Retirement planning: ten key steps.

Coping with the pressures and demands of everyday practice, some practitioners may not be overseeing their own financial circumstances as carefully as they should. Actually, retirement planning is not really as complicated as it may seem. Although some aspects are best left to experts, such as financial planners, tax specialists, attorneys or insurance and investment advisers, most of your own retirement planning should not be left to someone else. Here are 10 key steps that lead to a "first draft" of your own retirement plan.

TEN KEY STEPS

Step 1: Determine how much income you'll need. The fundamental challenge is to provide a certain level of annual "buying power" (not merely annual income) for the rest of your life and the life of your spouse. Inflation is the major obstacle, and your plan must confront it directly.

Choose a level of income in current dollars that would provide adequate buying power today in the region where you plan to live. Unless you expect major changes up or down in your standard of living, one good rule of thumb is to provide for buying power equal to 65% of your current income. Then decide how soon you would like to retire. Turn to exhibit 1, page 71, and unless you already have done some planning, be prepared for some unpleasant "sticker shock."

Exhibit 1 shows the annual dollars required to provide buying power equivalent to current income from $30,000 to $50,000 at any point up to 40 years in the future, assuming 4% inflation. Most planners assume 3% to 5% inflation, and it would be dangerous to assume a lower rate. The arithmetic is proportional, so to calculate dollars required to provide buying power equal to $100,000 current dollars, for example, multiply the figures for $50,000 times 2.

Exhibit 1: Income Dollars Required to Sustain Buying Power Assuming 4%

Inflation

                 Current income:
Year   $30,000      $40,000        $50,000
 1      31,200       41,600         52,000
 2      32,448       43,264         54,080
 3      33,746       44,995         56,243
 4      35,096       46,794         58,493
 5      36,500       48,666         60,833
 6      37,960       50,613         63,266
 7      39,478       52,637         65,797
 8      41,057       54,743         68,428
 9      42,699       56,932         71,166
10      44,407       59,210         74,012
11      46,184       61,478         76,973
12      48,031       64,041         80,052
13      49,952       66,603         83,254
14      51,950       69,267         86,584
15      54,028       72,038         90,047
16      56,189       74,919         93,649
17      58,437       77,916         97,395
18      60,774       81,033        101,291
19      63,205       84,274        105,342
20      65,734       87,645        109,556
21      68,363       91,151        113,938
22      71,098       94,797        118,496
23      73,941       98,589        123,236
24      76,899      102,532        128,165
25      79,975      106,633        133,292
26      83,174      110,899        138,623
27      86,501      115,335        144,168
28      89,961      119,948        149,935
29      93,560      124,746        155,933
30      97,302      129,736        162,170
31     101,194      134,925        168,657
32     105,242      140,322        175,403
33     109,451      145,935        182,419
34     113,829      151,773        189,716
35     118,383      157,844        197,304
36     123,118      164,157        205,197
37     128,043      170,724        213,404
38     133,164      177,553        221,941
39     138,491      184,655        230,818
40     144,031      192,041        240,051

[ILLUSTRATION OMITTED]

Step 2: Decide when you want to retire. Average life expectancy for middle-aged professionals, both male and female, now reaches well into the seventies, so it is prudent to plan that you will live well into your eighties. Add inflation to the equation, and you may decide to retire later, rather than sooner. You may even decide to redefine "retirement" to include a part-time, less stressful second career. If you are now 45 years old and planning to retire at age 65 with income equivalent to $50,000 today, assuming 4% inflation, your retirement plan must provide well over $100,000 in your first year of retirement and more than $240,000 per year when you reach 85! If you have done little or nothing so far to provide for retirement, the task ahead is enormous.

Step 3: Create an initial "benchmark plan" to use in evaluating options and alternatives. Although you may reach 85, a realistic retirement plan recognizes that you won't need to provide for retirement income forever. One approach is to build a retirement fund and plan to consume it over a long period of time--like a mortgage, but in reverse. Twenty to forty years after retirement, depending on the time frame you have chosen, your investment capital--and your ability to generate income--would be gone. Creating a benchmark plan based on this approach is one good way to start your personal planning process. The plan provides a sense of the magnitude of the task and becomes a framework for evaluating the impact of present assets, existing pension plan participation, possible inheritances, Social Security and other key factors.

