CFP - General Principles of Financial Planning (15% of the exam) - Section B.13

Education needs analysis

Projecting future education costs with an education inflation rate, computing the required lump sum or periodic saving, and adjusting for expected financial aid, the number of years of study and the client's time horizon.

Education funding calculations

Practice question for this objective

Free sampleGeneral Principles of Financial Planningmedium

A planner is starting an education needs analysis for a client whose child enrols on a degree course in exactly nine years. Tuition costs 22,000 dollars a year in today's money, education costs are expected to rise by 5.5 per cent a year, and the education portfolio is expected to earn 7.5 per cent a year. Tuition is payable at the start of each academic year, so the planner will value the stream as an annuity due at the enrolment date using an inflation-adjusted rate. Which pair correctly states the first year's tuition payable on the enrolment date and the inflation-adjusted rate to use?

A22,000 dollars and 1.90 per cent
B35,620 dollars and 2.00 per cent
C35,620 dollars and 1.90 per cent Correct
D37,579 dollars and 2.00 per cent

Set up an education funding calculation by inflating the first payment to the enrolment date and deriving the real rate by division. Two set up figures drive the whole calculation. The first tuition payment falls on the enrolment date, nine years away, so it is 22,000 multiplied by 1.055 to the power 9. That factor is 1.619094, giving 35,620 dollars. The rate must be inflation-adjusted because the payments after the first keep growing at 5.5 per cent while the fund earns 7.5 per cent, so it is (1.075 divided by 1.055) minus 1, which is 0.02 divided by 1.055, or 0.0189573, that is 1.90 per cent. Subtracting 5.5 from 7.5 to get 2.00 per cent is an approximation that breaks down as rates and time horizons grow, and inflating for ten years counts the year of enrolment twice.

Why A is wrong: The rate is right but the cost is the amount payable today, not on the enrolment date. Tuition rises for the whole nine years before the first payment, so using the current figure understates every payment in the stream.

Why B is wrong: The inflated cost is right but the rate is the simple difference between 7.5 per cent and 5.5 per cent. Subtracting the rates rather than dividing the growth factors overstates the real return slightly and understates the fund needed at enrolment.

Why C is correct: The cost is 22,000 multiplied by 1.055 to the power 9, and the rate is (1.075 divided by 1.055) minus 1. Both the inflation of the first payment and the division of the two growth rates are done as the annuity due method requires.

Why D is wrong: This inflates for ten years rather than nine, counting the enrolment year twice, and also subtracts the rates instead of dividing the growth factors. Both errors are common when the timeline is drawn with the first payment one year after enrolment.

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Exam traps in General Principles of Financial Planning

Answers that look right on this material and are not. Each one is a distractor from a different question in the CFP bank for this domain.

Approximately 3,557 dollars a year
Why it is wrong: This inflates the first year's cost correctly but discounts the four tuition payments at the nominal 9 per cent return rather than the inflation-adjusted rate. Ignoring the 6 per cent education inflation that continues during the course understates the fund needed at enrolment and therefore understates the deposit.
Approximately 78,092 dollars
Why it is wrong: This is the same calculation done as an ordinary annuity, which pushes every tuition payment back by one year. The stem states that tuition falls due at the start of each academic year, so the first payment coincides with the enrolment date and is not discounted within the annuity.
9,277 dollars
Why it is wrong: This is the level payment answer, found by inflating the goal to 134,391.64 dollars and dividing by the 8 percent ordinary annuity factor of 14.4865625, and it is a defensible funding method but not the one the stem specifies, because a level payment is constant in nominal terms and so front-loads the burden rather than rising with inflation.

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