Use the attached worksheet 1 to help Al and Linda Stone, who would like to retir

Question

Use the attached worksheet 1 to help Al and Linda Stone, who would like to retire while they are still relatively young - in about 20 years. Both have promising careers, and both make good money. As a result, they are willing to put aside whatever is necessary to achieve a comfortable lifestyle in retirement. Their current level of house-hold expenditures (excluding savings) around $75,000 a year, and they expend to spend even more in retirement; they thing they will need about 125% of that amount. They estimate that their social security benefits will amount to $20,000 a year in today's dollars and they wil receive another $35,000 annually from their company pension plans. They feel that future inflation will amount to 3% a year; in addition, they think they will be able to earn about 12% on their investments prior to retirement and 8% afterward. Use the worksheet to find out how big their investment nest egg will have to be and how much they will have to save annually in order to accumulate the needed amount within the next 20 years. 8

Explanation / Answer

I.        Estimated Household Expenditures in Retirement:

a.      Approximate number of years to Retirement – 20 Years

b.      Current level of annual household expenditures, excluding savings - $75,000

c.      Estimated household expenses in retirement as a percent of current expenses – 125%

d.      Estimated annual household expenditures in retirement (b*c) - $93,750

II.          Estimated Income in Retirement –

e.      Social security, annual income - $20,000

f.       Company/employer pension plans, annual amounts - $35,000

g.      Other sources, annual amounts – Nil

h.      Total annual income (e+f+g) - $55,000

i.       Additional required income, or annual shortfall (d-h) - $38,750

III.          Inflation Factor –

j.       Expected average annual rate of inflation over the period to retirement – 3%

k.      Inflation factor (Appendix A): Based on 20 years to retirement (A) and an expected average annual rate of inflation (j) – 1.806

l.       Size of inflation adjusted annual shortfall (i*k) - $69,982.50

IV.          Funding the Shortfall –

m.    Anticipated return on assets held after retirement – 8%

n.      Amount of retirement funds required – size of nest egg (l/m) - $8,74,781.25

o.      Expected rate of return prior to retirement – 12%

p.      Compound interest factor (Appendix B): Based on 20 years to retirement (A) and an expected rate of return on investments of 12% - 72.052

q.      Annual savings required to fund retirement nest egg (n/p) - $12,140.97

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