Retire CH2 Retirement Planning Flashcards by John Mussman

Approximately 80% of men work past age 65.

a. True b. False

b. False

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The RLE is the time period beginning at retirement and ending at death.

a. True b. False

a. True

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As the RLE increases because of early retirement, there is generally both an increased need of funds to finance the RLE and a shortened WLE in which to save and accumulate assets.

a. True b. False

a. True

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The WRR is an estimate of the
percentage of annual income needed during retirement compared to income earned prior to retirement.

a. True b. False

a. True

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The two methods for calculating WRR are the top-down approach and the budgeting approach.

a. True b. False

a. True

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Capital needs analysis is the process of calculating the amount of investment capital needed at retirement to maintain the pre-retirement lifestyle.

a. True b. False

. True

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The annuity method assumes that the individual will die at the expected life expectancy with a retirement account balance of zero.

a. True b. False

. True

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The capital preservation model, the purchasing power preservation model, and the capitalization of earnings model are used to mitigate the risk of outliving retirement funds.

a. True b. False

. True

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Which of the following expenditures will most likely increase during retirement?

a. Clothing costs. b. Travel. c. FICA. d. Savings.

The correct answer is b.

Travel is the most likely expenditure to increase during retirement. Many other costs will likely be
reduced after the retiree leaves the workforce, including a reduction in clothing expenses and the
elimination of payroll taxes. An individual’s savings may also be eliminated because a retirement plan
requires the use of the accumulated savings during retirement.

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Gemma, a 35-year-old client who earns $45,000 a year, pays 7.65% of her gross pay in Social Security payroll taxes, and saves 8% of her annual gross income. Assume that Gemma wants to maintain her exact pre-retirement lifestyle. Calculate Gemma’s wage replacement ratio using the top-down approach (round to the nearest %) and using pre-tax dollars.

a. 70%. b. 80%. c. 84%. d. 90%.

c. 84 %

Dollar Value Percentage
$45,000.00 = 100.00% Salary
(3,600.00) = (8.00%) Less: current savings
(3,442.50) = (7.65%) Less: payroll taxes
$37,957.50 = 84.35% Wage Replacement Rati

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Omar would like to determine his financial needs during retirement. All of the following are expenditures he might eliminate in his retirement needs calculation except:

a. The $200 per month he spends on drying cleaning for his work suits.
b. The $1,500 mortgage payment he makes that is scheduled to end five years into retirement.
c. The FICA taxes he pays each year.
d. The $2,000 per month he puts into savings.

The correct answer is b.

Omar would not eliminate his mortgage since it will not be paid off at retirement. He would eliminate
the dry cleaning expense, FICA taxes, and savings expense since he would most likely no longer have
these expenditures during retirement

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Scarlett has the following expenditures during the current year: Expense
1. Health Care $800
2. Savings $4000
3. Travel $500
4. Gifts to Grandchildren $1,000

Which of these expenditures would you expect to decrease during Scarlett’s retirement?

a. 2 only.
b. 1 and 3.
c. 2 and 4.
d. 1, 2, 3, and 4.

The correct answer is a.

Scarlett is likely to decrease her savings during retirement. She is likely to increase her health care
expense since she will begin to age and need more medical attention. She is likely to increase her travel
expense as she will have more free time available for travel. She is likely to increase the amounts she
gives to her grandchildren since she will be in the distribution phase.

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Niles and Daphne are near retirement. They have a joint life expectancy of 25 years in retirement. Daphne anticipates their annual income in retirement will need to increase each year at the rate of inflation, which they assume is 4%.
Based on the assumption that their first year retirement need, beginning on the first day of retirement, for annual income will be $85,000, of which they have $37,500 available from other sources, and an annual after-tax rate of return of 6.5%,
calculate the total amount that needs to be in place when Niles and Daphne begin their retirement.

a. $743,590.43.
b. $859,906.74.
c. $892,478.21.
d. $906,131.31.

The correct answer is d.

