Retirement Planning Financial Planners

1. Retirement Planning Financial Planners Chapter 2: Introduction to Retirement Funding

2. Factors Affecting Retirement Planning • Remaining Work Life Expectancy (RWLE) • Retirement Life Expectancy (RLE) • Savings • Annual Income Needs • Wage Replacement Ratio (WRR) • Inflation • Retirement Income Sources • Investment Returns • Qualitative Factors

3. Work Life Expectancy (WLE) • The period of time a person is expected to be in the work force. • Period during which one saves and accumulates for retirement. • Generally 30-40 years, but has been decreasing due to advanced education and early retirement.

4. Remaining Work Life Expectancy (RWLE) • Work period that remains at a given point in time before retirement. • The number of years a client has to save for retirement. • 93% of people retire between ages 62 and 65.

5. Retirement Life Expectancy (RLE) • Time period beginning at retirement and ending at death. • Time period planned for by the financial planner and the retiree during the work life.

6. WLE and RLE Relationship • Move inversely with each other: • As WLE increases, RLE decreases. • As RLE increases, WLE decreases. • As WLE decreases, RLE increases. • As RLE decreases, WLE increases. • A change in one variable could create additional funding needs, or decrease funding needs.

7. Savings and Investment Issues • Savings Issues • Savings Amount • Savings Rate • Timing of Savings • Too little, too late? • Investment Issues • Asset Classes • Rates of return? • Exhibit 2.11 on Page 28 • Inflation • Risk Tolerance • Lake Tahoe or Lake Mattoon?

8. Savings Amount • An individual should begin saving early (Exhibit 2.6 on page 23)

9. Savings Rate • The average savings amount based on consumption. • In 2010, personal savings rate increased to 6% from 1% in 2005 • Recall that even at the age of 25, an individual should be saving at least 10%.

10. Timing of Savings • Earlier: more compounding. • Later: you will never catch up. • Assumption: • Returns don’t vary from mean

11. Investment Decisions • Asset Class Selection • Varying Risks/Returns • Factors • Age • Risk Tolerance • See Exhibit 2.11 on page 28 • Inflation • Loss of purchasing power • See Exhibit 2.12 on page 31

12. Retirement Needs Analysis • How much income/money does an individual need during his retirement? • Increased Needs • Health Care • Travel • Decreased Needs • Mortgage eliminated…interest only mortgages??? • Payroll/Social Security Taxes • Need to save • Work-related expenses (dry-cleaning, parking, lunches)

13. Wage Replacement Ratio (WRR) • Estimate of the percentage of an individual’s income earned prior to retirement needed during retirement. • Methods of Calculating • Top-Down Approach • Uses percentages and common sense. • “Best guess” when not close to retirement • Bottom-Up (Budgeting) Approach • Determines which preretirement expenses are needed during retirement. • More accurate when close to retirement

14. Sources of Retirement Income • Social Security • Company-Sponsored Retirement Plans • Personal Retirement Plans • IRAs, Roth IRAs • Personal Savings • Taxable Savings Accounts • Continued Employment

15. Qualitative Factors in Retirement • Involuntary vs. Voluntary Retirement • Emotional and Psychological Factors • Loss of esteem from job • Boredom • Relocation Decisions • Travel

16. Risks to Financial Independence (1 of 2)

17. Risks to Financial Independence (2 of 2)

18. Capital Needs Analysis • The process of calculating the amount of investment capital needed at retirement. • Calculation methods • Annuity Method • Capital Preservation Model • Purchasing Power Preservation Model • Utilizes many estimates. • Increases risk of error.

19. Annuity Method • Calculate WRR. • Top-down/Budgeting Approach • Determine gross dollar needs. • Determine net dollar needs. • Reduce gross needs by expected Social Security. • Inflate net dollar needs by CPI rate to retirement age. • Calculate capital needed at retirement age. • Present value of the annuity due of preretirement dollar needs. • What rate of return for investments? • See Example 2.7 on pages 47-49.

20. Capital Preservation Model • Maintains the original capital balance needed at retirement for the entire retirement life expectancy. • See Example 2.6 on pages 37-38.

21. Capital And Purchasing Power Preservation Models • Maintain the purchasing power of the original capital balance at retirement for the entire retirement life expectancy. • See Examples 2.8 and 2.9.

22. To Reduce Estimate Risk • Sensitivity Analysis • Changing variable assumptions to determine the effects to the retirement plan. • Which variables matter • Example on page 43: inflation.

23. To Reduce Estimate Risk • Monte Carlo Analysis • Mathematical tool used to illustrate the unpredictability of the real world and its effects on an individual’s retirement plan. • Returns vary from median • What is likelihood plan will fail: outlive money? • Sustainable withdrawal rate: 4% • Better to use historical patterns rather than random returns?

24. Sustainable Withdrawal Rate • If I retire with $1 million in retirement savings, how much can I spend each year? • Do you want spending to increase each year with inflation? • If withdrawals need to grow over retirement life expectancy, portfolio will be subject to volatility • Timing of volatility (negative returns) has huge impact on withdrawal rate • Amount of inflation also has significant impact • Research: historically 4% but may be high in low return environment