Question

Barry and Samantha are starting to take their retirement planning seriously. They are both 51 and plan to retire in 15 years at the age of 66. They expect to live 20 years in retirement (a life expectancy of 86). Between their 401k and IRA accounts they currently have $132,400 in retirement savings.

They currently have a combined income of $85,000 per year and expect to be able to live comfortably in retirement with 80% of their current purchasing power. They expect inflation to be 2.0% per year for the rest of their lives. They also expect to earn 10% per year on their investments, both now and in retirement.

Conduct an analysis of their retirement planning needs and provide them with a professionally written letter. In the letter and attached schedules provide information that answers the following questions. Please include a description of the relevant assumptions and any explanatory comments that make the results easier to understand.

            What amount of annual income will they need (after adjusting for inflation) in each of the twenty years of retirement to have the purchasing power of 80% of their current income?

            Assuming they will continue to earn 10% on their investments, how much money will they need to have in their retirement accounts when they retire so that it will provide the twenty years of income?

            Taking into account what they currently have in savings, how much will they have to save each month to meet their retirement needs?

            Sensitivity analysis: Redo the analysis assuming that they only earn 8% on their investments, instead of 10%. Determine the needed amounts so they have the money they need in retirement.

Note: Assume that all payments will be made at the end of the year (ordinary annuity).

Answer 1

Dear Barry and Samantha, Congratulations on beginning your journey towards planning for your retirement. Thank you for choosing us as your advisors along this journey. We are happy to answer your questions and to help you to assure a comfortable, planned retirement period. Please find attached the schedules for your retirement plans. Please get back to us, in case of any questions. Regards, XYZ Financial Advisor Schedule 1 - Age and Life Expectancy Current Age	51 years
Expected Retirement Age	66 years
No. of years to retirement, i.e. accumulation period	15 years
Life Expectancy	86 years
No. of years after retirement, i.e. expense period	20 years
Schedule 2 - Computation of monthly savings for accumulation period at 10% return rate
Rate of return during accumulation period of 15 years	10%
Expected rate of return after retirement	10%
Inflation rate	2%
Inflation adjusted return after retirement (((1+10%)/(1+2%))-1)*100	7.843%
Current purchasing power per annum	$85,000
Expected post retirement annual expenditure @80% of current purchasing power	$68,000
Inflation rate	2%
Annual expenditure during period of retirement, adjusted for inflation ($68,000((1+2%)^20years))	$1,01,044
No. of years after retirement	20
Inflation adjusted return during period of retirement	7.843%
Corpus required on retirement to ensure annual expenses for retirement period	$10,03,768
Current corpus amount	$1,32,400
Expected amount of current corpus at start of retirement, adjusted for 10% return p.a. during accumulation period	$5,53,068
Thus, further savings required, to ensure corpus amount	$4,50,700
Present value of further savings, adjusted for 10% return p.a. during accumulation period	$107,894
Thus, monthly savings required at present at 10% return rate	$8,991

Schedule 3 - Computation of monthly savings for accumulation period at 8% return rate

Rate of return during accumulation period of 15 years	8%
Expected rate of return after retirement	8%
Inflation rate	2%
Inflation adjusted return after retirement (((1+8%)/(1+2%))-1)*100	5.882%
Current purchasing power per annum	$85,000
Expected post retirement annual expenditure @80% of current purchasing power	$68,000
Inflation rate	2%
Annual expenditure during period of retirement, adjusted for inflation ($68,000((1+2%)^20years))	$1,01,044
No. of years after retirement	20
Inflation adjusted return during period of retirement	5.882%
Corpus required on retirement to ensure annual expenses for retirement period	$11,70,156
Current corpus amount	$1,32,400
Expected amount of current corpus at start of retirement, adjusted for 8% return p.a. during accumulation period	$4,19,995
Thus, further savings required, to ensure corpus amount	$7,50,161
Present value of further savings, adjusted for 10% return p.a. during accumulation period	$236,482
Thus, monthly savings required at present at 10% return rate	$19,707

Sensitivity to change in rate of return = ($19707-$8991)*1%/2% = $5358 per month