Exhibit 2, page 72, is a benchmark plan that shows how much a 45-year-old practitioner must save starting now to provide the equivalent of $50,000 of current buying power each year for 20 years, beginning at age 65, if money is simply set aside and invested at a 6% return. The contribution increases by 5% annually, assuming an increased capacity to save as time goes by, but even the initial deposits of just over $2,500 per month are significant for the average practitioner currently earning under $100,000 a year. For example, the $31,386 "deposit" figure for 1995 is based on the initial monthly payment of $2,557 that increases each month at the 5% annual rate. The balance for 1995 is the sum of the deposits plus the total investment income at the end of the year.

Exhibit 2: Benchmark Retirement Scenario--Beginning at Age 45 to Provide

Equivalent of $50,000 Current Dollars for 20 Retirement Years Starting in 2015

                Other retirement  Investment
Year  Deposits      income          income        Draw     Balance
1994                                                           $0
1995  $31,386        $0              $846          $0      32,232
1996   32,955         0             2,823           0      68,010
1997   34,603         0             5,014           0     107,626
1998   36,333         0             7,437           0     151,397
1999   38,150         0            10,113           0     199,659
2000   40,057         0            13,060           0     252,776
2001   42,060         0            16,301           0     311,137
2002   44,163         0            19,859           0     375,159
2003   46,371         0            23,760           0     445,290
2004   48,690         0            28,031           0     522,010
2005   51,124         0            32,699           0     605,833
2006   53,680         0            37,798           0     697,311
2007   56,364         0            43,359           0     797,034
2008   59,182         0            49,418           0     905,635
2009   62,142         0            56,014           0   1,023,791
2010   65,249         0            63,187           0   1,152,227
2011   68,511         0            70,981           0   1,291,719
2012   71,937         0            79,443           0   1,443,099
2013   75,534         0            88,623           0   1,607,256
2014   79,310         0            98,574           0   1,785,140
2015   27,308         0           106,745      74,858   1,844,335
2016        0         0           106,946     116,022   1,835,259
2017        0         0           106,252     120,663   1,820,849
2018        0         0           105,233     125,489   1,800,593
2019        0         0           103,857     130,509   1,773,942
2020        0         0           102,091     135,729   1,740,304
2021        0         0            99,899     141,158   1,699,044
2022        0         0            97,243     146,805   1,649,483
2023        0         0            94,081     152,677   1,590,887
2024        0         0            90,370     158,784   1,522,473
2025        0         0            86,062     165,135   1,443,400
2026        0         0            81,106     171,741   1,352,764
2027        0         0            75,448     178,610   1,249,601
2028        0         0            69,029     185,755   1,132,876
2029        0         0            61,788     193,185   1,001,479
2030        0         0            53,656     200,912     854,223
2031        0         0            44,564     208,949     689,838
2032        0         0            34,433     217,307     506,965
2033        0         0            23,182     225,999     304,148
2034        0         0            10,724     235,039      79,833
2035        0         0               584      80,417           0

Assumptions: 4% inflation, 6% investment return, saving capacity increasing 5% annually.

Required savings: Initial $2,557 monthly payment, increasing at 5% annual rate. Balance at beginning of retirement: $1,847,659.

Note: The software used to produce this table rounds figures, so manual calculations may not produce identical results.

Step 4: Modify your benchmark plan to reflect your present assets, your spouse's and your pension plans, Social Security, probable inheritances and other factors. By the time they begin to think seriously about retirement, usually in their 40s, most practitioners have accumulated at least some liquid assets, and many have begun to participate in some kind of retirement fund accumulation, such as individual retirement accounts, Keogh plans and tax-deferred annuities. The impact of these elements and others should be reflected in a modified benchmark plan, as illustrated by exhibit 3, page 73. The "deposit" column increases as it does in exhibit 2. The $310,787 figure in "other retirement income" for 2015 represents $300,000 from the practice sale plus eight months of Social Security.

Exhibit 3: Modified Retirement Scenario--Beginning at Age 45 to Provide

Equivalent of $50,000 Current Dollars for 20 Retirement Years Starting in May 2015 (Reflecting Practice Sale and Social Security Income)