BEGIN Mode

N = 25

i = [(1.065  1.04) - 1] x 100 = 2.4038

PV = ? <906,131.3080

PMT = 85,000 - 37,500 = 47,500

FV = 0

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Steve and Roslyn are retiring together today and they wish to receive $40,000 of income (in the equivalent of today’s dollars) at the beginning of each year from their portfolio. They assume inflation will be 4% and they expect to realize an after tax return of 8%. Based on life expectancies, they estimate their retirement period to be about 30 years.

They want to know how much they should have in their fund today.

$731,894.20.

Rationale

BEGIN Mode
N = 30
i = [(1.08 ÷ 1.04) - 1] x 100 = 3.8462
PV = ?
PMT = 40,000
FV = 0

PV = <731,894.1954>

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how much will Bowie need to have accumulated as of the day he retires to adequately provide for his retirement lifestyle?

$726,217.09.
$784,314.45.
$1,050,813.28.
$1,101,823.40.

$1,101,823.40.

Rationale
Step 1: Determine the present value of capital needs:
Current Income $60,000
Wage Replacement Ratio x 80%
Present Value of Capital Needs $48,000

Step 2: Determine the future value of the capital needed in the first year of retirement:
PV $48,000
N (number of years until retirement) 10
i (inflation rate) 3
PMT 0
FV $64,507.99

Step 3: Determine the amount of savings (capital balance) needed at retirement to fund expenses throughout remainder of life expectancy using an annuity due:
PMTAD $64,507.99
N (retirement life expectancy) 33 (95-62)
i (inflation rate) 4.854 ((1.08 ÷ 1.03)) -1) x 100
FV 0
PV (capital balance needed at retirement) $1,101,823.40

Note: Answer c is the ordinary annuity amount!

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Scarlett has the following expenditures during the current year:
Expense Amount
1. Health Care $800
2. Savings $4,000
3. Travel $500
4. Gifts to Grandchildren $1,000

Which of these expenditures would you expect to decrease during Scarlett’s retirement?

2 only.
1 and 3.
2 and 4.
1, 2, 3, and 4.

2 only.
Rationale

Scarlett is likely to decrease her savings during retirement. She is likely to increase her health care expense since she will begin to age and need more medical attention. She is likely to increase her travel expense as she will have more free time available for travel. She is likely to increase the amounts she gives to her grandchildren since she will be in the distribution phase.

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Tyrone, age 25, expects to retire at age 60. He expects to live until age 90. He anticipates needing $45,000 per year in today’s dollars during retirement. Tyrone can earn a 12% rate of return and he expects inflation to be 4%. How much must Tyrone save, at the beginning of each year, to meet his retirement goal?

$3,980.76.
$4,585.46.
$4,879.29.
$5,135.72

$4,585.46.

$41,987.10 represents the amount necessary for retirement in today’s dollars.

Note: For the HP10BII, the first 35 cash flows may have to be split into the initial $0 cash flow followed by 34 more $0 cash flows. This change depends on the age of the calculator.

Which factors may affect an individual’s retirement plan?

Work life expectancy
Retirement life expectancy
Savings rate
Investment returns
Inflation

1 and 2.
1, 2, and 3.
1, 2, 3, and 4.
All of the above.

All of the above.

Rationale

All of the factors listed may affect an individual’s retirement plan - either positively or negatively. Reduced work life expectancy may provide an insufficient savings period while an increased retirement life expectancy increases capital needs. A low savings rate or poor investment returns may create an inability to meet capital requirements. Increased inflation rates will reduce purchasing power.

Bowie, age 52, has come to you for help in planning his retirement. He works for a bank, where he earns $60,000. Bowie would like to retire at age 62. He has consistently earned 8% on his investments and inflation has averaged 3%. He is expected to live until age 95 and he has a wage replacement ratio of 80%. Bowie wants to determine the amount of money necessary to provide him with the necessary capital balance at retirement.

How much more of a capital balance would he need at retirement if he were to use the purchasing power preservation model instead of the straight annuity model assuming he has a zero balance today?

