Question

6. Retirement Planning for Jennifer and Lennon.

Jenifer is an early bird for everything. She starts to contribute $1,000 to her own 401(K) plan right after she joined company A.E. Corp (at the age of 30). Jenifer's colleague, Lennon, is a late bird for everything. He decides to enjoy his life before he turns 45 and then contributes to his 401(K). Over a coffee break, he learns that Jenifer contributes $1,000 per month now. He figured that if he can contribute $2,000 every month starting from age 45 he would have contributed the same amount as Jenifer when they turn 60 years old (he thought they will both contribute a total of $360,000 = 1000 * 30 *12 also = 2000 *15 *12). In this way, he can lead a pretty decent life style before he turns 45 and have the same amount of retirement funds as Jenifer. After his quick calculation, he decides to persuade Jenifer to do the same. 1) If you were Jenifer, do you agree with Lennon? What seems to be the most important factor to determine the end balance in the retirement plan? 3) What other factors are also important with a 401(K) plan? 4) How can you guide your clients like Jennifer and Lennon to make sound financial decisions to optimize their retirement investments? What should you do differently?

Answer 1

1) I would not agree with John because the most important factor which has been overlooked by John is the compounding power of money. Even though the amount of principal are same for both but the interest component over the years for Jenifer is huge. Assuming 2% saving rate , Jenifer would end up with a corpus of around $60mn, thanks to her early saving habit , whereas John would save only $3mn , 20 times less. Thus, John should adopt early saving habit for his retirement plans to match up with Jenifer.

3)Other factors which are important are: With age medical expenditures would shoot up. Thus making larger contributions at later stage of life is difficult than making small contributions at early age. Both must declare the beneficiaries in the event of death so that their hard earned money goes to someone they love.

4) Additional suggestions for them is to set aside money for emergency funds as well because dipping from the retirement corpus for exigent purposes is not a good idea. The portion of income contribution to retirement corpus should rise linearly with your income and other plans like health and insurance should not be clubbed along with your retirement plan. They should be planned separately.