum insured is the difference between the two (i.e. A+B). If the net asset is negative, then the required amount is the sum of the two values (i.e. A+B). Below is a table to help your calculations:
3. Capital Retention Approach
This approach assumes that, after the death of the insured, their family members can solely rely on the monetary benefits of the insurance and also leave extra assets for their descendants. In setting up the insurance policy, the required accumulated capitals and expected interest rates should be taken into consideration, such that the income adequately covers the family expenditures after the death of the insured.
However, insurance companies will set an upper limit on the sum insured according to the personal income and the total asset value of the insured. Therefore, the targeted sum insured is still subject to the approval of the insurance company.
Other Insurance Policies
1. Personal accident insurance
Accidents cause injuries and deaths, and thus can be very disheartening. If unfortunately the breadwinner of the family dies or is disabled in an accident, the family may suddenly become helpless.
Accident insurances do not have the power to prevent accidents but without it, families could suffer severe financial blows if accidents do happen.
Below are four main categories of accident insurances:
- Accidental death compensation
Definition: Accidental death compensation equals to the entire sum insured.
- Accidental disability compensation
Definition: The amount of compensation is determined according to the degree of disability. Since the terms of disability coverage are wider than accidental death, the premium is correspondingly higher.
- Accidental disability income compensation
Definition: The condition for this type of compensation is the loss of working ability due to accidents, resulting in a loss of income. Therefore, the insured must have a stable job before purchasing the insurance, and needs to provide relevant proofs of employment before claiming the compensation. With the extra protection, the type of insurance has one of the highest premiums among accident insurances.
- Accidental medical compensation
Definition: Under this compensation plan, the medical expenses incurred by accidents will be compensated. With the sum insured as the maximum amount of compensation, the amount of compensation could be reduced correspondingly if such compensations include deductibles.
Although accidental medical and inpatient medical are both reimbursable on actual costs, the coverage of the compensations is different. Under normal circumstances, accidental medical insurance cover both in- or out-patient expenses, and some plans may also include Chinese herbalist/ bonesetter treatments without extra costs. On the other hand, basic inpatient medical insurance generally does not include outpatient or Chinese herbalist/ bonesetter treatments. If the insured needs additional protection, extra insurance costs will be incurred.
Important points to note when purchasing insurances
When underwriting the conditions for accident insurances, some insurers will include terms such as “caused by external factors” or “apparent injuries”, otherwise the claims would not be accepted. Such information can be obtained from the insurance companies.
The premium for accident insurance is fixed. It usually does not increase with the age of the insured person, but varies with the occupation of the insured.
Accidental death and disability coverage
The compensation is usually determined by the state of the limbs, vision and hearing of the insured, while the amount of compensation is determined by the degree of injury, with the maximum being the sum insured.
2. Critical illness insurance
Some people may think that critical illness insurances are unnecessary if they have good health. In fact, many harmful substances are released into the environment in industrial processes nowadays, causing changes in natural environments and affecting our lives. In our daily lives, we may have negligently taken in a lot of harmful or carcinogenic food substances. This explains why cancer has become a top killer in our society nowadays.
Critical illness insurance often is a one-time compensation. The comprehensive compensation generally covers 30-50 kinds of disease. The insured should be aware that there is usually a 90- to 180-day waiting period. If the insured has pre-existing illness at the time of insurance purchase, insurance companies may require the individual to complete a body check and it may impose extra terms and restrictions on the basis of health conditions:
- Not accepting the purchase, or
- Raising the premium, or
- Not compensating for pre-existing illnesses
3. Inpatient medical insurance
The insured is compensated for inpatient medical treatments of illnesses. Nowadays the price to stay in private hospitals in Hong Kong can be very expensive, from thousands to even millions of dollars. The actual medical fees incurred are directly reimbursed under this type of insurance, but most plans include deductibles which require policy holders to pay more out of pocket before the insurance benefits begin. Moreover, during the waiting period, which may last from 30 to 60 days, apart from accidental claims, most illnesses will be excluded from the insurance coverage.
4. Hospitalization income insurance
Inpatients can receive daily, weekly or monthly monetary benefits to cover short-term needs in funds. Therefore, even if the insured has no income due to hospitalization, they can rely on the compensation to maintain household expenditures.
5. Travel insurance
Purchasing insurance before traveling allows you to spend your vacation in a carefree way. If you become a victim of theft or accidents, you should report the incident to local authorities within 24 hours and remember to take the receipt for claiming compensations. Also, if there are urgent matters or accidents, you should call the insurance hotline as soon as possible to obtain relevant help.
6. Home insurance
Home insurance has a wider coverage, including fires, floods, third party liabilities, thefts and even injuries of passersby caused by the peeling off of building exteriors, leakage of water pipes and injuries of your home guests. Home insurance should be purchased, for both rented and purchased property, to protect your valuables.
Paying taxes can be a heavy burden, but it is also the responsibility of a citizen. If we can make effective and legal tax planning and arrangements under the current tax policies and deductions, we can minimize the amount of payable tax. And if you invest wisely, you could see your savings to grow.