$82,897.54.
$86,921.69.
$109,496.29.
$230,545.41

230,545.41.
Rationale
First, calculate the amount needed at retirement using the straight annuity model:

Step 1: Determine the present value of capital needs:
Current Income $60,000
Wage Replacement Ratio x 80%
Present Value of Capital Needs $48,000

Step 2: Determine the future value of the capital needed in the first year of retirement:
PV $48,000
N (number of years until retirement) 10
i (inflation rate) 3
PMT 0
FV $64,507.99

The purchasing power preservation model assumes that the purchasing power of the accumulated fund balance necessary under the annuity model is preserved until life expectancy. Therefore, the capital balance needed at retirement ($1,101,823.40 as calculated using the annuity method) must first be adjusted for inflation.

Note: Numbers may be slightly off due to rounding.
N = 33
i = 3
PMT = $0
PV@95 = $1,101,823.40
FV@62 = $2,922,405.03

It will require $2,922,405.03 at age 95 to equal the purchasing power of $1,101,823.40 at age 62.

The final step is to calculate the lump sum needed at age 62 to grow to $2,922.405.03 at age 95:
N = 33
i = 8
PMT = $0
FV@95 = $2,922,405.03
PV@62 = $230,545.41

Note: These last two calculation can be done in one step by using an inflation-adjusted discount rate.

Contributing $1,500 to his retirement fund at the end of each year beginning at age 18 through age 50, with an average annual return of 12%, how much does Juan have in his retirement account at this time to use toward a possible early retirement?

$346,766.42.
$399,987.65.
$457,271.58.
$541,890.55.

$457,271.58.
Rationale

N = 50 - 18 = 32
i = 12
PV = 0
PMT = <1,500>
FV = ?
<457,271.5789>

Angus would like to retire in 11 years at the age of 66. He would like to have sufficient retirement assets to allow him to withdraw 90% of his current income, less Social Security, at the beginning of each year. He expects to receive $24,000 per year from Social Security in today’s dollars. Angus is conservative and assumes that he will only earn 9% on his investments, that inflation will be 4% per year and that he will live to be 106 years old.

If Angus currently earns $150,000, how much does he need at retirement?

$1,955,893.
$2,049,927.
$3,011,008.
$3,155,768.

3,155,768.
Rationale
The answer is calculated as follows:
Step 1
Salary $150,000
x 90%
$135,000
(24,000)
$111,000

Step 2
N 11 years to retirement
i 4
PV $111,000
PMT 0
FV $170,879.40

Step 3
N 40 years to retirement
i 4.8077 [(1.09 ÷ 1.04)-1] x 100 (the real i)
PMTAD $170,879.40
FV $0
PV $3,155,767.79

Note: Answer c is the ordinary annuity amount

Bowie, age 52, has come to you for help in planning his retirement. He works for a bank, where he earns $60,000. Bowie would like to retire at age 62. He has consistently earned 8% on his investments and inflation has averaged 3%. Assuming he is expected to live until age 95 and he has a wage replacement ratio of 80%, how much must Bowie save at the end of each year, from now until retirement, to provide him with the necessary capital balance assuming he has a zero balance today?

$67,163.98.
$70,424.36.
$72,537.10.
$76,058.31

$76,058.31.

Step 1: Determine the present value of capital needs:
Current Income $60,000
Wage Replacement Ratio x 80%
Present Value of Capital Needs $48,000

Step 2: Determine the future value of the capital needed in the first year of retirement:

PV $48,000
N (number of years until retirement) 10
i (inflation rate) 3
PMT 0
FV $64,507.99

Step 3: Determine the amount of savings (capital balance) needed at retirement to fund expenses throughout remainder of life expectancy using an annuity due:

PMTAD $64,507.99
N (retirement life expectancy) 33 (95-62)
i (inflation rate) 4.854 ((1.08 ÷ 1.03)) -1) x 100
FV 0
PV (capital balance needed at retirement) $1,101,823.40

Step 4: Determine the amount of annual savings needed to fund the goal:
N (retirement life expectancy) 10 (62-52)
i 8
FV@62 $1,101,823.40
PV (capital balance needed at retirement) 0
PMTOA $76,058.31

Niles and Daphne are near retirement. They have a joint life expectancy of 25 years in retirement. Daphne anticipates their annual income in retirement will need to increase each year at the rate of inflation, which they assume is 4%. Based on the assumption that their first year retirement need, beginning on the first day of retirement, for annual income will be $85,000, of which they have $37,500 available from other sources, and an annual after-tax rate of return of 6.5%,

calculate the total amount that needs to be in place when Niles and Daphne begin their retirement.

