Module 1 Flashcards
Serial Savings Approach
1.) Deflate the lump sum needed at retirement into today’s dollars, using the inflation rate as the discount rate.
2.) Calculate the payment using the discounted lump sum from step 1 as a future value and an inflation-adjusted return as the interest rate.
3.) Once payment has been solved, it will need to be increased by the inflation rate in order to arrive at the end of first year payment.
Level Savings Approach
Example. Returning to Fred and Wilma, we determined that they needed to save an additional $1,144,480 by the beginning of retirement to make up for their shortfall from Social Security and any inflation-adjusted pensions to achieve the level of retirement income that they desired using the capital utilization method ($30,000 in today’s dollars, $62,813 in retirement year one dollars). Remember that Fred and Wilma have 25 years until retirement, so the annual level savings amount would be:
1,144,480 FV
25 N
7 I/YR
PMT = $18,095
Capital Preservation Calculator Equation
Be in “Begin” Mode
Enter Initial Value “FV”
Enter Number of Years “N”
Enter Annual Return “I/YR”
Hit “PV”
Inflation-Adjusted Return Equation
((1+Return/1+Inflation) - 1) x 100
Capital Utilization Approach Calculator Equation
Use “Begin” Mode
Enter Payments per Year “PMT”
Enter Number of Years “N”
Enter Inflation Adjusted Return “I/YR”
Hit “PV” to Solve
Capital Preservation Approach
Living off only the cash flow of an asset pool
Capital Utilization Approach
If all assumptions turn out exactly as expected, then the retirees will have an inflation-adjusted annuity (called a serial payment) for the rest of their lives, and then die at their assumed life expectancy, with a retirement account balance of $0.
Four Steps for Determining a Retirement Savings Need
Step 1: Calculate net annual retirement income need. Subtract any sources of inflation-adjusted income from total need. These sources may include Social Security and pension plan benefits. You will arrive at the net annual retirement income need that must be saved for.
Step 2: Adjust income deficit for inflation over preretirement period. Determine income needed in the first year of retirement, as adjusted for inflation.
Step 3: Determine total retirement fund needed. The calculated lump-sum retirement fund is the total retirement fund needed on day one of retirement. This amount, invested at the assumed investment return rate, will generate annual income payments equal to the income deficit which will grow with inflation each year.
Step 4: Determine savings amount needed—level payment and serial payments. Once the lump-sum amount needed at retirement is determined, then an annual level savings amount, or serial payments amounts (adjusted for inflation each year) can be calculated.
What two qualities should retirement goals have to make them useful in planning?
Specific and Prioritized
SMART Goals
Specific
Measurable
Action-Oriented
Realistic
Time-Oriented
Net Cash Flow (or Deficit) =
Cash Inflows – Cash Outflows
Net Worth =
Assets – Liabilities
Six-Steps of the Retirement Planning Process (EGADIM)
E – Establish client relationship
G – Gather data
A – Analyze data
D – Develop plan
I – Implement plan
M – Monitor plan
During retirement, John wants to receive $50,000 at the end of each year for the rest of his life. To calculate the amount that he will need to save, you need to solve for…
Ordinary annuity-set calculator at end.
Mary wants to retire the first of next year. She wants to receive annual retirement income payments on the first day of each year, starting when she retires. To solve the amount of capital required to provide her the income she wants, you need to solve for…
Annuity due; set calculator to the begin mode.