There are currently three main types of direct taxes in Hong Kong:
1.Salaries Tax–imposed on all income arising in or derived from Hong Kong from an office, employment or any pension
2.Profits Tax–imposed on profits from operating businesses in Hong Kong
3.Property Tax–imposed on income from leasing property in Hong Kong
Most taxpayers are single income earners who pay salaries tax. The amount of salaries tax payable is determined by your net chargeable income with the progressive rate, or by your total net income with the standard rate, whichever is lower. Not only can applicants enjoy basic allowance, child allowance and dependent parent allowance, they can also enjoy the following deductions:
- Expenses that are incurred in the production of income, excluding family or personal expenses
- Depreciation for plant and machinery essential to producing your assessable income
- Expenses of self-education
- Donations made to approved charitable organizations
- Fees paid to a residential care home for a parent or grandparent
- Home loan interest
- Contributions to a Mandatory Provident Fund Scheme or recognized occupational retirement scheme
Please see the analysis below:
Net Chargeable Income = Income – Deductions – Allowances
Net Income = Income – Deductions
Tax rates for the 2017/18 year of assessment:
Tax rates for the 2018/19 onwards year of assessment:
Year of Assessment starts from 1st April every year to 31st March in the next year.
Profits and Property Tax
If you need to pay profits tax and/ or property tax in addition to salaries tax, you can consider applying for personal assessment. Personal assessment processes the multiple incomes of a taxpayer and selects the lower amount from standard rate and progressive rate. This shows that personal assessment is not a tax, but is a tax relief for payers of profits and/ or property tax.
Tax Planning Arrangements
1. Tax Loans
Generally speaking, taxes roughly equal to the wages of 1-2 months. For taxpayers with no habit of saving money or who spends all money every month, it is very difficult to raise sufficient funds when the tax season comes. They can consider low-interest tax loans to help pay their taxes. Some people even take advantages of the low interest rates to get more funds for investments.
Something we should note is that if we suffer losses in our investments and do not have enough cash to pay our taxes, tax penalties are usually higher than the interests from tax loans. Furthermore, we should set up a schedule to clear our debts after paying taxes in order to prevent the interest rates from snowballing.
Some people may use credit cards to pay taxes. The advantage is that the banks will directly pay the taxes upfront to the IRS, and you will then have a 56-day interest-free repayment period, which is equivalent to postponing the taxpaying date. There may even be points and gifts to reward the usage of the credit card. However, some banks require more time to process taxpaying applications and may cause cardholders to miss the tax payment deadline. If you would like to pay your taxes by credit card, you should apply to your bank in advance to avoid extra fees.
2. Tax Reserves
A more positive way of financial planning is to set aside tax expenses every month. Since taxes account for 1-2 months’ wages, we should set aside at least 10-20% of our monthly salary before spending the rest. If you are on a tight budget, you can consider cutting some unnecessary expenses, such as dining out or upgrading your mobile phone.
If you lack motivation to start saving, you can consider purchasing tax reserve certificates. The Tax Reserve Certificates Scheme is a “Save for Tax” scheme to help taxpayers avoid paying fines for late taxes. After opening a TRC account, taxpayers can purchase the certificates through various electronic channels, such as eTAX, PPS, monthly bank autopay, etc. The interest rate of TRC is adjusted with the market interest rate, and the interests earned will be used for payment of the TRC holder’s tax.
Many people, whether rich or poor, spend their lives accumulating their wealth. When we leave this world, passing on our wealth and legacy becomes the last matter in our lives that requires financial planning. Settling the inheritance of our estate early on can reduce conflicts and can ensure the living standards of our loved ones. There are many tools that can be used for estate planning, including wills, trusts, life insurance and management rights purchase agreements, etc.
Wills are the most basic documents for transferring wealth after death. If you do not establish a will in your lifetime, your estate will be managed according to the ruling of the court. Beneficiaries may then have to face complicated probate procedures with unnecessary expenses.
If the deceased made a will, then their estate would be arranged according to their wishes. When you make a will, you should take note of the following (or visit http://www.clic.org.hk）:
- When the testator signs the will according to their own wish, there should be 2 witnesses on the scene.
- The witnesses also need to sign the will according to their own wish in the presence of the testator (but not necessarily in the presence of the other witness).
To people with assets of higher net values, setting up a trust account is an economical way to gain full control of when and how to use or allocate their assets. Trusts usually involve settlors, trustees and beneficiaries. Settlors can allocate their assets to specific beneficiaries through contracts with trustees, while trustees must manage the assets according to the terms of the contract.
The advantages of setting up a trust are that settlers have the right to change or cancel established trusts in their lifetimes, and that trusts can be very confidential. Setting up a comprehensive trust account can ensure that your assets will be managed according to your wishes after your death, minimize tax expenditures, prevent expenses and delays from verification of wills, and keep your financial information confidential. Even if you unfortunately become disabled, your assets are still under protection and will be managed appropriately.