$743,590.43.
$859,906.74.
$892,478.21.
$906,131.31.

$906,131.31.

Rationale

BEGIN Mode

N = 25 life expectancy
i = [(1.065 ÷ 1.04) - 1] x 100 = 2.4038
PV = ?
PMT = 85,000 - 37,500 = 47,500
FV = 0
<906,131.3080>

Marla is planning for her retirement. She is currently 37 years old and plans to retire at age 62 and live until age 97. She currently earns $100,000 per year and anticipates needing 80% of her income during retirement. Marla anticipates Social Security will provide her with $15,000 per year at age 62, leaving her with required savings to provide $65,000 ($100,000 x 0.80 - $15,000) annually during retirement. She believes she can earn 11% on her investments and inflation will be 2% per year. Marla would like to preserve the purchasing power of her capital balance during retirement. How much must Marla save at the end of each year,

if she wants to make her last savings payment at age 62 to meet her retirement goal and maintain the purchasing power of her retirement savings until age 97?

$4,758.88.
$10,899.37.
$11,464.44.
$11,565.52

11,464.44.
Rationale

Step #1: Determine the NPV at time period zero.

Which of the following expenditures will most likely increase during retirement? Clothing costs. Travel. FICA. Savings

Travel. Rationale Travel is the most likely expenditure to increase during retirement. Many other costs will likely be reduced after the retiree leaves the workforce, including a reduction in clothing expenses and the elimination of payroll taxes. An individual’s savings may also be eliminated because a retirement plan requires the use of the accumulated savings during retirement.

Ralf, a 40-year-old nurse who earns $80,000 a year, saves 14% of his annual gross income. Assume that Ralf wants to maintain his exact pre-retirement lifestyle. Calculate Ralf’s wage replacement ratio using the top-down approach (round to the nearest %) and using pre-tax dollars. 70%. 78%. 86%. 92%.

78 %. Rationale Dollar Value Percentage $80,000.00 = 100.00% Salary ($11,200.00) = (14.00%) Minus: Current savings ($6,120.00) = (7.65%) Minus: Payroll taxes $62,680.00 = 78.35% Wage Replacement Ratio

Which of the following statements is false? To be more conservative in planning for an individual’s retirement, extend the individual’s life expectancy. A Monte Carlo Analysis uses a random number generator to provide the advisor with an array of possible outcomes utilizing the same fact pattern. A sensitivity analysis helps the advisor determine the single most effective factor in a retirement plan. The capital preservation model assumes that at life expectancy the client will have exactly the same account balance as he did at retirement.

A sensitivity analysis helps the advisor determine the single most effective factor in a retirement plan. Rationale No one factor is the most important factor in a retirement plan. Sensitivity analysis gives the planner an understanding of how each factor affects the overall retirement plan.

Kwame and Rosa, both age 40, have $80,000 of combined retirement assets. They both expect to retire at the age of 65 with a life expectancy of 100 years old. They expect to earn 10% on the assets within their retirement accounts before retirement and 8% during their retirement. If they do not make any additional contributions to their account and they receive a fixed monthly annuity benefit for life, what is the monthly benefit (annuity due) amount they will receive during retirement?

$6,115.60. Rationale PV = $80,000.00 N = 25 i = 10 FV = $866,776.48 PV = $866,776.48 N = 420 (12 x 35) i = 0.6667 (8/12) PMTAD = $6,115.60 Note: Answer d is the ordinary annuity amount!

