Retirement Needs Analysis - Review Questions Flashcards
Which part of the Medicare coverage includes hospital insurance benefits?
Choose the best answer.
1) Part A
2) Part B
3) Part C
4) Part D
1) Part A
Part A provides hospital insurance benefits.
What variables make it difficult to create a financial plan that is exact? (Select all that are true.)
1) future investment return rates
2) future tax rates
3) the client’s exact life expectancy
4) defined benefit plans
1) future investment return rates
2) future tax rates
3) the client’s exact life expectancy
Planners and clients should not expect exactness in the financial planning targets. There are too many variables, such as future investment return rates, future tax rates and the client’s exact life expectancy. Nevertheless, the targets for retirement planning are near enough to try to quantify plans and make sure they are systematically carried out.
Jane and Jim have 20 years until retirement, when they expect their total expenses to be $6,500 per month. Jane should have state pension income in retirement of $36,000 per year, while Jim expects to have Social Security benefits of $1,600 per month. Jane is ineligible for Social Security benefits due collecting a non-covered pension and not having accumulated Social Security benefits. Jane and Jim’s planner has determined that inflation should be estimated at 2.7% per year, and given the client’s risk tolerance she would like to use 6% per year as an estimated investment return for portfolio assets. The planner has also determined that to be conservative, no inflation adjustments should be incorporated for Jane’s pension. Jane and Jim’s current retirement portfolio consists of $150,000, and at retirement they expect to have a combined effective tax rate of 18%. Based on retirement age and mortality they expect to live in retirement for 35 years.
Calculate the amount Jim and Jane need to cover total annual expenses in their first year of retirement on a before tax basis.
1) $162,065
2) $78,000
3) $132,893
4) $100,730
1) $162,065
The keystrokes are: PV = $6,500 month × 12 months = $78,000 after-tax / (1 − .18 tax rate) to arrive at the before tax amount of ($95,121.9512); n = 20; i = 2.7; FV = $162,065.1451
Jane and Jim have 20 years until retirement, when they expect their total expenses to be $6,500 per month. Jane should have state pension income in retirement of $36,000 per year, while Jim expects to have Social Security benefits of $1,600 per month. Jane is ineligible for Social Security benefits due collecting a non-covered pension and not having accumulated Social Security benefits. Jane and Jim’s planner has determined that inflation should be estimated at 2.7% per year, and given the client’s risk tolerance she would like to use 6% per year as an estimated investment return for portfolio assets. The planner has also determined that to be conservative, no inflation adjustments should be incorporated for Jane’s pension. Jane and Jim’s current retirement portfolio consists of $150,000, and at retirement they expect to have a combined effective tax rate of 18%. Based on retirement age and mortality they expect to live in retirement for 35 years.
What is the inflation-adjusted rate of return in this scenario for Jim and Jane?
1) 3.3%
2) 5.84%
3) 3.21%
4) 3.11%
3) 3.21%
Two ways to arrive at the answer are: 1.06 / 1.027 − 1 × 100 = 3.2132% 1.027 Enter 1.06 press the “Delta Sign Change Key” = 3.2132%
Incorrect answers: 3.3% results from simply subtracting the inflation rate from investment return; 5.84% uses the shortcut method but with investment return as numerator and not difference between investment and inflation return as numerator; 3.11% using long method but with 1+inflation rate as numerator, also reversing sign on end result to make it a positive number.
Jane and Jim have 20 years until retirement, when they expect their total expenses to be $6,500 per month. Jane should have state pension income in retirement of $36,000 per year, while Jim expects to have Social Security benefits of $1,600 per month. Jane is ineligible for Social Security benefits due collecting a non-covered pension and not having accumulated Social Security benefits. Jane and Jim’s planner has determined that inflation should be estimated at 2.7% per year, and given the client’s risk tolerance she would like to use 6% per year as an estimated investment return for portfolio assets. The planner has also determined that to be conservative, no inflation adjustments should be incorporated for Jane’s pension. Jane and Jim’s current retirement portfolio consists of $150,000, and at retirement they expect to have a combined effective tax rate of 18%. Based on retirement age and mortality they expect to live in retirement for 35 years.
How much capital will Jane and Jim require at the start of their retirement?
1) $2,229,427
2) $2,349,658
3) $3,377,964
4) $2,032,322
1) $2,229,427
To calculate capital required at retirement follow these steps:
Determine future value of Social Security payments and subtract from future expense needs. (This may also be done by repeating the calculation of step one and subtracting the present value of Social Security from projected need).
