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Retirement > Chapter 2 - Retirement Planning Accumulations and Distributions > Flashcards

Chapter 2 - Retirement Planning Accumulations and Distributions Flashcards

1
Q

Define Annuity Method

A

Determines how much a client needs to fund their retirement based on the assumption that the person will die exactly at the assumed life expectancy with a retirement account balance of zero

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2
Q

Define Capital Needs Analysis

A

The process of calculating the amount of investment capital needed at retirement to maintain the pre-retirement lifestyle and mitigate the impact of inflation during retirement years.

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3
Q

Define Capital Preservation Model (CP)

A

A capital needs analysis method that assumes that at client’s life expectancy, the client has exactly the same account balance as they did at the beginning of retirement.

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4
Q

Define Lepto-Kurtic

A

A distribution that appears to be normal but has more area under the two tails than a normal distribution (i.e. fat tails)

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5
Q

Define Monte Carlo Analysis

A

A mathematical tool used to calculate the success of an individual’s retirement portfolio using changing variables.

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6
Q

Define Purchasing Power Preservation Model (PPP)

A

A capital needs analysis method that assumes that at a client’s life expectancy, the client will have a capital balance with the purchasing power equal to the purchasing power at the beginning of retirement.

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7
Q

Define Pure Annuity Concept

A

The basic capital needs analysis approach, generally prepared on a pretax basis.

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8
Q

Define Remaining Work Life Expectancy (RWLE)

A

The work period that remains at a given point in time before retirement.

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9
Q

Define Retirement Life Expectancy (RLE)

A

The time period beginning at retirement and extending until death; the RLE is the period of retirement that must be funded.

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10
Q

Define Savings Rate

A

The average savings amount in the U.S. based on consumption.

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11
Q

Define Sensitivity Analysis

A

A tool used to understand the range of outcomes for each variable in a retirement plan by totaling each variable toward the undesirable side of the risk to determine the impact of a small change in that variable on an overall plan.

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12
Q

Define Suitability

A

Having a reasonable basis to believe that a recommended transaction or investment strategy is appropriate for a client, after considering the client’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance and other relevant issues.

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13
Q

Define Wage Replacement Ratio (WRR)

A

An estimate percentage of income needed at retirement compared to earnings prior to retirement.

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14
Q

Define Work Life Expectancy (WLE)

A

The period of time a person is expected to be in the work force, generally 30-40 years.

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15
Q

What is superannuation?

A

The possibility of a retired individual living longer than planned for, and thus running the risk of running out of money.

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16
Q

What is unrelated business taxable income?

A
  • Income earned by a tax-exempt entity that is subject to taxation.
  • Gross income derived from any unrelated trade or business regularly carried on by an exempt organization, less the deductions directly connected with carrying on the trade or business.
17
Q

What types of organizations and accounts are subject to tax on unrelated business income? 8

A
  • Traditional IRAs
  • Roth IRAs
  • Simplified Employee Pensions (SEP-IRAs)
  • Savings Incentive Match Plans for Employee (Simple IRAs)
  • State and municipal colleges and universities
  • Qualified state tuition programs
  • Medical Savings Accounts (MSAs)
  • Coverdell savings accounts
18
Q

Generally, an unrelated trade or business includes one that meets which three requirements?

A
  1. It is a trade or business
  2. It is regularly carried on, and
  3. It is not substantially related to furthering the exempt purpose of the organization.
19
Q

Generally, income from what sources is excluded from unrelated business taxable income? 6

A
  • Dividends
  • Interest
  • Payments with respect to securities loans
  • Annuities
  • Royalties
  • Rental incomes
20
Q

What makes a qualified plan or an IRA subject to the unrelated business tax rules?

A

If it:

  • Operates a trade or business,
  • Owns an interest in a pass through organization, such as a partnership or an S corporation, that is operating a trade or business,
  • Owns an interest in a master limited partnership, or
  • Uses debt to generate portfolio income, as in the case of margin debt.
21
Q

What expenses may decline in retirement? 6

A
  1. Costs associated with employment
  2. Mortgage Costs if the mortgage debt is scheduled to be repaid by retirement
  3. Costs of children
  4. Payroll costs
  5. Costs of savings
  6. Possible lifestyle adjustments (less cars, less entertainment)
22
Q

What expenses may increase in retirement?

A
  1. Rising cost of health care and increased medical expenses
  2. Increasing expenditures and/or gifts to relatives
  3. Rising property taxes
  4. Possible lifestyle changes (more travel, second home)
23
Q

What are the two approaches to calculating wage replacement ratios and when is each appropriate?

A

Top Down Approach
-Take gross income as 100% and then after taxes and savings, the remaining amount will be the % needed.
-It is frequently used with younger clients where income and expenditure patterns are unlikely to remain constant over time.
Bottom-Up (Budgeting) Approach
-An advisor will work with the client to determine which costs in the current (pre-retirement) budget will change (increase or decrease) in the retirement budget.
-Used with older clients because as a person nears retirement age, it is possible to examine the actual current expenditure patterns of the person and to more accurately forecast the retirement expenditure patterns.

24
Q

What are the main sources of retirement income?

A
  1. Social security
  2. Private pension and company sponsored retirement plans
  3. Personal assets and savings
  4. Working during retirement
25
Q

What are the three methods for analyzing capital needs?

A
  • Basic Annuity Method
  • Capital Preservation Model
  • Purchasing Power Preservation Model
26
Q

Before calculating the capital needs analysis, what must assumptions be made regarding?

A
  • Wage Replacement Ratio
  • Work Life Expectancy
  • Retirement Life Expectancy
  • Inflation
  • Earnings
  • Social Security
  • Any other benefits
27
Q

What are the various techniques an advisor can employ to help begin to understand the effect of the range of probable outcomes fore each variable in the plan?

A
  • Range estimates
  • Sensitivity analysis
  • Simulations like the Monte Carlo Analysis
28
Q

What does range analysis allow an advisor to do?

A

To project what outcome will occur if they use a range of assumptions (e.g. 2.5%-3.5% inflation) for a variable as opposed to a single mean expectation (3% inflation)

29
Q

What are some problems with Monte Carlo Analysis? 4

A
  • Assumes normal distribution, serial independence, and linear relationships for investments returns (none of which are true)
  • Stock returns are not normally distributed - kurtosis is higher than expected (Stock returns are actually lepto-kurtic)
  • Means and standard deviations for stock returns vary over time rather than remain static
  • Many Monte Carlo Analysis ignore income tax consequences.
30
Q

If a plan doesn’t look like it will work with current projections, what changes could be made to possibly make it work? 6

A
  1. The annual or monthly retirement needs are reduced
  2. The annual or monthly savings amount is reduced
  3. Expected investment earnings are increased
  4. Expected inflation is reduced
  5. The WLE is increased
  6. The RLE is decreased
31
Q

For retirees that are going to retain investment risk, what are two common approaches that can be utilized to reduce the risks of outliving retirement accumulation?

A
  1. 4 percent per year approach

2. Money-for-life approach

32
Q

What is the 4 percent per year approach?

A

Limit withdrawals from the capital accumulation to four percent per year.

33
Q

What is the Money-for-Life approach?

A

Divide capital into 6 unequal tranches with each tranche representing five years of retirement. Invest the funds for each tranche in varying asset classes expected to produce inflation adjusted returns of about five-to-six percent per year on average across all tranches.

34
Q

Why is a 60/40 portfolio such a popular allocation during retirement?

A

It provides a good balance between income, growth, and downside protection.

Retirement (11 decks)

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