Cathy and her twin sister Carley, both age 25, each believe they have the superior savings plan. Cathy saved $5,000 at the end of each year for ten years then let her money grow for 30 years. Carley on the other hand waited 10 years then began saving $5,000 at the end of each year for 30 years. They both earned 9% on their investment and are 65 years old today and ready to retire. Which of the following statements is correct? Both strategies are equal as they have equal account balances at age 65. Cathy’s strategy is better because she has a greater account balance at age 65. Carley’s strategy is better because she has a greater account balance at age 65. Neither strategy is better because Carley has a greater account balance but Cathy contributed less.

Cathy strategy is better because she has a greater account balance at age 65. Rationale Not only is Cathy’s account balance greater, but she has also contributed less money. See the following table for reconciliation. Cathy Carley PV 0 PV 0 N 10 N 30 i 9 i 9 PMTOA $5,000 PMTOA $5,000 FV@35 $75,964.65 FV@65 $681,537.69 PV@35 $75,964.65 N 30 i 9 PMTOA 0 FV@65 $1,007,874.53 Total Investment = $50,000 Total Investment = $150,000

Tiffany, a self-employed dentist, currently earns $100,000 per year. Tiffany has always been a self proclaimed saver, and saves 25% per year of her Schedule C net income. Assume Tiffany paid $13,000 in Social Security taxes. Tiffany plans to pay off her home mortgage at retirement and live debt free. She currently spends $25,000 per year on her mortgage. What do you expect Tiffany’s wage replacement ratio to be at retirement based on the above information?

37.00%. Rationale The answer is calculated as follows: Dollar Value Percentage Salary $100,000 100.00% Salary SE Taxes ($13,000) (13.00%) Self-employment taxes Savings ($25,000) (25.00%) Savings Mortgage ($25,000) (25.00%) Mortgage paid off $37,000 37.00%

Berta saves $3,000 per year, for ten years, at the end of each year starting at age 26 and ending at age 35. She invests the funds in an account earning 10% annually. Berta stops investing at age 35, but continues to earn 10% annually until she reaches the age of 65. In contrast, Charlie saves $3,000 per year at the end of the year between the ages of 36 and 65 inclusively and invests in a similar account to Berta, earning 10% annually. What is the value of Berta's and Charlie's separate accounts at age 65?

Berta $834,296 Charlie $493,482 Rationale Berta Charlie PV 0 PV 0 N 10 N 30 i 10 i 10 PMTOA $3,000 PMTOA $3,000 FV@35 $47,812.27 FV@65 $493,482.07 PV@35 $47,812.27 N 30 i 10 PMTOA 0 FV@65 $834,295.60 Total Investment = $30,000 Total Investment = $90,000

Omar would like to determine his financial needs during retirement. All of the following are expenditures he might eliminate in his retirement needs calculation except: The $200 per month he spends on dry cleaning for his work suits. The $1,500 mortgage payment he makes that is scheduled to end five years into retirement. The FICA taxes he pays each year. The $2,000 per month he puts into savings.

The $1,500 mortgage payment he makes that is scheduled to end five years into retirement. Rationale Omar would not eliminate his mortgage since it will not be paid off at retirement. He would eliminate the dry cleaning expense, FICA taxes, and savings expense since he would most likely no longer have these expenditures during retirement.

Marla is planning for her retirement. She is currently 37 years old and plans to retire at age 62 and live until age 97. She currently earns $100,000 per year and anticipates needing 80% of her income during retirement. Marla anticipates Social Security will provide her with $15,000 per year at age 62, leaving her with required savings to provide $65,000 ($100,000 x 0.80 - $15,000) annually during retirement. She believes she can earn 11% on her investments and inflation will be 2% per year. How much must Marla save at the end of each year, if she wants to make her last savings payment at age 62 to meet her retirement goal? $10,846.78. $10,899.37. $11,861.07. $13,414.60.

10,899.37. Rationale Step #1: Determine the NPV at time period zero. This step determines the amount of savings required today (time period zero) to meet the retirement goal. It considers the income required during retirement after considering Social Security and the percentage of current income needed.