                Other retirement  Investment
Year  Deposits     income(*)        income        Draw     Balance
1994                                                           $0
1995  $21,767         $0            $587           $0     $22,354
1996   22,855          0           1,958            0      47,167
1997   23,998          0           3,477            0      74,643
1998   25,198          0           5,158            0     104,999
1999   26,458          0           7,013            0     138,470
2000   27,781          0           9,057            0     175,308
2001   29,170          0          11,305            0     215,784
2002   30,628          0          13,773            0     260,185
2003   32,160          0          16,478            0     308,823
2004   33,768          0          19,440            0     362,031
2005   35,456          0          22,678            0     420,166
2006   37,229          0          26,214            0     483,609
2007   39,090          0          30,071            0     552,770
2008   41,045          0          34,273            0     628,088
2009   43,097          0          38,848            0     710,033
2010   45,252          0          43,822            0     799,107
2011   47,515          0          49,228            0     895,850
2012   49,890          0          55,096            0   1,000,837
2013   52,385          0          61,463            0   1,114,685
2014   55,004          0          68,365            0   1,238,054
2015   18,939    310,787          85,646       74,858   1,578,568
2016        0     16,719          91,535      116,022   1,570,799
2017        0     17,387          90,942      120,663   1,558,465
2018        0     18,083          90,069      125,489   1,541,129
2019        0     18,806          88,892      130,509   1,518,317
2020        0     19,558          87,380      135,729   1,489,527
2021        0     20,341          85,504      141,158   1,454,213
2022        0     21,154          83,230      146,805   1,411,793
2023        0     22,001          80,524      152,677   1,361,640
2024        0     22,881          77,347      158,784   1,303,084
2025        0     23,796          73,660      165,135   1,235,405
2026        0     24,748          69,418      171,741   1,157,831
2027        0     25,738          64,576      178,610   1,069,534
2028        0     26,767          59,082      185,755     969,628
2029        0     27,838          52,884      193,185   1,857,166
2030        0     28,951          45,925      200,912     731,129
2031        0     30,109          38,142      208,949     590,432
2032        0     31,314          29,471      217,307     433,911
2033        0     32,566          19,842      225,999     260,320
2034        0     33,869           9,179      235,039      68,329
2035        0     11,588             500       80,417           0

(*)Practice sale and Social Security.

Assumptions: 4% inflation; 6% investment return; $300,000 net at practice sale; Social Security income $1,333 monthly in May 2015, increasing 4% annually.

Required savings: Initial $1,774 monthly payment, increasing at 5% annual rate. Balance at beginning of retirement: $1,281,413.

Note: The software used to produce this table rounds figures, so manual calculations may not produce identical results.

Many practitioners will be surprised at the degree to which their efforts to date fall short of providing adequate retirement funding. Most of us are quick to recognize the devastating impact of inflation on college tuition and automobile prices, but slow to see its effect on the arithmetic of retirement.

Step 5: Estimate the future cash flow from sale of your practice or partnership interest and incorporate it into your planning framework. Exhibit 3 assumes sale of the practice at age 65 for a one-time payment of $300,000--approximately equal to the present value (at retirement) of $400,000-plus spread over a five-year payout. The selling price assumption may seem quite conservative, but based on our experience, practitioners' track records are not good in terms of realizing full value from practice sales at retirement age.

The modified benchmark plan should reflect a conservative sales price estimate. In exhibit 3, we are assuming a practice that currently produces income of $75,000 annually is worth 2.5 times that, or $225,000 paid over five years without interest. Given only a 4% to 5% inflationary increase in the performance level of the practice, the after-tax present value of the practice sale would be approximately $300,000 in 20 years. To plan on anything greater than this would be wishful thinking. (See "Practice Valuation: Thumb Rules and Common Sense," by Robert B. Scott Jr., JofA, Dec.92, page 74.)

Step 6: Determine and obtain adequate term life and disability insurance to provide a "safety net" in the event of your incapacity or death before retirement. Insurance is a complex topic that will not be considered at length in this article. However, there are two important retirement planning functions that life insurance can fulfill; practitioners should evaluate both carefully.

First, practice sales usually involve significant payment over a five-year period. However, if a practitioner's untimely death triggers buyout provisions of a practice protection or partnership agreement, the surviving spouse may find it difficult not only to wait five years for the full amount but also to assume the risk that practice dissipation under new management may jeopardize the payout. Life insurance provides immediate, certain payout to the spouse and protects the buyer against the need for an immediate buyout.

Second, a family's income and a spouse's overall retirement accumulation will be jeopardized by an untimely death. The earlier death occurs, the greater the dollar amount of the problem. Term insurance, especially decreasing term insurance, may be a suitable and cost-effective option because it is financially efficient.

Since long-term disability can jeopardize a practitioner's retirement program, as well as his or her income, disability coverage also must be evaluated and integrated into the program. An exploratory discussion with a reliable insurance broker or agent should take place once you have begun to appreciate the magnitude of the challenge of retirement.

Step 7: Explore alternative approaches to accumulation of the required retirement capital. This is where most practitioners need, but often fail to seek, qualified and unbiased professional advice, after retirement needs have been defined and existing or anticipated assets have been inventoried. Most practitioners will face a significant gap between their existing situations and their retirement goals. They should consult a reliable financial planner who can recommend an investment adviser. Even a CPA who is successful and knowledgeable about many areas of accounting can benefit greatly by getting objective advice from another expert.

