RETIREMENT BENEFITS

Your client, Steven, age 43, has come to you for assistance with retirement planning. He provides you with the following facts.

· He earns $80,000 annually.

· His wage replacement ratio has been determined to be 80%.

· He expects inflation will average 3% for his entire life expectancy.

· He expects to work until 68, and live until 90.

· He currently has $60,000 saved, and he is averaging a 9% rate of return and expects to continue to earn the same return over time.

· He has been saving $3,000 annually in his 401(k) plan.

· Additionally, Social Security Administration has notified him that his annual retirement benefit, in today’s dollars will be $26,000.

1. Using calculations, explain to Steven why it is realistic to use a wage replacement ratio of 80%.

2. Using the annuity method, calculate how much capital Steven will need to be able to retire at age 68.

3. Given his current resources, does he have sufficient resources to achieve his retirement goal? Using calculations, show and explain your answer to Steven.

4. Provide Steven with 3 alternatives for meeting his retirement goal. In doing so, use calculations to show the impact of each alternative.

Before hiring you as his financial planner, Steven was going to another planner. He mentions that the other planner calculated this retirement needs another way, so he asks you to calculate his retirement needs using other methods.

5. Using the capital preservation method, calculate how much capital Steven needs in order to retire at 68.

6. Using the purchasing power preservation method, calculate how much capital Steven needs in order to retire at 68.

7. In your own words, provide Steven with the advantages and disadvantages of each method and explain why the amounts calculated are different with the three methods.

8. In your own words, provide Steven with the advantages and disadvantages of 2 investment instruments that are used specifically to save for retirement. Which would you recommend and why?

Your completed Case Study must contain a minimum of 700 words and 2 citations in current APA format. Acceptable sources are personal finance journals, magazines, or newspapers.

1. Steven’s current age is 43 years. He plans to work till the age of 68 years. This means that he still has around 25 years to work and save for retirement. He is currently earning $ 80,000 annually.

His replacement ratio is 80%. This means that he expects to receive $ 64,000 annually upon his retirement. Of this amount, the social security administration will provide $ 26,000 (as adjusted for the inflation). Also there is a current saving of $ 60,000 in his hands on which interest will also be accumulated, to provide for the future benefits. Also he is currently also saving @ $ 3,000 per annum. Compounded interests will also be earned on the same.

Therefore, these savings should be sufficient to earn a replacement ratio of 80%.

2. In order to maintain the payout ratio of 80% and a retirement benefits of $ 64,000 (as adjusted for inflation) starting 69th year of life, he will need an annuity of:

= 64,000 (1.03)^25

= $ 134,001.79 or $ 134,000.00 (approx.)

Further he is expected to receive $ 26,000 p.a. from SSA, adjusted for inflation:

= 26,000 (1.03^25)

= $ 54,438.23 or $ 54,440 (approx.)

Therefore he will need the following amount and their present values are as follows:

Therefore, Stevens need to save $ 109,522.96 in present dollar worth to be able to retire at the age of 69.

3. Stevens require $ 109,522.96 for retirement, whereas he is having only $ 60,000 worth of current savings only. Therefore his current savings are not sufficient to cover for his retirement needs. He needs a further $ 49,522.96 or $ 49,525.00 (approx.) for his retirement needs to be saved in current dollar terms.

4. Following are the alternatives before Stevens to plan for his retirement:

a) Make an additional investment of $ 49,525.00 in the existing saving account, and there is no need for further investment.

b) Make an annual equated investment of :

=

= $ 16,507.65 or $ 16,510.00 per annum.

c) Or may choose to invest some amount as lump-sum and balance as equated instalments.

5. The above calculations were made as per the capital utilization method. However as per the capital preservation method, Stevens need to save enough money so that after his life the principal portion of money saved remains intact.

As per this method he needs to save the following amount:

=

=

= $ 1,326,000

The present value of this amount is:

=

= $ 153,733.00

6. As per purchasing power preservation method, Stevens need to save enough money (as adjusted for inflation) to maintain the purchasing power as today.

As per this method he will need the following amount per annum starting 69th year to maintain the current purchasing power:

= (64,000 – 26,000)×1.0325

= $ 79,560 (approx.)

And, to attain this he needs to have following amount of savings at the end of 68th year:

= 79560 ×

= $ 958,030.00 (approx.)

Its present value in today’s term is:

=

= $ 111,100.00 (approx.)

1. The main advantages and disadvantages of above given methods are:

a) Capital utilization method. The main advantage of this method is that the individual does not have to save amount more than sufficient for him to survive his life time. It is also not heavy on the assessee’s budget. And its main disadvantage is that if the individual survive more than his expected life, he will fall short of fund.

b) Capital preservation method. The main advantage of this method is that the capital investment of the individual is intact, and he can pass the same to his heirs as well (after his death). And the main disadvantage is, that it requires a lot of investment and is heavy on budget.

c) Purchasing power preservation method. This is a method that takes the special care of the purchasing power parity of the in individual. It aims to maintain the same income level for the individual at it is currently. The main disadvantage of this method is that it is based on assumption for the inflation rate, which may also deviate.

2. The main advantage and disadvantages of two investment options available for Stevens are:

a. 401(k) plan. The main advantage of this investment option is that it is a safe investment option that provides tax benefits to the investors. The investors also have option to choose between defined contributions and benefit plans.

b. Investment in savings deposits account. The main advantage of such investment is easy deposit and withdrawals and very low risk. The main disadvantage of such plans is low returns.