Marcus has been employed by GCD Enterprises for 15 years, and currently earns $60,000 per year. Marcus saves $15,000 per year. He plans to pay off his home at retirement and live debt free. He currently spends $12,000 per year on his mortgage. What do you expect Marcus’ wage replacement ratio to be based on the above information?

Solution: The correct answer is 47.35% Calculate the Wage Replacement Ratio: Salary $60,000 100.00% Payroll Taxes ($4,590) 7.65% Savings ($15,000) 25.00% Mortgage Paid-Off ($12,000) 20.00% Costs in Retirement $28,410 47.35%

Jeff wants to retire in 15 years when he turns 65. Jeff wants to have enough money to replace 75% of his current income less what he expects to receive from Social Security at the beginning of each year. He expects to receive $20,000 per year from Social Security in today’s dollars. Jeff is conservative and wants to assume a 6% annual investment rate of return and assumes that inflation will be 4% per year. Based on his family history, Jeff expects that he will live to be 95 years old. If Jeff currently earns $100,000 per year and he expects his raises to equal the inflation rate, approximately how much does he need at retirement to fulfill his retirement goals? A. $1,268,887 B. $2,242,055 C. $2,285,172 D. $3,057,348

The correct answer is C. $100,000 current earnings x 75% replacement = $75,000 - $20,000 in SS benefits = $55,000 income in retirement. Step #1 - NPV at Time Period Zero Answer: 953,522.61

Which of the following statements about retirement funding is FALSE? A. Retirement funding aims to calculate how much money a person needs to accumulate to maintain their lifestyle in retirement. B. Assumptions about future rates of return and life expectancy must be made, since these variables are unknown. C. There are multiple models that provide a foundation for estimating needed retirement capital. D. Financial planning software generally does not allow for adjusting assumptions such as inflation.

Solution: The correct answer is D. Choice D is a false statement, Financial planning software does allow for adjusting assumptions about variable such as inflation, rates of return, life expectancy, and other variables that go into retirement needs calculations. financial planning software enables the user to model different scenarios by changing the assumptions. Choice A is a true statement. Retirement funding is used in the financial services industry to assist clients with determining their success in funding their retirement needs based on assumptions. Choice B is a true statement. We can not predict the future and therefore use assumptions to model retirement funding scenarios. Choice C is a true statement. Models such as the capital needs approach, annuity method and uneven cashflow method are some examples of models used to estimated retirement funding.

Which of the following statements is true regarding superannuation risk for retirees? A. Superannuation risk refers to the risk of losing money in the stock market. B. Superannuation risk can generally be eliminated by purchasing rental properties. C. Superannuation increased as more employees moved from defined benefit to defined contribution retirement plans. D. Superannuation risk refers to the risk of having too much income in retirement.

Solution: The correct answer is C. Superannuation risk refers specifically to the risk of outliving one's retirement savings, which is a major concern for retirees who have to self-manage assets in defined contribution plans Choice A is incorrect: Investment risk is the risk of losing money in the stock market. Choice B is incorrect. Purchasing rental property can possibly mitigate the risk or superannuation but will not eliminate the risk. Choice D is incorrect. Superannuation risk refers to the risk of outliving one's retirement savings.

Marla is planning for her retirement. She is currently 37 years old and plans to retire at age 62 and live until age 97. She currently earns $100,000 per year and anticipates needing 80% of her income during retirement. Marla anticipates Social Security will provide her with $15,000 per year at age 62, leaving her with required savings to provide $65,000 ($100,000 x 0.80 - $15,000) annually during retirement. She believes she can earn 11% on her investments and inflation will be 2% per year. Marla would like to preserve her capital so that the capital balance required at age 62 is maintained until age 97. How much must Marla save at the end of each year, if she wants to make her last savings payment at age 62 to meet her retirement goal and maintain her capital balance? $2,379.57. $10,899.37. $11,181.92.

$11,181.92. Rationale Step #1: Determine the NPV at time period zero