Planning For Retirement

1. Planning For Retirement Press F5 for slide show. Backup slides are hidden in slide show but available in normal view. Dr. Thomas E. Bell May 4, 2007

2. Approach to Planning • Do Classical Equity Financial Projection • Deal with Risk Management and Cash Flow • Project Financial Needs • Decide on Residence • Cover Medical Insurance • Decide When to Begin Social Security • Recognize Demographics and Their Impacts • Take Actions

3. Growth of Savings

4. Growth of Savings Transaction Costs

5. Growth of Savings Transaction Costs Management Fees

6. Growth of Savings Transaction Costs Management Fees Inflation

7. Growth Plus Additional Savings Transaction Costs Plus Savings of $5,000 per Year (and Its Growth) Management Fees Inflation

8. Approach to Planning • Do Classical Equity Financial Projection • Deal with Risk Management and Cash Flow • Project Financial Needs • Decide on Residence • Cover Medical Insurance • Decide When to Begin Social Security • Recognize Demographics and Their Impacts • Take Actions

9. Equity Risk and Coping with It Dow Jones Industrial Average

10. Equity Risk and Coping with It Dow Jones Industrial Average Bad Time to Sell

11. Bond Interest Rate Risk Coupon Rate = 5% Length 25 years Principal = $1,000 Present Value Prevailing Interest Rate

12. Risk Coping Strategy:Asset Allocation Cash: Enough to pay expenses for 4 months + 3% for taking advantage of market opportunities Bonds: Enough maturing each year to pay expenses for that year – for about 5 years; perhaps hold some value in bond fund(s) Equities: Remainder, but probably not more than 65% of retirement assets. May include REITs Real Estate: Probably not included in retirement assets unless beyond residence

13. Approach to Planning • Do Classical Equity Financial Projection • Deal with Risk Management and Cash Flow • Project Financial Needs • Decide on Residence • Cover Medical Insurance • Decide When to Begin Social Security • Recognize Demographics and Their Impacts • Take Actions

14. Example Minimum Computation • Pre-retirement annual expenditure of $100,000 • Post-retirement expenditures 80% of pre-retirement expenditure • Social Security income of $15,000 per annum • To live off income for $80,000 per annum with average yield of 6.8%, must have: • (80,000 – 15,000) = 65,000 = ~1,000,000 • 0.068 0.068 • For reserve of $100,000, need to have at least $1,100,000 prior to retiring

15. Risk-Reduction Computation • Invest funds in bonds for 3 years of down-market • 3 * $65,000 = $195,000 at 4% after transaction costs for $7,800 income per year • (80,000–15,000–7,800) = 57,200 = $841,176 (equities) 0.068 0.068 • = $841,176 + $195,000 + $100,000 = $1,136,176 • Reduce return assumption to cope with inflation or with long-term reduction in economic opportunity – say, to 4% • (80,000–15,000–7,800) + 195,000 + 100,000 = $1,725,000 • 0.04

16. More-Detailed Personal Analysis

17. Approach to Planning • Do Classical Equity Financial Projection • Deal with Risk Management and Cash Flow • Project Financial Needs • Decide on Residence • Cover Medical Insurance • Decide When to Begin Social Security • Recognize Demographics and Their Impacts • Take Actions

18. Criteria for New Residence • Don’t buy on top of an earthquake fault (or within 200 feet of it) • Don’t buy below sea level (or below 20 feet above it) • Avoid hurricane areas. The 70-year hurricane cycle is approaching its peak, so the East Coast will likely experience real problems • Don’t buy where taxes are high – income taxes, sales taxes, property taxes, personal property taxes • Buy where you can be warm (at least inside) • Buy near relatives (especially children)

19. Some Alternatives • Retirement community • Condominium in attractive area • Smaller house in less-expensive area • Recreational Vehicle • Moving from place to place However • Ensure medical and other support services are available • Consider cultural changes carefully • Be very, very careful about foreign residences

20. Approach to Planning • Do Classical Equity Financial Projection • Deal with Risk Management and Cash Flow • Project Financial Needs • Decide on Residence • Cover Medical Insurance • Decide When to Begin Social Security • Recognize Demographics and Their Impacts • Take Actions

21. Long Term Care Costs Avg. Daily Avg. Daily Avg. Home Homemkr Nursing Nursing Monthly Health Services Home Home Cost in Aide Avg. Rate: Rate: Assisted Avg. Hrly Hourly Private Semi-Prvt Lvg. Fac Rate Rate Los Angeles 203.95 155.07 2,725.81 24.57 18.14 Oakland 242.27 187.64 2,765.56 34.37 19.89 Rest of State 184.97 166.05 2,541.01 28.17 18.51 Sacramento 241.13 170.52 2,617.07 43.24 19.44 Santa Ana 247.99 175.74 2,755.62 23.60 18.21 San Diego 197.59 172.50 2,674.05 33.45 19.50 San Francisco 268.40 221.47 3,172.59 44.97 21.37 San Jose 254.00 189.73 2,580.40 24.38 17.87 State Average 230.03 179.84 2,729.01 32.09 19.11 Source: 2006 Cost of Care Survey, Genworth Financial, March 2006