Step 8: Calculate and begin making monthly or quarterly deposits to build the necessary retirement capital. Self-discipline is the obvious key to implementing a retirement program because many important and desirable short-term goals may interfere with even the best intentions. The usual wide assortment of discretionary expenditures tempt us in many directions.

Priorities must be set, and hard decisions must be made, based on each practitioner's unique personal values, but the process must be started as soon as possible if you are serious about achieving your retirement goals. Many different approaches to retirement can succeed if started soon enough, but nothing will work if you wait too long.

Step 9: Develop a practice protection plan to provide for eventual succession and immediate backup in the event of unexpected illness or untimely death. Many independent practitioners wait too long to develop a successor or to plan for the orderly and profitable sale of their practice. Many hire the least expensive staff they can find--part-timers, recent graduates and paraprofessionals--thereby increasing their own current income by ignoring the need for long-term continuity. All too often, health problems develop when CPAs are in their 50s and 60s, and the practice base erodes just when the practice value should be peaking.

The value of a small accounting practice often is hundreds of thousands of dollars. Together with equity in the principal residence, it often accounts for the bulk of the practitioner's net worth. Unfortunately, it is a fleeting kind of value, and any one of a long list of events can reduce it or destroy it entirely, literally overnight. For example, the departure of a key staff member to start his or her own practice can result in the loss of clients worth tens of thousands of dollars annually, with an immediate and equal reduction in the practice value.

The impact of long-term disability or death on practice market value can be devastating. When a practitioner can't assist in the transfer of his or her practice it is likely to be less successful, with a much greater probability of client loss. More to the point, competitors or key employees cannot be relied on to pay for something they can get for free.

CPAs should develop contractual arrangements for other practitioners or key employees to service their clientele in the event of short-term disability or to buy the practice in the event of long-term disability or death. Such arrangements, plus written contracts with all key employees that include enforceable covenants not to compete, can go a long way toward preserving practice market value. (See "Practice Continuation Agreements," by John A. Eads, JofA, Oct. 91, page 50.)

Step 10: Review Your plan annually to identify needed changes. Perspectives change with age, and new circumstances may redefine retirement needs or affect professional income. A retirement lifestyle that seems necessary at age 40 may hold less attraction as time passes. Death or illness in the family, divorce, relocation to a different part of the country, more--or less--professional success and a host of other factors may combine to alter retirement goals.

The practitioner's world and life are dynamic, and the best retirement plans will require periodic modifications to remain suitable to changing circumstances. An annual review with your financial planner and investment adviser is a prudent step to maintain your plan's integrity and usefulness.

THE ESSENTIALS

For most practitioners, retirement income must be self-generated. Commonly held notions about retirement funding are often wildly unrealistic. Inflation can destroy 70% of your buying power in 20 years or less, so practitioners must begin early to plan for retirement if they are to be successful. They must protect against loss of their ability to generate retirement resources with health, disability and life insurance.

Each practitioner's retirement plan must be unique, reflecting expectations and lifestyle, geographic area, family situation, asset base, other pensions and a multitude of factors and issues far beyond the scope of this article. But understanding the magnitude of the challenge is a good start.

Practitioners also must understand the critical importance of the market value of their practices or partnership interests in the arithmetic of retirement, and they must know how to maximize, protect and reap that full value in retirement, disability or death. Recognizing the problem and studying the possibilities are 90% of the battle. The rest is persistence.

RELATED ARTICLE: EXECUTIVE SUMMARY

* CPAs COPING WITH THE PRESSURES and demands of running their practices often don't fully plan for their own retirements.

* THERE ARE 10 KEY STEPS TO PLANNING a retirement, and they cover much of what a CPA needs to know to make informed decisions.

* THE STEPS INCLUDE:

1. Determining how much income will be needed.

2. Deciding when to retire.

3. Creating an initial "benchmark plan" to evaluate options.

4. Modifying the benchmark plan to reflect your specific status.

5. Estimating the future cash from the sale of your practice or partnership interest.

6. Obtaining adequate life and disability insurance.

7. Exploring alternative approaches to accumulation of the required retirement capital.

8. Making regular deposits to build sufficient retirement capital.

9. Developing a practice protection plan.

10. Reviewing the plan annually and making necessary changes.

* THE KEYS TO RETIREMENT PLANNING are a realistic understanding of how much money will be needed, early planning and persistence.