Question

Your client, Steven, age 43, has come to you for assistance with retirement planning. He provides you with the following facts. He earns $80,000 annually. His wage replacement ratio has been determined to be 80%. He expects inflation will average 3% for his entire life expectancy. He expects to work until 68, and live until 90. He currently has $60,000 saved, and he is averaging a 9% rate of return and expects to continue to earn the same return over time. He has been saving $3,000 annually in his 401(k) plan. Additionally, Social Security Administration has notified him that his annual retirement benefit, in today’s dollars will be $26,000. 4. Provide Steven with 3 alternatives for meeting his retirement goal. In doing so, use calculations to show the impact of each alternative. . Using the capital preservation method, calculate how much capital Steven needs in order to retire at 68. 6. Using the purchasing power preservation method, calculate how much capital Steven needs in order to retire at 68.

Answer 1

Soln : There are 3 methods to calculate the retirement goal.

1) Annuity Method, i.e. he will have 0 amount at the end of life expectancy.

Now, wage replacemet ratio = 80000*80% = $64000, it is the yearly requirement after retirement

Currently saved and social security = 60000 + 26000 = $86000 , when he is 43 years old.

Lets calculate the total amount P, required to generate the $64000 from retirement age to life expectancy i.e. for 22 years.

P = 64000/1.09 + 64000*1.03/1.09^2 +.........+ 64000*1.03²¹/1.09²² = $759719 (approx.)

From savings, he will be able to save : $3000 annually

On solving for $3000 each year growing at 9% till 68 i.e for 25 years , we get $254102

And 86000 grows at 9% for 25 years = $741585 = 86000*1.09^25

Hence , it is sufficient to have this savings.

In case if Capital preservation is used, that means the amount 759719 is to be kept till life expectancy.

i.e. 759719/1.09²⁵ = $88103 is required extra at retirement.

Total fund required at retirement = 114096 + 759719 = $873815

Similarly in case if purchasing power preservation is used, the amount required in addition to the amount calculated in annuity part will be equal to inflation adjusted same value 759719 at life expectancy i.e.= 759719 + 759719*(1.03/1.09)²² = 759719 + 218620 = $978339 (approx.)