22. Medical Insurance Costs Comprehensive Medical at Age 50 (15 years ago) Per Individual (Annually) $1,276

23. Medical Insurance Costs Comprehensive Medical at Age 50 (15 years ago) Per Individual (Annually) $1,276 Private Insurance Today (Wife, age 64) $5,000 deductible Medical Plan $10,716 Medicare Today (Me, age 66) Part A $ 0 Part B $ 1,122 Medigap F $ 1,607 Part D $ 277 $3,006

24. Medical Insurance Costs Comprehensive Medical at Age 50 (15 years ago) Per Individual (Annually) $1,276 Private Insurance Today (Wife, age 64) $5,000 deductible Medical Plan $10,716 Medicare Today (Me, age 66) Part A $ 0 Part B $ 1,122 Medigap F $ 1,607 Part D $ 277 $3,006 Cost of medical insurance (e.g. $21,000 per couple plus cost for kids) discourages early retirement

25. Medicare Plans Part A: Hospital Insurance with ~$1,000 deductible & limits Probably already paid for by payroll deductions Part B: Medical Insurance with deductibles, co-pays, limits Current cost $93.50/mnth but higher for high earners Part C: HMO/PPO-type alternatives (instead of parts B & D) Cost varies by provider and benefits Part D: Drug coverage with plans defined by insurers Cost and benefits vary greatly Medigap: Covers “donut holes” and adds coverages Benefits of each plan defined, varying costs

26. Medigap Plans

27. Approach to Planning • Do Classical Equity Financial Projection • Deal with Risk Management and Cash Flow • Project Financial Needs • Decide on Residence • Cover Medical Insurance • Decide When to Begin Social Security • Recognize Demographics and Their Impacts • Take Actions

28. Social Security • Benefits largely dependent on: • Income during working years • When benefits are begun • Age for full benefits increases over time • Currently (as practical matter) 85% of benefits are taxed as normal income • “Contributions” you make are actually used to pay current retirees • Payments to you will come from the next generation’s “contributions”

29. Benefit, as a percentage of PIA, beginning at age-- Full Retirement Ages

30. Approach to Planning • Do Classical Equity Financial Projection • Deal with Risk Management and Cash Flow • Project Financial Needs • Decide on Residence • Cover Medical Insurance • Decide When to Begin Social Security • Recognize Demographics and Their Impacts • Take Actions

31. United States Demographics Baby Boomers Gen X Gen Y Workers/Retiree = 4.76

32. Baby Boomers Gen X Gen Y Workers/Retiree = 4.76

33. Baby Boomers Gen X Gen Y Workers/Retiree = 3.08

34. Baby Boomers Gen X Gen Y Workers/Retiree = 2.59

35. Social Security (OASDI) To Social Security “Trust Fund” Bonds (Effectively Counts As Revenue To Feds) Employer “Contribution” Current Year Social Security Payments Employee “Contribution”

36. Social Security (OASDI) From Social Security “Trust Fund” Bonds (Effectively Counts As Expense To Feds) Employer “Contribution” Current Year Social Security Payments Employee “Contribution”

37. Shortfall to Pay Scheduled Benefits plus75 Percent Revenue Contribution to SMI Percentage of GDP Shortfall

38. Inter-Generational Transfer (Baby Boomers Promised that Gen X and Gen Y Would Fund) Funding Mechanisms (“Contributions” that are mandatory) Baby Boomers Generation X Generation Y

39. Potential Federal/State Changes • Change SS “full retirement age” matrix & COLA • Accelerate “means test” on Social Security benefits • Accelerate “means test” on Medicare coverage • Cap medical payments and/or encourage inflation • Reduce deductions in tax code (e.g., interest deduction on homes, Proposition 13, education deduction, etc.) • Eliminate tax-exemption on bonds, capital gains rate, charitable deductions • Ration medical care (as in Canada, UK) • Tax Roth IRAs • Introduce state/national Net Worth Tax

40. Approach to Planning • Do Classical Equity Financial Projection • Deal with Risk Management and Cash Flow • Project Financial Needs • Decide on Residence • Cover Medical Insurance • Decide When to Begin Social Security • Recognize Demographics and Their Impacts • Take Actions

41. Immediate Actions to Take • Immediately summarize your financial assets: investment, pension/retirement, and real estate • Examine ALL your retirement assets (including 401(k)s, IRAs, pension plans, etc.) to determine payment provisions and yields • Respond to yields that are inadequate • Decide generally what to do about your residential real estate, mortgage, and future needs • Project your situation (through retirement) based on classical as well as realistic assumptions, your real situation, and your probable retirement requirements • Perform sensitivity analyses based on projections of the economy and taxation • Plan your future based on projections

42. Future Actions to Take 50: start “catch-up contributions” to IRA/401(k) 55: plan your mortgage; if you will want to relocate, start planning how to do so 59: put together an estate plan 63: decide whether to roll-over 401(k)s; position your investments to provide cash, income, and growth 64: ensure real estate is appropriate 64½: decide on medical insurance plan(s) 64¾: apply for Medicare (if that’s your plan) 65?: retire and start taking distributions (whenever) 65+: apply for Social Security (if not earlier) 66: track your retirement investments and pensions closely 72½: take required distributions from IRAs

43. Don’t be obsessive; enjoy life.

44. Don’t be obsessive; enjoy life. Remember: In the end, we’re all dead