RETIREMENT PLANNING in .NET

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RETIREMENT PLANNING
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232 - Retirement Planning
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TOPIC 72: RETIREMENT NEEDS ANALYSIS
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1 Assumptions for Retirement Planning A In ation The costs of goods and services that retirees use most often increase faster than the general rate of in ation measured by the Consumer Price Index (CPI) B Retirement period and life expectancy Retirement period is contingent on various factors: years until retirement, years in retirement, and family history/longevity C Lifestyle Before retiring, have your clients attempt to live on 80 percent of their current income You can offer to invest the remainder Most clients need more than 100 percent to maintain their current standard of living D Total return Project investment return and project the tax rate 2 Financial needs A Living costs B Charitable and bene ciary gifting objectives: To stretch your client s retirement income, you may want to explore charitable estate planning strategies and reduce your client s current, ongoing contributions to charity C Medical costs, including long-term care needs analysis D Other (trust and foundation funding, education funding, etc): current residence, food costs, car loans, auto insurance costs, clothing cost, health insurance premiums, recreation costs, future savings, and income taxes 3 Income sources A Total return assumptions (1) Return assumptions include all sources of future income, such as quali ed retirement plans, tax-deferred plans, and Social Security (2) Retirement income-need analysis calculation comprehensive example: PV I N FV PMT Present value Interest rate Number of periods Future value Payment
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Jim Parker is currently age 37 and Sarah Parker is age 34 The Parkers would like to retire when Jim is age 65 (preretirement period of 28 years) The retirement income need is $70,000 in today s dollars They will need to provide for retirement income until Sarah has reached age 95 (postretirement period of 33 years) They expect to earn an after-tax return of 8 percent, and in ation of 3 percent The planner anticipates Social Security income to be $15,000 at retirement Step 1 Adjust income de cit for in ation over preretirement period Solve future value of income de cit in rst year of retirement Subtract Social Security income to arrive at a net amount of $55,000 PV = $55,000, I = 3%, N = 28, solve FV $125,836 Determine retirement fund needed to meet income de cit Solve lump sum needed at beginning of retirement (present value annuity due) to fund annual income de cit that increases annually with in ation (ie, a growing annuity) Find in ation-adjusted rate of return [(108/103) 1] 100 = 485%
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Topic 72: Retirement Needs Analysis - 233 The in ation-adjusted rate of return is a serial payment It increases each year by the assumed in ation rate Calculator should be set to begin mode, because payments are expected at the beginning of each year PMT = $125,836; I = 485; N = 33; FV = 0; solve PV $2,150,395 Change calculator back to end mode Step 2 Analyze current assets and project growth from now to retirement This amount is compared with the need projected in Step 1 The Parkers have $150,000 in assets targeted for retirement purposes Find the future value of these assets at retirement PV = $150,000; I = 8; N = 28; solve FV $1,294,065 Shortfall is $2,150,395 $1,294,065 = $856,329 Step 3 Determine additional savings needs by solving for yearly payments Use level payment or serial payment Level payment accounts for in ation Remember that an 8 percent after-tax return is the nominal rate In basic terms, the nominal return = real rate + in ation rate Solve for payment FV = $856,329; N = 28; I = 8%, PV = 0; solve PMT $8,982 The Parkers will need to save $8,982 each year during the accumulation phase to reach the shortfall of $856,329 in assets Serial payments provide an in ation adjustment during the accumulation years because the payments increase each year by the in ation rate (this was automatically done during the level payment calculation) In order to calculate the rst year serial payment, in ation must be removed from the future value of current assets because it will be accounted for in the serial payments and cannot be counted twice The shortfall value of $856,329 is de ated for in ation FV = $856,329; N = 28; I = 3%, PMT = 0; solve PV $374,281 The in ation-adjusted interest rate is used for serial payments It was earlier calculated as [(108/103) 1] 100 = 485% Calculate rst year serial payments FV = $374,281; N = 28; I = 485; PV = 0; solve PMT $6,562 This amount is increased by the in ation rate to provide the rst year serial payments $6,562 103 = $6,759 If this amount is increased for in ation each year, the total future value at retirement will equal $856,329 Therefore, either using the level payment method or the serial payment method will yield the same result at retirement B Probabilistic analysis assumptions (1) The Monte Carlo system uses baseline information, such as age and the current value and composition of investments, along with certain assumptions about the unknown future, such as changing in ation rates, life expectancy and investment returns Then
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234 - Retirement Planning the program runs through hundreds or thousands of random combinations to determine how much a client can safely spend at retirement (2) Monte Carlo can be misleading if a planner uses the wrong assumptions 4 Alternatives to compensate for projected cash- ow shortfalls A Consider making the maximum contribution to quali ed retirement plans B Decrease current and future expenditures C Participate in more aggressive investments D Advance the retirement age or lower the desired amount of income E Accept more risk by increasing the expected rate of return in forecasts F Consider serial (increasing) annual payments versus level annual payments
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