Retirement Needs Analysis

Question 1

What is probably the most important assumption we have to make on a retirement plan?

Answer 1

• Life expectancy (longevity risk)
• Remember to use CONSERVATIVE NUMBERS
• Do NOT use life expectancy actuarial tables (this just means that life expectancy of 80 means that half the people are still alive at 80 and the other half have passed)

Question 2

Sequence of Returns (Market Volatility)

Answer 2

• This is the risk of receiving lower/negative returns in the EARLY YEARS of retirement when distributions are occurring

Question 3

How can sequence risk be mitigated?

Answer 3

• Annuities (fixed)
• Lower-risk portfolios
• Sufficent cash allocations/emergency funds to partially or fully suspend portfolio distributions for mulitple years

Question 4

Inflation

Answer 4

• Retirement portfolios should be designed to OFFSET the effects of inflation
• Support inflation-adjusted distributions throughout retirement

Question 5

Some reasons for decreased expenses in retirement

Answer 5

• No longer saving for retirement
• Elimination of FICA or SE taxes
• Work-related expenses, such as commuting, clothing, professional dues
• Mortgage debt and children’s education expenses may be fully funded and completed

Question 6

Some reasons for increased expenses in retirement

Answer 6

• Traveling more, vacations, entertainment, recreation
• Increased medical increases
• Increased philanthropy

Question 7

Income Replacement Ratio

Answer 7

• Usually 70-85% of worker’s last year’s of income
• Top-down approach to determining retirement needs
  
  • Useful for the beginning stages of retirement planning

Question 8

Clients’ own budgets for retirement planning

Answer 8

• Considered the bottom-up approach
• Gives a more accurate picture for the indiviudal’s situation for the amount of income they need in retirement
• Much better for when someone is getting closer to retirement

Question 9

Wage Growth

Answer 9

• Wage growth rates should be used in preretirement calculations

Question 10

Bequest Motives

Answer 10

• This is the desire to leave assets at time of death
• This increases the amount of assets needed at retirement (and annual savings)

Question 11

Some common sources of retirement income

Question 12

What does being conservative in retirement projections mean?

Answer 12

• Overstating inflation
• Understating investment returns
• Overstating life expectancy

Question 13

SS income tax

Answer 13

• Generally, it is tax free
  
  • Although up to 85% of Social Security income can be included in taxable income

Question 14

What are the first and second largest sources of income for retirees?

Answer 14

1. SS
2. Employer plan benefits

Question 15

Quick note on Roth IRAs tax-free distribituion requirements

Answer 15

• Roth IRA has been opened for 5 years (starts after FIRST CONTRIBTION to a Roth IRA)
• Individual is 59.5 years old

Question 16

Rental and Other Passive Income

Answer 16

• Passive investments can provide a steady stream of income and insulate retirees from fluctuations in the stock market
• Passive rental real estate can provide tax deductions (can offset ordinary or passive income based on AGI)

Question 17

What are the steps in calculating how much a client will need for retirement?

Answer 17

1. Calculate income needed at retirement in today’s dollars
   
   1. Mulitply current annual income x desired income replacement ratio
   2. Then, subtract annual Social Security Benefits, in today’s dollars, from this amount
   3. = Desired net retirement income goal
   4. Calculate inflation-adjusted income goal at retirement (usually wage growth = inflation rate)
   5. Once you have inflated-income goal, subtract all other income that client is projected to receive in retirement (annuities, pensions, rental income, employment income, etc)
2. Figure out how much client needs to have accumulated at retirement age to fund desired income for the REMAINDER OF THEIR LIFE
   
   1. PMT starts at BEG mode
   2. Use inflation-adjusted return rate
   3. Duration of payments is life expectancy MINUS retirement age
3. Now solve for annual savings required
   
   1. Back in END MODE

Question 18

Stress testing

Answer 18

• Process of changing ONE variable to an EXTREME point and seeing how it affects the outcome of the retirement projections while holding the other variables constant

Question 19

Common stress test factors

Answer 19

• Increasing inflation rates
• Extending life expectancy
• Lowering investment returns
• Lowering retirement age

Question 20

Other ways to reduce retirement plan uncertainty

Answer 20

• Purchase insurance such as LTC
• Estimate specific large expenses and factor them in the analysis
• Annuity for longevity risk (or start at lower distribution rate)
• Annuity for sequence risk (gurantees income will cover certain basic needs)
• Invest more in stocks and other investments to outpace inflation

Question 21

Methods for calculating retirement funding/income distribution

Answer 21

• Annuity method
• Backtesting
• 4% rule
• Monte Carlo analysis

Question 22

Annuity Method and pros and cons

Answer 22

• Assumes a constant rate of return and assumes money is completely spent at death
• Cons
  
  • Market returns fluctuate, and that sequence of returns matters in retirement
  • If client lives just one year longer, plan fails (because it assumes last dollar is paid out at death)

Question 23

Historical Backtesting

Answer 23

• Uses historical market returns to project future returns on the account
  
  • If you were to live 25 years in retirement, then you would project the last 25 years of investment returns
• Cons
  
  • Nearly impossible that the exact same market patten will occur going forward
  • Past results do not preduct future results

Question 24

4% Rule

Answer 24

• To calculcate amount of assets needed at retirement, take first year of portfiolio distribution needed and DIVIDE BY 4%
  
  • Gives you 25 x the first year’s distribution amount
  • Subsequence distribtuions are increased by inflation annually
  • Based on 60/40 allocation
• Cons
  
  • Assumes client wants to take same level of income each year, which most probably want more in the beginning of retirement (adjusted for inflation)
  • Some could feel uncomfortable with allocation
  • Assumes portfolio will perform similarly to past returns

Question 25

Monte Carlos Analysis

Answer 25

• Uses a random number generator based on a selected return and standard deviation.
• Thousands of trial runs
• Cons
  
  • Only as good as its INPUTS
  • If projected average return or standard deviations are incorrect, analysis will be skewed
  • Assumes market returns are normally distributed, which is not true of the market

Question 26

Traditional Retirement

Answer 26

• Means that when a client retires, they quit working and live off the retirement income they built up during their working years

Question 27

Rebound back to Work

Answer 27

• May retire and then return to work at some point in the future
• Could be planned or a result of the retiree desiring the emotional, social, or financial benefits of work.
• Could benefit annual savings amount, although health could get in the way and may not be able to return back to work

Question 28

Gradual Retirement

Answer 28

• Keeps working in retirement but gradually slows down and works fewer hours
• Also reduces risk of being rehired (because they are already working)

Question 29

New Venture

Answer 29

• Could start a business they are passionate about
• Could be risky obviously