Question

In: Finance

Tommy plans to retire in 25 years (1st withdrawal in year 26). He is told by...

Tommy plans to retire in 25 years (1st withdrawal in year 26). He is told by Simon that a desirable standard of living in 26 years will require $180,249 per year. Tommy wants to be able to maintain that level of purchasing power forever (Assume inflation = 3% per year). Tommy plans to increase his savings by 2% per year and expects to earn 6% per year on his investments.

How much does Tommy have to save the first year to fund his retirement goal?

Solutions

Expert Solution

Step 1 : Calculate Retirement Corpus

To calculate the corpus reqired at the time of retirement, we need to use the PV function of excel:

  • Retirement Period = 20 Years (Lets assume he'll live 20 years after retirement, ie, from 60 years to 80 years)
  • Effective rate of return = 2.91%

Retirement Corpur Required = $2,782,790

Step 2 : Calculation of First Year Investment

  • Saving period = 25 years
  • Goal Required = $2,782,790
  • Rate of Return = (1+6%)*(1+2%)-1 = 8.12%

This can be solved using the PMT function excel:

Hence, the first year investment needs to be $34,594, which will increased by 2% every year to reach the goal.


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