20 N 2.7 I 1600*12 CHS PV 0 PMT → FV = 32,712.23
Annual Expenses - 162,065
The keystrokes are: PV = $6,500 month × 12 months = $78,000 after-tax / (1 − .18 tax rate) to arrive at the before tax amount of ($95,121.9512); n = 20; i = 2.7; FV = $162,065.1451
Subtract Social Security from annual expenses:
162,065 − 32,712.23 = 129,352.77 → this is shortfall net of Social Security and gross of pension
Calculate capital required gross of pension:
g BEG 35 N 3.21 i 129,352.77 CHS PMT 0 FV → PV = 2,782,679.77 → this is capital required at retirement gross of pension.
Calculate present value of pension at retirement:
g BEG 35 N 6 i 36,000 PMT 0 FV → PV = 553,253.08
Note that some practitioners would use the current “riskless rate of return” to calculate the present value of the non-inflation adjusted pension rather than the expected investment return. The yield on a 30 year government bond is often used for a riskless rate of return)
Subtract value of pension from gross need:
2,782,679.77 − 553,253.08 = 2,229,426.69 → this is actual capital required at retirement net of pension
Incorrect answers: $2,349,658 payment set to END, no adjustment for Social Security or pension, using non-inflation-adjusted rate of return; $3,377,964 payment set to END and no adjustment for Social Security or pension, but using inflation-adjusted rate of return; $2,032,322 payment set to BEG, subtracting Social Security, using inflation-adjusted rate of return but taking out present value of pension at retirement calculation as end of year payments and not beginning of year payments.
Rank the following pension options in order from the highest initial benefit to lowest initial benefit:
I) Life with Period Certain
II) Single Life Annuity
III) Joint and Survivor Annuity
1) I, III, II
2) II, I, III
3) II. III, I
4) III, I, II
2) II, I, III
Single life annuities will always provide the highest benefit amount as payments cease immediately upon the death of the annuitant with no subsequent payments. Life with period certain will provide a higher benefit that joint and survivor annuities as payments to beneficiaries are limited to the guaranteed certain period (usually 5, 10, 15 or 20 years). Full joint and survivor annuities provide the lowest initial benefits as the insurer or pension fund is committing to continuing payments in some form for the longer of two lifetimes, creating the greatest potential for an extended period of benefit payments.
All of the following statements are true regarding pre-tax and Roth contributions to retirement plans EXCEPT:
1) When considering whether to make pre-tax or Roth contributions, current income amounts, time horizon to
retirement, present tax rates, and expected future tax rates must all be considered.
2) Generally clients making pre-tax contributions can contribute greater amounts but may need to use a portion
of the accumulated account value to pay taxes that will be due on distributions in retirement.
3) All other factors being equal, $10,000 in Roth assets is less valuable than $10,000 in pre-tax assets at
retirement.
4) The differences between pre-tax and Roth assets are evident only when assets are contributed and/or
withdrawn.
3) All other factors being equal, $10,000 in Roth assets is less valuable than $10,000 in pre-tax assets at
retirement.
$10,000 of accumulated assets within a Roth account is inherently more valuable than $10,000 in pre-tax assets as no tax liabilities will be due when a qualifying withdrawal is made. The full $10,000 will be available to meet retirement needs. The value of a $10,000 withdrawal of pre-tax assets will be reduced by income taxes owed on this withdrawal. A client with an effective tax rate of 20% will have only $8,000 available for retirement expenses with withdrawing $10,000 from a pre-tax account.
Which of the following are characteristics of a lump sum pension:
I) Transfers investment risk to the client and away from the pension plan
II) It provides an effective hedge against longevity risk
III) It may allow clients to provide a legacy to children or grandchildren.
IV) It will allow the client the opportunity to hedge against inflation risk.
1) I, III, & IV
2) I, II, III, & IV
3) II & IV
4) I & IV
1) I, III, & IV
Income pensions, not lump sums, provide an effective hedge against longevity risk.
Preparing a detailed retirement plan requires complete knowledge of a client’s financial situation. All of the following is relevant information to the preparation of a retirement plan EXCEPT:
1) The summary plan description for a client’s current group disability insurance.
2) Details of a repayment plan the client has established with the IRS for unpaid tax liabilities.
3) A statement outlining projected pension benefits.
4) The book value of a closely held business listed on the client’s tax return.
4) The book value of a closely held business listed on the client’s tax return.
for purposes of retirement planning the book value of a business is not relevant as this may bear little relation to the dollar amount a client may be able to realize from a business that will aid in funding retirement needs. Details of an existing or proposed succession plan specifying how much a client may receive in return for the transfer of the business and when they will receive it would be much more relevant to the retirement planning process.
